Definition of Gross Income

7/28/2019 Definition of Gross Income

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1. Definition of Gross IncomeWhat is income?

A) Definition under the NIRC: all income derived from whatever source, including (but not

limited) to the following items:1) compensation for services in whatever form paid, including but not limited to fees, salaries,

wages, commissions and similar items

2) gross income derived from the conduct of trade or business or the exercise of a profession

3) gains derived from dealings in property

4) interests

5) rents

6) royalties

7) dividends

8) annuities

9) prizes and winnings

10) pensions

11) partner's distributive share from the net income of the general professional partnership

NOTE: Everything which falls under this definition is part of gross income. BUT, that does not

necessarily mean that it is taxable

B) Haig-Simmons Definition

Personal income may be defined as the algebraic sum of

1) the market value of rights exercised in consumption; and

2) the change in value of the store or property rights between the beginning and the end of the

period in question

The problem with the definition given:

1) what are property devaluation (e.g. car value depreciation) - who decides the value of one's

property rights

2) liquidity - without a sale of one's property, an individual may not have available cash to pay

for tax on the property, even though the assessed value has increased.

C) Eisner v. Macomber definition

The gain derived from capital, from labor, or from both combined (this is very restrictive)

Net income should include dividends and also gains or profits and income derived from any

source whatever, but this does NOT include stock dividends

D) Commissioner v. Glenshaw

3 part test to determine the income (this expanded the Eisner definition of income)


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1) an accession to wealth (is A richer?)

2) clearly realized (has some event happened such that A received money?)

3) compete dominion over the money

Sec 32 of the NIRC follows the Glenshaw definition

2. Exclusions from Gross Income

1) life insurance proceeds (benefits)

2) amount received by insured as return of premium

3) value of property acquired as gifts, bequests, and devises (but its doesn't include income from

such property)

4) compensation for injuries or sickness plus damages received

5) income exempt under treaty obligations

6) retirement benefits, pensions, gratuities

7) amount received as a consequence of separation

8) miscellaneous items

a) income derived from foreign governments social security benefits, retirement gratuities,

pensions and other similar benefits

b) benefits due under the laws of the US administered by the US Veterans Administration

c) income from investment in the Philippines in loans, bonds or other domestic securities, or

from deposits in banks in the Philippines

d) income derived by the government or its political subdivisions public utility

e) prizes and awards

i. the recipient was selected without any action on his part

ii. recipient not required to render service as a condition

f) prizes and awards in sport competition

g) 13th month pay and other benefits

h) GSIS, SSS, Medicare and other contributions

i) Gains from the sale of bonds, debentures or other certificates of indebtedness

j) Gains from redemption of shares in mutual fund

ITEMS OF GROSS INCOME

SEC. 32. Gross Income.

(A) General Definition. Except when otherwise provided in this Title, gross income means all

income derived from whatever source, including (but not limited to) the following items:

(1) Compensation for services in whatever form paid, including, but not limited to fees, salaries,

wages, commissions, and similar items;


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(2) Gross income derived from the conduct of trade or business or the exercise of a profession;

(3) Gains derived from dealings in property;

(4) Interests;

(5) Rents;

(6) Royalties;(7) Dividends;

(8) Annuities;

(9) Prizes and winnings;

(10) Pensions; and

(11) Partner's distributive share from the net income of the general professional partnership.

(B) Exclusions from Gross Income. The following items shall not be included in gross income and

shall be exempt from taxation under this Title:

(1) Life Insurance. The proceeds of life insurance policies paid to the heirs or beneficiaries upon

the death of the insured, whether in a single sum or otherwise, but if such amounts are held by the

insurer under an agreement to pay interest thereon, the interest payments shall be included in gross

income.

(2) Amount Received by Insured as Return of Premium. 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.

(3) Gifts, Bequests, and Devises. The value of property acquired by gift, bequest, devise, or

descent: Provided, however, That income from such property, as well as gift, bequest, devise, or

descent of income from any property, in cases of transfers of divided interest, shall be included in

gross income.

(4) Compensation for Injuries or Sickness. Amounts received, through Accident or Health

Insurance or under Workmen's Compensation Acts, as compensation for personal injuries or

sickness, plus the amounts of any damages received, whether by suit or agreement, on account of

such injuries or sickness.

(5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty

obligation binding upon the Government of the Philippines.

(6) Retirement Benefits, Pensions, Gratuities, etc.

(a) Retirement benefits received under Republic Act No. 7641 and those received by officials and

employees of private firms, whether individual or corporate, in accordance with a reasonable private

benefit plan maintained by the employer: Provided, That the retiring official or employee has been

in the service of the same employer for at least ten (10) years and is not less than fifty (50) years of

age at the time of his retirement: Provided, further, That the benefits granted under this

subparagraph shall be availed of by an official or employee only once. For purposes of this

Subsection, the term 'reasonable private benefit plan' means a pension, gratuity, stock bonus or


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profit-sharing plan maintained by an employer for the benefit of some or all of his officials or

employees, wherein contributions are made by such employer for the officials or employees, or

both, for the purpose of distributing to such officials and employees the earnings and principal of

the fund thus accumulated, and wherein it is provided in said plan that at no time shall any part of

the corpus or income of the fund be used for, or be diverted to, any purpose other than for theexclusive benefit of the said officials and employees.

(b) Any amount received by an official or 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 or other physical disability or for any cause beyond the control of the said official or

employee.

(c) The provisions of any existing law to the contrary notwithstanding, social security benefits,

retirement gratuities, pensions and other similar benefits received by resident or nonresident

citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign

government agencies and other institutions, private or public.

(d) 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.

(e) Benefits received from or enjoyed under the Social Security System in accordance with the

provisions of Republic Act No. 8282.

(f) Benefits received from the GSIS under Republic Act No. 8291, including retirement gratuity

received by government officials and employees.

(7) Miscellaneous Items.

(a) Income Derived by Foreign Government. Income derived from investments in the Philippines

in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the

Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying

refinancing from foreign governments, and (iii) international or regional financial institutions

established by foreign governments.

(b) Income Derived by the Government or its Political Subdivisions. Income derived from any

public utility or from the exercise of any essential governmental function accruing to the

Government of the Philippines or to any political subdivision thereof.

(c) Prizes and Awards. Prizes and awards made primarily in recognition of religious, charitable,

scientific, educational, artistic, literary, or civic achievement but only if:

(i) The recipient was selected without any action on his part to enter the contest or proceeding; and

(ii) The recipient is not required to render substantial future services as a condition to receiving the

prize or award.

(d) Prizes and Awards in Sports Competition. All prizes and awards granted to athletes in local

and international sports competitions and tournaments whether held in the Philippines or abroad

and sanctioned by their national sports associations.

(e) 13th Month Pay and Other Benefits. Gross benefits received by officials and employees of


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public and private entities: Provided, however, That the total exclusion under this subparagraph shall

not exceed Thirty thousand pesos (P30,000) which shall cover:

(i) Benefits received by officials and employees of the national and local government pursuant to

Republic Act No. 6686;

(ii) Benefits received by employees pursuant to Presidential Decree No. 851, as amended byMemorandum Order No. 28, dated August 13, 1986;

(iii) Benefits received by officials and employees not covered by Presidential Decree No. 851, as

amended by Memorandum Order No. 28, dated August 13, 1986; and

(iv) Other benefits such as productivity incentives and Christmas bonus: Provided, further, That the

ceiling of Thirty thousand pesos (P30,000) may be increased through rules and regulations issued by

the Secretary of Finance, upon recommendation of the Commissioner, after considering, among

others, the effect on the same of the inflation rate at the end of the taxable year.

(f) GSIS, SSS, Medicare and Other Contributions. GSIS, SSS, Medicare and Pag-Ibig contributions,

and union dues of individuals.

(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. Gains realized

from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness

with a maturity of more than five (5) years.

(h) Gains from Redemption of Shares in Mutual Fund. Gains realized by the investor upon

redemption of shares of stock in a mutual fund company as defined in Section 22(BB) of this Code.

1. Compensation for Personal Services

a. in money

b. in kind

i) Convenience-of-the-employer rule

INTEREST INCOME

1. Taxable

2. Not Taxable

3. Imputed Interest on inter-company loans/advances

INCOME UNDER LEASE AGREEMENT (Sec. 49, RR-2)


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1. Rent

2. Obligations of lessor to third parties assumed and paid by lessee

3. Advance Rental

4. Leasehold Improvements

DIVIDEND INCOME

Dividend represents a distribution of the profits by a corporations

1. Kinds of dividends recognized in law

a. Cash - when taxable, the measure of income is the amount of money received

b. Property - when taxable, the measure of income is the FMV of the property received. A dividend paid

in shares of stocks of another corporation, or in treasury stocks, is a property dividend.

c. Stock

Held: "Stock dividends" are not "income," the same cannot be taxed under that provision of Act No.

2833 which provides for a tax upon income. Under the guise of an income tax, property which is not anincome cannot be taxed.

2. Measure of income in cash and property dividend

3. stock dividend

a. When taxable - if it gives the shareholder an interest different from that which his former stock

represented

i) Measure of Income - FMV of the shares of stocks received

b. When not taxable - if the new shares confer no different interest or rights than the old


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i) Adjusted cost per share where the stock received as dividend is all of substantially the same

character or preference as the stock upon which the stock dividend is paid, the cost of each share shall

be equal to the cost of the old shares divided by the total number of the old and new shares. The new

basis per share is used in computing any gain or loss upon any subsequent sale of the shares.

4. Liquidated Dividend

5. Essentially Equivalent to distribution of taxable dividends

General Rule

Section 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the U.S. Revenue Code of 1928. It

laid down the general rule known as the proportionate test wherein stock dividends once issued form

part of the capital and, thus, subject to income tax. Specifically, the general rule states that:A stock

dividend representing the transfer of surplus to capital account shall not be subject to tax.

Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under

the US Revenue Code, this provision originally referred to stock dividends only, without any exception.

Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient. So

that the mere issuance thereof is not yet subject to income tax as they are nothing but an enrichment

through increase in value of capital investment. As capital, the stock dividends postpone the realization

of profits because the fund represented by the new stock has been transferred from surplus to capital

and no longer available for actual distribution. Income in tax law is an amount of money coming to a

person within a specified time, whether as payment for services, interest, or profit from investment. It

means cash or its equivalent. It is gain derived and severed from capital, from labor or from both

combined - so that to tax a stock dividend would be to tax a capital increase rather than the income. In

a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be

subjected to income tax until that gain has been realized. Before the realization, stock dividends are

nothing but a representation of an interest in the corporate properties. As capital, it is not yet subject to

income tax. It should be noted that capital and income are different. Capital is wealth or fund; whereas

income is profit or gain or the flow of wealth. The determining factor for the imposition of income tax is

whether any gain or profit was derived from a transaction.

The Exception

However, 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 it represents a distribution


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of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis

supplied).

Although redemption and cancellation are generally considered capital transactions, as such, they are

not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable

gain from such transactions. Simply put, depending on the circumstances, the proceeds of redemptionof stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute

property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise

the freedom of choice. Having realized gain from that redemption, the income earner cannot escape

income tax.

As qualified by the phrase such time and in such manner, the exception was not intended to

characterize as taxable dividend every distribution of earnings arising from the redemption of stock

dividends. So that, whether the amount distributed in the redemption should be treated as the

equivalent of a taxable dividend is a question of fact, which is determinable on the basis of the

particular facts of the transaction in question. No decisive test can be used to determine the

application ofthe exemption under Section 83(b) The use of the words such manner and essentially

equivalent negative any idea that a weighted formula can resolve a crucial issue - Should the

distribution be treated as taxable dividend. On this aspect, American courts developed certain

recognized criteria, which includes the following:

1) the presence or absence of real business purpose,

2) the amount of earnings and profits available for the declaration of a regular dividend and the

corporations past record with respect to the declaration of dividends,

3) the effect of the distribution as compared with the declaration of regular dividend,

4) the lapse of time between issuance and redemption,

5) the presence of a substantial surplus and a generous supply of cash which invites suspicion as does a

meager policy in relation both to current earnings and accumulated surplus.

A. Interest

1. Interest Deductible From Gross Income

(1) In General. The amount of interest paid or incurred within a taxable year on indebtedness in

connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross

income: Provided, however, That the taxpayer's otherwise allowable deduction for interest expense shall

be reduced by an amount equal to the following percentages of the interest income subjected to final

tax:

Forty-one percent (41%) beginning January 1, 1998;

Thirty-nine percent (39%) beginning January 1, 1999; and

Thirty-eight percent (38%) beginning January 1, 2000.

(2) Exceptions. No deduction shall be allowed in respect of interest under the succeeding


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subparagraphs:

(a) If within the taxable year an individual taxpayer reporting income on the cash basis incurs an

indebtedness on which an interest is paid in advance through discount or otherwise: Provided, That

such interest shall be allowed as a deduction in the year the indebtedness is paid: Provided, further,

That if the indebtedness is payable in periodic amortizations, the amount of interest which correspondsto the amount of the principal amortized or paid during the year shall be allowed as deduction in such

taxable year;

(b) If both the taxpayer and the person to whom the payment has been made or is to be made are

persons specified under Section 36(B); or

(c) If the indebtedness is incurred to finance petroleum exploration.

(3) Optional Treatment of Interest Expense. At the option of the taxpayer, interest incurred to acquire

property used in trade, business or exercise of a profession may be allowed as a deduction or treated as

a capital expenditure.

2. Interest Not Deductible

No deduction is allowed in respect of interest under the following:

a. ADVANCE INTEREST - if within the taxable year an individual taxpayer reporting income on the cash

basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise

Provided, that such interest shall be allowed as a deduction in the year the indebtedness is paid.

Provided further, that if the indebtedness is payable in periodic amortizations the amount of interest

which corresponds to the amount of the principal amortized or paid during the year shall be allowed as

a deduction in such taxable year.

**under this provision, the phrase "within the taxable year" assumes a modified meaning. For example, a

taxpayer using the cash basis method of accounting borrows money in which interest is paid in advance

through discount. He obtains a loan of P1,000,000 in October 1998 subject to 20% interest; hence, after

paying the advance interest of P200,000 he receives only P 800,000.00 Can the borrower/taxpayer claim

the deduction when he files his ITR in April 1999?

It depends on w/n the principal obligation had been paid.

i. if the entire principal obligation had been paid, then the entire amount of interest can be claimed as

itemized deduction

ii. if only 1/2 of the obligation has been paid, only 1/2 interest can be claimed as itemized deduction;

iii. if no payment had been paid on the principal obligation, the advance interest paid cannot be

claimed as deduction on the year that it was paid.


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b. PERSONS UNDER 36b - if both the taxpayer and the person to whom the payment has been made or

is to be made are persons specified under section 36B, namely:

i. between members of a family

ii. between an individual and a corporation more than 50% in value of the outstanding stock of which is

owned, directly or indirectly, by or for such individual; andiii. between two corporations more than 50% in value of the outstanding stock of each of which is

owned, directly or indirectly, by or for the same individual;

iv. between the grantor and a fiduciary of any trust; or

v. between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with

respect to each trust

vi. between a fiduciary or a trust and a beneficiary

c. PETROLEUM OPERATION - if the indebtedness is incurred to finance petroleum operation.

3. Prepaid Interest Of Individual On Cash Method Of Accounting

Comm. V. Vda De Prieto (109 Phil 592)

Facts: Vda. de Prieto conveyed by way of gifts to her 4 children real property with a total assessed value

of P892,497.50. After the filing of the gift tax returns, CIR appraised the real property donated for gift

tax purposes at P1,231,268.00 and assessed the total sum of P117,706.50 as donor's gift tax, interests

and compromises due thereon. Of the total sum of P117,706.50 paid by respondent the sum of

P55,978.65 represents the total interest on account of delinquency. This sum of P55,978.65 was claimed

as deduction. Petitioner, however, disallowed the claim and as a consequence of such disallowance

assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the

aforesaid P55,978.65, including interest, surcharge and compromise for the late payment.

Issue: w/n the interest paid by respondent for the late payment of her donor's tax is deductible from her

gross income

Held: YES.

1) Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that

there should be interest upon it, and that what is claimed as an interest deduction should have been

paid or accrued within the year. It is here conceded that the interest paid by respondent was in

consequence of the late payment of her donor's tax, and the same was paid within the year it is sought

to be deducted.


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2) The term "indebtedness" has been defined as an unconditional and legally enforceable obligation for

the payment of money. Within the meaning of that definition, it is apparent that a tax may be

considered an indebtedness. "Although taxes already due have not, strictly speaking, the same concept

as debts, they are, however, obligations that may be considered as such. Where statute imposes a

personal liability for a tax, the tax becomes, at least in a board sense, a debt. It follows that the interestpaid by herein respondent for the late payment of her donor's tax is deductible from her gross income

under section 30 (b) of the Tax Code above quoted.

3) The uniform ruling is that interest on taxes is interest on indebtedness and is deductible.

4) In conclusion, we are of the opinion and so hold that although interest payment for delinquent taxes

is not deductible as tax under Section 30(c) of the Tax Code and section 80 of the Income Tax

Regulations, the taxpayer is not precluded thereby from claiming said interest payment as deduction

under section 30(b) of the same Code.

4. Reduction Of Interest Expense On Interest Income Subjected To Final Tax Under TRA of 1997

5. RR 13-2000 (Nov. 20, 2000)

Requirement for deductibility of Interest Expense

SEC. 3. TAX INCENTIVES ACCRUING TO THE ADOPTING PRIVATE ENTITY. A pre-qualified adopting

private entity, which enters into an Agreement with a public school, shall be entitled to the following tax

incentives:

(a) Deduction from the gross income of the amount of contribution/donation that were actually, directly

and exclusively incurred for the Program, subject to limitations, conditions and rules set forth in Section

34(H) of the Tax Code, plus an additional amount equivalent to fifty percent (50%) of such

contribution/donation subject to the following conditions:

(1) That the deduction shall be availed of in the taxable year in which the expenses have been paid or

incurred;

(2) That the taxpayer can substantiate the deduction with sufficient evidence, such as official receipts or

delivery receipt and other adequate records

(2.1) The amount of expenses being claimed as deduction;

(2.2) The direct connection or relation of the expenses to the adopting private entitys participation in

the Adopt-a-School Program. The adopting private entity shall also provide a list of projects and/or

activities undertaken and the cost of each undertaking, indicating in particular where and how the

assistance has been utilized as supported by the Agreement; and

(2.3) Proof or acknowledgment of receipt of the contributed/donated property by the recipient public


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school.

(3) That the application, together with the approved Agreement endorsed by the National Secretariat,

shall be filed with the Revenue District Office (RDO) having jurisdiction over the place of business of the

donor/adopting private entity, copy furnished the RDO having jurisdiction over the property, if the

contribution/donation is in the form of real property.(b) Exemption of the Assistance made by the donor from payment of donors tax pursuant to Sections

101 (A)(2) and (B)(1) of the Tax Code of 1997.

B. Taxes

Sec. 34, C, NIRC

(1) In General. - Taxes paid or incurred within the taxable year in connection with the taxpayer's

profession, trade or business, shall be allowed as deduction, except

(a) The income tax provided for under this Title;

(b) Income taxes imposed by authority of any foreign country; but this deduction shall be allowed in the

case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of

paragraph (3) of this subsection (relating to credits for taxes of foreign countries);

(c) Estate and donor's taxes; and

(d) Taxes assessed against local benefits of a kind tending to increase the value of the property

assessed.

Provided, That taxes allowed under this Subsection, when refunded or credited, shall be included as part

of gross income in the year of receipt to the extent of the income tax benefit of said deduction.

(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in trade or

business in the Philippines and a resident foreign corporation, the deductions for taxes provided in

paragraph (1) of this Subsection (C) shall be allowed only if and to the extent that they are connected

with income from sources within the Philippines.

(3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his return his desire to

have the benefits of this paragraph, the tax imposed by this Title shall be credited with:

(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a domestic

corporation, the amount of income taxes paid or incurred during the taxable year to any foreign

country; and

(b) Partnerships and Estates. - In the case of any such individual who is a member of a general

professional partnership or a beneficiary of an estate or trust, his proportionate share of such taxes of

the general professional partnership or the estate or trust paid or incurred during the taxable year to a

foreign country, if his distributive share of the income of such partnership or trust is reported for

taxation under this Title.

An alien individual and a foreign corporation shall not be allowed the credits against the tax for the


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taxes of foreign countries allowed under this paragraph.

(4) Limitations on Credit. - The amount of the credit taken under this Section shall be subject to each of

the following limitations:

(a) The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the

same proportion of the tax against which such credit is taken, which the taxpayer's taxable income fromsources within such country under this Title bears to his entire taxable income for the same taxable year;

and

(b) The total amount of the credit shall not exceed the same proportion of the tax against which such

credit is taken, which the taxpayer's taxable income from sources without the Philippines taxable under

this Title bears to his entire taxable income for the same taxable year.

(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from the amounts

claimed as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall

notify the Commissioner; who shall redetermine the amount of the tax for the year or years affected,

and the amount of tax due upon such redetermination, if any, shall be paid by the taxpayer upon notice

and demand by the Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded

to the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition

precedent to the allowance of this credit may require the taxpayer to give a bond with sureties

satisfactory to and to be approved by the Commissioner in such sum as he may require, conditioned

upon the payment by the taxpayer of any amount of tax found due upon any such redetermination. The

bond herein prescribed shall contain such further conditions as the Commissioner may require.

(6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this Section may, at the

option of the taxpayer and irrespective of the method of accounting employed in keeping his books, be

taken in the year which the taxes of the foreign country were incurred, subject, however, to the

conditions prescribed in Subsection (C)(5) of this Section. If the taxpayer elects to take such credits in

the year in which the taxes of the foreign country accrued, the credits for all subsequent years shall be

taken upon the same basis and no portion of any such taxes shall be allowed as a deduction in the

same or any succeeding year.

(7) Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed only if the

taxpayer establishes to the satisfaction of the Commissioner the following:

(a) The total amount of income derived from sources without the Philippines;

(b) The amount of income derived from each country, the tax paid or incurred to which is claimed as a

credit under said paragraph, such amount to be determined under rules and regulations prescribed by

the Secretary of Finance; and

(c) All other information necessary for the verification and computation of such credits.

Sec. 80-82, RR-2

Sec. 80. Taxes in general.As a general rule, taxes are deductible with the exception of those with

respect to which the law does not permit deduction. However, in the case of a nonresident alien


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individual and a foreign corporation, deduction is allowed only if and to the ex that the taxes for which

deduction is claimed are connected with income from sources within the Philippines.

Import duties paid to the proper customs officers, and business, occupation, license, privilege, excise

and stamp taxes and any other taxes of every name or nature paid directly to the Government of the

Philippines or to any political subdivision thereof, are deductible. The word taxes means taxes, properand no deduction should be allowed for amounts representing interest, surcharge, or penalties incident

to delinquency. Postage is not a tax. Automobile registration fees are considered taxes. Taxes are

deductible at most only by the person upon whom they are imposed. Thus the merchants sales tax

imposed by law upon sales is not deductible by the individual purchaser even though the tax may be

billed to him as a separate item.

In computing the net income of an individual no deduction is allowed for the tax is imposed upon his

interest as shareholder of a bank or other corporation, which are paid by the corporation without

reimbursements from the taxpayer. The amount so paid should not be included in the income of the

shareholder.

In the case of corporate bonds or other obligations containing a tax-free covenant clause, the

corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to

deduct such payment from gross income on any ground.

Sec. 81. Income tax imposed by the government of the Philippines. The law does not permit the

deduction of the income tax paid to or accrued in favor of the Government of the Philippines, and in no

case may the taxpayer avail of such deduction.

Sec. 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country.

Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country (including

the United States and possessions thereof) are allowed as deductions only if the taxpayer does not

signify in his return his desire to have to any extent the benefits of the provisions of law allowing credits

against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the

Philippines whose income from sources within such foreign country is not subject to income tax, only

that portion of the taxes paid to such foreign country which corresponds to his net income subject to

the Philippine income tax shall be allowed as deduction.

1. Deductible From Gross Income

GENERAL RULE: Taxes paid or incurred within the taxable year in connection with the taxpayer's

profession, trade or business, shall be allowed as deduction.

** Import duties paid to the proper customs officers and business, occupation, license, privilege, excise


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and stamp taxes and any other taxes of every name or nature paid directly to the Government of the

Philippines or to any political subdivision thereof, are deductible. The word "taxes" means taxes proper

and no deduction shall be allowed for amounts representing interest, surcharge, or penalties incident to

delinquency. Postage is not a tax. Automobile registration fees are considered taxes. Taxes are

deductible as such only by the person upon whom they are imposed. Thus the merchants sales taximposed by law upon sales is not deductible by the individual purchasers even though the tax may be

billed to him as a separate item.

EXCEPTIONS:

a. Income tax

b. Income taxes imposed by authority of any foreign country (but this deduction shall be allowed in the

case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of tax

credits paid to foreign countries)

c. Estate and donor's taxes

d. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed.

Provided, that the taxes allowed under this subsection, when refunded or credited shall be included as

part of gross income in the year of receipt to the extent of the income tax benefit of said deduction.

Others (under Sec 80-82, RR2):

a. Taxes paid by a nonresident alien individual and a foreign corporation - taxes are deductible only if

and to the extent that the taxes for which deduction is claimed are connected with income from sources

within the Philippines;

b. Income tax imposed by the Philippine government - the law does not allow the deduction of the

income tax paid to or accrued in favor of the government and in no case may the taxpayer avail of such

deduction;

c. income, war profits, and excess profits taxes imposed by the authority of a foreign country - allowed

as deductions only if the taxpayer does not signify in his return his desire to have to any extent the

benefits of the provisions of law allowing credits against the tax for taxes of foreign countries. In the

case of a citizen of a foreign country residing in the Philippines whose income from sources within such

foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country

which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction.

** In computing the net income of an individual, no deduction is allowed for the tax is imposed upon

his interest as shareholder of a bank or other corporation, which are paid by the corps w/o

reimbursements from the taxpayer. The amount so paid should not be included in the income of the

shareholder.


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** In case of corporate bonds or other obligations containing a tax-free covenant clause, the

corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to

deduct such payment from gross income on any ground.

2. Not deductible from Gross Income

Sec. 82-83, RR-2

Sec. 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country.

Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country (including

the United States and possessions thereof) are allowed as deductions only if the taxpayer does not

signify in his return his desire to have to any extent the benefits of the provisions of law allowing credits

against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the

Philippines whose income from sources within such foreign country is not subject to income tax, only

that portion of the taxes paid to such foreign country which corresponds to his net income subject to

the Philippine income tax shall be allowed as deduction.

Sec. 83. Estate, inheritance, and gift taxes; taxes assessed against local benefits. Estates, inheritance,

and gist taxes are not deductible.

So-called taxes, more properly assessments, paid for local benefits, such as street, sidewalk, and other

like improvements, imposed because of and measured by some benefit inuring directly to the property

against which the assessment is levied, do not constitute an allowable deduction from gross income. A

tax is considered assessed against local benefits when the property subject to the tax is limited to the

property benefited. Special assessments are not deductible, even though an incidental benefit may

inure to the public welfare. The taxes deductible are those levied for the general public welfare, by the

proper taxing authorities at a like rate against all property in the territory over which such authorities

have jurisdiction. When assessments are made for the purpose of maintenance or repair of local

benefits, the taxpayer may deduct assessments paid as an expense incurred in business, if the payment

of such assessments is necessary to the conduct of his business. When the assessments are made for

the purpose of constructing local benefits, the payments by the taxpayer are in the nature of capital

expenditures and are not deductible. Where assessments are made for the purpose of both

construction and maintenance or repairs, the burden is on the taxpayer to show the allocation of the

amounts assessed to the different purposes. If the allocation can not be made, none of the amounts so

paid is deductible.

3. Meaning of the term taxes


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Sec. 80, RR-2

The word taxes means taxes, proper and no deduction should be allowed for amounts representing

interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration

fees are considered taxes.

4. Tax Credits vs. Tax Deduction

CIR v. Lednicky, et al. (11 SCRA 609)

Facts: The respondents, V.E. Lednicky and Maria Valero Lednicky, are husband and wife, both American

citizens residing in the Philippines, and have derived all their income from Philippine sources for the

taxable years in question. In compliance with Phil tax law, they filed their income tax return for 1955 and

1956. In 1956, they filed an amended income tax return claiming a tax deduction for federal income

taxes which they paid to the United States in the year 1955. In 1959, they likewise claimed a similar tax

deduction for the 1956 return. Comm of IR failed to answer the claim for refund, thus they filed a

petition with the Tax Court.

Issue: whether a US citizen residing in the Philippines who derives income wholly from sources within

the Republic of the Philippines, may deduct from his gross income the income taxes he has paid to the

US government for the taxable year on the strength of sec 30 (c-1) of the Phil Internal Revenue

Code?[1]

Held:

1. The wording of Sec 30 shows the code's intent that the right to deduct income taxes paid to foreign

government from the taxpayer's gross income is given only as an ALTERNATIVE to his right to claim a

tax credit for such foreign income taxes under Sec 30 so that unless the alien resident has a right to

claim such tax credit if he so chooses, he is precluded from deducting the foreign income taxes from his

gross income. The law provides that the deduction shall be allowed if the taxpayer in his return does

not signify his desire to have the benefits of tax credits for taxes paid to foreign countries. Thus, the

statutes assumes that the taxpayer in question may also signify his desire to claim a tax credit and waive

the deduction.

2. No double credit (i.e, for claiming twice the benefits of his payment of foreign taxes, by deduction

from gross income and by tax credit) exists here. This danger cannot exist if the taxpayer cannot claim

benefit under either of these headings at his option, so that he must be entitled to a tax credit

(respondent here are NOT entitled to tax credit because all their income is derived from Phil sources), or

the option to deduct from gross income disappears altogether.

3. No double taxation exists. Double taxation becomes obnoxious only when the taxpayer is taxed twice
http://www.blogger.com/post-create.g?blogID=3490533786910594568#_ftn1http://www.blogger.com/post-create.g?blogID=3490533786910594568#_ftn1http://www.blogger.com/post-create.g?blogID=3490533786910594568#_ftn1http://www.blogger.com/post-create.g?blogID=3490533786910594568#_ftn1


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for the benefit of the same governmental entity. In the present case, although the taxpayer would have

to pay two taxes on the same income but the Philippine government only receives the proceeds of one

tax, there is no obnoxious double taxation.

5. Fines and Penalties

Guttierez v. Collector (14 SCRA 33)

Fines and penalties paid for late payment of taxes are not deductible.

Gutierrez also claimed for deduction the fines and penalties which he paid for late payment of taxes.

While Section 30 allows taxes to be deducted from gross income, it does not specifically allow fines and

penalties to be so deducted. Deductions from gross income are matters of legislative grace; what is not

expressly granted by Congress is withheld. Moreover, when acts are condemned by law and their

commission is made punishable by fines or forfeitures, to allow them to be deducted from the

wrongdoer's gross income, reduces, and so in part defeats, the prescribed punishment.

E. LOSSES

Sec. 93-101, RR-2

1. Kinds of Taxpayers and their losses

Individuals

To be fully deductible:

it must not be compensated by insurance and

incurred in a taxpayers trade or

incurred in any transaction entered into for profit or

of property connected with the trade or business if arising from fires, storm, shipwreck, or other

casualty, or from robbery, theft or embezzlement. No loss shall be allowed as deduction if at the time of

filing of the return, such loss has been claimed as deduction for estate or inheritance tax purposes in

the estate or inheritance tax return.

Corporations

Can deduct losses actually sustained and charged off within the year and not compensated for by

insurance or otherwise.

Nonresident alien and foreign corporations


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Can deduct losses sustained in business or trade conducted within the Philippines, losses of property

within the Philippines arising from fires, storms, shipwreck or other casualty and from robbery, theft or

embezzlement, and losses actually sustained in transactions entered into for profit in the Philippines,

although not connected with their trade or business, not compensated by insurance or otherwise.

Summary: Requisites for deductibility of losses

Must be incurred in trade, business or profession of the taxpayer, or of property connected with the

trade, business or profession, arising from fires, storms, shipwreck, or other casualties, or from robbery,

theft or embezzlement;

Must be actually sustained and not merely anticipated, and must be charged off within the taxable year;

Must be evidenced by closed and completed transaction;

Must not be compensated for by insurance or other form of indemnity

A sworn declaration of loss sustained from casualty or robbery, theft or embezzlement during the

taxable year must be filed with the Bureau of Internal Revenue within a period of not less than 30 days

nor more than 90 days from the date of discovery of the casualty;

Must not have been claimed as deduction in the estate tax return.

2. Completed Transactions

Fernandez Hermanoz v. CIR, 29 SCRA 552

Facts: Fernandez Hermanos Inc. is a domestic corporation organized for the principal purpose of

engaging in business as an investment company. The CIR disallowed the following deductions:

1. losses in Mati Lumber Co in 1950

2. losses or bad debts in Palawan Manganese Mines Inc in 1951

3. losses in Balamban Coal Mines in 1950 and 1951

4. losses in Hacienda Dalupiri and Hacienda Samal from 1950-1954

Held: The Supreme Court discussed the allowance or disallowance of each in the following manner:

1. Allowed. These losses represent the shares of stock (worth P8,050) petitioner acquired from Mati in

Jan. 1, 1948. The petitioner was correct in writing off and claiming as a deduction in 1950 the amount

on the ground that the lumber company had ceased operations and became insolvent in that year. The

CIR was incorrect in arguing that since the company still owned a sawmill and some equipment, the

shares of stock still had value. The proper assessment would be to treat as income for the year in which

petitioner gets the proceeds from the liquidation of those assets.

2. Disallowed. These losses represent part of the loans extended by the petitioner to its 100% owned

subsidiary. Petitioner advanced financial assistance to Palawan from 1945 to 1952. By way of payment,

Palawan was to give petitioner 15% of net profits. Whether Palawan was able to pay the loans or not


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because it continued to operate at a loss is immaterial. Petitioner cannot properly claim as a loss the

advances given to Palawan in 1951 for that year. There can be no partial writing off as a loss or bad

debt under the Tax Code. Those losses or bad debts ascertained within the taxable year are deductible

in full or not at all. Petitioner continued to give Palawan advances even beyond 1951. It was only in

1956 when Palawan decided to cease operations.3. Disallowed. These losses represent sums spent by the petitioner for the operation of its Balamban

coal mines in 1950 and 1951. The petitioner should have treated them as losses in 1952 when the mines

were abandoned and not in 1950 and 1951 on the ground that the mines made no sales of coal during

those years.

4. Allowed. These losses represent sums spent by petitioner for the operation of the 2 haciendas. The

amounts were properly reported as deductions for the correct years. The only reason why the CIR

disallowed them was on the ground that the farms were operated solely for pleasure or as a hobby and

not for profit. But the Supreme Court is not convinced, and being for business, the petitioner may

properly deduct the same.

3. Special Rules on losses

a) Voluntary Removal of Buildings

If the building is demolished by the owner for some practical reasons, say the building is no longer safe,

then the loss which was sustained in a closed and completed transaction is deductible from gross

income.

If the taxpayer buys real estate with an existing old building with the intention of demolishing it and

constructing a new one, then the loss sustained in demolishing the old building is not deductible from

gross income, the value of the real estate, exclusive of old improvements, being presumably equal to

the purchase price of the land and building plus the cost of removing the useless building.

Sec. 97, RR-2

b) Loss of Useful Value of Assets

When, through some change in business conditions, the usefulness in the business of some or all of the

capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such

assets permanently from use in such business, he may claim as deduction the actual loss sustained.

In determining the amount of the loss, adjustment must be made for improvements, depreciation, the

salvage value of the property. This exception to the rule requiring a sale or other disposition of property

in order to establish a loss requires proof of some unforeseen cause by reason of which the property

has been prematurely discarded, as for example:


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1. where any increase in the cost or change in the manufacture of any product makes it necessary to

abandon such manufacture, to which special machinery is exclusively devoted, or

2. where legislation directly or indirectly makes the continued profitable use of the property impossible.

This exception DOES NOT APPLY

1. to a case where the useful life of property terminates solely as a result of those gradual process forwhich depreciation allowance are authorized.

2. to inventories other than capital assets

This exception applies to buildings only when they are permanently abandoned or permanently

devoted to a radically different use, and to machinery only when its use as such is permanently

abandoned.

Sec. 98, RR-2

c) Shrinkage in value of Stocks

A person possessing stock of a corporation cannot subtract from gross income any amount claimed as

a loss merely on account of shrinkage in value of a stock through fluctuation of the market or

otherwise. The loss allowable in such case is that wholly suffered when the stock is disposed of. If stock

of a corporation becomes worthless, its cost or other basis determined in accordance with these

regulations may be deducted by the owner in the taxable year in which the stock became worthless,

provided a satisfactory showing of its worthlessness is made, as in the case of bad debts.

Sec. 99, RR-2

4. Wagering Losses

Deductible only to the extent of gains from such transactions. Example, if winnings amounted to 10,000

and the losses amounted to 6,000, only 4,000 of the net winnings is taxable. However, if the winnings

are 5,000 and losses are 6,000, the 1,000 net losses cannot be claimed as a deduction from gross

income.

5. Substantation of Losses

RR 12-77

In general the amount of casualty loss deductible is the difference between the FMV of the property

immediately before and the FMV after the casualty, but not exceeding the cost or book value of the


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property, reduced by any insurance or other compensation received.

In case of total destruction of property used in business, the net book value of the property

immediately before the loss should be used as the basis of claiming the loss, reduced by any amount of

insurance or compensation received.

In case of partial destruction of property used in business, the replacement cost to restore the propertyto its normal operating condition should be used in computing deductible loss, but in no case should it

be more than the net book value immediately before the casualty. Depreciation over the remaining

useful life is computed by dividing the replacement cost by the remaining useful life of the property.

6. Foreign Exchange Losses

Bir Ruling 144-85

Issue: Whether foreign exchange losses, which have accrued by reason of devaluation, are deductible

for income tax purposes?

Held: Foreign exchange losses which have accrued by reason of devaluation but where remittances

have not yet been made are not deductible for income tax purposes.

- the annual decrease in the value of property is not normally allowable as a loss. To be allowable, the

loss must be realized.

- When foreign currency acquired in connection with a transaction in the regular course of business is

disposed of, ordinary gain or loss results from the fluctuations. The loss is deductible only for the year it

is actually sustained. It is sustained during the year in which the loss occurs as evidenced by closed and

completed transaction and as fixed by identifiable events occurring in that year. A closed transaction is

a taxable event which has been consummated. No taxable event has as yet been consummated prior to

the remittance of the scheduled amortization. Accordingly, foreign exchange losses sustained as a result

of devaluation of the peso vis--vis the foreign currency, but which remittance of scheduled

amortization consisting of principal and interest payments on a foreign loan has not actually been

made are not deductible from gross income for income tax purposes.

Interbank Guiding Rate

RMC No. 26-85

Beginning Jan. 1, 1985, the conversion rate to be applied shall be the prevailing interbank reference

rate for the day of the transaction.

In the event that the foreign exchange rate as stated in the above paragraph (a) is impractical or not

feasible, the average interbank reference during the year shall apply.

For the purpose of converting the tax liability in US dollar to Philippine peso, the prevailing interbank

rate at the time of payment shall be applied when paid before the due date of the tax or the prevailing


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interbank reference rate at the due date of tax when paid on or after the due date of the tax.

When currency involved is other than US dollar, the foreign currency shall first be converted to US

dollar at the prevailing exchange rates between the two currencies.

This circular does not apply to transaction covered by RMC 30-84 regarding the imposition of

additional 1% gross receipt tax on buying and selling of foreign exchange of peso by bank, non-bankfinancial intermediaries and other authorized foreign exchange dealers or agents and RMC 32-84 in

determining the cost basis of certain commodities imported beginning Jan. 1, 1984, the value and

prices thereof are quoted in foreign currency.

7. Abandonment of Losses

In case a contract area where petroleum operations are undertaken is partially or fully abandoned, all

accumulated exploration and development expenditures pertaining thereto shall be allowed as

deduction; however, those incurred before Jan. 1, 1979 can be deducted only from income derived from

the same contract area. In all cases, notice of abandonment shall be filed with the Commissioner.

The unamortized cost of a producing well subsequently abandoned, and the undepreciated cost of

equipment directly used therein are also deductible in the year such well, equipment or facility is

abandoned by the contractor. If such abandoned well is recentered and production is resumed, or if

such equipment or facility is restored into service, the said costs shall be included as part of gross

income in the year of resumption or restoration and shall be amortized or depreciated.

8. Net Operating Loss Carry-Over (NOLCO)

The net operating loss of the business or enterprise for any taxable year immediately preceding the

current taxable year, which had not been previously offset as deduction from gross income shall be

carried over as a deduction from gross income for the next 3 consecutive taxable years immediately

following the year of such loss, provided that any net loss incurred in a taxable year during which the

taxpayer is exempt from income tax shall not be allowed as a deduction.

The deduction is allowed only if there has been no substantial change in the ownership of the business

or enterprise in that

a. Not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a

corporation, is held by or on behalf of the same persons; or

b. Not less than 75% of the paid up capital of the corporation, if the business is in the name of a

corporation, is held by or on behalf of the same persons.

For mines other than oil and gas wells, a net operating loss without the benefit of incentives provided


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under EO No. 226,as amended, incurred in any of the first 10 years of operation may be carried over as

a deduction, from taxable income for the next 5 years immediately following the year of such loss. The

entire amount of the loss shall be carried over to the first of the 5 taxable years following the loss, and

any portion of such loss which exceeds the taxable income of such first year shall be deducted in like

manner from the taxable income of the next remaining 4 years.

Net operating loss = excess of allowable deductions over gross income.

RR 14-2001

a) Three Year Period

b) No substantial Change in Ownership (75% Rule)

F. BAD DEBTS

1. Requirements for Deductibility

I. there must be an existing indebtedness due to the taxpayer which must be valid and legally

demandable

II. it must be connected with the taxpayers trade, business, or practice of profession

III. it must not be sustained in a transaction entered into between related parties enumerated under Sec.

36 (b)

IV. it must be actually charged off the books of accounts of the taxpayer as of the end of the taxable

year.

V. It must be actually ascertained to be worthless and uncollectible as of the end of the taxable year.

*Before a debt can be ascertained to be worthless, the creditor must have taken all reasonable steps to

collect within the period of prescription, and in the light of the following circumstances, acting in good

faith, he may justify an ascertainment of worthlessness of a debt:

i. insufficiency of collateral

ii. bankruptcy or insolvency

iii. loss of evidence of indebtedness

iv. disappearance of debtor, who fled leaving no properties

v. death of debtor leaving no properties

vi. injury to debtor incapacitating him from work

vii. fruitless efforts to collect small amounts from debtors scattered all over the country.


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Collector v. Goodrich, 21 SCRA 1336

CRITERIA FOR ASCERTAINING WORTHLESSNESS OF DEBTS.- The statute permits the deduction of debts

"actually ascertained to be worthless within the taxable year" obviously to prevent arbitrary action by

the taxpayer to unduly avoid tax liability. The ascertainment of worthlessness of bad debts requiresproof of two facts: (1) that the taxpayer did in fact ascertain the debt to be worthless in the year the

deduction is sought; and (2) in so doing, he acted in good faith. Good faith is not enough. The taxpayer

must show that he had reasonably investigated the relevant facts and had drawn a reasonable inference

from the information thus obtained by him.

WHERE SMALL AMOUNTS ARE INVOLVED, WRITING THEM OFF, WHEN JUSTIFIED.- Considering the

small amounts involved, the taxpayer may be justified in feeling that the unsuccessful efforts therefore

exerted to collect the same would suffice to warrant their being written off. "It is foolish to spend good

money after bad."

2. Tax Benefit Rule

RR 5-99

The recovery of bad debts previously claimed as deduction shall be included as part of gross income in

the year of recovery to the extent of the income tax benefit of said deduction.

Under the tax benefit rule, the recovery of amounts deducted in previous years from gross income

become taxable income unless to the extent thereof, the deduction did not result in any tax benefit to

the taxpayer.

Example: If in the year the taxpayer claimed deduction of bad debts written-off, he realized a reduction

of the income tax due from him on account of the said deduction, his subsequent recovery thereof from

his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said taxpayer did

not benefit from the deduction of the said bad debt written-off because it did not result to any

reduction of his income tax in the year of such deduction (i.e. where the result of his business operation

was a net loss even without deduction of the bad debts written-off), then his subsequent recovery

thereof shall be treated as a mere recovery or return of capital, hence, not treated as receipt of realized

taxable income.

- not deductible.

- Refer to E10 above on who are related taxpayers.

3. Bad Debts between Related Parties


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Losses from sale or exchange of property that are not deductible

- those made between related taxpayers.

Who are related taxpayers?members of a family (brothers/sisters of the whole or half blood, spouse, ancestors and lineal

descendants

an individual and corporation, if the individual owns, directly or indirectly, more than 50% in value of

the outstanding stock

two corporations, if more than 50% in value of the outstanding stock in both is owned, directly or

indirectly, by the same individual, if either one of such corporations was a personal holding company or

a foreign personal holding company

the grantor and a fiduciary of any trust

fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each

trust

fiduciary of a trust and a beneficiary of such trust.

Sec. 30 [b], NIRC)

(B) Mutual savings bank not having a capital stock represented by shares, and cooperative bank without

capital stock organized and operated for mutual purposes and without profit;

4. Requirements for Deductibility of Bad Debts including banks

RR 5-99

See F1 on requirements

In the case of banks, in lieu of requisite no. 5 above, the BSP, thru its Monetary board, shall ascertain

the worthlessness and uncollectibility of the bad debts and it shall approve the writing off of the said

indebtedness from the banks books of accounts at the end of the taxable year. The bank though

should still comply with requisites nos. 1-4 as enumerated above before it can avail of the benefit of

deduction.

Amount not deductible

i. if partially secured by a mortgage, the portion not covered by the mortgage is deductible.

ii. In case of insolvency of the debtor, the difference between the amount of the claim and the amount

received in distribution of assets of the bankrupt.

iii. The difference between the amount received by a creditor of a decedent in distribution of the assets

of the decedents estate and the amount of the claim.

iv. The purchase price paid by a purchaser of accounts receivable which cannot be collected and


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charged off as bad debts in his books.

v. The amount absolved if the debt is compromised and the debtor is insolvent.

SALE OR EXCHANGE OF PROPERTY

A. CAPITAL ASSETS

Sec. 39, NIRC - Capital Assets: The term capital assets means property held by the taxpayer (whether

or not connected with his trade or business), but does NOT include stock in trade by the taxpayer, or

other property of a kind which would properly be included in the inventory of a taxpayer if on hand at

the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the

ordinary course of his trade or business, or property used in the trade or business, of a character which

is subject to the allowance for depreciation provided in subsection F of 34, or real property used in

trade or business of the taxpayer

1. Definition of capital asset

RR NO. 7-2003, Dec. 27, 2002

Guidelines in determining whether a real property is capital or ordinary asset

Providing the Guidelines in Determining Whether a Particular Real Property is a Capital Asset or an

Ordinary Asset Pursuant to Section 39(A)(1) of the National Internal Revenue Code of 1997 for Purposes

of Imposing the Capital Gains Tax under Sections 24(D), 25(A)(3), 25(B) and 27(D)(5), or the Ordinary

Income Tax under Sections 24(A), 25(A) & (B), 27(A), 28(A)(1) and 28(B)(1), or the Minimum Corporate

Income Tax (MCIT) under Sections 27(E) and 28(A)(2) of the same Code

Scope. Pursuant to Section 244 of the National Internal Revenue Code of 1997 (Code), these

Regulations are hereby promulgated to implement Sec. 39(A)(1), providing for the purpose the

guidelines in determining whether a particular real property is a capital asset or an ordinary asset.

SECTION 2. Definition Of Terms. For purposes of these Regulations, the following terms shall be

defined as follows:

a. Capital assets shall refer to all real properties held by a taxpayer, whether or not connected with his

trade or business, and which are not included among the real properties considered as ordinary assets

under Sec. 39(A)(1) of the Code.

b. Ordinary assets shall refer to all real properties specifically excluded from the definition of capital

assets under Sec. 39(A)(1) of the Code, namely:

1. Stock in trade of a taxpayer or other real property of a kind which would properly be included in the

inventory of the taxpayer if on hand at the close of the taxable year; or

2. Real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade


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or business; or

3. Real property used in trade or business (i.e., buildings and/or improvements) of a character which is

subject to the allowance for depreciation provided for under Sec. 34(F) of the Code; or

4. Real property used in trade or business of the taxpayer.

Real properties acquired by banks through foreclosure sales are considered as their ordinary assets.However, banks shall not be considered as habitually engaged in the real estate business for purposes

of determining the applicable rate of withholding tax imposed under Sec. 2.57.2(J) of Revenue

Regulations No. 2-98, as amended.

c. Real property shall have the same meaning attributed to that term under Article 415 of Republic Act

No. 386, otherwise known as the "Civil Code of the Philippines."

d. Real estate dealer shall refer to any person engaged in the business of buying and selling or

exchanging real properties on his own account as a principal and holding himself out as a full or part-

time dealer in real estate.

e. Real estate developer shall refer to any person engaged in the business of developing real properties

into subdivisions, or building houses on subdivided lots, or constructing residential or commercial units,

townhouses and other similar units for his own account and offering them for sale or lease.

f. Real estate lessor shall refer to any person engaged in the business of leasing or renting real

properties on his own account as a principal and holding himself out as lessor of real properties being

rented out or offered for rent.

g. Taxpayers engaged in the real estate business shall refer collectively to real estate dealers, real estate

developers, and/or real estate lessors. Conversely, the term "taxpayers not engaged in the real estate

business" shall refer to persons other than real estate dealers, real estate developers and/or real estate

lessors. A taxpayer whose primary purpose of engaging in business, or whose Articles of Incorporation

states that its primary purpose is to engage in the real estate business shall be deemed to be engaged

in the real estate business for purposes of these Regulations.

SECTION 3. Guidelines in Determining Whether a Particular Real Property is a Capital Asset or Ordinary

Asset.

a. Taxpayers engaged in the real estate business. Real property shall be classified with respect to

taxpayers engaged in the real estate business as follows:

1. Real Estate Dealer. All real properties acquired by the real estate dealer shall be considered as

ordinary assets.

2. Real estate Developer. All real properties acquired by the real estate developer, whether

developed or undeveloped as of the time of acquisition, and all real properties which are field by the

real estate developer primarily for sale or for lease to customers in the ordinary course of his trade or

business or which would properly be included in the inventory of the taxpayer if on hand at the close of

the taxable year and all real properties used in the trade or business, whether in the form of land,

building, or other improvements, shall be considered as ordinary assets.


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3. Real Estate Lessor. All real properties of the real estate lessor, whether land and/or improvements,

which are for lease/rent or being offered for lease/rent, or otherwise for use or being used in the trade

or business shall likewise be considered as ordinary assets.

4. Taxpayers habitually engaged in the real estate business. All real properties acquired in the course

of trade or business by a taxpayer habitually engaged in the sale of real estate shall be considered asordinary assets. Registration with the HLURB or HUDCC as a real estate dealer or developer shall be

sufficient for a taxpayer to be considered as habitually engaged in the sale of real estate. If the taxpayer

is not registered with the HLURB or HUDCC as a real estate dealer or developer, he/it may nevertheless

be deemed to be engaged in the real estate business through the establishment of substantial relevant

evidence (such as consummation during the preceding year of at least six (6) taxable real estate sale

transactions, regardless of amount; registration as habitually engaged in real estate business with the

Local Government Unit or the Bureau of Internal Revenue, etc.).

A property purchased for future use in the business, even though this purpose is later thwarted by

circumstances beyond the taxpayer's control, does not lose its character as an ordinary asset. Nor does

a mere discontinuance of the active use of the property change its character previously established as a

business property.

b. Taxpayer not engaged in the real estate business. In the case of a taxpayer not engaged in the real

estate business, real properties, whether land, building, or other improvements, which are used or being

used or have been previously used in the trade or business of the taxpayer shall be considered as

ordinary assets. These include buildings and/or improvements subject to depreciation and lands used in

the trade or business of the taxpayer.

A depreciable asset does not lose its character as an ordinary asset, for purposes of the instant

provision, even if it becomes fully depreciated, or there is failure to take depreciation during the period

of ownership.

Monetary consideration or the presence or absence of profit in the operation of the property is not

significant in the characterization of the property. So long as the property is or has been used for

business purposes, whether for the benefit of the owner or any of its members or stockholders, it shall

still be considered as an ordinary asset. Real property used by an exempt corporation in its exempt

operations, such as a corporation included in the enumeration of Section 30 of the Code, shall not be

considered used for business purposes, and therefore, considered as capital asset under these

Regulations.

Real property, whether single detached; townhouse; or condominium unit, not used in trade or business

as evidenced by a certification from the Barangay Chairman or from the head of administration, in case

of condominium unit, townhouse or apartment, and as validated from the existing available records of

the Bureau of Internal Revenue, owned by an individual engaged in business, shall be treated as capital

asset.

c. Taxpayers changing business from real estate business to non-real estate business. In the case of a

taxpayer who changed its real estate business to a non-real estate business, or who amended its


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Articles of Incorporation from a real estate business to a non-real estate business, such as a holding

company, manufacturing company, trading company, etc., the change of business or amendment of the

primary purpose of the business shall not result in the re-classification of real property held by it from

ordinary asset to capital asset. For purposes of issuing the certificate authorizing registration (CAR) or

tax clearance certificate (TCL), as the case may be, the appropriate officer of the BIR shall at all timesdetermine whether a corporation purporting to be not engaged in the real estate business has at any

time amended its primary purpose from a real estate business to a non-real estate business.

d. Taxpayers originally registered to be engaged in the real estate business but failed to subsequently

operate. In the case of subsequent non-operation by taxpayers originally registered to be engaged in

the real estate business, all real properties originally acquired by it shall continue to be treated as

ordinary assets.

e. Treatment of abandoned and idle real properties. Real properties formerly forming part of the

stock in trade of a taxpayer engaged in the real estate business, or formerly being used in the trade or

business of a taxpayer engaged or not engaged in the real estate business, which were later on

abandoned and became idle, shall continue to be treated as ordinary assets. Real property initially

acquired by a taxpayer engaged in the real estate business shall not result in its conversion into a

capital asset even if the same is subsequently abandoned or becomes idle.

Provided however, that properties classified as ordinary assets for being used in business by a taxpayer

engaged in business other than real estate business as defined in Section 2(g) hereof are automatically

converted into capital assets upon showing of proof that the same have not been used in business for

more than two (2) years prior to the consummation of the taxable transactions involving said properties.

f. Treatment of real properties that have been transferred to a buyer/transferee, whether the transfer is

through sale, barter or exchange, inheritance, donation or declaration of property dividends.

Real properties classified as capital or ordinary asset in the hands of the seller/transferor may change

their character in the hands of the buyer/transferee. The classification of such property in the hands of

the buyer/transferee shall be determined in accordance with the following rules:

1. Real property transferred through succession or donation to the heir or donee who is not engaged in

the real estate business with respect to the real property inherited or donated, and who does not

subsequently use such property in trade or business, shall be considered as a capital asset in the hands

of the heir or donee.

2. Real property received as dividend by the stockholders who are not engaged in the real estate

business and who do not subsequently use such real property in trade or business shall be treated as

capital assets in the hands of the recipients even if the corporation which declared the real property

dividend is engaged in real estate business.

3. The real property received in an exchange shall be treated as ordinary asset in the hands of the

transferee in the case of a tax-free exchange by taxpayer not engaged in real estate business to a

taxpayer who is engaged in real estate business, or to a taxpayer who, even if not engaged in real estate

business, will use in business the property received in the exchange.


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g. Treatment of real property subject of involuntary transfer. In the case of involuntary transfers of

real properties, including expropriation or foreclosure sale, the involuntariness of such sale shall have no

effect on the classification of such real property in the hands of the involuntary seller, either as capital

asset or ordinary asset, as the case may be.

2. Definition of Income

Sec 22 (z) the term ordinary income includes any gain from sale or exchange of property which is not

a capital asset. Any gain from the sale or exchange of property which is treated or considered under

other provisions of this title, as ordinary income shall be treated as gain from the sale or exchange of

property which is not a capital asset as defined in sec 39 A.

Calasanz v.CIR 144 SCRA 664 (October 9, 1986)

Facts: Ursula Calasanz inherited from her father an agricultural land. Improvements were introduced to

make such land saleable and later in it was sold to the public at a profit. The Revenue examiner

adjudged Ursula and her spouse as engaged in business as real estate dealers and required them to pay

the real estate dealers tax.

Issue: Whether or not the gains realized from the sale of the lots are taxable in full as ordinary income

or capital gains taxable at capital gain rates?

Held: The activities of Calasanz are indistinguishable from those invariably employed by one engaged in

the business of selling real estate. One strong factor is the business element of development which is

very much in evidence. They did not sell the land in the condition in which they acquired it. Inherited

land which an heir subdivides and makes improvements several times higher than the original cost of

the land is not a capital asset but an ordinary asses. Thus, in the course of selling the subdivided lots,

they engaged in the real estate business and accordingly the gains from the sale of the lots are ordinary

income taxable in full.

3. Net capital gain, net capital loss

Net Capital Gain-means the excess of the gains from the sales or exchanges of capital assets over the

losses from such sales or exchanges.

Net Capital Loss-means the excess of the losses from sales or exchanges of capital assets over the gains

from such sales or exchanges.


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4. Ordinary loss

Ordinary loss- includes any loss from the sale or exchange of property which is not a capital asset.

5. Percentage Taken into Account

Percentage Taken into Account- in the case of a taxpayer, other than a corporation, only 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:

a. one hundred percent (100%) if the capital asset has been held for not more than 12 months

b. fifty percent (50%) if the capital asset has been held for more than12 months

6. Limitation on Capital Loss

Limitation on Capital Loss - Losses from sales or exchanges of capital assets shall be allowed only to the

extent of the gains from such sales or exchanges.

A. DETERMINATION OF GAIN OR LOSS FROM SALE OR TRANSFER OF PROPERTY

1. Computation of gain or loss

Sec 40, NIRC: computation of gain or loss: the gain from sale or other disposition of property shall be

the excess of the amount realized therefrom over the basis or adjusted basis for determining gain, and

the loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized.

The amount realized from the sale or other disposition of property shall be the sum of money received

plus the fair market value of the property received.

2. Cost or Basis for Income Tax Purposes

The basis of property shall be-

a. the cost thereof in the case of property acquired on or after March 1, 1913, if such property was

acquired by purchase

b. the fair market price or value as of the date of acquisition, if the same was acquired by inheritance

c. if the property was acquired by gift, the basis shall be the same as if it would be in the hands of the

donor, except if that if such basis is greater than the fair market value of the property at the time of the

gift, then for the purpose of determining loss, the basis shall be such fair market value

d. if the property was acquired for less than an adequate consideration in money or moneys worth, the

basis is the amount paid by the transferee for the property


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3. Exchange of Property Tax-free exchange

General rule: upon exchange or sale of property, the entire amount of the gain or loss, as the case may

be, shall be recognized.

Exception: no gain or loss shall be recognized if in pursuance of a plan of merger or consolidation-

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

corporation, which is a party to the merger or consolidation

b. a shareholder exchanges stock in a corporation, which is a party to the merger or consolidation,

solely for the stock of another corporation also a party to the merger or consolidation

c. a security holder of a corporation, which is a party to the merger of consolidation exchanges his

securities in such corporation, solely for stock or securities in another corporation, a party to the merger

or consolidation.

i. Merger or Consolidation

BIR Ruling No. 383-87, Nov. 25, 1987

This is a ruling as to whether the merger of Delta Farms, Inc. (DFI) and Evergreen Farms, Inc. (EFI)

qualifies as a tax-exempt re-organization under Section 35(c)(2) of the Tax Code, as amended.

It is represented that DFI and EFI are both domestic corporations duly registered to engage in

agricultural development projects in the Philippines; that 70% of the equity of both corporations are

owned by Mr. Juanito R. Ignacio (Ignacio) while 30% thereof, belongs to Philippine Packing Corporation

(PPC) which is another domestic corporation and its four (4) individual nominees who are merely

holders of one qualifying share each; that prompted by the desire of both companies to achieve

efficiency and economy of operation by reducing administrative and operating costs and to strengthen

DFI, a merger has been proposed wherein EFI shareholders will exchange all their EFI shares solely for

shares in DFI; that as a result of the merger, DFI will be the surviving corporation which will continue to

be owned 70% by Ignacio and 30% by PPC, with EFI then ceasing to exist, that based on the Audited

Financial Statements of EFI as of March 31, 1987, since the net worth of EFI is P16,338,495.00, EFI

stock

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Definition of Gross Income

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