REVENUE REGULATIONS NO. 01-79 (Regulations governing the taxation of non-resident citizens)

Who are considered as nonresident citizens. — The term "non-resident citizen" means one who establishes to the satisfaction of the Commissioner of Internal Revenue the fact of his physical presence abroad with the definite intention to reside therein and shall include any Filipino who leaves the country during the taxable year as:

a. Immigrant — one who leaves the Philippines to reside abroad as an immigrant for which a foreign visa as such has been secured.

b. Permanent employee — one who leaves the Philippines to reside abroad for employment on a more or less permanent basis.

c. Contract worker — one who leaves the Philippines on account of a contract of employment which is renewed from time to time within or during the taxable year under such circumstances as to require him to be physically present abroad most of the time during the taxable year. To be considered physically present abroad most of the time during the taxable year, a contract worker must have been outside the Philippines for not less than 183 days during such taxable year.

Any such Filipino shall be considered a non-resident citizen for such taxable year with respect to the income he derived from foreign sources from the date he actually departed from the Philippines.

A Filipino citizen who has been previously considered as a non-resident citizen and who arrives in the Philippines at any time during the taxable year to reside therein permanently shall also be considered a non-resident citizen for the taxable year in which he arrived in the Philippines with respect to his income derived from sources abroad until the date of his arrival.

Proof of intention. — A Filipino citizen who leaves the Philippines to reside abroad either as an immigrant or for permanent employment or a contract worker, shall submit to the Commissioner of Internal Revenue proof of his intention of leaving the Philippines to reside permanently abroad. A returning non-resident citizen, on the other hand, must present proof of his intention to return to and reside permanently in the Philippines. Such proof of intention shall be attached to his income tax return (BIR Form No. 1701C) and may consist of the following:

a. In the case of an immigrant, photostat or xerox copy of his foreign visa.b. In the case of one leaving for permanent employment abroad, a certificate from his employer showing the

nature and duration of his employment.c. In the case of a contract worker —

a. Certificate of the employer; orb. Copy of the contract of employment; orc. Other documentary evidence.

d. In the case of a returning non-resident citizen — a. Xerox copy of his passport bearing the stamp of Philippine immigration authorities showing that he is

a returning resident as distinguished from a mere Balikbayan.b. Other documentary evidence.

Computation of income and tax. — A. On income derived from all sources outside the Philippines. —

1. What to include as gross income. — The gross income of a non-resident citizen derived from sources outside the Philippines includes all income enumerated under Section 29 of the National Internal Revenue Code, whether or not such income is exempted from income tax in the foreign country where it was derived.If the income is in foreign currency other than US dollars, it shall first be converted into US dollars at the average annual rate of exchange of the foreign currency and the US dollar for the year in which the income was earned.

2. Rate of tax. — Beginning with the taxable year 1978, there shall be imposed on the adjusted gross income of non-resident citizen a tax computed as follows:

On the amount not exceeding $6,000 1%On the amount exceeding $6,000 but not exceeding $20,000 $60.00 plus 2% of excess

over $6,000.On the amount exceeding $20,000 $340.00 plus 3% of excess

over $20,000.

3. Computation of Adjusted Gross Income. — The adjusted gross income is arrived at by deducting from the gross income the following:a. Personal exemption of $2,000 if the non-resident citizen is single or a married person legally

separated from his or her spouse, or $4,000 if married or head of a family;b. The total amount of the national income tax actually paid to the national government of the

foreign country of his residence.4. Head of Family. — The term "head of family" is defined as "an unmarried man or woman with one or

both parents, or one or more brothers or sisters, or one or more legitimate, recognized natural, or adopted children living with and dependent upon him or her for their chief support where such brothers, sisters, or children are not more than twenty-one years of age, unmarried and not gainfully

employed or where such children are incapable of self-support because they are mentally or physically defective.

5. Computation of tax. — The computation of the tax due from a non-resident citizen on income derived abroad is illustrated as follows:

Mr. Juan de la Cruz, 35 years old, Filipino, married to Maria, with a dependent son, Jose and a resident of Los Angeles, California. For U.S. Federal Income Tax purposes, he filed a joint return containing the following data and claimed the optional standard deductions and used the optional tax tablets:

Income:Wage, Salaries, Tips, Others $7,814.65Dividends received from qualified U.S. domestic corporation —$482.50

(less exclusion ----$200.00) 282.50Interest Income on savings deposit 110.17Income other than wages (Wife's prize in photo contest) 200.00

————TOTAL GROSS INCOME $8,407.32LESS: Adjustment to income (moving expenses) 60.00

————Adjusted Gross Income $8,347.32

TAX DUE PER IRS TABLES $ 325.00Tax payments and creditsTotal Federal income taxwithheld $484.30Other payments (gasoline tax, etc.) 32.67

————Total payments and credits $516.97

————AMOUNT REFUNDABLE (191.97)

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For Philippine income tax purposes, his income shall be computed as follows:Gross Income $8,407.32ADD: Excluded dividend income taxable

under Philippine Income Tax Law 200.00————

Total Gross Income $8,607.32LESS:

(a) Personal Exemption as married $4,000(b) Foreign National Income Tax paid

(Attach copy of Federal Income TaxReturn and evidence of payment) 325

———Total Deductions [add (a) & (b)] 4,325.00

————ADJUSTED GROSS INCOME SUBJECT TO TAX $4,282.32

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Tax Due:Adjusted Gross Income $4,282.32At 1% rate (not over $6,000.00) x .01

————Amount payable $42.82

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On income derived from sources within the Philippines. — The tax due on income derived by a non-resident citizen from sources within the Philippines shall be computed in the same manner as the income tax payable by resident citizens and resident aliens.

RR 5-01 (Sec. 2) Filing of Information Returns no longer required -- Non-resident citizens exempt from tax with respect to income derived from sources outside the Philippines in accordance with Section 23(B) and (C), in relation to Section 22 (E) and Section 51 (a)(2)(d) and (A)(3) of the Tax Code of 1997, but who are nevertheless mandated to file information returns pursuant to RMO 30-99 and RR 9-99 shall no longer be required to file the same on their income derived from sources outside the Philippines beginning taxable year 2001.

INCOME TAX; Overseas Contract Worker - Section 23(C) of the Tax Code of 1997 provides that anindividual citizen of the Philippines who is working and deriving income from abroad as an overseas

contract worker is taxable only on income from sources within the Philippines. Corollary thereto, Section22(E)(3) of the same Code provides that a citizen of the Philippines who works and derives income fromabroad and whose employment thereat requires him to be physically present abroad most of the time duringthe taxable year.Thus, for purposes of exemption from income tax, a citizen must be deriving foreign-sourced income forbeing a non-resident citizen or for being an overseas contract worker (CW). All employees whose servicesare rendered abroad for being seconded or assigned for at least 183 days may fall under the first categoryand are therefore exempt from payment of Philippine income tax. The phrase "most of the time" shall meanthat the said citizen shall have stayed abroad for at least 183 days in a taxable year. (Sec. (2)(c), RevenueRegulations No. 1-79)The same exemption applies to an overseas contract worker but as such worker, the time spent abroad is notmaterial for tax exemption purposes. All that is required is for the worker's employment contract to passthrough and be registered with the Philippine Overseas Employment Agency (POEA). (BIR Ruling No.033-2000 dated September 05, 2000)

RR 2 (Secs 5 and 6)SECTION 5. Definition. — A "non-resident alien individual" means an individual —(a) Whose residence is not within the Philippines; and(b) Who is not a citizen of the Philippines.An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the Philippines for purposes of the income tax. Whether he is a transient or not is determined by his intentions with regard to the length and nature of his stay. A mere floating intention indefinite as to time, to return to another country is not sufficient to constitute him a transient. If he lives in the Philippines and has no definite intention as to his stay, he is a resident. One who comes to the Philippines for a definite purpose which in its nature may be promptly accomplished is a transient. But if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and to that end the alien makes his home temporarily in the Philippines, he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose for which he came has been consummated or abandoned.SECTION 6. Loss of residence by alien. — An alien who has acquired residence in the Philippines retains his status as a resident until he abandons the same and actually departs from the Philippines. An intention to change his residence does not change his status as a resident alien to that of a nonresident alien. Thus an alien who has acquired a residence in the Philippines is taxable as a resident for the remainder of his stay in the Philippines.

REVENUE REGULATIONS NO. 10-98 issued September 2, 1998 prescribes the regulations to implement RA No. 8424 relative to the imposition of income taxes on income derived under the Foreign Currency Deposit and Offshore Banking Systems. Specifically, interest income which is actually or constructively received by a resident citizen of the Philippines or by a resident alien individual from a foreign currency bank deposit will be subject to a final withholding tax of 7.5%. The depository bank will withhold and remit the tax. If a bank account is jointly in the name of a non-resident citizen, 50% of the interest income from such bank deposit will be treated as exempt while the other 50% will be subject to a final withholding tax of 7.5%. The Regulations will apply on taxable income derived beginning January 1, 1998 pursuant to the provisions of Section 8 of RA 8424. In case of deposits which were made in 1997, only that portion of interest which was actually or constructively received by a depositor starting January 1, 1998 is taxable.

REVENUE REGULATIONS NO. 02-82 (Taxation of Sales of Shares of Stock Classified as Capital Assets.)

Definition of Terms. — For the purpose of these regulations, the following definitions of terms are hereby adopted:(a) "Stock classified as capital assets" shall mean all stocks and securities held by taxpayers other than dealers in securities. (b) "Dealer in securities" includes all persons who for their own account are engaged in the sale of stock, bonds, exchange, bullion, coined money, bank notes, promissory notes, or other securities as licensed by the Securities and Exchange Commission. Notwithstanding the foregoing, nothing in these regulations shall preclude the Commissioner of Internal Revenue from treating other taxpayers engaged in similar activities but not licensed by the Securities and Exchange Commission as a dealer in securities. (c) "Gross selling price" is the total amount of money or its equivalent which the purchaser pays the vendor to receive or get the goods.

Persons Liable to the Tax. — The following persons are liable to the tax provided for in Section 5 of these Regulations: (a) individual taxpayer, citizens or alien; (b) corporate taxpayer, domestic or foreign; (c) other taxpayers not falling under (a) or (b), such as estate, trust, trust funds and pension funds among others.

Persons Not Liable to the Tax. — The taxes imposed herein shall not apply to the following: (a) gains derived by dealers in securities; (b) gains on sale of shares of stock to the extent invested in new shares of stock in banks, non-bank financial intermediaries and corporations organized primarily to hold equities in banks, in accordance with Presidential Decree No. 1739 ; and

(c) all other gains which are specifically exempt from income tax under existing investment incentives and other special law.

Imposition of the Tax. — (a) Sales of shares of stock listed and traded through a local stock exchange. — A tax of 1/4 of 1% shall be imposed on the gross selling price of the shares of stock sold, exchanged or transferred through the facilities of a stock exchange registered with the Securities and Exchange Commission. (b) Shares of stock not traded through a local stock exchange. — Net capital gains derived during the taxable year from sales, exchanges, transfers or similar transaction shall be taxed as follows:

Not over P100,000 10% Over P100,000 20%

Determination of Tax Base. — In determining the tax base, the following rules shall apply:(a) Determination of selling price. — The selling price of the shares of stocks shall be the fair market value of the shares of stocks transferred or exchanged and not the fair market value of the property received in exchange. If the total consideration of the sale or disposition consists partly in cash or money and partly in kind, the selling price shall be the fair market value of the shares disposed. (1) In the case of shares traded through the stock exchange, "fair market value" shall consist of the actual selling price as shown in the sales confirmation issued by the member of the stock exchange through whom the sale was effected. (2) In the case of shares not traded through the stock exchange, but listed in one or more stock exchanges, the highest closing price on the day when the shares are sold, transferred or exchanged, shall be the "fair market value." When no sale is made in any stock exchange, the highest closing price on the day nearest to the day of sale, transfer or exchange of the shares shall be the fair market value. (3) In the case of sale, transfer or exchange of shares not listed in the stock exchange, the following rules shall be observed:

(i) In general, the unlisted shares shall be valued at their book value nearest the valuation date. The book value of these unlisted shares of stock shall be prima facie considered as their fair market value.

(ii) In case the shares are valued on a basis lower than their book values, a justification for the deviation from the book value, together with the evidences in support thereof, should be submitted. The following factors are considered relevant in the valuation of shares of stock of closed corporations.

A) The nature of the business and the financial history of the enterprise, from the date of incorporation B) The economic outlook in general and the business condition and outcome of the specific industry in particular C) The financial condition of the business D) The earning capacity of the company E) The dividend paying capacity F) Goodwill G) Sales of stocks and size of the block of stock to be valued H) Market price of stocks of corporations engaged in the same or similar line of business to be valued I) Existence of corporate debts in favor of the family of the principal shareholder J) Restrictive agreements impairing the alienability of the stock K) Investments in business or property maintained at a deficit L) Dividend arrearages M) Voting rights of stockholders N) Difficulty in liquidating the assets

If such lower fair market valuation is not clearly established and documented, the book value of the unlisted shares of stock shall be adopted. If there have been previous sales/exchanges of the unlisted shares of stock, the price at which these shares exchanged hands should be taken/considered as its fair market value/s. (b) Determination of cost. — The cost basis for determining the capital gains or losses shall be the basis as determined in accordance with the provisions of Section 35 of the National Internal Revenue Code, as amended, and its implementing regulations applied in the following manner: (1) If the stocks can be identified, then the cost shall be the actual purchase price plus all costs of acquisition such as commission, documentary tax, transfer fees, etc. (2) If the stocks cannot be properly identified, then the cost to be assigned shall be computed on the basis of the first-in, first-out (FIFO) method. However - (3) If books of accounts are maintained by the seller where every transaction of a particular stocks are recorded, then the moving average method shall be applied rather than the first-in, first-out, (FIFO) method. (4) In all cases, stock dividend received must be assigned a corresponding cost by allocating the original cost of acquisition to the total number of shares composed of the original shareholdings plus the number of shares of stocks received as stock dividend. (c) In determining the deductibility of capital losses, the following rules shall apply: (1) The provisions of Section 33 of the National Internal Revenue Code, as amended, and its implementing regulations on the non-deductibility of losses on wash sales. (2) The net capital losses sustained during the taxable year shall be allowed as a capital loss deductible in the same taxable year only. (3) The entire amount of capital gains and capital loss shall be considered without taking into account the period or duration during which the stocks were held by the seller up to disposition for purposes of computing net capital gains.

(d) Installment sales of shares of stock not listed and traded through any local stock exchange. — In cases of gains arising from installment sales of shares of stocks, the provisions of Section 43 of the National Internal Revenue Code, as amended, and its implementing regulations shall apply.

… If a taxpayer elects and is qualified to pay the capital gains tax on stock transaction on installments, the amount of the tax due on its installment payment shall be determined as follows:

The net capital gains tax shall be computed on the basis of the entire amount of gain realized from the sale or disposition of shares of stock and the tax so computed may be paid in installments. The amount of the tax on each installment shall be the proportion of the tax so determined which bears to the total installment payment received over the total selling price or to the total contract price, in case of sale or mortgaged shares of stock or where the mortgage on such shares is assumed by the purchaser. For this purpose, installment received shall mean —

(i) On the date of sale or disposition. — First payment received, including the excess of the mortgage, if any, assumed by the purchaser over the basis of the property sold.

(ii) Succeeding installments. — Installment payments actually received by seller.

Effect of Non-payment of Tax. — No sale, exchange, transfer or similar transaction intended to convey ownership of, or title to any share of stock shall be registered in the books of the corporation unless the receipt of payment of the tax herein imposed is filed with and recorded by the stock transfer agent or secretary of the corporation. It shall be duty of the aforesaid persons to inform the Bureau of Internal Revenue in case of non-payment of tax.Any stock transfer agent or secretary of the corporation who caused the registration in violation of the aforementioned requirement shall be punished by a fine of not more than P2,000.00 or by imprisonment for not more than six months, or both.

REVENUE REGULATIONS NO. 8-98 issued September 2, 1998 amends pertinent portions of Revenue Regulations Nos. 11-96 and 2-98 relative to the tax treatment of the sale, transfer or exchange of real property. Specifically, the Capital Gains Tax (CGT) Return will be filed by the seller within 30 days following each sale or disposition of real property. Payment of the CGT will be made to an Authorized Agent Bank (AAB) located within the Revenue District Office (RDO) having jurisdiction over the place where the property being transferred is located. Creditable withholding taxes, on the other hand, deducted and withheld by the withholding agent/buyer on the sale, transfer or exchange or real property classified as ordinary asset will be paid by the withholding agent/buyer upon filing of the return with the AAB located within the RDO having jurisdiction over the place where the property being transferred is located. Payment will have to be done within 10 days following the end of the month in which the transaction occurred, provided, however, that taxes withheld in December will be filed on or before January 25 of the following year.

REVENUE REGULATIONS NO. 13-99 issued September 14, 1999 prescribes the regulations for the exemption of a citizen or a resident alien individual from the payment of the 6% Capital Gains Tax on the sale, exchange or disposition of his principal residence. In order for a person to be exempted from the payment of the tax, he should submit, together with the required documents, a Sworn Declaration of his intent to avail of the tax exemption to the Revenue District Office having jurisdiction over the location of his principal residence within (30) days from the date of the sale, exchange or disposition of the principal residence. The proceeds from the sale, exchange or disposition of the principal residence must be fully utilized in acquiring or constructing the new principal residence within eighteen (18) calendar months from the date of the sale, exchange or disposition. In case the entire proceeds of the sale is not utilized for the purchase or construction of a new principal residence, the Capital Gains Tax will be computed based on the formula specified in the Regulations.

If the seller fails to utilize the proceeds of sale or disposition in full or in part within the 18-month reglementary period, his right of exemption from the Capital Gains Tax did not arise on the extent of the unutilized amount, in which event, the tax due thereon will immediately become due and demandable on the 31st day after the date of the sale, exchange or disposition of the principal residence.

If the individual taxpayer's principal residence is disposed in exchange for a condominium unit, the disposition of the taxpayer's principal residence will not be subjected to the Capital Gains Tax herein prescribed, provided that the said condominium unit received in the exchange will be used by the taxpayer-transferor as his new principal residence.

REVENUE REGULATIONS NO. 14-2000 issued December 29, 2000 amends Sections 3(2), 3 and 6 of RR No. 13-99 relative to the sale, exchange or disposition by a natural person of his "principal residence".

The residential address shown in the latest income tax return filed by the vendor/transferor immediately preceding the date of sale of said real property shall be treated, for purposes of these Regulations, as a conclusive presumption about his true residential address, the certification of the Barangay Chairman, or Building Administrator (in case of condominium unit), to the contrary notwithstanding, in accordance with the doctrine of admission against interest or the principle of estoppel.

The seller/transferor's compliance with the preliminary conditions for exemption from the 6% capital gains tax under Sec. 3(1) and (2) of the Regulations will be sufficient basis for the RDO to approve and issue the Certificate Authorizing Registration (CAR) or Tax Clearance Certificate (TCC) of the principal residence sold, exchanged or disposed by the aforesaid taxpayer. Said CAR or TCC shall state that the said sale, exchange or disposition of the taxpayer's principal residence is exempt from capital gains tax pursuant to Sec. 24 (D)(2) of the Tax Code, but subject to compliance with the post-reporting requirements imposed under Sec. 3(3) of the Regulations.

REVENUE REGULATIONS NO. 4-99 issued March 16, 1999 further amends Revenue Memorandum Order No. 6-92 relative to the payment of Capital Gains Tax and Documentary Stamp Tax on extrajudicial foreclosure sale of capital assets initiated by banks, finance and insurance companies. Where the right of redemption of the mortgagor exists, the certificate of title of the mortgagor will not be cancelled yet even if the property had already been subjected to foreclosure sale. Instead, only a brief memorandum will be annotated at the back of the certificate of title, and the cancellation of the title and the subsequent issuance of a new title in favor of the purchaser/highest bidder depends on whether the mortgagor will redeem or not the mortgaged property within one year from the issuance of the certificate of sale. Thus, no transfer of title to the highest bidder can be effected yet until and after the lapse of the one-year period from the issuance of the said certificate of sale. In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no Capital Gains Tax will be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. In case of non-redemption, the Capital Gains Tax on the foreclosure sale shall become due based on the bid price of the highest bidder, but only upon the expiration of the one-year period of redemption, and will be paid within thirty (30) days from the expiration of the said one-year redemption period. The corresponding Documentary Stamp Tax will be levied, collected and paid by the person making, signing, issuing, accepting or transferring the real property wherever the document is made, signed, issued, accepted or transferred where the property is situated in the Philippines.

RA 9504: Amended Sec22, adding definitions (GG) and (HH); Sec24(A) on the Rate of Income Tax; 34(L) on Optional Standard Reduction; Sec35(A) and (B) for Allowance of Personal Exemption for Individual Taxpayer (General and Dependents); Sec79(A) on Requirement of Withholding

BIR RULING NO. 317-92

Gentlemen :This refers to your letter dated July 13, 1992 stating that in June 1990, your client, Ayala Land, Inc. (ALI) and Appleyard Properties, Inc. (API) entered into a Memorandum of Agreement (MOA) for the construction of an office building on that lot owned by ALI located along Ayala Avenue, Makati, to be known as 6750 Ayala Office Tower (Building) or such other name as the parties may subsequently adopt; that pursuant to the terms of the MOA, ALI and API each contributed equal amounts to the construction costs of the office tower and 351 parking stalls, in consideration of each of them acquiring the ownership of such numbers of specifically designated whole floors in the proportion of 60% (ALI) and 40% (API) respectively, of the net leasable floor area of 22,335 square meters of the office tower, and the right to use the parking stalls and storage spaces in the same proportion of 60%/40%; that while there would be separate ownership of specifically designated whole floors, common areas expenses, maintenance and insurance costs, real estate taxes, commercial center dues and expenses would be shared by ALI and the API in the same proportion; that upon the expiration of the 48 year term of the MOA in year 2038, the ownership of all the floors or portions of the building allocated to API shall automatically be transferred to ALI; that the principal objective of both ALI and API is to lease out to third party tenants the specific floors separately owned by them; that considering the present softness in the market, they believe that it would be to their mutual interest to pool together their respective floors in the Building for the purpose of leasing them under standard rental rate, and to use a common agent to handle contract negotiations, tenant relations, maintenance, accounting of income and expenses; that to carry out their common objectives, ALI and API now propose to enter into another agreement, a Joint Venture Agreement (JVA); that under the JVA, ALI and API will contribute money to a common fund for the initial and, if necessary, additional working capital of the joint venture; that ALI will be appointed as manager of the joint venture and subject to the mutual control of ALI and API, shall be responsible, among others, for the leasing of the Building floors or portions thereof owned by ALI and API; that irrespective of who owns the floor or floors, or portions of the Building that are leased out, the JV will hold the rental receipts in a common pool and the net balance every quarter, after deducting all expenses chargeable thereto, such as salaries of JV personnel and maintenance expenses, shall be distributed to ALI and API in same proportion of 60%/40% as dividends; that the JV will have a life of three years; and that upon its dissolution, each party will receive the rentals for the floors owned by it and shoulder its own expenses, independently of the other. cdtaiIn connection therewith, you now pose the following queries: "1. Whether or not the Memorandum of Agreement entered into by and between ALI and API in 1990 providing for the construction of the office tower has, by itself, created a separately taxable joint venture; "2. Whether or not the joint venture to be subsequently entered into by and between ALI and API, for the leasing of the Building floors or portions thereof separately owned by them will be considered as a corporation taxable as such, separate and distinct from ALI and API; "3. Whether or not the rentals to be paid by the tenants of the Building to the joint venture during the term of the JVA are to be treated as income of the joint venture; "4. Whether or not the distributions by the joint venture of the net income from its operations to ALI and API will be considered as dividend distributions taxable to ALI and API."

In reply thereto, I have the honor to inform you that to constitute a "joint venture" certain factors are essential: "(a) each party to the venture must make a contribution, not necessarily of capital, but by way of services, skill, knowledge, material or money; "(b) profits must be shared among the parties; "(c) there must be a joint proprietary interest and right of mutual control over the subject matter of the enterprise; "(d) usually, there is single business transaction rather than a general or continuous transaction" (Words and Phrases, Vol. 23, p. 230) Likewise, a joint venture was created when two corporations while registered and operating separately were placed under one sole management which operated the business affairs of said companies as though constituted a single entity thereby obtaining substantial economy and profits in the operation (Collector vs. Batangas Transportation et al. 102 Phil. 822; See also BIR Ruling Nos. 020(b)-020-80-187-82 dated June 3, 1982; 24-000-00-115-86 dated July 17, 1986; 069-90 dated May 9, 1990 and 254-91 dated November 26, 1991). The Memorandum of Agreement entered into by and between ALI and API in 1990 providing for the construction of the aforementioned office tower has not by itself created a taxable joint venture. However, the joint venture to be subsequently entered into by and between ALI and API, for the leasing of the Building floors or portions thereof separately owned by them will create, a joint venture subject to tax under Section 24(a) of the Tax Code, as amended, separate and distinct from ALI and API.Moreover, the rentals to be received by the joint venture from the tenants in the Building are income to the joint venture. Furthermore, the distribution by the joint venture of its net income to ALI and API are in the nature of dividends which are not subject to tax under Section 24(e)(4) of the Tax Code, as amended.This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation the same could not be substantiated then this ruling shall be considered null and avoid.

REVENUE MEMORANDUM CIRCULAR No. 76-2003SUBJECT : Tax Exemptions of Non-Stock, Non-Profit Corporations Section 30, Tax Code of 1997 and Non-stock, Non-Profit Educational Institutions under Paragraph 3, Section 4, Article XIV of the Constitution.

NON-STOCK, NON-PROFIT CORPORATIONSOrganizations enumerated under Section 30 of the Tax Code of 1997 are exempt from the payment of income tax on income received by them as such organization.However, they are subject to the corresponding internal revenue taxes imposed under the Tax Code of 1997 on their income derived from any of their properties, real or personal, or any activity conducted for profit regardless of the disposition thereof (i.e. rental payment from their building/premises), which income should be returned for taxation.In addition, their interest income from currency bank deposits and yield or any other monetary benefit from deposit substitute instruments and from trust funds and similar arrangement, and royalties derived from sources within the Philippines are subject to the 20% final withholding tax: provided, however, that interest income derived by them from a depository bank under the expanded foreign currency deposit system shall be subject to 7 1/2% final withholding tax pursuant to Section 27(D)(1) in relation to Section 57(A), both of the Tax Code of 1997.It shall also be constituted as a withholding agent for the government if they acts as an employer and any of their employee receives compensation income subject to withholding tax under Section 79(A), Chapter XIII, Title II of the Tax Code of 1997, as implemented by Revenue Regulations No. 2-98, or if they makes income payments to individuals or corporations subject to the withholding tax provided for in Section 57 of the Tax Code of 1997, also as implemented by Revenue Regulations No. 2-98.

NON-STOCK, NON-PROFIT EDUCATIONAL INSTITUTIONSThe exemption of non-stock, non-profit educational institutions refers to internal revenue taxes imposed by the National Government on all revenues and assets used actually, directly and exclusively for educational purposes (Paragraph 3, Section 4, Article XIV of the Constitution).Furthermore, revenues derived from assets used in the operation of cafeterias/canteens and bookstores are exempt from taxation provided they are owned and operated by the educational institution as ancillary activities and the same are located within the school premises.Pursuant to Section 109(m) of the Tax Code of 1997, private educational institutions shall be exempt from value-added tax provided they are accredited as such either by the Department of Education, Culture and Sports or by the Commission on Higher Education. However, this exemption does not extend to their other activities involving sale of goods and services.However, they shall be subject to internal revenue taxes on income from trade, business or other activity, the conduct of which is not related to the exercise or performance by such educational institutions of their educational purposes or functions (Sec. 2, Finance Department Order No. 137-87 as amended by Finance Department Order No. 92-88) i. e. rental payment from their building/premises.Unlike non-stock, non-profit corporations, their interest income from currency bank deposits and yield from deposit substitute instruments used actually, directly and exclusively in pursuance of their purposes as an educational institution, are exempt from the 20% final tax and 7 ½% tax on interest income under the expanded foreign currency deposit system imposed under Section 27(D)(1) of the Tax Code of 1997, subject to compliance with the conditions that as a tax-exempt educational institution, they shall on an annual basis submit to the Revenue District Office concerned an annual information return and duly audited financial statement together with the following:

(a) Certification from their depository banks as to the amount of interest income earned from passive investment not subject to the 20% final withholding tax and 7 ½% tax on interest income under the expanded foreign currency deposit system imposed by Section 27(D)(1) of the Tax Code of 1997;(b) Certification of actual utilization of the said income; and

(c) Board Resolution by the school administration on proposed projects (i.e., construction and/or improvement of school buildings and facilities, acquisition of equipment, books and the like) to be funded out of the money deposited in banks or placed in money markets, on or before the 14th day of the fourth month following the end of its taxable year (Sec. 3, Finance Department Order No. 137-87).

Finally, the exemption does not cover withholding taxes. As an educational institution, they are constituted as withholding agents for the government required to withhold the tax on compensation income of their employees, or the withholding tax on income payments to persons subject to tax pursuant to Section 57 of the Tax Code of 1997. In both cases, in order to monitor the activities being conducted by these institutions, it is mandatory that they should maintain their respective set of books of accounts as prescribed in Section 235 of the Tax Code of 1997.Furthermore, both institutions are subject to the payment of the annual registration fee of P500.00 as prescribed in Section 236(B) of the Tax Code of 1997. They are also required under Section 6(C) in relation to Section 237 of the same Code to issue duly registered receipts or sales or commercial invoices for each sale or transfer of merchandise or for services rendered which are not directly related to the activities for which they are registered.

RR 2-82 (see page 3)

RR 8-98 (see page 5)

REVENUE REGULATIONS NO. 4-99 issued March 16, 1999 further amends Revenue Memorandum Order No. 6-92 relative to the payment of Capital Gains Tax and Documentary Stamp Tax on extrajudicial foreclosure sale of capital assets initiated by banks, finance and insurance companies. Where the right of redemption of the mortgagor exists, the certificate of title of the mortgagor will not be cancelled yet even if the property had already been subjected to foreclosure sale. Instead, only a brief memorandum will be annotated at the back of the certificate of title, and the cancellation of the title and the subsequent issuance of a new title in favor of the purchaser/highest bidder depends on whether the mortgagor will redeem or not the mortgaged property within one year from the issuance of the certificate of sale. Thus, no transfer of title to the highest bidder can be effected yet until and after the lapse of the one-year period from the issuance of the said certificate of sale. In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no Capital Gains Tax will be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. In case of non-redemption, the Capital Gains Tax on the foreclosure sale shall become due based on the bid price of the highest bidder, but only upon the expiration of the one-year period of redemption, and will be paid within thirty (30) days from the expiration of the said one-year redemption period. The corresponding Documentary Stamp Tax will be levied, collected and paid by the person making, signing, issuing, accepting or transferring the real property wherever the document is made, signed, issued, accepted or transferred where the property is situated in the Philippines.

REVENUE REGULATIONS NO. 9-98 issued September 2, 1998 prescribes the regulations to implement RA No. 8424 relative to the imposition of the Minimum Corporate Income Tax (MCIT) on domestic corporations and resident foreign corporations. Specifically, an MCIT of 2% of the gross income as of the end of the taxable year is imposed upon any domestic corporations beginning the 4th taxable year immediately following the taxable year in which such corporation commenced its business operations. The MCIT will be imposed whenever such operation has zero or negative taxable income or whenever the amount of MCIT is greater than the normal income tax due from such operation. In the case of a domestic corporation whose operations or activities are partly covered by the regular income tax system and partly covered under a special income tax system, the MCIT will apply on operations covered by the regular income tax system.

The Regulations will apply to domestic and resident foreign corporations on their aforementioned taxable income derived beginning January 1, 1998 pursuant to the pertinent provisions of RA 8424, provided, however, that corporations using the fiscal year accounting period and which are subject to MCIT on income derived pertaining to any month or months of the year 1998 will not be imposed with penalties for late payment of the tax.

RR 15-02 (See book)

REVENUE REGULATIONS NO. 10-76 (Regulations governing taxation of Offshore Banks and Foreign Currency Deposit Units of depository banks established under P.D. 1034 and 1035, respectively)

Definition of Terms. —a. "Offshore Banking" shall refer to the conduct of banking transactions in foreign currencies involving the receipt of funds principally from external sources and the utilization of such funds as provided in Presidential Decree No. 1034.b. "Offshore Banking Unit" hereinafter referred to as OBU, shall mean a branch, subsidiary or affiliate of a foreign banking corporation which is duly authorized by the Central Bank of the Philippines, as a separate accounting unit, to transact offshore banking business in the Philippines in accordance with the provisions of P.D. 1034 as implemented by Central Bank Circular No. 546.

c. "Deposits" shall mean funds in foreign currencies which are accepted and held by an off-shore banking unit in the regular course of business, with the obligation to return an equivalent amount to the owner thereof, with or without interest.d. "Resident" shall mean — (1) an individual citizen of the Philippines residing therein; or (2) an individual who is not a citizen of the Philippines but is permanently residing therein; or (3) a corporation or other juridical person organized under the laws of the Philippines. (4) a branch, subsidiary, affiliate, extension office or any other unit of corporations or juridical persons organized under the laws of any foreign country operating in the Philippines.e. "Non-resident" shall mean an individual, corporation or other juridical person not included in the above definition of "residents".f. "Foreign Currency Deposit Unit" (FCDU) shall mean an accounting unit or department in a local bank or in an existing local branch of foreign banks, which is authorized by the Central Bank of the Philippines to operate under the expanded foreign currency deposit system, in accordance with the provisions of P.D. 1035, as implemented by Central Bank Circular No. 547. The FCDU authority shall be distinguished from the authority to accept foreign currency deposits under R.A. No. 6426, as implemented by Central Bank Circular No. 343.g. "Gross offshore income" shall mean all income arising from transactions allowed by the Central Bank of the Philippines conducted by and between — 1) in the case of an offshore banking unit with another offshore banking unit or with an expanded Foreign Currency Deposit unit or with a non-resident; 2) in the case of an expanded Foreign Currency Deposit Unit with another expanded Foreign Currency Deposit Unit or with an Offshore Banking Unit or with a non-resident.h. "Gross onshore income" shall mean gross interest income arising from foreign currency loans and advances to and/or investments with residents made by Offshore Banking Units or expanded Foreign Currency Deposit Units. Such gross interest income shall include all fees, commissions and other charges which are integral parts of the income from the above transactions.

Rates of income tax to be imposed. —The rates or income tax to be imposed, which shall be in lieu of all other taxes such as, but not limited to privilege tax, gross receipts tax, documentary and science stamp tax and profit remittance tax, are as followers: (a) On offshore income, there shall be imposed an income tax of five percent (5%) based on net offshore income as computed in Section 4.Income realized by offshore banking units on transactions with local commercial banks including branches of foreign banks that may be authorized by the Central Bank of the Philippines to transact business with offshore banking units shall likewise be subject to the same tax, except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation of the Monetary Board, to be subject to the usual income tax payable by banks. (b) In the case of gross onshore income as defined in Section 2(h) above, the tax shall be ten percent (10%) thereof and shall be a final tax. (c) Income not covered by paragraphs (a) and (b) above shall be subject to the usual corporate taxes imposed by the National Internal Revenue Code, as amended.

Manner of computation of net income. — (a) Net offshore income for purposes of Section 3, paragraph (a) above, shall be the amount remaining after deducting from the gross offshore income during the taxable year the following items:

1) the proportion of total interest expenses for the same period based on the ratio of offshore interest income which bears to the total gross interest income;

2) the proportion of general administrative expenses based on the ratio of net offshore income which bears to the total net income after deducting only interest expenses mentioned in sub-paragraph (1) above.

3) Likewise, there shall be allowed a reasonable amount of head office expenses in accordance with the ratio specified in sub-paragraph (2) above. (b) In the case of onshore income, the gross interest income without the benefit of any deduction corresponding to the allocable onshore income, shall be the amount upon which the ten percent (10%) withholding income tax shall be computed......

Income of non-resident. —Any income of non-residents from transactions with either an offshore banking unit or with an expanded Foreign Currency Deposit Unit shall be exempt from any and all taxes.

Income of foreign personnel. —There shall be levied, collected and paid for each taxable year upon the gross income received by every alien individual employed by offshore banking units in the Philippines as salaries, wages, annuities, compensations, remunerations and emoluments from such offshore banking units a tax equal to fifteen (15%) percent of such gross income. The aforesaid tax shall be deducted and withheld at source in the same manner and condition as that provided under Supplement "A" — Withholding on Wages of Commonwealth Act No. 466, as amended.

Privileges of the offshore banking units. —The offshore banking units shall be exempt from all forms of local licenses, fees, dues, imposts or any other local taxes or burdens. The license fee paid by offshore banking units shall be allowed as a deduction in accordance with Section 4 of these regulations.

REVENUE REGULATIONS NO. 14-77 (Amending Revenue Regulations No. 10-76)

Section 2(h) is hereby amended to read as follows:"SEC. 2(h). Gross onshore income shall mean gross interest income arising from foreign currency loans and advances to and/or investments with residents made by offshore banking units or expanded foreign currency deposit units. In the case of foreign currency loan transactions, such gross interest income shall refer only to the stipulated interest and shall not include any and all fees, commissions and other charges which are integral parts of the income from the above transactions."

Section 3(b) is hereby amended to read as follows:"SEC. 3(b). In the case of gross onshore income as defined in Section 2(h) above, the tax shall be ten percent (10%) thereof and shall be a final tax. Any and all fees, commissions and other charges which are integral parts of the charges imposed on foreign currency loan transactions are exempt from the tax herein imposed."

Section 5(b) is hereby amended to read as follows:"SEC. 5(b). For onshore income — In the case of onshore income realized by an offshore banking unit or by an expanded Foreign Currency Deposit Unit, the income need not be included in the quarterly income tax return to be filed as required above as the payor-borrower under Section 53, in relation to Section 54, of the National Internal Revenue Code, is constituted as the withholding agent charged with the obligation of deducting, withholding and remitting to the Commissioner of Internal Revenue the income tax due thereon within the period prescribed by law with the appropriate return in accordance with existing revenue and Central Bank regulations. Regardless, therefore, of whether the accounting method of an OBU-creditor in cash or accrual basis, the withholding tax will be withheld and remitted only after the due date of payment of the interest incurred by an onshore borrower.

RR 10-98 (see page 3)

RA 9337, amending … intercorporate dividends (NIRC 1997)

BIR RULING [DA-145-07]

Gentlemen :This refers to your letter dated December 27, 2006 requesting for confirmation of your opinion that the cash dividends declared by SM Investment Corporation (SM Investments), a Philippine domestic corporation whose shares of stock are traded and listed in the Philippine Stock Exchange (PSE), to Asia Opportunities Limited (Asia Opportunities), a corporation organized and existing under the laws of the British Virgin Island (BVI), are subject to 15% preferential withholding tax pursuant to Section 28 (B) (5) (b) of the Tax Code of 1997, as amended by Republic Act (R.A.) No. 9337.In reply thereto, please be informed that Section 2 of R.A. No. 9337 reads as follows:"SEC. 2. Section 28(A)(1) and (B)(1) and (5)(b) of the same Code, as amended, are hereby further amended to read as follows:SEC. 28. Rates of Income Tax on Foreign Corporations. —xxx xxx xxx(B) Tax on Nonresident Foreign Corporation. —xxx xxx xxx(5) Tax on Certain Incomes Received by a Nonresident Foreign Corporation. —xxx xxx xxx(b) Intercorporate Dividends. — A final withholding tax at the rate of fifteen percent (15%) is hereby imposed on the amount of cash and/or property dividends received from a domestic corporation, which shall be collected and paid as provided in Section 57(A) of this Code, subject to the condition that the country in which the nonresident foreign corporation is domiciled, shall allow a credit against the tax due from the nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent to twenty percent (20%), which represents the difference between the regular income tax of thirty-five percent (35%) and the fifteen percent (15%) tax on dividends as provided in this subparagraph: Provided, That effective January 1, 2009, the credit against the tax due shall be equivalent to fifteen percent (15%), which represents the difference between the regular income tax of thirty percent (30%) and the fifteen percent (15%) tax on dividends;xxx xxx xxx"This Office had already occasioned to rule on the matter, when it said in BIR Ruling No. 208-89 dated September 28, 1989, as follows:"Generally, under the above-quoted Section 24(b)(5)(B) of the Tax Code, as amended, dividend paid to a non-resident foreign corporation is subject to withholding tax at the rate of 35%. However, if the country where the non-resident foreign corporation is domiciled allows a credit against the tax due from the non-resident corporation taxes deemed to have been paid in the Philippines in an amount equivalent to 20% of such dividend, or does not subject such dividend to taxation, then dividend paid to such non-resident foreign corporation are taxed only at the rate of 15%.Thus, since the International Business Companies Ordinance of the Territory of the British Virgin Islands . . . does not impose any tax on dividend received from foreign sources, which logically would include those received from Philippine

corporations by foreign corporations domiciled therein, then said cash dividend . . . is subject only to the preferential withholding tax rate of 15% imposed under then Section 25(B)(5)(B) of the Tax Code, as amended (now Section 28(B)(5)(b) of the Tax Code of 1997)."SUCH BEING THE CASE, this Office hereby confirms your opinion that the cash dividends received by Asia Opportunities from SM Investments, a Philippine domestic corporation are subject to the 15% preferential withholding tax rate imposed under Section 28(B)(5)(b) of the Tax Code of 1997, as amended by R.A. No. 9337.This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void.

ITAD RULING NO. 102-02Gentlemen :This refers to your letter dated February 14, 2002 requesting confirmation of your opinion that the royalty payments by your client, Energizer Philippines, Inc. (Energizer), to Eveready Battery Company, Inc. (Eveready) are subject to the preferential tax rate of fifteen percent (15%) pursuant to the "most favored nation" clause of the RP-US tax treaty in relation to the RP-Netherlands tax treaty.It is represented that Eveready is a non-resident foreign corporation duly organized and existing under the laws of the United States of America with principal office at Trust Center, 1209 Orange Street, City of Wilmington, Delaware; that it is not registered either as a corporation or as a partnership licensed to do business in the Philippines its evidenced by the Certificate of Non-Registration issued by the Securities and Exchange Commission dated February 20, 2002; that Energizer is a corporation duly organized and existing under Philippine laws; that Eveready and Energizer entered into a Renewal Agreement dated October 11, 1994 whereby Eveready granted to Energizer the right to use its trademarks and patents, technical information, business information, data, and know-how relating to the manufacture, use and sale of licensed products; that the said Agreement was duly registered with the then Technology Transfer Registry under Certificate of Registration No. 1652 dated January 19, 1995 and was renewed for another 10 years ending on October 15, 2009; and that in consideration of the aforementioned rights granted to Energizer, Energizer shall pay Eveready a royalty of three percent (3%), as amended, based on the net sales or net sale value of all the licensed products manufactured, used, sold or assigned by Energizer during the term of the Agreement.In reply, please be informed that Article 13 of the RP-US tax treaty reads as follows:Article 13--ROYALTIES(1) Royalties derived by a resident of one of the Contracting States from sources within the other Contracting State may be taxed by both Contracting States.(2) However, the tax imposed by that other Contracting State shall not exceed — (b) In the case of the Philippines, the least of: (i) 25 percent of the gross amount of the royalties, (ii) 15 percent of the gross amount of the royalties, where the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities, and (iii) the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third State. (Emphasis supplied)(3) The term "royalties" as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes used for radio or television broadcasting; any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience. The term "royalties" also includes gains derived from the sale, exchange or other disposition of any such right or property which are contingent on the productivity, use, or disposition thereof."xxx xxx xxx"On the other hand, Article 12 of the RP-Netherlands tax treaty provides:Article 12--ROYALTIES1. Royalties arising in one of the States and paid to a resident of the other State may be taxed in that other State.2. However, such royalties may also be taxed in the State in which they arise, and according to the laws of that State, but if the recipient is the beneficial owner of the royalties the tax so charged shall not exceed. (a) 10 per cent of the gross amount of the royalties where the royalties are paid by an enterprise registered, and engaged in preferred areas of activities in that State; and (b) 15 per cent of the gross amount of the royalties in all other cases."xxx xxx xxx"

Based on the foregoing, the tax imposed on royalties derived by a resident of the United States from sources within the Philippines shall be the lowest rate of Philippine tax that may be imposed an royalties of the same kind paid under similar circumstances to a resident of a third State. This is the "most-favored nation"` clause found in Article 13(2)(b)(iii) of the RP-US tax treaty. In this connection, it must be noted that the royalties arising from the Philippines and paid to a resident of the Netherlands may also be taxed in the Philippines but the tax so charged shall not exceed 15 per cent of the gross amount of royalties in cases other than royalties paid by in enterprise registered in preferred areas of activities in the Philippines. The term "royalties" as used in this Article means any payment of any kind received as a consideration for the use of, or right to use, any patent, trademark, design or model, secret formula or process, or for the use of, or the right to use of, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.In the case of Commissioner of Internal Revenue vs. S.C. Johnson and Son, Inc., and Court of Appeals, G.R. No. 127105 promulgated on June 25, 1999, the Supreme Court interpreted the "most-favored-nation" clause, particularly the phrase "paid under similar circumstances," as referring to the manner of payment or taxes and not to the subject matter of the tax which is royalties. Hence, the "most-favored-nation" clause of the RP-US tax treaty must be interpreted not only in relation

to Article 12 of the RP-Netherlands tax treaty but also in connection with the provisions on the elimination of double taxation of both.A perusal of the RP-US and the RP-Netherlands tax treaties, particularly their provisions on the avoidance of double taxation, shows a similarity on the manner of payment of taxes, that is, the allowable foreign tax credit on both treaties is the amount actually paid in the Philippines.Such being the case, and since Energizer is not registered and engaged in preferred areas of activities in the Philippines, this Office is of the opinion and so holds that the royalty payments by Energizer to Eveready are subject to the preferential tax rate of 15% of the gross amount of royalties pursuant to the "most-favored-nation" provision of the RP-US tax treaty in relation to the RP-Netherlands tax treaty. (BIR Ruling No. ITAD-54-00 dated March 7, 2000)Moreover, the above royalty payments by Energizer shall be subject to the 10% value-added tax (VAT) under Section 108(A)(1) and (3) of the Tax Code of 1997. Section 4.102-1(b) of the implementing Revenue Regulation No. 7-95 provides that:"The VAT on rental and/or royalties payable to non-resident foreign corporations or owners for the sale of services and use or lease of properties in the Philippines shall be based on the contract price agreed upon by the licensor and the license. The license shall be responsible for the payment of VAT on such rentals and/or royalties in behalf of the non-resident foreign corporation or owner by filing a separate VAT declaration/return (BIR Form No. 1600 – Monthly Remittance Return of Value-Added Tax and Other Percentage Taxes Withheld) for this purpose. The duly validated VAT declaration/return is sufficient evidence in claiming input tax credit by the licensee."Accordingly, Energizer shall be responsible for the withholding of income tax at the rate of 15% of the gross amount of royalties. Moreover, Energizer shall also be responsible for the withholding of the value-added tax (VAT) at the rate of 10% of the contract amount by filing a separate return using BIR Form No. 1600, which, if duly validated, shall be sufficient evidence in claiming input tax credit. This ruling is issued on the basis of the foregoing facts as represented. However, if upon investigation it shall be disclosed that the facts are different, then this ruling shall be considered null and void.

REVENUE REGULATIONS NO. 2 - 2001 (Implementing the Provision on Improperly Accumulated Earnings Tax Under Section 29 of the Tax Code of 1997)

Concept of Improperly Accumulated Earnings Tax (IAET). - Pursuant to Section 29 of the Code, there is imposed for each taxable year, in addition to other taxes imposed under Title II of the Tax Code of 1997, a tax equal to 10% of the improperly accumulated taxable income of 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. The rationale is that if the earnings and profits were distributed, the shareholders would then be liable to income tax thereon, whereas if the distribution were not made to them, they would incur no tax in respect to the undistributed earnings and profits of the corporation. Thus, a tax is being imposed in the nature of a penalty to the corporation for the improper accumulation of its earnings, and as a form of deterrent to the avoidance of tax upon shareholders who are supposed to pay dividends tax on the earnings distributed to them by the corporation.

The touchstone of the liability is the purpose behind the accumulation of the income and not the consequences of the accumulation. Thus, if the failure to pay dividends is due to some other causes, such as the use of undistributed earnings and profits for the reasonable needs of the business, such purpose would not generally make the accumulated or undistributed earnings subject to the tax. However, if there is a determination that a corporation has accumulated income beyond the reasonable needs of the business, the 10% improperly accumulated earnings tax shall be imposed.

Determination of Reasonable Needs of the Business. - An accumulation of earnings or profits (including undistributed earnings or profits of prior years) is unreasonable if it is not necessary for the purpose of the business, considering all the circumstances of the case. To determine the "reasonable needs" of the business in order to justify an accumulation of earnings, these Regulations hereby adhere to the so-called "Immediacy Test" under American jurisprudence as adopted in this jurisdiction. Accordingly, the term "reasonable needs of the business" are hereby construed to mean the immediate needs of the business, including reasonably anticipated needs. In either case, the corporation should be able to prove an immediate need for the accumulation of the earnings and profits, or the direct correlation of anticipated needs to such accumulation of profits. Otherwise, such accumulation would be deemed to be not for the reasonable needs of the business, and the penalty tax would apply.

For purposes of these Regulations, the following constitute accumulation of earnings for the reasonable needs of the business: a. Allowance for the increase in the accumulation of earnings up to 100% of the paid-up capital of the corporation as of Balance Sheet date, inclusive ofaccumulations taken from other years; b. Earnings reserved for definite corporate expansion projects or programs requiring considerable capital expenditure as approved by the Board of Directors or equivalent body; c. Earnings reserved for building, plants or equipment acquisition as approved by the Board of Directors or equivalent body; d. Earnings reserved for compliance with any loan covenant or pre-existing obligation established under a legitimate business agreement; e. Earnings required by law or applicable regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution; f. In the case of subsidiaries of foreign corporations in the Philippines, all undistributed earnings intended or reserved for investments within the Philippines as can be proven by corporate records and/or relevant documentary evidence.

Coverage. The 10% Improperly Accumulated Earnings Tax (IAET) is imposed on improperly accumulated taxable income earned starting January 1, 1998 by domestic corporations as defined under the Tax Code and which are classified as closely-held corporations. Provided, however, that Improperly Accumulated Earnings Tax shall not apply to the following corporations: a. Banks and other non-bank financial intermediaries; b. Insurance companies; c. Publicly-held corporations; d. Taxable partnerships; e. General professional partnerships; f. Non- taxable joint ventures; and g. Enterprises duly registered with the Philippine Economic Zone Authority (PEZA) under R.A. 7916, and enterprises registered pursuant to the Bases Conversion and Development Act of 1992 under R.A. 7227, as well as other enterprises duly registered 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.

For purposes of these Regulations, closely-held corporations are those corporations at least fifty percent (50%) in value of the outstanding capital stock or at least fifty percent (50%) of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than twenty (20) individuals. Domestic corporations not falling under the aforesaid definition are, therefore, publicly-held corporations.

For purposes of determining whether the corporation is closely held corporation, insofar as such determination is based on stock ownership, the following rules shall be applied: 1. Stock Not Owned by Individuals. - Stock owned directly or indirectly by or for a corporation, partnership, estate or trust shall be considered as being owned proportionately by its shareholders, partners or beneficiaries. 2. Family and Partnership Ownership. – An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family, or by or for his partner. For purposes of this paragraph, the ‘family of an individual’ includes his brothers or sisters (whether by whole or half-blood), spouse, ancestors and lineal descendants. 3. Option to Acquire Stocks. - If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option and each one of a series of option shall be considered as an option to acquire such stock. 4. Constructive Ownership as Actual Ownership. - Stock constructively owned by reason of the application of paragraph (1) or (3) hereof shall, for purposes of applying paragraph (1) or (2), be treated as actually owned by such person; but stock constructively owned by the individual by reason of the application of paragraph (2) hereof shall not be treated as owned by him for purposes of again applying such paragraph in order to make another the constructive owner of such stock.

Provided, however, that a branch of a foreign corporation is not covered by these Regulations, the same being a resident foreign corporation.

Tax Base of Improperly Accumulated Earnings Tax. - For corporations found subject to the tax, the "Improperly Accumulated Taxable Income" for a particular year is first determined by adding to that year’s taxable income the following: a. income exempt from tax; b. income excluded from gross income; c. income subject to final tax; and d. the amount of net operating loss carry-over (NOLCO) deducted.

The taxable income as thus determined shall be reduced by the sum of: a. income tax paid/payable for the taxable year; b. dividends actually or constructively paid/issued from the applicable year’s taxable income; c. amount reserved for the reasonable needs of the business as defined in these Regulations emanating from the covered year’s taxable income.

The resulting "Improperly Accumulated Taxable Income" is thereby multiplied by 10% to get the Improperly Accumulated Earnings Tax (IAET). Once the profit has been subjected to IAET, the same shall no longer be subjected to IAET in later years even if not declared as dividend. Notwithstanding the imposition of the IAET, profits which have been subjected to IAET, when finally declared as dividends, shall nevertheless be subject to tax on dividends imposed under the Tax Code of 1997 except in those instances where the recipient is not subject thereto.

For purposes of determining the source of earnings or profits declared or distributed from accumulated income for each taxable year, the dividends shall be deemed to have been paid out of the most recently accumulated profits or surplus and shall constitute a part of the annual income of the distributee for the year in which received pursuant to Section 73(C) of the Code. Provided, however, that where the dividends or portion of the said dividends declared forms part of the accumulated earnings as of December 31, 1997, or emanates from the accumulated income of a particular year and, therefore, is an exception to the preceeding statement, such fact must be supported by a duly executed Board Resolution to that effect.

Period for Payment of Dividend/Payment of IAET. - The dividends must be declared and paid or issued not later than one year following the close of the taxable year, otherwise, the IAET, if any, should be paid within fifteen (15) days thereafter.

Determination of Purpose to Avoid Income Tax. - The fact that a corporation is a mere holding company or investment company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members. Likewise, the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business

shall be determinative of the purpose to avoid the tax upon its shareholders or members. In both instances, the corporation may, by clear preponderance of evidence in its favor, prove the contrary.

For purposes of these Regulations, the term "holding or investment company" shall refer to a corporation having practically no activities except holding property, and collecting the income therefrom or investing the same.

The following are prima facie instances of accumulation of profits beyond the reasonable needs of a business and indicative of purpose to avoid income tax upon shareholders: a. Investment of substantial earnings and profits of the corporation in unrelated business or in stock or securities of unrelated business; b. Investment in bonds and other long-term securities; c. Accumulation of earnings in excess of 100% of paid-up capital, not otherwise intended for the reasonable needs of the business as defined in these Regulations.

In order to determine whether profits are accumulated for the reasonable needs of the business as to avoid the imposition of the improperly accumulated earnings tax, the controlling intention of the taxpayer is that which is manifested at the time of accumulation, not subsequently declared intentions which are merely the product of afterthought. A speculative and indefinite purpose will not suffice. The mere recognition of a future problem or the discussion of possible and alternativesolutions is not sufficient. Definiteness of plan/s coupled with action/s taken towards its consummation are essential.

IMPROPERLY ACCUMULATED EARNINGS TAX; publicly-held corporation - Abbot-Phils., as a wholly-owned subsidiary of Abbot-US, will be considered as being owned proportionately by Abbott-US shareholders. The ownership of a domestic corporation, for purposes of determining whether it is a closely-held corporation or a publicly-held corporation, is ultimately traced to the individual shareholders of the parent company. Accordingly, Abbot-Phils. is considered a publicly-held corporation exempt from the Improperly Accumulated Earnings Tax. This is based on the representation that as of the year end 2000, Abbot-US had 101 to 272 shareholders holding a combined 1,545,937,133 shares of common stock, and the twenty largest shareholders of Abbott-US as of September 30, 2001 own an aggregate of 30.1% of Abbot-US issued as outstanding shares. Based on Section 4 of Revenue Regulations No. 2-2001, closely-held corporations are those corporations at least 50% in value if the outstanding capital stock or at least 50% of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than 20 individuals. Abbot-Phils. does not fall under the definition of a closely-held corporation. (BIR Ruling No. 025-2002 dated June 25, 2002)

EO 226--Article 39. Incentives to Registered Enterprises. All registered enterprises shall be granted the following incentives to the extent engaged in a preferred area of investment;

(a) Income Tax Holiday.

(1) For six (6) years from commercial operation for pioneer firms and four (4) years for non-pioneer firms, new registered firms shall be fully exempt from income taxes levied by the National Government. Subject to such guidelines as may be prescribed by the Board, the income tax exemption will be extended for another year in each of the following cases:

i. the project meets the prescribed ratio of capital equipment to number of workers set by the Board;

ii. utilization of indigenous raw materials at rates set by the Board;

iii. the net foreign exchange savings or earnings amount to at least US$500,000.00 annually during the first three (3) years of operation.

The preceding paragraph notwithstanding, no registered pioneer firm may avail of this incentive for a period exceeding eight (8) years.

(2) For a period of three (3) years from commercial operation, registered expanding firms shall be entitled to an exemption from income taxes levied by the National Government proportionate to their expansion under such terms and conditions as the Board may determine; Provided, however, That during the period within which this incentive is availed of by the expanding firm it shall not be entitled to additional deduction for incremental labor expense.

(3) The provision of Article 7 (14) notwithstanding, registered firms shall not be entitled to any extension of this incentive.

(b) Additional Deduction for Labor Expense. For the first five (5) years from registration a registered enterprise shall be allowed an additional deduction from the taxable income of fifty percent (50%) of the wages corresponding to the increment in the number of direct labor for skilled and unskilled workers if the project meets the prescribed ratio of capital equipment to number of workers set by the Board: Provided, That this additional deduction shall be doubled if the activity is located in less developed areas as defined in Art. 40.

(c) Tax and Duty Exemption on Imported Capital Equipment. Within five (5) years from the effectivity of this Code, importations of machinery and equipment and accompanying spare parts of new and expanding registered enterprise shall be exempt to the extent of one hundred percent (100%) of the customs duties and national internal revenue tax

payable thereon: Provided, That the importation of machinery and equipment and accompanying spare parts shall comply with the following conditions:

(1) They are not manufactured domestically in sufficient quantity, of comparable quality and at reasonable prices;

(2) They are reasonably needed and will be used exclusively by the registered enterprise in the manufacture of its products, unless prior approval of the Board is secured for the part-time utilization of said equipment in a non-registered activity to maximize usage thereof or the proportionate taxes and duties are paid on the specific equipment and machinery being permanently used for non-registered activities; and

(3) The approval of the Board was obtained by the registered enterprise for the importation of such machinery, equipment and spare parts.

In granting the approval of the importations under this paragraph, the Board may require international canvassing but if the total cost of the capital equipment or industrial plant exceeds US$5,000,000, the Board shall apply or adopt the provisions of Presidential Decree Numbered 1764 on International Competitive Bidding.

If the registered enterprise sells, transfers or disposes of these machinery, equipment and spare parts without prior approval of the Board within five (5) years from date of acquisition, the registered enterprise and the vendee, transferee, or assignee shall be solidarily liable to pay twice the amount of the tax exemption given it.

The Board shall allow and approve the sale, transfer or disposition of the said items within the said period of five (5) years if made:

(aa) to another registered enterprise or registered domestic producer enjoying similar incentives;

(bb) for reasons of proven technical obsolescence; or

(cc) for purposes of replacement to improve and/or expand the operations of the registered enterprise.

(d) Tax Credit on Domestic Capital Equipment. A tax credit equivalent to one hundred percent (100%) of the value of the national internal revenue taxes and customs duties that would have been waived on the machinery, equipment and spare parts, had these items been imported shall be given to the new and expanding registered enterprise which purchases machinery, equipment and spare parts from a domestic manufacturer: Provided, That (1) That the said equipment, machinery and spare parts are reasonably needed and will be used exclusively by the registered enterprise in the manufacture of its products, unless prior approval of the Board is secured for the part-time utilization of said equipment in a non-registered activity to maximize usage thereof; (2) that the equipment would have qualified for tax and duty-free importation under paragraph (c) hereof; (3) that the approval of the Board was obtained by the registered enterprise; and (4) that the purchase is made within five (5) years from the date of effectivity of the Code. If the registered enterprise sells, transfers or disposes of these machinery, equipment and spare parts, the provisions in the preceding paragraph for such disposition shall apply.

(e) Exemption from Contractor's Tax. The registered enterprise shall be exempt from the payment of contractor's tax, whether national or local.

(f) Simplification of Customs Procedure. Customs procedures for the importation of equipment, spare parts, raw materials and supplies, and exports of processed products by registered enterprises shall be simplied by the Bureau of Customs.

(g) Unrestricted Use of Consigned Equipment. Provisions of existing laws notwithstanding, machinery, equipment and spare part consigned to any registered enterprises shall not be subject to restrictions as to period of use of such machinery, equipment and spare parts Provided, that the appropriate re-export bond is posted unless the importation is otherwise covered under subsections (c) and (m) of this Article. Provided, further, that such consigned equipment shall be for the exclusive use of the registered enterprise.

If such equipment is sold, transferred or otherwise disposed of by the registered enterprise the related provision of Article 39 (c) (3) shall apply. Outward remittance of foreign exchange covering the proceeds of such sale, transfer or disposition shall be allowed only upon prior Central Bank approval.

(h) Employment of Foreign Nationals. Subject to the provisions of Section 29 of Commonwealth Act Number 613, as amended, a registered enterprise may employ foreign nationals in supervisory, technical or advisory positions for a period not exceeding five (5) years from its registration, extendible for limited periods at the discretion of the Board: Provided, however, That when the majority of the capital stock of a registered enterprise is owned by foreign investors, the position of president, treasurer and general manager or their equivalents may be retained by foreign nationals beyond the period set forth herein.

Foreign nationals under employment contract within the purview of this incentive, their spouses and unmarried children under twenty-one (21) years of age, who are not excluded by Section 29 of Commonwealth Act Numbered 613, as amended, shall be permitted to enter and reside in the Philippines during the period of employment of such foreign nationals.

A registered enterprise shall train Filipinos as understudies of foreign nationals in administrative, supervisory and technical skills and shall submit annual reports on such training to the Board.

(i) Exemption on Breeding Stocks and Genetic Materials. The importation of breeding stocks and genetic materials within ten (10) years from the date of registration or commercial operation of the enterprise shall be exempt from all taxes and duties: Provided, That such breeding stocks and genetic materials are (1) not locally available and/or obtainable locally in comparable quality and at reasonable prices; (2) reasonably needed in the registered activity; and (3) approved by the Board.

(j) Tax Credit on Domestic Breeding Stocks and Genetic Materials. A tax credit equivalent to one hundred percent (100%) of the value of national internal revenue taxes and customs duties that would have been waived on the breeding stocks and genetic materials had these items been imported shall be given to the registered enterprise which purchases breeding stocks and generic materials from a domestic producer: Provided, 1) That said breeding stocks and generic materials would have qualified for tax and duty free importation under the preceding paragraph; 2) that the breeding stocks and genetic materials are reasonably needed in the registered activity; 3) that the approval of the board has been obtained by the registered enterprise; and 4) that the purchase is made within ten (10) years from date of registration or commercial operation of the registered enterprise.

(k) Tax Credit for Taxes and Duties on Raw Materials. Every registered enterprise shall enjoy a tax credit equivalent to the National Internal Revenue taxes and Customs duties paid on the supplies, raw materials and semi-manufactured products used in the manufacture, processing or production of its export products and forming part thereof, exported directly or indirectly by the registered enterprise: Provided, however, that the taxes on the supplies, raw materials and semi- manufactured products domestically purchased are indicated as a separate item in the sales invoice.

Nothing herein shall be construed as to preclude the Board from setting a fixed percentage of export sales as the approximate tax credit for taxes and duties of raw materials based on an average or standard usage for such materials in the industry.

(l) Access to Bonded Manufacturing/Trading Warehouse System. Registered export oriented enterprises shall have access to the utilization of the bonded warehousing system in all areas required by the project subject to such guidelines as may be issued by the Board upon prior consultation with the Bureau of Customs.

(m) Exemption from Taxes and Duties on Imported Spare Parts. Importation of required supplies and spare parts for consigned equipment or those imported tax and duty free by a registered enterprise with a bonded manufacturing warehouse shall be exempt from customs duties and national internal revenue taxes payable thereon, Provided, However, That at least seventy percent (70%) of production is exported; Provided, further, that such spare parts and supplies are not locally available at reasonable prices, sufficient quantity and comparable quality; Provided, finally, That all such spare parts and supplies shall be used only in the bonded manufacturing warehouse of the registered enterprise under such requirements as the Bureau of Customs may impose.

(n) Exemption from Wharfage Dues and any Export Tax, Duty, Impost and Fee. The provisions of law to the contrary notwithstanding, exports by a registered enterprise of its non- traditional export products shall be exempted of its non-traditional export products shall be exempted from any wharfage dues, and any export tax, duty, impost and fee.

RA 7916 (Secs.23-25)Fiscal Incentives. – Business establishments operating within the ECOZONES shall be entitled to the fiscal incentives as provided for under Presidential Decree No. 66, the law creating the Export Processing Zone Authority, or those provided under Book VI of Executive Order No. 226, otherwise known as the Omnibus Investment Code of 1987. Furthermore, tax credits for exporters using local materials as Inputs shall enjoy the same benefits provided for in the Export Development Act of 1994.

Exemption from National and Local Taxes.- Except for real property taxes on land owned by developers, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu thereof, five percent (5%) of the gross income earned by all business enterprises within the ECOZONE shall be paid and remitted as follows: a. Three percent (3%) to the National Government; b. Two percent (2%) which shall be directly remitted by the business establishments to the treasurer’s office of the municipality or city where the enterprise is located.

Applicable National and Local Taxes. – All persons and services establishments in the ECOZONE shall be subject to national and local taxes under the National Internal Revenue Code and the Local Government Code.

REVENUE MEMORANDUM ORDER NO. 63-99 issued August 13, 1999 prescribes the policies and guidelines on the determination of taxable income on inter-company loans or advances pursuant to Section 50 of the Tax Code, as amended. The arm's length bargaining standard will be used as the ultimate test for determining the correct gross income and deductions between two or more enterprises under common control.

RR 2 (Sec.49)Improvements by lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases;(a) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.(b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.

If for any other reason than a bona fide purchase from the lessee by the lessor the lease is terminated, so that the lessor comes into possession or control of the property prior to the time originally fixed for the termination of the lease, the lessor receives additional income for the year in which the lease is so terminated to the extent that the value of such buildings or improvements when he became entitled to such possession exceeds the amount already reported as income on account of the erection of such buildings or improvements. No appreciation in value due to causes other than the premature termination of the lease shall be included. Conversely, if the building or improvements are destroyed prior to the expiration of the lease, the lessor is entitled to deduct as a loss for the year when such destruction takes place the amount previously reported as income because of the erection of such buildings or improvements, less any salvage value subject to the lease to the extent that such loss was not compensated for by insurance. If the buildings or improvements destroyed were acquired prior to March 1, 1913, the deduction shall be based on the cost or the value subject to the lease to the extent that such loss was not compensated for by insurance.

RR 2 (Secs. 250-256)Dividends. — Dividends, for the purpose of the law, comprise any distribution whether in cash or other property, in the ordinary course of business, even though extraordinary in amount, made by a domestic or resident foreign corporation, joint-stock company, partnership, joint account (cuentas en participacion), association, or insurance company to the shareholders or members out of its earnings or profits accumulated since March 1, 1913.Although interest on certain Government bonds and other similar obligations is not taxable when received by a corporation, upon amalgamation with the other funds of the corporation, such income loses its identity and when distributed to shareholders, is taxable to the same extent as other dividend.A taxable distribution made by a corporation to individual stockholders or members shall be included is the gross income of the distributees when the cash of other property is unqualifiedly made subject to their demand. Dividends, in cash or other property received by an individual, are subject to tax in his hands in the same manner another income.Dividends, whether in cash or other property, received by a domestic or resident foreign corporation from a domestic corporation are taxable only to the extent of 25 per cent thereof in accordance with Section 24 of the Code. Dividends received by a domestic corporation from a foreign corporation, whether resident or nonresident, are taxable to the extent that they constitute income from sources within the Philippines, as provided in Section 37 (a) (2) (b) of the Code. Dividends paid by the domestic corporation to a nonresident foreign corporation are taxable in full. (For definition of the different classes of corporations, see Section 84 of the Code).

Dividends paid in property. — Dividends paid in securities or other property (other than its own stock), in which the earnings of a corporation have been invested, are income to the recipients to the amount of the full market value of such property when receivable by individual stockholders. When receivable by corporations, the amount of such dividends includible for purposes of the tax on corporations are specified in Section 24 of the Code. (See also Section 250 of these regulations). A dividend paid in stock of another corporation is not a stock dividend, even though the stock distributed was acquired through the transfer by the corporation declaring the dividends of property to the corporation the stock of which is distributed as a dividend. Where a corporation declares a dividend payable in a stock of another corporation, setting aside the stock to be so distributed and notifying the stockholders of its action, the income arising to the recipients of such stock is its market value at the time the dividend becomes payable. Scrip dividends are subject to tax in the year in which the warrants are issued.

Stock dividends. — A stock dividend which represents the transfer of surplus to capital account is not subject to income tax. However a dividend in stock may constitute taxable income to the recipients thereof notwithstanding the fact that the officers or directors of the corporation (as defined in Section 84) choose to call such distribution as a stock dividend. The distinction between a stock dividend which does not, and one which does, constitute income taxable to the shareholder is the distinction between a stock dividend which works no change in the corporate entity, the same interest in the same corporation being represented after the distribution by more shares of precisely the same character, and a stock dividend where there either has been a change of corporate identity or a change in the nature of the shares issued as dividends whereby the proportional interest of the shareholders after the distribution is essentially different from his former interests. A stock dividend constitutes income if it gives the shareholder an interest different from that which his former stock holdings represented. A stock dividend does not constitute income if the new shares confer no different rights or interests than did the old — the new certificates plus the old representing the same proportionate interest in the net assets of the corporation as did the old.

Sale of stock received as dividends. — Stock issued by a corporation, as a dividend, does not constitute taxable income to a stockholder in such corporation, but gain may be derived or loss sustained by the stockholder, whether individual or corporate, from the sale of such stock, which gain or loss will be treated as arising from the sale or exchange of a capital asset. (See Section 34 of the Code.) The amount of gain derived or loss sustained from the sale of such stock, or from the sale of the stack with respect to which it is issued, shall be determined in accordance with the following rules: (a) Where the stock issued as dividend is all or substantially the same character or preference as the stock upon which the stock dividend is paid, the cost of each share (or when acquired prior to March 1, 1913, the fair market value as of

such date) will be the quotient of the cost (or such fair market value) of the old shares of stock divided by the total number of the old and new shares. (b) Where the stock issued as a dividend is in whole or in part of a character or preference materially different from the stock upon which the stock dividend is paid, the cost (and when acquired prior to March 1, 1913, the fair market value as of such date) of the old shares of stock shall be divided between such old stock and the new stock, in proportion, as nearly as may be, to the respective value of each class of stock, old and new, at the time the new shares of stock are issued, and the cost (or when acquired prior to March 1, 1913, the fair market value as of such date) of each share of stock will be the quotient of the cost (or such fair market value as of March 1, 1913) of the class to which such share belongs divided by the number of shares in that class. (c) Where the stock with respect to which a stock dividend is issued was purchased at different times and at different prices and the identity of the lots can. not be determined, any sale of the original stock, will be charged to the earliest purchases of such stock, and any sale of dividend stock issued with respect to such stock will be presumed to have been made from the stock issued with respect to the earliest purchased stock, to the amount of the dividend chargeable to such stock. (d) Where the stock with respect to which a stock dividend is declared was purchased at different times and at different prices, and the dividend stock issued with respect to such stock can not be identified as having been issued with respect to any particular lot of such stock, then any sale of such dividend stock will be presumed to have been made from the stock issued with respect to the earliest purchased stock, to the amount of the stock dividend chargeable to such stock.

Declaration and subsequent redemption of a stock dividend. — A true stock dividend is not subject to tax on its receipt in the hands of the recipient. Nevertheless, if a corporation, after the distribution of a 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 taxable dividend, the amount received in redemption or cancellation of the stocks shall be treated as a taxable dividend to the extent of the earnings or profits accumulated by such corporation since March 1, 1913.

Sources of distribution. — For the purpose of income taxation every distribution made by a corporation is made out of earnings or profits to the extent thereof and from the most recently accumulated earnings or profits. In determining the source of a distribution, consideration should be given first, to the earnings or profits of the taxable year; second, to the earnings or profits accumulated since February 28, 1913, only in the case where, and to the extent that, the distribution made during the taxable year are not regarded as out of the earnings or profits of the taxable year and all the earnings or profits accumulated since February 28, 1913, have been distributed; and, fourth, to sources other than earnings or profits only after the earnings or profits have been distributed.

Distribution in liquidation. — In all cases where a corporation (as defined in Section 84) distributes all of its property or assets in complete liquidation or dissolution, the gain realized from the transaction by the stockholder, whether individual or corporate, is taxable to the extent recognized in Section 34(b) of the Code. For this purpose, the term "complete liquidation" includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation under which the transfer of all the assets under liquidation is to be complete within a reasonable time from the date of the first distribution, usually not to exceed one year from the time of such first distribution. If the amount received by the stockholder in liquidation is less than the cost or other basis of the stock, the loss in the transaction is deductible to the extent allowed in Section 34(c) of the Code.

BIR RULING NO. 322-87

Gentlemen :This refers to your letter dated July 23, 1987 stating that your company is a trading concern and at present it is in the process of liquidation; and that your individual stockholders will receive their liquidating dividends in excess of their investment. In reply, I have the honor to inform you that since the individual stockholders of your company will receive upon its complete liquidation all its assets as liquidating dividends, they will thereby realize capital gain or loss. The gain, if any, derived by the individual stockholders consisting of the difference between the fair market value of the liquidating dividends and the adjusted cost to the stockholders of their respective shareholdings in the said corporation (Sec. 83 (a), Sec. 256, Income Tax Regulations) shall be subject to income tax at the rates prescribed under Section 21(a) of the Tax Code, as amended by Executive Order No. 37. cdaMoreover, pursuant to Section 34(b) of the Tax Code, as amended by Executive Order No. 37, only 50% of the aforementioned capital gain is reportable for income tax purposes if the shares were held by the individual stockholders for more than twelve months and 100% of the capital gains if the shares were held for less than twelve months.

RR 2 (Sec.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.

REVENUE MEMORANDUM CIRCULAR NO. 13-80 (Treatment of Tax Refunds and Tax Credits When Received.)

1. Refunds/Tax Credits under Section 295 of the Tax Code. — Taxes previously claimed and allowed as deductions, but subsequently refunded or granted as tax credit pursuant to Section 295 of the Tax Code, should be declared as part of the gross income of the taxpayer in the year of receipt of the refund or tax credit. However, the following taxes, when refunded or credited, are not declarable for income tax purposes inasmuch as they are not allowable as deductions: a. Income tax imposed in Title III of the Tax Code; b. Income, war-profit and excess profits taxes imposed by authority of a foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign countries); c. Estate and gift taxes; d. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed; e. Stock transaction tax; f. Energy tax; and g. Taxes which are not allowable as deductions under the law. 2. Special Tax Credits granted under R.A. 5186; R.A. 6135 and P.D. 535. — These tax credits and their tax consequences are as follows: a. Sales, compensating and specific taxes are paid on supplies and raw materials imported by a registered export producer. Said taxes are given as tax credit to be used in the payment of taxes, duties, charges and fees due to the national government in connection with its operations. (Sec. 7(a), R.A. No. 6135) The tax credits granted should form part of the gross income to the enterprise in the year of receipt of tax credit as said taxes paid are considered allowable deductions for income taxes purposes. b. In some cases, a registered BOI and tourism enterprise assumes payment of taxes withheld and due from the foreign lender-remittee on interest payments on foreign loans. In such cases, the enterprise is given a tax credit for taxes withheld subject to certain conditions. (Sec. 7(f), R.A. No. 5186; Sec. 8(c), P.D. No. 535) Said taxes assumed by the registered enterprise represent necessary and ordinary expenses incurred by the enterprise; hence, deductible from its gross income. Therefore, the tax credits granted necessarily constitute taxable income of the enterprise.

REPUBLIC ACT No. 4917 (AN ACT PROVIDING THAT RETIREMENT BENEFITS OF EMPLOYEES OF PRIVATE FIRMS SHALL NOT BE SUBJECT TO ATTACHMENT, LEVY, EXECUTION, OR ANY TAX WHATSOEVER.)

Section 1. Any provision of law to the contrary notwithstanding, the retirement benefits received by officials and employees of private firms, whether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer shall be exempt from all taxes and shall not be liable to attachment, garnishment, levy or seizure by or under any legal or equitable process whatsoever except to pay a debt of the official or employee concerned to the private benefit plan or that arising from liability imposed in a criminal action: Provided, That the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less than fifty years of age at the time of his retirement: Provided, further, That the benefits granted under this Act shall be availed of by an official or employee only once: Provided, finally, That in case of separation of an official or employee from the service of the employer due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee, any amount received by him or by his heirs from the employer as a consequence of such separation shall likewise be exempt as hereinabove provided.

As used in this Act, the term "reasonable private benefit plan" means a pension, gratuity, stock bonus or profit sharing plan maintained by an employer for the benefit of some or all of his officials and employees, wherein contributions are made by such employer or officials and employees, or both, for the purpose of distributing to such officials and employees the earnings and principal of the fund thus accumulated, and wherein it is provided in said plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees.

REPUBLIC ACT NO. 7833 (AN ACT TO EXCLUDE THE BENEFITS MANDATED PURSUANT TO REPUBLIC ACT NO. 6686 AND PRESIDENTIAL DECREE NO. 851, AS AMENDED, AND OTHER BENEFITS FROM THE COMPUTATION OF GROSS COMPENSATION INCOME FOR PURPOSES OF DETERMINING TAXABLE COMPENSATION INCOME, AMENDING FOR THE PURPOSE SECTION 28(B)(8) OF THE NATIONAL INTERNAL REVENUE CODE, AS AMENDED) SECTION 1. A new sub-paragraph to be known as sub-paragraph (F) is hereby inserted at the end of Section 28(b)(8) of the National Internal Revenue Code, as amended, which shall read as follows:

"(F) 13th month pay and other benefits.

"(i) Benefits received by officials and employees of the national and local governments 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; and "(iv) Other benefits such as productivity incentives and Christmas bonus in an amount not exceeding Twelve thousand pesos (P12,000) which shall be integrated in the 13th month pay solely for purposes of this Act." "Provided, however, That the exclusion shall only apply to the first Thirty thousand pesos (P30,000)."

Sec. 2. The exclusion herein provided shall cover benefits paid or accrued beginning January 1, 1994. For purposes of reimbursing the officials or employees who may have received the benefits covered by this Act before its effectivity, the withholding agents are hereby authorized not to deduct the withholding taxes in the immediately succeeding payroll periods corresponding to the amount previously withheld from the benefits.

Sec. 3. The Secretary of Finance shall, upon the recommendation of the Commissioner of Internal Revenue, promulgate the necessary rules and regulations for the effective implementation of the provision of this Act.

REVENUE REGULATIONS NO. 02-95 (Implementing Republic Act No. 7833, An Act to Exclude the Benefits Mandated Pursuant to Republic Act No. 6686 and Presidential Decree No. 851, as Amended, and other Benefits from the Computation of Gross Compensation Income for the Purposes of Determining Taxable Compensation Income, Amending for the Purpose Section 28 (b) (8) of the National Internal Revenue Code, as Amended)

Definition of Terms. — For purposes of these Regulations, the following definitions of words and phrases are hereby adopted:a) "Act" — refers to Republic Act No. 7933.b) "Exclusions" — shall mean the total benefits which are not included in the computation of gross compensation income for purposes of determining taxable compensation income and are, therefore, exempt from the withholding tax on wages.c) "Gross compensation income" — means all remunerations for services performed by an employee for his employer, whether paid in cash or in kind, unless specifically excluded under Secs. 27 and 28 of the NIRC, as amended.d) "Immediately succeeding payroll period" — refers to the payroll period beginning January, 1995.e) "Other benefits" — refer to all benefits other than the 13th month pay, such as, the annual Christmas bonus given by private offices, 14th month pay, mid-year productivity incentive bonus, gifts in cash or in kind and other similar benefits received by an official or employee for one calendar year in an amount not exceeding Twelve Thousand Pesos (P12,000.00) as maximum limit. f) "Taxable compensation income" — means gross compensation income less personal and additional exemptions provided for under Sec. 29 (l) of the NIRC, as amended.g) "13th month pay" — refers to the mandatory one month basic salary of an official or employee of the National Government, Local Government Units, agencies and instrumentalities, including government-owned and -controlled corporations, and of private offices received after the 12th month pay.h) "Total benefits" — refer to the sum of all the benefits received by an official or employee for one calendar year in accordance with the provisions of the "Act."i) "Which shall be integrated in" — shall mean "which shall be added to".

Benefits Exempted from Income Tax. — For purposes of determining the taxable compensation income, the following benefits shall be excluded from the gross compensation income, viz:a) 13th month pay equivalent to the mandatory one (1) month basic salary of officials and employees of the Government (whether national or local), including government-owned and -controlled corporations, and of private offices received after the 12th month pay beginning CY 1994; andb) Other benefits, such as, Christmas bonus given by, private offices to their officials and employees, productivity incentives bonus, loyalty award, gifts in cash or in kind and other benefits of similar nature actually received by officials and employees of both Government and private offices in an amount not exceeding Twelve Thousand Pesos (12,000.00) for one (1) calendar year.

The above-stated exclusions [(a) and (b)] shall cover benefits paid or accrued beginning January 1, 1994 but shall be limited only to an amount not exceeding Twelve Thousand Pesos (P12,000.00) in the case of the "other benefits" contemplated under paragraph (b) above, provided, however, that when added to the 13th month pay, the total amount of tax exempt benefits shall not exceed Thirty Thousand Pesos (P30,000.00).

ILLUSTRATIONS:CASE NO. 1.During CY 1994, Mr. "A", and official of a private corporation, received the following 13th month pay and other benefits from his employer, such as:

13th month pay P30,000.00Other benefits:

Christmas bonus P15,000.0014th month pay 30,000.00Mid-year productivitybonus 10,000.00 55,000.00

———— ————TOTAL BENEFITS RECEIVED

for CY 1994 P85,000.00

========In this illustration, Mr. "A" shall only be exempted on his 13th month pay of P30,000. His "other benefits" amounting to P55,000 are subject to the withholding tax on wages.

CASE NO. 2.On the other hand, Mr. "B", a government employee, received the following 13th month pay and other benefits, such as:

13th month pay/Christmas bonus P8,000.00Other benefits:

Productivity incentives bonus P12,000.00Cash gift 1,000.00

13,000.00———— ————

TOTAL BENEFITS RECEIVEDfor CY 1994 P21,000.00

========

Mr. "B" shall only be exempt on a total of P20,000.00, representing 13th month pay of P8,000.00 plus "other benefits" of P12,000.00 only.

Computation of Refundable/Creditable Taxes Withheld on the Exempt 13th Month Pay and Other Benefits. — (a) In general. — The employer shall compute the refundable/creditable amount of taxes withheld on the exempt 13th month pay and other benefits of employees through the annualized computation prescribed in Section 71(8)(2)(b) of Revenue Regulations No. 6-82, as amended by RR No. 4-93, implementing R.A. No. 7497, otherwise known as the "Final Withholding Tax on Compensation Income."(b) Refund/Credit to Employees of Excess Taxes Withheld. — Any excess in the taxes withheld resulting from the annualized computation shall be credited/refunded to the employees. In return, the employer is entitled to deduct the amount refunded/credited from the remittable amount of taxes withheld from compensation income in the current month in which refund/credit was made, and in the succeeding months thereafter until the amount refunded/credited by the employer is fully repaid.

ILLUSTRATIONS:1. The year-end adjustment computation resulted to a REFUND.(aa) Employee with Only One Employee During the Year.

ABC COMPANYEmployee "A" (single)—————————Salaries P78,000.0013th month pay 12,000.00Other Benefits 10,000.00

—————Gross Compensation Income P100,000.00

Less: Non-taxable Benefits:13th month pay P12,000Other benefits 10,000 22,000.00

——— ————P78,000.00

Less: Personal Exemption 9,000.00—————

Taxable Compensation P69,000.00Tax Due P7,785.00Less: Tax Withheld (13,675.00)

—————AMOUNT TO BE REFUNDED by (P5,890.00)

ABC CO. to Employee "A" ========on or before JANUARY 25, 1995 OR TO BE CREDITED against Taxes Withheld due from the Employee for Succeeding Month/s Beginning following Sample Computation

No. 1 (cc).(bb) Employee with Successive Employment Within the Year.

Employee "B" (single)—————————

ABC Co. DEF. Co.(Previous Employer) (Present Employer)Jan.-June, 1994 Nov.-Dec., 1994

Salaries/Allowances P78,000.00 Salaries P20,000.0013th Month Pay 12,000.00 13th month pay 8,000.00Other Benefits 10,000.00 Other Benefits 3,000.00

————— —————P100,000.00 P31,000.00

Less: Personal ADD: Income FromExemption 9,000.00 Previous Employer 100,000.00

————— —————

LESS:Net Taxable Non TaxableIncome 91,000.00 Benefits:

13th Month Pay

TAX DUE P11,965.00 ABC Co. P12,000TAX WITHHELD P11,965.00

DEF Co. 8,000 P20,000

*Other BenefitsABC Co. P10,000DEF Co. 3,000

———P13,000 10,000 30,000.00

——— ————P101,000.00

LESS: Personal Exemption 9,000.00————

Taxable CompensationIncome P92,000.00

TAX DUE P12,155.00TAX WITHHELDABC Co. P11,965.00DEF Co. 3,279.66 (15,244.66)

AMOUNT TO BE REFUNDED BY DEF Co.to EMPLOYEE "B" on or before (P3,089.66)JANUARY 25, 1995 —————ORTO BE CREDITED against Taxes Withhelddue from Employee for Succeeding Month/sbeginning January 1995. (Please seeSample Computation No. 1 (cc).

(cc) Crediting of Refundable Amounts Against Taxes Withheld Due From Employees For The Succeeding Month/s.

Amount of refund to be credited against taxes withheld due from Employee "B" [Based on Sample Computation No. 1 (bb) above) beginning January, 1995 — P 3,089.66——————————————————————————————Computation of Taxes Withheld for the month of January, 1995

Salaries/AllowancesTaxable: P10,000.00

——————————————————————————————Tax Required to be Withheld for the month of January, 1995

(Use Line 2 Col. 8 of theWithholding Tax Table): P1,359.66

Less: Refund for CY 1994 due toNon-Taxability of Bonus andOther Benefits beginningJan. 1995 (3,035.66)

————Balance to be credited in succeeding

month/s (P1,730.00)

February. 1995Tax Required to be Withheld for the month of February P1,359.66Amount to be creditedfor February (1,730.00)

————Balance of Amount to be Credited for the Monthof March (P370.34)

March. 1995Tax Required to be Withheld for the Monthof March P1,359.66Amount to be Credited for March (370.34)

————Amount to be Remitted for March on or before

April 10, 1995 P989.32=======

2. The year-end adjustment resulted to a COLLECTIBLE AMOUNT (instead of a refund).During CY 1994, an employee (single) of a private corporation, received the following compensation, month pay and other benefits:

Salaries/allowances P5,000/mo. x 12 mos. P60,000.0013th Month pay 5,000.00Gift in kind 5,000.00Cash gift 10,000.00Christmas Bonus 5,000.00

—————Total Gross Compensation Income P85,000.00

Less: 13th Month Pay P5,000Other Benefits 12,000 17,000.00

——— ————Gross Compensation Income AfterDeducting Exclusions Under RA 7333 68,000.00Less: Personal Exemption 9,000.00

————Taxable Compensation Income P59,000.00Tax Due P3,925.00Tax WithholdJan.-Nov., 1994 P393.80/mo. x 11 mos. (4,331.80)

—————Tax Collectible to be Withheld from P1,593.20December salary =========

Note: NO REFUND OF WITHHOLDING TAX FOR BONUS AND OTHER BENEFITS WOULD RESULT DUE TO UNDER WITHOLDING IN PREVIOUS MONTHS OF THE YEAR.

Refund/Credit of Taxes Withheld from employees Separated from Employment. — a) An employee separate from the service of his previous employer but is presently employed by another employer shall be refunded/credited the taxes withheld on his exempt 13th month pay and other benefits by his present employer. The present employer shall compute the aforesaid excess withholding tax using the annualized computation set forth in Section 7I (B) (2) (b) of RR No., 6-82, as amended by RR No. 4-93.(b) An employee who has been separated from a previous employer but has no present employment shall claim his refund of excess tax withheld on his 13th month pay and other benefits by filing with the BIR a refundable income tax return for CY 1994, provided that the refundable ITR for 1994 reflects the taxes withheld on his 13th month pay and other benefits.

Concurrent Multiple Employments. — An employee is employed by two or more employers at the same time during the taxable year shall be refunded/credited the taxes withheld on his 13th month pay and "other benefits" by his main employer, e.g., the employer paying the highest wage/salary. The said main employer shall determine the maximum allowable 13th month pay and "other benefits" received from both main and secondary employer/s in annualizing the taxable compensation income at year-end adjustment. For this purpose, the secondary employer/s shall furnish the main employer a certification as to the amount of the 13th month pay and other benefits received by the employee.

The Employee's Withholding Statement (W-2). — The employer shall furnish each employee with the original and duplicate copies of BIR Form W-2 showing the name and address of the employer, employer's TIN, name and address of the employee, taxpayer/employee's TIN, amount of exemptions claimed, the sum of compensation paid (excluding the total non-taxable benefits), the amount of tax due and the amount of tax withheld during the calendar year.The statement must be signed by both the employer or other authorized officer and the employee and shall contain a written declaration that it is made under the penalties of perjury.

If the employer is the Government of the Philippines, its political subdivision, agency or instrumentality or government-owned or controlled corporation, the statement shall be signed by the duly designated officer or employee.

Footnotes - The maximum allowable deduction for "Other Benefits" is P12,000.00. However, since the total 13th month pay and 'other benefits' should not exceed P 30,000, only P10,000.00 'other benefits" can be added to P 20,000, representing Mr. "B's" total 13th month pay from his previous and present employers.

REVENUE MEMORANDUM CIRCULAR NO. 36-94 (Publishing the full text of Republic Act No. 7833 — an Act excluding the benefits mandated pursuant to Republic Act No. 6686 and Presidential Decree No. 851, as amended, and other benefits from the computation of gross compensation income for purposes of determining taxable compensation income, amending for the purpose Section 28 (b) (8) of the National Internal Revenue Code, as amended.

SALIENT FEATURES (of RA 7833)1. Before the amendment of Section 28 (b) (8) of the National Internal Revenue Code (NIRC) by R.A. No. 7833, the following benefits received by officials and employees of both public (national and local) and private offices, viz:(F) 13th month pay and other benefits. a. Annual Christmas bonus equivalent to one (1) month basic salary and additional cash gift of One Thousand Pesos (P1,000.00) received by National and Local Government officials and employees starting CY 1988 in accordance with R.A. No. 6686; b. Benefits received by employees pursuant to P.D. No. 851 , as amended by Presidential Memorandum Order No. 28 dated August 13, 1986 requiring all employers to pay all their rank-and-file employees a 13th month pay not later than December 24 of every year; c. Benefits received by officials and employees not covered by P.D. No. 851, as amended; and d. Other benefits such as productivity incentives and Christmas bonus in an amount not exceeding Twelve Thousand Pesos (P12,000.00) which shall be integrated in the 13th month pay solely for purposes of R.A. No. 7833 were taxable compensation income under Section 21(a) in relation to Section 72, both of the NIRC, as amended, subject to withholding tax under Revenue Regulations No. 6-82, as amended by Revenue Regulations No. 4-93.

2. Under sub-paragraph (F) of Section 28 (b) (8) of the NIRC, as amended by R.A. No. 7833, the 13th month pay and other benefits aforestated, received by officials and employees of the National Government, Local Government Units and agencies, including government-owned and controlled corporations, as well as by officials and employees of private corporations and entities, are exempt from income tax, and consequently from the withholding tax on wages. Provided, that the exclusions/exemptions from gross compensation income shall cover the 13th month pay and "other benefits" in the aggregate amount not exceeding P30,000 received by the officials and employees paid or accrued beginning January 1, 1994. The aforesaid "other benefits " as contemplated under Section 1 (F) (iv) of R.A. No. 7833 shall not exceed P12,000, which amount shall be integrated in the 13th month pay. Accordingly, benefits in excess of P30,000.00 shall be taxable and subject to the withholding tax only insofar as the amount in excess of P30,000.00.

Illustration: During CY 1994, Mr. "X", an employee of a private corporation, received the following 13th month pay and other benefits from his employer, such as:

13th month pay P15,000.00Christmas bonus 10,000.00 Other benefits:

Gift in kind 2,000.00Additional cash gift 1,000.00Mid-year productivityincentive bonus 5,000.00

_________TOTAL P33,000.00

========

Under the amendment introduced by R.A. No. 7833 to Section 28(b)(8) of the NIRC, wherein sub-paragraph (F) has been inserted at the end thereof, the computation of the amount of the benefits which shall be excluded/exempted from the taxable compensation income and/or those subject to withholding tax on wages, if any, shall be as follows:

I. Computation of whether the full amount of subject "other benefits", ascontemplated under Section 1 (F) (iv) of RA 7833, is exempt fromwithholding tax on wages.

Christmas bonus P10,000Plus: Other benefits:

Gift in kind P 2,000Additional cash gift 1,000Mid-year productivityincentive bonus 5,000 8,000

--- ---TOTAL P18,000

Less: P12,000 maximum exemptionfor "other benefits" ascontemplated under Sec.1(F)(iv) of RA 7833 (12,000)

---TAXABLE "OTHER BENEFITS"SUBJECT TO WITHHOLDING TAXON WAGES P 6,000

======

II. Computation of total benefits excluded/exempted from withholding tax onwages when the "other benefits" are integrated in the 13th month pay.

13th month pay P15,000Plus: Maximum allowable exemption/

exclusion of P12,000 for"other benefits" as contemplatedunder Sec. 1 (F) (iv) of RA 7833(please refer to ComputationNo. I above) 12,000

---TOTAL EXCLUSIONS/EXEMPTION FROM TAXABLE COMPENSATION INCOME P27,000

======

3. For purposes of reimbursing the officials and employees of the income taxes withheld and already remitted to the BIR, the following guidelines shall be followed: a. Employers who have already given the 13th month pay and other benefits to their employees, and had withheld and remitted the tax due thereon prior to the approval of R.A. No. 7833 (December 8, 1994) shall, in annualizing and computing the annual income and the tax due from their employees, exclude the 13th month pay and other benefits. Any excess in the tax withheld shall be refunded by the employer to the respective employees or credited against the tax required to be withheld from the compensation of the employees beginning January, 1995. The employer shall then be allowed to credit and deduct from its subsequent remittances of taxes withheld on compensation income of their employees for the succeeding months; b. Taxes withheld on the 13th month pay and other benefits given last November, which should otherwise be remitted by the employer-withholding agent on December 12, 1994, shall no longer be remitted to the BIR. Said withheld amount should be refunded to the employees concerned; and c. The exemption/exclusion provided for under R.A. No. 7833 shall cover the 13th month pay and "other benefits" in the aggregate amount not exceeding P30,000 received by the officials and employees paid or accrued beginning January 1, 1994, provided, however, that the aforesaid "other benefits" as contemplated under Sec. 1 (F) (iv) of R.A. No. 7833 shall not exceed P12,000 which amount shall be integrated in the 13th month pay.

REVENUE REGULATIONS NO. 10-2000 issued December 29, 2000 amends further RR Nos. 2-98, 3-98 and 8-98 with respect to the exemption of monetized leave credits of government officials and employees and the enumeration of "de minimis" benefits which are exempt from income tax on compensation and from fringe benefits tax.

REVENUE REGULATIONS NO. 10-00 (Further Amendments to Revenue Regulations No. 2-98 and 3-98, as Last Amended by Revenue Regulations No. 8-2000)

Section 2.78.1(A)(3), (6)(b)(ii) and (7) of Revenue Regulations No. 2-98, as last amended by Revenue Regulations No. 8-2000, is hereby further amended to read as follows:"Sec. 2.78.1. Withholding of Income Tax on Compensation Income. —"(A) . . ."(1) Compensation paid in kind. — . . ."xxx xxx xxx"(3) Facilities and privileges of relatively small value. —"xxx xxx xxx"The following shall be considered as "de minimis" benefits not subject to INCOME TAX AS WELL AS withholding tax on compensation income of both managerial and rank and file employees:(a) Monetized unused vacation leave credits of PRIVATE employees not exceeding ten (10) days during the year AND THE MONETIZED VALUE OF LEAVE CREDITS PAID TO GOVERNMENT OFFICIALS AND EMPLOYEES;(b) Medical cash allowance to dependents of employees not exceeding P750.00 per employee per semester or P125 per month;(c) Rice subsidy of P1,000.00 or one (1) sack of 50-kg. rice per month amounting to not more than P1,000.00;(d) Uniform and clothing allowance not exceeding P3,000 per annum;(e) Actual yearly medical benefits not exceeding P10,000 per annum;(f) Laundry allowance not exceeding P300 per month;(g) Employees achievement awards, e.g., for length of service or safety achievement, which must be in the form of a tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding P10,000

received by the employee under an established written plan which does not discriminate in favor of highly paid employees;(h) Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum;(i) Flowers, fruits, books, or similar items given to employees under special circumstances, e.g., on account of illness, marriage, birth of a baby, etc., and(j) Daily meal allowance for overtime work not exceeding twenty five percent (25%) of the basic minimum wage." "xxx xxx xxx"(6) Fixed or variable transportation, representation and other allowances —"xxx xxx xxx"(b) . . ."(i) . . ."(ii) The employee is required to account/liquidate for the expenses in accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of ADVANCES MADE over ACTUAL EXPENSES shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/advances for travelling and entertainment expenses which are pre-computed on a daily basis and are paid to an employee while he is on an assignment or duty need not be subject to the requirements of substantiation and to withholding." "(iii) . . ."(7) Vacation and sick leave allowances. Amounts of "vacation allowances or sick leave credits" which are paid to an employee constitute compensation. Thus, the salary of an employee on vacation or on sick leave, which IS paid notwithstanding his absence from work constitutes compensation. However, the monetized value of unutilized vacation leave credits of ten (10) days or less which ARE paid to PRIVATE employees during the year AND THE MONETIZED VALUE OF LEAVE CREDITS PAID TO GOVERNMENT OFFICIALS AND EMPLOYEES SHALL NOT BE SUBJECT TO INCOME TAX AND CONSEQUENTLY TO WITHHOLDING TAX.""xxx xxx xxx

Section 2.33 (C) of Revenue Regulations No. 3-98, as last amended by Revenue Regulations No. 8-2000, is hereby further amended to read as follows:"Sec. 2.33. Special Treatment of Fringe Benefits(A) Imposition of Fringe Benefits Tax —xxx xxx xxx(B) Definition of Fringe Benefit —xxx xxx xxx(C) Fringe Benefits Not Subject to Fringe Benefits Tax — In general, the fringe benefits tax shall not be imposed on the following fringe benefits:(1) . . .(2) . . .(3) . . .(4) De minimis benefits as defined in these Regulations;(5) . . .(6) . . .xxx xxx xxxThe term "DE MINIMIS" benefits which are exempt from the fringe benefits tax shall, in general, be limited to facilities or privileges furnished or offered by an employer to his employees that are of relatively small value and are offered or furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his employees such as the following:(a) Monetized unused vacation leave credits of PRIVATE employees not exceeding ten (10) days during the year AND THE MONETIZED VALUE OF LEAVE CREDITS PAID TO GOVERNMENT OFFICIALS AND EMPLOYEES;(b) Medical cash allowance to dependents of employees not exceeding P750.00 per employee per semester or P125 per month;(c) Rice subsidy of P1,000.00 or one (1) sack of 50-kg. rice per month amounting to not more than P1,000.00;(d) Uniform and clothing allowance not exceeding P3,000 per annum;(e) Actual yearly medical benefits not exceeding P10,000 per annum;(f) Laundry allowance not exceeding P300 per month;(g) Employees achievement awards, e.g., for length of service or safety achievement, which must be in the form of a tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding P10,000 received by the employee under an established written in which does not discriminate in favor of highly paid employees;(h) Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum;(i) Flowers, fruits, books, or similar items given to employees under special circumstances, e.g., on account of illness, marriage, birth of a baby, etc., and(j) Daily meal allowance for overtime work not exceeding twenty-five percent (25%) of the basic minimum wage."

REVENUE REGULATIONS NO. 03-98 (Implementing Section 33 of the National Internal Revenue Code, as Amended by Republic Act No. 8424 Relative to the Special Treatment of Fringe Benefits)

SPECIAL TREATMENT OF FRINGE BENEFITS

(A) Imposition of Fringe Benefits Tax — A final withholding tax is hereby imposed on the grossed-up monetary value of fringe benefit furnished, granted or paid by the employer to the employee, except rank and file employees as defined in these Regulations, whether such employer is an individual, professional partnership or a corporation, regardless of whether the corporation is taxable or not, or the government and its instrumentalities except when: (1) the fringe benefit is required by the nature of or necessary to the trade, business or profession of the employer; or (2) when the fringe benefit is for the convenience or advantage of the employer. The fringe benefit tax shall be imposed at the following rates:

Effective January 1, 1998 - 34%Effective January 1, 1999 - 33%Effective January 1, 2000 - 32%

The tax imposed under Sec. 33 of the Code shall be treated as a final income tax on the employee which shall be withheld and paid by the employer on a calendar quarterly basis as provided under Sec. 57 (A) (Withholding of Final Tax on certain Incomes) and Sec. 58 A (Quarterly Returns and Payments of Taxes Withheld) of the Code.The grossed-up monetary value of the fringe benefit shall be determined by dividing the monetary value of the fringe benefit by the following percentages and in accordance with the following schedule:

Effective January 1, 1998 - 66%Effective January 1, 1999 - 67%Effective January 1, 2000 - 68%

The grossed-up monetary value of the fringe benefit represents the whole amount of income realized by the employee which includes the net amount of money or net monetary value of property which has been received plus the amount of fringe benefit tax thereon otherwise due from the employee but paid by the employer for and in behalf of his employee, pursuant to the provisions of this Section.

Coverage — These Regulations shall cover only those fringe benefits given or furnished to managerial or supervisory employees and not to the rank and file.The term, "RANK AND FILE EMPLOYEES" means all employees who are holding neither managerial nor supervisory position. The Labor Code of the Philippines, as amended, defines "managerial employee" as 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. "Supervisory employees" are 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.

Moreover, these regulations do not cover those benefits properly forming part of compensation income subject to withholding tax on compensation in accordance with Revenue Regulations No. 2-98. Fringe benefits which have been paid prior to January 1, 1998 shall not be covered by these Regulations.

Determination of the Amount Subject to the Fringe Benefit Tax — In general, the computation of the fringe benefits tax would entail (a) valuation of the benefit granted and (b) determination of the proportion or percentage of the benefit which is subject to the fringe benefit tax. That the Tax Code allows for the cases where only a portion (i.e. less than 100 per cent) of the fringe benefit is subject to the fringe benefit tax is clearly stated in Section 33 (a) of R.A. 8424 which stipulates that fringe benefits which are "required by the nature of, or necessary to the trade, business or profession of the employer, or when the fringe benefit is for the convenience or advantage of the employer" are not subject to the fringe benefit tax. Thus, in cases where the fringe benefits entail joint benefits to the employer and employee, the portion which shall be subject to the fringe benefits tax and the guidelines for the valuation of fringe benefits are defined under these rules and regulations.

Unless otherwise provided in these regulations, the valuation of fringe benefits shall be as follows:(1) If the fringe benefit is granted in money, or is directly paid for by the employer, then the value is the amount granted or paid for.(2) If the fringe benefit is granted or furnished by the employer in property other than money and ownership is transferred to the employee, then the value of the fringe benefit shall be equal to the fair market value of the property as determined in accordance with Sec. 6 (E) of the Code (Authority of the Commissioner to Prescribe Real Property Values).(3) If the fringe benefit is granted or furnished by the employer in property other than money but ownership is not transferred to the employee, the value of the fringe benefit is equal to the depreciation value of the property.Taxation of fringe benefit received by a non-resident alien individual who is not engaged in trade or business in the Philippines — A fringe benefit tax of twenty-five percent (25%) shall be imposed on the grossed-up monetary value of the fringe benefit. The said tax base shall be computed by dividing the monetary value of the fringe benefit by seventy-five per cent (75%).

Taxation of fringe benefit received by (1) an alien individual employed by regional or area headquarters of a multinational company or by regional operating headquarters of a multinational company; (2) an alien individual employed by an offshore banking unit of a foreign bank established in the Philippines; (3) an alien individual employed by a foreign service contractor or by a foreign service subcontractor engaged in petroleum operations in the Philippines; and (4) any of their Filipino individual employees who are employed and occupying the same position as those occupied or held by the alien employees. — A fringe benefit tax of fifteen per cent (15%) shall be imposed on the grossed-up monetary value of the fringe benefit. The said tax base shall be computed by dividing the monetary value of the fringe benefit by eighty-five per cent (85%).

Taxation of fringe benefit received by employees in special economic zones — Fringe benefits received by employees in special economic zones, including Clark Special Economic Zone and Subic Special Economic and Free Trade Zone, are also covered by these regulations and subject to the normal rate of fringe benefit tax or the special rates of 25% or 15% as provided above.

Definition of Fringe Benefit — In general, except as otherwise provided under these regulations, for purposes of this Section, the term "FRINGE BENEFIT" means any good, service, or other benefit furnished or granted by an employer in cash or in kind, in addition to basic salaries, to an individual employee (except rank and file employee as defined in these regulations) such as, but not limited to the following:

(1) Housing;(2) Expense account;(3) Vehicle of any kind;(4) Household personnel, such as maid, driver and others;(5) Interest on loan at less than market rate to the extent of the difference between the market rate and actual rate granted;(6) Membership fees, dues and other expenses borne by the employer for the employee in social and athletic clubs or other similar organizations;(7) Expenses for foreign travel;(8) Holiday and vacation expenses;(9) Educational assistance to the employee or his dependents; and(10) Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows.

For this purpose, the guidelines for valuation of specific types of fringe benefits and the determination of the monetary value of the fringe benefits are give below. The taxable value shall be the grossed-up monetary value of the fringe benefit.(1) Housing privilege — (a) If the employer leases a residential property for the use of his employee and the said property is the usual place of residence of the employee, the value of the benefit shall be the amount of rental paid thereon by the employer, as evidenced by the lease contract. The monetary value of the fringe benefit shall be fifty per cent (50%) of the value of the benefit. (b) If the employer owns a residential property and the same is assigned for the use of his employee as his usual place of residence, the annual value of the benefit shall be five per cent (5%) of the market value of the land and improvement, as declared in the Real Property Tax Declaration Form, or zonal value as determined by the Commissioner pursuant to Section 6(E) of the Code (Authority of the Commissioner to Prescribe Real Property Values), whichever is higher. The monetary value of the fringe benefit shall be fifty per cent (50%) of the value of the benefit. cdaThe monetary value of the housing fringe benefit is equivalent to the following:

MV = [5%(FMV or ZONAL VALUE] X 50%WHERE:MV = MONETARY VALUEFMV = FAIR MARKET VALUE

(c) If the employer purchases a residential property on installment basis and allows his employee to use the same as his usual place of residence, the annual value of the benefit shall be five per cent (5%) of the acquisition cost, exclusive of interest. The monetary value of fringe benefit shall be fifty per cent (50%) of the value of the benefit. (d) If the employer purchases a residential property and transfers ownership thereof in the name of the employee, the value of the benefit shall be the employer's acquisition cost or zonal value as determined by the Commissioner pursuant to Section 6(E) of the Code (Authority of the Commissioner to Prescribe Real Property Values), whichever is higher. The monetary value of the fringe benefit shall be the entire value of the benefit. (e) If the employer purchases a residential property and transfers ownership thereof to his employee for the latter's residential use, at a price less than the employer's acquisition cost, the value of the benefit shall be the difference between the fair market value, as declared in the Real Property Tax Declaration Form, or zonal value as determined by the Commissioner pursuant to Sec. 6(E) of the Code (Authority of the Commissioner to Prescribe Real Property Values), whichever is higher, and the cost to the employee. The monetary value of the fringe benefit shall be the entire value of the benefit. (f) Housing privilege of military officials of the Armed Forces of the Philippines (AFP) consisting of officials of the Philippine Army, Philippine Navy and Philippine Air Force shall not be treated as taxable fringe benefit in accordance with the existing doctrine that the State shall provide its soldiers with necessary quarters which are within or accessible from the military camp so that they can be readily on call to meet the exigencies of their military service. (g) A housing unit which is situated inside or adjacent to the premises of a business or factory shall not be considered as a taxable fringe benefit. A housing unit is considered adjacent to the premises of the business if it is located within the maximum of fifty (50) meters from the perimeter of the business premises. (h Temporary housing for an employee who stays in a housing unit for three (3) months or less shall not be considered a taxable fringe benefit. cdasia

(2) Expense account — (a) In general, expenses incurred by the employee but which are paid by his employer shall be treated as taxable fringe benefits, except when the expenditures are duly receipted for and in the name of the employer and the expenditures do not partake the nature of a personal expense attributable to the employee. (b) Expenses paid for by the employee but reimbursed by his employer shall be treated as taxable benefits except only when the expenditures are duly receipted for and in the name of the employer and the expenditures do not partake the nature of a personal expense attributable to the said employee. (c) Personal expenses of the employee (like purchases of groceries for the personal consumption of the employee and his family members) paid for or reimbursed by the employer to the employee shall be treated as taxable fringe benefits of the employee whether or not the same are duly receipted for in the name of the employer. (d) Representation and transportation allowances which are fixed in amounts and are regular received by the employees as part of their monthly compensation income shall not be treated as taxable fringe benefits but the same shall be considered as taxable compensation income subject to the tax imposed under Sec. 24 of the Code.

(3) Motor vehicle of any kind — (a) If the employer purchases the motor vehicle in the name of the employee, the value of the benefit is the acquisition cost thereof. The monetary value of the fringe benefit shall be the entire value of the benefit, regardless of whether the motor vehicle is used by the employee partly for his personal purpose and partly for the benefit of his employer. (b) If the employer provides the employee with cash for the purchase of a motor vehicle, the ownership of which is placed in the name of the employee, the value of the benefits shall be the amount of cash received by the employee. The monetary value of the fringe benefit shall be the entire value of the benefit regardless of whether the motor vehicle is used by the employee partly for his personal purpose and partly for the benefit of his employer, unless the same was subjected to a withholding tax as compensation income under Revenue Regulations No. 2-98. (c) If the employer purchases the car on installment basis, the ownership of which is placed in the name of the employee, the value of the benefit shall be the acquisition cost exclusive of interest, divided by five (5) years. The monetary value of the fringe benefit shall be the entire value of the benefit regardless of whether the motor vehicle is used by the employee partly for his personal purpose and partly for the benefit of his employer. (d) If the employer shoulders a portion of the amount of the purchase price of a motor vehicle the ownership of which is placed in the name of the employee, the value of the benefit shall be the amount shouldered by the employer. The monetary value of the fringe benefit shall be the entire value of the benefit regardless of whether the motor vehicle is used by the employee partly for his personal purpose and partly for the benefit of his employer. Cdpr (e) If the employer owns and maintains a fleet of motor vehicles for the use of the business and the employees, the value of the benefit shall be the acquisition cost of all the motor vehicles not normally used for sales, freight, delivery service and other non-personal used divided by five (5) years. The monetary value of the fringe benefit shall be fifty per cent (50%) of the value of the benefit.

The monetary value of the motor vehicle fringe benefit is equivalent to the following:MV = [(A)/5] X 50%

where:MV = Monetary valueA = acquisition cost

(f) If the employer leases and maintains a fleet of motor vehicles for the use of the business and the employees, the value of the benefit shall be the amount of rental payments for motor vehicles not normally used for sales, freight, delivery, service and other non-personal use. The monetary value of the fringe benefit shall be fifty per cent (50%) of the value of the benefit. (g) 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 benefits tax. (h) The use of yacht whether owned and maintained or leased by the employer shall be treated as taxable fringe benefit. The value of the benefit shall be measured based on the depreciation of a yacht at an estimated useful life of 20 years.(4) Household expenses — Expenses of the employee which are borne by the employer for household personnel, such as salaries of household help, personal driver of the employee, or other similar personal expenses (like payment for homeowners association dues, garbage dues, etc.) shall be treated as taxable fringe benefits. (5) Interest on loan at less than market rate (a) If the employer lends money to his employee free of interest or at a rate lower than twelve per cent (12%), such interest foregone by the employer or the difference of the interest assumed by the employee and the rate of twelve per cent (12%) shall be treated as a taxable fringe benefit. (b) The benchmark interest rate of twelve per cent (12%) shall remain in effect until revised by a subsequent regulation. (c) This regulation shall apply to installment payments or loans with interest rate lower than twelve per cent (12%) starting January 1, 1998. prcd(6) Membership fees, dues, and other expenses borne by the employer for his employee, in social and athletic clubs or other similar organizations. — These expenditures shall be treated as taxable fringe benefits of the employee in full.(7) Expenses for foreign travel — (a) Reasonable business expenses which are paid for by the employer for the foreign travel of his employee for the purpose of attending business meetings or conventions shall not be treated as taxable fringe benefits. In this instance, inland travel expenses (such as expenses for food, beverages and local transportation) except lodging cost in a hotel (or similar establishments) amounting to an average of US$300.00 or less per day, shall not be subject to a fringe benefit tax. The expenses should be supported by documents proving the actual occurrences of the meetings or conventions.The cost of economy and business class airplane ticket shall not be subject to a fringe benefit tax. However, 30 percent of the cost of first class airplane ticket shall be subject to a fringe benefit tax. (b) In the absence of documentary evidence showing that the employee's travel abroad was in connection with business meetings or conventions, the entire cost of the ticket, including cost of hotel accommodations and other expenses incident thereto shouldered by the employer, shall be treated as taxable fringe benefits. The business meetings shall be evidenced by official communications from business associates abroad indicating the purpose of the meetings. Business conventions shall be evidenced by official invitations/communications from the host organization or entity abroad. Otherwise, the entire cost thereof shouldered by the employer shall be treated as taxable fringe benefits of the employee. (c) Travelling expenses which are paid by the employer for the travel of the family members of the employee shall be treated as taxable fringe benefits of the employee.(8) Holiday and vacation expenses — Holiday and vacation expenses of the employee borne by his employer shall be treated as taxable fringe benefits.(9) Educational assistance to the employee or his dependents — (a) The cost of the educational assistance to the employee which are borne by the employer shall, in general, be treated as taxable fringe benefit. However, a scholarship grant to the employee by the employer shall not be treated as taxable fringe benefit if the education or study involved is directly connected with the employer's trade, business or

profession, and there is a written contract between them that the employee is under obligation to remain in the employ of the employer for period of time that they have mutually agreed upon. In this case, the expenditure shall be treated as incurred for the convenience and furtherance of the employer's trade or business. (b) The cost of educational assistance extended by an employer to the dependents of an employee shall be treated as taxable fringe benefits of the employee unless the assistance was provided through a competitive scheme under the scholarship program of the company. cda(10) Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows — The cost of life or health insurance and other non-life insurance premiums borne by the employer for his employee shall be treated as taxable fringe benefit, except the following: (a) contributions of the employer for the benefit of the employee, pursuant to the provisions of existing law, such as under the Social Security System (SSS), (R.A. No. 8282, as amended ) or under the Government Service Insurance System (GSIS) (R.A. No. 8291 ), or similar contributions arising from the provisions of any other existing law; and (b) the cost of premiums borne by the employer for the group insurance of his employees.

Fringe Benefits Not Subject to Fringe Benefits Tax — In general, the fringe benefits tax shall not be imposed on the following fringe benefits: (1) Fringe benefits which are authorized and exempted from income tax under the Code or under any special law; (2) Contributions of the employer for the benefit of the employee to retirement, insurance and hospitalization benefit plans; (3) Benefits given to the rank and file, whether granted under a collective bargaining agreement or not; (4) De minimis benefits as defined in these Regulations; (5) If the grant of fringe benefits to the employee is required by the nature of, or necessary to the trade, business or profession of the employer; or(6) If the grant of the fringe benefit is for the convenience of the employer.The exemption of any fringe benefit from the fringe benefit tax imposed under this Section shall not be interpreted to mean exemption from any other income tax imposed under the Code except if the same is likewise expressly exempt from any other income tax imposed under the Code or under any other existing law. Thus, if the fringe benefit is exempted from the fringe benefits tax, the same may, however, still form part of the employee's gross compensation income which is subject to income tax, hence, likewise subject to a withholding tax on compensation income payment.

The term "DE MINIMIS" benefits which are exempt from the fringe benefit tax shall, in general, be limited to facilities or privileges furnished or offered by an employer to his employees that are of relatively small value and are offered or furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his employees such as the following:

(1) Monetized unused vacation leave credits of employees not exceeding ten (10) days during the year ;(2) Medical cash allowance to dependents of employees not exceeding P750 per semester or P125 per month ;(3) Rice subsidy of P350 per month granted by an employer to his employees ;(4) Uniforms given to employees by the employer ;(5) Medical benefits given to the employees by the employer ;(6) Laundry allowance of P150 per month ;(7) Employee achievement awards, e.g. for length of service or safety achievement, which must be in the form of a tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding one-half (1/2) month of the basic salary of the employee receiving the award under an established written plan which does not discriminate in favor of highly paid employees ; dctai(8) Christmas and major anniversary celebrations for employees and their guests ;(9) Company picnics and sports tournaments in the Philippines and are participated exclusively by employees ; and(10) Flowers, fruits, books or similar items given to employees under special circumstances, e.g. on account of illness, marriage, birth of a baby, etc. .

=========

In general, under this illustration, the XYZ Corporation shall not further claim deduction for allowing its Assistant Vice-President the use of its residential property since the cost for the use thereof has already been recovered as deduction from its gross income under "Depreciation Expense". However, since the fringe benefit tax in the amount of P10,732.32, assumed and paid by XYZ corporation has not as yet been recovered by way of deduction from gross income, the same shall be allowed as a deduction from its gross income. XYZ Corporation shall take up the foregoing in its books of accounts, as follows:

Debit: Fringe Benefit Tax Expense P10,732.32Credit: Cash/Fringe Benefit Tax PayableP10,732.32

To record fringe benefit tax expense for the residential property furnished to employees.However, if the cost of the aforesaid condominium unit subject to depreciation allowance (example: its

acquisition cost is only P7,000,000.00) is lesser than its fair market value as determined by the Commissioner (i.e. P10,000,000.00), the excess amount (i.e. P3,000,000.00) shall be amortized throughout the remaining estimated useful life of the residential property used in computing the said employer's depreciation expense and allowed as a deduction from the said employer's gross income as fringe benefit expense. Thus, if the remaining estimated useful life thereof during the year 1998 is fifteen (15) years, its monthly amortization shall be computed as follows:

Monthly amortization (P3,000,000.00 divided by15 years divided by 12 months) P16,666.67

In this case, XYZ Corporation shall take up the foregoing in its books of accounts as follows:

Debit: Fringe benefit expense P16,666.67Debit: Fringe benefit tax P10,732.32Credit: Income constructively realized P16,666.67Credit: Cash/Fringe benefit tax payable P10,732.32

To record fringe benefit and fringe benefit tax expenses and income constructively realized from the use of company-owned residential property furnished to employees.

REVENUE REGULATIONS NO. 08-00 (Amending Sections 2.78.1(A)(1), (A)(3), (A)(6), (A)(7), and (B)(11)(b) of Revenue Regulations No. 2-98, as Amended , and Section 2.33(C) of Revenue Regulations No. 3-98, with Respect to "De Minimis" Benefits, Additional Compensation Allowance (ACA), Representation and Transportation Allowance (RATA) and Personal Economic Relief Allowance (PERA))

Amended to further clarify certain benefits/privileges received by the employees which are not considered as items of income and therefore not subject to income tax and consequently, to the withholding tax. Likewise amended is the enumeration of the items of de-minimis benefits which are exempt from fringe benefits tax as appearing under Sec. 2.33(C) of Revenue Regulations No. 3-98.

Amendments. — Sec. 2.78.1(A)(1), (A)(3), (A)(6), (A)(7), (B)(11)(b) and(B)(13) are hereby amended to read as follows:"Sec. 2.78.1. Withholding of Income Tax on Compensation Income. —"(A) . . ."(1) Compensation paid in kind. — . . .''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 Commissioner."(3) Facilities and privileges of relatively small value. — Ordinarily, facilities and privileges (such as entertainment, medical services, or so-called "courtesy discounts" on purchases), otherwise known as "de minimis benefits," furnished or offered by an employer to his employees, are not considered as compensation subject to INCOME TAX AND CONSEQUENTLY TO withholding tax, if such facilities are offered or furnished by the employer merely as means of promoting the health, goodwill, contentment, or efficiency of his employees."THE FOLLOWING SHALL BE CONSIDERED AS "DE MINIMIS" BENEFITS NOT SUBJECT TO WITHHOLDING TAX ON COMPENSATION INCOME OF BOTH MANAGERIAL AND RANK AND FILE EMPLOYEES:(a) MONETIZED UNUSED VACATION LEAVE CREDITS OF EMPLOYEES NOT EXCEEDING TEN (10) DAYS DURING THE YEAR ;(b) MEDICAL CASH ALLOWANCE TO DEPENDENTS OF EMPLOYEES NOT EXCEEDING P750.00 PER EMPLOYEE PER SEMESTER OR P125 PER MONTH;(c) RICE SUBSIDY OF P1,000.00 OR ONE (1) SACK OF 50-KG. RICE PER MONTH AMOUNTING TO NOT MORE THAN P1,000.00.(d) UNIFORMS AND CLOTHING ALLOWANCE NOT EXCEEDING P3,000 PER ANNUM;(e) ACTUAL YEARLY MEDICAL BENEFITS NOT EXCEEDING P10,000 PER ANNUM;(f) LAUNDRY ALLOWANCE NOT EXCEEDING P300 PER MONTH;(g) EMPLOYEES ACHIEVEMENT AWARDS, E.G., FOR LENGTH OF SERVICE OR SAFETY ACHIEVEMENT, WHICH MUST BE IN THE FORM OF A TANGIBLE PERSONAL PROPERTY OTHER THAN CASH OR GIFT CERTIFICATE, WITH AN ANNUAL MONETARY VALUE NOT EXCEEDING P10,000.00 RECEIVED BY THE EMPLOYEE UNDER AN ESTABLISHED WRITTEN PLAN WHICH DOES NOT DISCRIMINATE IN FAVOR OF HIGHLY PAID EMPLOYEES;(h) GIFTS GIVEN DURING CHRISTMAS AND MAJOR ANNIVERSARY CELEBRATIONS NOT EXCEEDING P5,000 PER EMPLOYEE PER ANNUM;(i) FLOWERS, FRUITS, BOOKS, OR SIMILAR ITEMS GIVEN TO EMPLOYEES UNDER SPECIAL CIRCUMSTANCES, E.G., ON ACCOUNT OF ILLNESS, MARRIAGE, BIRTH OF A BABY, ETC.; AND(j) DAILY MEAL ALLOWANCE FOR OVERTIME WORK NOT EXCEEDING TWENTY FIVE PERCENT (25%) OF THE BASIC MINIMUM WAGE."

THE AMOUNT OF "DE MINIMIS' BENEFITS CONFORMING TO THE CEILING HEREIN PRESCRIBED SHALL NOT BE CONSIDERED IN DETERMINING THE P30,000 CEILING OF "OTHER BENEFITS" PROVIDED UNDER SECTION 32(B)(7)(e) OF THE CODE. HOWEVER, IF THE EMPLOYER PAYS MORE THAN THE CEILING PRESCRIBED BY THESE REGULATIONS, THE EXCESS SHALL BE TAXABLE TO THE EMPLOYEE RECEIVING THE BENEFITS ONLY IF SUCH EXCESS IS BEYOND THE P30,000.00 CEILING. PROVIDED, FURTHER, THAT 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."(4) . . .(5) . . "(6) Fixed or variable transportation, representation and other allowances. —"(a) IN GENERAL, fixed or variable transportation, representation and other allowances which are received by a public officer or employee of a private entity, in addition to the regular compensation fixed for his position or office, is compensation subject to withholding. PROVIDED, HOWEVER, THAT REPRESENTATION AND TRANSPORTATION ALLOWANCE (RATA) GRANTED TO PUBLIC OFFICERS AND EMPLOYEES UNDER THE GENERAL APPROPRIATIONS ACT AND THE PERSONNEL ECONOMIC RELIEF ALLOWANCE (PERA) WHICH ESSENTIALLY CONSTITUTE REIMBURSEMENT FOR EXPENSES INCURRED IN THE PERFORMANCE OF GOVERNMENT PERSONNEL'S OFFICIAL DUTIES SHALL NOT BE SUBJECT TO INCOME TAX AND CONSEQUENTLY TO

WITHHOLDING TAX. PROVIDED FURTHER, THAT PURSUANT TO E.O. 219 WHICH TOOK EFFECT ON JANUARY 1, 2000, ADDITIONAL COMPENSATION ALLOWANCE (ACA) GIVEN TO GOVERNMENT PERSONNEL SHALL NOT BE SUBJECT TO WITHHOLDING TAX PENDING ITS FORMAL INTEGRATION INTO THE BASIC PAY. CONSEQUENTLY, AND EFFECTIVE FOR THE TAXABLE YEAR 2000, ACA SHALL BE CLASSIFIED AS PART OF THE "OTHER BENEFITS" UNDER SECTION 32(B)(7)(e) OF THE CODE WHICH ARE EXCLUDED FROM GROSS COMPENSATION INCOME PROVIDED THE TOTAL AMOUNT OF SUCH BENEFITS DOES NOT EXCEED P30,000.00."(b) Any amount paid specifically, either as advances or reimbursements for traveling, representation and other bona fide ordinary and necessary expenses incurred or reasonably expected to be incurred by the employee in the performance of his duties are not compensation subject to withholding, if the following conditions are satisfied:"(i) It is for ordinary and necessary traveling and representation or entertainment expenses paid or incurred by the employee in the pursuit of the trade, business or profession; and"(ii) The employee is required to account/liquidate for the foregoing expenses in accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of actual expenses over advances made shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/advances for traveling and entertainment expenses which are pre-computed on a daily basis and are paid to an employee while he is on an assignment or duty need not be subject to the requirements of substantiation and to withholding. ""xxx xxx xxx"(B) Exemptions from withholding tax on compensation. The following income payments are exempted from the requirement of withholding tax on compensation:"xxx xxx xxx"(11) Thirteenth (13th) month pay and other benefits. —"(a) . . ."(b) Other benefits such as Christmas bonus, productivity incentives, loyalty award, gift in cash or in kind and other benefits of similar nature actually received by officials and employees of both government and private offices, INCLUDING THE ADDITIONAL COMPENSATION ALLOWANCE ("ACA") GRANTED AND PAID TO ALL OFFICIALS AND EMPLOYEES OF THE NATIONAL GOVERNMENT AGENCIES (NGAs) INCLUDING STATE UNIVERSITIES AND COLLEGES (SUCs), GOVERNMENT-OWNED AND/OR CONTROLLED CORPORATIONS (GOCCs), GOVERNMENT FINANCIAL INSTITUTIONS (GFIs) AND LOCAL GOVERNMENT UNITS (LGUs)"The above stated exclusions (a) and (b) shall cover benefits paid or accrued during the year provided that total amount shall not exceed thirty thousand pesos (P30,000.00) which may be increased through rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner, after considering, among others, the effect on the same of the inflation rate at the end of the taxable year.""(12) . . ."(13) FACILITIES AND PRIVILEGES OF RELATIVELY SMALL VALUE OR 'DE MINIMIS' BENEFITS AS DEFINED UNDER THESE REGULATIONS."

REVENUE REGULATIONS NO. 10-00

Section 2.78.1(A)(3), (6)(b)(ii) and (7) of Revenue Regulations No. 2-98, as last amended by Revenue Regulations No. 8-2000, is hereby further amended to read as follows:"Sec. 2.78.1. Withholding of Income Tax on Compensation Income. —"(A) . . ."(1) Compensation paid in kind. — . . ."xxx xxx xxx"(3) Facilities and privileges of relatively small value. —"xxx xxx xxx"The following shall be considered as "de minimis" benefits not subject to INCOME TAX AS WELL AS withholding tax on compensation income of both managerial and rank and file employees:(a) Monetized unused vacation leave credits of PRIVATE employees not exceeding ten (10) days during the year AND THE MONETIZED VALUE OF LEAVE CREDITS PAID TO GOVERNMENT OFFICIALS AND EMPLOYEES;(b) Medical cash allowance to dependents of employees not exceeding P750.00 per employee per semester or P125 per month;(c) Rice subsidy of P1,000.00 or one (1) sack of 50-kg. rice per month amounting to not more than P1,000.00;(d) Uniform and clothing allowance not exceeding P3,000 per annum;(e) Actual yearly medical benefits not exceeding P10,000 per annum;(f) Laundry allowance not exceeding P300 per month;(g) Employees achievement awards, e.g., for length of service or safety achievement, which must be in the form of a tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding P10,000 received by the employee under an established written plan which does not discriminate in favor of highly paid employees;(h) Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum;(i) Flowers, fruits, books, or similar items given to employees under special circumstances, e.g., on account of illness, marriage, birth of a baby, etc., and(j) Daily meal allowance for overtime work not exceeding twenty five percent (25%) of the basic minimum wage.""xxx xxx xxx"(6) Fixed or variable transportation, representation and other allowances —"xxx xxx xxx

"(b) . . ."(i) . . ."(ii) The employee is required to account/liquidate for the expenses in accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of ADVANCES MADE over ACTUAL EXPENSES shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/advances for travelling and entertainment expenses which are pre-computed on a daily basis and are paid to an employee while he is on an assignment or duty need not be subject to the requirements of substantiation and to withholding." "(iii) . . ."(7) Vacation and sick leave allowances. Amounts of "vacation allowances or sick leave credits" which are paid to an employee constitute compensation. Thus, the salary of an employee on vacation or on sick leave, which IS paid notwithstanding his absence from work constitutes compensation. However, the monetized value of unutilized vacation leave credits of ten (10) days or less which ARE paid to PRIVATE employees during the year AND THE MONETIZED VALUE OF LEAVE CREDITS PAID TO GOVERNMENT OFFICIALS AND EMPLOYEES SHALL NOT BE SUBJECT TO INCOME TAX AND CONSEQUENTLY TO WITHHOLDING TAX.""xxx xxx xxxSECTION 2. Section 2.33 (C) of Revenue Regulations No. 3-98, as last amended by Revenue Regulations No. 8-2000, is hereby further amended to read as follows:"Sec. 2.33. Special Treatment of Fringe Benefits(A) Imposition of Fringe Benefits Tax —xxx xxx xxx(B) Definition of Fringe Benefit —xxx xxx xxx(C) Fringe Benefits Not Subject to Fringe Benefits Tax — In general, the fringe benefits tax shall not be imposed on the following fringe benefits:(1) . . .(2) . . .(3) . . .(4) De minimis benefits as defined in these Regulations;(5) . . .(6) . . .xxx xxx xxxThe term "DE MINIMIS" benefits which are exempt from the fringe benefits tax shall, in general, be limited to facilities or privileges furnished or offered by an employer to his employees that are of relatively small value and are offered or furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his employees such as the following:(a) Monetized unused vacation leave credits of PRIVATE employees not exceeding ten (10) days during the year AND THE MONETIZED VALUE OF LEAVE CREDITS PAID TO GOVERNMENT OFFICIALS AND EMPLOYEES;(b) Medical cash allowance to dependents of employees not exceeding P750.00 per employee per semester or P125 per month;(c) Rice subsidy of P1,000.00 or one (1) sack of 50-kg. rice per month amounting to not more than P1,000.00;(d) Uniform and clothing allowance not exceeding P3,000 per annum;(e) Actual yearly medical benefits not exceeding P10,000 per annum;(f) Laundry allowance not exceeding P300 per month;(g) Employees achievement awards, e.g., for length of service or safety achievement, which must be in the form of a tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding P10,000 received by the employee under an established written in which does not discriminate in favor of highly paid employees;(h) Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum;(i) Flowers, fruits, books, or similar items given to employees under special circumstances, e.g., on account of illness, marriage, birth of a baby, etc., and(j) Daily meal allowance for overtime work not exceeding twenty-five percent (25%) of the basic minimum wage.""xxx xxx xxx"

REVENUE REGULATIONS NO. 13-2000 issued December 29, 2000 implements the provisions of Section 34(B) of the Tax Code of 1997 relative to the requirements for the deductibility of interest expense from the gross income of a corporation or an individual engaged in trade, business or in the practice of profession.

In general, subject to certain limitations, the following are the requisites for the deductibility of interest expense from gross income: a) there must be an indebtedness; b) there should be an interest expense paid or incurred upon such indebtedness; c) the indebtedness must be that of the taxpayer; d) the indebtedness must be connected with the taxpayer's trade, business or exercise of profession; e) the interest expense must have been paid or incurred during the taxable year; f) the interest must have been stipulated in writing; g) the interest must be legally due; h) the interest payment arrangement must not be between related taxpayers; i) the interest must not be incurred to finance petroleum operations; and j) 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

REVENUE REGULATIONS NO. 13-00 (Implementing Section 34(B) of the Tax Code of 1997 on the Requirements for Deductibility of Interest Expense from the Gross Income of a Taxpayer.)

Scope. — Pursuant to the provisions of Section 244 of the Tax Code of 1997, these Regulations are hereby promulgated to implement the provisions of Section 34(B) of the same Code on the requirements for deductibility of interest expense from the gross income of a corporation or an individual engaged in trade, business or in the practice of profession.

Definition of Terms. — For purposes of these Regulations, the following words and phrases shall have the following meanings, viz: (a) Interest — shall refer to the payment for the use or forbearance or detention of money, regardless of the name it is called or denominated. It includes the amount paid for the borrower's use of money during the term of the loan, as well as for his detention of money after the due date for its repayment. (b) Taxpayer — shall refer to a person, whether natural or juridical, engaged in trade, business or in the exercise of profession, except one earning compensation income arising from personal services rendered under an employer-employee relationship.

Requisites for Deductibility of Interest Expense. — In general, subject to certain limitations, the following are the requisites for the deductibility of interest expense from gross income, viz: (a) There must be an indebtedness; (b) There should be an interest expense paid or incurred upon such indebtedness; (c) The indebtedness must be that of the taxpayer, (d) The indebtedness must be connected with the taxpayer's trade, business or exercise of profession; (e) The interest expense must have been paid or incurred during the taxable year; (f) The interest must have been stipulated in writing; (g) The interest must be legally due; (h) 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 ; (i) The interest must not be incurred to finance petroleum operations; and (j) 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.

Rules on the Deductibility of Interest Expense. — (a) General Rule. — In general, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with the taxpayer's trade, business or exercise of profession shall be allowed as a deduction from the taxpayer's gross income. (b) Limitation. — The amount of interest expense paid or incurred by a taxpayer in connection with his trade, business or exercise of a profession from an existing indebtedness shall be reduced by an amount equal to the following percentages of the interest income earned which had been subjected to final withholding tax depending on the year when the interest income was earned, viz:

Forty-one percent (41%) beginning January 1, 1998;Thirty-nine percent (39%) beginning January 1, 1999; andThirty-eight percent (38%) beginning January 1, 2000 and thereafter.

This limitation shall apply regardless of whether or not a tax arbitrage scheme was entered into by the taxpayer or regardless of the date when the interest bearing loan and the date when the investment was made for as long as, during the taxable year, there is an interest expense incurred on one side and an interest income earned on the other side, which interest income had been subjected to final withholding tax. This rule shall be observed irrespective of the currency the loan was contracted and/or in whatever currency the investments or deposits were made.

Illustration: Supposing on January 15, 1998, Company A, who has a deposit account with BCD Bank, obtained a loan from XYZ Financing Corporation in connection with the operation of its business. Assume that Company A's net income for the year 1998 before the deduction of the interest expense amounted to P1,000,000. For the year 1998, the interest income it derived from the said deposit with BCD Bank amounted to P180,000 on which a final tax of P36,000 had been withheld. Its interest expense on the loan obtained from XYZ Financing Corporation during the same year amounted to P150,000.Under this illustration, the deductible interest expense, the taxable income and the income tax due of Company A shall be computed as follows:

1998Net income before interest expense P1,000,000Less: Interest expense P150,000

Less: 41% of interest income fromdeposit (41% x P180,000) 73,800

————Deductible interest expense 76,200

————Taxable income P923,800

————

Income tax due for taxable year 1998 (34%) P314,092========

(c) Interest on Unpaid Taxes. — Provisions of Sec. 4(b) hereof to the contrary notwithstanding, interest incurred or paid by the taxpayer on all unpaid business-related taxes shall be fully deductible from gross income and shall not be subject to the limitation on deduction heretofore mentioned. Thus, such interest expense incurred or paid shall not be diminished by the percentage of interest income earned which had been subjected to final withholding tax. CTSHDI (d) Other cases where interest expense is not deductible from gross income. — No interest expense shall be allowed as deduction from gross income in any of the following cases:

(1) If within the taxable year, an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise: Provided, That such interest shall be allowed as a deduction in the year the indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic amortization, the amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as deduction in such taxable year.

Illustration: Mr. Cruz, a self-employed individual, consistently employs the cash-basis accounting method in keeping his books of accounts. Assuming that on January 1, 1998, he contracted a loan of P1,000,000 from XYZ Bank for use in his business operations. Terms: Payable in two (2) years at 15% interest per annum, payable in advance. On January 1, 1998, he received from the bank the proceeds of his loan in the sum of P700,000, net of interest paid in advance in the amount of P300,000.

In general, the interest expense shall be taken for the taxable year in which "paid or incurred" or "paid or accrued" depending upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income, the deduction should be taken as of a different period. Thus, a self-employed individual is allowed to deduct from his gross income the entire amount of interest expense actually paid during the taxable year. However, if the interest expense is paid in advance and the accounting method used by the self-employed individual is the cash-basis accounting method, such interest expense paid in advance shall only be allowed as deduction in the year when he has fully paid his liability. So that if the said debtor has fully paid his loan as of the end of the taxable year 1999, his interest expense paid in advance on January 1, 1998 in the amount of P300,000 shall only be allowed as deduction from his gross income in the taxable year 1999.

On the other hand, even if the interest expense is paid in advance but the indebtedness is payable in periodic amortization, the amount of interest expense which corresponds to the amount of the principal amortized or paid during the respective years 1998 and 1999 shall be allowed as deduction in such respective taxable years.

(2) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Sec. 36(B) of the Tax Code of 1997, viz:

(i) Between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors and lineal descendants; or(ii) Between an individual and a corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly and indirectly, by or for such individual; or(iii) Between two corporations more than fifty percent (50%) in value of the

outstanding stock of each of which is owned, directly or indirectly, by or for the same individual; or

(iv) Between the grantor and a fiduciary of any trust; or(v) Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or(vi) Between a fiduciary of a trust and a beneficiary of such trust.

(3) If the indebtedness on which the interest expense is paid is incurred to finance petroleum exploration in the Philippines. The non-deductible interest expense herein referred to pertains to interest or other consideration paid or incurred by a Service Contractor engaged in the discovery and production of indigenous petroleum in the Philippines in respect of the financing of its petroleum operations, pursuant to Section 23 of P.D. No. 8 , as amended by P.D. No. 87 , otherwise known as "The Oil Exploration and Development Act of 1972." (e) Optional treatment of interest expense on capital expenditure. — At the option of the taxpayer, interest expense on a capital expenditure incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction in full in the year when incurred, the provisions of Sec. 36 (A)(2) and (3) of the Tax Code of 1997 to the contrary notwithstanding, or may be treated as a capital expenditure for which the taxpayer may claim only as a deduction the periodic amortization of such expenditure.

REVENUE REGULATIONS NO. 10-02 (Implementing the Provisions of Section 34(A)(1)(a)(iv) of the Tax Code of 1997, Authorizing the Imposition of a Ceiling on "Entertainment, Amusement and Recreational Expenses")

To provide a ceiling on the amount of entertainment, amusement and recreation expense claimed by individual taxpayers engaged in business or in the practice of their profession and of domestic or resident foreign corporations, to arrive at the taxable income subject to income tax under Sections 24(A); 25(A)(1) ; 26 ; 27(A), (B) and (C) ; 28(A)(1); 28(A)(6)(b) and Section 61.

Coverage. — These regulations shall cover entertainment, amusement and recreation expenses of the following taxpayers: a. Individuals engaged in business, including taxable estates and trusts; b. Individuals engaged in the practice of profession; c. Domestic corporations;

d. Resident foreign corporations; e. General professional partnerships, including its members.

Definition of Terms. — For purposes of these Regulations, the term "Entertainment, Amusement and Recreation Expenses" includes representation expenses and/or depreciation or rental expense relating to entertainment facilities, as described below. The term "Representation Expenses" shall refer to expenses incurred by a taxpayer in connection with the conduct of his trade, business or exercise of profession, in entertaining, providing amusement and recreation to, or meeting with, a guest or guests at a dining place, place of amusement, country club, theater, concert, play, sporting event, and similar events or places. For purposes of these Regulations, representation expenses shall not refer to fixed representation allowances that are subject to withholding tax on wages pursuant to appropriate revenue regulations. In the case particularly of a country, golf, sports club, or any other similar club where the employee or officer of the taxpayer is the registered member and the expenses incurred in relation thereto are paid for by the taxpayer, there shall be a presumption that such expenses are fringe benefits subject to fringe benefits tax unless the taxpayer can prove that these are actually representation expenses. For purposes of proving that said expense is a representation expense and not fringe benefits, the taxpayer should maintain receipts and adequate records that indicate the (a) amount of expense (b) date and place of expense (c) purpose of expense (d) professional or business relationship of expense (e) name of person and company entertained with contact details. The term "Entertainment Facilities" shall refer to (1) a yacht, vacation home or condominium; and (2) any similar item of real or personal property used by the taxpayer primarily for the entertainment, amusement, or recreation of guests or employees. To be considered an entertainment facility, such yacht, vacation home or condominium, or item of real or personal property must be owned or form part of the taxpayer's trade, business or profession, or rented by such taxpayer, for which the taxpayer claims a depreciation or rental expense. A yacht shall be considered an entertainment facility under these Regulations if its use is in fact not restricted to specified officers or employees or positions in such a manner as to make the same a fringe benefit for purposes of imposing the fringe benefits tax. The term "Guests" shall mean persons or entities with which the taxpayer has direct business relations, such as but not limited to, clients/customers or prospective clients/customers. The term shall not include employees, officers, partners, directors, stockholders, or trustees of the taxpayer.

Exclusions. — The following expenses are not considered entertainment, amusement and recreation expenses as defined under Section 2 hereof. a. Expenses which are treated as compensation or fringe benefits for services rendered under an employer-employee relationship, pursuant to Revenue Regulations 2-98 , 3-98 and amendments thereto; b. Expenses for charitable or fund raising events; c. Expenses for bonafide business meeting of stockholders, partners or directors; d. Expenses for attending or sponsoring an employee to a business league or professional organization meeting; e. Expenses for events organized for promotion, marketing and advertising including concerts, conferences, seminars, workshops, conventions, and other similar events; f. Other expenses of a similar nature.

Notwithstanding the foregoing, such items of exclusions may, nonetheless, qualify as items of deduction under Section 34 of the Tax Code of 1997, subject to conditions for deductibility stated therein.

Requisites of Deductibility of "Entertainment, Amusement and Recreation Expense". — The following are the requisites for deductibility of entertainment, amusement and recreation expense as defined above subject to the ceiling prescribed under Section 5 of these Regulations: a. It must be paid or incurred during the taxable year; b. It must be: (i) directly connected to the development, management and operation of the trade, business or profession of the taxpayer; or (ii) directly related to or in furtherance of the conduct of his or its trade, business or exercise of a profession; c. It must not be contrary to law, morals, good customs, public policy or public order; d. It must not have been paid, directly or indirectly, to an official or employee of the national government, or any local government unit, or of any government-owned or controlled corporation (GOCC), or of a foreign government, or to a private individual, or corporation, or general professional partnership (GPP), or a similar entity, if it constitutes a bribe, kickback or other similar payment; e. It must be duly substantiated by adequate proof. The official receipts, or invoices, or bills or statements of accounts should be in the name of the taxpayer claiming the deduction; and f. The appropriate amount of withholding tax, if applicable, should have been withheld therefrom and paid to the Bureau of Internal Revenue.

Ceiling on Entertainment, Amusement, and Recreation Expense. — There shall be allowed a deduction from gross income for entertainment, amusement and recreation expense, as defined in Section 2 of these Regulations, in an amount equivalent to the actual entertainment, amusement and recreation expense paid or incurred within the taxable year by the taxpayer, but in no case shall such deduction exceed 0.50 percent (%) of net sales (i.e., gross sales less sales returns/allowances and sales discounts) for taxpayers engaged in sale of goods or properties; or 1.00 percent (%) of net revenue (i.e., gross revenue less discounts) for taxpayers engaged in sale of services, including exercise of profession and use or lease of properties. However, if the taxpayer is deriving income from both sale of goods/properties and services, the allowable entertainment, amusement and recreation expense shall in all cases be determined based on an apportionment formula taking into consideration the percentage of the net sales/net revenue to the total net sales/net revenue, but which in no case shall exceed the maximum percentage ceiling provided in these Regulations.

Apportionment Formula:Net sales/net revenue—–——————–———— x Actual ExpenseTotal Net sales and net revenue

Illustration: ERA Corporation is engaged in the sale of goods and services with net sales/net revenue of P200,000 and P100,000 respectively. The actual entertainment, amusement and recreation expense for the second semester of 2002 totaled to P3,000.

*Apportionment FormulaSale of Goods (P200,000/P300,000) x P3,000Sale of Services(P100,000/P300,000) x P3,000

**Maximum Percentage CeilingSale of Goods (P200,000 x 0.50%)Sale of Services (P100,000 x 1%)

In the above illustration, ERA Corporation can only claim a total of P2,000 as entertainment, amusement and recreation expense.

Notwithstanding the ceiling imposed on such expense, the claimed expense shall be subject to verification and audit for purposes of determining its deductibility as well as compliance with the substantiation requirements as provided in these Regulations. However, if after verification a taxpayer is found to have shifted the amount of the entertainment, amusement and recreation expense to any other expense in order to avoid being subjected to the ceiling herein prescribed, the amount shifted shall be disallowed in its totality, without prejudice to such penalties as may be imposed by the Tax Code of 1997.

BIR RULING NO. 006-00

Gentlemen :This refers to your letter dated November 6, 1998 stating that with reference to Section 34(B) of the Tax Reform Act of 1997 disallowing as a deduction a portion of Bank's interest expense representing 41% of interest income subjected to final tax, you are of the understanding that the said provision was introduced to mitigate the effects of the so-called tax arbitrage scheme where taxpayers save approximately 14% on taxes by placing their excess funds in government securities and pay only a 20% tax on the interest derived therefrom instead of the 34% corporate tax that will be imposed had such excess been used for other income-generating activities not subject to final tax; that as a result of the Codal provision, taxpayers will no longer enjoy the tax benefit/savings that otherwise may be derived from the tax arbitrage; that the 12-year treasury bonds were given by the Government as payment for its liabilities to PNB as embodied in the Memorandum of Agreement (MOA) dated August 14, 1995 executed between the National Government, as represented by the Department of Finance, and PNB; and that PNB, therefore, has not engaged in a tax arbitrage scheme.

Based on the foregoing representations and documents submitted, you are now requesting for a ruling that interest income derived by PNB from the treasury bonds be excluded in the determination of the interest expense not allowable as deduction from gross income.

In reply, please be informed that pursuant to Section 34(B) of the Tax Code of 1997, although as a general rule, the amount of interest expense paid or incurred by a taxpayer within a taxable year on indebtedness in connection with his trade, business or exercise of profession shall be allowed as a deduction from his gross income, the said interest expense, however, shall be reduced if the taxpayer has derived certain interest income which had been subjected to final withholding tax. The said reduction shall be equal to the following percentages of the interest income earned depending on the year when the interest income was earned, viz:

Forty-one percent (41%) beginning January 1, 1998;Thirty-nine percent (39%) beginning January 1, 1999; andThirty-eight percent (38%) beginning January 1, 2000 and thereafter.This limitation shall apply regardless of whether or not a tax arbitrage scheme was entered into by the taxpayer

or regardless of the date of the interest-bearing loan and the date when the investment was made, for as long as, during the taxable year, there is an interest expense incurred on one side and an interest income earned on the other side, which interest income had been subjected to final withholding tax.

Accordingly, your request that your interest income derived from the said treasury bonds be excluded in the determination of the interest expense not allowable as deduction from gross income is hereby denied pursuant to Section 34(B) of the Tax Code of 1997.

REVENUE REGULATIONS NO. 12-77 (Substantiation requirement for losses arising from casualty, robbery, theft or embezzlement)

Pursuant to the provisions of Section 326 in relation to Section 4 of the National Internal Revenue Code of 1977, these regulations are hereby promulgated to govern the manner of reporting losses arising from casualty, robbery, theft, or embezzlement, for income tax purposes.

Nature of deductible losses. — Any loss arising from fires, storms or other casualty, and from robbery, theft or embezzlement, is allowable as a deduction under Section 30(d) for the taxable year in which the loss is sustained. The term "casualty" is the complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, or unusual nature. It denotes accident, some sudden invasion by hostile agency, and excludes progressive deterioration through steadily operating cause. Generally, theft is the criminal appropriation of another's property to the use of the taker. Embezzlement is the fraudulent appropriation of another's property by a person to whom it has been entrusted or into whose hands it has lawfully come.

Requirements of substantiation. — The taxpayer bears the burden of proving and substantiating his claim for deduction for losses allowed under Section 30(d) and should comply with the following substantiation requirements: (a) A declaration of loss which must be filed with the Commissioner of Internal Revenue or his deputies within a certain period prescribed in these regulations after the occurrence of the casualty, robbery, theft or embezzlement. (b) Proof of the elements of the loss claimed, such as the actual nature and occurrence of the event and amount of the loss.

Declaration of loss. — Within forty-five days after the date of the occurrence of casualty or robbery, theft or embezzlement, a taxpayer who sustained loss therefrom and who intends to claim the loss as a deduction for the taxable year in which the loss was sustained shall file a sworn declaration of loss with the nearest Revenue District Officer. The sworn declaration of loss shall contain, among other things, the following information: (a) The nature of the event giving rise to the loss and the time of its occurrence; (b) A description of the damaged property and its location; (c) The items needed to compute the loss such as cost or other basis of the property; depreciation allowed or allowable if any; value of property before and after the event; cost of repair; (d) Amount of insurance or other compensation received or receivable.

Evidence to support these items should be furnished, if available. Examples are purchase contracts and deeds, receipted bills for improvements, and pictures and competent appraisals of the property before and after the casualty.

Proof of loss. — (a) In general. — The declaration of loss, being one of the essential requirements of substantiation of a claim for a loss deduction, is subject to verification and does not constitute sufficient proof of the loss that will justify its deductibility for income tax purposes. Therefore, the mere filing of a declaration of loss does not automatically entitle the taxpayer to deduct the alleged loss from gross income. The failure, however, to submit the said declaration of loss within the period prescribed in these regulations will result in the disallowance of the casualty loss claimed in the taxpayer's income tax return. The taxpayer should therefore file a declaration of loss and should be prepared to support and substantiate the information reported in the said declaration with evidence which he should gather immediately or as soon as possible after the occurrence of the casualty or event causing the loss. (b) Casualty loss. — Photographs of the property as it existed before it was damaged will be helpful in showing the condition and value of the property prior to the casualty. Photographs taken after the casualty which show the extent of damage will be helpful in establishing the condition and value of the property after it was damaged. Photographs showing the condition and value of the property after it was repaired, restored or replaced may also be helpful.

Furthermore, since the valuation of the property is of extreme importance in determining the amount of loss sustained, the taxpayer should be prepared to come forward with documentary proofs, such as cancelled checks, vouchers, receipts and other evidence of cost.

The foregoing evidence should be kept by the taxpayer as part of his tax records and be made available to a revenue examiner, upon audit of his income tax return and the declaration of loss. (c) Robbery, theft or embezzlement losses. — To support the deduction for losses arising from robbery, theft or embezzlement, the taxpayer must prove by credible evidence all the elements of the loss, the amount of the loss, and the proper year of the deduction. The taxpayer bears the burden of proof, and no deduction will be allowed unless he shows the property was stolen, rather than misplaced or lost. A mere disappearance of property is not enough, nor is a mere error or shortage in accounts.

Failure to report theft or robbery to the police may be a factor against the taxpayer. On the other hand, a mere report of alleged theft or robbery to the police authorities is not a conclusive proof of the loss arising therefrom.

Determination of amount deductible. — (a) In general. — The amount of casualty loss deductible is limited to the difference between the value of the property immediately preceding the casualty and its value immediately thereafter, but shall not exceed an amount equal to the cost or other adjusted basis of the property, or depreciated cost in the case of property used in business, reduced by any insurance or other compensation received.

(b) Method of valuation. — (i) The fair market value of the property immediately before and immediately after the casualty for purposes of determining the amount of casualty loss deductible under this section shall be ascertained by an impartial but competent appraisal. This appraisal must recognize the effects of any general market decline affecting undamaged, as well as damaged property, which may occur simultaneously with the casualty in order that any deduction under this section shall be limited to actual loss resulting from damage to property.

(ii) The cost of repairs to the property damaged is acceptable as evidence of the loss of value if the taxpayer shows that (1) the repairs are necessary to restore the property to its condition immediately before the casualty, (2) the amount spent for such repairs is not excessive, (3) the repairs do not cover more than the damage suffered, and (4) the value of the property after the repairs does not as a result of the repairs exceed the value of the property immediately before the casualty. (c) Examples.The application of this section may be illustrated by the following examples:

(i) Property not used in business:Cost or adjusted basis P18,000.00Value of property before casualty 15,000.00Value of property after casualty 10,000.00Insurance recovered 3,000.00

The casualty loss is computed as follows:Value of property before casualty P15,000.00Value of property after casualty 10,000.00

–––––––––Difference P5,000.00

========

Loss to be taken into account for purposes of Section 30(d):lesser amount of property actually destroyed (P5,000)or adjusted basis of propertyactually destroyed (P18,000)P5,000.00

Less: Insurance received 3,000.00––––––––

AMOUNT OF LOSS DEDUCTIBLE P2,000.00=======

(ii) Property used in business:(A) Total destruction. — In case of losses arising from total destruction of property used in business (ordinary asset) the net book value (cost less accumulated depreciation) immediately preceding the casualty should be used as the basis in claiming losses, also to be reduced by any amount of insurance or compensation received.

To illustrate:Assume that —Acquisition cost of property P10,000Accumulated depreciation 5,000Insurance recovered 2,500

Amount deductible is computed as follows:Acquisition cost P10,000Less: Accumulated depreciation 5,000

–––––––Amount of loss suffered P5,000Less: Amount recovered through insurance 2,500

–––––––AMOUNT DEDUCTIBLE P2,500

======

(B) Partial destruction. — In case of losses arising from partial damages of property used in business, the replacement cost to restore the property back to its normal operating condition should be used for purposes of computing deductible losses, but in no case shall the deductible loss be more, than the net book value of the property as a whole immediately before the casualty. The excess over the net book value immediately before the casualty should be capitalized subject to depreciation over the remaining useful life of the property.

To illustrate:Assume:Acquisition cost P100,000Accumulated depreciation 90,000

––––––––Net book value P10,000

=======Estimated remaining useful life 5 yearsReplacement cost of damaged portion P20,000

––––––––In the above example, the loss deductible for tax purposes would be limited to P10,000 which is equal to the net book value of the whole property:Net book value P10,000Replacement cost 20,000

–––––––Excess of replacement cost to becapitalized P10,000

======

Consequently, the new cost basis subject to depreciation charges over the remaining useful life of the property which is five (5) years, would be P20,000 as shown hereunder:

Net book value before casualty P10,000Add: Excess of replacement cost over

book value 10,000–––––––

New cost basis P20,000======

Yearly depreciation —P20,000–––––––5 years = P4,000

(iii) Farm losses. — In the case of losses sustained, by farmers, the following rules shall apply:(a) Loss of livestock. — The loss sustained in the death of livestock shall be allowed as a deduction to the

extent of the acquisition cost only if no inventories are taken into account in determining the income from the business of farming.If inventories are taken into account in determining the income from the trade or business of farming, no deduction shall be allowed for losses sustained during the taxable year upon livestock or other products, whether purchased for resale or produced on the farm, to the extent such losses are reflected in the inventory on hand at the close of the taxable year.

(b) Other farm losses. — Where ground is prepared and planted or stocked as in case of sugar, coconut and other agricultural plantations, orchards, fishponds and other farms and its value is completely destroyed by the overflow or seepage of water from natural causes, the cost of the preparation and planting or stocking up to the time of the disaster shall be deductible loss in the year in which it is incurred.

Determination of amount deductible — robbery, theft and embezzlement losses. — The amount deductible in respect of robbery, theft and embezzlement loss shall be determined consistently with the manner prescribed in the preceding section for determining the amount of casualty loss allowable as a deduction. In applying the provisions of the preceding section for this purpose, the fair market value of the property immediately after the theft shall be considered to be zero. This section does not apply to losses reflected in the inventories of the taxpayer.

Example:In 1969, B purchases for personal use a diamond brooch costing P40,000. On November 30, 1975 at which time it has a fair market value of P35,000 the brooch was stolen. The brooch was fully insured against theft. A controversy develops with the insurance company over its liability in respect of the loss. However, in 1976; B has a reasonable prospect of recovery of the fair market value of the brooch from the insurance company. The controversy is settled in March, 1977, at which time B receives P20,000 in insurance proceeds to cover the loss from theft. No deduction for loss is allowable for 1975 or 1976; but the amount of the deduction allowable for the taxable year 1977 is P15,000, computed as follows:

Value of property immediately before theft P35,000Less: Value of property immediately after

theft -0-–––––––

Loss to be taken into account (P35,000 butnot to exceed adjusted basis of P40,000at the time of theft) P35,000Less: Insurance received in 1977 20,000

–––––––Deduction allowable for 1977 P15,000

======

Year of deduction. — If a casualty occurs which may result in a loss and, in the year of such casualty or event, there exist a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. Whether a reasonable prospect of recovery exist with respect to a claim for a reimbursement of a loss is a question of fact to be determined upon an examination of all facts and

circumstances. Whether or not such reimbursement will be received may be ascertained with reasonable certainty, for example, by a settlement of the claim, by an adjudication of the claim, or by an abandonment of the claim. When a taxpayer claims that the taxable year in which a loss is sustained is fixed by his abandonment of the claim for reimbursement, he must be able to produce objective evidence of his having abandoned the claim, such as the execution of a release.

REVENUE REGULATIONS NO. 14-01 (Implementing Section 34(D)(3) of the National Internal Revenue Code of 1997 Relative to the Allowance of Net Operating Loss Carry-Over (NOLCO) as a Deduction from Gross Income.)

Scope. — Pursuant to the provisions of Section 244 of the National Internal Revenue Code of 1997 (hereinafter referred to as the Code), these Regulations are hereby promulgated to govern the deduction from gross income of the Net Operating Loss Carry-Over (NOLCO) pursuant to Section 34 (D) (3) of the Code

General Principles and Policies. — 2.1 For purposes of these Regulations, the allowance for deduction of NOLCO shall be limited only to net operating losses accumulated beginning January 1, 1998.2.2 In general, NOLCO shall be allowed as a deduction from the gross income of the same taxpayer who sustained and accumulated the net operating losses regardless of the change in its ownership. This rule shall also apply in the case of a merger where the taxpayer is the surviving entity.2.3 Unless otherwise provided in these Regulations, NOLCO of the taxpayer shall not be transferred or assigned to another person, whether directly or indirectly, such as, but not limited to, the transfer or assignment thereof through a merger, consolidation or any form of business combination of such taxpayer with another person.2.4 NOLCO shall also be allowed if there has been no substantial change in the ownership of the business or enterprise in that not less than 75% in nominal value of outstanding issued shares or not less than 75% of the paid up capital of the corporation, if the business is in the name of the corporation, is held by or on behalf of the same persons.

The 75% equity, ownership or interest rule prescribed in these Regulations shall only apply to a transfer or assignment of the taxpayer's net operating losses as a result of or arising from the said taxpayer's merger or consolidation or business combination with another person. In case the transfer or assignment of the taxpayer's net operating losses arises from the said taxpayer's merger, consolidation or combination with another person, the transferee or assignee shall not be entitled to claim the same as deduction from gross income unless, as a result of the said merger, consolidation or combination, the shareholders of the transferor/assignor, or the transferor (in case of other business combinations) gains control of at least 75% or more in nominal value of the outstanding issued shares or paid up capital of the transferee/assignee (in case the transferee/assignee is a corporation) or 75% or more interest in the business of the transferee/assignee (in case the transferee/assignee is other than a corporation).2.5 Unless otherwise provided in these Regulations, an individual (including estate or trust) engaged in trade or business or in the exercise of profession, or a domestic or resident foreign corporation may be allowed to claim deduction of his/its corresponding NOLCO: Provided, however, that an individual who claims the 10% optional standard deduction shall not simultaneously claim deduction of the NOLCO: Provided, further, that the three-year reglementary period shall continue to run notwithstanding the fact that the aforesaid individual availed of the 10% optional standard deduction during the said period.2.6 The three-year reglementary period on the carry-over of NOLCO shall continue to run notwithstanding the fact that the corporation paid its income tax under the "Minimum Corporate Income Tax" computation.2.7 NOLCO shall be availed of on a "first-in, first-out" basis.2.8 The net operating loss incurred by a taxpayer in the year in which a substantial change in ownership in such taxpayer occurs shall not be affected by such change in ownership, notwithstanding subsections 2.3 and 2.4.

Definition of Terms. — For purposes of these Regulations, the words and phrases herein provided shall mean as follows: 3.1 Gross Income — Except as otherwise provided in these Regulations, the term "Gross Income" means the pertinent items of income referred to in Section 32(A) of the Tax Code of 1997 which are required to be declared in the taxpayer's Income Tax Return for purposes of computing his taxable income as defined in Section 31 of the same Code. All exempt income and other items of income subject to final tax shall not form part of the gross income. 3.2 Allowable Deductions — The term "Allowable Deductions" means the items of deduction enumerated under Section 34(A) to (J) and Section 34(M) , including the special deductions allowed to insurance companies under Section 37 of the Code, but excluding NOLCO and any item of incentive deduction allowable under any special law that does not actually involve cash outlay: Provided, that, in the case of an individual entitled to claim the Optional Standard Deduction (OSD) under Section 34(L) , in lieu of the deductions enumerated under Section 34(A) to (K) , the term "allowable deductions" shall mean the aforesaid OSD plus deduction of premium payments on health and/or hospitalization insurance as provided under Section 34(M) of the Code, if applicable. 3.3 Net Operating Loss — The term Net Operating Loss" shall mean the excess of allowable deduction over gross income of the business in a taxable year. 3.4 Nominal Value of Outstanding Issued Shares — The term "Nominal Value of Outstanding Issued Shares " shall refer to the par value (in case of par value shares of stock) or stated value (in case of no par value shares of stock) of shares of stock issued to the stockholders of the corporation. 3.5 Paid Up Capital of the Corporation — The term "Paid Up Capital of the Corporation" shall refer to the total amount paid by stockholders for their subscriptions in the shares of stock of the corporation, including any amount paid over and above the par value or stated value of the share of stock (e.g., premium on capital). For this purpose, the taxpayers shall maintain complete and accurate records of the paid-up capital of the shareholders.

3.6 Taxable Income — The term "Taxable Income" means the excess amount of the pertinent items of gross income over the allowable deductions and/or personal and additional exemptions, if any, authorized under the Code or under any special law. 3.7 Taxable Year — The term "Taxable Year" means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is computed under Title II of the Code. Taxable year includes, in the case of a return made for a fractional part of a year, the period for which such return is made. The term "Fiscal Year" means an accounting period of twelve (12) months ending on the last day of any month other than December. 3.8 Substantial Change in the Ownership of the Business or Enterprise — The term "Substantial Change in the Ownership of the Business or Enterprise" shall refer to a change in the ownership of the business or enterprise as a result of or arising from its merger or consolidation or combination with another person in the manner as provided in subsection 2.4 of these Regulations. Any change in ownership as a result of or arising thereunder shall not be treated as a substantial change for as long as the stockholders of the party thereto, to whom the net operating loss is attributable, gains or retains 75% or more interest after such merger or consolidation or combination. 3.9 Merger — For purposes of these Regulations, the term "Merger" shall refer to the absorption of a corporation by another corporation, the latter retaining its own name and identity and acquiring the assets, liabilities, franchises and powers of the former, and the absorbed corporation ceasing to exist as a separate juridical person. 3.10 Consolidation — For purposes of these Regulations, the term "Consolidation" shall refer to a situation when two or more corporations are extinguished, and by the same process a new one is created, taking over the assets and assuming the liabilities of the said extinguished corporations; or the unification of two or more corporations into a single new corporation, having the combined capital, franchises and powers of all its constituents. 3.11 Combination — For purposes of these Regulations, the term "Combination" shall refer to a situation when an owner of a business, organized as a sole proprietorship, admits a partner in his business for the purpose of forming a co-partnership, or any such business combination which, in effect, is similar or synonymous thereto. 3.12 By or on Behalf of the Same Persons — The term "By or on Behalf of the Same Persons" shall refer to the maintenance of ownership despite change as when:

1. No actual change in ownership is involved in case the transfer involves change from direct ownership to indirect ownership, or vice versa.Illustration:

Facts: P Corporation owns Q Corporation that has NOLCO. P Corporation transfers Q Corporation's shares to R Corporation in exchange for 100% of R Corporation shares.

Held: Q Corporation's NOLCO is retained because Q Corporation's shares are held "by" R Corporation "on behalf of" P Corporation, the original owner.

2. No actual change in ownership is involved as in the case of merger of the subsidiary into the parent company.Illustration:

Facts: X Corporation owns 100% of Y Corporation. Y Corporation owns 100%, of Z Corporation. Z Corporation has NOLCO. Z Corporation is merged into Y Corporation.

Held: Z Corporation's NOLCO should be retained and transferred to Y Corporation. Prior to the merger, X Corporation already indirectly owned Z Corporation, i.e., Z Corporation's shares were held "by" Y Corporation "on behalf of" X Corporation. After the merger, X now directly owns Z Corporation [absorbed corporation] which continues to exist in Y Corporation.

Any reference in these Regulations to the "75% equity, ownership, or interest rule", "75% or more in nominal value", "75% or more interest", and other similar terms shall be construed within the context of this definition.

Notwithstanding the above, in determining whether there is actual change in ownership in the above-mentioned and similar cases, each and every step of the transaction shall be considered and the whole transaction or series of transactions shall be treated as a single unit.

Taxpayers Entitled to Deduct NOLCO from Gross Income. — Any individual (including estates and trusts) engaged in trade or business or in the exercise of his profession, and domestic and resident foreign corporations subject to the normal income tax (e.g., manufacturers and traders) or preferential tax rates under the Code (e.g., private educational institutions, hospitals, and regional operating headquarters) on their taxable income as defined in Section 3 of these Regulations shall be entitled to deduct from his/its gross income for the current year his/its accumulated net operating losses for the immediately preceding three (3) consecutive taxable years: Provided, however, that net operating losses incurred or sustained prior to January 1, 1998 shall not qualify for purposes of the NOLCO. Provided, further, that any provision of these Regulations notwithstanding, the following shall not be entitled to claim deduction of NOLCO: 4.1 Offshore Banking Unit (OBU) of a foreign banking corporation, and Foreign Currency Deposit Unit (FCDU) of a domestic or foreign banking corporation, duly authorized as such by the Bangko Sentral ng Pilipinas (BSP); 4.2 An enterprise registered with the Board of Investments (BOI) 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; 4.3 An enterprise registered with the Philippine Economic Zone Authority (PEZA), pursuant to R.A. No. 7916 , as amended, with respect to its PEZA-registered business activity. Its accumulated net operating losses incurred or sustained during the period of its PEZA registration shall not qualify for purposes of the NOLCO; 4.4 An enterprise registered under R.A. No. 7227 , otherwise known as the Bases Conversion and Development Act of 1992, e.g., SBMA-registered enterprises, with respect to its registered business activity. Its accumulated net operating losses incurred or sustained during the period of its said registered operation shall not qualify for purposes of the NOLCO; 4.5 Foreign corporations engaged in international shipping or air carriage business in the Philippines; and

4.6 In general, any person, natural or juridical, enjoying exemption from income tax, pursuant to the provisions of the Code or any special law, with respect to its operation during the period for which the aforesaid exemption is applicable. Its accumulated net operating losses incurred or sustained during the said period shall not qualify for purposes of the NOLCO.

Determination of Substantial Change in the Ownership of the Business. 5.1 Time of Determination of Substantial Change in the Ownership of the Business; Determined as of the End of the Taxable Year — The substantial change in the ownership of the business or enterprise shall be determined as of the end of the taxable year when NOLCO is to be claimed as deduction. Whether or not substantial change in ownership occurred shall be determined on the basis of any change in the ownership of interest in the said business or enterprise arising from or incident to its merger, or consolidation, or combination with another person (e.g., in the case of merger or consolidation of two or more corporations, such change shall be determined based on the ownership of the outstanding shares of stock issued or based on paid-up capital as of the end of the taxable year, and as a result of or arising from the said merger or consolidation). 5.2 When Change Occurs — A change in the ownership of the business occurs when the person who sustained net operating losses enters into a merger, or consolidation or combination with another person, thereby resulting to the transfer or conveyance of the said net operating losses, to another person, in the course of the said merger or consolidation or combination.

(a) When No Substantial Change Occurs — No substantial change in ownership of the business occurs if, as a result of the said merger or consolidation or combination, the stockholders of the transferor, or the transferor, in case of other business combinations, gains control of at least 75% or more in nominal value of the outstanding issued shares or paid-up capital of the transferee-assignee (in case the transferee-assignee is a corporation) or 75% or more interest in the business of the transferee-assignee (in case the transferee-assignee is other than a corporation).

(b) When Substantial Change Occurs — A substantial change in ownership of the business occurs if, as a result of the transaction referred to in subsection 5.2 (a) hereof, the stockholders of the transferor or the transferor, in case of other business combinations, gains control of the aforesaid transferee-assignee only to the extent of less than 75%.

Entitlement to Net Operating Loss Carry-Over.— 6.1 In General — In general, only net operating losses incurred by a qualified taxpayer for the period beginning January 1, 1998 may be carried over to the next three (3) immediately succeeding taxable years following the year of such loss for purposes of the NOLCO deduction. Provided, however, that for mines other than oil and gas wells, a net operating loss without the benefit of incentives provided for under Executive Order No. 226, otherwise known as the Omnibus Investments Code of 1987, as amended, incurred in any of the first ten (10) years of operation may be carried over as a deduction from taxable income for the next five (5) years immediately following the year of such loss. Provided, further, that the entire amount of the loss shall be carried over to the first of the five (5) taxable years following the loss, and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining (4) four years. 6.2 Transitory Apportionment of NOLCO, in Case of Corporation Using the Fiscal Year Accounting Period — In general, only net operating losses incurred beginning January 1, 1998 may be claimed as a NOLCO deduction. In the case of a corporation using a fiscal year accounting period as of the said dates whose result of operations for the fiscal year 1997-1998 shows a net operating loss, the allowable NOLCO for the succeeding fiscal years shall be determined, as follows:NOLCO for the entire fiscal year (1997-1998) xxxMultiplied by the ratio of: No. of months in 1998

———————————12 mos. covering FY 97-98 xxx

NOLCO to be carried over to FYs 1998-1999, 1999-2000,and/or 2000-2001 xxx

6.3 Where Taxpayer is Exempt, or Partly Exempt from Income Tax, or Enjoying Preferential Tax Treatment Under Special Laws — Net operating loss or losses incurred by any person who is exempt from income tax, or enjoying preferential tax treatment pursuant to the provisions of special laws, shall not be allowed a NOLCO deduction (e.g., any BOI-registered enterprise enjoying income tax holiday pursuant to E.O. No. 226, as amended, otherwise known as the Omnibus Investments Code of 1987; or any PEZA-registered enterprise enjoying preferential tax treatment or income tax holiday pursuant to R.A. No. 7916, as amended; any person enjoying preferential tax treatment pursuant to R.A. No. 7227, otherwise known as the Bases Conversion and Development Act of 1992. See Section 4 of these Regulations for further discussion).

In case any of the aforementioned persons is engaged in both registered and unregistered business activities under any of the aforesaid laws (e.g., a corporation with a BOI-registered activity enjoying income tax holiday; and other unregistered business activities not enjoying any BOI incentive) the net operating loss or losses sustained or incurred by the said BOI-enterprise from its registered activities shall not be allowed as NOLCO deduction from its gross income derived from the unregistered business activities. 6.4 Quarterly and Annual Availment of NOLCO — NOLCO shall be allowed as deduction in computing the taxpayer's income taxes per quarter and annual final adjustment income tax returns: Provided, however, that if per the taxpayer's final annual adjustment income tax return, the entire operations for the year resulted to a net operating loss, such net operating loss may be claimed as NOLCO deduction in the immediately succeeding taxable year: Provided, further, that NOLCO may be claimed as deduction only within a period of three (3) consecutive taxable years immediately following the year the net operating loss was sustained or incurred. In order that compliance with this three-year statutory requisite may be effectively monitored, the taxpayer shall, at all times, show its NOLCO deduction, in its income tax return, as a

separate item of deduction. In no case may NOLCO be claimed, as a part of the taxpayer's other itemized deductions, like under deduction of "losses," in general. 6.5 NOLCO in Relation to the Minimum Corporate Income Tax (MCIT) — In general, domestic and resident foreign corporations subject to the normal income tax rate are liable to the 2% MCIT, if applicable, computed based on gross income, whenever the amount of the MCIT is greater than the normal income tax due (computed with the benefit of NOLCO, if any), pursuant to Sections 27 or 28 of the Code. Thus, such corporation cannot enjoy the benefit of NOLCO for as long as it is subject to MCIT in any taxable year. Provided, however, that the running of the three-year period for the expiry of NOLCO is not interrupted by the fact that such corporation is subject to MCIT in any taxable year during such three-year period.

Presentation of NOLCO in Tax Return and Unused NOLCO in the Income Statement. — The NOLCO shall be separately shown in the taxpayer's income tax return (also shown in the Reconciliation Section of the Tax Return) while the Unused NOLCO shall be presented in the Notes to the Financial Statements showing, in detail, the taxable year in which the net operating loss was sustained or incurred, and any amount thereof claimed as NOLCO deduction within three (3) consecutive years immediately following the year of such loss. Failure to comply with this requirement will disqualify the taxpayer from claiming the NOLCO.

BIR RULING NO. 206-90

Gentlemen :This refers to your letter dated June 25, 1990 requesting in behalf of your client, Porcelana Mariwasa, Inc. (PMI), a ruling confirming your opinion that the foreign exchange loss incurred by PMI is a deductible loss in 1990.It is represented that PMI is a corporation established and organized under Philippine laws; that it has existing US dollar loans from Noritake Company, Limited (Noritake) and Toyota Tsusho Corporation (Toyota) in the aggregate amounts of US $7,636,679.17 and US $3,054,671.27, respectively, that in 1989, the parties agreed to convert the said dollar denominated loans into pesos at the exchange rate prevailing on June 30, 1989; that in December 1989, both agreements were approved by the Central Bank subject to the submission of a copy each of the signed agreements incorporating the conversion; that thereafter, drafts of the amended agreements were submitted to the Central Bank for pre-approval; that on January 29, 1990, the Central Bank advised your office on their findings and comments on the said drafts which were considered and incorporated in the final amended agreements; that in June 1990, the parties submitted to the Central Bank the signed agreements; that you are of the opinion that in the case of your client, the resultant loss on conversion of US dollar denominated loans to peso is more than a shrinkage in value of money; that the approval by the Central Bank and the signing by the parties of the agreements covering the said conversion established the loss, after which, the loss became final and irrevocable, so that recoupment is reasonably impossible; and that having been fixed and determinable, the loss is no longer susceptible to change, hence, it could fairly be stated that such has been sustained in a closed and completed transaction.In reply, please be informed that the annual increase in value of an asset is not taxable income because such increase has not yet been realized. The increase in value i.e., the gain, could only be taxed when a disposition of the property occurred which was of such a nature as to constitute a realization of such gain, that is, a severance of the gain from the original capital invested in the property. The same conclusion obtains as to losses. The annual decline in the value of property is not normally allowable as a deduction. Hence, to be allowable the loss must be realized. (Surre Warren, Federal Income Taxation (1950, pp. 422-4) When foreign currency acquired in connection with a transaction in the regular course of business is disposed ordinary gain or loss results from the fluctuations. (Pr Hall Federal Taxes, Vol. 1, par. 6261) The loss is deductible only for the year it is actually sustained. It is sustained during the year in which the loss occurs as evidenced by the completed transaction and as fixed by identifiable occurring in that year. (par, 6570, 34 Am. Jur. 2d, 1976 closed transaction is a taxable event which has been consummated (p. 231 Black Law's Dictionary, Fifth Editions) No taxation event has as yet been consummated prior to the remittance of the scheduled amortization. Accordingly, your request for confirmation of your aforesaid opinion is hereby denied considering that foreign exchange losses sustained as a result of conversion or devaluation of the peso vis-a-vis the foreign currency or US dollar and vice versa but which remittance of scheduled amortization consisting of principal and interests payment on a foreign loan has not actually been made are not deductible from gross income for income tax purposes.

BIR RULING NO. 144-85

Gentlemen :This refers to your letter dated July 1, 1985 requesting a ruling as to whether foreign exchange losses which have accrued by reason of devaluation are deductible for income tax purposes. The losses arose from matured but unremitted principal repayments on loans affected by the debt restructuring program in the Philippines.In reply thereto, I have the honor to inform you that annual increase in value of an asset is not taxable income because such increase has not yet been realized. The increase in value, i.e., the gain, could only be taxed when a disposition of the property occurred which was of such a nature as to constitute a realization of such gain, that is, a severance of the gain from the original capital invested in the property. The same conclusion obtains as to losses. The annual decrease in the value of property is not normally allowable as a loss. Hence, to be allowable the loss must be realized. (Surrey and Warren, Federal Income Taxation (1950), pp. 422-4)When foreign currency acquired in connection with a transaction in the regular course of business is disposed of ordinary gain or loss results from the fluctuations. (Prentice-Hall Federal Taxes, Vol. 1, par. 6261) The loss is deductible only for

the year it is actually sustained. It is sustained during the year in which the loss occurs as evidenced by closed and completed transaction and as fixed by identifiable events occurring in that year. (par. 6570, 34 Am Jur 2d, 1976) A closed transaction is a taxable event which has been consummated. (p. 231 Black's Law Dictionary, Fifth Edition) No taxable event has as yet been consummated prior to the remittance of the scheduled amortization. Accordingly, foreign exchange losses sustained as a result of devaluation of the peso vis-a-vis the foreign currency e.g., US dollar, but which remittance of scheduled amortization consisting of principal and interests payments on a foreign loan has not actually been made are not deductible from gross income for income tax purposes.

REVENUE REGULATIONS NO. 05-99 (Implementing Section 34(E) of the Tax Code of 1997 on the Requirements for Deductibility of Bad Debts from Gross Income)

Definition of Terms. — For purposes of these regulations, the following words and phrases shall have the following meaning, viz: a. "Bad debts" — shall refer to those debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered. b. "Securities" — shall mean shares of stock in a corporation and rights to subscribe for or to receive such shares. The term includes bonds, debentures, notes or certificates, or other evidence of indebtedness, issued by any corporation, including those issued by a government or political subdivision thereof, with interest coupons or in registered form. c. "Actually ascertained to be worthless" — In general, a debt is not worthless simply because it is of doubtful value or difficult to collect. Worthlessness is not determined by an inflexible formula or slide rule calculation but upon the exercise of sound business judgment. The determination of worthlessness in a given case must depend upon the particular facts and the circumstances of the case. A taxpayer may not postpone a bad debt deduction on the basis of a mere hope of ultimate collection or because of a continuance of attempts to collect notes which have long become overdue, and where there is no showing that the surrounding circumstances differ from those relating to other notes which were charged off in a prior year. While a mere hope probably will not justify postponement of the deduction, a reasonable possibility of recovery will permit the account to be carried along notwithstanding that the probabilities are that the debt may not be collected at all. The creditor may offer evidence to show some expectation that the debt would have been paid in the intervening years, and that subsequently, the hope was shattered or appeared to have been unfounded. If, for example, the creditor could show that during the years he attempted to collect the debt, the debtor had property the title of which was in dispute but which would enable him to pay his debts when the title was cleared, the creditor would be entitled to defer the deduction on the ground that there was no genuine ascertainment of worthlessness.Thus, accounts receivable, the amount whereof is insignificant and the collection of which through court action may be more costly to the taxpayer, may be written-off as bad debts even without conclusive evidence that the taxpayer's receivable from a debtor has definitely become worthless.

Good faith does not require that the taxpayer be an "incorrigible optimist" but on the other hand, he may not be unduly pessimistic. Creditors do not have to wait until some turn of the wheel of fortune may bring their debtors into affluence. The taxpayer may strike a middle course between pessimism and optimism and determine debts to be worthless in the exercise of sound business judgment based upon as complete information as is reasonably ascertainable. The taxpayer need not have perfect discernment. d. "Actually charged off from the taxpayers books of accounts" — This phrase means that the amount of money lent by the taxpayer (in the course of his business, trade or profession) to his debtor had been recorded in his books of account as a receivable has actually become worthless as of the end of the taxable year, that the said receivable has been cancelled and written-off from the said taxpayer's books of account. A mere recording in the taxpayer's books of account of estimated uncollectible accounts does not constitute a write-off of the said receivable, hence, shall not be a valid basis for its deduction as a bad debt expense. In no case may any bad debt deduction be allowed unless the facts pertaining to the money or property lent and its cancellation or write-off from the taxpayer's accounting records, after having been determined that the same has actually become worthless, have been complied with by the taxpayer.

Requisites for Valid Deduction of Bad Debts From Gross Income. — General Rule. — In general, the requisites for deductibility of bad debts are: (1) There must be an existing indebtedness due to the taxpayer which must be valid and legally demandable; (2) The same must be connected with the taxpayer's trade, business or practice of profession; (3) The same must not be sustained in a transaction entered into between related parties enumerated under Sec. 36(B) of the Tax Code of 1997 ; (4) The same must be actually charged off the books of accounts of the taxpayer as of the end of the taxable year; and (5) The same must be actually ascertained to be worthless and uncollectible as of the end of the taxable year.

Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to demonstrate with reasonable degree of certainty the uncollectibility of the debt. The Commissioner of Internal Revenue will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor in determining whether a debt is worthless, or the assigning of the case for collection to an independent collection lawyer who is not under the employ of the taxpayer and who shall report on the legal obstacle and the virtual impossibility of collecting the same from the debtor and who shall issue a statement under oath showing the propriety of the deductions thereon made for alleged bad debts. Thus, where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction.

Exception: In the case of banks, however, in lieu of requisite No. 5 above, the Bangko Sentral ng Pilipinas (BSP), thru its Monetary Board, shall ascertain the worthlessness and uncollectibility of the bad debts and it shall approve the writing off of the said indebtedness from the banks' books of accounts at the end of the taxable year. The bank though should still comply with requisites Nos. 1-4 as enumerated above before it can avail of the benefit of deduction.

Also, in no case may a receivable from an insurance or surety company be written-off from the taxpayer's books and claimed as bad debts deduction unless such company has been declared closed due to insolvency or for any such similar reason by the Insurance Commissioner.

Tax Benefit Rule. — The recovery of bad debts previously allowed as deduction in the preceding year or years shall be included as part of the taxpayer's gross income in the year of such recovery to the extent of the income tax benefit of said deduction.

Example: If in the year the taxpayer claimed deduction of bad debts written-off, he realized a reduction of the income tax due from him on account of the said deduction, his subsequent recovery thereof from his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said taxpayer did not benefit from the deduction of the said bad debt written-off because it did not result to any reduction of his income tax in the year of such deduction (i.e. where the result of his business operation was a net loss even without deduction of the bad debts written-off), then his subsequent recovery thereof shall be treated as a mere recovery or a return of capital, hence, not treated as receipt of realized taxable income.

Securities Becoming Worthless. — If securities, as defined under Sec. 2(b) hereof, held as capital asset, are ascertained to be worthless and charged off within the taxable year, the loss resulting therefrom shall be considered as a loss from the sale or exchange of capital asset made on the last day of such taxable year. The taxpayer, however, has to prove through clear and convincing evidence that the securities are in fact worthless.

This rule, however, is not true in the case of banks or trust companies incorporated under the laws of the Philippines, a substantial part of whose business is the receipt of deposits.

REVENUE MEMORANDUM ORDER NO. 38-83 (Guidelines for Allowance of Deductions for Certain Income Payments Under Section 30 (1) of the Tax Code.)

Background 1.1 Section 30 (1) of the National Internal Revenue Code, as amended by Batas Pambansa Blg. 135 , provides: "(1) Additional requirement for deductibility of certain payments. - Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income for which depreciation or amortization may be allowed under this section and Section 29 , shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance with this section, Sections 54 and 93 of this Code. " 1.2 The abovequoted provisions of the Tax Code is frequently cited by Revenue Examiners in their reports of investigation to justify disallowances of certain expense and other itemized deductions for which the taxpayer is obliged to make a withholding under Sections 54 and 93 of the Code and implementing regulations. Since the amounts otherwise deductible are substantial, some taxpayers have vigorously protested the literal application of the said provision in the audit and investigation of their income tax liabilities. 1.3 In order to minimize audit controversies and to achieve uniformity in implementing the aforequoted provision of Section 30(1), this Revenue Memorandum Order is hereby issued to prescribe guidelines that shall be observed by revenue officers for allowing or disallowing items of deductions referred to in the said Section.

The Rationale of Section 30(1) 2.1 PD 1351 which became effective April 17, 1978 added Section 30(1) to the Code (originally as paragraph (m) of Section 30) as an additional requirement for deductibility of itemized deductions representing income payments which are subject to withholding. Batas Pambansa Blg. 125 which was approved September 7, 1979 expanded the scope of the items of deductions subject to the requirement by including amounts taken into account in computing gross income for which depreciation or amortization may be allowed. The obvious purpose of this provision is to compel compliance with the requirements of Sections 54 and 93. 2.2 Considering that the existing ad valorem (surcharges and interests), as well as the specific penalties (fine and imprisonment), are adequate to compel taxpayers/withholding agents to comply with the requirements of the withholding tax law and regulations, outright disallowance of deductions representing income payment for mere failure to withhold and remit will in effect, in case of corporations, be tantamount to the imposition of additional 25% or 35% "surcharge" (equivalent to the normal corporate tax rates). 2.3 In order to minimize the onerous effect of literal application of Section 30(1), allowance or disallowance of a deduction falling under the said paragraph of Section 30 shall be determined in accordance with the following guidelines.

Guidelines For Applying Section 30(1). 3.1 An amount claimed as deduction on which a tax is supposed to have been withheld under Sections 54 and 93 shall be allowed if in the course of his audit and/or investigation, the examiner discovers that:

3.1/1 No withholding of creditable or final tax was made but the payee reported the income and the withholding agent/taxpayer pays during the original audit and investigation the surcharges, interest and penalties incident to the failure to withhold the tax.

3.1/2 No withholding of creditable or final tax was made and the recipient-payee failed to report the income on due date thereof, but the withholding agent pays during the original audit and investigation the amount supposed to have been withheld, inclusive of surcharges, interest and penalties incident to his failure to withhold.

3.1/3 The withholding agent erroneously underwithheld the tax but pays during the original audit and investigation the difference in the amount supposed to have been withheld, inclusive of surcharges, interest and penalties incident to such error. 3.2 Items of deductions disallowed due to non-compliance with Section 30 (1), the deficiency income tax assessment for which had been issued before the effectivity of this Revenue Memorandum Order may be allowed upon payment not later than May 15, 1984 of the withholding tax required and supposed to have been withheld and/or surcharges, interest and penalties. However, no refund or credit arising from such re-allowance of a previously disallowed deduction shall be granted.

SECTION 119. Personal, living, and family expenses. — Personal, living, and family expenses are not deductible. Insurance paid on a dwelling owned and occupied by a taxpayer is a personal expense and not deductible. Premiums paid for life insurance by the insured are not deductible. In the case of a professional man who rents a property for residential purposes, but incidentally receives his clients, patients, or callers in connection with his professional work (his place of business being elsewhere), no part of the rent is deductible as a business expense. If however, he uses part of the house for his office, such portion of the rent as is properly attributable to such office is deductible. Where the father is legally entitled to the services of his minor children, any allowances which he gives them, whether said to be in consideration of services or otherwise, are not allowable deductions in his return of income. Alimony, and an allowance paid under a separation agreement are not deductible from gross income.

SECTION 120. Capital expenditures. — No deduction from gross income may be made for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of the taxpayer's property, or for any amount expended in restoring property or in making good the exhaustion thereof for which an allowance for depreciation or depletion or other allowance is or has been made. Amounts expended for securing a copyright and plates, which remain the property of the person making the payments, are investments of capital. The cost of defending or perfecting title to property constitutes a part of the cost of the property and is not a deductible expense. The amount expended for architect's services is part of the cost of the building. Commissions paid in purchasing securities are a part of the cost of such securities. Commissions paid in selling securities are an offset against the selling price. Expenses of the administration of an estate, such as court costs, attorney's fees, and executor's commissions, are chargeable against the "corpus" of the estate and are not allowable deductions. Amounts to be assessed and paid under an agreement between bondholders or shareholders of a corporation, to be used in a reorganization of the corporation, are investments of capital and not deductible for any purpose in return of income.

In the case of a corporation, expenses for organization, such as incorporation fees, attorney's fees and accountants' charges, are ordinarily capital expenditures; but where such expenditures are limited to purely incidental expenses, a taxpayer may charge such items against income in the year in which they are incurred. A holding company which guarantees dividends at a specified rate on the stock of a subsidiary corporation for the purpose of securing new capital for the subsidiary and increasing the value of its stockholdings in the subsidiary may not deduct amounts paid in carrying out this guaranty in computing its net income, but such payments may be added to the cost of its stock in the subsidiary.

SECTION 121. Premiums on life insurance of employees. — Any amounts paid for premiums on any life insurance policy covering the life of an officer or employee or of any person financially interested in the business of the taxpayer when the taxpayer is directly or indirectly a beneficiary under such policy are not deductible.

SECTION 122. Losses from sales or exchanges of property. — No deduction is allowed in respect of losses from sales or exchanges of property, directly or indirectly —(a) Between members of a family. As used in Section 31, the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants;(b) Except in the case of distributions in liquidation, between an individual and a corporation more than fifty per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;(c) Except in the case of distributions in liquidation, between two corporations more than 50 per cent in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign personal holding company;(d) Between a grantor and a fiduciary of any trust;(e) Between the fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor with respect to each trust; or(f) Between a fiduciary of a trust and a beneficiary of such trust. (Section 32 of the Code)

SECTION 132. Definition of "capital assets." — The law provides that the term "capital assets" shall be held to mean property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in subsection (f) of Section 30 of the Code. The term "capital asset" includes all classes of property not specifically excluded by Section 30(a).

The exclusion from the term "capital assets" of property used in the trade or business of a taxpayer of a character which is subject to the allowance for depreciation provided in Section 30(f) of the Code is limited to property

used by the taxpayer in the trade or business at the time of the sale or exchange. It has no application to gains or losses arising from the sale of real property used in the trade or business to the extent that such gain or loss is allocable to the land, as distinguished from depreciable improvements upon the land. To such gain or loss allocable to the land, the limitations of Section 34(b) and (c) apply (such limitation may be inapplicable to a dealer in real estate, but, if so, it is because he holds the land primarily for sale to customers in the ordinary course of his trade or business, not because land is subject to a depreciation allowance). Gains or losses from the sale or exchange of property used in the trade or business of the taxpayer of a character which is subject to the allowance for depreciation provided in Section 30(f) of the Code, will not be subject to the percentage provisions of Section 34(b) and losses from such transactions will not be subject to the limitation of losses provided in Section 30(c). (Real property used in taxpayer's trade or business is no longer capital asset per Am. R.A. 82.)

SECTION 136. Basis for determining gain or loss from sale of property. — For the purpose of ascertaining the gain or loss from the sale or exchange of property, the basis is the cost of such property, or in the case of property which should be included in the inventory, its latest inventory value. But in the case of property acquired before March 1, 1913, when its fair market value as of that date is in excess of its cost, the gain to be included in gross income is the excess of the amount realized therefor over such fair market value. (See illustration I, Section 137 of these regulations). Also in the case of property acquired before March 1, 1913, when its fair market value as of that date is lower than its cost the deductible loss is the excess of such fair market value over the amount realized therefor. (See Illustration II, Id.). No gain or loss is recognized in the case of property sold or exchanged (a) at more than cost but less than its fair market value as of March 1, 1913 (See Illustration III, Id.), or (b) at less than cost but at more than its fair market value as of March 1, 1913. (See Illustration IV, Id., Id., Id.) In any case proper adjustment must be made in computing gain or loss from the exchange or sale of property for any depreciation or depletion sustained and allowable as deduction in computing net income; the amount of depreciation previously charged off by the taxpayer shall be deemed to be true depreciation sustained unless shown by clear and convincing evidence to be incorrect. What the fair market value of property was as of March 1, 1913, is a question of fact to be established by evidence which will reasonably and adequately make it appear. The nature and extent of the sales and the circumstances under which they were made should be considered. Prices received at forced sales or for small lots of property may be and often are no real indication of the value of the amount of property in question. For instance, sales from time to time of a small number of shares of stock is little indication of the value of a large or controlling interest in the corporation. If the taxpayer can not determine the cost of securities purchased prior to March 1, 1913, because of the loss, destruction, or failure to keep records, the value of the securities at the date of approximate date of acquisition may be used in determining the cost basis for purposes of computing the gain or loss from the sale of the securities. When the date or approximate date of acquisition is unknown, no general rule can be stated for determining the cost value of such securities. Each case must be considered separately upon its own facts.

SECTION 137. Illustrations of the computation of gain or loss from the sale or exchange of property acquired prior to March 1, 1913. — To avoid complexity no adjustment has been made in these examples for depreciation or depletion.In the case of property acquired before March 1, 1913, when its fair market value as of that date is in excess of its cost, the taxable gain is the excess of the amount realized therefor over such fair market value.

ILLUSTRATION IFair Market

Cost Value Sale Price Taxable gainMar. 1, 1913

P20,000 P30,000 P40,000 P10,000

Excess of amount realized over fairmarket value as of March 1, 1913.Gain attributed to the period priorto March 1, 1913 not taxable.

In the case of property acquired before March 1, 1913, when its fair market value as of that date is lower than its cost, the deductible loss is the excess of such fair market value over the amount realized therefor.

ILLUSTRATION IIFair Market

Cost Value Sale Price Taxable gainMar. 1, 1913

P20,000 P10,000 P6,000 P4,000

Excess of fair market value overamount realized. Loss attributable tothe period prior to March 1, 1913, notdeducible.

No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or disposed of at more than cost but at less than its fair market value as of that date.

ILLUSTRATION III

Fair MarketCost Value Sale Price Taxable gain

Mar. 1, 1913P20,000 P60,000 P40,000 No taxable gain or deductible loss.

Reason: A gain on whole transaction,which gain is attributed to period priorto March 1,1913.

No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or disposed of at less than cost but at more than its fair market value as of that date.

ILLUSTRATION IV

Fair MarketCost Value Sale Price Taxable gain

Mar. 1, 1913P20,000 P6,000 P10,000 No taxable gain or deductible loss.

Reason: A loss on whole transaction,which loss is attributable to periodprior to March 1, 1913.

Where the cost is equal to or greater than the fair market value as of March 1, 1913, and the selling price exceeds the cost, the gain to be included in gross income is the excess of the selling price over the cost.

ILLUSTRATION VFair Market

Cost Value Sale Price Taxable gainMar. 1, 1913

P20,000 P10,000 P40,000 P20,000

Reason: Gain on whole transaction,all of which is attributable to periodsubsequent to March 1, 1913.

Where the fair market value as of March 1, 1913, is equal to or greater than the cost and the selling price is less than the cost, the deductible loss is the amount by which the cost exceeds the selling price.

ILLUSTRATION VIFair Market

Cost Value Sale Price Taxable gainMar. 1, 1913

P20,000 P30,000 P10,000 P10,000Reason: Loss on whole transaction, allof which is attributable to periodsubsequent to March 1, 1913. Onlyactual loss sustained deductible.

SECTION 138. Sale of property acquired by gift. — In computing the gain or loss from the sale or other disposition of property acquired by gift, the basis shall be the selling price and the fair market value of the property at the time the gift was made, or its fair market value as of March 1, 1913, if acquired prior thereto, determined in accordance with the next two preceding sections. In the case of gifts made on or after July 1, 1939, the value taken as a basis for gift tax purposes shall be considered as the fair market value in computing gain or loss from the sale or other disposition of the property.

SECTION 139. Sale of property acquired by devise, bequests, or inheritance. — In computing the gain or loss from the sale or other disposition of property acquired by devise, bequest, or inheritance, the basis shall be the fair market price or value of such property at the time of the death of the decedent. The term "property acquired by bequest, devise, or inheritance" as used herein includes (a) such property interests as the taxpayer has received as the result of a transfer, or creation of a trust, in contemplation of or intended to take effect in possession or enjoyment at or after death, and (b) such property interest as the taxpayer has received as the result of the exercise by a person of a general power of appointment (1) by will, or (2) by deed executed in contemplation of or intended to take effect in possession or enjoyment at or after death. In the case of property acquired by gift, bequest, devise, or inheritance, prior to March 1, 1913, the taxable gain or deductible loss from the sale or other disposition thereof shall be computed in accordance with sections 136 and 137 of these regulations. In the case of property acquired by bequest, devise or inheritance, its value as appraised for the purpose of the inheritance tax shall be deemed to be its fair market value when acquired. DaIACS

SECTION 140. Exchange of property. — Gain or loss arising from the acquisition and subsequent disposition of property is realized only when as the result of a transaction between the owner and another person the property is converted into

other property (a) that is essentially different from the property disposed of, and (b) that has a market value. The requirement that the property received in exchange must be "essentially different from the property disposed of" implies that there must be a change in substance and not merely a change in form. By way of illustration, if a taxpayer owning ten shares of stock exchanges his stock certificate for a voting trust certificate, no income is realized. The term "market value" means the fair value of the property in money as between one who wishes to purchase and one who wishes to sell. It is not, however, what can be obtained for the property when the owner is under peculiar compulsion to sell or the purchaser to buy; nor is it a purely speculative value which an owner could not reasonably expect to obtain for the property although he might possibly be fortunate enough to do so. "Market value" is the price at which a seller willing to sell at a fair price and a buyer willing to buy at a fair price, both having reasonable knowledge of the facts, will trade. Evidence as to the assets and liabilities of a corporation and as to its earnings may furnish definite indications of the market value of its stock.

SECTION 141. Determination of gain or loss from the exchange of property. — The amount of income derived or loss sustained from an exchange of property is the difference between the market value at the time of the exchange of the property received in exchange and the original cost, or other basis, of the property exchange. If the property exchanged was acquired prior to March 1, 1913, see Sections 136 and 137 of these regulations.

SECTION 142. Readjustment of interest in a registered copartnership. — When a partner retires from a duly registered copartnership, or the partnership is dissolved, he realizes a gain or loss measured by the difference between the price received for his interest and the cost to him of his interest in the partnership including in such cost the amount of his share in any undistributed partnership net income earned since he became a partner on which the income tax has been paid. However, if such interest in the partnership was acquired prior to March 1, 1913, both the cost as hereinbefore provided and the amount of such interest as of date, plus the amount of the shares in any undistributed partnership net income earned since March 1, 1913, on which the income tax has been paid, shall be ascertained and the taxable gain derived or the deductible loss sustained shall be computed as provided in Sections 136 and 137 of these regulations. If the partnership distributes its assets in kind and not in cash, the partner realizes gain or suffers loss according to the market value of the property received in liquidation. Whenever a new partner is admitted, to a partnership, or any existing partnership is reorganized, the facts as to such change or reorganization should be fully set forth in the next return of income, in order that the Commissioner of Internal Revenue may determine whether any gain or loss has been realized by any partner.

SECTION 143. Basis of stock or securities acquired in "wash sales". — In the sale or other disposition of stocks or securities the acquisition of which (or the contract or option to acquire which) resulted in the non deductibility of the loss from the sale or other disposition of substantially identical stock or securities the basis shall be the basis of the substantially identical stock so sold or disposed of, increased or decreased, as the case may be, by the difference, if any, between the price at which the stock or securities was acquired and the price at which such substantially identical stock or securities were sold or otherwise disposed of. The application of this rule may be illustrated by the following examples:

EXAMPLE (1): A purchased a share of common stock of the X Corporation for P100 in 1936, which he sold January 15, 1940, for P80.00. On February 1, 1940, he purchased a share of common stock of the same corporation for P90.00. No loss from the sale is recognized under Section 33 of the Code. The basis of the new share is P110; that is, the basis of the old share (P100) increased by P10, excess of the price at which the new share was acquired (P90) over the price at which the old share was sold (P80).

EXAMPLE (2): A purchased a share of common stock of the X corporation for P100 in 1936, which he sold January 15, 1940, for P80. On January 1, 1940, he purchased a share of common stock of the same corporation for P70. No loss from the sale is recognized under Section 33 of the Code. The basis of the new share is P90; that is, the basis of the old share (P100) decreased by P10, the excess of the price at which the old share was sold (P80) over the price at which the new share was acquired (P70). (See Section 131 of these regulations).

RR 18-01 (See book)

RMR 1-02 (See book)

REVENUE AUDIT MEMORANDUM ORDER NO. 01-95 (Audit Guidelines and Procedures on the Proper Determination of the Income Tax Liability of Philippine Branches and Liaison Offices of Multi-National Enterprises (MNEs) Engaged in Soliciting Orders, Purchaser, Service Contracts, Trading, Construction and Other Activities in the Philippines.)

I. RationaleWhereas Revenue Audit Memorandum Order (RAMO) No. 1-86 dated April 25, 1986 imposes income tax on the gross income generated from constructive trading and commission income derived from brokering activities of Philippines branches of MNEs engaged in trading activities.Whereas RAMO No. 1-86 makes no recognition of such factors as the nature of item traded, the risk involved and participation of the local branch;Whereas the implementation of RAMO No. 1-86 makes use of much approximations and estimates;

Therefore, this Order is issued to revise RAMO No. 1-86 and to cover taxation of Philippine branches and liaison offices of MNEs engaged in soliciting orders, purchases, services contracts, trading, construction and other activities.With this Order, taxation of Philippine branches and liaison offices of MNEs engaged in soliciting orders, purchases, service contracts, trading, constructions and other activities becomes more practical, easy and equitable. At the same time, this Order addresses taxation of construction and other activities by the same Philippine branches and liaison offices of MNEs as separate undertakings.

II. ObjectivesThis Order is issued to: a) Amend and supersede RAMO No. 1-86 dated April 25, 1986 which provides for the procedures for tax audit of Philippine branches or foreign corporation. b) Address the issue on the proper determination of the income tax liability of Philippine branches and liaison offices of MNEs pursuant to Section 43 of the National Internal Revenue Code (NIRC) wherein the Commissioner of Internal Revenue (CIR) is authorized to distribute, apportion or allocate gross income or deduction among organizations in order to clearly reflect the income of any such organization. c) Provide guidelines on implementation of policies on the proper determination of the income tax liability of Philippine branches and liaison offices of MNEs. d) Prescribed the minimum procedure required in the audit of the income tax liability of Philippine branches and liaison offices of MNEs.

III. Coverage a) This Order shall pay only to Philippine branches and liaison of Japanese trading firms which are members of the Sogo Shoshas and registered with the Japanese Chamber of Commerce and Industry (JCCI), and also all other foreign trading companies similarly situated as determined by the Commissioner of Internal Revenue. b) Furthermore, the content of this Order will apply only to income tax liabilities of Philippine branches and liaison offices of MNEs and will not affect the withholding, including branch profit remittance, and business tax obligations of the same Philippine branches and liaison offices of MNEs which shall be subject to the provisions of the National Internal Revenue Code (NIRC).

IV. Guidelines1. The Philippine income tax due from soliciting orders, purchaser, service contracts, trading, construction and other activities of the Philippine branches and liaison offices of MNEs will be ascertained using the following formula.For solicitation and trading activities{(Worldwide Operating Sales to the Philippines attribution tax)}{( Income X Worldwide Sales X rate X rate )}For construction and other activitiesplus {(Net Income from construction and other activities X tax rate )}2. In implementing the above formula, the following terms shall be construed to mean as follows: (a) Worldwide (W/W) shall include head office accounts and those of branches located in difference countries but shall exclude subsidiary accounts. (b) W/W Operating Income shall include the Gross Income minus Selling General & Administrative expenses. Operating Income does not include non-operating and extraordinary items like interest expense, exchange profit/loss capital gains/losses or other income/loss not related not related to operation. (c) Sales to the Philippines shall be defined as the aggregated amount of exports and offshore transactions to the Philippines by the Head Office, all branches and liaison offices and shall include the amount of indent transactions from which commissions are generated. These shall also include imported materials and equipment of construction projects undertaken in the Philippines, but shall exclude local service income from construction projects or onshore income from local construction. (d) W/W Sales shall consist of domestic, export, import and offshore transactions which include nor only principal transactions but also indent transactions from which commissions are generated. (e) Attribution rate shall mean a rate of 75% to be applied against formula. (f) The tax rate to be applied shall be in accordance with Section 25(a) of the NIRC which is 35%. (g) Net income on construction shall consist of local service income from construction projects income from construction projects less the costs associated with local construction projects including the cost of locally purchased materials equipment, if any. (h) Net income on all other activities shall consist of income such as branches and liaison offices of MNEs are engaged in, net of costs and expenses associated with such income.3. In the application of the formula, no offsetting of losses from one line of business to the detriment of the other line of business shall be allowed. This would mean that the tax due from each line of business shall be computed independently from the other line of business.

V. Procedures1. Request documents containing information on the nature of business transactions of the taxpayer as follows: a) the structure of the Philippine branch or liaison office, the Home Office, other branches or more than 50% owned or controlled subsidiaries located outside the Philippines dealing with the local branch; b) the ownership, relationship, extent of control, directors and officers of the Philippine branch or liaison office and the Home Office; c) the business activity of the MNE and how it relates to the activity of the local branch or liaison office and other branches or more than 50% owned or controlled subsidiaries dealing with the local company

2. Ascertain the mathematical accuracy and completeness of the income tax return, financial statements and supporting schedules filed by the taxpayer.3. Require the submission of financial statements exclusive for transactions dealing with construction and all other activities and have a certified public accountant render an opinion as to its fairness and conformity with accepted accounting standards.For solicitation/trading activities4. Obtain a copy of the Worldwide Financial Statement duly certified by an independent public accountant of the country which issues the financial statements and authenticated by the Philippine Embassy or Consulate situated within the country where the Home Office of the MNE is located.5. Verify correctness of Worldwide Operating Income and the Worldwide Sales figures against the financial statements obtained in 4 above.6. Request for a summary of Sales to the Philippines duly certified by an independent public accountant and authenticated by the Philippine Embassy or Consulate situated within the country where the Home Office of the MNE is located. The Sales to the Philippine shall include the offshore portion of the local construction projects which includes the supply of machinery and equipment.7. Request for presentation of copies of pertinent sales invoices, bills of lading, freight and insurance coverages and other documents to verify Sales to the Philippines, on a test sampling basis.For construction activities8. Review all Contracts and analyze the nature of the Contracts, the parties involved, the terms and conditions, the total contract price, the payment and other pertinent information.9. Determine method of accounting, whether completed contract or the percentage of completion, and check the correctness of take up in the books of accounts.10. Segregate the income from exempt transactions from that of taxable transactions, if applicable.11. Determine the total contract price and composition of the project. The total contract price includes: a. Supply of Machinery and Equipment

(Sometimes referred to as the "offshore portion") xx b. Supply of Labor/Civil Works

(Sometimes referred to as the "onshore portion") xx——

Total Contract Price xx====

12. Verify that only the supply of local/civil works (onshore portion) is included in computation of profit/loss on local construction project.13. Determine if costs and expenses corresponded only to the service portion of the project referred to in 11 above.14. Be aware of charging of income and expenses by mere book entries using the branch/home office account.For all other activities15. Verify that all income from other activities are included as part of the gross income16. Ensure that only expenses related to the activities above are included in the determination of the net income.

REVENUE AUDIT MEMORANDUM ORDER NO. 01-86 (Procedure for Tax Audit of Philippine Branches of Foreign Corporations)

Background 1.1 Some branches of foreign corporations engage in business in the Philippines by soliciting orders from local importers. These branches are called "liaison offices or branches." Sales made from such solicitations are not reported by these branches as their own sales purportedly because the branch office merely relays to its head office abroad purchase orders from local importers and it is purportedly its head office that actually consummates the sales. At the end of the taxable period, the branch office simply reports for income tax purposes its purported share of the income generated from sales but the allocation of this purported share is left entirely at the discretion of its head office. The revenue service is completely at the mercy of multi-national companies. cda1.2 Some branches engage in business in the Philippines by soliciting orders from local importers and relays this information to its head office abroad. The head office in turn solicits prospective exporters for a compensation. At the end of the taxable period, the head office allocates a certain portion of the compensation to its branch in the Philippines. The branch in turn reports its purported share for income tax purposes but does not pay the commercial broker's tax thereon purportedly because the compensation was received from its head office and purportedly because the branch cannot be legally considered a commercial broker in relation to its head office since the branch and its head office possess only a single legal personality (PHILIPP BROTHERS OCEANIC, INC. vs. COMMISSIONER OF INTERNAL REVENUE, CTA Case No. 3140, March 8, 1984). Again, in this second situation, allocation of the compensation is left at the discretion of the head office — the revenue service also left at the mercy of these multi-national companies.

Legal Consequences2.1 The foregoing scope of activities of these branch offices is considered under R.A. 5455 as business acts. "'Doing business' shall include soliciting orders, purchases, service contracts opening offices, whether called 'liaison' offices or branches. . . . any other act or acts that imply a continuity of commercial dealings or arrangements, and contemplate to that extent the performance of acts or works, or the exercise of some of the functions normally incident to, and in progressive prosecution of, commercial gain or of the purpose and object of the business organization." (SEC. 1 (1), R.A. 5455).

2.2 These branch offices, like any other businesses, are required by law to account for their business operations in accordance with generally accepted accounting practices (SEC. 38, NIRC). Thus, a branch office although not possessing a separate and distinct juridical personality is, however, considered under generally accepted accounting practices as a distinct character, a separate business unit and should be "supplied by the home office with cash and merchandise and such other assets as may be needed" (Advance Accounting by Simons and Karrenbrock, 4th ed., p. 202). Generally accepted accounting practices also dictate that income and expenses of the branch shall be segregated from those of the home office in order to clearly reflect their respective operating results (ibid). cdasia2.3 The doctrine on corporate fiction is not absolute — the veil of corporate fiction may be legally pierced should it be used to subvert just application of laws. ". . . Where the corporate form or organization is adopted or a corporate entity is asserted in an endeavor to evade a statute or to modify its intent, courts will disregard the corporation or its entity. This has been applied to violations of . . . tax laws, . . ." (FLETCHER, 170-171, Commentaries and Jurisprudence on the Commercial Laws of the Philippines by Agbayani, Vol. 3, 1970 ed., p. 21). ". . . Where a corporation is a dummy, is unreal or a sham and serves no business purposes and is intended only as a blind, the corporate form may be ignored for the law cannot countenance a form that is bald and a mischievous fiction." (LIDDEL & CO. v. COLLECTOR OF INTERNAL REVENUE, L-9687, June 30, 1961, citing Gregory v. Helvering, 293 US 465, L. ed. 596-599; Higgins v. Smith, 1940, 308 US 406 L. ed., cited in p. 20, Commentaries and Jurisprudence on the Commercial Laws of the Philippines by Agbayani, Vol. 3, 1970 ed.). ". . . To allow a taxpayer to deny tax liability on the ground that the sales were made through another and distinct corporation when it is proved that the latter is virtually owned by the former or that they are practically one and the same is to sanction a circumvention of our tax laws." (ibid). Corporate fiction may be inquired upon where there is "inadequacy of capital . . ., confusion of affairs . . . and direct intervention in management causing inequitable results (Ballantine, 314; Rorhlick, 417-422).

Branch Operation and Consequences3.1 The Philippine branch solicits purchase orders from local buyers, relays the information to its home office abroad, and the home office purportedly directly makes the sale. In this type of operation: (i) Sales purportedly consummated abroad by the home office shall be treated as sales constructively consummated in the Philippines and made by the branch office, hence, income therefrom shall be considered income from sources within the Philippines; (ii) the branch shall record and report the gross selling price of commodities sold thru its home office; and (iii) report for income tax purposes its net income therefrom. (iv) Since under this situation, the import taxes, duties and charges have already been paid by the local buyers, the same shall not anymore be chargeable against the branch.

Under this paragraph, these transactions are treated sales constructively consummated by the branch office in accordance with generally accepted accounting practices required under Section 38 of the Tax Code since the branch solicitations are actually trading acts. Accordingly, the home office is obligated to supply its branch with merchandise in pursuing its trading business in the Philippines. Hence, sales purportedly made directly by its home office shall be considered no more than merely a constructive supplying of the merchandise to its branch which eventually constructively sells the same to Philippine buyers.3.2 The branch solicits purchase orders from local buyers, relays the information to its home office, the home office solicits prospective sellers abroad and eventually receives compensation for services rendered.

In this second type of operation: (i) the branch shall be considered "a commercial broker" or indentor; (ii) its share from compensation as allocated by its home office shall be subject to commercial broker gross receipts tax; (iii) the branch shall provide itself with the corresponding fixed tax as a commercial broker; and (iv) pay income tax on its share of the compensation.

Under this paragraph, the branch office shall be considered a commercial broker since its activities is well within the ambit of the term "broker". Brokers are ". . . those who are engaged for others in the negotiation of contracts relative to property with the custody of which they have no concern. They act as negotiators in bringing other persons together to bargain; generally, they ought not to sell in their own names, have no implied authority to receive payment, are not entrusted with the physical possession of the principal's goods when engaged to buy or sell, and have no special property therein or lien thereon." (8 Am. Jur. 889-890, cited in Philipp Brothers Oceanic, Inc. v. The Commissioner of Internal Revenue, CTA Case No. 3140, March 8, 1984).

Audit Procedure4.1 For constructive trading by branch office (a) Determine gross sales generated from branch's constructive trading (from solicitations made by the branch); (b) Require the Philippine branch to submit duly authenticated (i) income statement; and (ii) statement of cost of sales re worldwide operation of the entire corporation during the taxable year; (c) Extract the gross income generated from such constructive sales by applying against the gross constructive sales the gross profit rate shown in the cost of sale statement referred to in paragraph (b) (ii) above.

Illustration: Assume that the gross profit ratio, based on worldwide statement of cost of sales, is 20% and the gross constructive sales amounts to P1,000,000. Gross income therefrom shall be computed as follows:

Gross sales P1,000,000 Gross income therefrom (20% G/P rate) P200,000 (d) Check from the records of the Bureau of Customs all shipments coming from the branch's home office during the taxable year in determining the branch's constructive sales in the Philippines.

(e) Require the branch to reconcile computations of its constructive sales in the Philippines. 4.2 For broker activity by branch office (a) Verify veracity of the amount of compensation allocated to the branch by its home office; (b) Require submission of sworn declaration from home office on the correctness of the allocated share of the branch office and cross check this declaration in connection with the branch records re extent of solicitations undertaken in the Philippines during the tax year; (c) Require the branch to pay the corresponding fixed tax as a commercial broker; (d) Require the branch to pay the corresponding commercial broker's gross receipts tax, based on its total share from compensation derived for services rendered in the Philippines; and (e) Determine also the branch income tax obligation for the said income which is being considered income from sources within the Philippines.

REVENUE AUDIT MEMORANDUM ORDER NO. 04-86 (Audit Guidelines in the Allocation of Home Office Overhead Expenses Under Section 37(b) of the National Internal Revenue Code.)

In order to avoid delay and conflict in the determination of Philippine sources taxable net income of foreign taxpayers for purposes of Philippine income tax, this Revenue Audit Memorandum is issued.

Background 1.1 In computing net income from sources within the Philippines, Section 37(b) provides that from the gross income from sources within the Philippines ". . . there shall be deducted the expenses, losses and other deductions properly allocated thereto and a ratable part of any expenses, interests and losses and other deductions effectively connected with the business or trade conducted exclusively within the Philippines which cannot be definitely allocated to some items or class of gross income . . . " casia1.2 These deductions are difficult to verify because substantial amounts thereof are incurred in the head office or elsewhere and the corresponding supporting documents and books of accounts are not accessible to local taxing authorities. 1.3 Heretofore only an audit certificate is presented to substantiate the deductions incurred abroad which are allocated and pro-rated to Philippine source gross income. 1.4 In implementing the above provision of the National Internal Revenue Code, there is a need for adequate and satisfactory proof and explanations in order that the claimed deductions of the foreign taxpayer may be allowed for income tax purposes.

Audit Procedure 2.1 Functional analysis — At the start of investigation there should be a detailed examination of the functions performed both by the Home Office and the Local Branch. For this purpose, an organization and functional chart of the home office and local branch should be secured. 2.11 The functions should be determined and then listed. Who does what? What is required to do it? Who needs whom for what? 2.12 After having listed the functions performed by each entity, the functions themselves must be analyzed. Could anyone else perform these functions? How difficult are they? What skill, equipment and processes are needed?2.2 On the basis of the functional analysis, the claimed deduction properly allocable can now be determined by applying the tests of (a) relevance (necessary) to the local branch and (b) reasonable (ordinary) charges keeping always in mind the arm's length principle in transactions between related parties. 2.3 As to the deductions which cannot be definitely allocated, the following are required: 2.31 Breakdown or Schedule of Home or Foreign Office expenses being pro-rated, together with an explanation of the nature of each expense. Take note of deductions which are directly allocable to income earned outside the Philippines. 2.32 Basis of pro-ration — (a) Determine if the basis and method of pro-ration are being applied consistently from year to year. (b) Is the same amount of Home Office expenses being allocated world-wide?

In all instances, be on the lookout for: a. Charges applicable to newly opened foreign branches but are being claimed as deductions by the Philippine branch; b. Functions are being performed for some branches but not for others, and yet no adjustments are made on the allocation; c. or any other scheme of over-allocating costs to the Philippine branch.

REVENUE REGULATIONS NO. 2-98 issued May 17, 1998 prescribes the regulations to implement Republic Act (RA) No. 8424 relative to the Withholding on Income subject to the Expanded Withholding Tax and Final Withholding Tax, Withholding of Income Tax on Compensation, Withholding of Creditable Value- Added Tax and Other Percentage Taxes. Said Regulations will take effect on compensation income paid beginning January 1,1998. No penalties for non-compliance with the new features of the Tax Code will apply until May 15, 1998.