2ND Exam Coverage

I. GENERAL PRINCIPLES:

All items of income are subject to income tax, unless clearly exempted under specific provisions of the Internal Revenue Code. (Section 31 NIRC) Items of income include interests and gains from dealings in property. (Section 32 NIRC) Interests are, generally, subject to the ordinary income tax rates. They enjoy a special income tax rate treatment only if there are specific provisions of the Internal Revenue Code granting such special income tax rate treatment. (See Section 24 and Section 27 NIRC) The ordinary income tax rates for individual taxpayers are specified in Section 24 of the National Internal Revenue Code. The ordinary income tax rate for corporations is currently thirty two percent (32%). (See Section 27(A) NIRC)

2. FOR INDIVIDUALS:

Interests from bank deposits, or from deposit substitutes, or from trust funds are subject to a final income tax of twenty percent (20%). (Section 24(B) NIRC) Interests from depository banks under the expanded foreign currency deposit system are subject to a final income tax of seven and one-half percent (7-1/2%). (Section 24(B) NIRC) Interests from long-term deposit or investment (in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments evidenced by certificates) in such form prescribed by the Bangko Sentral ng Pilipinas (BSP), with maturities of five years or more, are exempted from income tax, unless pre-terminated before the fifth year. (Section 24(B) NIRC) The exemption from income tax of interests from long-term deposit or investment applies only to individual taxpayers. It does not apply to corporations. (See Chapter III NIRC)

3. FOR DOMESTIC CORPORATIONS:

Interests received by a domestic corporation from bank deposits, or from deposit substitutes, or from trust funds are subject to a final income tax of twenty-percent (20%). (Section 27(D) NIRC) Interests received by a domestic corporation from a depository bank, under the expanded foreign currency deposit system, is subject to a final income tax of seven and one-half percent (7-1/2%). Interests received by depository banks from currency loans granted, under the expanded foreign currency deposit system, to residents are subject to a final income tax of ten percent (10%). All other interests that are not from bank deposits, or from deposit substitutes, or from trust funds, or from the expanded foreign currency deposit system are subject to the normal corporate rate of thirty two percent (32%).

4. CAPITAL GAINS:

Section 32(B)(7)(g) does not apply to interest income. It applies only to gains derived from dealings in property. To be more precise, Section 32(B)(7)(g) deals with gains derived from the sale or exchange or retirement of specific type of property, namely, bonds, debentures, or other certificates of indebtedness. It exempts the gains from the sale or exchange or retirement of qualified bonds, debentures, or other certificates of indebtedness, but not the interests on the same bonds, debentures, or other certificates of indebtedness. In my view, the bonds, debentures, or other certificates of indebtedness that could qualify for exemption under Section 32(B)(7)(g) of the National Internal Revenue Code are only those long-term investments evidenced by certificates prescribed by the Bangko Sentral ng Pilipinas under Section 24(B)(1) and Section 25(A)(2) of the National Internal Revenue Code. No other bonds, debentures, or certificates of indebtedness would qualify under Section 32(B)(7)(g).

5. DISTINCTION BETWEEN INTERESTS AND GAINS:

Interests are ordinary income. They are fixed, periodic, and determinable income. Gains derived from dealings in property are not fixed, periodic, and determinable income. Gains arise from appreciation in the value of property. Appreciation in the value of property results from market forces. Gains derived from dealings in property are, strictly speaking, capital gains from the disposition of capital assets.

6. SOVEREIGN POWER TO TAX:

Exemption from taxation is a derogation of the sovereign power of the State to tax. Therefore, it must be strictly construed against the taxpayer. The taxing authority must deny the exemption, unless the law under which the exemption is claimed clearly grants it. Any doubt must be resolved in favor of the State. This rule is so important that even the Constitution itself provides that "No law granting any tax exemption shall be passed without the concurrence of a majority of all the members of the Congress." (Section 28(4), Article VI of the Constitution)

7. THE BIR RULING:

In its ruling dated 31 May 2001, the Bureau of Internal Revenue ruled that the zero bonds issued by the government are not subject to the withholding tax on deposit substitutes. The Bureau of Internal Revenue is correct. The interest on the zero bonds is not subject to the final income tax of twenty percent (20%). It is subject to the normal corporate tax of 32%. Therefore, there is no possibility of withholding a twenty percent (20%) final tax on the interest of the zero bonds. The interest on the zero bonds is not derived from bank deposits, or from deposit substitutes, or from trust funds, or from the expanded foreign currency deposit system. It is derived from the zero bonds themselves, which are not deposits substitutes. They are not marketed to twenty (20) or more lenders and, therefore, do not constitute public for income tax purposes. The interest on these zero bonds, therefore, is not subject to a special income tax rate treatment. It does not qualify for the final income tax of twenty percent (20%). It must, therefore, be subjected to the normal corporate rate of thirty two percent (32%) on corporations.

8. TAX REVENUE LOSSES:

In terms of tax revenue, the government stands to lose heavily in the zero bond transaction. From media reports, it seems the government issued in the aggregate P35,000,000,000.00 ten-year zero bonds and received in turn P10,170,000,000.00 in cash. If the cash received by the government of P10,170,000,000.00 is subtracted from the P35,000,000,000.00, which is the aggregate total of zero bonds issued, there remains a balance of P24,830,000,000.00, which will represent accumulated interest over the ten-year period of the zero bonds. Therefore, the tax revenue loss of the government will be P35,000,000,000.00 less P10,170,000,000.00 equals PP24,830,000,000.00 times 32% corporate tax equals P7,945,600,000.00.

9. POWER OF SUPERVISION AND CONTROL:

The Department of Finance has supervision and control over the Bureau of Internal Revenue (Section 1, NIRC). In addition, the Secretary of Finance has the power of review over the rulings of the Commissioner of Internal Revenue (Section 4, NIRC). Evidently, all these powers were not put into operation in this zero bond transaction. It is very likely that the huge tax revenue loss of the government and the enormous problem that is now full-blown could have been avoided if the Department of Finance exercised its powers over the Bureau of Internal Revenue.

National Internal Revenue Code of 1997 as amended (NIRC)

INCOME TAXATION

Income Tax is defined as a tax on all yearly profits arising from property, professions, trades, or offices, or as a tax on the person’s income, emoluments, profits and the like [Fisher v. Trinidad, 43 Phil. 981].

It may be succinctly defined as a tax on income, whether gross or net, realized in one taxable year.

Income tax is generally classified as an excise tax. It is not levied upon persons, property, funds or profits but upon the right of a person to receive income or profits.

In the Philippines, income tax is imposed on the net income of citizens, resident aliens, domestic corporations, and nonresident aliens and foreign corporations engaged in trade or business within the Philippines [Sec. 24 (A), Sec. 25 (A), Sec. 27 (A), Sec. 28 (A), NIRC]. It is also imposed on the gross income of nonresident aliens and foreign corporations-not doing business in the Philippines [Sec. 25 (B), (C), (D), Sec. 28

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(B), NIRC]. It is further imposed as a final tax on certain passive income (interests, royalties, prizes, and other winnings), cash and property dividends, capital gains from the sale of domestic shares of stock and real property classified as capital assets located in the Philippines [Sec. 24 (B), Sec. 25 (A) (2), (3), Sec. 27 (D), Sec. 28 (A), NIRC].

Income Tax Law aims to mitigate the evils arising from the inequalities of wealth by a progressive scheme of taxation which places the burden of on those best able to pay [Madrigal v. Rafferty & Concepcion, G.R. No. L-12287, August 7, 1918].

INCOME TAX SYSTEMS

GLOBAL TAX SYSTEM Under a global tax system, it did not matter whether the income received by the taxpayer is classified as compensation income, business or professional income, passive investment income, capital gain, or other income. All items of gross income, deductions, and personal and additional exemptions, if any, are reported in one income tax return, and one set of tax rates are applied on the tax base.

SCHEDULAR TAX SYSTEM Different types of incomes are subject to different sets of graduated or flat income tax rates. The applicable tax rate(s) will depend on the classification of the taxable income and the basis could be gross income or net income. Separate income tax returns (or other types of return applicable) are filed by the recipient of income for the particular types of income received.

SEMI-SCHEDULAR OR SEMI-GLOBAL TAX SYSTEM All compensation income, business or professional income, capital gain and passive income not subject to final tax, and other income are added together to arrive at the gross income, and after deducting the sum of allowable deductions, the taxable income is subjected to one set of graduated tax rates or normal corporate income tax. With respect to such income the computation is global. For those other income not mentioned above, they remain subject to different sets of tax rates and covered by different returns.

Note: The Philippines, under EO 37 (1986) and RA 8424 (1998), follows a semi-schedular and semi-global tax system.

FEATURES OF THE PHILIPPINE INCOME TAX LAW DIRECT TAX

The tax burden is borne by the income recipient upon whom the tax is imposed.

PROGRESSIVE -The tax rate increases as the tax base increases. It is founded on the ability to pay principle and is consistent with Sec. 28, Art. VI, 1987 Constitution.

COMPREHENSIVE- The Philippines has adopted the most comprehensive system of imposing income tax by adopting the citizenship principle, the residence principle, and the source principle. Any of the three principles is enough to justify the imposition of income tax on the income of a resident citizen and a domestic corporation that are taxed on a worldwide income.

SEMI-SCHEDULAR OR SEMI-GLOBAL TAX SYSTEM- The Philippines follows the semi-schedular or semi-global system of income taxation, although certain passive investment incomes and capital gains from sale of capital assets (namely: (a) shares of stock of domestic corporations, and (b) real property) are subject to final taxes at preferential tax rates.

NATIONAL TAX - It is imposed and collected by the National Government throughout the country.

EXCISE TAX - It is imposed on the right or privilege of a person to receive or earn income. It is not a personal tax or a property tax.

CRITERIA IN IMPOSING PHILIPPINE INCOME TAX

Citizenship or Nationality Principle- A citizen of the Philippines is subject to Philippine income tax

a) on his worldwide income, if he resides in the Philippines; or

b) only on his income from sources within the Philippines, if he qualifies as a nonresident citizen.

Residence Principle- A resident alien is liable to pay Philippine income tax on his income from sources within the Philippines but is exempt from tax on his income from sources outside the Philippines.

Source of Income Principle- An alien is subject to Philippine income tax because he derives income from sources within the Philippines. Thus, a non-resident alien or non-resident foreign corporation is liable to pay Philippine income tax on income from sources within the Philippines, such as dividend interest, rent, or royalty, despite the fact that he has not set foot in the Philippines.

The income tax law adopts the most comprehensive tax situs of nationality and residence of the taxpayer and of the generally accepted and internationally recognized income tax base. [Tan v. De Rosario, G.R. No. 109289 October 3, 1994] Resident citizens and domestic corporations are subjected to income tax liability on their income from all sources within and without the Philippines. The law adopts the source rule with respect to income received by taxpayers, other than resident citizens and domestic corporations.

TYPES OF PHILIPPINE INCOME TAX

1. Graduated income tax on individuals 2. Normal corporate income tax on corporations 3. Minimum corporate income tax on corporations 4. Special income tax on certain corporations 5. Capital gains tax on sale or exchange of shares of

stock of a domestic corp. classified as capital assets 6. Capital gains tax on sale or exchange of real

property classified as capital asset 7. (7)Final withholding tax on certain passive

investment income paid to residents 8. Final withholding tax on income payments made to

non-residents 9. Fringe benefits tax on fringe benefits of supervisory

or managerial employees 10. Branch profit remittance tax 11. Tax on improperly accumulated earnings of

corporations

TAXABLE PERIOD

The accounting periods used in determining the taxable income of taxpayers are:

(1) Calendar Year - Accounting period of 12 months ending on the last day of December

(2) Fiscal Year - Accounting period of 12 months ending on the last day of any month other than December [Sec. 22(Q), NIRC]. (3) Short Period- Accounting period which starts after the first month of the tax year or ends before the last month of the tax year (less than 12 months).

INSTANCES WHEREBY SHORT ACCOUNTING PERIOD ARISES

1. When a corporation is newly organized. 2. When a corporation is dissolved. 3. When a corporation changes accounting period. 4. When the taxpayer dies.

"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 (Tax on Income).

Taxable year includes, in the case of return made for a fractional part of a year under the provisions of Title II, the period for which such return is made [Sec. 22 (P), NIRC].

WHEN CALENDAR YEAR SHALL BE USED IN COMPUTING TAXABLE INCOME:

1. If the taxpayer's annual accounting period is other than a fiscal year; or

2. if the taxpayer has no annual accounting period; or 3. If the taxpayer does not keep books of accounts; or 4. If the taxpayer is an individual [Sec. 43, NIRC].

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KINDS OF TAXPAYERS

DEFINITION OF EACH KIND OF TAXPAYER

Taxpayer- any person subject to tax imposed by Title II of the Tax Code [Sec. 22(N), NIRC].

Person- means an individual, a trust, estate or corporation [Sec. 22(A), NIRC].

For income tax purposes, taxpayers are classified generally as follows:

1. (1) Individuals2. (2) Corporations;3. (3) Partnerships; and 4. (4) Estates and Trusts.

INDIVIDUAL TAXPAYER

Citizens

1. Resident Citizens (RC) 2. Non-resident Citizens (NRC)

a. (a) Citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein.

b. (b) Citizen who leaves the Philippines during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis.

c. (c) Citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year.

d. (d) Citizen previously considered as non- resident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines Treated as NRC with respect to his income derived from sources abroad until the date of his arrival in the Philippines

Aliens

(1) Resident Alien

An alien actually present in the Philippines who is not a mere transient or sojourner is a resident for income tax purposes.

No/Indefinite Intention = RESIDENT: If he lives in the Philippines and has no definite intention as to his stay, he is a resident. A mere floating intention indefinite as to time, to return to another country is not sufficient to constitute him a transient.

Definite Intention = TRANSIENT: One who comes to the Philippines for a definite purpose, which in its nature may be promptly accomplished, is a transient.

Exception: Definite Intention but such cannot be promptly accomplished; If his purpose is of such nature that an extended stay may be necessary for its accomplishment, and thus the alien makes his home temporarily in the Philippines, then he becomes a resident.

(2) Non-resident Alien

Engaged in trade or business within the Philippines - If the aggregate period of his stay in the Philippines is more than 180 days during any calendar year.

Not engaged in trade or business within the Philippines - If the aggregate period of his stay in the Philippines does not exceed 180 days.

Special class of individual employees

Minimum Wage Earner

a) A worker in the private sector paid the statutory minimum wage;

b) An employee in the public sector with compensation income of not more than the statutory minimum wage in the non-agricultural sector where he/she is assigned.

Corporations

Includes all types of corporations, partnerships (no matter how created or organized), joint stock companies, joint accounts, associations, or insurance companies, whether or not registered with the SEC.

Excludes general professional partnerships (GPP), joint venture or consortium formed for the purpose of undertaking construction projects, joint venture or consortium engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the government.

(1) Domestic corporations – A corporation created and organized under its laws (the law of incorporation test).

(2) Foreign corporations – A corporation which is not domestic.

a. (a) Resident foreign corporations – Foreign corporation engaged in trade or business within the Philippines. Doing business – The term implies a continuity of commercial dealings and arrangements, and contemplates, 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 for the purpose and object of the business organization. [RA 7042, Foreign Investments Act] In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character [CIR v. BOAC]

b. (b) Non-resident foreign corporations – Foreign corporation not engaged in trade or business within the Philippines

(3) Joint venture and consortium – Essential factors of a joint venture or consortium:

a) Each party 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) There is a single business transaction.

Partnership

The Tax Code mandates that every other type of business partnership is subject to income tax in the same manner and at the same rate as an ordinary corporation.

General Professional Partnerships (GPP)

A general professional partnership is a partnership formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business.

Not considered as a taxable entity for income tax purposes. The partners themselves are liable, not the partnership, are liable for the payment of income tax in their individual capacities.

Estates and Trusts

Taxable estates and trusts are taxed in the same manner and on the same basis as an individual.

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Co-ownership

For income tax purposes, the co-owners in a co- ownership report their share of the income from the property owned in common by them in their individual tax returns for the year and the co- ownership is not considered as a separate taxable entity or a corporation.

INCOME TAXATION

DEFINITION

Income Tax is defined as a tax on all yearly profits arising from property, professions, trades, or offices, or as a tax on the person’s income, emoluments, profits and the like [Fisher v. Trinidad].

NATURE

Income tax is generally classified as an excise tax. It is not levied upon persons, property, funds or profits but upon the right of a person to receive income or profits.

GENERAL PRINCIPLES

o A resident citizen of the Philippines is taxable on all income derived from sources within and without the Philippines;

o A nonresident citizen is taxable only on income derived from sources within the Philippines;

o An individual citizen of the Philippines who is working and deriving income from abroad as an overseas contract worker is taxable only on income derived from sources within the Philippines: Provided, That a seaman shall be treated as an overseas contract worker if he is

citizen of the Philippines; and receives compensation for services

rendered abroad as a member of the complement of a vessel engaged exclusively in international trade

o An alien individual, whether a resident or not of the Philippines, is taxable only on income derived from sources within the Philippines;

o A domestic corporation is taxable on all income derived from sources within and without the Philippines; and

o A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. [Sec. 23]

INCOME DEFINITION

(a) income means all wealth which flows to the taxpayer other than a mere return of capital. It includes gain derived from the sale or other disposition of capital assets. Income is a gain derived from labor or capital, or both labor and capital; and includes the gain derived from the sale or exchange of capital assets.

(b) It is an amount of money coming to a person within a specified time, whether as payment for services, interest or profit from investment. Unless otherwise specified. It means cash or its equivalent. Income can also be thought of as a flow of the fruits of one's labor. [Conwi v. CTA, G.R. No. 48532 August 31, 1992]

(c) Income may be received in the form of cash, property, service, or a combination of the three. NATURE Income includes earnings, lawfully or unlawfully acquired, without consensual recognition, express or implied, of an obligation to repay and without restriction as their disposition. [James v. US, 366 US 213]

WHEN INCOME IS TAXABLE

Existence of taxable income

a) There is INCOME, gain or profit b) RECEIVED or REALIZED during the taxable year c) NOT EXEMPT from income tax

a. "The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit;

capital is a tree, income the fruit." A tax on income is not a tax on property. "Income," as here used, can be defined as "profits or gains." [Madrigal vs. Rafferty (1918)]

b. A mere increase in the value of property is not income, but merely unrealized increase in capital. [1 Mertens, Sec. 5.06]The increase in the value of property is also known as appraisal surplus or revaluation increment.

WHEN IS THERE INCOME? When there is a FLOW of wealth other than mere return of capital during the taxable period.

REALIZATION OF INCOME

Tests of Realization Actual vis-à-vis Constructive receipt

1. Actual receipt – Income is actually reduced to possession. The realization of gain may take the form of actual receipt of cash.

2. Constructive receipt– An income is considered constructively received when it is credited to the account of, or segregated in favour of a person. The person may withdraw the said account credited in his favor anytime without any substantial limitations or conditions upon which payment or enjoyment is to be made or exercised. Examples of constructive receipt of income are:

a. (1) Interest credited on savings bank deposit b. (2) Matured interest coupons not yet collected

by the taxpayer c. (3) Dividends applied by the corporation

against the indebtedness of a stockholder d. (4) Share in the profit of a partner in a general

professional partnership, although not yet distributed, is regarded as constructively received; or

e. (5) Intended payment deposited in court (consignation).

The doctrine of constructive receipt is designed to prevent the taxpayer using the cash basis from deferring or postponing the actual receipt of taxable income. Without the rule, the taxpayer can conveniently select the year in which he will report the income. [Dimaampao]

For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income or expense? The accrual of income and expense is permitted when the all-events test has been met. This test requires:

1. fixing of a right to income or liability to pay; and 2. the availability of the reasonable accurate

determination of such income or liability [CIR v. Isabela Cultural Corporation].

The “As If” Theory of Constructive Income is designed to prevent a cash basis taxpayer to delay reporting of income. It also resumes the existence of income on transactions supposedly not subject to tax. [Valencia and Roxas]

RECOGNITION OF INCOME

Methods of accounting in reporting income and expenses

Cash method vis-à-vis Accrual method–Cash method generally reports income upon cash collection and reports expenses upon payment. If earned from rendering of services, income is to be reported in the year when collected, whether earned or unearned. [Sec. 108, NIRC].

Accrual method generally reports income when earned and reports expense when incurred. If earned from sale of goods, income is to be reported in the year of sale, irrespective of collection. [Sec. 106, NIRC].

Income realized pertains to the accrual basis of accounting, when recognition of income in the books is when it is realized and expenses are recognized when incurred. It is the right to

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receive and not the actual receipt that determines the inclusion of the amount in gross income

Examples:

1. interest or rent income earned but not yet received 2. rent expense accrued but not yet paid 3. wages due to workers but remaining unpaid

Generally, trade and manufacturing businesses use accrual method while servicing businesses use cash method. If the service business opted to report on accrual basis, such method can only be applied when it comes to reporting of expense. To prevent tax evasion, individual taxpayers whose business consists of the sale of inventories cannot use cash method. [Valencia and Roxas]

Installment method vis-à-vis Deferred method vis-à-vis Percentage of completion method (in long- term contracts)

Installment Method is a special method of accounting whereby income on installment sales of property during the year is allowed to be reported in installments in proportion to the installment payments actually received in that year, which the gross profit realized or to be realized when payment is completed, bears to the total contract price [Sec. 49, NIRC].

Income may be reported on the installment basis in the following cases:

Sales of personal property by a dealer – A dealer who regularly sells or otherwise disposes of personal property on the installment plan

Sales of real property (inventory) and casual sales of personalty

1. casual sale or other casual disposition of personal property (not of a kind which would be includible in the inventory of the taxpayer if on hand at the close of the taxable year) where the selling price > P1,000 and the initial payments do not exceed 25% of the selling price, or

2. sale or other disposition of real property (inventory), if the initial payments do not exceed 25% of the selling price. Note: This sale is subject to creditable withholding tax and normal tax which is 30% for corporate taxpayer or 5% to 32% for individual taxpayer.

Sales of real property considered as capital asset by individuals

An Individual who sells or disposes of real property, considered as capital asset, if initial payments do not exceed 25% of the selling price, may pay the capital gains tax in installments [Sec. 49(C), NIRC]. Note: This sale is subject to a capital gains tax of 6% based on the selling price or zonal value, whichever is higher.

Note: Initial payments are the total payments received in cash or property (other than evidences of indebtedness such as promissory notes, mortgages given) by the seller upon or before the execution of the instrument of sale during the taxable year of the disposition of the real property. Considered as initial payments are the downpayment and all other payments received by the seller during the year of sale, including excess mortgage assumed by the buyer over the basis or cost of the property sold. It contemplates at least one other payment in addition to the initial payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no payment during the first year, the income may not be returned on the installment basis.

Selling Price - is the total amount or price of the sale including the cash or property received and all notes of the buyer or mortgages assumed by him.

Contract Price is the amount which the purchaser contracts to pay the seller in cash. It includes the excess of the mortgages assumed over the cost or other basis of the property sold

Change from accrual to installment basis

A taxpayer entitled to the benefits of a dealer in personal property may elect for any taxable year to report his taxable income on the installment basis. In computing his income for the year of change or any subsequent year, amounts actually received during any such year on account of sales or other dispositions of property made in any prior year shall not be excluded. [see Sec. 49(D), NIRC].

Deferred Payment

a) If the initial payments exceed 25% of the selling price, the gain realized may be reported on a deferred payment method.

b)The taxable gain or income returnable during the year of sale is the difference between the selling or contract price and the cost of the property, even though the entire purchase price has not been actually received in the year of sale.

c) The obligations of the purchaser received by the vendor are to be considered as equivalent of cash.

PERSONAL Property Real property Dealer Dealer in personal property who regularly sells in installment plan: Installment method

*held as ordinary asset regardless of amount of percentage of initial payments

Installment method; Provided, initial payments do not exceed 25% of selling price If exceeds 25%-- Deferred payment method

*held as inventory

Casual sale Installment method; Provided: (1) Selling price exceeds php1,000 (2) Initial payments do not exceed 25% of selling price

If either of 2 or both conditions not met— Deferred payment method

*personal property not considered inventorySale by individual

Installment method; Provided, initial payments do not exceed 25% of selling price

*held as capital asset

PERCENTAGE OF COMPLETION (IN LONG-TERM CONTRACTS)

Income from long-term construction contracts refers to the earnings derived from construction of a building, installation or other construction contract usually covering a period in excess of one year. When income is derived from long- term construction contracts, it is generally reported on the basis of percentage of completion made every year that will be evidence by the certificates of engineers or architects. The reportable income is calculated by deducting from the contract price the actual cost of construction.

In recognizing realized revenue for long-term construction contracts, accountants usually follow two methods:

i. Completed contract method – requires recognition of revenue only when the contract is finally completed; and

ii. Percentage of completion method – requires recognition of income based on the progress of work.

Long-term contracts are no longer allowed to be reported based on the completed contract method basis beginning January 1, 1998 pursuant to RA 8424; hence, all long- term contracts must be reported using the percentage of completion method.

Tests in determining whether income is earned for tax purposes

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(1) Realization test – no taxable income until there is a separation from capital of something of exchangeable value, thereby supplying the realization or transmutation which would result in the receipt of income (Eisner v Macomber). Thus, stock dividends are not income subject to income tax on the part of the stockholder when he merely holds more shares representing the same equity interest in the corporation that declared stock dividends (Fisher v Trinidad).

2. Claim of right doctrine (or Doctrine of Ownership, command, or control) – a taxable gain is conditioned upon the presence of a claim of right to the alleged gain and the absence of a definite unconditional obligation to return or repay that which would otherwise constitute a gain. To collect a tax would give the government an unjustified preference as to the part of the money that rightfully and completely belongs to the victim. The embezzler’s title is void.

(3) Economic benefit test, Doctrine of Proprietary Interest – any economic benefit to the employee that increases his net worth, whatever may have been the mode by which it is effected, is taxable. Thus, in stock options, the difference between the fair market value of the shares at the time the option is exercised and the option price constitutes additional compensation income to the employee at the time of exercise (not upon the grant or vesting of the right).

(4) Severance Test - Under the doctrine of severance test of income, in order that income may exist, is necessary that there be a separation from capital of something of exchangeable value. The income required a realization of gain.

(5) All Events Test – Under the accrual method of accounting, expenses are deductible in the taxable year in which:

1. all events have occurred which determine the liability; and

2. the amount of liability can be determined with reasonable accuracy.

“All events test” requires:

i. Fixing a right to income or liability to pay; and ii. The availability of reasonably accurate determination

of such income or liability.

All of the above tests are followed in the Philippines for purposes of determining whether income is received by the taxpayer or not during the year [Mamalateo].

GROSS INCOME

DEFINITION

Gross Income means the pertinent items of income referred to in Section 32(A) of the Tax Code. It includes all income derived from whatever source (unless exempt from tax by law), including, but not limited to, the following items:

1. Gross income derived from the conduct of Trade or business or the exercise of a profession

2. Rents 3. Interests 4. Prizes and winnings 5. Compensation for services in whatever form paid,

including, but not limited to fees, salaries, wages, commissions, and similar items

6. Annuities 7. Royalties 8. Dividends 9. Gains derived from dealings in property 10. Pensions 11. Partner’s distributive share from the net income of

the general professional partnership (GPP) [Sec 32A, NIRC]

The list here is NOT exclusive The term “gross income” whenever used without

qualification, is comprehensive, as defined above, and is different from the limited meaning of gross income for purposes of minimum corporate income tax or the gross income tax of corporations. Gross income includes gross profit from ordinary business and other income not subject to passive income tax or final withholding tax.

Gross income means income, gain, or profit subject to income tax.

It includes the compensation for personal services, business income, profits, and income derived from any source whatever (whether legal or illegal)

It excludes unless it is exempt from income tax under the Constitution, tax treaty, or statute or it is subject to final withholding income tax in accordance with the semi- global or semi-schedular tax system adopted by the Philippines.

It is the difference between gross sales/revenue and the cost of goods sold/services. The definition of gross income is broad and comprehensive to include proceeds from sales of transport documents. [Mamalateo]

CONCEPT OF INCOME FROM WHATEVER SOURCE DERIVED

“Income derived from whatever source” means inclusion of all income not expressly exempted within the class of taxable income under the laws irrespective of the voluntary or involuntary action of the taxpayer in producing the gains, and whether derived from legal or illegal sources (i.e. gambling, extortion, smuggling, etc.)

GROSS INCOME VIS-À-VIS NET INCOME VIS- À-VIS TAXABLE INCOME

(a) Gross income - means income, gain or profit subject to tax.

(b) Net income – means gross income less statutory deductions and/or exemptions [Sec. 31, NIRC]

(c) Taxable income – means the pertinent items of gross income specified in the Tax Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by the Tax Code or other special laws [Sec. 31, NIRC]. It is synonymous to the term “net income” [Valencia and Roxas]

CLASSIFICATION OF INCOME AS TO SOURCE

Source is ascribed to the place wherein the income is earned. It is governed by the situs of taxation. This classification of income is necessary to determine whether such income is subject to tax or not. Income may be:

(1) Derived entirely from sources within the Philippines [Se. 42A, NIRC]. Examples: compensation for labor or service derived from Philippine sources; interest on bonds, notes, deposits and the like earned in the Philippines; dividends declared by domestic corporations; rentals and royalties from property located within the Philippines; and gains, profits and income from sale of real property as well as from personal property in the Philippines. As a rule, incomes earned within the Philippines are taxable.

(2) Derived entirely from sources without the Philippines [Sec. 42C, NIRC]. Examples: compensation for labor or service rendered by overseas contract workers; interest on bonds, notes, deposits and the like earned abroad; dividends declared by nonresident foreign corporation; rental and royalties from property located outside the Philippines; and gains, profits and income from sale of real property as well as from personal property located outside the Philippines. As a rule, incomes earned with the Philippines are taxable.

(3) Derived from sources partly within or partly without the Philippines. Examples: gains, profits and income from transportation or other services rendered partly within and partly outside, and dividend received by a resident citizen from a resident foreign corporation. (Sec. 43(E), NIRC). In general, when an income is earned partly from within and partly from without, only income within is taxable in the Philippines, except if the taxpayer is a resident citizen or a domestic corporation. A Filipino citizen or a domestic corporation whose income is derived from within and without the Philippines is generally subject to tax.

SOURCES OF INCOME SUBJECT TO TAX

Compensation Income

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Income arising from an employer-employee (ER-EE) relationship. It means all remuneration for services performed by an EE for his ER, including the cash value of all remuneration paid in any medium other than cash [Sec. 78(A)], unless specifically excluded by the Tax Code.

It includes, but is not limited to, salaries and wages, honoraria and emoluments, allowances (e.g., transportation, representation, entertainment), commissions, fees (including directors’ fees, if the director is, at the same time, an employee of the payor-corporation), tips, taxable bonuses, fringe benefits except those subject to Fringe Benefit Tax (FBT) under Section 33 of the Tax Code, and taxable pensions and retirement pay (e.g. retirement benefits earned without meeting the conditions for exemption thereof, such as retirement of less than 50 years of age.)

General Rule: every form of compensation income is taxable regardless of how it is earned, by whom it is paid, the label by which it is designated, the basis upon which it is determined, or the form in which it is received. The basis upon which remuneration is paid is immaterial. It may be paid on the basis of piece of work, percentage of profits, hourly, weekly, monthly, or annually.

Exception: The term wages does NOT include remuneration paid:

1. For agricultural labor paid entirely in products of the farm where the labor is performed, or

2. For domestic service in a private home, or3. For casual labor not in the course of the employer's

trade or business, or 4. For services by a citizen or resident of the Philippines

for a foreign government or an int’l organization. [Sec. 78(A)]

Note: The term “agricultural labor” does not include services performed in connection with forestry, lumbering or landscaping.

The term “remuneration for domestic services” refers to remuneration paid for services of a household nature performed by an employee in or about the private home of the person whom he is employed. The services of household personnel furnished to an employee (except rank and file employees) by an employer shall be subject to the fringe benefits tax pursuant to Sec. 33 of the Tax Code. A private home is the fixed place of abode of an individual or family. If the home is utilized primarily for the purpose of supplying board or lodging to the public as a business enterprise, it ceases to be a private home and remuneration paid for services performed therein is not exempted. Services of the household nature in or about a private home include services rendered by cooks, maids, butlers, valets, laundresses, gardeners, chauffeurs of automobiles for family use. The remuneration paid for the services which are performed in or about rooming or lodging houses, boarding houses, clubs, hotels, hospitals or commercial officer or establishments is considered as compensation. Remuneration paid for services performed as a private secretary, even if they are performed in the employer’s home is considered as compensation.

The term “casual labor” includes labor which is occasional, incidental or regular. “Not in the course of the employer’s trade or business” includes labor that does not promote or advance the trade or business of the employer.

The term “remuneration paid for services performed as an employee of a foreign government or an international organization” includes not only remuneration paid for services performed by ambassadors, ministers and other diplomatic officers and employees but also remuneration paid for services performed as consular or other officer or employee of a foreign government or as a non-diplomatic representative of such government.

Compensation income including overtime pay, holiday pay, night shift differential pay, and hazard pay, earned by MINIMUM WAGE EARNERS (MWE) who has no other returnable income are NOT taxable and not subject to withholding tax on wages [RA 9504]Provided, however, that an employee shall not enjoy the privilege of being a MWE and, therefore, his/her entire earning are not exempt from income tax and, consequently, from withholding tax if he receives/earns

additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the allowable statutory amount of P30,000, taxable allowance, and other taxable income other than the statutory minimum wage (SMW), holiday pay, overtime pay, hazard pay and night shift differential pay.

MWEs receiving other income, such as income from the conduct of trade, business, or practice of profession, except income subject to final tax, in addition to compensation income are not exempted from income tax on their income earned during the taxable year.

This rule, notwithstanding, the SMW, Holiday Pay, overtime pay, night differential pay and hazard pay shall still exempt from withholding tax.

Forms of compensation and how they are assessed

(a) Cash – If compensation is paid in cash, the full amount received is the measure of the income subject to tax.

(b) Medium other than money – If services are paid for in a medium other than money (e.g. shares of stock, bonds, and other forms of property), the fair market value (FMV) of the thing taken in payment is the amount to be included as compensation subject to tax. If the services are rendered at a stipulated price, in the absence of evidence to the contrary, such price will be presumed to be the FMV of the remuneration received.

(c) Living quarters or meals - General Rule: The value to the employee of the living quarters and meals given by the employer shall be added to his compensation subject to withholding.

Exception: If living quarters/meals are furnished to an employee for the convenience of the employer the value needed NOT be included as part of compensation income.

(d) Facilities and privileges of a relatively small value - Facilities and privileges (such an 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 generally, are NOT considered as compensation subject to income tax and therefore 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.

Convenience of the Employer Rule Allowances in kind furnished to the employee for and as necessary incident to the performance of his duties are not taxable [Valencia and Roxas].

If meals, living quarters, and other facilities and privileges are furnished to an employee for the convenience of the employer, and incidental to the requirement of the employee’s work or position, the value of that privilege need not be included as compensation [Henderson v. Collector]

The amount of “de minimis” benefits confirming to the ceiling prescribed shall not be considered in determining the P30,000 ceiling of “other benefits” excluded from gross income under Section 32 (b)(7)(e) of the Tax Code, Provided, that the excess of the ‘de minimis’ benefits over their respective ceilings prescribed by these regulations shall be considered as part of “other benefits” and the employee receiving it will be subject to tax only on the excess over the P30,000 ceiling, Provided, further, that MWEs receiving, ‘other benefits’ exceeding the P30,000 limit shall be taxable on the excess benefits, as well as on his salaries, wages, and allowances, just like an employee receiving compensation income beyond the SMW. Any amount given by the employer as benefits to its employees, whether classified as “de minimis” benefits or fringe benefits, shall constitute as deductible expense upon such employer. Where compensation is paid in property other than money, the employer shall make necessary arrangements to ensure that the amount of the tax required to be withheld is available for payment to the BIR.

Classification of Gross Compensation Income

Basic salary or wage

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(1) Salary – earnings received periodically for a regular work other than manual labor. Example: monthly salary of an employee

(2) Wages – earnings received usually according to specified intervals of work, as by the hour, day, or week. Example: a carpenter’s wage.

Backwages are subject to income tax and withholding tax on wages [BIR Ruling No. DA- 073-2008]

Honoraria – payments given in recognition for services performed for which the established practice discourages charging a fixed fee. Example: honorarium of a guest lecturer

Fixed or variable allowances i.e. Transportation, Representation, and other allowances such as Cost of Living Allowances (COLA)

General Rule: Fixed or variable transportation, representation or other allowances that 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 tax. [Rev. Regs. 2-98]

Exception: Any amount paid specifically, either as advances or reimbursements for travelling, 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 tax, provided the following conditions are satisfied:

a) (a) It is for ordinary and necessary traveling and representation or entertainment expenses paid or incurred by the employee in the pursuit of the employer’s trade, business or profession; and

b) (b) The employee is required to account or liquidate for the foregoing expenses. The excess of actual expenses over advances made shall constitute taxable income if such amount is not returned to the employer. 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 Section 34 of the Tax Code.

Note: 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 are NOT subject to withholding tax on wages and substantiation requirements.

Commission – usually a percentage of total sales or on certain quota of sales volume attained as part of incentive such as sales commission.

Fees – received by an employee for the services rendered to the employer including a director’s fee of the company, fees paid to the public officials such as clerks of court or sheriffs for services rendered in the performance of their official duty over and above their regular salaries.

Tips and Gratuities – those paid directly to the employee (usually by a customer of the employer) which are not accounted for by the employee to the employer. (taxable income but not subject to withholding tax) [RR NO. 2-98, Sec. 2.78.1]

Hazard or Emergency Pay – additional payment received due to the workers’ exposure to danger or harm while working. It is normally added to the basic salary together with the overtime pay and night differential to arrive at gross salary.

Retirement Pay – a lump sum payment received by an employee who has served a company for a considerable period of time and has decided to withdraw from work into privacy. [RR 6-82, Sec. 2b]

In general, retirement pay is taxable except in the following instances:

(1) SSS or GSIS retirement pays.

(2) Retirement pay (R.A. 7641) due to old age provided the following requirements are met:

a) The retirement program is approved by the BIR Commissioner;

b) It must be a reasonable benefit plan. (Its implementation must be fair and equitable for the benefit of all employees)

c) The retiree should have been employed for 10 years in the said company;

d) The retiree should have been 50 years old or above at the time of retirement; and

e) It should have been availed of for the first time.

Separation pay – taxable if voluntarily availed of. It shall not be taxable if involuntary i.e. death, sickness, disability, reorganization/merger of company and company at the brink of bankruptcy or for any cause beyond the control of the said official or employee.

“For any cause beyond the control.” –

1. Connotes involuntariness on the part of the official or employee

2. The separation from the service of the official or employee must not be asked for or initiated by him.

3. The separation was not of his own making.4. 4. Such fact shall be duly established by the

employer by competent evidence which should be attached to the monthly return for the period in which the amount paid due to the involuntary separation was made.

5. (6) Amounts received by reason of involuntary separation remain EXEMPT from income tax even if the official or the employee, at the time of separation, had rendered less than ten (10) years of service and/or is below fifty (50) years of age.

6. (7)Any payment made by an employer to an employer to an employee on account of dismissal, constitutes compensation regardless of whether the employer is legally bound by contract, statute, or otherwise, to make such payment.

Pension – a stated allowance paid regularly to a person on his retirement or to his dependents on his death, in consideration of past services, meritorious work, age, loss, or injury. Pension is taxable unless the law states otherwise, OR unless the BIR approves the pension plan of a private company.

Vacation and sick leave- rules in determining whether money received for vacation and sick leave is taxable or not:

1. If paid or availed of as salary of an employee who is on vacation or on sick leave notwithstanding his absence from work, it constitutes TAXABLE compensation income. [RR 6-82, 2d]

2. Monetized value of unutilized VACATION leave credits of ten (10) days or less which were paid to private employees during the year, and the monetized value of vacation and sick leave credits paid to government officials and employees are NOT subject to income tax and to the withholding tax. These are ‘de minimis’ benefits.’ [RR no. 5-2011, Sec 2.78.1(A)(7)] Note: monetization of sick leave credits of private employees even if not exceeding 10 days is not exempt from income tax and withholding tax on wages.

3. Terminal leave or money value of accumulated vacation and sick leave benefits received by heir upon death of employee is not taxable.

Thirteenth month pay and other benefits - Not taxable if the total amount received is P30,000 or less. Any amount exceeding P30,000 is taxable. [Sec. 32 (7)e, NIRC]

Fringe Benefits and De Minimis

o Fringe Benefits – any good, service, or other benefit furnished or granted by an employer, in cash or in kind, in addition to basic salaries of an individual employee [Sec. 33, NIRC]

o De Minimis – privileges of relatively small value as given by the employer to his employees. Fringe Benefits and De Minimis are not considered compensation subject to income tax and withholding tax.

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Overtime Pay – premium payment received for working beyond regular hours of work which is included in the computation of gross salary of employee. It constitutes compensation.

Profit Sharing – the proportionate share in the profits of the business received by the employee in addition to his wages.

Awards for special services – awards for past services or suggestions to employers resulting in the prevention of theft or robbery, etc. are also compensations.

Beneficial Payments – such as where employer pays the income tax owed by an employee are additional compensation income.

Other forms of compensation – other forms received due to services rendered are compensation paid in kind, e.g., insurance premium paid by the employer for insurance coverage where the heirs of the employee are the beneficiaries is the employee’s income.

Note: Any amount which is required by law to be deducted by the employer from the compensation of an employee including the withheld tax is considered as part of the employee’s compensation and is deemed to be paid to the employee as compensation at the time the deduction is made. (This also applies to deductions not required by law.)

WITHHOLDING TAX ON COMPENSATION INCOME

The income recipient (i.e., EE) is the person liable to pay the tax on income, yet to improve the collection of compensation income of EEs, the State requires the ER to withhold the tax upon payment of the compensation income.

FRINGE BENEFITS

Special treatment of fringe benefits

Persons liable: The Employer (as a withholding agent), whether individual, professional partnership or a corporation, regardless of whether the corporation is taxable or not, or the government and its instrumentalities, is liable to remit the fringe benefit tax to the BIR once fringe benefit is given to a managerial or supervisory employee.

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

Managerial employee: one who is vested with the 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: 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.

All employees not falling within any of the above definitions are considered rank-and-file employees.

Fringe benefit tax is imposed on fringe benefits received by supervisory and managerial employees. The fringe benefits of rank and file employees are treated as part of compensation income subject to income tax and withholding tax on compensation.

Definition

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 employees) 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 and similar organizations

7. Expenses for foreign travel 8. Holiday and vacation expenses9. Educational assistance to the employee or his

dependents; and 10. Life or health insurance and other non-life insurance

premiums or similar amounts on excess of what the law allows.[Sec. 33(B)]

Tax Rate and Tax Base

1. Tax base is based on the grossed-up monetary value (GMV) of fringe benefits.

2. Rate is generally 32% 3. GMV represents:

a. the whole amount of income realized by the employee which includes the net amount of money or net monetary value of property that has been received; and

b. the amount of fringe benefit tax due from the employee which has been withheld and paid by the employer for and in behalf of his employee.

How GMV is determined

GMV is determined by dividing the actual monetary value of the fringe benefit by 68% [100% - tax rate of 32%]. For example, the actual monetary value of the fringe benefit is P1,000. The GMV is equal to P1,470.59 [P1,000 / 0.68]. The fringe benefit tax, therefore, is P470.59 [P1470.59 x 32%].

Special Cases:

(1) For fringe benefits received by non-resident alien not engaged in trade of business in the Philippines (NRANETB), the tax rate is 25% of the GMV. The GMV is determined by dividing the actual monetary value of the fringe benefit by 75% [100% - 25%].

(2) For fringe benefits received by alien individuals and Filipino citizens employed by regional or area headquarters, regional operating headquarters, offshore banking units (OBUs), or foreign service contractor or by a foreign subcontractor engaged in petroleum operations in the Philippines, or by any of their Filipino individual employees who are employed and occupying the same positions as those occupied by the alien employees, the tax rate is 15% of the GMV. The GMV is determined by dividing the actual monetary value of the fringe benefit by 85% [100% - 15%].

(3) What is the tax implication if the employer gives ‘fringe benefits’ to rank-and-file employees? Fringe benefits given to a rank- and-file employee are treated as part of his compensation income subject to normal tax rate and withholding tax on compensation income, except de minimis benefits and benefits provided for the convenience of the employer.

Payor of Fringe Benefit Tax (FBT): The employer withholds and pays the FBT but the law allows him to deduct such tax from his gross income.

Taxable and non-taxable fringe benefits

Fringe Benefits NOT subject to Tax

1. Fringe benefits not considered as gross income – i. (a) if it is required or necessary to the business of

employer ii. (b) if it is for the convenience or advantage of

employer 2. Fringe Benefit that is not taxable under Sec. 32 (B) –

Exclusions from Gross Income 3. Fringe benefits not subject to Fringe Benefit Tax:

i. (a) Fringe Benefits which are authorized and exempted from income tax under the Code or under special laws;

ii. (b) Contributions of the employer for the benefit of the employee for retirement, insurance and hospitalization benefit plans;

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iii. (c) Benefits given to the rank-and-file employees, whether granted under a collective bargaining agreement or not; and

iv. (d) Fringe benefits granted for the convenience of the employer;

v. (e) De minimis benefits

The exemption of any FB from the FBT shall not be interpreted to mean exemption from any other income tax imposed under the Tax Code except if the same is likewise expressly exempt from any other income tax imposed under the Tax Code or under any other existing law. Thus, if the FB is exempted from the FBT, the same may, however, still form of the employee’s gross compensation income which is subject to income tax; hence, likewise subject to withholding tax on compensation income payment.

De minimis benefits (exempt from income tax as well as withholding tax on compensation income of both managerial and rank and file EEs)

a)Monetized unused vacation leave credits of private employees not exceeding ten (10) days during the year;

b)Monetized value of vacation and sick leave credits paid to government officials and employees;

c) Medical cash allowance to dependents of employees, not exceeding P750 per employee per semester or P125 per month;

d)Rice subsidy of P1,500 or one (1) sack of 50 kg. rice per month amounting to not more than P1,500;

e)Uniform and Clothing allowance not exceeding P5,000 per annum (RR 8-2012)

f) Actual medical assistance, e.g. medical allowance to cover medical and healthcare needs, annual medical/executive check-up, maternity assistance, and routine consultations, not exceeding P10,000.00 per annum;

g)Laundry allowance not exceeding P300 per month; h)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;

i) Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum; and

j) Daily meal allowance for overtime work and night/graveyard shift not exceeding twenty- five percent (25%) of the basic minimum wage on a per region basis; [Revenue Regulation No. 5-2011]

All other benefits given by employers which are not included in the above enumeration shall NOT be considered as "de minimis" benefits and hence, shall be subject to withholding tax on compensation (rank and file employees) and FBT (managerial/supervisory employees).

Housing Privilege Fringe Benefit Tax Base (Monetary Value)

(1) LEASE of residential property for the residential use of employee

MV= 50% of lease payments where MV = monetary value of the FB

(2) Assignment of residential property owned by employer for use of employee

MV= [5% (FMV or ZV, whichever is higher) x 50%]

(3) Purchase of residential property in installment basis for the use of the employee

MV= 5% x acquisition cost exclusive of interest x 50%

(4) Purchase of residential property and ownership is transferred in the name of the employee

MV= FMV or ZV, whichever is highe

ZV = Zonal Value = value of the land or improvement, as declared in the Real Property Declaration Form FMV = Fair Market Value = FMV as determined by the Commissioner of Internal Revenue

Non-taxable housing fringe benefit:

(1) Housing privilege of the Armed Forces of the Philippines (AFP) officials – i.e, those of the Philippine Army, Philippine Navy, or Philippine Air Force

(2) A housing unit, which is situated inside of adjacent to the premises of a business or factory maximum of 50 meters from perimeter of the business premises

(3) Temporary housing for an employee who stays in housing unit for three months or less

MOTOR Vehicle

Motor Vehicle Fringe Benefit Tax Base(1) Purchased in the name of the employee

MV= acquisition cost

(2) Cash given to employee to purchase in his own nam

MV= cash received by employee

(3) Purchase on installment, in the name of employee

MV= acquisition cost exclusive of interest

(4) Employee shoulders part of the purchase price, ownership in the name of employee

MV= amount shouldered by employer

(5) Employer owns and maintains a fleet of motor vehicles for use of the business and of employees

MV= (AC/5) x 50%

(6) Employer leases and maintains a fleet for the use of the business and of employees

MV= 50% of rental payment

Professional Income Refers to fees received by a professional from the practice of his profession, provided that there is NO employer-employee relationship between him and his clients.

Income from Business

(a) Any income derived from doing business

(b) Doing business: The term implies a continuity of commercial dealings and arrangements, and contemplates, 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, the purpose and object of its organization.

Income from Dealings in Property

Dealings in property such as sales or exchanges may result in gain or loss. The kind of property involved (i.e., whether the property is a capital asset or an ordinary asset) determines the tax implication and income tax treatment, as follows:

Taxable Net Income = Ordinary Net Income + Net Capital Gains (other than those subject to final CGT)

Ordinary Asset Capital Asset Gain from sale and exchange or other disposition

Oridnary Gain ( Part of Gross income )

Capital Gain

Loss from sale, exchange, or other disposition

Ordinary Loss ( Part of allowable deductions from gross income)

Capital loss

Excess of Gain over losses

Part of Gross income Net Capital Gain Excess of losses over gains

Part Allowable Deduction from gross income

Net Capital Loss

Types of Properties

Capital vs Ordinary Assets

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Ordinary Assets Capital assets (1)Stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year.

Property held by the taxpayer, whether or not connected with his trade or business which is not an ordinary asset. Generally, they include:

(2) Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

(1) stocks and securities held by taxpayers other than dealers in securities

(3) Property used in the trade or business of a character which is subject to the allowance for depreciation, or

(2) real property not used in trade or business, such as residential house and lot, idle or vacant land or building

(4) Real property used in the trade or business of the taxpayer, including property held for rent.

(3)investment property, such as interest in a partnership, stock investment(4)Personal or non- business properties, such as family car, home appliances, jewelry.

TYPES OF GAINS FROM DEALINGS IN PROPERTY

(1) Ordinary income vis-à-vis Capital gain. – If the asset involved is classified as ordinary, the entire amount of the gain from the transaction shall be included in the computation of gross income [Sec 32(A)], and the entire amount of the loss shall be deductible from gross income. [Sec 34(D)]. (See Allowable Deductions from Gross Income - Losses)

If the asset involved is a capital asset, the rules on capital gains and losses apply in the determination of the amount to be included in gross income. (See Capital Gains and Losses). These rules do not apply to: (a) real property with a capital gains tax (final tax), or (2) shares of stock of a domestic corporation with a capital gains tax (final tax). Also, sale of shares of stock of a domestic corporation, held as capital assets, through the stock exchange by either individual or corporate taxpayers, is subject to ½ of 1% percentage tax based on gross selling price.

The following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net capital gain, net capital loss, and net income:

i. If the taxpayer is an individual – 100% if the capital asset has been held for not more than 12 months; and 50% of the capital asset has been held for more than 12 months

ii. If the taxpayer is a corporation – 100%, regardless of the holding period of the capital asset [Sec. 39(B), NIRC]

The tax rules for the gains or losses from sales or exchanges of capital assets over ordinary assets are as follows:

1. Net capital gain is added to ordinary gain but net capital loss is not deductible from ordinary gain.

2. Net ordinary loss is deductible from ordinary gain. 3. Capital losses are deductible only to the extent of

the capital gain.4. There is a net capital loss carry-over on the net

capital asset’s loss in a taxable year which may be deducted as a short-term capital loss from the net capital gain of the subsequent taxable year; provided that the following conditions shall be observed:

5. The taxpayer is other than a corporation; 6. The amount of loss does not exceed the income

before exemptions at the year when the loss was sustained; and

7. The holding period should not exceed 12 months. [Valencia]

When a capital gain or capital loss is sustained by a corporation, the following rules shall be observed:

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

2. Capital gains and losses are recognized to the extent of their full amount.

3. Capital losses are deductible only to the extent of capital gains.

4. Net capital losses are not deductible from ordinary gain or income but ordinary losses are deductible from net capital gains.

Note: For sale, barter, exchange or other forms of disposition of shares of stock subject to the 5%/10% capital gains tax on the net capital gain during the taxable year, the capital losses realized from this type of transaction during the taxable year are deductible only to the extent of capital gains from the same type of transaction during the same period. If the transferor of the shares is an individual, the rule on holding period and capital loss carry-over will not apply, notwithstanding the provisions of Section 39 of the Tax Code as amended. [RR 6-2008, c.4]

(1) Actual gain vis-à-vis Presumed gain

Presumed Gain: In the sale of real property located in the Philippines, classified as capital asset, the tax base is the gross selling price or fair market value, whichever is higher. The law presumes that the seller makes a gain from such sale. Thus, whether or not the seller makes a profit from the sale of real property, he has to pay 6% capital gains tax. In fact, her has to pay the tax, even if he incurs an actual loss from the sale thereof. (Note, however, that where an individual sells his real property classified as a capital asset to the government, he has the option whether to be taxed at the graduated income tax rates or at 6% capital gains tax.)

Actual Gain: The tax base in the sale of real property classified as an ordinary asset is the actual gain. If the seller incurs a loss from the sale, such loss may be deducted from his gross income during the taxable year. The ordinary gain shall be added to the operating income and the net taxable income shall be subject to the graduated rates from 5% to 32% (if an individual) or to 30% corporate tax or to 2% MCIT (if a corporation).

Computation of the amount of gain and loss- LIBOG PA MORE

Amount realized from sale or other disposition LESS basis or adjusted Basis = NET GAIN (LOSS)

Note: Amount realized from sale or other disposition of property = sum of money received + fair market value of the property (other than money) received

Note: When a taxpayer sells a real or personal property, he should deduct its cost from its selling price to measure the gain or loss from the sales transaction [Sec. 40, NIRC].

(2) Long term capital gain vis-à-vis Short term capital gain

Long-term capital gain: Capital asset is held for more than twelve month before it is sold. Only 50% of the gain is recognized.

Short-term capital Gain: Capital asset is held for less than 12 months. 100% of the gain is subject to tax.

(3) Net Capital Gain vis-à-vis Net Capital Loss

Net Capital Gain is the excess of the gains over the losses on sales or exchange of capital assets during the taxable year.

Net Capital Loss means the excess of the losses over the gains on sales or exchanges of capital assets during the taxable year. [Sec. 39A, NIRC]

(4) Computation of the amount of Gain or Loss

For income tax purposes the following rules should be observed regarding the cost and expenses of the capital assets:

1. the costs and expenses of the acquisition are to be capitalized, and

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2. the expenses of disposition are to be treated as reduction from the selling price. [Valencia]

Cost or basis of the property sold

In computing the gain or loss from the sale or other disposition of property, the BASIS shall be as follows:

a)Property acquired by purchase – its acquisition cost, i.e., the purchase price plus expenses of acquisition.

b)Property which should be included in the inventory – its latest inventory value [RR-2 sec 136]

c) Property acquired by devise, bequest or inheritance – its fair market price or value as of the date of acquisition (inheritance)

d)Property acquired by gift or donation – the basis is the same as it would be in the hands of the donor or at the last preceding owner by whom it was not acquired by gift, or the fair market value at the time the gift was made, whichever is lower

e)Property acquired for less than an adequate consideration in money’s worth – the amount paid by the transferee for the property

Cost or basis of the property exchanged in corporate reorganizations: Sales or exchanges resulting in non-recognition of gains or losses:

Exchange Solely in Kind –

1. If in pursuance of a plan of merger or consolidation, exchanges:

a. (a) Between the corporations which are parties to the merger or consolidation (property solely for stocks);

b. (b) Between a stockholder of a corporation party to a merger or consolidation and the other corporation, which is a party to the merger or consolidation (stock in a corporation solely for the stock of another corporation);

c. (c) Between a security holder of a corporation party to a merger or consolidation and the other corporation, which is a party to the merger or consolidation (securities solely for securities)

2. Transfer to a controlled corporation – a person transfers his property to a corporation in exchange for stocks in such a corporation, resulting in acquisition of corporate control by said person, alone or together with others not exceeding four (4).

Exchange Not Solely in Kind –

Gain, but not the loss, shall be recognized if, in connection with an exchange described in the above exceptions:

An individual, a shareholder, a security holder or a corporation receives not only stock or securities permitted to be received without the recognition of gain or loss, but also money and/or property.

The gain, if any, but not the loss, shall be recognized but in an amount not in excess of the sum of the money and the fair market value of such other property received.

As to the shareholder, if the money and/or other property received has the effect of a distribution of a taxable dividend, there shall be taxed as dividend to the shareholder an amount of the gain recognized not in excess of his proportionate share of the undistributed earnings and profits of the corporation.

The remainder, if any, of the gain recognized shall be treated as a capital gain [Sec. 40 (C) (3) (a), NIRC].

(b) The transferor corporation receives not only stock permitted to be received without the recognition of gain or loss but also money and/or other property, then –

o (i) if the corporation receiving such money and/or other property distributes it in pursuance of the plan of merger or consolidation, no gain to the corporation shall be recognized from the exchange, but

o (ii) if the corporation receiving such other property and/or money does not distribute it in

pursuance of the plan of merger or consolidation, the gain, if any, but not the loss to the corporation shall be recognized.

The gain shall be recognized in an amount not in excess of the sum of such money and the fair market value of such other property so received, which is not distributed [Sec. 40 (C) (3) (b), NIRC].

If an individual, stockholder, security holder or corporation receives on the exchange not only stock or securities but also money and/ or property (boot), the gain but not the loss shall be recognized, in an amount not exceeding the sum of the money and fair market value of the property received.

If the money or other property received has the effect of a distribution of a taxable dividend, there shall be taxed as dividend to the stockholder an amount of the gain recognized not in excess of his proportionate share of the undistributed earnings and profits of the corporation.

The remainder, if any, of the gain recognized shall be treated as a capital gain.

SUBSTITUTED BASIS OF STOCK OR SECURITIES RECEIVED BY TRANSFEROR UPON THE EXCHANGE:

Original basis (cost) of the property, stock or securities exchanged/transferred

LESS: (a) money received, if any; and (b) FMV of the other property received. Balance

ADD: (a) the amount treated as dividend of the shareholder; and (b) the amount of any gain that was recognized on the exchange. Basis (Cost) of the stock received

Notes:

o The property received as “boot” shall have as basis its FMV

o If as part of the consideration to the transferor, the transferee of property assumes a liability of the transferor or acquires from the latter property subject to a liability, such assumption or acquisition (in the amount of liability), shall be treated as money received by the transferor on the exchange

o If the transferor receives several kinds of stocks or securities, the Commissioner is authorized to allocate the basis among the several classes of stocks or securities received.

SUBSTITUTED BASIS OF PROPERTY TRANSFERRED

The basis of the property transferred in the hands of the transferee shall be the same as it would be in the hands of the transferor increased by the amount of the gain recognized to the transferor on the transfer [Sec. 40 (C)(5), NIRC].

Recognition of gain or loss in exchange of property:

General rule- Upon the sale or exchange of property, the ENTIRE amount of the gain or loss shall be recognized.

Exceptions- No gain or loss shall be recognized:

1. If in pursuance of a plan of merger or consolidation: i. (a) A corporation, which is a party to a merger or

consolidation, exchanges property solely for stock in a corporation, which is a party to the merger or consolidation;

ii. (b) A shareholder exchanges stock in a corporation, which is a party to a merger or consolidation, solely for the stock of another corporation also a party to the merger or consolidation; or

iii. (c) A security holder of a corporation, which is a party to the merger or consolidation, exchanges his securities in such corporation, solely for stock or securities in another corporation, a party to the merger or consolidation.

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2. If property is transferred to a corporation by a person in exchange for stock or unit of participation in such a corporation, of which as a result of such exchange, said person, alone or together with others not exceeding 4 persons, gains control of the corporation.

- Stocks issued for services shall not be considered as issued in property.

Meaning of merger, consolidation, control, securities

a) Merger and consolidation for tax purposes - shall mean (1) The ordinary merger or consolidation; or (2) The acquisition by one corporation of all or substantially all the properties of another corporation solely for stock [Sec. 40(C )(6)

b) (b), NIRC]. (b) Requirements to establish merger or consolidation

a. Must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation

b. In determining whether a bona fide business purpose exists, each and every step of the transaction shall be considered and the whole transaction or series of transaction shall be treated as a single unit

c. The property transferred must constitute a substantial portion of the property of the transferor [Sec. 40(C)(6)(b), NIRC]. Note: In determining whether the property transferred constitutes a substantial portion of the property of the transferor, the term ‘property’ shall be taken to include the cash assets of the transferor [Sec. 40(C)(b), NIRC].

c) “Substantially All”: the acquisition by one corporation of at least 80% of the assets, including cash, of another corporation, which has the element of permanence and not merely momentary holding.

d) Securities: bonds and debentures but not "notes" of whatever class or duration [Sec. 40(C)(6)(a), NIRC]

e) Control: ownership of stocks in a corporation possessing at least fifty-one percent (51%) of the total voting power of all classes of stocks entitled to vote [Sec. 40(C)(6)(c), NIRC].

(5) Income tax treatment of capital loss

(a) Capital loss limitation rule (applicable to both corporations and individuals)

General Rule: Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges [Sec. 39(C), NIRC].

EXCEPTION for Banks and Trust Companies: If a bank or trust company incorporated under the laws of the Philippines, a substantial part of whose business is the receipt of deposits, sells any bond, debenture, note, certificate or other evidence of indebtedness issued by any corporation (including one issued by a government or political subdivision thereof) with interest coupons or in registered form, any loss resulting from such sale shall not be subject to the foregoing limitation and shall not be included in determining the applicability of such limitation to other losses [Sec. 39(C), NIRC].

(b) Net loss carry-over rule (applicable only to individuals)

If an individual sustains in any taxable year a net capital loss, such loss (in an amount not in excess of the net income for the year) shall be treated in the succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than 12 months [Sec. 39(D), NIRC].

(6) Dealings in real property situated in the Philippines

Persons Liable and Transactions Affected

A. Individual taxpayers, estates and trusts (1) Sale or exchange or other disposition of real property considered as capital assets. (2) Includes "pacto de retro sale" and other conditional sale.

B.Domestic Corporation Sale or exchange or disposition of lands and/or building which are not actually used in business and are treated as capital asset.

Rate and Basis of Tax - A final withholding tax of 6% is based on the gross selling price or fair market value or zonal value whichever is higher.

Note: Gain or loss is immaterial, there being a conclusive presumption of gain.

(7) Dealings in shares of stock of Philippine corporations

Persons Liable to the Tax

A. Individual taxpayer, whether citizen or alien; B.Corporate taxpayer, whether domestic or foreign; and C.Other taxpayers not falling under (a) and (b) above, such

as estate, trust, trust funds and pension funds, among others.

Persons not liable

1. Dealers in securities 2. Investor in shares of stock in a mutual fund company 3. All other persons who are specifically exempt from

national internal revenue taxes under existing investment incentives and other special laws.

Shares listed and traded through the stock exchange other than sale by a dealer in securities.

(1) ½ of 1% of the gross selling price of the stock or gross value in money of the shares of stock sold, bartered, exchanged or otherwise disposed which shall be assumed and paid by the seller or transferor through the remittance of the stock transaction tax by the seller or transferor’s broker.

(2) Note: In the nature of percentage tax and not income tax; exempt from income tax per Section 127 (d): “Any gain derived from the sale, barter, exchange or other disposition of share of stock under this section shall be exempt from taxes imposed in Sections 24(C), 27(D)(2), 28(A)(8)(c), and 28(B)(5)(c) of this Code and from the regular individual or corporate income tax.”

(3) Note: Percentage tax under Sec. 127 is NOT DEDUCTIBLE for income tax purposes.

Shares not listed and traded through the stock exchange ---

Net capital gains derived during the taxable year from sale, exchange, or transfer shall be taxed as follows (on a per transaction basis):

Amount of capital Gain Tax Rate Not over 100,000 5%On any amout in excess of 100,000

10%

(8) Sale of principal residence

Principal residence: the family home of the individual taxpayer (RR 14-2000)

Disposition of principal residence (capital asset) is exempt from Capital Gains Tax, provided:

i. Sale or disposition of the old principal residence; ii. By natural persons - citizens or aliens provided that they

are residents taxable under Sec. 24 of the Code (does not include an estate or a trust);

iii. The proceeds of which is fully utilized in (a) acquiring or (b) constructing a new principal residence within eighteen (18) months from date of sale or disposition;

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iv. Notify the Commissioner within thirty (30) days from the date of sale or disposition through a prescribed return of his intention to avail the tax exemption;

v. Can only be availed of onlyonce every ten (10) years; vi. The historical cost or adjusted basis of his old principal

residence shall be carried over to the cost basis of his new principal residence

vii. If there is no full utilization, the portion of the gains presumed to have been realized shall be subject to capital gains tax.

viii. Portion of presumed gains subject to CGT: (Unutilized/GSP) x (higher of GSP or FMV)

Passive Investment Income

Under Sec 24(B), a final tax is imposed upon gross passive income of citizen and resident aliens. An income is considered passive if the taxpayer merely waits for it to be realized.

(a) Interest Income - An earning derived from depositing or lending of money, goods or credits [Valencia and Roxas] e.g., interest income from government securities such as Treasury Bills.

Unless exempted by law, interest income received by the taxpayer, whether or not usurious, is subject to income tax.

(b) Dividend Income A form of earnings derived from the distribution made by a corporation out of its earnings or profits and payable to its stockholders, whether in money or in property.

In general, dividends are included in the gross income of the stockholder, unless they are exempt from tax or subject to final ax at preferential rate under the Tax Code.

1. Cash dividend – Dividends are included in the gross income of the stockholder, unless they are exempt from tax or subject to tax at preferential rate under the NIRC. Cash dividend is the most common form of dividend, valued at the amount of money received by the stockholder. Cash dividend and property dividend are subject to income tax.

2. Stock dividend – Stock dividend is generally exempt from income tax, EXCEPT:

i. (a) If a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent that it represents a distribution of earnings or profits (Sec. 73(B), NIRC); or

ii. (b) Where there is an option that some stockholders could take cash or property dividends instead of stock dividends; some stockholders exercised the option to take cash of property dividends; and the exercise of option resulted in a change of the stockholders’ proportionate share in the outstanding share of the corporation.

3. Property dividend - Dividends are included in the gross income of the stockholder, unless they are exempt from tax or subject to tax at preferential rate under the NIRC. Cash dividend and property dividend are subject to income tax.

4. Liquidating dividend – Represents distribution of all the property or assets of a corporation in complete liquidation or dissolution. It is strictly not dividend income, but rather is treated in effect, as a sale of shares of stock resulting in capital gain or loss. The difference between the cost or other basis of the stock and the amount received in liquidation of the stock is a capital gain or a capital loss. Where property is distributed in liquidation, the amount received is the FMV of such property. The income is subject to ordinary income tax rates and NOT to the FWT on dividends.

SUMMARY OF TAXES ON DIVIDENDS

Tax exempt if :

1. Received from a domestic corporation by

a. Another domestic corporation b. Resident foregoing corporation

2. Received from a cooperative 3. Pure stock dividend4. Pure liquidating dividend (return of capital)

Subject to final tax

If received from a domestic corporation by a

1. Citizen or resident alien = 10% final tax 2. Nonresident alien doing business in the Philippines =

20% final tax 3. Nonresident alien not doing business in the

Philippines = 25% final tax 4. Non-resident foreign corporation = 20% final tax if

with reciprocity or 35 % if without reciprocity

Subject to Normal Tax

Dividends are subject to year end normal tax of individual or corporation if such dividends are

1. Not included as tax-exempt dividends2. Not subject to final tax3. Distributive shares of partner in professional

partnership

(a) Royalty Income - Royalty is a valuable property that can be developed and sold on a regular basis for a consideration; in which case, any gain derived therefrom is considered as an active business income subject to the normal corporate tax. Where a person pays royalty to another for the use of its intellectual property, such royalty is generally a passive income of the owner thereof subject to withholding tax.

(b) Rental Income - Refers to earnings derived from leasing real estate as well as personal property. Aside from the regular amount of payment for using the property, it also includes all other obligations assumed to be paid by the lessee to the third party in behalf of the lessor (e.g., interest, taxes, loans, insurance premiums, etc.) [RR 19-86]

Rent income may be in the following forms:

a)Cash, at the stipulated price b)Obligations of the lessor to third persons paid or assumed

by the lessee in consideration of the contract of lease, e.g., real estate tax on the property leased assumed by the lessee

c) Advance payment 1. (1) If the advance payment is actually a loan

to the lessor, or an option money for the property, or a security deposit for the faithful performance of certain obligations of the lessee, such advance payment is not income to the lessor.

2. (2) However, a security deposit that is applied to rental is taxable income to the lessor.

3. (3) If the advance payment is, in fact, a pre-paid rental, received by the lessor under a claim of right and without restriction as to its use, then such payment is income to the lessor.

4. (4) Pre-paid rent must be reported in full in the year of receipt, regardless of the accounting method used by the lessor.

(1) Lease of personal property – Rental income on the lease of personal property located in the Philippines and paid to a non-resident taxpayer shall be taxed as follows

NON resident corporation

Non resident Alien

Vessel 4.5% 25%Aircraft, machineries and other equipment

7.5% 25%

Other assets 30% 25%

(2) Lease of real property

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Lessor Tax Rate Citizen Resident Alien Non-resident alien engaged in trade or business in the Philippines

Net taxable income shall be subject to the graduated income tax rates

Non-resident alien not engaged in trade or business in the Philippines

Rental income from real property located in the Philippines shall be subject to 25% final withholding tax unless a lower rate is imposed pursuant to an effective tax treaty

Domestic Corporation Resident Foreign Corporation

Net taxable income shall be subject to 30% corporate income tax or its gross income will be subject to 2% MCIT

Non-resident Foreign Corporation

Gross rental income from real property located in the Philippines shall be subject to 30% corporate income tax, such tax to be withheld and remitted by the lessee in the Philippines

(3) Tax treatment of:

(a) Leasehold improvements by lessee- Rent Income from leasehold improvements:

I. Outright method- lessor shall report as income FMV of the buildings or improvements subject to the lease in the year of completion.

II. Spread-out method- lessor shall spread over the remaining term of the lease the estimated depreciated (book) value of such buildings or improvements at the termination of the lease, and reports as income for each remaining term of the lease an aliquot part thereof. estimated BV at the end of the lease contract/ remaining lease term = Income per year

If for any 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, lessor receives additional income for the year which the lease is so terminated to the extent of 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 building or improvement. No appreciation in value due to causes other than the premature termination of lease shall be included [Sec. 49, Rev. Reg. No. 2].

If the building or other leasehold improvement is destroyed before 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 the improvement, less any salvage value, to the extent that such loss was not compensated by insurance [Sec. 49, Rev. Reg. No. 2]

(b) VAT added to rental/paid by the lessee

o If the lessee is VAT-registered, treat VAT paid as input VAT;

o If the lessee is not VAT-registered OR not liable to VAT, treat VAT paid as additional rent expense deductible from gross income.

(c) Advance Rental/ Long Term Lease

Pre-paid rent must be reported in full in the year of receipt, regardless of the accounting method used by the lessor.

Annuities, Proceeds from life insurance or other types of insurance

Annuities are installment payments received for life insurance sold by insurance companies.

The aleatory contract of life annuity binds the debtor to pay an annual pension or income during the life of one or more

determinate persons in consideration of a capital consisting of money or other property, whose ownership is transferred to him at once with the burden of the income. [Art. 2021, New Civil Code]

The annuity payments represent a part that is taxable and not taxable. If part of annuity payment represents interest, then it is a taxable income. If the annuity is a return of premium, it is not taxable.

Prizes and awards

A prize is a reward for a contest or a competition. It represents remuneration for an effort reflecting one’s superiority.

Contest prizes and awards received are generally taxable. Such payment constitutes gain derived from labor.

The EXCEPTIONS are as follows:

(1) Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievements are EXCLUSIONS from gross income if:

a)The recipient was selected without any action on his part to enter a contest or proceedings; and

b)The recipient is not required to render substantial future services as a condition to receiving the prize or award.

(2) Prizes and awards granted to athletes in local and international sports competitions and tournaments held in the Philippines and abroad and sanctioned by their national associations shall be EXEMPT from income tax.

Pensions, retirement benefit, or separation pay

1. paid for past employment services rendered. 2. a stated allowance paid regularly to a person on his

retirement or to his dependents on his death, in consideration of past services, meritorious work, age, loss or injury. It is generally taxable unless the law states otherwise. [VALENCIA, Income Taxation 5th ed. (200/’’9)]

Income from any source whatever

Inclusion of all income not expressly exempted within the class of taxable income under the laws irrespective of the voluntary or involuntary action of the taxpayer in producing the gains, and whether derived from legal or illegal sources.

Forgiveness of indebtedness – The cancellation or forgiveness of indebtedness may have any of three possible consequences:

a) It may amount to payment of income. If, for example, an individual performs services to or for a creditor, who, in consideration thereof, cancels the debt, income in that amount is realized by the debtor as compensation for personal services.

b)It may amount to a gift. If a creditor wishes merely to benefit the debtor, and without any consideration therefore, cancels the debt, the amount of the debt is a gift to the debtor and need not be included in the latter’s report of income.

c) It may amount to a capital transaction. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of a payment of dividend.

Tax Benefit Rule

This is a general principle in taxation which states that is a taxpayer deducted an item on his income tax return and enjoyed a tax benefit (reduced his income tax) thereby, and in a subsequent year recovers all or part of that item, he will recognize gross income in the year the deducted item is recovered. The rule has both an inclusionary and an exclusionary component, i.e., the recovery is included in the taxpayer’s gross income to the extent that the taxpayer obtained a tax benefit from the prior year’s deduction, and the recovery is excluded to the extent that the prior year’s deduction did not provide a tax benefit.

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Recovery of accounts previously written-off – B d debts claimed as a deduction in the preceding year(s) but subsequently recovered 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. There is an income tax benefit when the deduction of the bad debt in the prior year resulted in lesser income and hence tax savings for the company. [Sec. 4, RR 5-99]

GlowingGloria- Illustration in BOC UP 2014 page 56

Receipt of tax refunds or credit – General rule: a refund of a tax related to the business or the practice of profession, is taxable income (e.g., refund of fringe benefit tax) in the year of receipt to the extent of the income tax benefit of said deduction (i.e., the tax benefit rule applies).

Exceptions: However, the following tax refunds are not to be included in the computation of gross income:

1. Philippine income tax, except the fringe benefit tax 2. Income tax imposed by authority of any foreign

country, if the taxpayer claimed a credit for such tax in the year it was paid or incurred.

3. Estate and donor’s taxes 4. Taxes assessed against local benefits of a kind

tending to increase the value of the property assessed (Special assessments)

5. Value Added Tax 6. Fines and penalties due to late payment of tax 7. Final taxes (8) Capital Gains Tax

Note: The enumeration of tax refunds that are not taxable (income) is derived from an enumeration of tax payments that are not deductible from gross income.

If a tax is not an allowable deduction from gross income when paid (no reduction of taxable income, hence no tax benefit), the refund is not taxable.

SOURCE RULES IN DETERMINING INCOME FROM WITHIN AND WITHOUT

The following items of gross income shall be treated as gross income from sources WITHIN the Philippines:

Interests- Derived from sources within the Philippines, and interests on bonds, notes or other interest- bearing obligation of residents.

Ultimately, the situs of interest income is the residence of the debtor.

Dividends - Dividends received:

1. from a domestic corporation; and 2. from a foreign corporation, UNLESS less than 50% of its

gross income for the previous 3- year period was derived from sources within the Philippines [in which case it will be treated as income partly from within and partly from without].

The income which is considered as derived from within the Philippines is obtained by using the following formula:

Philippine gross income/ within wourlwide gross income x dividend = Income

Note: of the corporation giving the dividend As a rule, the situs of dividend income is the residence of the corporation declaring the dividend.

Services- Compensation for labor or personal services performed in the Philippines: As a rule, the situs of compensation is the place of performance of the services.

Rentals and Royalties From property located in the Philippines or from any interest in such property, including rentals or royalties for –

1. The use of or the right or privilege to use in the Philippines any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right;

2. The use of, or the right to use in the Philippines any industrial, commercial or scientific equipment;

3. The supply of scientific, technical, industrial or commercial knowledge or information;

4. The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in

i. (a), any such equipment as is mentioned in

ii. (b) or any such knowledge or information as is mentioned in (c);

5. The supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from such nonresident person;

6. Technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme; and

7. The use of or the right to use: 8. Motion picture films;

i. (i) Films or video tapes for use in connection with television; and

ii. (ii) Tapes for use in connection with radio broadcasting.

As a rule, the situs of rental income is the place where the property is located. The situs of royalty income is where the rights are exercised.

Sale Of Real Property

As a rule, the situs of the income from sale of real property is where the realty is located.

Sale Of Personal Property

General Rule: Gains, profits and income from the sale of personal property, subject to the following rules:

Place of purchase Place of sale Treatment Pilipinas kong minumutya

Abroad Income from without

Abroad Pilipinas kong minumutya

Income from abroad

Note: in other words, the situs of the income from the sale of personal property is the place of sale

Exceptions:

(1) Gain from the sale of shares of stock in a domestic corporation Treated as derived entirely from sources within the Philippines regardless of where the said shares are sold.

(2) Gains from the sale of (manufactured) personal property:

(a) produced (in whole or in part) by the taxpayer within and sold without the Philippines, or

(b) produced (in whole or in part) by the taxpayer without and sold within the Philippines Treated as derived partly from sources within and partly from sources without the Philippines.

Place of Production

Place of Sale Treatment

Pilipinas Abroad Partly within, partly without

Abroad Pilipinas Partly within, partly without

Shares of Stock of Domestic Corporation

Treated as derived entirely from sources within the Philippines regardless of where the said shares are sold.

SITUS OF INCOME TAX

Income situs Interest Residence of the debtor Dividends Residence of corporation Services Place of performance Rentals Location of the property Royalties Place of exercise

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Sale of property Location of realty Sale of personal (a) Tangible

(1) Purchase and sale: Location of Sale (2) Manufactured w/in and sold w/o: Partly w/in and partly w/o (3) Manufactured w/o and sold w/in: Partly w/in and partly w/o

(b) Intangible General rule: Place of Sale Exception: Shares of stock of domestic corporations: Place of incorporation

Shares of stocks of domestic corporation

Place of incorporation

EXCLUSIONS FROM GROSS INCOME

Exclusions from gross income refer to income received or earned but is not taxable as income because it is exempted by law or by treaty. Such tax-free income is not to be included in the income tax return unless information regarding it is specifically called for. Receipts which are not in fact income are, of course, excluded from gross income.

The exclusion of income should not be confused with the reduction of gross income by the application of allowable deductions. While exclusions are simply not taken into account in determining gross income, deductions are subtracted from gross income to arrive at net income. [De Leon]

Items of Exclusions representing return of capital

(a) Amount of capital is generally recovered through deduction of the cost or adjusted basis of the property sold from the gross selling price or consideration, or through the deduction from gross income of depreciation relating to the property used in trade or business before it is sold.

(b) It may also related to indemnities, such as proceeds of life insurance paid to the insured’s beneficiaries and return of premiums paid by the insurance company to the insured under a life insurance, endowment or annuity contract.

(c) Damages, in certain instances, may also be exempt because they represent return of capital.

Items of Exclusion because it is subject to another internal revenue tax

The value of property acquired by gift, bequest, devise or descent is exempt from income tax on the part of the recipient because the receipt of such property is already subject to transfer taxes (estate tax or donor’s tax)

Items of Exclusions because they are expressly exempt from income tax

1. Under the Constitution 2. Under a tax treaty 3. Under special laws

Rationale for the exclusions

The term “exclusions” refers to items that are not included in the determination of gross income because:

a)They represent return of capital or are not income, gain or profit;

b)They are subject to another kind of internal revenue tax;

c) They are income, gain or profit expressly exempt from income tax under the Constitution, tax treaty, Tax Code, or a general or special law. [Mamalateo]

Taxpayers who may avail of the exclusions

Exclusion Taxpayer Return of the capital All taxpayer since there is

no income Already subject to internal All taxpayer unless provided

revenue tax that income is to be included

Express exclusion As expressly provided

Exclusions distinguished from deductions and tax credit

Exclusions from gross income refer to flow of wealth to the taxpayer which are not treated as part of gross income for purposes of computing the taxpayer’s taxable income, due to the following reasons: (1) it is exempted by the Constitution or a statute; or (2) it does not come within the definition of income. Deductions, on the other hand, are the amounts which the law allows to be subtracted from gross income in order to arrive at net income.

Exclusions pertain to the computation of gross income, while deductions pertain to the computation of net income. Exclusions are something received or earned by the taxpayer which do not form part of gross income while deductions are something spent or paid in earning gross income.

Tax Credit refers to amounts subtracted from the computed tax in order to arrive at taxes payable.

(1) Exclusions Under the Constitution

(a) Income derived by the government or its political subdivisions from the exercise of any essential governmental function

(b) Also, all assets and revenues of a non- stock, non-profit private educational institution used directly, actually and exclusively for private educational purposes shall be exempt from taxation.

(2) Exclusions Under the Tax Code (Sec. 32, NIRC)

(a) Proceeds of life insurance policies.—

General rule: The proceeds of life insurance policies paid to his estate or to any beneficiary (but not a transferee for a valuable consideration), directly or in trust, upon the death of the insured, are excluded from the gross income of the beneficiary. However, if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments received by the insured shall be included in gross income. The interest income shall be taxed at the graduated income tax rates.

(b) Return of premium paid.—

General rule: The amount received by the insured as a return of premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract is a return of capital and not income.

This refers to the cash surrender value of the contract.

Exception: If the amounts received by the insured (when added to the amounts already received before the taxable year under such contract) exceed the aggregate premiums or considerations paid (whether or not paid during the taxable year), then the excess shall be included in gross income.

(c) Amounts received under life insurance, endowment or annuity contracts.

—Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts) under a life insurance, endowment or annuity contracts are excluded from gross income, but if such amounts (when added to amounts already received before the taxable year under such contract) exceed the aggregate premiums of considerations paid (whether or not paid during the taxable year), then the excess shall be included in gross income. However, in the case of a transfer for valuable consideration, by assignment or otherwise, of a life insurance, endowment , or annuity contract, or any interest therein, only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee are exempt from taxation.

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(d) Value of property acquired by gift, bequest, devise or descent.—

Gifts, bequests and devises (which are subject to estate or gift taxes) are excluded from gross income, BUT not the income from such property. If the amount received is on account of services rendered, whether constituting a demandable debt or not, or the use or opportunity to use of capital, the receipt is income [Pirovano v. Commissioner G.R. No. L-19865, July 31, 1965].

(e) Amount received through accident or health insurance (Compensation for damages).—

As a rule, amounts received through accident or health insurance or under workmen’s compensation acts, as compensation for personal injuries or sickness, plus the amount of any damages received, whether by suit or agreement, on account of such injuries or sickness are excluded from gross income.

Examples of nontaxable and taxable damages recoveries are:

Nontaxable – compensation for damages on account of

Taxable – compensation for damages on account of

(1) Personal (physical) injuries or sickness

(1) Actual damages for loss of anticipated profit

(2) Any other damages recovered on account of personal injuries or sickness

(2) .Moral and exemplary damages awarded as a result of break of contract

(3) Exemplary and moral damages for out-of-court settlement, including attorney’s fee

(3) Interest for non- taxable damages above

(4) Alienation of affection, or breach of promise to marry

(4) Any damages as compensation for unrealized income

(5) Any amount received as a return of capital or reimbursement of expenses

(f) Income exempt under tax treaty.—

Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines.

(g) Retirement benefits, pensions, gratuities, etc.. These are

1. Retirement benefits under RA 7641, RA 4917, and Section 60(B) of the NIRC

2. Terminal pay 3. Retirement Benefits from foreign government

agencies 4. Veterans benefits5. Benefits under the Social Security Act 6. GSIS benefits

Retirement benefits received under RA 7641(The Retirement Pay Law) and those received by officials and employees of private firms under a reasonable private benefit plan (RPBP) maintained by the employer under RA 4917 (now Section 32(B)(6)(a) of NIRC) are excluded from gross income subject to income tax.

RA 7641 RPBPRetiring employee must be in the service of same employer CONTINUOUSLY for at least five (5) years

Retiring official or employee must have been in the service of the same employer forat least ten (10) years.

Retiring employee must be at least sixty (60) years oldbut not more than 65 years of age at the time of retirement

Retiring official or employee must be at least fifty (50) years old at the time of retirement

Availed of only once, and only when there is no RPBP

Retiring employee shall not have previously availed of the privilege under a retirement benefit plan of the same or another employerPlan must be reasonable. Its implementation must be fair and equitable for the benefit of all employees

(e.g. from president to laborer)Plan must be approved by BIR

A '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 employees wherein contributions are made by such employer, or employees, or both for the purpose of distributing to such employees the earnings and principal of the fund thus accumulated by the trust in accordance with such plan (trust fund)

Further, it should be provided in the plan that at no time prior to the satisfaction of all liabilities with respect to employees under any trust, 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 his employees.

Terminal pay/Separation pay

Any amount received by an employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death, sickness, other physical disability or for any cause beyond the control of the employee. The phrase “for any cause beyond the control of the said official or employee” means that the separation of the employee must be involuntary and not initiated by him.

The separation must not be of his own making.

Notes:

Sickness must be life-threatening or one which renders the employee incapable of working

Retrenchment of the employee due to unfavorable business conditions or financial reverses is considered as involuntary. However, resignation or availment of an optional early retirement plan is voluntary and bars a claim under this provision.

BIR Ruling 143-98: The “terminal leave pay” (amount paid for the commutation of leave credits) of retiring government employees is considered not part of the gross salary, and is exempt from taxes. The government recognizes that for most public servants, retirement pay is always less than generous if not meager and scrimpy. Terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits. [Commissioner v. Castaneda, 203 SCRA 72].

Retirement BENEFITS from foreign government agencies – The social security benefits, retirement gratuities, pensions and other similar benefits received by resident or non-resident citizens or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions, private or public;

Payments of VETERANS benefits under U.S. Veterans Administration – Payments of benefits due or to become due to any person residing in the Philippines under the laws of the United States administered by the United States Veterans Administration

Social Security Act benefits – Payments of benefits received under the Social Security Act of 1954 (RA 8282), as amended, e.g., Maternity Benefits

GSIS benefits – Benefits received from GSIS under the GSIS Act of 1937, as amended, and the retirement gratuity received by government officials and employees are not taxable. [Sec. 32B6., NIRC; Sec. B1, RR 2-98]

Winnings, prizes and award, including those in sports competitions.—All prizes and awards granted to athletes:

(1) in local and international sports competitions and tournaments whether held in the Philippines or abroad, AND

(2) sanctioned by their national sports associations shall not be included in gross income and shall be tax exempt. [Sec. 32 B7d, NIRC]

Prizes and awards made primarily in recognition of charitable, literary, educational, artistic, religious,

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scientific, or civic achievement are not taxable, provided:

(1) Recipient was selected without any action on his part to enter the contest or proceeding; and

(2) Recipient is not required to render substantial future services as a condition to receiving the prize or award

(3) Under special laws

Personal Equity and Retirement Account

(1) Under R.A. 6657 (Comprehensive Agrarian Reform Package Law), gain arising from the transfer of agricultural property covered by the law shall be exempt from capital gains tax.

(2) Under R.A. 6938 [Cooperative Code of the Philippines], as amended by R.A. 9520, cooperatives transacting business with both members and non-members shall not be subject to tax on their transactions with members. In relation to this, the transactions of members with the cooperative shall not be subject to any taxes and fees, including but not limited to final taxes on members' deposits.

(3) Under R.A. 7916 (PEZA Law), as amended, PEZA-registered enterprises are given income tax holidays of six or four years from the date of commercial operations, depending on whether their activities are considered pioneer or non-pioneer.

(4) Under R.A. 9178 [Barangay Micro Business Enterprises Act of 2002], BMBEs shall be exempt from income tax for income arising from the operation of the enterprise.

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