INCOME+TAX+RRS

B. TAX ON INDIVIDUALS

3.b. FINAL INCOME TAX (RR 10-98, RR 08-98)

REVENUE REGULATION 10-98

Definitions

(A) Foreign Currency Deposit System — shall refer to the conduct of banking transactions whereby any person whether natural or juridical may deposit foreign currencies forming part of the Philippine international reserves, in accordance with the provisions of Republic Act No. 6426 entitled "An Act Instituting a Foreign Currency Deposit System in the Philippines, and For Other Purposes."

(B) Foreign Currency Deposit Unit (FCDU) — shall refer to that unit of a local bank or of a local branch of a foreign bank authorized by the Bangko Sentral Ng Pilipinas (BSP) to engage in foreign currency-denominated transactions, pursuant to the provisions of R.A. 6426, as amended. ("Local bank" shall refer to a thrift bank or a commercial bank organized under the laws of the Republic of the Philippines. "Local branch of a foreign bank" shall refer to a branch of a foreign bank doing business in the Philippines, pursuant to the provisions of R.A. No. 337, as amended).

(C) Offshore Banking System — shall refer to the conduct of banking transactions in foreign currencies involving the receipt of funds principally from external and internal sources and the utilization of such fund pursuant to Presidential Decree No. 1034 as implemented by CB (now BSP) Circular No. 1389, as amended.

(D) Offshore Banking Unit (OBU) — shall mean a branch, subsidiary or affiliate of a foreign banking corporation which is duly authorized by the Bangko Sentral Ng Pilipinas (BSP) to transact offshore banking business in the Philippines in accordance with the provisions of Presidential Decree No. 1034 as implemented by CB (now BSP) Circular No. 1389, as amended.

(E) Deposits — shall mean funds in foreign currencies which are accepted and held by an Offshore Banking Unit or Foreign Currency Deposit Unit in the regular course of business, with the obligation to return an equivalent amount to the owner thereof, with or without interest.

Sec. 2.24. Income Tax Rate of Interest Income from Foreign Currency Deposit. —

(A) Individual Income Tax on Interest Income from a Depository Bank under the Foreign Currency Deposit System

(1) Interest income which is actually or constructively received by a resident citizen of the Philippines or by a resident alien individual from a foreign currency bank deposit shall be subject to a final withholding tax of seven and one-half percent (7.5%). The depository bank shall withhold and remit the tax pursuant to Sections 57 and 58 (withholding tax at source) of the Code.

(2) If a bank account is jointly in the name of a non-resident citizen such as an overseas contract worker, or a Filipino seaman, and his spouse or dependent who is a resident in the Philippines, fifty percent (50%) of the interest income from such bank deposit shall be treated as exempt while the other fifty percent (50%) shall be subject to a final withholding tax of seven and one-half percent (7.5%).

D) Illustration.

Mr. Juan de la Cruz, a Filipino citizen who is residing in the Philippines has a US dollar account with ABC Bank. His gross interest earnings from his bank deposit for the first quarter of 1998 (i.e. from January 1 to March 31, 1998) amounted to US$1,000.00. This gross interest earning shall be considered as constructively received by Mr. De la Cruz during the first quarter of 1998 and shall be subject to a seven and one-half percent (7.5%) final withholding tax. The 7.5% final withholding tax which is due thereon is US$75.00.

Sec. 2.27 and Sec. 2.28 — Corporate Income Tax on Interest Income from a Depository Bank under the Foreign Currency Deposit System.

(A) Interest income which is actually or constructively received by a domestic corporation or a resident foreign corporation from a foreign currency bank deposit shall be subject to a final withholding tax at the rate of seven and one-half percent (7.5%) based on the gross amount of such interest income. The depository bank shall withhold and remit the tax pursuant to the provisions of Sections 57 and 58 (withholding tax at source) of the Code.


SECTION 2. Final Tax on Sales, Exchanges or Transfers of Real Properties Classified as Capital Assets. — The rate of six percent (6%) shall be imposed on capital gains presumed to have been realized by the seller from the sale, exchange or other disposition of real properties located in the Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the Code (i.e., the authority of the Commissioner to prescribe the real property values), whichever is higher.

In case of disposition of real property made by individuals to the government or to any of its political subdivisions or agencies or to government-owned or -controlled-corporations, the tax to be imposed shall be determined either under the normal income tax rate imposed in Section 24(A) or under a final capital gains tax of six percent (6%) imposed under Section 24(D)(1), both of the Tax Code of 1997, at the option of the taxpayer.

SECTION 4. Creditable Withholding Tax on the Sale, Transfer or Exchange of Real Property Classified as Ordinary Asset. — A creditable withholding tax based on the gross selling price/total amount of consideration or the fair market value determined in accordance with Section 6(E) of the Code, whichever is higher, paid to the seller/owner for the sale, transfer or exchange of real property, other than capital asset, shall be imposed upon the withholding agent/buyer, in accordance with the following schedule:

A. Upon the following values of real property, where the seller/transferor is habitually engaged in the real estate business as per proof of registration with the HLURB or HUDCC:

With a selling price of Five hundred thousand pesos (P500,000.00) or less = 1.5%

With a selling price of more than Five hundred thousand pesos (P500,000.00) but not more than Two million pesos (P2,000,000.00) = 3.0%

With a selling price of more than Two million pesos (P2,000,000.00) = 5.0%

B. Where the seller/transferor is not habitually engaged in the real estate business = 7.5%

C. Where the seller/transferor is exempt from creditable withholding tax in accordance with Section 2.57.5 of Revenue Regulations No. 2-98 = Exempt

4.a. RESIDENT CITIZENS AND RESIDENT ALIENS (RR 2, 2-98, § 5/6)


SECTION 5. Definition. — A "non-resident alien individual" means an individual —

(a) Whose residence is not within the Philippines; and

(b) Who is not a citizen of the Philippines.

An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the Philippines for purposes of the income tax. Whether he is a transient or not is determined by his intentions with regard to the length and nature of his stay. A mere floating intention indefinite as to time, to return to another country is not sufficient to constitute him a transient. If he lives in the Philippines and has no definite intention as to his stay, he is a resident. One who comes to the Philippines for a definite purpose which in its nature may be promptly accomplished is a transient. But if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and to that end the alien makes his home temporarily in the Philippines, he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose for which he came has been consummated or abandoned.

SECTION 6. Loss of residence by alien. — An alien who has acquired residence in the Philippines retains his status as a resident until he abandons the same and actually departs from the Philippines. An intention to change his residence does not change his status as a resident alien to that of a nonresident alien. Thus an alien who has acquired a residence in the Philippines is taxable as a resident for the remainder of his stay in the Philippines.


SECTION 2.78.1. Withholding of Income Tax on Compensation Income. —

(A) Compensation Income Defined. — In general, the term "compensation" means all remuneration for services performed by an employee for his employer under an employer-employee relationship, unless specifically excluded by the Code.

The name by which the remuneration for services is designated is immaterial. Thus, salaries, wages, emoluments and honoraria, allowances, commissions (e.g. transportation, representation, entertainment and the like); fees including director's fees, if the director is, at the same time, an employee of the employer/corporation; taxable bonuses and fringe benefits except those which are subject to the fringe benefits tax under Sec. 33 of the Code; taxable pensions and retirement pay; and other income of a similar nature constitute compensation income.

The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes compensation. Thus, it may be paid on the basis of piece-work, or a percentage of profits; and may be paid hourly, daily, weekly, monthly or annually.

Remuneration for services constitutes compensation even if the relationship of employer and employee does not exist any longer at the time when payment is made between the person in whose employ the services had been performed and the individual who performed them.

(1) Compensation paid in kind. — Compensation may be paid in money or in some medium other than money, as for example, stocks, bonds or other forms of property. If services are paid for in a medium other than money, the fair market value of the thing taken in payment is the amount to be included as compensation subject to withholding. 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 fair market value of the remuneration received. If a corporation transfers to its employees its own stock as remuneration for services rendered by the employee, the amount of such remuneration is the fair market value of the stock at the time the services were rendered .

(2) Living quarters or meals. — If a person receives a salary as remuneration for services rendered, and in addition thereto, living quarters or meals are provided, the value to such person of the quarters and meals so furnished shall be added to the remuneration paid for the purpose of determining the amount of compensation subject to withholding. However, if living quarters or meals are furnished to an employee for the convenience of the employer, the value thereof need not be included as part of compensation income.

(3) Facilities and privileges of a relatively small value. — Ordinarily, facilities and privileges (such as entertainment, medical services, or so called "courtesy" discounts on purchases), furnished or offered by an employer to his employees generally, are not considered as compensation subject to withholding if such facilities or privileges are of relatively small value and are offered or furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his employees.

Where compensation is paid in property other than money, the employer shall make necessary arrangements to ensure that the amount of the tax required to be withheld is available for payment to the Commissioner.

(4) Tips and gratuities. — Tips or gratuities paid directly to an employee by a customer of the employer which are not accounted for by the employee to the employer are considered as taxable income but not subject to withholding.

(5) Pensions, retirement and separation pay. — Pensions, retirement and separation pay constitute compensation subject to withholding, except those provided under Subsection B of this section.

(6) Fixed or variable transportation, representation and other allowances —

(a) IN GENERAL, fixed or variable transportation, representation and other allowances which are received by a public officer or employee or officer or employee of a private entity, in addition to the regular compensation fixed for his position or office, is compensation subject to withholding.

(b) Any amount paid specifically, either as advances or reimbursements for travelling, representation and other bonafide ordinary and necessary expenses incurred or reasonably expected to be incurred by the employee in the performance of his duties are not compensation subject to withholding, if the following conditions are satisfied:

(i) It is for ordinary and necessary travelling and representation or entertainment expenses paid or incurred by the employee in the pursuit of the trade, business or profession; and

(ii) The employee is required to account/liquidate for the foregoing expenses in accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of actual expenses over advances made shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/advances for travelling and entertainment expenses which are pre-computed on a daily basis and are paid to an employee while he is on an assignment or duty need not be subject to the requirement of substantiation and to withholding.

(7) Vacation and sick leave allowances. — Amounts of "vacation allowances or sick leave credits" which are paid to an employee constitute compensation. Thus, the salary of an employee on vacation or on sick leave, which are paid notwithstanding his absence from work, constitutes compensation. However, the monetized value of unutilized vacation leave credits of ten (10) days or less which were paid to the employee during the year are not subject to income tax and to the withholding tax .

(8) Deductions made by employer from compensation of employee. — 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.

(9) Remuneration for services as employee of a nonresident alien individual or foreign entity. — The term "compensation" includes remuneration for services performed by an employee of a nonresident alien individual, foreign partnership or foreign corporation, whether or not such alien individual or foreign entity is engaged in trade or business within the Philippines. Any person paying compensation on behalf of a non-resident alien individual, foreign partnership, or foreign corporation which is not engaged

in trade or business within the Philippines is subject to all provisions of law and regulations applicable to an employer.

(10) Compensation for services performed outside the Philippines. — Remuneration for services performed outside the Philippines by a resident citizen for a domestic or a resident foreign corporation or partnership, or for a non-resident corporation or partnership, or for a non-resident individual not engaged in trade or business in the Philippines shall be treated as compensation which is subject to tax.

A non-resident citizen as defined in these regulations is taxable only on income derived from sources within the Philippines. In general, the situs of the income whether within or without the Philippines, is determined by the place where the service is rendered.

(B) Exemptions from withholding tax on compensation. — The following income payments are exempted from the requirement of withholding tax on compensation:

(1) Remunerations received as an incident of employment, as follows:

(a) Retirement benefits received under Republic Act under 7641 and those received by officials and employees of private firms, whether individual or corporate, under a reasonable private benefit plan maintained by the employer which meet the following requirements:

(i) The plan must be reasonable;

(ii) The benefit plan must be approved by the Bureau;

(iii) The retiring official or employee must have 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 retirement; and

(iv) The retiring official or employee should not have previously availed of the privilege under the retirement benefit plan of the same or another employer.

(b) Any amount received by an official or employee or by his heirs from the employer due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee, such as retrenchment, redundancy, or cessation of business.

The phrase "for any cause beyond the control of the said official or employee" connotes involuntariness on the part of the official or employee. The separation from the service of the official or employee must not be asked for or initiated by him. The separation was not of his own making. Whether or not the separation is beyond the control of the official or employee, being essentially a question of fact, shall be determined on the basis of prevailing facts and circumstances. It 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.

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.

Any payment made by 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.

(c) Social security benefits, retirement gratuities, pensions and other similar benefits received by residents or non-resident 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 law of the United States administered by the United States Veterans Administration;

(e) Payments of benefits made under the Social Security System Act of 1954 as amended; and

(f) Benefits received from the GSIS Act of 1937, as amended, and the retirement gratuity received by government officials and employees.

(2) Remuneration paid for agricultural labor —

(a) Remuneration for services which constitute agricultural labor and paid entirely in products of the farm where the labor is performed is not subject to withholding. In general, however, the term, "agricultural labor" does not include services performed in connection with forestry, lumbering or landscaping.

(b) Remuneration paid entirely in products of the farm where the labor is performed by an employee of any person in connection with any of the following activities is excepted as remuneration for agricultural labor:

(i) The cultivation of soil;

(ii) The raising, shearing, feeding, caring for, training, or management of livestock, bees, poultry, or wildlife; or

(iii) The raising or harvesting of any other agricultural or horticultural commodity. The term "farm" as used in this subsection includes, but is not limited to stock, dairy, poultry, fruits and truck farms, plantations, ranches, nurseries ranges, orchards, and such greenhouse and other similar structures as are used primarily for the raising of agricultural or horticultural commodities.

(c) The remuneration paid entirely in products of the farm where labor is performed for the following services in the employ of the owner or tenant or other operator of one or more farms is not considered as remuneration for agricultural labor, provided the major part of such services is performed on a farm:

(i) Services performed in connection with the operation, management, conservation, improvement, or maintenance of any such farms or its tools or equipments; or

(ii) Services performed in salvaging timber, or clearing land brush and other debris left by a hurricane or typhoon.

The services described in (i) above may include for example, services performed by carpenters, painters, mechanics, farm supervisors, irrigation engineers, bookkeepers, and other skilled or semi-skilled workers, which contribute in any way to the conduct of the farm or farms, as such, operated by the person employing them, as distinguished from any other enterprise in which such person may be engaged. Since the services described in this paragraph must be performed in the employ of the owner or tenant or other operator of the farm, the exception does not extend to remuneration paid for services performed by employees of a commercial painting concern, for

example, which contracts with a farmer to renovate his farm properties.

(d) Remuneration paid entirely in products of the farm where labor is performed by an employee in the employ of any person in connection with any of the following operations is not considered as remuneration for agricultural labor without regard to the place where such services are performed:

(i) The making of copra, stripping of abaca, etc.;

(ii) The hatching of poultry;

(ii) The raising of fish;

(iv) The operation or maintenance of ditches, canals, reservoirs, or waterways used exclusively for supplying or storing water for farming purposes; and

(v) The production or harvesting of crude gum from a living tree or the processing of such crude gum into gum spirits or turpentine and gum resin, provided such processing is carried on by the original producer of such crude gum.

(e) Remuneration paid entirely in products of the farm where labor is performed by an employee in the employ of a farmer or a farmer's cooperative, organization or group in the handling, planting, drying, packing, packaging, processing, freezing, grading, storing or delivering to storage or to market or to carrier for transportation to market, of any agricultural or horticultural commodity, produced by such farmer or farmer-members of such organization or group, is excepted as remuneration for agricultural labor. Services performed by employees of such farmer or farmer's organization or group in handling, planting, drying, packaging, processing, freezing, grading, storing, or delivering to storage or to market or to carrier for transportation to market of commodities produced by persons other than such farmer or members of such farmer's organization or group are not performed "as an incident to ordinary farming operation".

All payments made in cash or other forms other than products of the farm where labor is performed, for services constituting agricultural labor as explained above, are not within the exception.

(3) Remuneration for domestic services. — Remuneration paid for services of a household nature performed by an employee in or about the private home of the person by whom he is employed is not subject to withholding. However, 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 Code, as amended.

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.

In general, services of a 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 above enumerated which are performed in or about rooming or lodging houses, boarding houses, clubs, hotels, hospitals or commercial offices 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;

(4) Remuneration for casual labor not in the course of an employer's trade or business. — The term "casual labor" includes labor which is occasional, incidental or regular. The expression "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.

Thus, any remuneration paid for labor which is occasional, incidental or irregular, and does not promote or advance the employer's trade or business, is not considered as compensation.

EXAMPLE: A's business is that of operating a sawmill. He employs B, a carpenter, at an hourly wage to repair his home. B's work is irregular and he spends, the greater part of two days in completing the work. Since B's labor is casual and is not in the course of A's business, the remuneration paid for such services is exempted.

Any remuneration paid for casual labor, that is, labor which is occasional, incidental or irregular, but which is rendered in the course of the employer's trade or business, is considered as compensation.

EXAMPLE: E is engaged in the business of operating a department store. He employs additional clerks for a short period. While the services of the clerks may be casual, they are rendered in the course of the employer's trade or business and therefore the remuneration paid for such services is considered as compensation.

Any remuneration paid for casual labor performed for a corporation is considered as compensation;

(5) Compensation for services by a citizen or resident of the Philippines for a foreign government or an international organization. — Remuneration paid for services performed as an employee of a foreign government or an international organization is exempted. The exemption 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.

(6) Damages. — Actual, moral, exemplary and nominal damages received by an employee or his heirs pursuant to a final judgment or compromise agreement arising out of or related to an employer-employee relationship.

(7) 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, provided however, that interest payments agreed under the policy for the amounts which are held by the insured under such an agreement shall be included in the gross income.

(8) Amount received by the insured as a return of premium. — The amount received by the insured, as a return of premium or 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.

(9) 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 amount of any damages received whether by suit or agreement on account of such injuries or sickness.

(10) Income exempt under treaty. — Income of any kind to the extent required by any treaty obligation binding upon the Government of the Philippines.

(11) Thirteenth (13th ) month pay and other benefits. —

(a) Thirteenth (13th) month pay equivalent to the mandatory one (1) month basic salary of officials and employees of the government,

(whether national or local), including government-owned or controlled corporations, and or private offices received after the twelfth (12th) month pay; and

(b) Other benefits such as Christmas bonus, productivity incentive bonus, loyalty award, gifts in cash or in kind and other benefits of similar nature actually received by officials and employees of both government and private offices.

The above stated exclusions (a) and (b) shall cover benefits paid or accrued during the year provided that the total amount shall not exceed thirty thousand pesos (P30,000.00) which may be increased through rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner, after considering, among others, the effect on the same of the inflation rate at the end of the taxable year.

(12) GSIS, SSS, Medicare and other contributions. — GSIS, SSS, Medicare and Pag-Ibig contributions, and union dues of individual employees.

4.b. NON RESIDENT CITIZENS (RR 1-79/ RR 9-99)

REVENUE REGULATIONS NO. 01-79

SECTION 2. Who are considered as nonresident citizens. —

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

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

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

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

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

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


SECTION 2. Pertinent Provisions:

Section 22 (E) "The term 'non resident citizen' means:

(1) 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.

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

(3) A 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.

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

The taxpayer shall submit proof to the Commissioner to show his intention of leaving the Philippines to reside permanently abroad or to return to and reside in the Philippines as the case may be for the purpose of this Section."

Section 23 (B) "A non-resident citizen is taxable only on income derived from sources within the Philippines."

Section 23 (C) "An individual citizen of the Philippines who is working and deriving income abroad as an overseas contract worker is taxable only on income from sources within the Philippines: Provided, That a seaman who is a citizen of the Philippines and who receives compensation for services rendered abroad as a member of the complement of a vessel engaged exclusively in international trade shall be treated as an overseas contract worker."

4.d. PERSONAL EXEMPTION AND/OR ADDITIONAL EXEMPTIONS (RR 10-08/ 16-08)


SECTION 3. Section 2.79 of RR 2-98, as amended, is hereby further amended to read as follows:

"Sec. 2.79. Income Tax Collected at Source on Compensation Income. —

NOTE: Section A to H deleted

(I) Right to Claim Withholding Exemptions. — An employee receiving compensation shall be entitled to withholding exemptions as provided in the Code, as amended. In order to receive the benefit of such exemptions, the employee must file the Application for Registration (BIR Form No. 1902), upon employment, or a Certificate of Update of Exemption and of Employer's and Employee's Information (BIR Form No. 2305), in case of updates on changes in his exemption. The withholding exemption to which an employee is entitled depends upon his status and the number of dependents qualified for additional exemptions. Each employee shall be allowed to claim the following amount of exemptions, with respect to compensation paid on or after July 6, 2008.

(1) Personal and additional exemptions. —

(a) Basic personal exemptions. —

Individual taxpayers regardless of status are entitled to P50,000 personal exemption.

(b) Additional exemptions for taxpayers with dependents. — An individual whether single or married, shall be allowed an additional exemption of Twenty Five Thousand Pesos (P25,000) for each qualified dependent child, provided that the total number of dependents for which additional exemptions may be claimed shall not exceed four (4) dependents. The additional exemptions for QDC shall be claimed by only one of the spouses in the case of married individuals.

A dependent means a legitimate, illegitimate or legally adopted child chiefly dependent upon and living with the taxpayer if such dependent is not more than twenty-one (21) years of age, unmarried and not gainfully employed or if such dependent, regardless of age, is incapable of self-support because of mental or physical defect.

The husband shall be the proper claimant of the additional exemption for qualified dependent children unless he explicitly waives his right in favor of his wife in the Application for Registration (BIR Form No. 1902) or in the Certificate of Update of Exemption and of Employer's and Employee's Information (BIR Form No. 2305), whichever is applicable: Provided, however, that where the spouse of the employee is unemployed or is a non-resident citizen deriving income from foreign sources, the employed spouse within the Philippines shall be automatically entitled to claim the additional exemptions for children.

Every employer should ascertain whether or not a child being claimed is a qualified dependent under the provisions of these Regulations. If the employee should have additional dependent(s), as defined above, during the taxable year, he may claim the corresponding additional exemption, as the case may be, in full for such year.

If the taxpayer dies during the taxable year, his estate may still claim the personal and additional exemptions for himself and his dependent(s) as if he died at the close of such year. If the spouse or any of the dependents dies or if any of such dependents marries, becomes twenty-one (21) years old or becomes gainfully employed during the taxable year, the taxpayer may still claim the same exemptions as if the spouse or any of the dependents died, or as if such dependents married, became twenty-one (21) years old or became gainfully employed at the close of such year. Provided, that in 2008, the pro-rated personal and additional exemptions shall apply as stated in the regulations.

The personal and additional exemptions herein above stated shall apply after the transitory period.

EXAMPLE X: Mr. M got married on July 20, 2008, when his girlfriend was four (4) months pregnant. On December 26, 2008, the wife gave birth to twins. Earnings from January 1 to July 5, 2008 is P150,000.00 and for the rest of 2008, he earned P200,000.00 more. The tax due for 2008 is computed as follows:

Compensation Income (January 1-July 5, 2008) P150,000.00 Compensation Income (July 6 to December 31, 2008) 200,000.00 –––––––––– Total Compensation for 2008 350,000.00 ========= Less: Personal Exemption P41,000.00 Additional Exemption (16,500 x 2) 33,000.00 (74,000.00) Taxable Compensation Income P276,000.00

––––––––––– Tax Due: 250,000.00 P50,000.00 26,000.00 x 30% 7,800.00 ––––––––––– Total P57,800.00"

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SUBJECT : Implementing the Provisions of Section 34 (L) of the Tax Code of 1997, as Amended by Section 3 of Republic Act No. 9504, Dealing on the Optional Standard Deduction (OSD) Allowed to Individuals and Corporations in Computing Their Taxable Income

TO : All Revenue Officers and Others Concerned

SECTION 1. Scope. — Pursuant to Sec. 244, in relation to Sec. 3 of Republic Act No. 9504 (RA 9504) amending Sec. 34 (L) of the Tax Code of 1997 (Code), as amended, these Regulations are hereby promulgated in order to implement the provisions on Optional Standard Deduction (OSD) for individuals and corporations.

SECTION 2. Persons Covered. — The following may be allowed to claim OSD in lieu of the itemized deductions (i.e. items of ordinary and necessary expenses allowed under Sections 34 (A) to (J) and (M), Section 37, other special laws, if applicable):

1. Individuals:

i. Resident Citizen

ii. Non-resident citizen

iii. Resident Alien

iv. Taxable estates and trusts

2. Corporations:

i. Domestic corporation

ii. Resident foreign corporation

SECTION 3. Determination of the Amount of Optional Standard Deduction for Individuals. — The OSD allowed to individual taxpayers shall be a maximum of forty percent (40%) of gross sales or gross receipts during the taxable year. If the individual is on the accrual basis of accounting for his income and deductions, the OSD shall be based on the gross sales during the taxable year. On the other hand, if the individual employs the cash basis of accounting for his income and deductions, the OSD shall be based on his gross receipts during the taxable year.

It should be emphasized that the "cost of sales" in case of individual seller of goods, or the "cost of services" in the case of individual seller of services, are not allowed to be deducted for purposes of determining the basis of the OSD pursuant to this Section inasmuch as the law (RA 9504) is specific as to the basis thereof which states that for individuals, the basis of the 40% OSD shall be the "gross sales" or "gross receipts" and not the "gross income".

For other individual taxpayers allowed by law to report their income and deductions under a different method of accounting (e.g. percentage of completion basis, etc.) other than cash and accrual method of accounting, the "gross sales" or "gross receipts" pursuant to this Section shall be determined in accordance with said acceptable method of accounting.

SECTION 4. Determination of the Amount of Optional Standard Deduction for Corporations. — In the case of corporate taxpayers subject to tax under Sections 27 (A) and 28 (A) (1) of the Code, as amended, the OSD allowed shall be in an amount not exceeding forty percent (40%) of their gross income.

For purposes of these Regulations, "Gross Income" shall mean the gross sales less sales returns, discounts and allowances and cost of goods sold. "Gross sales" shall include only sales contributory to income taxable under Sec. 27 (A) of the Code. "Cost of goods sold" shall include the purchase price or cost to produce the merchandise and all expenses directly incurred in bringing them to their present location and use.

For trading or merchandising concern, "cost of goods sold" means the invoice cost of goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit.

For manufacturing concern, "cost of goods sold" means all costs incurred in the production of the finished goods such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or warehouse. The term may be used interchangeably with "cost of goods manufactured and sold".

In the case of sellers of services, the term "gross income" means the "gross receipts" less sales returns, allowances, discounts and cost of services. "Cost of services" means all direct costs and expenses necessarily incurred to provide the services required by the customers and clients including (a) salaries and employee benefits of personnel, consultants and specialists directly rendering the service, and (b) cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used and cost of supplies: Provided, however, that "cost of services" shall not include interest expense except in the case of banks and other financial institutions. The term "gross receipts" as used herein means amounts actually or constructively received during the taxable year. However, for taxpayers engaged as sellers of services but employing the accrual basis of accounting for their income, the term "gross receipts" shall mean amounts earned as gross revenue during the taxable year.

The items of gross income under Section 32 (A) of the Code, as amended, which are required to be declared in the income tax return of the taxpayer for the taxable year are part of the gross income against which the OSD may be deducted in arriving at taxable income. Passive incomes which have been subjected to a final tax at source shall not form part of the gross income for purposes of computing the forty percent (40%) optional standard deduction.

For other taxpayers allowed by law to report their income and deductions under a different method of accounting (e.g. percentage of completion basis, etc.) other than cash and accrual method of accounting, the "gross income" pursuant to this Section shall be determined in accordance with said acceptable method of accounting.

SECTION 5. Illustrative Examples in Determining the Basis of the 40% OSD for Individuals and Corporations. — Suppose a retailer of goods, whose accounting method is under the accrual basis, has a gross sales of P1,000,000.00 with a cost of sales amounting to P800,000. The computation of the OSD for individuals and corporations shall be determined as follows:

If Individual If Corporation

Gross Sales P1,000,000 P1,000,000

Less: Cost of Goods Sold 800,000

–––––––––– ––––––––––

Basis of the OSD P1,000,000 P200,000

X OSD Rate (maximum) .40 .40

–––––––––– ––––––––––

OSD Amount P400,000 P80,000

========= =========

If the taxpayer opts to use the OSD in lieu of the itemized deduction allowed under Section 34 of the Code, as amended, his/its net taxable income shall be as follows:

If Individual If Corporation

Gross Sales P1,000,000 P1,000,000

Less: Cost of Sales -800,000

–––––––––– ––––––––––

Gross Sales/Gross Income P1,000,000 P200,000

Less: OSD (maximum) 400,000 80,000

–––––––––– ––––––––––

Net Income P600,000 P120,000

========= =========

SECTION 6. Determination of the Optional Standard Deduction for General Professional Partnerships (GPPs) and Partners of GPPs. — Pursuant to Sec. 26 of the Code, a GPP is not subject to income tax imposed under Title II thereof. However, the partners shall be liable to pay income tax on their separate and individual capacities for their respective distributive share in the net income of the GPP.

Sec. 26 of the Code likewise provides that — "For purposes of computing the distributive share of the partners, the net income of the GPP shall be computed in the same manner as a corporation." As such, a GPP may claim either the itemized deductions allowed under Section 34 of the Code or in lieu thereof, it can opt to avail of the OSD allowed to corporations in claiming the deductions in an amount not exceeding forty percent (40%) of its gross income. The net income determined by either claiming the itemized deduction or OSD from the GPP's gross income is the distributable net income from which the share of each partner is to be determined. Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership.

The GPP is not a taxable entity for income tax purposes since it is only acting as a "pass-through" entity where its income is ultimately taxed to the partners comprising it. In computing taxable income defined under Section 31 of the Code, the individual partner can still claim either itemized deductions or optional standard deduction from his share in the net income of the GPP because said share is considered as gross income in the hands of the partner (Section 32 (A) (11) and Section 26, NIRC). If the GPP availed of the itemized deduction in computing its net income, the partners may still either claim itemized deduction or OSD from said share, provided, that, in claiming itemized deductions, the partner is precluded from claiming expenses already claimed by the GPP. In fine, if the GPP claimed itemized deductions and a partner is also claiming itemized deductions, the deductions allowed to the partner must be the ordinary and necessary expenses for the practice of profession which were not yet claimed by the GPP in computing its net income. The GPP and each of the partners are entitled to their own election of deductions to claim during the taxable year thereby resulting to four possibilities, namely: (1) the GPP may claim itemized deductions in computing net income and a partner may also claim itemized deductions in computing his taxable income; or (2) the GPP may claim OSD in computing net income while a partner may claim itemized deductions in computing his taxable income; or (3) the GPP may claim itemized deductions in computing net income while a partner may claim OSD in computing his taxable income; or (4) the GPP may claim OSD in computing net income and a partner may also claim OSD in computing his taxable income.

SECTION 7. Other Implications of the Optional Standard Deduction. — A taxpayer who elected to avail of the OSD not exceeding forty percent (40%) of gross sales or gross receipts, in case of an individual taxable under Secs. 24 (A) and 25 (A) (1) of the Tax Code, or forty percent (40%) of gross income, in case of a corporation subject to tax under Sec. 27 (A) or 28 (A) (1) of the same Code shall signify in his/its return such intention, otherwise he/it shall be considered as having availed himself of the itemized deductions allowed under Sec. 34 of the Code. Once the election to avail the OSD is signified in the return, it shall be irrevocable for the taxable year for which the return is made. This means that a taxpayer who initially filed a return availing OSD is precluded from amending said return in order to shift to the itemized deductions. An individual taxpayer who is entitled to and claimed the OSD shall not be required to submit with his tax return such financial statements otherwise required under the Code. Provided, that, except when the Commissioner otherwise permits, the said individual shall keep such records pertaining to his gross sales or gross receipts. In the case of a corporation, however, said corporation is still required to submit its financial statements when it files its annual income tax return and to keep such records pertaining to its gross income as herein defined.

In the filing of the quarterly income tax returns, the taxpayer may opt to use either the itemized deduction or OSD. However, in filing the final adjustment income tax return,

the taxpayer must make a choice as to what method of deduction it or he shall employ for the purpose of determining its/his taxable net income for the entire year. The taxpayer is, thus, not allowed to use a hybrid method of claiming its/his deduction for one taxable year.

4.e. SENIOR CITIZEN LAW

REVENUE REGULATION 7-2010, Implementing RA 9994

5.a. DEFINITION OF HEAD OF A FAMILY


Section 11, Paragraph 2

A head of family is an individual who actually supports and maintains in one household one or more individuals, who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. In the absence of continuous actual residence together, whether or not a person with dependent relatives is a head of a family within the meaning of the statute must depend on the character of the separation. If a father is absent on business, or a child or other dependent is away at school or on a visit, the common home being still maintained, the additional exemption applies. If, moreover, through force of circumstances a parent is obliged to maintain his dependent children with relatives or in a boarding house while he lives elsewhere, the additional exemption may still apply. If, however, without necessity, the dependent continuously makes his home elsewhere, his benefactor is not the head of a family, irrespective of the question of support. A resident alien with children abroad is not thereby entitled to credit as the head of a family. Chief support means principal or main support. Partial support not amounting to chief support will not entitle the taxpayer to claim exemption as a head of a family.

C. TAX ON CORPORATIONS

1. Definition of Corporations

BIR RULING 317-92

Ayala Land, Inc.(ALI) & Appleyard Properties, Inc(API) entered into a Memorandum of

Agreement (MOA) for the construction of the 6750 Bldg.. Pursuant to the MOA, they will contribute equal amounts to the construction costs & ALI will own 60% of the building while API will own 40%, while there is separate ownership, they will share common area expenses, real estate taxes, etc in the same proportion. ALI & API now propose to enter into a another agreement, a Joint Venture Agreement(JVA). Under the JVA, both ALI & API will contribute money as additional working capital & ALI will be appointed as manager & will be responsible for leasing the floors.

HELD: To constitute a "joint venture" certain factors are essential:

(a) each party to the venture must make a contribution, not necessarily of capital, but by way of services, skill, knowledge, material or money;

(b) profits must be shared among the parties;

(c) there must be a joint proprietary interest and right of mutual control over the subject matter of the enterprise;

(d) usually, there is single business transaction rather than a general or continuous transaction" (Words and Phrases, Vol. 23, p. 230)

Likewise, a joint venture was created when two corporations while registered and operating separately were placed under one sole management which operated the business affairs of said companies as though constituted a single entity thereby obtaining substantial economy and profits in the operation (Collector vs. Batangas Transportation et al. 102 Phil. 822; See also BIR Ruling Nos. 020(b)-020-80-187-82 dated June 3, 1982; 24-000-00-115-86 dated July 17, 1986; 069-90 dated May 9, 1990 and 254-91 dated November 26, 1991).

The MOA has not by itself created a taxable joint venture. However, the joint venture to be subsequently entered into by & between ALI & API will create a joint venture subject to tax.

Moreover, the rentals to be received by the joint venture from the tenants in the Building are income to the joint venture. Furthermore, the distribution by the joint venture of its net income to ALI and API are in the nature of dividends which are not subject to tax under Section 24(e)(4) of the Tax Code, as amended

2.b. SPECIAL CORPORATIONS

1. EDUCATIONAL INSTITUTIONS

DOF ORDER NO. 137-87 (As Amended by DOF DEPARTMENT ORDER NO. 149-95 with regard to Section 2.1 and 2.1.1)

SUBJECT: Rules and Regulations Implementing Section 4(3), Article XIV of the New Constitution —

Pursuant to Section 79(b) of the Revised Administrative Code, the following rules and regulations are hereby promulgated for the effective implementation of the provisions of the New Constitution, to wit:

"Section 4(3), Article XIV — All revenues and assets of non-stock, non-profit educational institution used actually, directly and exclusively for educational purposes, shall be exempt from taxes and duties . . ."

SECTION 1. Scope —

This set of guidelines shall govern the availment of exemption from the payment of internal revenue taxes and customs duties provided for under the National Internal Revenue Code, and the Tariff and Customs Code, both as amended.

1.1 Educational institution — means a non-stock, non-profit corporation/association duly registered under Philippine law, and operated exclusively for educational purposes, maintained and administered by private

individuals or groups, and offering formal education, issued a permit, to operate by the Department of Education, Culture and Sports (DECS) in accordance with existing laws and regulations.

1.2. Educational Activity Includes —

1.2.1. Instructing or training of individuals either through formal education. Formal education refers to the Institutionalized, chronologically graded and hierarchically structured educational system at all levels of education.

1.3. Utilization by Educational Institution — means

1.3.1. Any amount in cash or in kind (including administrative expenses) paid or utilized to accomplish one or more purposes for which it was created or organized, including grant of scholarship to deserving students and professorial chairs for the enhancement of professional course.

1.3.2. Any amount paid to acquire an asset used (or held for use) directly in carrying out one or more purposes for which the educational institution was created or organized, including the upgrading of existing facilities to support the conduct of the above activities.

1.3.3. Any amount in cash or in kind invested in an activity related to the educational purposes for which it was created or organized.

1.3.4. Any amount set aside for a specific project subject/ prior to approval of the Commissioner of Internal Revenue in writing. Application thereof must contain the following:

(i) the nature and purpose of the specific project and the amount programmed therefor;

(ii) a detailed description of the project, including estimated costs, sources of any future funds expected to be used for completion of the project, and the location or locations (general or specific) of any physical facilities to be acquired or constructed as part of the project; and

(iii) a statement by an authorized official of the corporation or association that the amount to be set aside will actually be disbursed for the specific project within two (2) years from the date of approval by the Commissioner of Internal Revenue, unless the nature of the project is such that the two (2) year period is impracticable.

1.3.5. Any amount set aside shall be evidenced by book entries and documents showing evidence of deposits or investments, including investment of the funds so set aside, or other documents that the Commissioner may require.

1.4. Non-Profit — means no part of the income inures directly or indirectly to any individual or member.

1.5. Operated exclusively — means primarily engaged in activities which accomplish the educational purposes. To meet the operational test, an organization must be engaged in activities furthering "public purposes" rather than private interests. It must not be operated for the benefit of designated individuals or the persons who created it.

1.6. Actually, Directly and Exclusively Used. — shall refer to the purpose for which the property is principally utilized for educational purposes.

1.7. Revenues — refer to income derived in pursuance of its purpose as an educational institution.

1.8. Assets — Any owned physical object (tangible) or right (intangible) having a money value; an item or source of wealth, expressed in terms of its cost, depreciated cost, or less frequently, some other value; hence, any cost benefiting a future period.

SECTION 2. Coverage of Exemption Under Section 4(3), Article XIV of the New Constitution —

The exemption herein contemplated refers to internal revenue taxes and customs duties, in appropriate cases, imposed by the national government on all revenues and assets of non-stock, non-profit educational institutions used actually, directly and exclusively for educational purposes.

2.1 NON-STOCK, NON-PROFIT EDUCATIONAL INSTITUTIONS ARE EXEMPT FROM TAXES ON ALL THEIR REVENUES AND ASSETS USED ACTUALLY, DIRECTLY, AND EXCLUSIVELY FOR EDUCATIONAL PURPOSES. They shall, however, be subject to internal revenue taxes on income from trade, business or other activity the conduct of which is not related to the exercise or performance by such educational institution of its educational purpose or function.

2.1.1 To ensure that the exempt interest income from Philippine currency deposits and yield from deposit substitute instruments are used actually, directly, and exclusively for educational purposes, the said educational institutions shall, on annual basis submit to the Revenue District Officer, together with the annual information return and duly audited financial statement, the following:

a) Certification from their depository banks as to the amount of interest income earned from passive investments not subject to the 20% final withholding tax imposed by Section 24(e) of the Tax Code, as amended;

b) Certification of actual utilization of the said income; and

c) Board Resolution by the school administration on proposed projects. (i.e. construction and/or improvement of school building and facilities; acquisition of equipments, books and the like) to be funded out of money deposited in banks or placed in money markets.

The RDO shall conduct an audit of the annual information return filed to determined compliance with the conditions set forth in the Certificate of exemption and the tax liabilities, if any.

2.2. Revenues derived from and assets used in the operations of cafeterias/canteens, dormitories, bookstores are exempt from taxation provided they are owned and operated by the educational institution as ancillary activities and the same are located within the school premises.

2.3. Revenues derived from and assets used in the operations of hospitals are exempt from taxation provided they are owned and operated by the educational institution as an indispensable requirement in the operation and maintenance of its medical school/college/institute.

SECTION 3. Non-Exemption from the Withholding Taxes. — Non stock educational institutions are constituted as withholding agents of the government to insure that the withholding tax liability of their employees, and other taxpayers to whom income payments are made, are complied with.

SECTION 6. Availment of Duty and Tax-Free Entry of Imported Articles. —

In order to avail of the duty and tax-free entry of imported articles under Section 4(3), Article XIV of the New Constitution, the following guidelines are hereby prescribed in addition to the usual import requirements:

6.1. The importer shall, prior to the importation, apply with the Department of Education, Culture and Sports for duty and tax exemption executed under oath by a duly authorized representative of the institution and supported by the following documents:

6.1.1. A copy of the Charter or other evidence of the character of the institution for which the articles are imported and the original of any order given by the importer.

6.1.3. Should the importation be made through a dealer or indentor, an affidavit of both the dealer or indentor and the ultimate consignee whose identity is indicated in the shipping documents. Such affidavit shall state the party who placed the order, the number of items and their respective values and such other matters as are related to the transaction.

6.2. The Department of Education, Culture and Sports shall verify and certify that the educational institution is non-stock and non-profit and that the imported articles are to be used actually, directly and exclusively for educational purposes and shall indorse the application for duty and tax exemption to the Department of Finance with appropriate recommendation.

6.3. The Department of Finance, based on the recommendation of the Department of Education, Culture and Sports, may allow the tax and/or duty-free entry of articles referred to under Section 4(3), Article XIV of the New Constitution upon compliance with the requirements herein indicated;

6.4. This does not, however, preclude the Department of Finance from requiring the submission of additional documents/undertakings should the need arise;

6.5. Articles entered tax and/or duty-free by educational institutions may not be sold, transferred or otherwise disposed of in any manner whatsoever to any person without the prior approval of the Department of Finance. Any transferee of said article shall be deemed the importer thereof, and the same shall be assessed at its entered value without depreciation.

3. INTERNATIONAL CARRIERS


SECTION 2. Definition Of Terms. — For purposes of these Regulations, the following terms shall be construed as follows:

(a) International air carrier — shall refer to a foreign airline corporation doing business in the Philippines having been granted landing rights in any Philippine port to perform international air transportation services/activities or flight operations anywhere in the world.

(b) Off-line carrier — shall refer to an international air carrier having no flight operations to and from the Philippines.

(c) On-line carrier — shall refer to an international air carrier having or maintaining flight operations to and from the Philippines.

(d) Off-line flights — shall refer to flight operations carried out or maintained by an international air carrier between ports or points outside the territorial jurisdiction of the Philippines, without touching a port or point situated in the Philippines, except when in distress or due to force majeure.

(e) On-line flights — shall refer to flight operations carried out or maintained by an international air carrier between ports or points in the territorial jurisdiction of the Philippines and any port or point outside the Philippines.

(f) Chartered flight — shall refer to flight operation which includes operations between ports or points situated in the Philippines and ports and points outside the Philippines, which includes block charter, placed under the custody and control of a charterer by a contract/charter for rent or hire relating to a particular airplane.

(g) "Originating from the Philippines" — shall include the following:

(1) Where passengers, their excess baggage, cargo and/or mail originally commence their flight from any Philippine port to any other port or point outside the Philippines;

(2) Chartered flights of passengers, their excess baggage, cargo and/or mail originally commencing their flights from any foreign port and whose stay in the Philippines is for more than forty-eight (48) hours prior to embarkation save in cases where the flight of the airplane belonging to the same airline company failed to depart within forty-eight (48) hours by reason of force majeure;

(3) Chartered flights of passengers, their excess baggage, cargo and/or mail originally commencing their flights from any Philippine port to any foreign port; and

(4) Where a passenger, his excess baggage, cargo and/or mail originally commencing his flight from a foreign port alights or is discharged in any Philippine port and thereafter boards or is loaded on another aircraft, owned by the same airline company, the flight from the Philippines to any foreign port shall not be considered originating from the Philippines, unless the time intervening between arrival and departure of said passenger, his excess baggage, cargo and/or mail from the Philippines exceeds forty-eight (48) hours, except, however, when the failure to depart within forty-eight (48) hours is due to reasons beyond his control, such as, when the only next available flight leaves beyond forty-eight (48) hours or by force majeure. Provided, however, that if the second aircraft belongs to a different airline company, the flight from the Philippines to any foreign port shall be considered originating from the Philippines regardless of the intervening period between the arrival and departure from the Philippines by said passenger, his excess baggage, cargo and/or mail.

(h) "Continuous and Uninterrupted Flight" — shall refer to a flight in the carrier of the same airline company from the moment a passenger, excess baggage, cargo, and/or mail is lifted from the Philippines up to the point of final destination of the passenger, excess baggage, cargo and/or mail. The flight is not considered continuous and uninterrupted if transshipment of passenger, excess baggage, cargo and/or mail takes place at any port outside the Philippines on another aircraft belonging to a different airline company.

(i) "Place of Final Destination" — shall refer to the place of final disembarkation designated or agreed upon by the parties in a contract of air transportation where the passengers, their excess baggage, cargo and/or mail are to be transported and unloaded by the contracting airline company.

(j) "Transient Passengers" — shall refer to a passenger who originated from outside of the Philippines towards a final destination also outside of the Philippines but stops in the Philippines for a period of less than forty eight (48) hours, or even more than forty-eight (48) hours, if the delay is due to force majeure or reasons beyond his control, wherein in both cases the passenger boarded an airplane of the same airline company bound to the place of final destination.

"Non-revenue passengers" — shall refer to the non-revenue passengers as defined under Resolution No. 788 of the International Air Transport Association regarding Free and Reduced Fare or Rate Transportation and any other Free/Reduced Rate Mileage Programs Administered by individual International Air Carriers.

"Adult passenger" — shall refer to a passenger who has attained his twelfth birthday.

"Children" — shall refer to passengers who have attained their second but not their twelfth birthday.

"Infant" — shall refer to a passenger who has not attained his second birthday.

(k) "Baggage" — shall refer to such articles, effects and other personal property of a passenger as are necessary or appropriate for wear, use, comfort or convenience in connection with his trip.

"Excess baggage" — shall refer to that part of the baggage which is in excess of that baggage which may be carried free of charge.

(l) "Refund" — shall refer to the repayment to the purchaser of all or a portion of the fare, rate or charge for unused carriage or service.

SECTION 3. Foreign Airline Companies Without Flights Starting From Or Passing Through Any Point In The Philippines. — An off-line airline having a branch office or a sales agent in the Philippines which sells passage documents for compensation or commission to cover off-line flights of its principal or head office, or for other airlines covering flights originating from Philippine ports or off-line flights, is not considered engaged in business as an international air carrier in the Philippines and is, therefore, not subject to Gross Philippine Billings Tax provided for in Section 28(A)(3)(a) of the Code nor to the three percent (3%) common carrier's tax under Section 118(A) of the same Code. This provision is without prejudice to classifying such taxpayer under a different category pursuant to a separate provision of the same Code.

SECTION 4. Tax Imposed On International Air Carrier With Flights Originating From Philippine Ports. — An international air carrier having flights originating from any port or point in the Philippines, as clarified in Sec. 2(g) and (h) hereof, irrespective of the place where passage documents are sold or issued, is subject to the Gross Philippine Billings Tax of 2½% imposed under Section 28(A)(3)(a) of the Code unless subject to a different tax rate under the applicable tax treaty to which the Philippines is a signatory.

SECTION 5. Determination Of Gross Philippine Billings. —

(a) In computing for "Gross Philippine Billings", there shall be included the total amount of gross revenue derived from passage of persons, excess baggage, cargo and/or mail, originating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the passage documents:

The gross revenue for passengers whose tickets are sold in the Philippines shall be the actual amount derived for transportation services, for a first class, business class or economy class passage, as the case may be, on its continuous and uninterrupted flight from any port or point in the Philippines to its final destination in any port or point of a foreign country, as reflected in the remittance area of the tax coupon forming an integral part of the plane ticket. For this purpose, the Gross Philippine Billings shall be determined by computing the monthly average net fare of all the tax coupons of plane tickets issued for the month per point of final destination, per class of passage (i.e., first class, business class, or economy class) and per classification of passenger (i.e., adult, child or infant), and multiplied by the corresponding total number of passengers flown for the month as declared in the flight manifest.

For tickets sold outside the Philippines, the gross revenue for passengers for first class, business class or economy class passage, as the case may be, on a continuous and uninterrupted flight from any port or point in the Philippines to final destination in any port or point of a foreign country shall be determined using the locally available net fares applicable to such flight taking into consideration the seasonal fare rate established at the time of the flight, the class of passage (whether first class, business class, economy class or non-revenue), the classification of passenger (whether adult, child or infant), the date of embarkation, and the place of final destination. Correspondingly, the Gross Philippine Billings for tickets sold outside the Philippines shall be determined in the manner as provided in the preceding paragraph.

Passage documents revalidated, exchanged and/or endorsed to another on-line international airline shall be included in the taxable base of the carrying airline and shall be subject to Gross Philippine Billings tax if the passenger is lifted/boarded on an aircraft from any port or point in the Philippines towards a foreign destination.

The gross revenue on excess baggage which originated from any port or point in the Philippines and destined to any part of a foreign country shall be computed based on the actual revenue derived as appearing on the official receipt or any similar document for the said transaction.

The gross revenue for freight or cargo and mail shall be determined based on the revenue realized from the carriage thereof. The amount realized for freight or cargo shall be based on the amount appearing on the airway bill after deducting therefrom the amount of discounts granted which shall be validated using the monthly cargo sales reports generated by the IATA Cargo Accounts Settlement System (IATA CASS) for airway bills issued through their cargo agents or the monthly reports prepared by the airline themselves or by their general sales agents for direct issues made. The amount realized for mails shall, on the other hand, be determined based on the amount as reflected in the cargo manifest of the carrier.

Provided, however, that in the case of the passenger's passage documents or flights from any port or point in the Philippines and back, that portion of revenue pertaining to the return trip to the Philippines shall not be included as part of "Gross Philippine Billings".

In cases where a flight is interrupted by force majeure resulting in the transshipment of the passengers, their excess baggage, freight, cargo and/or mail to another airplane operated by another airline company and transshipment takes place in another country, the Gross Philippine Billings shall be determined based on that portion of flight from the Philippines up to the point of said transshipment.

(b) Non-revenue passengers shall not be given value for purposes of computing the taxable base subject to tax. Refunded tickets shall likewise not be included in the computation of Gross Philippine Billings.

(c) In the case of a flight that originates from the Philippines but transshipment of passenger, excess baggage, cargo and/or mail takes place elsewhere in another aircraft belonging to a different airline company, the Gross Philippine Billings shall be that portion of the revenue corresponding to the leg flown from any point in the Philippines to the point of transshipment.

(d) In computing the taxable amount, the foreign exchange conversion rate to be used shall be the average monthly Airline Rate as provided in the Bank Settlement Plan (BSP) Monthly sales report or the Bankers Association of the Philippines (BAP) rate, whichever is higher. The average monthly BAP rate shall be computed by adding all the different BAP rates during the month and dividing the same by the number of days during the month.

6. FOREIGN CURRENCY DEPOSIT SYSTEM/ OFFSHORE BANKING UNITS

REPUBLIC ACT 9294, AMENDING THE TAX CODE TO READ

Sec. 27. Rates of Income Tax on Domestic Corporations. —

(D) Rates of Tax on Certain Passive Incomes. —

(3) Tax on Income Derived under the Expanded Foreign Currency Deposit System. — Income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with nonresidents, offshore banking units in the Philippines, local commercial banks including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and other depository banks under the expanded foreign currency deposit system shall be exempt from all taxes, except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation by the Monetary Board to be subject to the regular income tax payable by banks: Provided, however, That interest income from foreign currency loans granted by such depository banks under said expanded system to residents other than offshore banking units in the

Philippines or other depository banks under the expanded system shall be subject to a final tax at the rate of ten percent (10%).

Any income of nonresidents, whether individuals or corporations, from transactions with depository banks under the expanded system shall be exempt from income tax.

Sec. 28. Rates of Income Tax on Foreign Corporations. —

(A) Tax on Resident Foreign Corporations. —

(4) Offshore Banking Units. — The provisions of any law to the contrary notwithstanding, income derived by offshore banking units authorized by the Bangko Sentral ng Pilipinas (BSP), from foreign currency transactions with nonresidents, other offshore banking units, local commercial banks, including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with offshore banking units shall be exempt from all taxes except net income from such transactions as may be specified by the Secretary of Finance, upon recommendations of the Monetary Board which shall be subject to the regular income tax payable by banks: Provided, however, That any interest income derived from foreign currency loans granted to residents other than offshore banking units or local commercial banks, including local branches of foreign banks that may be authorized by the BSP to transact business with offshore banking units, shall be subject only to a final tax at the rate of ten percent (10%).

Any income of nonresidents, whether individuals or corporations, from transactions with said offshore banking units shall be exempt from income tax.

(7) Tax on Certain Incomes Received by a Resident Foreign Corporation. —

(a) Interest from Deposits and Yield or any other Monetary Benefit from Deposits Substitutes, Trust Funds and Similar Arrangements and Royalties. — Interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements and royalties derived from sources within the Philippines shall be subject to a final income tax at the rate of twenty percent (20%) of such interest: Provided however, That interest income derived by a resident foreign corporation from a depository bank under the expanded foreign currency deposit system shall be subject to a final income tax at the rate of seven and one-half percent (7½%) of such interest income.

(b) Income Derived under the Expanded Foreign Currency Deposit System. — Income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with nonresidents, offshore banking units in the Philippines, local commercial banks including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and other depository banks under the expanded foreign currency deposit system shall be exempt from all taxes, except net income from such transactions as may be specified by the secretary of Finance, upon recommendation by the Monetary Board to be subject to the regular income tax payable by banks: Provided, however, That interest income from foreign currency loans granted by such depositors banks under said expanded system to residents other than offshore banking units in the Philippines or other depository banks under the expanded system shall be subject to a final tax at the rate of ten percent (10%).

Any income of nonresidents, whether individuals or corporations, from transactions with depository banks under the expanded system shall be exempt from income tax.

REVENUE REGULATION 14-77 “Gross Onshore Income” shall mean gross interest income arising from foreign currency

loans and advances to and/or investments with residents made by offshore banking units or expanded foreign currency loan transactions. In the case of foreign currency loan transactions, such gross interest income shall refer only to the stipulated interest

and shall not include all fees, commissions and other charges which are integral parts of the income from the above transactions. Tax on Gross Onshore Income shall be 10% thereof and shall be a final tax

REVENUE REGULATION 10-98 (NOTE: Still relevant despite passage of RA 9294, look at the tax treatment on transactions with residents)

SECTION 2.22. Definition of Terms. —

(A) Foreign Currency Deposit System — shall refer to the conduct of banking transactions whereby any person whether natural or juridical may deposit foreign currencies forming part of the Philippine international reserves, in accordance with the provisions of Republic Act No. 6426 entitled "An Act Instituting a Foreign Currency Deposit System in the Philippines, and For Other Purposes."

(B) Foreign Currency Deposit Unit (FCDU) — shall refer to that unit of a local bank or of a local branch of a foreign bank authorized by the Bangko Sentral Ng Pilipinas (BSP) to engage in foreign currency-denominated transactions, pursuant to the provisions of R.A. 6426, as amended. ("Local bank" shall refer to a thrift bank or a commercial bank organized under the laws of the Republic of the Philippines. "Local branch of a foreign bank" shall refer to a branch of a foreign bank doing business in the Philippines, pursuant to the provisions of R.A. No. 337 , as amended).

(C) Offshore Banking System — shall refer to the conduct of banking transactions in foreign currencies involving the receipt of funds principally from external and internal sources and the utilization of such fund pursuant to Presidential Decree No. 1034 as implemented by CB (now BSP) Circular No. 1389, as amended.

(D) Offshore Banking Unit (OBU) — shall mean a branch, subsidiary or affiliate of a foreign banking corporation which is duly authorized by the Bangko Sentral Ng Pilipinas (BSP) to transact offshore banking business in the Philippines in accordance with the provisions of Presidential Decree No. 1034 as implemented by CB (now BSP) Circular No. 1389, as amended.

(E) Deposits — shall mean funds in foreign currencies which are accepted and held by an Offshore Banking Unit or Foreign Currency Deposit Unit in the regular course of business, with the obligation to return an equivalent amount to the owner thereof, with or without interest.

(F) Resident — shall mean

(1) an individual citizen of the Philippines residing therein; or

(2) an individual who is not a citizen of the Philippines but is permanently residing therein; or

(3) a corporation or other juridical person organized under the laws of the Philippines; or

(4) a branch, subsidiary, affiliate, extension office or other unit of corporations or juridical persons organized under the laws of any foreign country operating in the Philippines.

(G) "Non-resident" — shall mean an individual, corporation or other juridical person not included in the above definition of "resident".

(H) Filipino Overseas Contract Worker (OCW) — means an individual citizen of the Philippines referred to under Section 23(C) of the Code.

A Filipino Seaman is a citizen of the Philippines who receives compensation for services rendered abroad as a member of the complement of an ocean-going vessel engaged exclusively in international trade as referred to under Section 23(C) of the Code.

SECTION 2.27 and SECTION 2.28 — Corporate Income Tax on Interest Income from a Depository Bank under the Foreign Currency Deposit System.

(A) Interest income which is actually or constructively received by a domestic corporation or a resident foreign corporation from a foreign currency bank deposit shall be subject to a final withholding tax at the rate of seven and one-half percent (7.5%) based on the gross amount of such interest income. The depository bank shall withhold and remit the tax pursuant to the provisions of Sections 57 and 58 (withholding tax at source) of the Code.

(B) Compliance and Administrative Procedures for a Non-resident Corporation. The tax on interest income from foreign currency deposit shall be imposed unless the depositor, which is a non-resident corporation, can present documentary evidence that it is not a resident of the Philippines. Such evidence shall consist of the original or certified copy of all the following requirements:

(1) Certificate of registration of the corporation abroad; and

(2) Certification from the Securities and Exchange Commission (SEC) that the non-resident corporation is not licensed to do business in the Philippines.

(C) Taxation of Income of an FCDU or OBU from Foreign Currency Transactions. In general, income derived by an FCDU or an OBU from foreign currency transactions with residents of the Philippines, including local commercial banks, local branches of foreign banks, and other depository banks under the foreign currency deposit system, shall be subject to a final withholding tax of ten percent (10%) based on gross income pursuant to Sec. 27(D)(3) and Sec. 28(A)(4) of the Code. Income from foreign currency transactions shall include interest income from lending operations, including bank charges, commissions, service fees, and net foreign exchange transaction gains.

Income from foreign currency transactions with non-residents of the Philippines shall not be subject to income tax.

The person making the income payment shall withhold and remit the tax withheld pursuant to the provisions of Sections 57 and 58 of the Code. Thus, in the case of interest payment by a resident of the Philippines on a foreign currency loan from an OBU or an FCDU, the withholding agent shall be the said resident.

(D) Taxation of Other Incomes of an FCDU or an OBU . Income derived by an FCDU or an OBU from activities other than foreign currency transactions shall be subject to the pertinent income tax/taxes prescribed under Section 27 or Section 28 of the Code. To illustrate: Income derived by an FCDU from consultancy services and rentals shall be subject to an income tax based on net income at the tax rates prescribed under Section 27(A) of the Code. Capital gains derived from the sale, barter, exchange or disposition of shares of stocks in a domestic corporation shall be subject to tax prescribed under Section 27(D) of the Code.

The aforesaid depository bank shall file its corporate income tax return for income referred to in the preceding paragraph in accordance with the provisions of Section 52 of the Code. It shall also declare thereunder all other incomes derived during the taxable period which are subject to the final withholding taxes, the fact that such final withholding taxes have been withheld therefrom by the payor notwithstanding, indicating the following information:

(a) Name of the withholding agent;

(b) His/its address;

(c) His/its Taxpayer Identification Number (TIN);

(d) Period covered;

(e) Gross Income;

(f) Rate of final withholding tax applied; and

(g) Amount of final withholding tax withheld.

The submission of the foregoing information shall not be required with respect to its interest income derived from bank deposits.

7. PETROLEUM SERVICE CONTRACTOR AND SUB-CONTRACTOR

PRESIDENTIAL DECREE NO. 1354 - IMPOSING FINAL INCOME TAX ON SUBCONTRACTORS AND ALIEN EMPLOYEES OF SERVICE CONTRACTORS AND SUBCONTRACTORS ENGAGED IN PETROLEUM OPERATIONS IN THE PHILIPPINES UNDER PRESIDENTIAL DECREE NO. 87

SECTION 1. Tax on subcontractors. — Every subcontractor, whether domestic or foreign, entering into a contract with a service contractor engaged in petroleum operations in the Philippines shall be liable to a final income tax equivalent to eight percent (8%) of its gross income derived from such contract, such tax to be in lieu of any and all taxes, whether national or local: Provided, however, that any income received from all other sources within and without the Philippines in the case of domestic subcontractors and within the Philippines in the case of foreign subcontractors shall be subject to the regular income tax imposed under the National Internal Revenue Code. The term "gross income" means all income earned or received as a result of the contract entered into by the subcontractor with a service contractor engaged in petroleum operations in the Philippines under Presidential Decree No. 87.

SECTION 2. Taxation of aliens employed by petroleum service contractors and subcontractors. — Aliens who are permanent residents of a foreign country but who are employed and assigned in the Philippines by service contractors or by subcontractors engaged in petroleum operations in the Philippines, shall be liable to a final income tax equal to fifteen percent (15%) of the salaries, wages, annuities, compensations, remunerations and emoluments received from such contractors or subcontractors. Any income earned from all other sources within the Philippines by the said alien employees shall be subject to the income tax imposed under the National Internal Revenue Cod

7 to 11. ECOZONES 5% PREFERENTIAL TAX RATE


SECTION 2. Definitions. — For purposes of these Regulations the terms used herein shall be construed to have the following meanings:

a. SUBIC-ECOZONE — refers to the Subic Special Economic and Freeport Zone, created under Section 12 of R.A. No. 7227.

b. SUBIC-ECOZONE Registered Enterprise — refers to any business entity or concern located within the SUBIC-ECOZONE and duly registered with and/or licensed by the SBMA to operate any lawful economic activity within the SUBIC-ECOZONE.

c. SUBIC-ECOZONE Facilities Operator — refers to a SUBIC-ECOZONE Enterprise which operates facilities or services within the SUBIC-ECOZONE, including the subleasing of land or other property to other SUBIC-ECOZONE Enterprise

d. SBMA — refers to the Subic Bay Metropolitan Authority, established and created pursuant to Section 13 of the Republic Act No. 7227

e. ECOZONES or "Special Economic Zones" — shall refer to selected areas with highly developed or which have the potential to be developed into agro-industrial, industrial, tourist, recreational, commercial, banking, investment and financial centers established in accordance with Sec 5 & 6 of Republic Act No. 7916.

f. ECOZONE Registered Enterprise — refers to any business entity or concern within the ECOZONE duly registered with and/or licensed by the PEZA to operate any lawful economic activity within the ECOZONE. An ECOZONE Registered Enterprise may be classified as follows:

f.1 "ECOZONE Export Enterprise" — refers to an individual, association, partnership, corporation or other form of business organization which has been registered with the PEZA to engage in manufacturing, assembling or processing activity falling within the purview of the Act and resulting in the exportation of 100% of its production, unless a lower percentage of its production for exportation is prescribed by the PEZA Board subject to such terms and conditions as the latter may determine.

f.2 "ECOZONE Domestic Market Enterprise" — refers to an individual, association, partnership, corporation or other form of business organization which has been registered with the PEZA to engage in manufacturing, assembling or processing activity falling within the purview of the Act resulting in the sale of its finished products in the customs territory or in the non-restricted or authorized areas within the ECOZONE in its entirety or if exporting a portion of its production output, it continually fails to export at least fifty percent (50%) thereof for a period of three (3) years without any justifiable reason in case at least 60% of its working capital is owned by Philippine nationals or in case more than 40% of its working capital is owned by foreign nationals, it continually fails to export at least seventy percent (70%) of its production output for a period of three (3) years without any justifiable reason.

f.3 "ECOZONE Pioneer Enterprise" — shall mean an ECOZONE enterprise (1) engaged in the manufacture, processing or production and not merely in the assembly or packaging of goods, products, commodities or raw materials that have not been or are not being produced in the Philippines on a commercial scale or (2) which uses a design, formula, scheme, method, process or system of production or transformation of any element, substance or raw materials into another raw material or finished goods which is new and untried in the Philippines or (3) which produces non-conventional fuels or manufactures equipment which utilizes non-conventional sources of energy or uses or converts to coal or other non-conventional fuels or sources of energy in its production, manufacturing or processing operations: or (4) engaged in the pursuit of agri-export processing zone development or (5) given such status under the Investment Priorities Plan: Provided, That the final product in any of the foregoing instances involves or will involve substantial use and processing of domestic raw materials, whenever available, taking into account the risk and magnitude of investment.

f.4 "ECOZONE Free Trade Enterprise" — refers to an individual, association, partnership, corporation or other form of business organization which has been registered with the PEZA to engage in the importation of goods or merchandise within the restricted or free trade area in the ECOZONE tax and duty-free for immediate transshipment or for storage, repacking, sorting, mixing or manipulation and subsequent exportation unless the Board allows the sale thereof in the customs territory subject to the payment of customs duties and internal revenue taxes and to such other terms and conditions as it may determine.

f.5 "ECOZONE Utilities Enterprise" — shall refer to a business entity or concern within the ECOZONE duly registered with and/or franchised/licensed by the PEZA with or without the incentives provided under Republic Act No. 6957,

as amended, (the Build-Operate-Transfer Law) and/or with or without financial exposure on the part of the PEZA, such as contractors/operators of light and power systems, water supply and distribution systems, communications and transportation systems within the ECOZONE and other similar or ancillary activities as may be determined by the PEZA Board.

f.6 "ECOZONE Facilities Enterprise" — shall refer to a business entity or concern within the ECOZONE duly registered with and/or franchised/licensed by the PEZA with or without incentives provided under Republic Act No. 6957, as amended, (the Build-Operate-Transfer Law) and/or with or without financial exposure on the part of the PEZA such as contractors/operators of buildings, structures, warehouses, site development and road network, ports, sewerage and drainage system and other facilities for the development, operation and maintenance of the ECOZONE and other similar or ancillary activities as may be determined by the PEZA Board.

f.7 "ECOZONE Developer/Operator" — refers to a business entity or concern duly registered with and/or licensed by the PEZA to develop, operate and maintain an ECOZONE or any or all of the component IE, EPZ, Free Trade Zone or Tourist/Recreational Center and the required infrastructure facilities and utilities such as light and power system, water supply and distribution system, sewerage and drainage system, pollution control devices, communication facilities, paved road network, administration building and other facilities as may be required by the PEZA. The term shall include the PEZA and/or the Local Government Unit when by themselves or in joint venture with a qualified private entity, shall act as the Developer/Operator of the ECOZONES. As such, they shall be entitled to the same incentives under Rule XIV of these Rules in accordance with the pertinent provisions of Republic Act No. 7916 and the Omnibus Investments Code.

f.8 "ECOZONE Service Enterprise" — shall refer to a business entity or concern within the ECOZONE such as but not limited to those engaged in customs brokerage, trucking/forwarding services, parcel services, janitorial services, security services, insurance, and/or banking services, consultancy services, restaurants or such other services within the ECOZONE as may be determined by the Board, duly registered and/or licensed by the PEZA whose income derived within the ECOZONE shall be subject to taxes under the National Internal Revenue Code pursuant to Section 25 of the Republic Act No. 7916 as amended by Republic Act No. 8748.

f.9 "ECOZONE Tourism Enterprise" — shall refer to an individual, association, partnership, corporation or other business organization duly registered with the PEZA proposing to engage in the establishment and operation of tourist-oriented accommodations, restaurants operated as an integral part of a tourism facility (e.g. hotels, resorts, recreational centers), sports and recreational facilities within the ECOZONE.

g. Restricted Area — shall mean a specific area within the ECOZONE, which has been classified and/or fenced-in as export processing zone, free trade zone or such other similar areas as may be declared by governing Board.

h. PEZA — shall refer to the Philippine Economic Zone Authority

i. ZAMBO-ECOZONE — refers to the Zamboanga City Special Economic Zone and Freeport created pursuant to Sec. 3 of the Republic Act No. 7903.

j. ZAMBO-ECOZONE Enterprise — refers to any business entity or concern within the ZAMBO-ECOZONE, duly registered with and/or licensed by the ZAMBO-ECOZONE Authority to operate any lawful economic activity within the ZAMBO-ECOZONE.

k. ZAMBO-ECOZONE Authority — refers to the Zamboanga City Special Economic Zone Authority created under Sec. 5 of Republic Act No. 7903.

l. CAGAYAN-ECOZONE — refers to the Cagayan Special Economic Zone and Freeport created pursuant to Sec. 3 of the Republic Act No. 7922.

m. CAGAYAN-ECOZONE Enterprise — refers to any business entity or concern within the CAGAYAN-ECOZONE, duly registered with and/or licensed by the CEZA to operate any lawful economic activity within the CAGAYAN-ECOZONE.

n. CEZA — refers to Cagayan Economic Zone Authority created under Sec. 5 of Republic Act No. 7922.

o. Zone — refers to the SUBIC-ECOZONE, ECOZONES, ZAMBO-ECOZONE or CAGAYAN-ECOZONE, as the context may require.

p. Resident — refers to any individual who is registered and authorized by the SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA to establish and maintain a personal residence in the Zone where they are registered. CHIScD

q. Certificate of Registration — refers to the certificate issued by the SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA evidencing the registration of the business entity as an Enterprise in the applicable Zone where registered.

r. Certificate of Residency — refers to the certificate issued by the SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA evidencing the registration of an individual as a Resident of the applicable Zone where registered.

s. Date of Registration — shall refer to the date appearing in the Certificate of Registration or Certificate of Residency.

t. Customs — means the Philippine Bureau of Customs.

u. Customs Territory — refers to the portion of the Republic of the Philippines outside of SUBIC-ECOZONE, ECOZONE, ZAMBO-ECOZONE or the CAGAYAN-ECOZONE, as the case may be.

v. Articles — refers to any goods, wares, merchandise and in general, any thing which under the Tariff and Customs Code of the Philippines or other laws may be made or is the subject of importation or exportation.

w. Domestic Articles — refers to articles which are the growth, produce, or manufacture of the Philippines on which all national internal revenue taxes have been paid, if subject thereto, and upon which no drawback or bounty has been allowed; and articles of foreign origin on which all duties and taxes have been paid and upon which no drawback or bounty has been allowed, or which have previously been entered into Customs Territory free of duties or taxes.

x. Foreign Articles — refers to articles of foreign origin on which duties and taxes have not been paid, or if paid, upon which drawback or a bounty has been allowed, or which have not previously been entered into Customs Territory; or articles which are the growth, produce, or manufacture of the Philippines on which not all national internal revenue taxes have been paid, if subject thereto, or if paid, upon which drawback or a bounty has been allowed.

y. Transshipment — refers to transshipment of articles discharged at ports or airports of entry located in Customs territory destined for delivery and actually delivered to the Zone, and articles coming from the latter intended for export and actually exported thru a Philippine Customs port/airport of entry which may be transported under bond, upon examination, and consigned to the Collector at the port of destination/export who will allow the consignor or consignee, as the case may be, to make entry exportation.

z. Retail Sale — refers to the sale of articles in the Zone, in small quantities to any person, natural or juridical, for his/her/its own personal use and account and not for resale.

aa. Foreign Exchange — shall mean any currency other than the Philippine Peso acceptable for international reserve or authorized for international transaction by the Central Bank of the Philippines.

SECTION 3. National Tax Exemption and Incentives to Zone Registered Enterprises. — All ECOZONE-registered enterprises, CAGAYAN-ECOZONE registered enterprises and ZAMBO-ECOZONE registered enterprises who are covered by the special tax regime of 5%, including all SUBIC-ECOZONE registered enterprises doing business within the Zone shall enjoy the following:

a. Exemption from national internal revenue taxes on importations of raw materials for manufacture and actually manufactured into finished products, and capital goods and equipment needed for their business operation, within the Zone. Removal of raw materials, capital goods, equipment and consumer items out of the Zone for sale to non-Zone registered enterprises shall be subject to the usual taxes and duties provided for in Republic Act No. 7227 for SUBIC-ECOZONE.

b. Exemption from the national internal revenue taxes, such as gross receipts tax, VAT, ad valorem and excise taxes on their sales of goods and services for which they shall otherwise have been directly liable, except for local sales as discussed in sub-section f of this Section and unless provided for in other laws to the contrary.

c. Exemption from franchise, common carrier or value added taxes and other percentage taxes on public and service utilities and enterprises within the Zone for services rendered within Zone.

d. Preferential tax treatment on income earned/derived from business operations within the Zone or from foreign sources. However, in the case of telecommunications service, the income of the enterprise within the Zone shall be net of the share of the foreign telecommunications company, and in the case of common carriers by land, air or water, only that portion of the income and expenses for the transport of cargoes and passengers within the Zone shall be covered by the preferential income tax treatment and what is not covered shall be subject to the regular corporate income tax.

e. Purchases from enterprises in the Customs Territory of raw materials forming part of finished goods exported by the Zone registered enterprises shall be considered effectively zero-rated or exempt for VAT purposes depending on the fiscal incentives availed of by the Zone registered enterprise. The application of this rule on VAT will however be covered by a separate Revenue Regulations discussing in particular the VAT implications of transaction within, into and outside the Zone.

f. Zone registered enterprises may generate income from sources within the Customs Territory of but up to Thirty Percent (30%) of its total income from all sources only. All of the income of Zone registered enterprises generated from sources within the Customs Territory shall be subject to the internal revenue laws of the Customs Territory and the regular internal revenue taxes and rate imposed for enterprises in the Customs Territory.

Provided, however, that in the event SUBIC-ZONE registered enterprises shall generate income from sources within the Customs Territory in excess of thirty percent (30%) of its total income from all sources, all of its income shall be subject to the regular internal revenue tax rate imposed for enterprise in the Customs Territory.

g. Carriers who undertake to transship articles to and/or from the Zone to a Customs Bonded warehouse within the Customs Territory shall be bonded in an amount to be determined by the SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA and Bureau of Customs which shall not be less than fifty thousand (P50,000) pesos conditioned upon the carrier transporting and delivering without delay, and in accordance with rules and regulations in effect in the Customs Territory, to the Collector of Customs at the port of destination/export. The provisions of the Tariff and Customs Code, as amended, on transshipment, and its implementing regulations shall govern cases of transshipment for foreign articles to and/or from the Zone.

h. Articles which are manufactured in the Zone and exported therefrom to a foreign country shall, upon subsequent importation into customs territory, be subject to the laws on importation applicable to like articles manufactured in a foreign country.

Business enterprises operating within the Zone, but which are not registered by or accredited with SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA shall not be entitled to the preferential tax treatment provided for in Section 12(c) of the Republic Act No. 7227; Section 24 of Republic Act No. 7916; Section 4(f) of Republic Act No. 7903; and Section 4(c) of Republic Act No. 7922.

SECTION 5. Removal or Withdrawal from the Zone to Customs Territory. — Notwithstanding the above-mentioned tax and duty exemptions, foreign articles removed, withdrawn or otherwise disposed to the customs territory, shall be subject to the payment of customs duties and internal revenue taxes as ordinary importations in accordance with the provisions of the Tariff and Customs Code of the Philippines, as amended and National Internal Revenue Code and other applicable laws. Articles removed customs territory will be presumed to be foreign unless there is sufficient evidence presented to satisfy Customs officials that they are domestic articles, as defined in these regulations.

REPUBLIC ACT NO. 9400 - AN ACT AMENDING REPUBLIC ACT NO. 7227, AS AMENDED, OTHERWISE KNOWN AS THE BASES CONVERSION AND DEVELOPMENT ACT OF 1992, AND FOR OTHER PURPOSES

SECTION 1. Section 12 of Republic Act No. 7227, as amended, otherwise known as the Bases Conversion and Development Act of 1992, is hereby amended to read as follows:

"SEC. 12. Subic Special Economic Zone. — . . . .

"(a) . . .

"(b) The Subic Special Economic Zone shall be operated and managed as a separate customs territory ensuring free flow or movement of goods and capital within, into and exported out of the Subic Special Economic Zone, as well as provide incentives such as tax and duty-free importations of raw materials, capital and equipment. However, exportation or removal of goods from the territory of the Subic Special Economic Zone to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Tariff and Customs Code of the Philippines, as amended, the National Internal Revenue Code of 1997, as amended, and other relevant tax laws of the Philippines;

"(c) The provision of existing laws, rules and regulations to the contrary notwithstanding, no national and local taxes shall be imposed within the Subic Special Economic Zone. In lieu of said taxes, a five percent (5%) tax on gross income earned shall be paid by all business enterprises within the Subic Special Economic Zone and shall be remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the Subic Bay Metropolitan Authority (SBMA) for distribution to the local government units affected by the

declaration of and contiguous to the zone, namely: the City of Olongapo and the municipalities of Subic, San Antonio, San Marcelino and Castillejos of the Province of Zambales; and the municipalities of Morong, Hermosa and Dinalupihan of the Province of Bataan, on the basis of population (50%), land area (25%), and equal sharing (25%).

"xxx xxx xxx."

SECTION 2. Section 15 of Republic Act No. 7227, as amended, is hereby amended to read as follows:

'"SEC. 15. Clark Special Economic Zone (CSEZ) and Clark Freeport Zone (CFZ). — Subject to the concurrence by resolution of the local government units directly affected, the President is hereby authorized to create by executive proclamation a Special Economic Zone covering the lands occupied by the Clark military reservations and its contiguous extensions as embraced, covered and defined by the 1947 Military Bases Agreement between the Philippines and the United States of America, as amended, located within the territorial jurisdiction of Angeles City, municipalities of Mabalacat and Porac, Province of Pampanga, and the municipalities of Capas and Bamban, Province of Tarlac, in accordance with the provisions as herein provided insofar as applied to the Clark military reservations. The Clark Air Base proper with an area of not more than four thousand four hundred hectares (4,400 has.) with the exception of the twenty-two-hectare commercial area situated near the main gate and the Bayanihan Park consisting of seven and a half hectares (7.5 has.) located outside the main gate of the Clark Special Economic Zone, is hereby declared a freeport zone.

"The CFZ shall be operated and managed as a separate customs territory ensuring free flow or movement of goods and capital equipment within, into and exported out of the CFZ, as well as provide incentives such as tax and duty-free importation of raw materials and capital equipment. However, exportation or removal of goods from the territory of the CFZ to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Tariff and Customs Code of the Philippines, as amended, the National Internal Revenue Code of 1997, as amended, and other relevant tax laws of the Philippines. TCIEcH

"The provisions of existing laws, rules and regulations to the contrary notwithstanding, no national and local taxes shall be imposed on registered business enterprises within the CFZ. In lieu of said taxes, a five percent (5%) tax on gross income earned shall be paid by all registered business enterprises within the CFZ and shall be directly remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the treasurer's office of the municipality or city where they are located:

"The governing body of the Clark Special Economic Zone shall likewise be established by executive proclamation with such powers and functions exercised by the Export Processing Zone Authority pursuant to Presidential Decree No. 66, as amended: Provided, That it shall have no regulatory authority over public utilities, which authority pertains to the regulatory agencies created by law for the purpose, such as the Energy Regulatory Commission created under Republic Act No. 9436 and the National Telecommunications Commission created under Republic Act No. 7925.

"xxx xxx xxx

"Subject to the concurrence by resolution of the local government units directly affected and upon recommendation of the Philippine Economic Zone Authority (PEZA), the President is hereby authorized to create by executive proclamation Special Economic Zones covering the City of Balanga and the municipalities of Limay, Mariveles, Moring, Hermosa, and Dinalupihan, Province of Bataan.

"Subject to the concurrence by resolution of the local government units directly affected and upon recommendation of the PEZA, the President is hereby authorized to create by executive proclamation Special Economic Zones covering the municipalities of Castillejos, San Marcelino, and San Antonio, Province of Zambales.

"Duly registered business enterprises that will operate in the Special Economic Zones to be created shall be entitled to the same tax and duty incentives as provided for under Republic Act No. 7916, as amended: Provided, That for the purpose of administering these incentives, the PEZA shall register, regulate, and supervise all registered enterprises within the Special Economic Zones."

SECTION 3. A new Section 15-A is hereby inserted, amending Republic Act No. 7227, as amended, to read as follows:

"SEC. 15-A. Poro Point Freeport Zone (PPFZ) — The two hundred thirty-six and a half-hectare (236.5 has) secured area in the Poro Point Special Economic and Freeport Zone created under Proclamation No. 216, series of 1993, shall be operated and managed as a freeport and separate customs territory ensuring free flow or movement of goods and capital equipment within, into and exported out of the PPFZ. The PPFZ shall also provide incentives such as tax and duty-free importation of raw materials and capital equipment. However, exportation or removal of goods from the territory of the PPFZ to the other parts of the Philippine territory shall be subjected to customs duties and taxes under the Tariff and Customs Code of the Philippines, as amended, the National Internal Revenue Code of 1997, as amended, and other relevant tax law of the Philippines.

"The provisions of existing laws, rules and regulations to the contrary notwithstanding, no national and local taxes shall be imposed on registered business enterprises within the PPFZ. In lieu of said taxes, a five percent (5%) tax on gross income earned shall be paid by all registered business enterprises within the PPFZ and shall be directly remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the treasurer's office of the municipality or city where they are located.

"The governing body of the PPFZ shall have no regulatory authority over public utilities, which authority pertains to the regulatory agencies created by law for the purpose, such as the Energy Regulatory Commission created under Republic Act No. 9136 and the National Telecommunications Commission created under Republic Act No. 7925."

SECTION 4. A new Section 15-B is hereby inserted, amending Republic Act No. 7227, as amended, to read as follows:

"SEC. 15-B. Morong Special Economic Zone (MSEZ). — Duly registered business enterprises operating within the MSEZ created under Proclamation No. 984, series of 1997, shall be entitled to tax and duty-free importation of raw materials and capital equipment. In lieu of all national and local taxes except real property tax on land, a five percent (5%) tax on gross income earned shall be paid by all registered business enterprises which shall be directly remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the treasurer's office of the municipality or city where they are located."

SECTION 5. A new Section 15-C is hereby inserted, amending Republic Act No. 7227, as amended, to read as follows:

"SEC. 15-C. John Hay Special Economic Zone (JHSEZ). — Registered business enterprises which will operate after the effectivity of this Act, within the JHSEZ, created under Proclamation No. 420, series of 1994, shall be entitled to the same tax and duty incentives as provided for under Republic Act No. 7916, as amended: Provided, That for the purpose of administering these incentives,

the PEZA shall register, regulate, and supervise all registered enterprises within the JHSEZ: Provided, further, That the Conversion Authority and the John Hay Management Corporation (JHMC) shall only engage in acquiring, owning, holding, administering or leasing real properties, and in other activities incidental thereto."

4. BRANCH PROFIT REMITTANCE TAX

REVENUE MEMORANDUM CIRCULAR 55-80

FEATURES OF THE AMENDMENT

Two (2) amendments to Sec. 24(b) (2) (b) of the 1977 Tax Code on branch profit remittances have been effected by P.D. No. 1705. NOW ITS 28(A) (5). They are:

1. Reduction of the tax rate on the profits remitted by a branch office to its mother company authorized to engage in petroleum operations. — The tax on profits remitted by a branch office to its mother company authorized to engage in petroleum operations in the Philippines has been reduced to 7.5%.

2. Imposition of a branch profits tax on income effectively connected with business. — Fixed or determinable annual periodical gains, profits, and income on certain gains described in Section 24 (b)(1) or 53(b) (2) of the 1977 Tax Code, (i.e. income earned from Philippine sources by non-resident foreign corporations) are generally not considered branch profits subject to the 15% remittance tax unless the same are effectively connected with the conduct of a trade or business in the Philippines by the foreign corporation.

To be "effectively connected" it is not necessary that the income be derived from the actual operation of taxpayer-corporation's trade or business; it is sufficient that the income arises from the business activity in which the corporation is engaged.

For example, if a resident foreign corporation is engaged in the buying and selling of machineries in the Philippines and invests in some shares of stock on which dividends are subsequently received, the dividends thus earned are not considered effectively connected with its trade or business in this country.

On the other hand, if a resident foreign corporation with a branch office in the Philippines engaged in the canning business allows its trade name or brand to be used and royalties are received by its parent company, such royalties which constitute passive income, are effectively connected with its trade or business and should be subject to tax, if remitted abroad.

5. MINIMUM CORPORATE INCOME TAX


Sec. 2.27(E) MINIMUM CORPORATE INCOME TAX (MCIT) ON DOMESTIC CORPORATIONS —

(1) Imposition of the Tax — A minimum corporate income tax (MCIT) of two percent (2%) of the gross income as of the end of the taxable year (whether calendar or fiscal year, depending on the accounting period employed) is hereby imposed upon any domestic corporation beginning the fourth (4th) taxable year immediately following the taxable year in which such corporation commenced its business operations. The MCIT shall be imposed whenever such corporation has zero or negative taxable income or whenever the amount of minimum-corporate income tax is greater than the normal income tax due from such corporation.

For purposes of these Regulations, the term, "normal income tax" means the income tax rates prescribed under Sec. 27(A) and Sec. 28(A)(1) of the Code at 34% on January 1,

1998; 33% effective January 1, 1999; and at 32% effective January 1, 2000 and thereafter.

In the case of a domestic corporation whose operations or activities are partly covered by the regular income tax system and partly covered under a special income tax system, the MCIT shall apply on operations covered by the regular income tax system. For example, if a BOI-registered enterprise has a "registered" and an "unregistered" activity, the MCIT shall apply to the unregistered activity.

(2) Carry forward of excess minimum corporate income tax — Any excess of the minimum corporate income tax (MCIT) over the normal income tax as computed under Sec. 27(A) of the Code shall be carried forward on an annual basis and credited against the normal income tax for the three (3) immediately succeeding taxable years.

Illustration on how to carry forward excess minimum corporate income tax —

Excess of MCIT Normal Income Over the Normal

Year Tax MCIT Income Tax 1998 P50,000 P75,000 P25,000 1998 amount of tax payable P75,000 1999 P60,000 P100,000 P40,000 1999 amount of tax payable P100,000 2000 P100,000 P60,000 Computation of Net Amount of Tax Payable in 2000: Amount of tax payable P100,000 Less:

1998 excess MCIT (25,000) 1999 excess MCIT (40,000) P65,000

Net amount of tax payable P35,000

The taxpayer shall pay the MCIT whenever it is greater than the regular or normal corporate income tax which is imposed under Sec. 27(A) of the Code. The comparison between the normal income tax payable by the corporation and the MCIT shall be made at the end of the taxable year. Thus, under the example, the taxpayer will pay the MCIT of P75,000.00 since this amount is greater than the normal income tax of P50,000.00 in 1998.

In 1999, the firm will also pay the MCIT since the MCIT of P100,000.00 is greater than the normal income tax of P60,000.00.

In the year 2000, where the normal or regular corporate income tax of P100,000.00 is greater than the MCIT of P60,000.00, the firm will pay the normal income tax.

The corporation can credit the excess of its MCIT over the normal income tax for 1998 (i.e. P25,000) and 1999 (i.e. P40,000), or a total amount of P65,000 from the amount of normal income tax which is payable by the firm in the year 2000. Thus, the amount of income tax payable by the firm is P35,000 after deducting P65,000 from P100,000.

The excess MCIT is creditable against the normal income tax within the next three (3) years from payment thereof. Thus, in the illustration above where the corporation had an excess MCIT of P25,000 over its normal income tax in 1998, the P25,000 can be claimed as a tax credit against the normal income tax up to the year 2001 and only when the normal income tax is greater than the MCIT. The excess MCIT cannot be claimed as a credit against the MCIT itself or against any other losses.

8) Exceptions — The minimum corporate income tax (MCIT) shall apply only to domestic corporations subject to the normal corporate income tax prescribed under these Regulations. Accordingly, the minimum corporate income tax shall not be imposed upon any of the following:

(a) Domestic corporations operating as proprietary educational institutions subject to tax at ten percent (10%) on their taxable income; or

(b) Domestic corporations engaged in hospital operations which are nonprofit subject to tax at ten percent (10%) on their taxable income; and

(c) Domestic corporations engaged in business as depository banks under the expanded foreign currency deposit system, otherwise known as Foreign Currency Deposit Units (FCDUs), on their income from foreign currency transactions with local commercial banks, including branches of foreign banks, authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and other depository banks under the foreign currency deposit system, including their interest income from foreign currency loans granted to residents of the Philippines under the expanded foreign currency deposit system, subject to final income tax at ten percent (10%) of such income.

(d) Firms that are taxed under a special income tax regime such as those in accordance with RA 7916 and 7227 (the PEZA law and the Bases Conversion Development Act, respectively).

From 2004 Tax 1 Salvador

Relief from the MCIT – The Secretary of Finance, upon recommendation of the Commissioner, may suspend imposition of the MCIT upon submission of proof by the applicant-corporation, duly verified by the Commissioner’s authorized representative, that the corporation sustained substantial losses on account of a prolonged labor dispute or because of “force majeure” or because of legitimate business reverses. The MCIT on Resident Foreign Corporations – The MCIT shall only apply to resident foreign corporations which are subject to normal income tax. Accordingly, the MCIT shall not apply to the following resident foreign corporations:

1. international carrier 2. offshore banking units 3. regional operating headquarters 4. firms that are taxed under special income tax regime (such as

those enterprises registered with PEZA and enterprises registered pursuant to the Bases Conversion and Development Act

6. IMPROPERLY ACCUMULATED EARNINGS TAX


SEC. 3. Determination of Reasonable Needs of the Business. - An accumulation of earnings or profits (including undistributed earnings or profits of prior years) is unreasonable if it is not necessary for the purpose of the business, considering all the circumstances of the case. To determine the "reasonable needs" of the business in order to justify an accumulation of earnings, these Regulations hereby adhere to the so-called "Immediacy Test" under American jurisprudence as adopted in this jurisdiction. Accordingly, the term "reasonable needs of the business" are hereby construed to mean the immediate needs of the business, including reasonably anticipated needs. In either case, the corporation should be able to prove an immediate need for the accumulation of the earnings and profits, or the direct correlation of anticipated needs to such accumulation of profits. Otherwise, such accumulation would be deemed to be not for the

reasonable needs of the business, and the penalty tax would apply.

For purposes of these Regulations, the following constitute accumulation of earnings for the reasonable needs of the business:

a. Allowance for the increase in the accumulation of earnings up to 100% of the paid-up capital of the corporation as of Balance Sheet date, inclusive of accumulations taken from other years;

b. Earnings reserved for definite corporate expansion projects or programs requiring considerable capital expenditure as approved by the Board of Directors orequivalent body;

c. Earnings reserved for building, plants or equipment acquisition as approved by the Board of Directors or equivalent body;

d. Earnings reserved for compliance with any loan covenant or pre-existing obligation established under a legitimate business agreement;

e. Earnings required by law or applicable regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution;

f. In the case of subsidiaries of foreign corporations in the Philippines, all undistributed earnings intended or reserved for investments within the Philippines as can be proven by corporate records and/or relevant documentary evidence.

SEC. 4. Coverage. The 10% Improperly Accumulated Earnings Tax (IAET) is imposed on improperly accumulated taxable income earned starting January 1, 1998 by domestic corporations as defined under the Tax Code and which are classified as closely-held corporations. Provided, however, that Improperly Accumulated Earnings Tax shall not apply to the following corporations:

a. Banks and other non-bank financial intermediaries;

b. Insurance companies;

c. Publicly-held corporations;

d. Taxable partnerships;

e. General professional partnerships;

f. Non- taxable joint ventures; and

g. Enterprises duly registered with the Philippine Economic Zone Authority (PEZA) under R.A. 7916, and enterprises registered pursuant to the Bases Conversion and Development Act of 1992 under R.A. 7227, as well as other enterprises duly registered under special economic zones declared by law which enjoy payment of special tax rate on their registered operations or activities in lieu of other taxes, national or local.

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

For purposes of determining whether the corporation is closely held corporation, insofar as such determination is based on stock ownership, the following rules shall be applied:

1. Stock Not Owned by Individuals. - Stock owned directly or indirectly by or for a corporation, partnership, estate or trust shall be considered as being owned proportionately by its shareholders, partners or beneficiaries.

2. Family and Partnership Ownership. – An individual shall be considered as owning

the stock owned, directly or indirectly, by or for his family, or by or for his partner. For purposes of this paragraph, the ‘family of an individual’ includes his brothers or sisters (whether by whole or half-blood), spouse, ancestors and lineal descendants.

3. Option to Acquire Stocks. - If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option and each one of a series of option shall be considered as an option to acquire such stock.

4. Constructive Ownership as Actual Ownership. - Stock constructively owned by reason of the application of paragraph (1) or (3) hereof shall, for purposes of applying paragraph (1) or (2), be treated as actually owned by such person; but stock constructively owned by the individual by reason of the application of paragraph (2) hereof shall not be treated as owned by him for purposes of again applying such paragraph in order to make another the constructive owner of such stock.

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

SEC. 5. Tax Base of Improperly Accumulated Earnings Tax. - For corporations found subject to the tax, the "Improperly Accumulated Taxable Income" for a particular year is first determined by adding to that year’s taxable income the following:

a. income exempt from tax;

b. income excluded from gross income;

c. income subject to final tax; and

d. the amount of net operating loss carry-over (NOLCO) deducted.

The taxable income as thus determined shall be reduced by the sum of:

a. income tax paid/payable for the taxable year;

b. dividends actually or constructively paid/issued from the applicable year’s taxable income;

c. amount reserved for the reasonable needs of the business as defined in these Regulations emanating from the covered year’s taxable income.

The resulting "Improperly Accumulated Taxable Income" is thereby multiplied by 10% to get the Improperly Accumulated Earnings Tax (IAET).

Once the profit has been subjected to IAET, the same shall no longer be subjected to IAET in later years even if not declared as dividend. Notwithstanding the imposition of the IAET, profits which have been subjected to IAET, when finally declared as dividends, shall nevertheless be subject to tax on dividends imposed under the Tax Code of 1997 except in those instances where the recipient is not subject thereto.

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

SEC. 7. Determination of Purpose to Avoid Income Tax. - The fact that a corporation is a mere holding company or investment company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members. Likewise, the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members. In both instances, the corporation may, by clear preponderance of evidence in

its favor, prove the contrary.

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

The following are prima facie instances of accumulation of profits beyond the reasonable needs of a business and indicative of purpose to avoid income tax upon shareholders:

a. Investment of substantial earnings and profits of the corporation in unrelated business or in stock or securities of unrelated business;

b. Investment in bonds and other long-term securities;

c. Accumulation of earnings in excess of 100% of paid-up capital, not otherwise intended for the reasonable needs of the business as defined in these Regulations.

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

7. FRINGE BENEFIT TAX

REVENUE REGULATION 3-98 Valuation of Fringe Benefits:

1. if the fringe benefit is granted in money, or is directly paid for by the employer, then the value is the amount granted or paid for;

2. if the fringe benefit is granted or furnished by the employer in property other than money and ownership is transferred to the employee, then the value of the fringe benefit shall be equal to the fair market value of the property

3. if the fringe benefit is granted or furnished by the employer in property other than money but ownership is not transferred to the employee, the value of the fringe benefit is equal to the depreciation value of the property.


SECTION 1. Scope. — Pursuant to Section 244 of the 1997 Tax Code, in relation to Section 78 thereof pertaining to the withholding of income tax on compensation income, these Regulations are hereby promulgated amending Sections 2.78.1(A)(1), (A)(3), (A)(6), (A)(7), and (B)(11)(b) of Revenue Regulations No 2-98, as amended, to further clarify certain benefits/privileges received by the employees which are not considered as items of income and therefore not subject to income tax and consequently, to the withholding tax. Likewise amended is the enumeration of the items of de-minimis benefits which are exempt from fringe benefits tax as appearing under Sec. 2.33(C) of Revenue Regulations No. 3-98.

SECTION 2. Amendments. — Sec. 2.78.1(A)(1), (A)(3), (A)(6), (A)(7), (B)(11)(b) and(B)(13) are hereby amended to read as follows:

"Sec. 2.78.1. Withholding of Income Tax on Compensation Income. —

"(A) . . .

"(1) Compensation paid in kind. — . . .

''Where compensation is paid in property other than money, the employer shall make necessary arrangements to ensure that the amount of the tax required to be withheld is available for payment to the Commissioner.

"(3) Facilities and privileges of relatively small value. — Ordinarily, facilities and privileges (such as entertainment, medical services, or so-called "courtesy discounts" on purchases), otherwise known as "de minimis benefits," furnished or offered by an employer to his employees, are not considered as compensation subject to INCOME TAX AND CONSEQUENTLY TO withholding tax, if such facilities are offered or furnished by the employer merely as means of promoting the health, goodwill, contentment, or efficiency of his employees.

"THE FOLLOWING SHALL BE CONSIDERED AS "DE MINIMIS" BENEFITS NOT SUBJECT TO WITHHOLDING TAX ON COMPENSATION INCOME OF BOTH MANAGERIAL AND RANK AND FILE EMPLOYEES:

(a) MONETIZED UNUSED VACATION LEAVE CREDITS OF EMPLOYEES NOT EXCEEDING TEN (10) DAYS DURING THE YEAR;

(b) MEDICAL CASH ALLOWANCE TO DEPENDENTS OF EMPLOYEES NOT EXCEEDING P750.00 PER EMPLOYEE PER SEMESTER OR P125 PER MONTH;

(c) Rice subsidy of P1,500.00 or one (1) sack of 50 kg. rice per month amounting to not more than P1,500.00;

(d) Uniform and Clothing allowance not exceeding P4,000.00 per annum;

(e) ACTUAL YEARLY MEDICAL BENEFITS NOT EXCEEDING P10,000 PER ANNUM;

(f) LAUNDRY ALLOWANCE NOT EXCEEDING P300 PER MONTH;

(g) EMPLOYEES ACHIEVEMENT AWARDS, E.G., FOR LENGTH OF SERVICE OR SAFETY ACHIEVEMENT, WHICH MUST BE IN THE FORM OF A TANGIBLE PERSONAL PROPERTY OTHER THAN CASH OR GIFT CERTIFICATE, WITH AN ANNUAL MONETARY VALUE NOT EXCEEDING P10,000.00 RECEIVED BY THE EMPLOYEE UNDER AN ESTABLISHED WRITTEN PLAN WHICH DOES NOT DISCRIMINATE IN FAVOR OF HIGHLY PAID EMPLOYEES;

(h) GIFTS GIVEN DURING CHRISTMAS AND MAJOR ANNIVERSARY CELEBRATIONS NOT EXCEEDING P5,000 PER EMPLOYEE PER ANNUM;

(i) FLOWERS, FRUITS, BOOKS, OR SIMILAR ITEMS GIVEN TO EMPLOYEES UNDER SPECIAL CIRCUMSTANCES, E.G., ON ACCOUNT OF ILLNESS, MARRIAGE, BIRTH OF A BABY, ETC.; AND

(j) DAILY MEAL ALLOWANCE FOR OVERTIME WORK NOT EXCEEDING TWENTY FIVE PERCENT (25%) OF THE BASIC MINIMUM WAGE." SEHACI

THE AMOUNT OF "DE MINIMIS' BENEFITS CONFORMING TO THE CEILING HEREIN PRESCRIBED SHALL NOT BE CONSIDERED IN DETERMINING THE P30,000 CEILING OF "OTHER BENEFITS" PROVIDED UNDER SECTION 32(B)(7)(e) OF THE CODE. HOWEVER, IF THE EMPLOYER PAYS MORE THAN THE CEILING PRESCRIBED BY THESE REGULATIONS, THE EXCESS SHALL BE TAXABLE TO THE EMPLOYEE RECEIVING THE BENEFITS ONLY IF SUCH EXCESS IS BEYOND THE P30,000.00 CEILING. PROVIDED, FURTHER, THAT ANY AMOUNT GIVEN BY THE EMPLOYER AS BENEFITS TO ITS EMPLOYEES, WHETHER CLASSIFIED AS DE MINIMIS BENEFITS OR FRINGE BENEFITS, SHALL CONSTITUTE AS DEDUCTIBLE EXPENSE UPON SUCH EMPLOYER.

"(4) . . .

(5) . .

"(6) Fixed or variable transportation, representation and other allowances. —

"(a) IN GENERAL, fixed or variable transportation, representation and other allowances which are received by a public officer or employee of a private entity, in addition to the regular compensation fixed for his position or office, is compensation subject to withholding. PROVIDED, HOWEVER, THAT REPRESENTATION AND TRANSPORTATION ALLOWANCE (RATA) GRANTED TO PUBLIC OFFICERS AND EMPLOYEES UNDER THE GENERAL APPROPRIATIONS ACT AND THE PERSONNEL ECONOMIC RELIEF ALLOWANCE (PERA) WHICH ESSENTIALLY CONSTITUTE REIMBURSEMENT FOR EXPENSES INCURRED IN THE PERFORMANCE OF GOVERNMENT PERSONNEL'S OFFICIAL DUTIES SHALL NOT BE SUBJECT TO INCOME TAX AND CONSEQUENTLY TO WITHHOLDING TAX. PROVIDED FURTHER, THAT PURSUANT TO E.O. 219 WHICH TOOK EFFECT ON JANUARY 1, 2000, ADDITIONAL COMPENSATION ALLOWANCE (ACA) GIVEN TO GOVERNMENT PERSONNEL SHALL NOT BE SUBJECT TO WITHHOLDING TAX PENDING ITS FORMAL INTEGRATION INTO THE BASIC PAY. CONSEQUENTLY, AND EFFECTIVE FOR THE TAXABLE YEAR 2000, ACA SHALL BE CLASSIFIED AS PART OF THE "OTHER BENEFITS" UNDER SECTION 32(B)(7)(e) OF THE CODE WHICH ARE EXCLUDED FROM GROSS COMPENSATION INCOME PROVIDED THE TOTAL AMOUNT OF SUCH BENEFITS DOES NOT EXCEED P30,000.00.

"(b) Any amount paid specifically, either as advances or reimbursements for traveling, representation and other bona fide ordinary and necessary expenses incurred or reasonably expected to be incurred by the employee in the performance of his duties are not compensation subject to withholding, if the following conditions are satisfied:

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

"(ii) The employee is required to account/liquidate for the foregoing expenses in accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of actual expenses over advances made shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/advances for traveling and entertainment expenses which are pre-computed on a daily basis and are paid to an employee while he is on an assignment or duty need not be subject to the requirements of substantiation and to withholding. "

"xxx xxx xxx

"(B) Exemptions from withholding tax on compensation. The following income payments are exempted from the requirement of withholding tax on compensation:

"xxx xxx xxx

"(11) Thirteenth (13th) month pay and other benefits. —

"(a) . . .

"(b) Other benefits such as Christmas bonus, productivity incentives, loyalty award, gift in cash or in kind and other benefits of similar nature actually received by officials and employees of both government and private offices, INCLUDING THE ADDITIONAL COMPENSATION ALLOWANCE ("ACA") GRANTED AND PAID TO ALL OFFICIALS AND EMPLOYEES OF THE NATIONAL GOVERNMENT AGENCIES (NGAs) INCLUDING STATE UNIVERSITIES AND COLLEGES (SUCs), GOVERNMENT-OWNED AND/OR CONTROLLED CORPORATIONS (GOCCs), GOVERNMENT FINANCIAL INSTITUTIONS (GFIs) AND LOCAL GOVERNMENT UNITS (LGUs) SCADIT

"The above stated exclusions (a) and (b) shall cover benefits paid or accrued during the year provided that total amount shall not exceed thirty thousand pesos (P30,000.00) which may be increased through rules and regulations issued by the Secretary of Finance, upon

recommendation of the Commissioner, after considering, among others, the effect on the same of the inflation rate at the end of the taxable year."

"(12) . . .

"(13) FACILITIES AND PRIVILEGES OF RELATIVELY SMALL VALUE OR 'DE MINIMIS' BENEFITS AS DEFINED UNDER THESE REGULATIONS."

SECTION 3. Repealing Clause. — Sections 2.78.1(A)(1), (A)(3), (A)(6), (A)(7), and (B)(11)(b) of Revenue Regulations No. 2-98, including the enumeration of the items of de-minimis benefits which are exempt from fringe benefits tax as appearing under Sec. 2.33(C) of Revenue Regulations No. 3-98 are hereby modified and the inclusion of Sec. 2.78.1(B)(13) in accordance with the amendments under these Regulations. All other existing rules and regulations or parts thereof which are inconsistent with the provisions of these Regulations are hereby revoked, modified or amended accordingly.

REVENUE REGULATIONS NO. 005-11, Amendments to Revenue Regulations Nos. 2-98 and 3-98, as Last Amended by Revenue Regulations No. 5-2008, with Respect to "De Minimis Benefits"

TO : All Internal Revenue Officials and Others Concerned

Pursuant to Sections 4 and 244 in relation to Section 33 of the Tax Code of 1997, these Regulations are hereby promulgated to further amend Revenue Regulations (RR) No. 2-98, as last amended by RR No. 5-2008, with respect to "De Minimis" benefits which are exempt from income tax on compensation as well as from fringe benefit tax.

SECTION 1. Section 2.78.1 (A) (3) (c) and (d) of RR 2-98, as last amended by RR 5-2008, is hereby further amended to read as follows:

The following shall be considered as "de minimis" benefits not subject to income tax as well as withholding tax on compensation income of both managerial and rank and file employees:

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

(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 P4,000 per annum;

(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;

(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;

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 income tax as well as withholding tax on compensation income.

SECTION 2. Section 2.33 (C) of RR 3-98, as last amended by RR 5-2008, is hereby further amended to read as follows:

(C) Fringe Benefits Not Subject to Fringe Benefit Tax — In general, the fringe benefit tax shall not be imposed on the following fringe benefits:

xxx xxx xxx

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

(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 P4,000 per annum;

(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;

(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;

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 income tax as well as withholding tax on compensation income.

E.1. EXEMPT ENTITIES - PARTNERSHIP

BIR RULING NO. 294-88

In reply to your letter dated March 2, 1988, please be informed that a professional partnership of real estate brokers is exempt from income tax pursuant to Section 24(a) of the Tax Code, as amended. Accordingly, the commissions you will pay to said partnership for professional services rendered are exempt from the withholding tax provisions of Revenue Regulations No. 6-85 otherwise known as the revised and Consolidated Expanded Withholding Tax Regulations implementing Section 50(b) of the Tax Code, as amended.


SECTION 23. Distributive shares of partners. — The distributive share of the net profit of a general co-partnership must be included in the individual returns of the partners. But where the result of partnership operation is a loss, the loss will be divisible by the partners in the same proportion as the net income would have been divisible (or, if the partnership agreement provides for the division of a loss in a manner different from the division of a gain, in the manner so provided) and may be taken by the individual partners in their respective returns of income.

SECTION 24. Proof of exemption. — In order to establish its exemption, and thus be relieved of the duty of filing returns of income and paying the tax, it is necessary that every organization claiming exemption file an affidavit with the Commissioner of Internal Revenue, showing the character of the organization, the purpose for which it was organized, its actual activities, the sources of its income and its disposition, whether or not any of its income is credited to surplus or inures or may inure to the benefit of any private shareholder or individual, and in general, all facts relating to its operations which affect its right to exemption. To such affidavit should be attached a copy of the charter or articles of incorporation, the by-laws of the organization, and the latest financial statement showing the assets, liabilities, receipts, and disbursement of the organization.

Upon receipt of the affidavit and other papers by the Commissioner of Internal Revenue, the organization will be informed whether or not it is exempt. When an organization has established its right to exemption, it need not thereafter make and file a return of income as required under Section 46 of the Tax Code. However, the organization should file on or before April 15 of each year, an annual information return under oath, stating its gross income and expenses incurred during the preceding year, and a certificate showing that there has not been any substantial change in its By-Laws, Articles of Incorporation, manner of operation and activities as well as sources and disposition of income. (As amended by Revenue Regulations No. 7-64, approved November 25, 1964.)

SECTION 25. Agricultural and horticultural organizations. — The organizations contemplated by subsection (a) of Section 27 of the Code as entitled to exemption from income taxation are those which (1) have no net income inuring to the benefit of any member; (2) are educational or instructive in character; and (3) have as their objects the betterment of the conditions of those engaged in such pursuits, the improvement of the grade of their products, and the development of a higher degree of efficiency in their respective occupations. Organizations such as provincial fairs and like associations of a quasi-public character, which are designed to encourage the development of better agricultural and horticultural products through a system of awards, prizes, or premiums, and whose income derived from gate receipts, entry fees, donations, etc., is used exclusively to meet the necessary expenses of upkeep and operation, are thus exempt. On the other hand, associations which have for their purpose, for example, the holding of periodical race meets, the profits from which may inure to the benefit of their shareholders, are not exempt. Similarly, corporations engaged in growing agricultural or horticultural products or raising live stock or similar products for profits are not exempt from tax under this paragraph.

SECTION 26. Mutual savings bank. — In order that a corporation may be entitled to exemption as a mutual savings bank, it must appear that it is an organization (1) which

has no capital stock represented by shares, and (2) whose earnings less only the expenses of operation, are distributable wholly among the depositors. If it appears that the organization has shareholders who participate in the profits, the organization will not be exempt from income tax.

SECTION 27. Fraternal beneficiary societies. — A fraternal beneficiary society is exempt from tax only if operated under the "lodge system", or for the exclusive benefit of the members of a society so operating. "Operating under the lodge system" means carrying on its activities under a form of organization that comprises local branches, chartered by a parent organization and largely self-governing, called lodges, chapters, or the like. In order to be exempt, it is also necessary that the society should have an established system for payment to its members or their dependents of life, sick, accident, or other benefits.

SECTION 28. Building and loan associations. — (Now subject to tax, as amended by Sec. 4, R.A. 82.)

SECTION 29. Cemetery companies. — A cemetery company may be entitled to exemption, (1) if it is owned by and operated exclusively for the benefit of its lot owners, or (2) if it is not operated for profit. Any cemetery corporation chartered solely for burial purposes and not permitted by its charter to engage in any business not necessarily incident to that purpose, is exempt from income tax, provided that no part of its net earnings inures to the benefit of any private shareholder or individual. A cemetery company which fulfills the other requirement of the statute may be exempt, even though it issues preferred stock entitling the holders to dividend at a fixed rate, provided that its articles of incorporation require (a) that the preferred stock shall be retired at par as soon as sufficient funds are realized from sales, and (b) that all funds not required for the payment of dividends upon or for the retirement of preferred stock shall be used by the company for the care and improvement of the cemetery property.

A cemetery company having a capital stock represented by shares, or which is operated for profit or for the benefit of persons other than its members, does not come within the exempted class.

SECTION 30. Religious, charitable, scientific, athletic, cultural, and educational corporations. — A corporation falling among those enumerated in subsection (e) of Section 27 is exempt from tax on its income (other than income of whatever kind and character from its properties, real or personal) if such corporation meets two tests: (a) It must be organized and operated for one or more of the specified purposes; and (b) no part of its net income must inure to the benefit of private stockholders or individuals.

The income of such corporation which is considered as income from their properties, real or personal, generally consists of income from corporate dividends, rentals received from their properties, interests received from such capital loaned to other persons, income from agricultural lands owned by such corporations, profits from the sale of property, real or personal, and other similar income.

Income not derived from their properties, real or personal, are exempt. For example, in the case of a religious corporation, income from the conduct of strictly religious activities, such as fees received for administering baptismals, solemnizing marriages, attending burials, holding masses, and other like income, is exempt. In the case of an educational corporation, income from the holding of an educational fair or exhibit is exempt. However, if such exempt income is invested by the corporation, the income from such investment, as interests from the capital where the capital has been loaned or dividends on stock where the capital has been invested in shares of stock, will constitute taxable income. Donations and other similar contributions received by such corporation from other persons are exempt.

The clause "except income expressly exempt by this Title" appearing in subsection (e) of Section 27 refers to those classes of income which, in accordance with subsection (b) of Section 29, are exempt from taxation under Title II.

Charitable corporations include an association for the relief of the families of clergymen, even though the latter make a contribution to the fund established for this purpose; or for

furnishing the services of trained nurses to persons unable to pay for them; or for aiding the general body of litigants by improving the efficient administration of justice. Educational corporations may include associations whose sole purpose is the instruction of the public. But associations formed to disseminate controversial or partisan propaganda are not educational within the meaning of the law. Scientific corporations include an association for the scientific study of law with a view to improving its administration.

It does not prevent exemption that private individuals, for whose benefit a charity is organized, receive the income of the corporation or association. The law refers to individuals having a personal and private interest in the activities of the corporation, such as stockholders. If, however, a corporation issues "voting shares", which entitle the holders upon the dissolution of the corporation to receive the proceeds of its property, including accumulated income, the right to exemption ceases to exist, even though the by-laws provide that the shareholders shall not receive any dividend or other return upon their shares.

SECTION 31. Business leagues. — A business league is an association of persons having some common business interest, which limits its activities to work for such common interest and does not engage in a regular business of a kind ordinarily carried on for profit. Its work need not be similar to that of a chamber of commerce or board of trade. If it engages in a regular business of a kind ordinarily carried on for profit, the fact that the business is conducted on a cooperative basis or produces only sufficient income to be self-sustaining, is not ground for exemption. An association engaged in furnishing information to prospective investors, to enable them to make sound investments, is not exempt, since its members have no common business interest, even though all of its income is devoted to the purpose stated. A clearing house association, not organized for profit, no part of the net income of which inures to any private shareholder or individual, is exempt provided its activities are limited to the exchange of checks, and similar work for the common benefit of its members. An association of persons who are engaged in the transportation business, whether by land or water, which is designed to promote the legitimate objects of such business, and all of the income of which is derived from membership dues and is expended for office expenses is exempt from tax. DSITEH

SECTION 32. Civic leagues. — Civic leagues entitled to exemption comprise those not organized for profit but operated exclusively for purposes beneficial to the community as a whole. In general, organizations engaged in promoting the welfare of mankind are exempt from tax.

SECTION 33. Social clubs. — The exemption applies to practically all social and recreation clubs which are supported by membership fees, dues, and assessments. If a club, by reason of the comprehensive powers granted in the charter, engages in business or in agriculture or horticulture, for profit, such club is not organized and operated exclusively for pleasure, recreation, or social purposes, and any profit realized from such activities is subject to tax.

SECTION 34. Mutual insurance companies and like organizations. — It is necessary to exemption that the income of the company be derived solely from assessments, dues, and fees collected from members. If income is received from other sources, the corporation is not exempt. Income, however, from sources other than those specified does not prevent exemption where its receipt is a mere incident of the business of the company. Thus the receipt of interest upon a working bank balance, or of the proceeds of the sale of badges, office supplies, or equipment, will not defeat the exemption. The same is true of the receipt of interest upon Government bonds, where they were purchased and were afterwards sold. Where, however, such bonds are bought as a permanent investment, the receipt of the interest destroys the exemption. The receipt of what is, in substance, an entrance fee, charged by a mutual fire insurance company as a condition of membership, does not render the company taxable, although this fee is called a premium. If an organization issues policies for stipulated cash premiums, or if it requires advance deposits to cover the cost of the insurance and maintains investments from which income is derived, it is not entitled to exemption. On the other hand, an organization may be entitled to exemption, although it makes advance assessment for the sole purpose of meeting future losses and expenses, provided that the balance of such assessments remaining on hand at the end of the year is retained to meet losses and expenses or is

returned to members. An organization of a purely local character is one whose business activities are confined to a particular community, place, or district, irrespective, however, of political subdivisions.

SECTION 35. Farmers' cooperative marketing and purchasing association. — Cooperative associations, acting as sales agents for farmers or others, in order to come within the exemption must establish that for their own account they have no net income. Cooperative dairy companies, which are engaged in collecting milk and disposing of it or the products thereof and distributing the proceeds, less necessary operating expenses, among their members upon the basis of the quantity of milk or of butter fat in the milk furnished by such members are exempt from the tax. If the proceeds of the business are distributed in any other way than on such a proportionate basis, the company will be subject to tax. A farmers' association is not exempt from taxation where in accounting to farmers furnishing produce for the proceeds of sales it deducts more than the necessary selling expenses incurred. Cooperative associations acting as purchasing agents are not expressly exempt from tax, but rebates made to purchasers, whether or not members of the association, in proportion to their purchases may be excluded from gross income in computing the net income subject to tax. Any profits made from non-members and distributed to members in the guise of rebates are, of course, subject to tax.

Cooperative marketing associations duly incorporated under Act No. 3425, known as the Cooperative Marketing Law are exempt from income tax. (See also R.A. 702 exempting cooperative marketing associations.)

SINCO V. CIR, 100 PHIL 127

Appellee is a non-profit institution and since its organization it has never distributed any dividend or profit to its stockholders. Only part of its income went to the payment of its teachers or professors and to the other expenses of the colleges incident to an educational institution but none of the income had never been channeled to the benefit of any individual stockholders.

Held: Whatever payment is made to those who work for a school or college as a remuneration for their services is not considered as distribution of profit as would make the school one conducted for profit.

The proof of exemption required by section 243, Regulation No. 2, Department of Finance is intended to relieve the tax-payer of the duty of filing returns and paying the tax. The failure to observe the requirement called for therein can not constitute a waiver of the right to enjoy the exemption. To hold otherwise would be tantamount to incorporating into the tax laws same legislative matter by administrative regulation.

4. RP-US INCOME TAX TREATY – JUST SEE OLDER REVIEWERS

5. OMNIBUS INVESTMENTS CODE – EO 226

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

(a) Income Tax Holiday.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(bb) for reasons of proven technical obsolescence; or

(cc) for purposes of replacement to improve and/or expand the

operations of the registered enterprise.

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

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

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

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

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

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

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

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

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

(j) Tax Credit on Domestic Breeding Stocks and Genetic Materials. A tax credit equivalent to one hundred percent (100%) of the value of national internal revenue taxes and

customs duties that would have been waived on the breeding stocks and genetic materials had these items been imported shall be given to the registered enterprise which purchases breeding stocks and generic materials from a domestic producer: Provided, 1) That said breeding stocks and generic materials would have qualified for tax and duty free importation under the preceding paragraph; 2) that the breeding stocks and genetic materials are reasonably needed in the registered activity; 3) that the approval of the board has been obtained by the registered enterprise; and 4) that the purchase is made within ten (10) years from date of registration or commercial operation of the registered enterprise.

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

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

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

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

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

6. SPECIAL ECONOMIC ZONE ACT, R.A. 7916, AMENDED BY RA 8748

SEC. 23. Fiscal Incentives. – Business establishments operating within the ECOZONES shall be entitled to the fiscal incentives as provided for under Presidential Decree No. 66, the law creating the Export Processing Zone Authority, or those provided under Book VI of Executive Order No. 226, otherwise known as the Omnibus Investment Code of 1987.

Furthermore, tax credits for exporters using local materials as Inputs shall enjoy the same benefits provided for in the Export Development Act of 1994.

SEC. 24. Exemption from National and Local Taxes.- Except for real property taxes on land owned by developers, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu thereof, five percent (5%) of the gross income earned by all business enterprises within the ECOZONE shall be paid and remitted as follows:

a. Three percent (3%) to the National Government;

b. Two percent (2%) which shall be directly remitted by the business establishments to the treasurer’s office of the municipality or city where the enterprise is located.

SEC. 25. Applicable National and Local Taxes. – All persons and services establishments in the ECOZONE shall be subject to national and local taxes under the National Internal Revenue Code and the Local Government Code.

7. CIR v. CA, CTA & YMCA, GR. No. 124043, Oct. 14, 1998

Whether the earnings of YMCA from leasing out a portion of its premises to small shop owners like restaurants and canteen operators and the parking fees collected from non-members are exempt from taxation based on Sec 27 of the NIRC.

Held: NO, The exemption claimed by YMCA is expressly disallowed by the very wordings of the last paragraph of then Sec 27 which mandates that the income of exempt organizations from any of their properties, whether real or personal, be subject to tax imposed by the same Code. Further, it is exempt from paying property tax and not income tax.

The bare allegations alone that it is a non-stock, non-profit educational institution is insufficient to justify its exemption from the payment of income tax. YMCA is not a school or educational institution.

8. JEWELRY INDUSTRY DEVELOPMENT ACT, RA 8502

Section 3. Development incentives. – The following incentives shall be available to qualified jewelry enterprises in the jewelry industry:

a) Entitlement to zero (0) duty on imported raw materials which include precious metals, loose gems, precious stones, jewelry parts, accessories and supplies for use by jewelry enterprise, as specifically mentioned in Chapter 5 of Sec. I, Chapter 12 of Sec. II, Chapters 25, 26 and 27 of Sec. V, Chapters 28, 34 and 38 of Sec. VI, Chapter 70 of Sec. XIII, Chapter 71 of Sec. XIV, Chapter 83 of Sec. XV, and Chapter 96 of Sec. XX of the Tariff and Customs Code, as amended;

b) Exemption from the imposition of excise tax on all goods commonly or commercially known as jewelry, whether real or imitation pearls, precious and semi-precious stones and imitations thereof; all goods made of, or ornamented, mounted or fitted with precious metals or imitations thereof, as specifically mentioned in Sec. 150(a) of the National Internal Revenue Code of the Philippines, as amended;

c) Entitlement to zero (0) duty on imported capital equipment, including spare parts and toolings thereof falling within Chapter 69 of Sec. XIII, Chapter 82 of Sec. XV, Chapters 84 and 85 of Sec. XVI, and Chapter 90 of Sec. XVIII of the Tariff and Customs Code, as amended;

d) Additional deduction from taxable income of fifty percent (50%) of expenses incurred in training schemes approved by the appropriate agency and which shall be deductible during the financial year the expenses were incurred;

e) Gold and silver sales by the Bangko Sentral ng Pilipinas to jewelry enterprises wider minimal margins;

f) Authority for jewelry enterprises to buy gold and silver directly from other sources;

g) Inclusion of locally-manufactured jewelry in the government's tourist duty free shops including the promotion, advertisement and sale thereof; and

h) Jewelry enterprises availing of incentives provided under this Act shall still be eligible to incentives provided by other special laws such as Republic Act No. 7844 (Export Development Act of 1994), Republic Act No. 7916 (Special Economic Zone Act of 1995), Executive Order 226 (BOI Omnibus Investments Code), among others: Provided, That the activity is export-oriented and that there is no double availment of the same incentives.


Pursuant to Section 3 of Republic Act 8502, the following incentives shall be available to a qualified jewelry industry:

Entitlement to zero (0) duty on imported raw materials which include precious metals, loose gems, precious stones, jewelry parts, accessories and supplies for use by a jewelry enterprise, as specifically mentioned in Chapter 5 of Section 1, Chapter 12 of Section II, Chapters 25, 26 and 27 of Section V, Chapters 28, 34 and 38 of Section VI, Chapter 70 of Section XIII, Chapter 71 of Section XIV, Chapter 83 of Section XV, and Chapter 96 of Section XX, all of the Tariff and Customs Code, as amended;

Exemption from the imposition of excise tax on all goods commonly or commercially known as jewelry, whether real or imitations thereof; all goods made of, or ornamented, mounted or fitted with precious metals or imitations thereof, as specifically mentioned in Section 150(a) of the National Internal Revenue Code of the Philippines, as amended;

Entitlement to zero duty on imported capital equipment, including spare parts and toolings thereof falling within Chapter 69 of Section XIII, and Chapter 90 of Section XVIII of the Tariff and Customs Code, as amended;

Additional deduction from taxable income of fifty percent (50%) of expenses incurred in training schemes approved by the appropriate agency which shall be deductible during the financial year the expenses were incurred;

Gold and silver sales by the Bangko Sentral ng Pilipinas to jewelry enterprises under minimal margins;

Authority for jewelry enterprises to buy gold and silver directly from other sources;

Inclusion of locally-manufactured jewelry in the government's tourist duty free shops including the promotion, advertisement and sale thereof; and

Jewelry enterprises availing of incentives provided under the Act shall still be eligible to incentives provided by other special laws such as Republic Act No. 7844 (Export Development Act of 1994), Republic Act No. 7916 (Special Economic Zone Act of 1995), Executive Order 226 (BOI Omnibus Investment Code), among others: Provided, That the activity is export-oriented and that there is no double availment of the same incentives.

9. COOPERATIVE CODE OF THE PHILIPPINES, RA 6938

Section 61. Tax Treatment of Cooperatives. – Duly registered cooperatives under this Code which do not transact any business with non-members or the general public shall not be subject to any government taxes and fees imposed under the Internal Revenue Laws and other tax laws. Cooperatives not falling under this article shall be governed by the succeeding section.

Section 62. Tax and Other Exemptions. - Cooperatives transacting business with both members and non-members shall not be subject to tax on their transactions to members. Notwithstanding the provisions of the law or regulation to the contrary, such cooperatives dealing with non-members shall enjoy the following tax exemptions:

(1) Cooperatives with accumulated reserves and undivided net savings of not more than Ten million pesos (P10,000,000.00) shall be exempt from all national, city, provincial, municipal or barangay taxes of whatever name and nature. Such cooperatives shall be exempt from customs duties, advance sales or compensating taxes on their importation of machineries, equipment and spare parts used by them and which are not available locally as certified by the Department of Trade and Industry. All tax-free importations shall not be transferred to any person until after five (5) years, otherwise, the cooperative and the transferee or assignee shall be solidarily liable to pay twice the amount of the tax and/or duties thereon.

(2) Cooperatives with accumulated reserves and undivided net savings of more than Ten million pesos (P10,000,000.00) shall pay the following taxes at the full rate:

(a) Income Tax: On the amount allocated for interest on capitals: Provided, That the same tax is not consequently imposed on interest individually receive by members;

(b) Sales Tax: On sales to non members: Provided, however, That all cooperatives, regardless of classification, are exempt from the payment of income and sales taxes for a period of ten (10) years.

For cooperatives whose exemptions were removed by Executive Order No. 93, the ten-year period shall be reckoned from the effectivity date of said Executive Order. Cooperatives created after the approval of this Code shall be granted the same exemptions, the period of which shall be reckoned from the date of registration with the Authority: Provided, That at least twenty-five per cent (25%) of the net income of the cooperatives is returned to the members in the form of interest and/or patronage refunds;

(c) All other taxes unless otherwise provided herein; and

(d) Donations to charitable, research and educational institutions and reinvestment to socio-economic projects within the are of operation of the cooperative may be tax deductible.

(3) All cooperative, regardless of the amount of accumulated reserves and undivided net savings shall be exempt from payment of local taxes and taxes on transactions with banks and insurance companies: Provided, That all sales or services rendered for non-members shall be subject to the applicable percentage taxes except sales made by producers, marketing or service cooperatives: Provided further, That nothing in this article shall preclude examination of the books of accounts or other accounting records of the cooperative by duly authorized internal revenue officers for internal revenue tax purposes only, after previous authorization by the Authority.

(4) Any judge in his capacity as notary public, ex officio, shall render service, free of charge, to any person or group of persons requiring either the administration of oath or acknowledgment of articles of cooperation of a cooperative applicant for registration and instruments of loan from cooperative not exceeding Fifty thousand pesos (50,000.00).

(5) Any register of deeds shall accept for registration, free of charge, any instrument relative to a loan made under this Code which does not exceed Fifty thousand pesos (50,000.00) or the deeds of title of any property acquired by the cooperative or any paper or document drawn in connection with any action brought by the cooperative or with any court judgment rendered in its favor or any instrument relative to a bond of any accountable officer of a cooperative for the faithful performance of his duties and obligations.

(6) Cooperatives shall be exempt from the payment of all court and sheriff’s fees payable to the Philippine Government for and in connection with all actions brought under this Code, or where such actions is brought by the Cooperative Development Authority before the court, to enforce the payment of obligations contracted in favor of the cooperative.

(7) All cooperatives shall be exempt from putting up a bond for bringing an appeal against the decision of an inferior court or seeking to set aside any third party claim: Provided, That a certification of the authority showing that the net assets of the cooperative are in excess of the amount of the bond required by the court in similar cases shall be accepted by the court as sufficient bond.

(8) Any security issued by a cooperative, shall be exempt from provisions of the Securities Act provided such security shall not be speculative.

10. BARANGAY MICRO BUSINESS ENTERPRISES, R.A. 9178

Section 7. Exemption from Taxes and Fees – All BMBEs shall be exempt from tax for income arising from the operations of the enterprise.

The LGUs are encouraged either to reduce the amount of local taxes, fees and charges imposed or to exempt BMBEs from local taxes, fees and charges.

11. TOURISM ACT, R.A. 9593

Section 29. Intramuros Administration, National Parks Development Committee and

Nayong Pilipino Foundation. - The Intramuros Administration, the National Parks Development Committee and the Nayong Pilipino Foundation shall continue to be attached to the Department and operate under their respective charters. They may be authorized to operate TEZs, under the supervision of the TIEZA, as provided under Chapters IV and V of this Act, within their respective jurisdictions: Provided, That any restoration activity undertaken by the IA, the NPDC or the NPF may be entitled to a tax deduction equivalent to the full cost of the restoration activity directly incurred in accordance with the provisions of the National Internal Revenue Code, as amended.

Section 57. Exemption From Payment of Corporate Income Tax. - Notwithstanding any provision of existing laws, decrees, executive orders to the contrary, the TPB shall be exempt from the payment of corporate income tax, as provided under the National Internal Revenue Code (NIRC) of 1997, as amended.

Section 74. Exemption from Payment of Corporate Income Tax. - Notwithstanding any provision of existing laws, decrees, executive orders to the contrary, the TIEZA shall be exempt from the payment of corporate income tax, as provided under the NIRC.

Section 86. Fiscal Incentives Available to TEZ Operators and Registered Enterprises. - The following incentives may, in the discretion of the TIEZA Board, be granted to registered tourism enterprises within TEZs:

(a) Income Tax Holiday. New enterprises in Greenfield and Browdeld Tourism Zones shall, from the start of business operations, be exempt from tax on income for a period of six (6) years. This income tax holiday may be extended if the enterprise undertakes a substantial expansion or upgrade of its facilities prior to the expiration of the first six (6) years.

This extension shall consider the cost of such expansion or upgrade in relation to the original investment, but shall in no case exceed an additional six (6) years. These enterprises shall likewise be allowed to carry over as deduction from the gross income for the next six (6) consecutive years immediately following the year of the loss, their net operating losses for any taxable year immediately preceding the current taxable year which had not been previously offset as deduction from gross income.

An existing enterprise in a Brownfield Tourism Zone shall likewise enjoy the incentives extended to new enterprises in Green6eld and Brownfield Tourism Zones mentioned in the preceding paragraph. An existing enterprise in a Brownfield Tourism Zone shall be entitled to avail of a non - extendible income tax holiday if it undertakes an extensive expansion or upgrade of facilities. Such an income tax holiday shall consider the cost of such expansion or upgrade in relation to the original investment, but shall in no case exceed six (6) years to be counted from the time of completion of the expansion or upgrade: Provided, That capital expenditures subject to income tax holiday shall be understood to mean money spent to acquire or upgrade physical assets, such as buildings, machinery and equipment, intended to extend the life of an asset or increase the capacity or efficiency of a tourism enterprise that benefit the current and future periods: Provided, further, That in case of expansion involving the improvement of existing structures or constructing new ones, such expansion shall consider the substantial amount infused, the substantial number of rooms added or constructed and, where applicable, their change in classification from three - star to five - star establishments.

The provisions of this subsection shall likewise apply to tourism enterprises outside the zones.

(b) Gross Income Taxation. In lieu of all other national and local taxes, license fees, imposts and assessments, except real estate taxes and such fees as may be imposed by the TIEZA, a new enterprise shall pay a tax of five percent (5%) on its gross income earned, which shall be distributed as follows:

(1) One - third to be proportionally allocated among affected LGUs;

(2) One - third to the national government; and

(3) One - third to the TIEZA for the funding of its operations and its programs in the TEZs, which shall include the protection, maintenance and enrichment of the

environment, tangible cultural and historical heritage, and the intangible cultural heritage of communities within and surrounding the TEZs.

Gross income as used herein is defined under Section 27(A) of the NIRC, and further defined under relevant rules and regulations.

(c) Capital Investment and Equipment. Subject to rules and regulations which properly define capital investments and equipment necessary for various kinds of tourism enterprises, registered enterprises shall be entitled to an exemption of one hundred percent (100%) of all taxes and customs duties on importations of capital investment and equipment.

(d) Transportation and Spare Parts. Importation of transportation and the accompanying spare parts of new and expanding registered enterprises shall be exempt from customs duties and national taxes: Provided, That they are not manufactured domestically in sufficient quantity, of comparable quality and at reasonable prices, and that they are reasonably needed and will be used exclusively by an accredited tourism enterprise.

(e) Goods and Services. Subject to rules and regulations which properly define goods and services necessary for various kinds of tourism enterprises, registered enterprises shall be entitled to the following: (1) Importation of goods actually consumed in the course of services actually rendered by or through registered enterprises within a TEZ shall enjoy one hundred percent (100%) exemption from all taxes and customs duties: Provided, however, That no goods shall be imported for the purpose of operating a wholesale or retail establishment in competition with the DFPC; and

(2) A tax credit equivalent to all national internal revenue taxes paid on all locally - sourced goods and services directly or indirectly used by the registered enterprise for services actually rendered within the TEZ.

(f) Social Responsibility Incentive. A registered enterprise shall be entitled to a tax deduction equivalent to a reasonable percentage, not exceeding fifty percent (60%), of the cost of environmental protection or cultural heritage preservation activities, sustainable livelihood programs for local communities, and other similar activities.

F. INCLUSIONS AND EXCLUSIONS FROM GROSS INCOME


SECTION 39. What gross income includes. — Gross income includes, in general, compensation for personal and professional services, business income, profits from sales of and dealings in property, interests, rents, dividends, and gains, profits, and income derived from any source whatever, unless exempt from tax by law. In general, income is the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. Profit of citizens, resident aliens, or domestic corporations derived from sales in foreign commerce must be included in their gross income. Income may be in the form of cash or of property.

For the treatment of dividends for purposes of the tax, see Sections 250 to 256 of these regulations. For the treatment of capital gains, see Sections 132 to 135 of these regulations.

SECTION 40. Compensation for personal services. — Where no determination of compensation is had until the completion of the services, the amount received is ordinarily income for the taxable year of its determination, if the return is rendered on the accrual basis; or, for the taxable year in which received, if the return is rendered on a receipts and disbursements basis. Commissions paid salesman, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, and pensions or retiring allowances paid by private persons or by the Government of the United States or of the Philippines (except pensions exempt by law from tax) are income to the recipients; as are also marriage fees, baptismal offerings, sums paid for saying masses for the dead, and other contributions received by a clergyman, evangelists, or religious

worker for services rendered. However, so-called pensions awarded by one to whom no services have been rendered are mere gifts or gratuities and are not taxable.

SECTION 41. Compensation paid other than in cash. — Where services are paid for with something other than money, the fair market value of the thing taken in payment is the amount to be included as income. If the services were rendered at a stipulated price, in the absence of evidence to the contrary, such price will be presumed to be the fair value of the compensation received. Compensation paid an employee of a corporation in its stock is to be treated as if the corporation sold the stock for its market value and paid the employee in cash. When living quarters are furnished in addition to cash salary, the rental value of such quarters should be reported as income.

SECTION 42. Compensation paid in promissory notes. — Promissory notes or other evidence of indebtedness received in payment for services, and not merely as security for such payment, constitute income to the amount of their fair market value. A taxpayer receiving as compensation a note regarded as good for its face value at maturity, but not bearing interest, shall treat as income as of the time of receipt the fair discounted value of the note at that time. Thus, if it appears that such a note is or could be discounted on a 6 per cent basis, the recipient shall include such note in his gross income to the amount of its face value less discount computed at the prevailing rate for such transactions.

If the payment due on a note so accounted for are met as they become due, there should be included as income in respect of each such payment so much thereof as represents recovery for the discount originally deducted.

SECTION 43. Gross income from business. — In the case of a manufacturing, merchandising, or mining business, "gross income" means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. In determining the gross income, subtractions should not be made for depreciation, depletion, selling expenses or losses, or for items not ordinarily used in computing the cost of goods sold.

SECTION 44. Long term contracts. — Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used herein the term "long-term" contracts means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in par from such contracts may, as to such income, prepare their returns upon the following bases:

(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. In such case there should accompany the return certificate of architects, or engineers showing the percentage of completion during the taxable year of the entire work performed under contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the material and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. If upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner of Internal Revenue may permit or require an amended return.

(b) Gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice to so treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of the completion.

Where a taxpayer has filed his return in accordance with the method of accounting regularly employed by him in keeping his books and such method clearly reflects the income, he will not be required to change to either of the methods above set forth. If a taxpayer desires to change his method of accounting in accordance with paragraphs (a) and (b) above, a statement showing the composition of all items appearing upon his

balance sheet and used in connection with the method of accounting formerly employed by him, should accompany his return.

SECTION 45. Gross income of farmers. — A farmer reporting on the basis of receipts and disbursements (in which no inventory to determine profits is used) shall include in his gross income for the taxable year (1) the amount of cash or the value of merchandise or other property received from the sale of live stock and produce which were raised during the taxable year or prior years, (2) the profit from the sale of any live stock or other items which were purchased, and (3) gross income from all other sources. The profit from the sale of live stock or other items which were purchased is to be ascertained by deducting the cost from the sales price in the year in which the sale occurs, except that in the case of the sale of animals purchased as draft or work animals, or solely for breeding or dairy purposes and not for resale, the profit shall be the amount of any excess of the sales prices over the amount representing the difference between the cost and the depreciation theretofore sustained and allowed as a deduction in computing net income.

In the case of a farmer reporting on the accrual basis (in which an inventory is used to determine profits), his gross profits are ascertained by adding to the inventory value of live stock and products on hand at the end of the year the amount received from the sale of live stock products, and miscellaneous receipts for hire of teams, machinery, and the like, during the year, and deducting from this sum the inventory value of live stock and products on hand at the beginning of the year and the cost of live stock and products purchased during the year. In such cases all live stock raised or purchased for sale shall be included in the inventory at their proper valuation determined in accordance with the method authorized and adopted for the purpose. Also, live stock acquired for drafts, breeding, or dairy purposes and not for sale may be included in the inventory, instead of being treated as capital assets subject to depreciation, provided such practice is followed consistently by the taxpayer. In case of the sale of any live stock included in an inventory their cost must not be taken as an additional deduction in the return of income, as such deduction will be reflected in the inventory.

In every case of the sale of machinery, farm equipment, or other capital assets (which are not to be included in an inventory if one is used to determine profits) any excess over the cost thereof less the amount of depreciation theretofore sustained and allowed as a deduction in computing net income, shall be included as gross income. Where farm produce is exchanged for merchandise, groceries, or the like, the market value of the article received in exchange is to be included in gross income. Rents received in crop shares shall be returned as of the year in which the crop shares are reduced to money or a money equivalent. Proceeds of insurance, such as fire and typhoon insurance on growing crops, should be included in gross income to the amount received in cash or its equivalent for the crop injured or destroyed. If a farmer is engaged in producing crops which take more than a year from the time of planting to the time of gathering and disposing, the income therefrom may be computed upon the crop basis; but in any such cases the entire cost of producing the crop must be taken as a deduction in the year in which the gross income from the crop is realized.

As herein used the term "farm" embrace the farm in the ordinarily accepted sense, and includes stock, dairy, poultry, fruit, and truck farms, also plantations, ranches, and all land used for farming operations. All individuals, partnerships, or corporations that cultivate, operate, or manage farms for gain or profit either as owners, or tenants, are designated farmers. A person cultivating or operating a farm for recreation or pleasure, the result of which is a continual loss from year to year, is not regarded as a farmer.

SECTION 46. Sale of patents and copyrights. — A taxpayer disposing of patents or copyrights by sale should determine the profit or loss arising therefrom by computing the difference between the selling price and the cost. The taxable income in the case of patents or copyrights acquired prior to March 1, 1913, should be ascertained in accordance with the provisions of section 136 of these regulations. The profit or loss thus ascertained should be increased or decreased, as the case may be, by the amounts deducted on account of depreciation of such patent or copyrights since March 1, 1913, or since the date of acquisition if subsequent thereto.

SECTION 47. Sale of goodwill. — Gain or loss from a sale of goodwill results only when the business, or a part of it, to which the goodwill attaches is sold, in which case the gain or loss will be determined by comparing the sale price with the cost or other basis of the assets, including goodwill. If specific payment was not made for goodwill acquired after March 1, 1913, there can be no deductible loss with respect thereto, but gain may be realized from the sale of goodwill built up through expenditures which have been currently deducted. It is immaterial that goodwill may never have been carried on the books as an asset but the burden of proof is on the taxpayer to establish the cost or fair market value on March 1, 1913, of the goodwill sold.

SECTION 48. Annuities and insurance policies. — Annuities paid by religious, charitable, and educational corporations under an annuity contract are subject to tax to the extent that the aggregate amount of the payments to the annuitant exceeds the amounts paid by him as consideration for the contract. An annuity charged upon devised land is taxable to a donee-annuitant, whether paid by the devisee out of the rents of the land or from other sources. The devisee is not required to return as gross income the amount of rent paid to the annuitant, and he is not entitled to deduct from his gross income any sums paid to the annuitant. Amounts received by an insured as a return of premiums paid by him under life insurance, endowment, or annuity contracts, such as the so-called "dividends" of a mutual insurance company, which may be credited against the current premium, are not subject to tax. Distributions on paid-up policies which are made out of earnings of the insurance company subject to tax are in the nature of corporate dividends and should be included in the taxable income of the individual, without any credit for the amount of tax paid by the corporation at source.

SECTION 49. Improvements by lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases;

(a) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.

(b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.

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

SECTION 50. Forgiveness of indebtedness. — The cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If, for example, an individual performs services for a creditor, who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend.

SECTION 51. When income is to be reported. — Gains, profits, and income are to be included in the gross income for the taxable year in which they are received by the taxpayer, unless they are included when they accrue to him in accordance with the approved method of accounting followed by him. If a person sues in one year on a pecuniary claim or for property, and money or property is recovered on a judgment therefore in a later year, income is realized in that year, assuming that the money or property would have been income in the earlier year if then received. This is true of a recovery for patent infringement. Bad debts or accounts charged off subsequent to March 1, 1913, because of the fact that they were determined to be worthless, which are subsequently recovered, whether or not by suit, constitute income for the year in which recovered, regardless of the date when amounts were charged off.

SECTION 52. Income constructively received. — Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made. A book entry, if made, should indicate an absolute transfer from one account to another. If the income is not credited, but is set apart, such income must be unqualifiedly subject to the demand of the taxpayer. Where a corporation contingently credits its employees with bonus stock, but the stock is not available to such employees until some future date, the mere crediting on the books of the corporation does not constitute receipt.

SECTION 53. Examples of constructive receipt. — When interest coupons have matured and are payable, but have not been cashed, such interest payment though not collected when due and payable, is nevertheless available to the taxpayer and should therefore be included in his gross income for the year during which the coupons matured. This is true if the coupons are exchanged for other property instead of eventually being cashed. Defaulted coupons are income for the year in which paid. The distributive share of the profits of a partner in a general co-partnership duly registered is regarded as received by him, although not distributed. Interest credited on savings bank deposits, even though the bank nominally has a rule, seldom or never enforced, that it may require so many days' notice in advance of cashing depositors' checks, is income to the depositor when credited. An amount credited to shareholders of a building and loan association, when such credit passes without restriction to the shareholder, has taxable status as income for the year of the credit. When the amount of such accumulations has not become available to the shareholder until the maturity of a share, the amount of any share in excess of the aggregate amount paid in by the shareholder is income for the year of maturity of the share.

SECTION 54. Creation of corporate sinking fund. — If a corporation in order solely to secure payment of its bonds or other indebtedness, places property in trust, or sets aside certain amounts in a sinking fund under the control of a trustee who may be authorized to invest and reinvest such sums from time to time, the property or fund thus set aside by the corporation and held by the trustee is an asset of the corporation, and any gain arising therefrom is income of the corporation and shall be included as such in its annual return.

SECTION 55. Acquisition or disposition by a corporation of its own capital stock. — Whether the acquisition or disposition by a corporation of share of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock.

But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon the sale of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. Any gain derived from such transaction is subject to tax,

and any loss sustained is allowable as deduction where permitted by the provisions of Title II.

SECTION 56. Contributions by shareholders. — Where a corporation requires additional funds for conducting its business and obtains such needed money through voluntary pro rata payments by its shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an addition to and as a part of the operating capital of the company.

SECTION 57. Sale and retirement of corporate bonds. — (1) (a) If bonds are issued by a corporation at their face value, the corporation realizes no gain or loss. (b) If thereafter the corporation purchases and retires any of such bonds at a price in excess of the issuing price or face value, the excess of the purchase price over the issuing price or face value is a deductible expense for the taxable year. (c) If, however, the corporation purchases and retires any of such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the purchase price is gain or income for the taxable year.

(2) (a) If bonds are issued by a corporation at a premium, the net amount of such premium is gain or income which should be prorated or amortized over the life of the bond. (b) If thereafter the corporation purchases and retires any of such bonds at a price in excess of the issuing price minus any amount of premium already returned as income, the excess of the purchase price over the issuing price minus any amount of premium already returned as income (or over the face value plus any amount of premiums not yet returned as income) is a deductible expenses for the taxable year. (c) If, however, the corporation purchases and retires any of such bonds at a price less than the issuing price minus any amount of premium already returned as income, the excess of the issuing price minus any amount of premium already returned as income (or of the face value plus any amount of premium not yet returned as income) over the purchase price is gain or income for the taxable year.

(3) (a) If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and should be prorated or amortized over the life of the bonds. (b) If thereafter the corporation purchases and retires any of such bonds at a price in excess of the issuing price plus any amount of discount already deducted, the excess of the purchase price over the issuing price plus any amount of discount already deducted (or over the face value minus any amount of discount not yet deducted), is a deductible expense for the taxable year. (c) If, however, the corporation purchases and retires any of such bonds at a price less than the issuing price plus any amount of discount already deducted, the excess of the issuing price plus any amount of discount already deducted (or of the face value minus any amount of discount not yet deducted) over the purchase price is gain or income for the taxable year.

SECTION 58. Income of corporation from leased property. — Where a corporation has leased its property in consideration that the lessee shall pay in lieu of other rental an amount equivalent to a certain rate of dividend on the lessor's capital stock or the interest on the lessor's outstanding indebtedness, together with taxes, insurance or other fixed charges, such payments shall be considered rental payments and shall be returned by the lessor corporation as income, notwithstanding the fact that the dividends and interest are paid by the lessee directly to the shareholders and bondholders of the lessor. The fact that a corporation has conveyed or let its property and has parted with its management and control, or has ceased to engage in the business for which it was originally organized, will not relieve it from liability to the tax. While the payments made by the lessee directly to the bondholders or shareholders of the lessor are rentals as to both the lessee and lessor (rentals paid in one case and rentals received in the other), to the bondholders and the shareholders, such amounts are interest and dividend payments received as from the lessor and as such shall be accounted for in their returns.

SECTION 59. Gross income of a corporation in liquidation. — When a corporation is dissolved, its affairs are usually wound up by a receiver or trustee in dissolution. The corporate existence is continued for the purpose of liquidating the assets and paying the debts, and such receiver or trustee stands in the stead of the corporation for such purposes. Any sales of property by them are to be treated as if made by the corporation for the purpose of ascertaining the gain or loss.

SECTION 60. Gross income of foreign corporations. — The gross income of a foreign corporation subject to tax consists of its gross income from sources within the Philippines. Gross income from sources within the Philippines, as applied to foreign corporations, shall include interest received on bonds, notes, or other interest-bearing obligations issued by residents, corporate or otherwise, as well as income derived from dividends on the capital stock or from the net earnings of domestic or resident foreign corporations, joint stock companies, associations, or insurance companies, dividends from other foreign corporations to the extent provided in Section 37 of the Code, and likewise income from rentals and royalties from all sources within the Philippines.

2. EXCLUSIONS FROM GROSS INCOME


SECTION 61. Exclusions from gross income. — The term "gross income" as used in the Act does not include those items of income exempted by statute or by fundamental law. Such tax-free income should not be included in the income tax return unless information regarding it is specifically called for. The exclusion of such income should not be confused with the reduction of gross income by the application of allowable deductions.

SECTION 62. Proceeds of insurance. — The proceeds of life-insurance policies, paid by reason of the death of an insured to his estate or to any beneficiary (individual, partnership, or corporation, but not a transferee for a valuable consideration), directly or in trust, are excluded from the gross income of the beneficiary. It is immaterial whether the proceeds are received in a single sum or in installments. If, however, such proceeds are held by the insurer under an agreement to pay interest thereon, the interest payments must be included in gross income. 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 contract are excluded from gross income but, if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration 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 a 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.

SECTION 63. Amounts received as compensation for injuries or sickness. — The amounts received by an insured or his estate or beneficiaries through accident or health insurance or under workmen's compensation acts as compensation for personal injuries or sickness are excluded from the gross income of the insured, his estate, and other beneficiaries. Any damages recovered by suit or agreement on account of such injuries or sickness are similarly excluded from the gross income of the individual injured or sick, if living, or of his estate or other beneficiaries entitled to receive such damages, if dead.

SECTION 64. Gifts and bequests. — Property received as a gift or received under a will or testament or through legal succession, is exempt from the income tax, although the income therefrom or income derived from its investment, sale, or otherwise is not. An amount of principal paid under a marriage settlement is a gift. Neither alimony nor an allowance based on a separation agreement is taxable income.

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

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

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

3. EXCLUSION OF 13TH MONTH PAY


SECTION 2. Definition of Terms. — For purposes of these Regulations, the following definitions of words and phrases are hereby adopted:

e) "Other benefits" — refer to all benefits other than the 13th month pay, such as, the annual Christmas bonus given by private offices, 14th month pay, mid-year productivity incentive bonus, gifts in cash or in kind and other similar benefits received by an official or employee for one calendar year in an amount not exceeding Twelve Thousand Pesos (P12,000.00) as maximum limit.

f) "Taxable compensation income" — means gross compensation income less personal and additional exemptions provided for under Sec. 29 (l) of the NIRC, as amended.

g) "13th month pay" — refers to the mandatory one month basic salary of an official or employee of the National Government, Local Government Units, agencies and instrumentalities, including government-owned and -controlled corporations, and of private offices received after the 12th month pay.

h) "Total benefits" — refer to the sum of all the benefits received by an official or employee for one calendar year in accordance with the provisions of the "Act."

i) "Which shall be integrated in" — shall mean "which shall be added to".

SECTION 3. Benefits Exempted from Income Tax. — For purposes of determining the taxable compensation income, the following benefits shall be excluded from the gross compensation income, viz:

a) 13th month pay equivalent to the mandatory one (1) month basic salary of officials and employees of the Government (whether national or local), including

government-owned and -controlled corporations, and of private offices received after the 12th month pay beginning CY 1994; and

b) Other benefits, such as, Christmas bonus given by, private offices to their officials and employees, productivity incentives bonus, loyalty award, gifts in cash or in kind and other benefits of similar nature actually received by officials and employees of both Government and private offices in an amount not exceeding Twelve Thousand Pesos (12,000.00) for one (1) calendar year.

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

ILLUSTRATIONS:

CASE NO. 1.

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

13th month pay P30,000.00 Other benefits: Christmas bonus P15,000.00 14th month pay 30,000.00 Mid-year productivity bonus 10,000.00 55,000.00 ———— ———— TOTAL BENEFITS RECEIVED for CY 1994 P85,000.00 ======== In this illustration, Mr. "A" shall only be exempted on his 13th month pay of P30,000. His "other benefits" amounting to P55,000 are subject to the withholding tax on wages.

CASE NO. 2. DON’T THINK THIS STILL APPLIES!

On the other hand, Mr. "B", a government employee, received the following 13th month pay and other benefits, such as:

13th month pay/Christmas bonus P8,000.00 Other benefits: Productivity incentives bonus P12,000.00 Cash gift 1,000.00 13,000.00 ———— ———— TOTAL BENEFITS RECEIVED for CY 1994 P21,000.00 ========

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

SECTION 6. Concurrent Multiple Employments. — An employee is employed by two or more employers at the same time during the taxable year shall be refunded/credited the taxes withheld on his 13th month pay and "other benefits" by his main employer, e.g., the employer paying the highest wage/salary. The said main employer shall determine the maximum allowable 13th month pay and "other benefits" received from both main and secondary employer/s in annualizing the taxable compensation income at year-end adjustment. For this purpose, the secondary employer/s shall furnish the main employer a certification as to the amount of the 13th month pay and other benefits received by the employee.

INVENTORS AND INVENTION INCENTIVES ACT OF THE PHILIPPINES – RA. 7459

SECTION 2. Declaration of National Policy and Program. — It is hereby declared to be the national policy to give priority to invention and its utilization on the country's productive systems and national life; and to this end provide incentives to inventors and protect their exclusive right to their invention, particularly when the invention is beneficial to the people and contributes to national development and progress.

Pursuant to the national policy, the Government shall provide a program to set up a climate conducive to invention and innovation, give encouragement and support to inventors who are creative and resourceful, as well as the imbued with a deep sense of nationalism, and maximize the capability and productivity and inventors through incentives and other forms of assistance and support.

SECTION 3. Definition of Terms. —

a) Invention refers to, for purpose of this Act, any patented machine, product, process including implements or tools and other related gadgets of invention, utility model and industrial design patents.

b) Inventor refers to the patentee/s, heir/s, assignment/s, of an Invention letters patent, Utility Model letters or Industrial Design letters patent.

c) Technology means the application of knowledge or science which shall include all others such as inventions, innovations and results of researches.

d) Department refers to the Department of Science and Technology.

e) Institute refers to the Technology Application and Promotion Institute.

f) Patent Office refers to the Bureau of Patent, Trademark and Technology Transfer.

g) RDI's refer to the Research and Development Institute of the Department of Science and Technology.

ARTICLE III Tax Incentives and Tax Exemptions

SECTION 5. Tax Incentives. — Inventors, as certified by the Filipino Inventors Society and duly confirmed by the Screening Committee, shall be exempt from payment of license fees, permit fees and other business taxes in the development of their particular inventions. This is an exception to the taxing power of the local government units. The certification shall state that the manufacture of the invention is made on a commercial scale.

Inventors shall exempt from paying any fees involved in their application for registration of their inventions.

SECTION 6. Tax Exemption. — To promote, encourage, develop and accelerate commercialization of technologies developed by local researchers or adapted locally from foreign sources including inventions, any income derived from these technologies shall be exempted from all kinds of taxes during the first ten (10) years from the date of the first sale, subject to the rules and regulations of the Department of Finance: Provided, that this tax exemption privilege pertaining to invention shall be extended to the legal heir or assignee upon the death of the inventor.

The technologies, their manufacture or sale, shall also be exempt from payment of license, permit fees, customs duties and charges on imports.

4. EXEMPTION OF MINIMUM WAGE EARNERS


(B) Exemptions from Withholding Tax on Compensation. — The following income payments are exempted from the requirements of withholding tax on compensation:

xxx xxx xxx

(13) Compensation income of MWEs who work in the private sector and being paid the Statutory Minimum Wage (SMW), as fixed by Regional Tripartite Wage and Productivity Board (RTWPB)/National Wages and Productivity Commission (NWPC), applicable to the place where he/she is assigned.

The aforesaid income shall likewise be exempted from income tax.

'Statutory Minimum Wage' (SMW) shall refer to the rate fixed by the Regional Tripartite Wage and Productivity Board (RTWPB), as defined by the Bureau of Labor and Employment Statistics (BLES) of the Department of Labor and Employment (DOLE). The RTWPB of each region shall determine the wage rates in the different regions based on established criteria and shall be the basis of exemption from income tax for this purpose.

Holiday pay, overtime pay, night shift differential pay and hazard pay earned by the aforementioned MWE shall likewise be covered by the above exemption. Provided, however, that an employee who receives/earns additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the allowable statutory amount of P30,000.00, taxable allowances and other taxable income other than the SMW, holiday pay, overtime pay, hazard pay and night shift differential pay shall not enjoy the privilege of being a MWE and, therefore, his/her entire earnings are not exempt form income tax, and consequently, from withholding tax.

MWEs receiving other income, such as income from the conduct of trade, business, or practice of profession, except income subject to final tax, in addition to compensation income are not exempted from income tax on their entire income earned during the taxable year. This rule, notwithstanding, the SMW, Holiday pay, overtime pay, night shift differential pay and hazard pay shall still be exempt from withholding tax.

For purposes of these regulations, hazard pay shall mean the amount paid by the employer to MWEs who were actually assigned to danger or strife-torn areas, disease-infested places, or in distressed or isolated stations and camps, which expose them to great danger of contagion or peril to life. Any hazard pay paid to MWEs which does not satisfy the above criteria is deemed subject to income tax and consequently, to withholding tax.

In case of hazardous employment, the employer shall attach to the monthly Remittance Return of Withholding Tax on Compensation (BIR Form No. 1601C) for return periods March, June, September and December a copy of the list submitted to the nearest DOLE Regional/Provincial Offices — Operations Division/Unit showing the names of MWEs who received the hazard pay, period of employment, amount of hazard pay per month; and justification for payment of hazard pay as certified by said DOLE/allied agency that the hazard pay is justifiable.

The NWPC shall officially submit a Matrix of Wage Order by region (Annex "A"), and any changes thereto, within ten (10) days after its effectivity to the Assistant Commissioner, Collection Service, for circularization in the BIR.

Any reduction or diminution of wages for purposes of exemption from income tax shall constitute misrepresentation and therefore, shall result to the automatic disallowance of expense, i.e. compensation and benefits account, on the part of the employer. The offenders may be criminally prosecuted under existing laws.

(14) Compensation income of employees in the public sector with compensation income of not more than the SMW in the non-agricultural sector, as fixed by RTWPB/NWPC, applicable to the place where he/she is assigned.

The aforesaid income shall likewise be exempted from income tax.

The basic salary of MWEs in the public sector shall be equated to the SMW in the non-agricultural sector applicable to the place where he/she is assigned. The determination of the SMW in the public sector shall likewise adopt the same procedures and consideration as those of the private sector.

Holiday pay, overtime pay, night shift differential pay and hazard pay earned by the aforementioned MWE in the public sector shall likewise be covered by the above exemption. Provided, however, that a public sector employee who receives additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the allowable statutory amount of P30,000.00, taxable allowances and other taxable income other than the SMW, holiday pay, overtime pay, night shift differential pay and hazard pay shall not enjoy the privilege of being a MWE and, therefore, his/her entire earnings are not exempt from income tax and, consequently, from withholding tax.

MWEs receiving other income, such as income from the conduct of trade, business, or practice of profession, except income subject to final tax, in addition to compensation income are not exempted from income tax on their entire income earned during the taxable year. This rule, notwithstanding, the SMW, Holiday pay, overtime pay, night shift differential pay and hazard pay shall still be exempt from withholding tax.

For purposes of these regulations, hazard pay shall mean the amount paid by the employer to MWEs who were actually assigned to danger or strife-torn areas, disease-infested places, or in distressed or isolated stations and camps, which expose them to great danger of contagion or peril to life. Any hazard pay paid to MWEs which does not satisfy the above criteria is deemed subject to income tax and consequently to withholding tax.

In case of hazardous employment, the employer shall attach to the Monthly Remittance Return of Withholding Tax on Compensation (BIR Form No. 1601C) for return periods March, June, September and December a copy of Department of Budget and Management (DBM) circular/s, or equivalent, as to who are allowed to receive hazard pay.

SECTION 2. Section 2.78.5 shall be inserted to RR 2-98, as amended, to read as follows:

"Sec. 2.78.5. Computation of Wages.

The basis of the computation of the minimum wage rates prescribed by law shall be the normal working time of eight (8) hours a day.

The computation of wages shall be in accordance with the Collective Bargaining Agreement (CBA), if any, or the provisions of the Labor Code as implemented. Unless otherwise amended or repealed by subsequent pertinent laws, rules and regulations, the holiday pay, overtime pay, night shift differential and hazard pay shall be understood to be computed based on such agreement or labor law provisions.

In the determination of the minimum wage on a monthly basis, the withholding agent shall be guided by the prevailing minimum wage as reflected in the latest Matrix of Wage Order and its own policy on whether employees are (a) not considered paid on Saturdays and Sundays or rest days, (b) not considered paid on Sundays or rest days, (c) considered paid on rest days, special days and regular holidays, or (d) required to work everyday including Sundays or rest days, special days and regular holidays. The resulting number of days in the above enumerated categories are referred to as the factor or number of working/paid days in a year. (Annex "B")

On the first classification, the monthly SMW is computed by multiplying the applicable daily wage rate by the factor of 261 days and divide the same by twelve; the semi-monthly

at one-half (1/2) of the monthly rate and the weekly SMW is arrived at by spreading the annual minimum basic wage over fifty-two (52) weeks. Thus, on a P382.00 minimum daily wage in Metro Manila, the monthly SMW is P8,308.00, the semi-monthly at P4,154.00 and weekly P1,917.00.

On the second category, the monthly SMW is computed by multiplying the applicable daily wage rate by the factor of 313 days and divide the product by twelve. Hence, on a P382.00 minimum daily wage, the monthly SMW is P9,964.00, the semi-monthly at P4,982.00 and weekly at P2,300.00.

On the third classification, the monthly SMW is computed by multiplying the applicable daily wage rate by the factor of 365 days, divided by twelve. Thus, on a 382 minimum daily wage, the monthly SMW is P11,619.00, the semi-monthly at P5,810.00 and weekly at P2,681.00.

On the fourth classification, the monthly SMW is computed by multiplying the applicable daily wage rate by the factor of 392.5 days, divided by twelve. Hence, on a 382 minimum daily wage, the monthly SMW is P12,495.00, the semi-monthly at P6,247.00 and weekly at P2,883.00."

SECTION 3. Section 2.79 of RR 2-98, as amended, is hereby further amended to read as follows:

"Sec. 2.79. Income Tax Collected at Source on Compensation Income. —

(A) Requirement of Withholding. — Every employer must withhold from compensation paid an amount computed in accordance with these Regulations. Provided, that no withholding of tax shall be required on the SMW, including holiday pay, overtime pay, night shift differential and hazard pay of MWEs in the private/public sectors as defined in these Regulations. Provided, further, that an employee who receives additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the allowable statutory amount of P30,000.00, taxable allowances and other taxable income other than the SMW, holiday pay, overtime pay, hazard pay and night shift differential pay shall not enjoy the privilege of being a MWE and, therefore, his/her entire earnings are not exempt from income tax and, consequently, shall be subject to withholding tax.

(B) Computation of Withholding Tax on Compensation Income in General. — The procedures provided herein below shall govern the computation of withholding tax on the taxable compensation income of the employees. Provided, however, that taxable fringe benefits received by employees other than the rank and file, as defined in the Labor Code of the Philippines, as amended, shall be subject to a Fringe Benefits Tax, instead of the rates prescribed in the Revised Withholding Tax Tables pursuant to Sec. 24 (A) of the Code, as amended.

I. COMPENSATION FOR PERSONAL SERVICES IN KIND

HENDERSON V. COLLECTOR, 1 SCRA 649

Facts: Arthur Henderson is the President of the American Intl. Underwriters for the Phils. w/c represents a group of American cos. engaged in the business of general insurance (exc. in life insurance). he receives a basic annual salary of P30,000 and allowance for house rentals and utilities. Although he and his wife are childless and are only two in the family, they lived in a large apartment provided for by his employer. As company president, he and his wife had to entertain and put up houseguests for the company. The BIR now seeks to collect taxes on the allowances for rental and utilities expenses.

Held: The exigencies of Henderson's high executive position, not to mention social standing, demanded and compelled them to live in a more spacious and pretentious quarters like the ones they had occupied. Because they had to entertain and put up houseguests, the employer had to grant him allowances for

rental and utilities in addition to his annual basic salary to take care of those expenses for rental and utilities in excess of their personal needs. Hence, the fact that the taxpayers had to live or did not have to live in the apartment chosen by the employer is of no moment, for no part of the allowance redounded to the benefit of the Hendersons. Neither was there an amount retained by them. Their bills for rental were paid directly by the employer to the creditor.


(A) Compensation Income Defined. — In general, the term "compensation" means all remuneration for services performed by an employee for his employer under an employer-employee relationship, unless specifically excluded by the Code.

The name by which the remuneration for services is designated is immaterial. Thus, salaries, wages, emoluments and honoraria, allowances, commissions (e.g. transportation, representation, entertainment and the like); fees including director's fees, if the director is, at the same time, an employee of the employer/corporation; taxable bonuses and fringe benefits except those which are subject to the fringe benefits tax under Sec. 33 of the Code; taxable pensions and retirement pay; and other income of a similar nature constitute compensation income.

The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes compensation. Thus, it may be paid on the basis of piece-work, or a percentage of profits; and may be paid hourly, daily, weekly, monthly or annually.

Remuneration for services constitutes compensation even if the relationship of employer and employee does not exist any longer at the time when payment is made between the person in whose employ the services had been performed and the individual who performed them.

(1) Compensation paid in kind. — Compensation may be paid in money or in some medium other than money, as for example, stocks, bonds or other forms of property. If services are paid for in a medium other than money, the fair market value of the thing taken in payment is the amount to be included as compensation subject to withholding. 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 fair market value of the remuneration received. If a corporation transfers to its employees its own stock as remuneration for services rendered by the employee, the amount of such remuneration is the fair market value of the stock at the time the services were rendered.

(2) Living quarters or meals. — If a person receives a salary as remuneration for services rendered, and in addition thereto, living quarters or meals are provided, the value to such person of the quarters and meals so furnished shall be added to the remuneration paid for the purpose of determining the amount of compensation subject to withholding. However, if living quarters or meals are furnished to an employee for the convenience of the employer, the value thereof need not be included as part of compensation income.

(3) Facilities and privileges of a relatively small value. — Ordinarily, facilities and privileges (such as entertainment, medical services, or so called "courtesy" discounts on purchases), furnished or offered by an employer to his employees generally, are not considered as compensation subject to withholding if such facilities or privileges are of relatively small value and are offered or furnished by the employer merely as a means of promoting the health, goodwill, contentment, or efficiency of his employees.

Where compensation is paid in property other than money, the employer shall make necessary arrangements to ensure that the amount of the tax required to be withheld is available for payment to the Commissioner.

(4) Tips and gratuities. — Tips or gratuities paid directly to an employee by a customer of the employer which are not accounted for by the employee to the employer are considered as taxable income but not subject to withholding.

(5) Pensions, retirement and separation pay. — Pensions, retirement and separation pay constitute compensation subject to withholding, except those provided under Subsection B of this section.



(b) 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, if the following conditions are satisfied:


(ii) The employee is required to account/liquidate for the foregoing expenses in accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of actual expenses over advances made shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/ advances for travelling and entertainment expenses which are pre-computed on a daily basis and are paid to an employee while he is on an assignment or duty need not be subject to the requirement of substantiation and to withholding.

(7) Vacation and sick leave allowances. — Amounts of "vacation allowances or sick leave credits" which are paid to an employee constitute compensation. Thus, the salary of an employee on vacation or on sick leave, which are paid notwithstanding his absence from work, constitutes compensation. However, the monetized value of unutilized vacation leave credits of ten (10) days or less which were paid to the employee during the year are not subject to income tax and to the withholding tax.

(8) Deductions made by employer from compensation of employee. — 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.

(9) Remuneration for services as employee of a nonresident alien individual or foreign entity. — The term "compensation" includes remuneration for services performed by an employee of a nonresident alien individual, foreign partnership or foreign corporation, whether or not such alien individual or foreign entity is engaged in trade or business within the Philippines. Any person paying compensation on behalf of a non-resident alien individual, foreign partnership, or foreign corporation which is not engaged in trade or business within the Philippines is subject to all provisions of law and regulations applicable to an employer.

(10) Compensation for services performed outside the Philippines. — Remuneration for services performed outside the Philippines by a resident citizen for a domestic or a resident foreign corporation or partnership, or for a non-resident corporation or partnership, or for a non-resident individual not engaged in trade or business in the Philippines shall be treated as compensation which is subject to tax.

A non-resident citizen as defined in these regulations is taxable only on income derived from sources within the Philippines. In general, the situs of the income whether within or without the Philippines, is determined by the place where the service is rendered.

H. IMPUTED INTEREST INCOME ON INTER-COMPANY LOANS

REVENUE MEMORANDUM ORDER NO. 63-99

SUBJECT : Determination of Taxable Income on Inter-company Loans or Advances applying Section 50 of the NIRC, as Amended

1.1 To adopt the arm's length bargaining standard as the ultimate test for determining the correct gross income and deductions between two or more enterprises under common control.

1.2 To provide a means of redistributing or reapportioning income and expenses of taxpayers under common control after applying Section 50 of the NIRC, as amended.

2. Coverage:

This paper applies to all forms of bona fide indebtedness and includes:

2.1 Loans or advances of money or other consideration (whether or not evidence by a written instrument);

2.2 Indebtedness arising in the ordinary course of business out of sales, leases, or the rendition of services by or between members of the group, or any other similar extension;

2.3 But does not apply to alleged indebtedness which was in fact a contribution of capital or a distribution by a corporation with respect to its shares.

3. Applying Arm's Length on Section 50 of the NIRC, as amended

3.1 Section 50. Allocation of income and deductions. — In any case of two or more organizations, trades, or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner of Internal Revenue is authorized to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades or businesses.

3.2 Section 50 empowers the Commissioner to rectify abnormalities and distortions in income brought about by common control through the adoption of standards considered fair, reasonable or at arm's length.

3.3 This Order adopts the arm's length bargaining standard as the ultimate test for determining the fairness of related party transactions - i.e., "the standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer".

4. Determination of Taxable Income on Inter-company Loans or Advances

4.1 In general. Where one member of a group of controlled entities makes a loan or advances directly or indirectly, or otherwise becomes a creditor of another member of such group, and charges no interest, or charges interest at a rate which is not equal to an arm's-length rate as defined in subparagraph (2) of this paragraph, the Commissioner may make appropriate allocations to reflect an arm's length interest rate for the use of such loan or advance.

4.1.1 If payments are made to parties under common control according to a legally enforceable contract, the contract may still be recognized as valid. However, for purposes of determining the true taxable income of the parties involved, the interest rate charged may be subjected to reallocation.

4.1.2 Section 50 does not apply only to taxable entities. Reallocation may also apply to tax-exempt organizations.

4.2 Arm's Length interest rate.

4.2.1 In general. For purposes of this Order, the arm's length interest rate shall be the rate of interest which was charged or would have been charged at the time the indebtedness arose in independent transaction with or between unrelated parties under similar circumstances. All relevant factors will be considered, including the amount and duration of the loan, the security involved, the credit standing of the borrower, and the interest rate prevailing at the situs of the lender or creditor for comparable loans.

4.2.2 For purposes of determining the arm's length rate in domestic transactions, the interest rate to be used is the Bank Reference Rate (BRR) prescribed by the Bangko Sentral ng Pilipinas (BSP).

4.2.3 The fact that the interest rate actually charged on a loan or advance is expressly indicated on a written instrument does not preclude the application of Section 50 to such loan or advance.

5. Interest Period

5.1 The interest period shall commence at the date the indebtedness arises, except that with respect to indebtedness arising in the ordinary course of business out of sales, leases, or supply of goods and services which are generally considered as trade accounts receivables or payables, the interest period shall not commence if the taxpayer is able to establish that the normal trade practice in a given industry is to allow balances, in the case of similar transactions with unrelated parties, to remain outstanding for a longer period without charging interest.

5.2 For purposes of determining the period of time for which a balance is outstanding, payments or credits shall be applied against the earliest balance outstanding. The taxpayer may, in accordance with an agreement, apply such payments or credits in some other order in its books only after establishing that the arrangement is customary for parties in that particular business.

I. INCOME UNDER LEASE AGREEMENTS


SECTION 49. Improvements by lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases;

(a) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.

(b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.

If for any other reason than a bona fide purchase from the lessee by the lessor the lease is terminated, so that the lessor comes into possession or control of the property prior to the time originally fixed for the termination of the lease, the lessor receives additional

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

J. DIVIDEND INCOME


Section 250. Dividends. – Dividends, for the purpose of the law, comprise any distribution whether in cash or other property, in the ordinary course of business, even though extraordinary in amount made by a domestic or resident foreign corporation, joint-stock company, partnership, joint account, association, or insurance company to the shareholders or members out of its earnings or profits accumulated since March 1, 1913.

Although interest on certain Government bonds and other similar obligations is not taxable when received by a corporation, upon amalgamation with the other funds of the corporation, such income loses its identity and when distributed to shareholders, is taxable, the same extent as other dividends.

A taxable distribution made by a corporation to individual stockholders or members shall be included in the gross income of the distributees when the cash or other property is unqualifiedly made subject to their demand. Dividends, in cash or other property received by an individual, are subject to tax in his hands in the same manner as other income.

Dividends, whether in cash or other property received by a domestic or resident foreign corporation from a domestic corporation are taxable only to the extent of 25 per cent thereof in accordance with Section 24 of the Code. Dividends received by a domestic corporation from a foreign corporation, whether resident or nonresident, are taxable to the extent that they constitute income from sources within the Philippines, as provided in section 37 (a) (2) (b) of the Code. Dividends paid by the domestic corporation to a nonresident foreign corporation are taxable in full.

Section 251. Dividends paid in property. - Dividends paid in securities or other property (other than its own stock), in which the earnings of a corporation have been invested, are income to the recipients to the amount of the all market value of such property when receivable by individual stockholders. When receivable by corporations, the amount of such dividends includible for purposes of the tax on corporations are specified in section 24 of the Code. (See also section 250 of these regulations). A dividend paid in stock of another corporation is not a stock dividend. even though the stock distributed was acquired through the transfer by the corporation declaring the dividends of property to the corporation the stock of which is distributed as a dividend. Where a corporation declares a dividend payable in a stock of another corporation, setting aside the stock to be so distributed and notifying the stockholders of its action, the income arising to the recipient of such stock is its market value at the time the dividend becomes payable. Scrip dividends are subject to tax in the year in which the warrants are issued.

Section 252. Stock dividends. - A stock dividend which represents the transfer of surplus to capital account is not subject to income tax. However, a dividend in stock may constitute taxable income to the recipient thereof notwithstanding the fact that the officers or director of the corporation (as defined in section 84) choose to call such distribution as a stock dividend. The distinction between a stock dividend which does not, and one which does, constitute income taxable to the shareholder is the distinction between a stock

dividend which works no change in the corporate entity, the same interest In the same corporation being represented after the distribution by more shares of precisely the same character and a stock dividend where there either has been a Change of corporate identity or a change in the nature of the shares issued as dividends whereby the proportional interest of the shareholders after the distribution is essentially different from his former interest. A stock dividend constitutes income if it gives the shareholder an interest different from that which his former stock holdings represented. A stock dividend does not constitute income if the new shares confer no different rights or interest than did the old - the new certificates plus the old representing the same proportionate interest in the net asset of the corporation as did the old.

Section 253. Sale of stock received as dividends. - Stock issued by a corporation, as a dividend, does not constitute taxable income to a stockholder in such corporation, but gain may be derived or loss sustained by the stockholder, whether individual or corporate, from the sale of such stock, which gain or loss will be treated as arising from the sale or exchange of a capital asset. (See section 34 of the Code.) The amount of gain derived or loss sustained from the sale of such stock, or from the sale of the stock with respect to which it is issued, shall be determined in accordance with the following rules:

(a) Where the stock issued as dividend is as or substantially the same character or preference as the stock upon which the stock dividend is paid, the cost of each share (or when acquired prior to March, 1, 1913, the fair market value as of such date) will be the quotient of the cost (or such fair market value) of the old shares of stock divided by the total number of the old and new shares.

(b) Where the stock issued as a dividend is in whole or in part of a character or preference materially different from the stock upon which the stock dividend is paid, the cost (and when acquired prior to March 1,1913, the fair market value as of such date) of the old shares of stock shall be divided between such old stock and the new stock, in proportion, as nearly as may be, to the respective value of each class of stock old and new at the time the new shares of stock are issued, and the cost (or when acquired prior to March 1, 1913, the fair market value as of such date) of each share of stock will be the quotient of the cost (or such fair market value as of March 1, 1913) of the class to which such share belongs divided by the number of shares in that class.

(c) Where the stock with respect to which a stock dividend is issued was purchased at different times and at different prices and the identity of the lots cannot be determined, any sale of the original stock, will be charged to the earliest purchases, of such stock, and any sale of dividend stock issued with respect to such stock will be presumed to have been made from the stock issued with respect to the earliest purchased stock, to the amount of the dividend chargeable to such stock.

(d) Where the stock with respect to which a stock dividend is declared was purchased at different times and at different prices, and the dividend stock issued with respect to such stock cannot be identified as having been issued with respect to any particular lot of such stock, then any sale of such dividend stock will be presumed to have been made from the stock issued with respect to the earliest purchased stock, to the amount of the stock dividend chargeable to such stock.

Section 254. Declaration and subsequent redemption of a stock dividend. - A true stock dividend is not subject to tax on its receipt in the hands of the recipient. Nevertheless, if a corporation, after the distribution of a stock dividend, proceeds to cancel or redeem its stock at such time and in such manner as to make the distribution and cancellation or redemption essentially equivalent to the distribution of a taxable dividend, the amount received in redemption or cancellation of the stock shall be treated as a taxable dividend to the extent of the earnings or profits accumulated by such corporation since March 1, 1913

Section 255. Sources of distribution. – For the purpose of income taxation every distribution made by a corporation is made out of earnings or profits to the extent thereof and from the most recently accumulated earnings or profits. In determining the source of a distribution, consideration should be given first, to the earnings or profits of the taxable

year; second, to the earnings or profits, accumulated since February 28, 1913, only in the case where, and to the extent that, the distribution made during the taxable year are not regarded as out of the earnings or profits of the taxable year and all the earnings or profits accumulated since February 28, 1913, have been distributed; and, fourth, to sources other than earnings or profits only after the earnings or profits have been distributed.

Section 256. Distribution in liquidation. - In all case's where a corporation (as defined in section 84) distributes all of its property or assets in complete liquidation or dissolution, the gain realized from the transaction by the stockholder, whether individual or corporate, is taxable to the extent recognized in section 34 (b) of the Code. For this purpose, the term “complete liquidation” includes anyone of a series of distributions made by a corporation in complete cancellation or redemption of an of its stocks in accordance with a bona fide plan of liquidation under which the transfer of all the assets under liquidation is to be completed within a reasonable time from the date of the first distribution, usually not to exceed one year from the time of such first distribution. If the amount received by the stockholder in liquidation is less than the cost or other basis of the stock, the loss in the transaction is deductible to the extent allowed in section 34(c) of the Code.

BIR Ruling No. 108-93

Facts: SEA COMMERCIAL COMPANY, INC. (SEACOM), is a domestic corporation with an authorized capital stock of Thirty Million Pesos (P30,000,000.00), divided into Thirty Thousand (30,000) Preferred shares of stock and Two Hundred Seventy Thousand (270,000) Common shares of stock, all with a par value of One Hundred Pesos (P100.00) per share, of which One Hundred Fifty Five Thousand Three Hundred Two (150,302) Common shares of stock are issued and outstanding as of 31 December 1991; and that as of 31 December 1991, it had a total stockholder's equity in the amount of Thirty Four Million Seven Hundred Nine Thousand Five Hundred Five Pesos (P34,709,505.00), which include unrestricted retained earnings in the amount of Nineteen Million Four Hundred Sixty Nine Thousand Four Hundred Forty One Pesos (P19,469,441.00); that on 15 June 1992, the Corporation declared all of its unrestricted retained earnings as of 31 December 1991 as dividends in favor of stockholders of record as of 15 June 1992, payable on or before 15 April 1993, that said dividends shall be distributed in the form of cash in the amount of Seven Million Five Hundred Twenty Thousand Three and 08/100 Pesos (P7,520,003.08), and the following properties with a total book value of Eleven Million Nine Hundred Forty Nine Thousand Four Hundred Thirty Seven and 92/100 Pesos (P11,949,437.92). The aforementioned real and personal properties are capital assets of the Corporation, which are not used and not intended to be used by the Corporation in its ordinary course of business; that the properties declared as dividends were recorded in the books of the Corporation at their book values; that the total book value of the property dividends is equivalent only to Twenty-Five and 80/100 percent (25.8%) of SEACOM'S assets for the year ended 31 December 1991; and that the Corporation continues to do business and its stockholders have no intention of liquidating the corporation after the declaration of property dividends.

Ruling: The property dividend shall be recorded at the book value in the books of both the issuing corporation and the recipient stockholder. The BIR Ruling No. 21(c)(2)-028-89-130-89 applying Sections 250 and 251 of Revenue Regulations No. 2 stating that dividends paid in securities or other property (other than its own stock) in which the earnings of a corporation have been invested are income to the recipient to the amount of the full market value of such property when receivable by individual stockholders has already been modified having been rendered obsolete by Executive Order No. 37 (effective August 1, 1986) subjecting to income tax at 0% effective January 1, 1989, dividends received from a domestic corporation and the share of an individual partner in a partnership subject to tax under Section 24(a) of the Tax Code (BIR Ruling No. 276-91 December 26, 1991)

The proposed property dividend which shall be received by the stockholders of SEACOM shall be subject to a final withholding tax of zero (0%) percent, and the receiving stockholders shall not be subject to any income or capital gains tax arising from their receipt of these properties as property dividend. (Section 21(c)(2) of the Tax Code, as amended by Executive Order No. 37). However, certificates authorizing transfer of real estate properties without payment of the capital gains tax shall be secured from the

Revenue District Officer of the Revenue District where the property is located before said properties are transferred in the name of the recipient stockholders (BIR Ruling No. 028-89 dated February 22, 1989). Similarly, certificates authorizing transfer of shares of stock without payment of the capital gains tax shall be secured from the Revenue District Officer of the Revenue District where the principal place of office of the corporation declaring the dividends is located. It shall be the ministerial duty of the Revenue District Officer to issue said certificates.

SEACOM shall not be subject to any income or capital gains tax on the difference between the fair market value and the book value of the real estate properties declared and distributed as property dividends. This is because there is no realized gain considering the fact that the value used at the time of distribution is the book value.

Upon subsequent sale or other disposition of the property received as dividends by the stockholders, the basis of such shall also be its book value at the time of the dividend distribution.

COMM. V. MANNING, 66 SCRA 14

Under a trust agreement, Julius Reese who owned 24,700 shares of the 25,000 common shares of MANTRASCO, and the three private respondents who owned the rest, at 100 shares each, deposited all their shares with the Trustees. The trust agreement provided that upon Reese's death MANTRASCO shall purchase Reese's shares. The trust agreement was executed in view of Reese's desire that upon his death the Company would continue under the management of respondents. Upon Reese's death and partial payment by the company of Reeses's share, a new certificate was issued in the name of MANTRASCO, and the certificate indorsed to the Trustees. Subsequently, the stockholders reverted the 24,700 shares in the Treasury to the capital account of the company as stock dividends to be distributed to the stockholders. When the entire purchase price of Reese's interest in the company was paid in full by the latter, the trust agreement was terminated, and the shares held in trust were delivered to the company.

The Bureau of Internal Revenue concluded that the distribution of the 24,700 shares of Reese as stock dividends was in effect a distribution of the "assets or property of the corporation." It therefore assessed respondents for deficiency income taxes as well as for fraud penalty and interest charges.

On a petition for review, the Supreme Court held that the newly acquired shares were not treasury shares; their declaration as treasury stock dividends was a complete nullity and that the assessment by the Commissioner of fraud penalty and the imposition of interest charges pursuant to the provision of the Tax Code were made in accordance with law.

Where by the use of a trust instrument as a convenient technical device, respondents bestowed unto themselves the full worth and value of a deceased stockholder's corporate holding acquired with the very earnings of the companies, such package device which obviously is not designed to carry out the usual stock dividend purpose of corporate expansion reinvestment, e.g., the acquisition of additional facilities and other capital budget items, but exclusively for expanding the capital base of the surviving stockholders in the company, cannot be allowed to deflect the latter's responsibilities toward our income tax laws. The conclusion is ineluctable that whenever the company parted with a portion of its earnings "to buy" the corporate holdings of the deceased stockholders, it was in ultimate effect and result making a distribution of such earnings to the surviving stockholders. All these amounts are consequently subject to income tax as being, in truth and in fact, a flow of cash benefits to the surviving stockholders.

Where the surviving stockholders, by resolution, partitioned among themselves, as treasury stock dividends, the deceased stockholder's interest, and earnings of the corporation over a period of years were used to gradually wipe out the holdings therein of said deceased stockholder, the earnings (which in effect have been distributed to the surviving stockholders when they appropriated among themselves the deceased stockholder's interest), should be taxed for each of the corresponding years when payments were made to the deceased's estate on account of his shares. In other words, the Tax Commissioner may not asses the surviving stockholders, for income tax

purposes, the total acquisition cost of the alleged treasury stock dividends in one lump sum. However, with regard to payment made with the corporation's earnings before the passage of the resolution declaring as stock dividends the deceased stockholder's interest (while indeed those earnings were utilized in those years to gradually pay off the value of the deceased stockholder's holdings), the surviving stockholders should be liable (in the absence of evidence that prior to the passage of the stockholder's resolution the contributed of each of the surviving stockholder rose corresponding), for income tax purposes, to the extent of the aggregate amount paid by the corporation (prior to such resolution) to buy off the deceased stockholder's shares. The reason is that it was only by virtue of the authority contained in said resolution that the surviving stockholders actually, albeit illegally, appropriated and petitioned among themselves the stockholders equity representing the deceased stockholder's interest.

FISHER V. TRINIDAD, 43 PHIL 973

Are the "stock dividends" in the present case "income" and taxable?

A dividend is defined as a corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time. Until the dividend is declared, the corporate profits belong to the corporation and not to the stockholders, and are liable for the payment of the debts of the corporation.

A stock dividend, when declared, is merely a certificate of stock which evidences the interest of the stockholder in the increased capital of the corporation. There is a clear distinction between a cash dividend and a stock dividend. The one is a disbursement to the stockholder of accumulated earnings, and the corporation parts irrevocably with all interest therein; the other involves no disbursement by the corporation; the corporation parts with nothing to its stockholder. When a cash dividend is declared and paid to stockholders, such cash becomes the absolute property of the stockholders and cannot be reached by the creditors of corporation in the absence of fraud. The property represented by a stock dividend, however, still being the property of corporation, and not of the stockholder, it may be reached by an execution against the corporation, and sold as a part of the property of the corporation. In such a case, if all of the property of the corporation is sold under execution, then the stockholders certainly could not be charged with having received an income by virtue of the issuance of the stock dividend. If the ownership of the property represented by a stock dividend is still in the corporation and not in the holder of such stock, certainly such stock cannot be regarded as income to the stockholder. The stockholder has received nothing but a representation of an interest in the property of the corporation and, as a matter of fact, he may never receive anything, depending upon the final outcome of the business of the corporation.

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 an income cannot be taxed.

J.4. LIQUIDATING DIVIDEND

BIR Ruling 322-87

Facts: The Company is a trading concern and at present is in the process of liquidation; and that individual stockholders will receive their liquidating dividends in excess of their investment.

Ruling: Since the individual stockholders of the Company will receive upon its complete liquidation all its assets as liquidating dividends, they will thereby realize capital gain or loss. The gain, if any, derived by the individual stockholders consisting of the difference between the fair market value of the liquidating dividends and the adjusted cost to the stockholders of their respective shareholdings in the said corporation (Sec. 83 (a), Sec. 256, Income Tax Regulations) shall be subject to income tax at the rates prescribed under Section 21(a) of the Tax Code, as amended by Executive Order No. 37.

WISE & CO. INC., V. MEER, GR. L-48231

A distribution does not necessarily become a dividend by reason of the fact that it is called a dividend by the distributing corporation. "The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its stockholders upon dissolution." The determining element therefore is whether the distribution was in the ordinary course of business and with intent to maintain the corporation as a going concern, or after deciding to quit with intent to liquidate the business. Proceedings actually begun to dissolve the corporation or formal action taken to liquidate it are but evidentiary and not indispensable.

"The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock it is an ordinary dividend. However, if the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as in complete or partial liquidation and as payment by the corporation to the stockholder for his stock. The corporation is, in the latter instances, wiping out all or Part of the stockholders' interest in the company . . ."

Gains resulting from distributions made in complete liquidation or dissolution of a corporation as specifically contemplated in section 25 (a) of the former Income Tax Law, are taxable as income, whether the stockholder happens to be an individual or a corporation. Section 25 (a) of the law, far from limiting the taxability, provides that the gain thus realized is a "taxable income" — under the law so long as a gain is realized, it will be a taxable income whether the distribution comes from the earnings or profits of the corporation or from the sale of all of its assets in general, so long as the distribution is made "in complete liquidation or dissolution."

K. INCOME FROM ANY SOURCE WHATEVER


SECTION 50. Forgiveness of indebtedness. — The cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If, for example, an individual performs services for a creditor, who, in consideration thereof cancels the debt, income to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend.

SECTION 102. Bad debts. — Where all the surrounding circumstances indicate that a debt is worthless, and the debt is charged off on the books of the taxpayer within the year, the same may be allowed as a deduction in computing net income. There should accompany the return a statement showing the propriety of any deduction claimed for bad debts. Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to demonstrate, with a reasonable degree of certainty, the uncollectibility of the debt. Any amount subsequently received on account of a bad debt previously charged off and allowed as a deduction for income tax purposes, must he included in gross income for the taxable year in which received. In determining whether a debt is worthless the Commissioner of Internal Revenue will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor.

REVENUE MEMORANDUM CIRCULAR NO. 13-80

Subject : Treatment of Tax Refunds and Tax Credits When Received.

1. Refunds/Tax Credits under Section 295 of the Tax Code. —

Taxes previously claimed and allowed as deductions, but subsequently refunded or granted as tax credit pursuant to Section 295 of the Tax Code, should be declared as part of the gross income of the taxpayer in the year of receipt of the refund or tax credit. However, the following taxes, when refunded or credited, are not declarable for income tax purposes inasmuch as they are not allowable as deductions:

a. Income tax imposed in Title III of the Tax Code;

b. Income, war-profit and excess profits taxes imposed by authority of a foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign countries);

c. Estate and gift taxes;

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

e. Stock transaction tax;

f. Energy tax; and

g. Taxes which are not allowable as deductions under the law.

2. Special Tax Credits granted under R.A. 5186; R.A. 6135 and P.D. 535. —

These tax credits and their tax consequences are as follows:

a. Sales, compensating and specific taxes are paid on supplies and raw materials imported by a registered export producer. Said taxes are given as tax credit to be used in the payment of taxes, duties, charges and fees due to the national government in connection with its operations. (Sec. 7(a), R.A. No. 6135)

The tax credits granted should form part of the gross income to the enterprise in the year of receipt of tax credit as said taxes paid are considered allowable deductions for income taxes purposes.

b. In some cases, a registered BOI and tourism enterprise assumes payment of taxes withheld and due from the foreign lender-remittee on interest payments on foreign loans. In such cases, the enterprise is given a tax credit for taxes withheld subject to certain conditions. (Sec. 7(f), R.A. No. 5186; Sec. 8(c), P.D. No. 535)

Said taxes assumed by the registered enterprise represent necessary and ordinary expenses incurred by the enterprise; hence, deductible from its gross income. Therefore, the tax credits granted necessarily constitute taxable income of the enterprise.

DAMAGE RECOVERY - compensatory damages, as constituting returns of capital, are not taxable. Thus, amounts received as moral damages for personal actions, such as alienation of affections, libel, slander or breach of promise to marry, are not taxable.

GUTIERREZ V. COLLECTOR, 101 PHIL 743 The compensation or income derived from the expropriation of property located in the Philippines is an income from sources within the Philippines and subject to the taxing jurisdiction of the place

A.1. OPTIONAL STANDARD DEDUCTION


SUBJECT : Implementing the Provisions of Section 34 (L) of the Tax Code of 1997, as Amended by Section 3 of Republic Act No. 9504, Dealing on the Optional Standard Deduction (OSD) Allowed to Individuals and Corporations in Computing Their Taxable Income

SECTION 2. Persons Covered. — The following may be allowed to claim OSD in lieu of the itemized deductions (i.e. items of ordinary and necessary expenses allowed under Sections 34 (A) to (J) and (M), Section 37, other special laws, if applicable):

1. Individuals:

i. Resident Citizen

ii. Non-resident citizen

iii. Resident Alien

iv. Taxable estates and trusts

2. Corporations:

i. Domestic corporation

ii. Resident foreign corporation

NOTE: NON-RESIDENT ALIENS [W/NOT ENGAGED IN TBP] AND FOREIGN CORPORATIONS ARE NOT ENTITLED TO OSD

SECTION 3. Determination of the Amount of Optional Standard Deduction for Individuals. — The OSD allowed to individual taxpayers shall be a maximum of forty percent (40%) of gross sales or gross receipts during the taxable year. If the individual is on the accrual basis of accounting for his income and deductions, the OSD shall be based on the gross sales during the taxable year. On the other hand, if the individual employs the cash basis of accounting for his income and deductions, the OSD shall be based on his gross receipts during the taxable year.

It should be emphasized that the "cost of sales" in case of individual seller of goods, or the "cost of services" in the case of individual seller of services, are not allowed to be deducted for purposes of determining the basis of the OSD pursuant to this Section inasmuch as the law (RA 9504) is specific as to the basis thereof which states that for individuals, the basis of the 40% OSD shall be the "gross sales" or "gross receipts" and not the "gross income".

For other individual taxpayers allowed by law to report their income and deductions under a different method of accounting (e.g. percentage of completion basis, etc.) other than cash and accrual method of accounting, the "gross sales" or "gross receipts" pursuant to this Section shall be determined in accordance with said acceptable method of accounting.

SECTION 4. Determination of the Amount of Optional Standard Deduction for Corporations. — In the case of corporate taxpayers subject to tax under Sections 27 (A) and 28 (A) (1) of the Code, as amended, the OSD allowed shall be in an amount not exceeding forty percent (40%) of their gross income.

For purposes of these Regulations, "Gross Income" shall mean the gross sales less sales returns, discounts and allowances and cost of goods sold. "Gross sales" shall include only sales contributory to income taxable under Sec. 27 (A) of the Code. "Cost of goods sold" shall include the purchase price or cost to produce the merchandise and all expenses directly incurred in bringing them to their present location and use.

For trading or merchandising concern, "cost of goods sold" means the invoice cost of goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit.

For manufacturing concern, "cost of goods sold" means all costs incurred in the production of the finished goods such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or warehouse. The term may be used interchangeably with "cost of goods manufactured and sold".

In the case of sellers of services, the term "gross income" means the "gross receipts" less sales returns, allowances, discounts and cost of services. "Cost of services" means all direct costs and expenses necessarily incurred to provide the services required by the customers and clients including (a) salaries and employee benefits of personnel, consultants and specialists directly rendering the service, and (b) cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used and cost of supplies: Provided, however, that "cost of services" shall not include interest expense except in the case of banks and other financial institutions. The term "gross receipts" as used herein means amounts actually or constructively received during the taxable year. However, for taxpayers engaged as sellers of services but employing the accrual basis of accounting for their income, the term "gross receipts" shall mean amounts earned as gross revenue during the taxable year.

The items of gross income under Section 32 (A) of the Code, as amended, which are required to be declared in the income tax return of the taxpayer for the taxable year are part of the gross income against which the OSD may be deducted in arriving at taxable income. Passive incomes which have been subjected to a final tax at source shall not form part of the gross income for purposes of computing the forty percent (40%) optional standard deduction.

For other taxpayers allowed by law to report their income and deductions under a different method of accounting (e.g. percentage of completion basis, etc.) other than cash and accrual method of accounting, the "gross income" pursuant to this Section shall be determined in accordance with said acceptable method of accounting.

SECTION 5. Illustrative Examples in Determining the Basis of the 40% OSD for Individuals and Corporations. — Suppose a retailer of goods, whose accounting method is under the accrual basis, has a gross sales of P1,000,000.00 with a cost of sales amounting to P800,000. The computation of the OSD for individuals and corporations shall be determined as follows:

If Individual If Corporation Gross Sales P1,000,000 P1,000,000 Less: Cost of Goods Sold 800,000 –––––––––– –––––––––– Basis of the OSD P1,000,000 P200,000 X OSD Rate (maximum) .40 .40

–––––––––– –––––––––– OSD Amount P400,000 P80,000

========= =========

If the taxpayer opts to use the OSD in lieu of the itemized deduction allowed under Section 34 of the Code, as amended, his/its net taxable income shall be as follows:

If Individual If Corporation Gross Sales P1,000,000 P1,000,000 Less: Cost of Sales - 800,000

–––––––––– –––––––––– Gross Sales/Gross Income P1,000,000 P200,000 Less: OSD (maximum) 400,000 80,000 –––––––––– –––––––––– Net Income P600,000 P120,000

========= ========= SECTION 6. Determination of the Optional Standard Deduction for General Professional Partnerships (GPPs) and Partners of GPPs. — Pursuant to Sec. 26 of the Code, a GPP is not subject to income tax imposed under Title II thereof. However, the partners shall be liable to pay income tax on their separate and individual capacities for their respective distributive share in the net income of the GPP.

Sec. 26 of the Code likewise provides that — "For purposes of computing the distributive share of the partners, the net income of the GPP shall be computed in the same manner as a corporation." As such, a GPP may claim either the itemized deductions allowed under Section 34 of the Code or in lieu thereof, it can opt to avail of the OSD allowed to corporations in claiming the deductions in an amount not exceeding forty percent (40%) of its gross income. The net income determined by either claiming the itemized deduction or OSD from the GPP's gross income is the distributable net income from which the share of each partner is to be determined. Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership.

The GPP is not a taxable entity for income tax purposes since it is only acting as a "pass-through" entity where its income is ultimately taxed to the partners comprising it. In computing taxable income defined under Section 31 of the Code, the individual partner can still claim either itemized deductions or optional standard deduction from his share in the net income of the GPP because said share is considered as gross income in the hands of the partner (Section 32 (A) (11) and Section 26, NIRC). If the GPP availed of the itemized deduction in computing its net income, the partners may still either claim itemized deduction or OSD from said share, provided, that, in claiming itemized deductions, the partner is precluded from claiming expenses already claimed by the GPP. In fine, if the GPP claimed itemized deductions and a partner is also claiming itemized deductions, the deductions allowed to the partner must be the ordinary and necessary expenses for the practice of profession which were not yet claimed by the GPP in computing its net income. The GPP and each of the partners are entitled to their own election of deductions to claim during the taxable year thereby resulting to four possibilities, namely: (1) the GPP may claim itemized deductions in computing net income and a partner may also claim itemized deductions in computing his taxable income; or (2) the GPP may claim OSD in computing net income while a partner may claim itemized deductions in computing his taxable income; or (3) the GPP may claim itemized deductions in computing net income while a partner may claim OSD in computing his taxable income; or (4) the GPP may claim OSD in computing net income and a partner may also claim OSD in computing his taxable income.

SECTION 7. Other Implications of the Optional Standard Deduction. — A taxpayer who elected to avail of the OSD not exceeding forty percent (40%) of gross sales or gross receipts, in case of an individual taxable under Secs. 24 (A) and 25 (A) (1) of the Tax Code, or forty percent (40%) of gross income, in case of a corporation subject to tax under Sec. 27 (A) or 28 (A) (1) of the same Code shall signify in his/its return such intention, otherwise he/it shall be considered as having availed himself of the itemized deductions allowed under Sec. 34 of the Code. Once the election to avail the OSD is signified in the return, it shall be irrevocable for the taxable year for which the return is made. This means that a taxpayer who initially filed a return availing OSD is precluded from amending said return in order to shift to the itemized deductions. An individual taxpayer who is entitled to and claimed the OSD shall not be required to submit with his tax return such financial statements otherwise required under the Code. Provided, that, except when the Commissioner otherwise permits, the said individual shall keep such records pertaining to his gross sales or gross receipts. In the case of a corporation, however, said corporation is still required to submit its financial statements when it files its annual income tax return and to keep such records pertaining to its gross income as herein defined.

In the filing of the quarterly income tax returns, the taxpayer may opt to use either the itemized deduction or OSD. However, in filing the final adjustment income tax return, the taxpayer must make a choice as to what method of deduction it or he shall employ for the purpose of determining its/his taxable net income for the entire year. The taxpayer is, thus, not allowed to use a hybrid method of claiming its/his deduction for one taxable year.

B. EXPENSES IN GENERAL


SECTION 65. Business expenses. — Business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business. The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales is computing gross income. Among the items included in business expenses are management expenses, commissions, labor, supplies, incidental repairs, operating expenses of transportation, equipment used in the trade or business, traveling expenses while away from home solely in the pursuit of a trade or business, advertising and other selling expenses, together with insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property. A taxpayer is entitled to deduct the necessary expenses paid in carrying on his business from his gross income from whatever source.

SECTION 73. Pensions, compensation for injuries. — Amounts paid for pensions to retired employees or to their families or others dependent upon them, or on account of injuries received by employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. When the amount of the salary of an officer or employee is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered by the individual, such payments may be deducted. Salaries paid by employers to employees who are absent in the military, naval or other service of the Government, but who intend to return at the conclusion of such service, are allowable deductions. (See Section 118 of these regulations, relative to pension trust.)

SECTION 76. When charges are deductible. — Each year's return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses, interests, taxes, or other charges, he can not deduct them from the income of the next or any succeeding year. If it is recognized, however, that particularly in a going business of any magnitude there are certain overlapping items both of income and deduction, and so long as these overlapping items do not materially distort the income, they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts. Judgments or other binding judicial adjudication, on account of damages for patent infringement, personal injuries, or other cause, are deductible from gross income when the claim is so adjudicated or paid, unless taken under other methods of accounting which clearly reflect the correct deduction, less any amount of such damages as may have been compensated for by insurance or otherwise: If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year including such amount of loss in the deduction from gross income and may in proper cases file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in one year and discovered in another is ordinarily deductible for the year in which sustained.

1. REQUISITES FOR DEDUCTABILITY

VISAYAN CEBU TERMINAL CO. V. COLLECTOR (108 PHIL 320)

Doctrine: To be deductible, said business expenses must be ordinary and necessary expenses paid or incurred in carrying on any trade or business

Facts: Visayan Cebu Terminal (VCTC) is a corporation organized for the purpose of handling arrastre operations in the port of Cebu. It filed its ITR, certain entries therein were disallowed as expenses pertaining to the salaries of 2 officers, miscellaneous expenses,

and representation expenses. VCTC questions the disallowance of deductions claimed for representation expenses.

Held: disallowance proper. To be deductible, said business expenses must be ordinary and necessary expenses paid or incurred in carrying on any trade or business; that those expenses must also meet the further test of reasonableness in amount, this test being inherent in the phase ordinary and necessary. The explanation to the effect that the supporting papers of some of the expenses had been destroyed when the house of appellant’s treasurer was burned, is not satisfactory, for appellant’s records were supposed to be kept in its offices, not in the residence of one of its officers.

DISCUSSION:

An expense must satisfy the following conditions to be deductible from gross income under the category of expenses, in general:

1. it must be ordinary and necessary 2. it must be paid or incurred within the taxable year 3. it must be in carrying on, or directly attributable to, the development,

management, operation and/or conduct of the trade, business or exercise of profession; and

4. Substantiated by sufficient evidence such as official receipts or other adequate records showing: 1. The amount; and 2. The direct relation

An expense is considered ordinary, if it is normal in relation to the taxpayer’s business and the surrounding circumstances. The expense need not be recurring. The expense is necessary when it is intended to minimize losses or to maximize profits. The two conditions must be satisfied, such that an expense which is ordinary, but not necessary, or necessary, but not ordinary, is not deductible from gross income. A court may decide on when an expense is, or is not ordinary, but as much as possible, will refuse to substitute its judgment for that of the taxpayer on the necessity of the expense.

2. COMPENSATION FOR PERSONAL SERVICES


SECTION 70. Compensation for personal services. — Among the ordinary and necessary expenses paid or incurred in carrying on any trade or business may be included a reasonable allowance for salaries or other compensation for personal services actually rendered. The test of deductibility in the case of compensation payments is whether they are reasonable and are, in fact, payments purely for service. This test and its practical application may be further stated and illustrated as follows:

(1) Any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible. (a) An ostensible salary paid by a corporation may be a distribution of dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services, and the excessive payment correspond or bear a close relationship to the stockholdings of the officers or employees, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock. (b) An ostensible salary may be in part payment for property. This may occur, for example, where a partnership sells out to a corporation, the former partners agreeing to continue in the service of the corporation. In such a case it may be found that the salaries of the former partners are not merely for services, but in part constitute payment for the transfers of their business.

(2) The form or method of fixing compensation is not decisive as to deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a contingent basis are to be treated fundamentally on any basis different from that applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid pursuant to a free bargain

between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.

(3) In any event the allowance for compensation paid may not exceed what is reasonable in all the circumstances. It is in general just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises in like circumstances. The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.

SECTION 71. Treatment of excessive compensation. — The income tax liability of the recipient in respect of an amount ostensibly paid to him as compensation, but not allowed to be deducted as such by the payer, will depend upon the circumstances of each case. Thus, in the case of excessive payments by corporations, if such payments correspond or bear a close relationship to stockholdings, and are found to be distribution of earnings or profits, the excessive payments will be treated as dividend. If such payments constitute payment for property, they should be treated by the payer as a capital expenditure and by the recipient as part of the purchase price.

SECTION 72. Bonuses to employees. — Bonuses to employees will constitute allowable deductions from gross income when such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payment, when added to the stipulated salaries, do not exceed a reasonable compensation for the service rendered. It is immaterial whether such bonuses are paid in cash or in kind or partly in cash and partly in kind. Donations made to employees and others, which do not have in them the element of compensation or are in excess of reasonable compensation for services, are not deductible from gross income.

KUENZLE & STREIF, INC. V. CIR (106 PHIL 355)

Doctrine: Bonuses, when made in good faith and as additional compensation for services actually rendered, provided such payments when added to the stipulated salaries do not exceed a reasonable compensation for services, are deductible.

Facts: Petitioner filed its ITR and claimed deductions for certain items representing salaries, directors’ fees and bonuses of its non-resident president and VP, bonuses of some of its resident officers and employees, and interest on earned but unpaid salaries and bonuses of its officers and employees.

Held: Bonuses to employees made in good faith and as additional compensation for the services actually rendered by the employees are deductible, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered. The conditions precedents to the deduction of bonuses to employees are:

(1) the payment of the bonuses is in fact compensation;

(2) it must be for personal services actually rendered and

(3) the bonuses when added to the salaries, are reasonable when measured by the amount and quality of the services performed with relation to the business of the particular taxpayer.

There is no fixed test for determining reasonableness of a given bonus as compensation. This depends upon many factors one of them being the amount and quality of the services performed with relation to the business. Other tests are: Payment must be made in good faith. The character of the taxpayer’s business, the value and amount of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation. The size of the particular business, the employees’ qualifications and contributions to the business venture and general economic conditions. However, in determining whether the particular salary or compensation payments is reasonable, the

situation must be considered as a whole. Ordinarily, no single factor is decisive. It is important to keep in mind that it seldom happens that the application of one test can give a satisfactory answer, and that ordinarily, it is the interplay of several factors, properly weighed for the particular case, which must furnish the final answer.

3. TRAVELLING EXPENSES


SECTION 66. Traveling expenses. — Traveling expenses as ordinarily understood, include transportation expenses and meals and lodging. If the trip is undertaken for other than business purposes, the transportation expenses are personal expenses, and the meals and lodging are living expenses, and therefore, not deductible. If the trip is solely on business, the reasonable and necessary traveling expenses, including transportation expenses, meals and lodging, become business instead of personal expenses.

(a) If, then, an individual, whose business requires him to travel receives a salary as full compensation for his services, without reimbursement for traveling expenses, or is employed on a commission basis with no expense allowance, his traveling expenses, including the entire amount expended far meals and lodging, are deductible from gross income.

(b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall include in gross income, the amount so repaid and may deduct such expenses.

(c) If an individual receives a salary and also an allowance for meals and lodging, as for example, a per diem allowance in lieu of subsistence, the amount of the allowance should be included in gross income and the cost of such meals and lodging may be deducted therefrom.

A payment for the use of a sample room at a hotel for the display of goods is a business expense. Only such expenses as are reasonable and necessary in the conduct of the business and directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred to herein must attach to his return a statement showing (1) the nature of the business in which he is engaged; (2) the number of days away from home during the taxable year on account of business; (3) the total amount of expenses incident to meals and lodging while absent from home and business during the taxable year; (4) the total amount of other expenses incident to travel and claimed as a deduction.

Claim for the deductions referred to herein must be substantiated, when required by the Commissioner of Internal Revenue by record showing in detail the amount and nature of the expenses incurred.




(b) 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, if the following conditions are satisfied:


(ii) The employee is required to account/liquidate for the foregoing expenses in accordance with the specific requirements of substantiation for each category of expenses pursuant to Sec. 34 of the Code. The excess of actual expenses over advances made shall constitute taxable income if such amount is not returned to the employer. Reasonable amounts of reimbursements/advances for travelling and entertainment expenses which are pre-computed on a daily basis and are paid to an employee while he is on an assignment or duty need not be subject to the requirement of substantiation and to withholding.

4. COST OF MATERIALS


SECTION 67. Cost of materials. — Taxpayers carrying materials and supplies on hand should include in expenses the charges for materials and supplies only to the amount that they are actually consumed and used in operation during the year for which the return is made, provided that the cost of such materials and supplies has not been deducted in determining the net income for any previous year. If a taxpayer carries incidental materials or supplies on hand for which no record of consumption is kept or of which physical inventories at the beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his expenses and deduct from gross income the total cost of such supplies and materials as were purchased during the year for which the return is made, provided the net income is clearly reflected by this method.

5. REPAIRS


SECTION 68. Repairs. — The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditure. Repairs in the nature of replacement, to the extent that they arrest deterioration and appreciably prolong the life of the property should be charged against the depreciation reserves if such account is kept.

6. EXPENSES UNDER LEASE AGREEMENTS


SECTION 74. Rentals. — Where a leasehold is acquired for business purposes for a specified sum, the purchaser may take as a deduction in his return an aliquot part of such sum each year, based on the number of years the lease has to run. Taxes paid by a tenant to or for a landlord for business property are additional rent and constitute a deductible item to the tenant and taxable income to the landlord, the amount of the tax being deductible by the latter. The cost borne by a lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the buildings erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation.

7. EXPENSES FOR PROFESSIONALS


SECTION 69. Professional expenses. — A professional may claim as deductions the cost of supplies used by him in the practice of his profession, expenses paid in the operation and repair of transportation equipment used in making professional calls, dues to professional societies and subscriptions to professional journals, the rent paid for office

rooms, the expenses of the fuel, light, water, telephone, etc.; used in such offices, and the hire of office assistants. Amounts currently expended for books, furnitures, and professional instruments and equipment, the useful life of which is short, may be deducted. But amounts expended for books, furniture, and professional instruments and equipment of a permanent character are not allowable as deductions.

8. EXPENSES FOR FARMERS


SECTION 75. Expenses of farmers. — A farmer who operates a farm for profit is entitled to deduct from gross income as necessary expenses all amounts actually expended in the carrying on of the business of farming. The cost of ordinary tools of short life or small cost, such as hand tools, including shovels, rakes, etc., may be included. The cost of feeding and raising livestock may be treated as an expense deduction, in so far as such cost represents actual outlay, but not including the value of farm produce grown upon the farm or the labor of the taxpayer. Where a farmer is engaged in producing crops which take more than a year from the time of planting to the process of gathering and disposal, expenses deducted may be determined upon the crop basis, and such deductions must be taken in the year in which the gross income from the crop has been realized. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not an allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches, prior to the time when the productive state is reached may be regarded as investments of capital. Amounts expended in purchasing work, breeding or dairy animals are regarded as investments of capital, and may be depreciated unless such animals are included in an inventory in accordance with Section 149 of these regulations. The purchase price of transportation equipment even when wholly used in carrying on farm operations, is not deductible but is regarded as an investment of capital. The cost of gasoline or fuel, repairs, and upkeep of the transportation equipment if used wholly in the business of farming is deductible as an expense; if used partly for business purposes and partly for the pleasure or convenience of the taxpayer or his family, such cost may be apportioned according to the extent of the use for purposes of business and pleasure or convenience, and only the proportion of such cost justly attributable to business purposes is deductible as a necessary expense. If a farm is operated for recreation or pleasure and not on a commercial basis, and if the expenses incurred in connection with the farm are in excess of the receipt therefrom, the entire receipts from the sale of products may be ignored in rendering a return of income, and the expenses incurred, being regarded as personal expenses, will not constitute allowable deduction.

9. ENTERTAINMENT EXPENSES


(B)(2) Expense Account.—

In general, expenses incurred by the employee but which are paid by his employer shall be treated as taxable fringe benefits, except when the expenditures are duly receipted for and in the name of the employer and the expenditures do not partake the nature of a personal expense attributable to the employee.

Expenses paid for by the employee but reimbursed by his employer shall be treated as taxable benefits, except only when the expenditures are duly receipted for and in the name of the employer and the expenditures do not partake the nature of a personal expense attributable to the said employee.

Personal expenses of the employee (like purchases of groceries for the personal consumption of the employee and his family members) paid for or reimbursed by the employer to the employee shall be treated as taxable fringe benefits of the employee whether or not the same are duly receipted for in the name of the employer.

ALHAMBRA CIGAR & CIGARETTE MFG. CO. V. COLLECTOR (GR L-12026, MAY 29, 1959)

Whenever a controversy arises on the deductibility for purposes of income tax of certain items for alleged compensation of officers of the taxpayer corporation, two questions become material, namely: (a) Have personal services been actually rendered by said officers? (b) in the affirmative case, what is the reasonable allowance therefore?

12. EXPENSE FOR POLICE PROTECTION IS ILLEGAL

CALANOC V. COLLECTOR (113 PHIL 499)

Facts: Calanoc was authorized to solicit and receive contribution for orphans and destitute children of the Child Welfare Workers Club. He financed and promoted a boxing and wrestling exhibition for the said charitable purpose. CIR demanded payment of amusement tax for the exhibition based on an opinion from the Sec. of Finance that exemption from payment of amusement tax may be denied where the net proceeds are not substantial or where the expenses are exorbitant. Petitioner admitted that he could not justify the other expenses, such as those for police protection and gifts.

Held: The payment for police protection is illegal as it is a consideration given by the petitioner to the police for the performance by the latter of the functions required by them to be rendered by law. The expenditures for the gifts, for parties, and other items for representation are rather excessive, considering that the purpose of the exhibition was for a charitable cause.

13. CONSTRUCTIVE DIVIDENDS


SECTION 70. PAR. 2.

(1) Any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible. (a) An ostensible salary paid by a corporation may be a distribution of dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services, and the excessive payment correspond or bear a close relationship to the stockholdings of the officers or employees, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock.

14. CEILINGS FOR ENTERTAINMENT, AMUSEMENT AND RECREATIONAL EXPENSE


SECTION 5. Ceiling on Entertainment, Amusement, and Recreation Expense. — There shall be allowed a deduction from gross income for entertainment, amusement and recreation expense, as defined in Section 2 of these Regulations, in an amount equivalent to the actual entertainment, amusement and recreation expense paid or incurred within the taxable year by the taxpayer, but in no case shall such deduction exceed 0.50 percent (%) of net sales (i.e., gross sales less sales returns/allowances and sales discounts) for taxpayers engaged in sale of goods or properties; or 1.00 percent (%) of net revenue (i.e., gross revenue less discounts) for taxpayers engaged in sale of services, including exercise of profession and use or lease of properties. However, if the taxpayer is deriving income from both sale of goods/properties and services, the allowable entertainment, amusement and recreation expense shall in all cases be determined based on an apportionment formula taking into consideration the percentage of the net sales/net revenue to the total net sales/net revenue, but which in no case shall exceed the maximum percentage ceiling provided in these Regulations.

Apportionment Formula:

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

Ent., Amusement & Recreation Expense (EAR) Allowable Amt to be based on Max. Percentage claimed as EAR

Net sales/ Apportionment Ceiling of Expense (whichever is Net revenue Formula* EAR Expense** lower of col. 2 and 3) (1) (2) (3) (4) Sale of P200,000 P2,000 P1,000 P1,000 Goods Sale of 100,000 1,000 1,000 1,000 Services Total P300,000 P3,000 P2,000 P2,000

*Apportionment Formula Sale of Goods (P200,000/P300,000) x P3,000 Sale of Services(P100,000/P300,000) x P3,000 **Maximum Percentage Ceiling Sale of Goods (P200,000 x 0.50%) Sale of Services (P100,000 x 1%) In the above illustration, ERA Corporation can only claim a total of P2,000 as entertainment, amusement and recreation expense.

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

C. INTEREST


SUBJECT : Implementing Section 34(B) of the Tax Code of 1997 on the Requirements for Deductibility of Interest Expense from the Gross Income of a Taxpayer.

SECTION 2. Definition of Terms. — For purposes of these Regulations, the following words and phrases shall have the following meanings, viz:

(a) Interest — shall refer to the payment for the use or forbearance or detention of money, regardless of the name it is called or denominated. It includes the amount paid for the borrower's use of money during the term of the loan, as well as for his detention of money after the due date for its repayment.

SECTION 3. Requisites for Deductibility of Interest Expense. — In general, subject to certain limitations, the following are the requisites for the deductibility of interest expense from gross income, viz:

(a) There must be an indebtedness;

(b) There should be an interest expense paid or incurred upon such indebtedness;

(c) The indebtedness must be that of the taxpayer,

(d) The indebtedness must be connected with the taxpayer's trade, business or exercise of profession;

(e) The interest expense must have been paid or incurred during the taxable year;

(f) The interest must have been stipulated in writing;

(g) The interest must be legally due;

(h) The interest payment arrangement must not be between related taxpayers as mandated in Sec. 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997 ;

(i) The interest must not be incurred to finance petroleum operations; and

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

SECTION 4. Rules on the Deductibility of Interest Expense. —

(a) General Rule. — In general, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with the taxpayer's trade, business or exercise of profession shall be allowed as a deduction from the taxpayer's gross income.

(b) Limitation. — The amount of interest expense paid or incurred by a taxpayer in connection with his trade, business or exercise of a profession from an existing indebtedness shall be reduced by an amount equal to the following percentages of the interest income earned which had been subjected to final withholding tax depending on the year when the interest income was earned, viz:

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

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

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

NOTE: NOW THE PERCENTAGE IS 33% - SINCE JAN 1, 2009

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

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

Under this illustration, the deductible interest expense, the taxable income and the income tax due of Company A shall be computed as follows:

1998 Net income before interest expense P1,000,000 Less: Interest expense P150,000 Less: 41% of interest income from deposit (41% x P180,000) 73,800 ———— Deductible interest expense 76,200 ———— Taxable income P923,800 ———— Income tax due for taxable year 1998 (34%) P314,092 ======== (c) Interest on Unpaid Taxes. — Provisions of Sec. 4(b) hereof to the contrary notwithstanding, interest incurred or paid by the taxpayer on all unpaid business-related taxes shall be fully deductible from gross income and shall not be subject to the limitation on deduction heretofore mentioned. Thus, such interest expense incurred or paid shall not be diminished by the percentage of interest income earned which had been subjected to final withholding tax. CTSHDI

(d) Other cases where interest expense is not deductible from gross income. — No interest expense shall be allowed as deduction from gross income in any of the following cases:

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

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

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

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

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

(i) Between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors and lineal descendants; or

(ii) Between an individual and a corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly and indirectly, by or for such individual; or

(iii) Between two corporations more than fifty percent (50%) in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual; or

(iv) Between the grantor and a fiduciary of any trust; or

(v) Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or

(vi) Between a fiduciary of a trust and a beneficiary of such trust.

(3) If the indebtedness on which the interest expense is paid is incurred to finance petroleum exploration in the Philippines. The non-deductible interest expense herein referred to pertains to interest or other consideration paid or incurred by a Service Contractor engaged in the discovery and production of indigenous petroleum in the Philippines in respect of the financing of its petroleum operations, pursuant to Section 23 of P.D. No. 8 , as amended by P.D. No. 87 , otherwise known as "The Oil Exploration and Development Act of 1972."

(e) Optional treatment of interest expense on capital expenditure. — At the option of the taxpayer, interest expense on a capital expenditure incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction in full in the year when incurred, the provisions of Sec. 36 (A)(2) and (3) of the Tax Code of 1997 to the contrary notwithstanding, or may be treated as a capital expenditure for which the taxpayer may claim only as a deduction the periodic amortization of such expenditure.

COMM. V. VDA DE PRIETO (109 PHIL 592) –

Doctrine: TAX IS AN INDEBTEDNESS, thus interest on late payment of taxes is an allowable deduction.

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.

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.

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 interest paid 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.

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

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.

D. TAXES


SECTION 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 non-resident alien individual and a foreign corporation, deduction is allowed only if and to the extent 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 proper and no deductions 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 as such 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 taxes imposed upon his interest as shareholder of a bank or other corporation, which are paid by the corporation without reimbursement 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.

2. TAXES NOT DEDUCTIBLE FROM GROSS INCOME


SECTION 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.

SECTION 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.

SECTION 83. Estate, inheritance, and gift taxes: taxes assessed against local benefits. — Estate, inheritance, and gift 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 WORD TAXES

The word "taxes" means taxes proper and no deductions 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 V. DEDUCTIONS

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?

Held:

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.

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.

No double taxation exists. Double taxation becomes obnoxious only when the taxpayer is taxed twice 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.

CIR V. BICOLANDIA DRUG JULY 21 2006

Tax credit is an amount subtracted from an individual’s or entity’s tax liability to arrive at the total tax liability. A tax credit reduces the taxpayer’s liability, compared to a deduction which reduces taxable income upon which the tax liability is calculated. A credit differs from deduction to the extent that the former is subtracted from the tax while the latter is subtracted from income before the tax is computed.

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


SECTION 93. Losses by individuals. — Losses sustained by individuals during the year not compensated for by insurance or otherwise are fully deductible (except by non-resident aliens) —

(a) If incurred in a taxpayer's trade; or

(b) If incurred in any transaction entered into for profits; or

(c) Of property not connected with the trade or business if arising from fires, storm, shipwreck, or other casualty, or from robbery, theft or embezzlement. No loss shall, however, be allowed as a 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.

SECTION 94. Losses by corporations. — Domestic corporations may deduct losses actually sustained and charged off within the year and not compensated for by insurance or otherwise.

SECTION 95. Losses by non-resident alien and foreign corporation. — Non-resident aliens and foreign corporations are allowed only 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.

SECTION 96. Losses generally. — Losses must usually be evidenced by closed and completed transactions. Proper adjustment must be made in each case for expenditures or items of loss properly chargeable to capital account, and for depreciation, obsolescence, amortization, or depletion. Moreover, the amount of the loss must be reduced by the amount of any insurance or other compensation received, and by the salvage value, if any, of the property. A loss on the sale of residential property is not deductible unless the property was purchased or constructed by the taxpayer with a

view to its subsequent sale for pecuniary profit. No loss is sustained by the transfer of property by gift or death. Losses sustained in illegal transactions are not deductible.

SECTION 100. Losses of farmers. — Losses incurred in the operation of farms as business enterprises are deductible from gross income. If farm products are held for favorable markets, no deduction on account of shrinkage in weight or physical value or by deterioration in storage shall be allowed, except as such shrinkage may be reflected in an inventory if used to determine profits. The total loss by storm, flood, or fire of a prospective crop is not a deductible loss in computing net income. A farmer engaged in raising and selling stock, cattle, sheep, horses, etc., is not entitled to claim as a loss the value of animals that perish from among those animals that were raised on the farm, except as such loss is reflected in an inventory if used. If livestock has been purchased after March 1, 1913, for any purpose, and afterwards dies from disease, exposure, or injury, or is killed by order of the authorities, the actual purchase price of such stock, less any depreciation allowable as a deduction in computing net income, with respect to such perished, livestock, and also any insurance or indemnity recovered, may be deducted as a loss. The actual cost of other property (with proper adjustment for depreciation), which is destroyed by order of the authorities, may in like manner be claimed as a loss; but if reimbursement is made in whole or in part on account of stock killed or property destroyed, the amount received shall be reported as income for the year in which reimbursement is made. The cost of any feed, pasturage, or care which has been deducted as an expense of operation shall not be included as part of the cost of the stock for the purpose of ascertaining the amount of a deductible loss. If gross income is ascertained by inventories, no deduction can be made for livestock or products lost during the year, whether purchased for resale, produced on the farm, as such losses will be reflected in the inventory by reducing the amount of livestock or products on hand at the close of the year. If an individual owns and operates a farm, in addition to being engaged in another trade, business or calling, and sustains a loss from such operation of the farm, then the amount of loss sustained may be deducted from gross income received from all sources, provided the farm is not operated for recreation or pleasure.

SECTION 101. Capital losses; losses on wash sales of stock or securities. — Losses on sales or exchanges of capital assets are allowed to the extent provided in section 34 of the Code. If any securities which are capital assets become worthless during the taxable year, the loss resulting therefrom shall be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets. Losses on "wash sales" of stock or securities are treated in section 33 of the Code.

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 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

SECTION 97. Voluntary removal of buildings. — Loss due to the voluntary removal or demolition of old buildings, the scrapping of old machinery, equipment, etc., incident to renewals and replacements will be deductible from gross income. When a taxpayer buys real estate upon which is located a building, which he proceeds to raze with a view to erecting thereon another building, it will be considered that the taxpayer has sustained no deductible expense on account of the cost of such removal, 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.

SECTION 98. Loss of useful value. — 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 of such business, he may claim as deduction the actual loss sustained. In determining the amount of the loss, adjustment must be made, however, for improvements, depreciation and 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, where an 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 where new legislation directly or indirectly makes the continued profitable use of the property impossible. This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowance are authorized. It does not apply to inventories or to other than capital assets. The 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. Any loss to be deductible under this exception must be charged off in the books and fully explained in returns of income.

SECTION 99. Shrinkage in value of stocks. — A person possessing stock of a corporation can not deduct from gross income any amount claimed as a loss merely on account of shrinkage in value of such stock through fluctuation of the market or otherwise. The loss allowable in such case is that actually 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 be made, as in the case of bad debts.

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. SUBSTANTIATION OF LOSSES

REVENUE REGULATIONS NO. 12-77; Substantiation Requirement for Losses Arising from Casualty, Robbery, Theft or Embezzlement

SECTION 1. Nature of deductible losses. — Any loss arising from fires, storms or other casualty, and from robbery, theft or embezzlement, is allowable as a deduction under Section 30(d) for the taxable year in which the loss is sustained. The term "casualty" is the complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, or unusual nature. It denotes accident, some sudden invasion by hostile agency, and excludes progressive deterioration through steadily operating cause. Generally, theft is the criminal appropriation of another's property to the use of the taker. Embezzlement is the fraudulent appropriation of another's property by a person to whom it has been entrusted or into whose hands it has lawfully come.

SECTION 2. Requirements of substantiation. — The taxpayer bears the burden of proving and substantiating his claim for deduction for losses allowed under Section 30(d) and should comply with the following substantiation requirements:

(a) A declaration of loss which must be filed with the Commissioner of Internal Revenue or his deputies within a certain period prescribed in these regulations after the occurrence of the casualty, robbery, theft or embezzlement.

(b) Proof of the elements of the loss claimed, such as the actual nature and occurrence of the event and amount of the loss.

SECTION 3. Declaration of loss. — Within forty-five days after the date of the occurrence of casualty or robbery, theft or embezzlement, a taxpayer who sustained loss therefrom and who intends to claim the loss as a deduction for the taxable year in which the loss was sustained shall file a sworn declaration of loss with the nearest Revenue District Officer. The sworn declaration of loss shall contain, among other things, the following information:

(a) The nature of the event giving rise to the loss and the time of its occurrence;

(b) A description of the damaged property and its location;

(c) The items needed to compute the loss such as cost or other basis of the property; depreciation allowed or allowable if any; value of property before and after the event; cost of repair;

(d) Amount of insurance or other compensation received or receivable.

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

SECTION 4. Proof of loss. — (a) In general. — The declaration of loss, being one of the essential requirements of substantiation of a claim for a loss deduction, is subject to verification and does not constitute sufficient proof of the loss that will justify its deductibility for income tax purposes. Therefore, the mere filing of a declaration of loss does not automatically entitle the taxpayer to deduct the alleged loss from gross income. The failure, however, to submit the said declaration of loss within the period prescribed in these regulations will result in the disallowance of the casualty loss claimed in the taxpayer's income tax return. The taxpayer should therefore file a declaration of loss and should be prepared to support and substantiate the information reported in the said

declaration with evidence which he should gather immediately or as soon as possible after the occurrence of the casualty or event causing the loss.

(b) Casualty loss. — Photographs of the property as it existed before it was damaged will be helpful in showing the condition and value of the property prior to the casualty. Photographs taken after the casualty which show the extent of damage will be helpful in establishing the condition and value of the property after it was damaged. Photographs showing the condition and value of the property after it was repaired, restored or replaced may also be helpful.

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

The foregoing evidence should be kept by the taxpayer as part of his tax records and be made available to a revenue examiner, upon audit of his income tax return and the declaration of loss.

(c) Robbery, theft or embezzlement losses. — To support the deduction for losses arising from robbery, theft or embezzlement, the taxpayer must prove by credible evidence all the elements of the loss, the amount of the loss, and the proper year of the deduction. The taxpayer bears the burden of proof, and no deduction will be allowed unless he shows the property was stolen, rather than misplaced or lost. A mere disappearance of property is not enough, nor is a mere error or shortage in accounts.

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

SECTION 5. Determination of amount deductible. — (a) In general. — The amount of casualty loss deductible is limited to the difference between the value of the property immediately preceding the casualty and its value immediately thereafter, but shall not exceed an amount equal to the cost or other adjusted basis of the property, or depreciated cost in the case of property used in business, reduced by any insurance or other compensation received.

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

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

(c) Examples.

The application of this section may be illustrated by the following examples:

(i) Property not used in business:

Cost or adjusted basis P18,000.00 Value of property before casualty 15,000.00 Value of property after casualty 10,000.00 Insurance recovered 3,000.00 The casualty loss is computed as follows:

Value of property before casualty P15,000.00 Value of property after casualty 10,000.00 ––––––––– Difference P5,000.00 ======== Loss to be taken into account for purposes of Section 30(d): lesser amount of property actually destroyed (P5,000) or adjusted basis of property actually destroyed (P18,000) P5,000.00 Less: Insurance received 3,000.00 –––––––– AMOUNT OF LOSS DEDUCTIBLE P2,000.00 =======

(ii) Property used in business:

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

To illustrate:

Assume that — Acquisition cost of property P10,000 Accumulated depreciation 5,000 Insurance recovered 2,500 Amount deductible is computed as follows: Acquisition cost P10,000 Less: Accumulated depreciation 5,000 ––––––– Amount of loss suffered P5,000 Less: Amount recovered through insurance 2,500 ––––––– AMOUNT DEDUCTIBLE P2,500 ======

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

To illustrate: Assume: Acquisition cost P100,000 Accumulated depreciation 90,000 –––––––– Net book value P10,000

======= Estimated remaining useful life 5 years Replacement cost of damaged portion P20,000 ––––––––

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

Net book value P10,000 Replacement cost 20,000 ––––––– Excess of replacement cost to be capitalized P10,000 ======

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

Net book value before casualty P10,000 Add: Excess of replacement cost over book value 10,000 ––––––– New cost basis P20,000 ====== Yearly depreciation —

P20,000 ––––––– 5 years = P4,000

(iii) Farm losses. — In the case of losses sustained, by farmers, the following rules shall apply:

(a) Loss of livestock. — The loss sustained in the death of livestock shall be allowed as a deduction to the extent of the acquisition cost only if no inventories are taken into account in determining the income from the business of farming.

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

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

SECTION 6. Determination of amount deductible — robbery, theft and embezzlement losses. — The amount deductible in respect of robbery, theft and embezzlement loss shall be determined consistently with the manner prescribed in the preceding section for determining the amount of casualty loss allowable as a deduction. In applying the provisions of the preceding section for this purpose, the fair market value of the property immediately after the theft shall be considered to be zero. This section does not apply to losses reflected in the inventories of the taxpayer.

Example:

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

Value of property immediately before theft P35,000 Less: Value of property immediately after theft -0- ––––––– Loss to be taken into account (P35,000 but not to exceed adjusted basis of P40,000 at the time of theft) P35,000 Less: Insurance received in 1977 20,000 ––––––– Deduction allowable for 1977 P15,000 ======

SECTION 7. Year of deduction. — If a casualty occurs which may result in a loss and, in the year of such casualty or event, there exist a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. Whether a reasonable prospect of recovery exist with respect to a claim for a reimbursement of a loss is a question of fact to be determined upon an examination of all facts and circumstances. Whether or not such reimbursement will be received may be ascertained with reasonable certainty, for example, by a settlement of the claim, by an adjudication of the claim, or by an abandonment of the claim. When a taxpayer claims that the taxable year in which a loss is sustained is fixed by his abandonment of the claim for reimbursement, he must be able to produce objective evidence of his having abandoned the claim, such as the execution of a release.

6. FOREIGN EXCHANGE LOSSES


This refers to your letter dated July 1, 1985 requesting a ruling as to whether foreign exchange losses which have accrued by reason of devaluation are deductible for income tax purposes. The losses arose from matured but unremitted principal repayments on loans affected by the debt restructuring program in the Philippines.

In reply thereto, I have the honor to inform you that annual increase in value of an asset is not taxable income because such increase has not yet been realized. The increase in value, i.e., the gain, could only be taxed when a disposition of the property occurred which was of such a nature as to constitute a realization of such gain, that is, a severance of the gain from the original capital invested in the property. The same conclusion obtains as to losses. The annual decrease in the value of property is not normally allowable as a loss. Hence, to be allowable the loss must be realized. (Surrey and Warren, Federal Income Taxation (1950), pp. 422-4)

When foreign currency acquired in connection with a transaction in the regular course of business is disposed of ordinary gain or loss results from the fluctuations. (Prentice-Hall Federal Taxes, Vol. 1, par. 6261) The loss is deductible only for the year it is actually sustained. It is sustained during the year in which the loss occurs as evidenced by closed and completed transaction and as fixed by identifiable events occurring in that year. (par. 6570, 34 Am Jur 2d, 1976) A closed transaction is a taxable event which has been consummated. (p. 231 Black's Law Dictionary, Fifth Edition) No taxable event has as yet been consummated prior to the remittance of the scheduled amortization. Accordingly, foreign exchange losses sustained as a result of devaluation of the peso vis-a-vis the foreign currency e.g., US dollar, but which remittance of scheduled amortization consisting of principal and interests payments on a foreign loan has not actually been made are not deductible from gross income for income tax purposes.

REVENUE MEMORANDUM CIRCULAR NO. 26-85

Subject : Amending Revenue Memorandum Circular No. 5-85 dated February 26, 1985 on the Applicable Uniform Exchange Rate of U.S. Dollar to Philippine Peso for Internal Revenue Tax Purposes.

For the information and guidance of all concerned, the following rules as amended are hereby prescribed to govern the conversion of U.S. dollar and other foreign currencies to Philippine pesos contained in Revenue Memorandum Circular No. 5-85 dated February 26, 1985:

a) Beginning January 1, 1985, the conversion rate to be applied shall be the prevailing interbank reference rate for the day of the transaction.

b) 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.

c) For the purpose of converting the tax liability in U.S. 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 interbank reference rate at the due date of tax when paid on or after the due date of the tax.

d) When currency involved is other than U.S. dollar, the foreign currency shall first be converted to U.S. dollar at the prevailing exchanges rate between the two currencies.

8. NET OPERATING LOSS CARRY OVER


SUBJECT: Implementing Section 34(D)(3) of the National Internal Revenue Code of 1997 Relative to the Allowance of Net Operating Loss Carry-Over (NOLCO) as a Deduction from Gross Income.

SECTION 1. Scope. — Pursuant to the provisions of Section 244 of the National Internal Revenue Code of 1997 (hereinafter referred to as the Code), these Regulations are hereby promulgated to govern the deduction from gross income of the Net Operating Loss Carry-Over (NOLCO) pursuant to Section 34 (D) (3) of the Code, which provides:

"Net Operating Loss Carry-Over — 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 three (3) consecutive taxable years immediately following the year of such loss: Provided, however, That any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction under this Subsection. Provided, further, That a net operating loss carry-over shall be allowed only if there has been no substantial change in the ownership of the business or enterprise in that —

"(i) Not less than seventy percent (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

"(ii) Not less than seventy-five percent (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 purposes of this Subsection the term 'net operating loss' shall mean the excess of allowable deduction over gross income of the business in a taxable year:

"Provided, That for mines other than oil and gas wells, a net operating loss without the benefit of incentives provided for under Executive Order No. 226 , as amended otherwise known as the Omnibus Investments Code of 1987, incurred in any of the first ten (10) years of operation may be carried over as a deduction from taxable income for the next five (5) years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the

five (5) taxable years following the loss and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining four (4) years."

SECTION 2. General Principles and Policies. —

2.2 In general, NOLCO shall be allowed as a deduction from the gross income of the same taxpayer who sustained and accumulated the net operating losses regardless of the change in its ownership. This rule shall also apply in the case of a merger where the taxpayer is the surviving entity.

2.3 Unless otherwise provided in these Regulations, NOLCO of the taxpayer shall not be transferred or assigned to another person, whether directly or indirectly, such as, but not limited to, the transfer or assignment thereof through a merger, consolidation or any form of business combination of such taxpayer with another person.

2.4 NOLCO shall also be allowed if there has been no substantial change in the ownership of the business or enterprise in that not less than 75% in nominal value of outstanding issued shares or not less than 75% of the paid up capital of the corporation, if the business is in the name of the corporation, is held by or on behalf of the same persons.

The 75% equity, ownership or interest rule prescribed in these Regulations shall only apply to a transfer or assignment of the taxpayer's net operating losses as a result of or arising from the said taxpayer's merger or consolidation or business combination with another person. In case the transfer or assignment of the taxpayer's net operating losses arises from the said taxpayer's merger, consolidation or combination with another person, the transferee or assignee shall not be entitled to claim the same as deduction from gross income unless, as a result of the said merger, consolidation or combination, the shareholders of the transferor/assignor, or the transferor (in case of other business combinations) gains control of at least 75% or more in nominal value of the outstanding issued shares or paid up capital of the transferee/assignee (in case the transferee/assignee is a corporation) or 75% or more interest in the business of the transferee/assignee (in case the transferee/assignee is other than a corporation).

2.5 Unless otherwise provided in these Regulations, an individual (including estate or trust) engaged in trade or business or in the exercise of profession, or a domestic or resident foreign corporation may be allowed to claim deduction of his/its corresponding NOLCO: Provided, however, that an individual who claims the 10% optional standard deduction shall not simultaneously claim deduction of the NOLCO: Provided, further, that the three-year reglementary period shall continue to run notwithstanding the fact that the aforesaid individual availed of the 10% optional standard deduction during the said period.

2.6 The three-year reglementary period on the carry-over of NOLCO shall continue to run notwithstanding the fact that the corporation paid its income tax under the "Minimum Corporate Income Tax" computation.

2.7 NOLCO shall be availed of on a "first-in, first-out" basis.

2.8 The net operating loss incurred by a taxpayer in the year in which a substantial change in ownership in such taxpayer occurs shall not be affected by such change in ownership, notwithstanding subsections 2.3 and 2.4.

SECTION 3. Definition of Terms. — For purposes of these Regulations, the words and phrases herein provided shall mean as follows:

3.1 Gross Income — Except as otherwise provided in these Regulations, the term "Gross Income" means the pertinent items of income referred to in Section 32(A) of the Tax Code of 1997 which are required to be declared in the taxpayer's Income Tax Return for purposes of computing his taxable income as defined in Section 31 of the same Code. All exempt income and other items of income subject to final tax shall not form part of the gross income.

3.2 Allowable Deductions — The term "Allowable Deductions" means the items of deduction enumerated under Section 34(A) to (J) and Section 34(M) , including the special deductions allowed to insurance companies under Section 37 of the Code, but excluding NOLCO and any item of incentive deduction allowable under any special law that does not actually involve cash outlay: Provided, that, in the case of an individual entitled to claim the Optional Standard Deduction (OSD) under Section 34(L) , in lieu of the deductions enumerated under Section 34(A) to (K) , the term "allowable deductions" shall mean the aforesaid OSD plus deduction of premium payments on health and/or hospitalization insurance as provided under Section 34(M) of the Code, if applicable.

3.3 Net Operating Loss — The term Net Operating Loss" shall mean the excess of allowable deduction over gross income of the business in a taxable year.

3.4 Nominal Value of Outstanding Issued Shares — The term "Nominal Value of Outstanding Issued Shares " shall refer to the par value (in case of par value shares of stock) or stated value (in case of no par value shares of stock) of shares of stock issued to the stockholders of the corporation.

3.5 Paid Up Capital of the Corporation — The term "Paid Up Capital of the Corporation" shall refer to the total amount paid by stockholders for their subscriptions in the shares of stock of the corporation, including any amount paid over and above the par value or stated value of the share of stock (e.g., premium on capital). For this purpose, the taxpayers shall maintain complete and accurate records of the paid-up capital of the shareholders.

3.6 Taxable Income — The term "Taxable Income" means the excess amount of the pertinent items of gross income over the allowable deductions and/or personal and additional exemptions, if any, authorized under the Code or under any special law.

3.7 Taxable Year — The term "Taxable Year" means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is computed under Title II of the Code. Taxable year includes, in the case of a return made for a fractional part of a year, the period for which such return is made. The term "Fiscal Year" means an accounting period of twelve (12) months ending on the last day of any month other than December.

3.8 Substantial Change in the Ownership of the Business or Enterprise — The term "Substantial Change in the Ownership of the Business or Enterprise" shall refer to a change in the ownership of the business or enterprise as a result of or arising from its merger or consolidation or combination with another person in the manner as provided in subsection 2.4 of these Regulations. Any change in ownership as a result of or arising thereunder shall not be treated as a substantial change for as long as the stockholders of the party thereto, to whom the net operating loss is attributable, gains or retains 75% or more interest after such merger or consolidation or combination.

3.9 Merger — For purposes of these Regulations, the term "Merger" shall refer to the absorption of a corporation by another corporation, the latter retaining its own name and identity and acquiring the assets, liabilities, franchises and powers of the former, and the absorbed corporation ceasing to exist as a separate juridical person.

3.10 Consolidation — For purposes of these Regulations, the term "Consolidation" shall refer to a situation when two or more corporations are extinguished, and by the same process a new one is created, taking over the assets and assuming the liabilities of the said extinguished corporations; or the unification of two or more corporations into a single new corporation, having the combined capital, franchises and powers of all its constituents.

3.11 Combination — For purposes of these Regulations, the term "Combination" shall refer to a situation when an owner of a business, organized as a sole proprietorship, admits a partner in his business for the purpose of forming a co-partnership, or any such business combination which, in effect, is similar or synonymous thereto.

3.12 By or on Behalf of the Same Persons — The term "By or on Behalf of the Same Persons" shall refer to the maintenance of ownership despite change as when:

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

Illustration:

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

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

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

Illustration:

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

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

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

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

SECTION 4. Taxpayers Entitled to Deduct NOLCO from Gross Income. — Any individual (including estates and trusts) engaged in trade or business or in the exercise of his profession, and domestic and resident foreign corporations subject to the normal income tax (e.g., manufacturers and traders) or preferential tax rates under the Code (e.g., private educational institutions, hospitals, and regional operating headquarters) on their taxable income as defined in Section 3 of these Regulations shall be entitled to deduct from his/its gross income for the current year his/its accumulated net operating losses for the immediately preceding three (3) consecutive taxable years: Provided, however, that net operating losses incurred or sustained prior to January 1, 1998 shall not qualify for purposes of the NOLCO. Provided, further, that any provision of these Regulations notwithstanding, the following shall not be entitled to claim deduction of NOLCO:

4.1 Offshore Banking Unit (OBU) of a foreign banking corporation, and Foreign Currency Deposit Unit (FCDU) of a domestic or foreign banking corporation, duly authorized as such by the Bangko Sentral ng Pilipinas (BSP);

4.2 An enterprise registered with the Board of Investments (BOI) with respect to its BOI-registered activity enjoying the Income Tax Holiday incentive. Its accumulated net operating losses incurred or sustained during the period of such Income Tax Holiday shall not qualify for purposes of the NOLCO;

4.3 An enterprise registered with the Philippine Economic Zone Authority (PEZA), pursuant to R.A. No. 7916 , as amended, with respect to its PEZA-

registered business activity. Its accumulated net operating losses incurred or sustained during the period of its PEZA registration shall not qualify for purposes of the NOLCO;

4.4 An enterprise registered under R.A. No. 7227 , otherwise known as the Bases Conversion and Development Act of 1992, e.g., SBMA-registered enterprises, with respect to its registered business activity. Its accumulated net operating losses incurred or sustained during the period of its said registered operation shall not qualify for purposes of the NOLCO;

4.5 Foreign corporations engaged in international shipping or air carriage business in the Philippines; and

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

SECTION 5. Determination of Substantial Change in the Ownership of the Business.

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

5.2 When Change Occurs — A change in the ownership of the business occurs when the person who sustained net operating losses enters into a merger, or consolidation or combination with another person, thereby resulting to the transfer or conveyance of the said net operating losses, to another person, in the course of the said merger or consolidation or combination.

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

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

SECTION 6. Entitlement to Net Operating Loss Carry-Over.—

6.1 In General — In general, only net operating losses incurred by a qualified taxpayer for the period beginning January 1, 1998 may be carried over to the next three (3) immediately succeeding taxable years following the year of such loss for purposes of the NOLCO deduction. Provided, however, that for mines other than oil and gas wells, a net operating loss without the benefit of incentives provided for under Executive Order No. 226, otherwise known as the Omnibus Investments Code of 1987, as amended, incurred in any of the first ten (10) years of operation may be carried over as a deduction from

taxable income for the next five (5) years immediately following the year of such loss. Provided, further, that the entire amount of the loss shall be carried over to the first of the five (5) taxable years following the loss, and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining (4) four years.

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

In case any of the aforementioned persons is engaged in both registered and unregistered business activities under any of the aforesaid laws (e.g., a corporation with a BOI-registered activity enjoying income tax holiday; and other unregistered business activities not enjoying any BOI incentive) the net operating loss or losses sustained or incurred by the said BOI-enterprise from its registered activities shall not be allowed as NOLCO deduction from its gross income derived from the unregistered business activities.

6.4 Quarterly and Annual Availment of NOLCO — NOLCO shall be allowed as deduction in computing the taxpayer's income taxes per quarter and annual final adjustment income tax returns: Provided, however, that if per the taxpayer's final annual adjustment income tax return, the entire operations for the year resulted to a net operating loss, such net operating loss may be claimed as NOLCO deduction in the immediately succeeding taxable year: Provided, further, that NOLCO may be claimed as deduction only within a period of three (3) consecutive taxable years immediately following the year the net operating loss was sustained or incurred. In order that compliance with this three-year statutory requisite may be effectively monitored, the taxpayer shall, at all times, show its NOLCO deduction, in its income tax return, as a separate item of deduction. In no case may NOLCO be claimed, as a part of the taxpayer's other itemized deductions, like under deduction of "losses," in general.

6.5 NOLCO in Relation to the Minimum Corporate Income Tax (MCIT) — In general, domestic and resident foreign corporations subject to the normal income tax rate are liable to the 2% MCIT, if applicable, computed based on gross income, whenever the amount of the MCIT is greater than the normal income tax due (computed with the benefit of NOLCO, if any), pursuant to Sections 27 or 28 of the Code. Thus, such corporation cannot enjoy the benefit of NOLCO for as long as it is subject to MCIT in any taxable year. Provided, however, that the running of the three-year period for the expiry of NOLCO is not interrupted by the fact that such corporation is subject to MCIT in any taxable year during such three-year period.

SECTION 7. Presentation of NOLCO in Tax Return and Unused NOLCO in the Income Statement. — The NOLCO shall be separately shown in the taxpayer's income tax return (also shown in the Reconciliation Section of the Tax Return) while the Unused NOLCO shall be presented in the Notes to the Financial Statements showing, in detail, the taxable year in which the net operating loss was sustained or incurred, and any amount thereof claimed as NOLCO deduction within three (3) consecutive years immediately following the year of such loss. Failure to comply with this requirement will disqualify the taxpayer from claiming the NOLCO.

F. BAD DEBTS


SECTION 102. Bad debts. — Where all the surrounding circumstances indicate that a debt is worthless, and the debt is charged off on the books of the taxpayer within the year,

the same may be allowed as a deduction in computing net income. There should accompany the return a statement showing the propriety of any deduction claimed for bad debts. Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to demonstrate, with a reasonable degree of certainty, the uncollectibility of the debt. Any amount subsequently received on account of a bad debt previously charged off and allowed as a deduction for income tax purposes, must be included in gross income for the taxable year in which received. In determining whether a debt is worthless the Commissioner of Internal Revenue will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor.

Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all pro-ability not result in the satisfaction of execution on a judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction. Bankruptcy is generally an indication of the worthlessness of at least a part of an unsecured and unpreferred debt. Actual determination of worthlessness in bankruptcy is sometimes possible before and at other times only when a settlement in bankruptcy shall have been had. Where a taxpayer ascertained a debt to be worthless and charged it off in one year, the mere fact that bankruptcy proceedings instituted against the debtor are terminated in a later year, confirming the conclusion that the debt is worthless, will not authorize shifting the deduction to such later year. If a taxpayer computes his income upon the basis of valuing his notes or accounts receivable at their fair market value when received, which may be less than their face value, the amount deductible for bad debts in any case is limited to such original valuation.

SECTION 103. Examples of bad debts. — Worthless debts arising from unpaid wages, salaries, rents, and similar items of taxable income will not be allowed as a deduction unless the income such items represent has been included in the return of income for the year in which the deduction as a bad debt is sought to be made or in a previous year. Only the difference between the amount received in distribution of the assets of a bankrupt and the amount of the claim may be deducted as a bad debt. The difference between the amount received by a creditor of a decedent in distribution of the assets of the decedent's estate and the amount of his claim may be considered a worthless debt. A purchaser of accounts receivable which can not be collected and are consequently charged off the hooks as bad debt is entitled to deduct them, the amount of deduction to be based upon the price he paid for them and not upon their face value.

Where under foreclosure of a mortgage, the mortgagee buys the mortgaged property and credits the indebtedness with the purchase price, the difference between the purchase price and the indebtedness will not be allowable as a deduction for a bad debt, for the property which was security for the debt stands in the place of the debt. The determination of loss in such case is deferred until the disposal of the property.

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 requires proof 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."


SUBJECT : Implementing Section 34(E) of the Tax Code of 1997 on the Requirements for Deductibility of Bad Debts from Gross Income

SECTION 2. Definition of Terms. — For purposes of these regulations, the following words and phrases shall have the following meaning, viz:

a. "Bad debts" — shall refer to those debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered.

b. "Securities" — shall mean shares of stock in a corporation and rights to subscribe for or to receive such shares. The term includes bonds, debentures, notes or certificates, or other evidence of indebtedness, issued by any corporation, including those issued by a government or political subdivision thereof, with interest coupons or in registered form.

c. "Actually ascertained to be worthless" — In general, a debt is not worthless simply because it is of doubtful value or difficult to collect. Worthlessness is not determined by an inflexible formula or slide rule calculation but upon the exercise of sound business judgment. The determination of worthlessness in a given case must depend upon the particular facts and the circumstances of the case. A taxpayer may not postpone a bad debt deduction on the basis of a mere hope of ultimate collection or because of a continuance of attempts to collect notes which have long become overdue, and where there is no showing that the surrounding circumstances differ from those relating to other notes which were charged off in a prior year. While a mere hope probably will not justify postponement of the deduction, a reasonable possibility of recovery will permit the account to be carried along notwithstanding that the probabilities are that the debt may not be collected at all. The creditor may offer evidence to show some expectation that the debt would have been paid in the intervening years, and that subsequently, the hope was shattered or appeared to have been unfounded. If, for example, the creditor could show that during the years he attempted to collect the debt, the debtor had property the title of which was in dispute but which would enable him to pay his debts when the title was cleared, the creditor would be entitled to defer the deduction on the ground that there was no genuine ascertainment of worthlessness.

Thus, accounts receivable, the amount whereof is insignificant and the collection of which through court action may be more costly to the taxpayer, may be written-off as bad debts even without conclusive evidence that the taxpayer's receivable from a debtor has definitely become worthless. LexLib

Good faith does not require that the taxpayer be an "incorrigible optimist" but on the other hand, he may not be unduly pessimistic. Creditors do not have to wait until some turn of the wheel of fortune may bring their debtors into affluence. The taxpayer may strike a middle course between pessimism and optimism and determine debts to be worthless in the exercise of sound business judgment based upon as complete information as is reasonably ascertainable. The taxpayer need not have perfect discernment.

d. "Actually charged off from the taxpayers books of accounts" — This phrase means that the amount of money lent by the taxpayer (in the course of his business, trade or profession) to his debtor had been recorded in his books of account as a receivable has actually become worthless as of the end of the taxable year, that the said receivable has been cancelled and written-off from the said taxpayer's books of account. A mere recording in the taxpayer's books of account of estimated uncollectible accounts does not constitute a write-off of the said receivable, hence, shall not be a valid basis for its deduction as a bad debt expense. In no case may any bad debt deduction be allowed unless the facts pertaining to the money or property lent and its cancellation or write-off from the taxpayer's accounting records, after having been determined that the same has actually become worthless, have been complied with by the taxpayer.

SECTION 3. Requisites for Valid Deduction of Bad Debts From Gross income. — General Rule. — In general, the requisites for deductibility of bad debts are:

(1) There must be an existing indebtedness due to the taxpayer which must be valid and legally demandable;

(2) The same must be connected with the taxpayer's trade, business or practice of profession;

(3) The same must not be sustained in a transaction entered into between related parties enumerated under Sec. 36(B) of the Tax Code of 1997 ;

(4) The same must be actually charged off the books of accounts of the taxpayer as of the end of the taxable year; and

(5) The same must be actually ascertained to be worthless and uncollectible as of the end of the taxable year.

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

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

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

SECTION 4. Tax Benefit Rule. — The recovery of bad debts previously allowed as deduction in the preceding year or years shall be included as part of the taxpayer's gross income in the year of such recovery to the extent of the income tax benefit of said deduction. Example: If in the year the taxpayer claimed deduction of bad debts written-off, he realized a reduction of the income tax due from him on account of the said deduction, his subsequent recovery thereof from his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said taxpayer did not benefit from the deduction of the said bad debt written-off because it did not result to any reduction of his income tax in the year of such deduction (i.e. where the result of his business operation was a net loss even without deduction of the bad debts written-off), then his subsequent recovery thereof shall be treated as a mere recovery or a return of capital, hence, not treated as receipt of realized taxable income.

SECTION 5. Securities Becoming Worthless. — If securities, as defined under Sec. 2(b) hereof, held as capital asset, are ascertained to be worthless and charged off within the taxable year, the loss resulting therefrom shall be considered as a loss from the sale or exchange of capital asset made on the last day of such taxable year. The taxpayer,

however, has to prove through clear and convincing evidence that the securities are in fact worthless.

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

PHILEX MINING V. CIR APRIL 16, 2008

Doctrine: A taxpayer cannot deduct as bad debts the investment that it put into a Joint Venture Agreement.

G. DEPRECIATION


SECTION 105. Depreciation. — A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business may be deducted from gross income. For convenience such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a reasonable consistent plan whereby the aggregate of the amount so set aside, plus the salvage value, will, at the end of the useful life of the property in business, equal the basis of the property. Due regard must also be given to expenditures for current upkeep.

SECTION 106. Depreciable property. — The necessity for a depreciation allowance arises from the fact that certain property used in the business gradually approaches a point where its usefulness is exhausted. The allowances should be confined to property of this nature. In the case of tangible property, it applies to that which is subject to wear and tear, to decay or decline from natural causes, to exhaustion and to obsolescence due to the normal progress of the art, as where machinery or other property must be replaced by a new invention, or due to the inadequacy of the property to the growing needs of the business. It does not apply to inventories or to stock in trade, nor to land apart from the improvements or physical development added to it. It does not apply to bodies of minerals which through the process of removal suffer depletion. Property kept in repair may, nevertheless, be the subject of a depreciation allowance. The deduction of an allowance for depreciation is limited to property used in the taxpayer's trade or business. No such allowance may be made in respect to automobiles or other transportation equipment used solely for the pleasure, a building used by the taxpayer solely as his residence, nor in respect of furniture or furnishings therein, personal effects, or clothing; but properties and costumes used exclusively in a business, such as theatrical business, may be the subject of a depreciation allowance.

SECTION 107. Depreciation of intangible property. — Intangibles, the use of which in the trade or business is definitely limited in duration, may be the subject of a depreciation allowance. Examples are patents, copyrights, and franchises. Intangibles, the use of which in the business or trade is not so limited, will not usually be a proper subject of such an allowance. If however, an intangible asset acquired through capital outlay is known from experience to be of value in the business for only a limited period, the length of which can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a depreciation allowance, provided the facts are fully shown in the return or prior thereto to the satisfaction of the Commissioner of Internal Revenue.

SECTION 108. Capital sum recoverable through depreciation allowances. — The capital sum to be replaced by depreciation allowances is the cost or other basis of the property in respect of which the allowance is made. To this amount should be added from time to time the cost of improvements, additions, and betterment and from it should be deducted from time to time the amount of any definite loss or damage sustained by the property through casualty, as distinguished from the gradual exhaustion of its utility which

is the basis of the depreciation allowance. Where the lessee of real property erects buildings, or makes permanent improvements which become part of the realty and income has been returned by the lessor as a result thereof, as provided in Section 49 of these regulations, the capital sum to be replaced by depreciation allowance is the same as though no such buildings had been erected or such improvements made. No depreciation deduction will be allowed in the case of property which has been amortized to its scrap value and is no longer in use.

SECTION 109. Method of computing depreciation allowance. — The capital sum to be replaced should be charged off over the useful life of the property, either in equal annual installments or in accordance with any other recognized trade practice, such as an apportionment of the capital sum over units of production. Whatever plan or method of apportionment is adopted must be reasonable and must have due regard to operating conditions during the taxable period. While the burden of proof must rest upon the taxpayer to sustain the deductions taken by him, such deductions must not be disallowed unless shown by clear and convincing evidence to be unreasonable. The reasonableness of any claim for depreciation shall be determined upon the conditions known to exist at the end of the period for which the return is made. If it develops that the useful life of the property will be longer or shorter than the useful life as originally estimated under all the then known facts, the portion of the cost or other basis of the property not already provided for through depreciation allowances should be spread over the remaining useful life of the property as reestimated in the light of the subsequent facts, and depreciation deductions taken accordingly.

SECTION 110. Obsolescence. — With respect to physical property the whole or any portion of which is clearly shown by the taxpayer as being affected by economic conditions that will result in its being abandoned at a future date prior to the end of its normal useful life, so that depreciation deductions alone are insufficient to return the cost (or other basis) at the end of its economic term of usefulness, a reasonable deduction for obsolescence, in addition to depreciation, may be allowed in accordance with the facts obtaining with respect to each item of property concerning which a claim for obsolescence is made. No deductions for obsolescence will be permitted merely because, in the opinion of a taxpayer, the property may become obsolete at some later date. This allowance will be confined to such portion of the property on which obsolescence is definitely shown to be sustained and can not be held applicable to an entire property unless all portions thereof are affected by the conditions to which obsolescence is found to be due.

SECTION 111. Depreciation of patent or copyright. — In computing depreciation allowance in the case of a patent or copyright, the capital sum to be replaced is the cost or other basis of the patent or copyright. The allowance should be computed by an apportionment of the cost or other basis of the patent or copyright over the life of the patent or copyright since its grant, or since its acquisition by the taxpayer, or since March 1, 1913, as the case may be. If the patent or copyright was acquired from the Government, its cost consists of the various Government fees, cost of drawings, experimental models, attorney's fees, development or experimental expenses, etc., actually paid. Depreciation of a patent can be taken on the basis of the fair market value as of March 1, 1913, only when affirmative and satisfactory evidence of such value is offered. Such evidence should whenever practicable be submitted with the return. If the patent becomes obsolete prior to its expiration, such proportion of the amount on which its depreciation may be based as the number of years of its remaining life bears to the whole number of years intervening between the basic date when it legally expires may be deducted, if permission to do so is specifically secured from the Commissioner of Internal Revenue. Owing to the difficulty of allocating to a particular year the obsolescence of a patent, such permission will be granted only if affirmative and satisfactory evidence that the patent became obsolete in the year for which the return is made is submitted to the Commissioner of Internal Revenue. The fact that depreciation has not been taken in prior years does not entitle the taxpayer to deduct in any taxable year a greater amount for depreciation than would otherwise be allowable.

SECTION 112. Depreciation of drawings and models. — Where a taxpayer has incurred expenditures in his business for designs, drawings, patterns, models, or work of an experimental nature calculated to result in improvement of his facilities or his product, if

the period of usefulness of any such asset may be estimated from experience with reasonable accuracy, it may be the subject of depreciation allowances spread over such estimated period of usefulness. The facts must be fully shown in the return or prior thereto to the satisfaction of the Commissioner of Internal Revenue. Except for such depreciation allowances no deduction shall be made by the taxpayer against any sum so set up as an asset except on the sale or other disposition of such asset at a loss or on proof of a total loss thereof.

SECTION 113. Charging off depreciation. — A depreciation allowance, in order to constitute an allowable deduction from gross income, must be charged off. The particular manner in which it shall be charged off is not material, except that the amount measuring a reasonable allowance for depreciation must be either deducted directly from the book value of the assets or preferably credited to a depreciation reserve account, which must be reflected in the annual balance sheet. The allowances should be computed and charged off with express reference to specific items, units, or groups of property, each item or unit being considered separately or specifically included in a group with others to which the same factors apply. The taxpayer should keep such records to each item or unit of depreciable property as will permit the ready verification of the factors used in computing the allowance for each year for each item, unit, or group.

SECTION 114. Depreciation in the case of farmers. — A reasonable allowance for depreciation may be claimed on farm buildings (other than a dwelling occupied by the owner), farm machinery, and other physical property. A reasonable allowance for depreciation may also be claimed on live stock acquired for work, breeding, or dairy purposes, unless they are included in an inventory used to determine profits in accordance with these regulations. Such depreciation should be based on the cost or other basis and the estimated life of the live stock. If such live stock be included in an inventory no depreciation thereof will be allowed, as the corresponding reduction in their value will be reflected in the inventory.

SECTION 115. Statement to be attached to return. — To each return in which depreciation charges are claimed, there should be attached a statement showing the item, unit, or group of depreciable property, the cost price or its market value as of March 1, 1913, if acquired prior to that date, the rate of charge, amount previously deducted, and the amount claimed in the return. These data must agree with those appearing in the books of the taxpayer.

1. DEPRECIATION BASE

ZAMORA V. COLLECTOR 8 SCRA 163 (1963)

Petitioner Mariano Zamora alleges that the CTA erred in disallowing 3-½% per annum as the rate of depreciation of the Bay View Hotel Building but only 2-½%. In justifying depreciation deduction of 3-½%, Mariano Zamora contends that (1) the Ermita District, where the Bay View Hotel is located, is now becoming a commercial district; (2) the hotel has no room for improvement; and (3) the changing modes in architecture, styles of furniture and decorative designs, "must meet the taste of a fickle public". It is a fact, however, that the CTA, in estimating the reasonable rate of depreciation allowance for hotels made of concrete and steel at 2-½%, the three factors just mentioned had been taken into account already. Said the CTA—

Normally, an average hotel building is estimated to have a useful life of 50 years, but inasmuch as the useful life of the building for business purposes depends to a large extent on the suitability of the structure to its use and location, its architectural quality, the rate of change in population, the shifting of land values, as well as the extent and maintenance and rehabilitation. It is allowed a depreciation rate of 2-½% corresponding to a normal useful life of only 40 years (1955 PH Federal Taxes, Par 14 160-K). Consequently, the stand of the petitioners can not be sustained.

As the lower court based its findings on Bulletin F, petitioner Zamora, argues that the same should have been first proved as a law, to be subject to judicial notice. Bulletin F, is a publication of the US Federal Internal Revenue Service, which was made after a study of the lives of the properties. In the words of the lower court: "It contains the list of depreciable assets, the estimated average useful lives thereof and the rates of depreciation allowable for each kind of property. (See 1955 PH Federal Taxes, Par. 14, 160 to Par. 14, 163-0). It is true that Bulletin F has no binding force, but it has a strong persuasive effect considering that the same has been the result of scientific studies and observation for a long period in the United States after whose Income Tax Law ours is patterned." Verily, courts are permitted to look into and investigate the antecedents or the legislative history of the statutes involved (Director of Lands v. Abaya, et al., 63 Phil. 559). Zamora also contends that his basis for applying the 3-½% rate is the testimony of its witness Mariano Katipunan, who cited a book entitled "Hotel Management — Principles and Practice" by Lucius Boomer, President, Hotel Waldorf Astoria Corporation. As well commented by the Solicitor General, "while the petitioner would deny us the right to use Bulletin F, he would insist on using as authority, a book in Hotel management written by a man who knew more about hotels than about taxation. All that the witness did (Katipunan) . . . is to read excerpts from the said book (t.s.n. pp. 99-101), which admittedly were based on the decision of the U.S. Tax Courts, made in 1928 (t.s.n. p. 106)". In view hereof, We hold that the 2-½% rate of depreciation of the Bay View Hotel building, is approximately correct.

3. DEPRECIATION RATES

REVENUE REGULATIONS NO. 19-86 SUBJECT : Taxation of Leases TO : All Internal Revenue Officers and Others Concerned ANNEX "A" SCHEDULE OF DEPRECIATION Asset classification Depreciable Life 1. Land Transportation Equipment 4 years 2. Water Transport Equipment 8 years 3. Air Transport Equipment 8 years 4. Industrial Equipment 5 years 5. Agricultural Equipment 4 years 6. Construction Equipment 5 years 7. Telecommunication Equipment 5 years 8. Office Machines 3 years 9. Main Frame Computer 5 years 10. Materials Handling Equipment 5 years 11. Auxiliary Equipment 5 years (Please refer to subsequent pages for details of various asset classification) 1. LAND TRANSPORT EQUIPMENT 1.1 Automotive Vehicles 1.2 Passenger Bus 1.3 Tourist Bus 1.4 Asian Utility Vehicles 1.5 Light-Duty Trucks (Such as Pick-ups) 1.6 Medium-Duty Trucks (Such as Dump Trucks) 1.7 Heavy-Duty Trucks (Prime Mover) 1.8 Locomotives 1.9 Trailers (Flatbed & Skeletal) 1.10 Tankers (Bulk Carriers) 1.11 Motorcycles 1.12 And such other similar or related equipment, as may be mutually agreed upon from time to time. 2. WATER TRANSPORT EQUIPMENT 2.1 Tugboats 2.2 Barges 2.3 Tankers

2.4 Purse Seiner 2.5 Reefer Vessels 2.6 Container Vessels 2.7 Passenger Vessels 2.8 And such other similar or related equipment, as may be mutually agreed upon from time to time. 3. AIR TRANSPORT EQUIPMENT 3.1 Helicopters 3.2 Prop Aircraft 3.3 Turbo-Prop Aircraft 3.4 Jet Aircraft 3.5 And such other similar or related equipment, as may be mutually agreed upon from time to time. 4. INDUSTRIAL EQUIPMENT 4.1 Injection Moulding Machines 4.2 Extruding Machines 4.3 Foundry Equipment 4.3 Metal Fabrication Equipment 4.5 Welding Equipment 4.6 Logging Equipment 4.7 Sawmill Equipment 4.8 Woodworking Equipment 4.9 Kiln Drying Equipment 4.10 Refrigerating Equipment 4.11 Mining and Quarrying Equipment 4.12 Printing Equipment 4.13 Textile Machines 4.14 Refractory Equipment 4.15 Boilers 4.16 Industrial Pumps 4.17 Industrial Gas Manufacturing Equipment 4.18 Distilling Equipment 4.19 Laboratory Testing Equipment 4.20 Medical Equipment 4.21 Drilling Equipment 4.22 And such other similar or related equipment, as may be mutually agreed upon from time to time. 5. AGRICULTURAL EQUIPMENT 5.1 Threshers 5.2 Palay Drilers 5.3 Rice Mills 5.4 Corn Mills 5.5 Feed Mills 5.6 4-Wheel Tractors with farm implements 5.7 2-Wheel Tractors with farm implements 5.8 Track type agricultural tractors with farm implement 5.9 Hard Tractors with prime mover and farm implements 5.10 Irrigation Pumps/Aerators 5.11 Diesel Engines 5.12 And such other similar or related equipment, as may be mutually agreed upon from time to time. 6. CONSTRUCTION EQUIPMENT 6.1 Bulldozers (Track type or wheel) 6.2 Loaders (Track type of Wheel) 6.3 Compactors 6.4 Motor Graders 6.5 Tractor-Scrapers 6.6 Off-Highway Trucks

6.7 Excavators (Track Type or Wheel) 6.8 Crushing Plant 6.9 Concrete Batching Plant 6.10 Asphalt Mixing Plant 6.11 Pipelayers 6.12 Asphalt Laying Machines 6.13 Hydraulic Breakers 6.14 And such other similar or related equipment, as may be mutually agreed upon from time to time. 7. TELECOMMUNICATIONS EQUIPMENT 7.1 PABX Systems 7.2 Telex Machines 7.3 VFT Equipment 7.4 Teleprinters 7.5 Broadcasting Equipment 7.6 Transmitting Equipment 7.7 And such other similar or related equipment, as may be mutually agreed upon from time to time. 8. OFFICE MACHINES 8.1 Adding Machines 8.2 Copiers 8.3 Calculators 8.4 Typewriters 8.5 Mini-Computers 8.6 Micro-Computers 8.7 Stencil Machines 8.8 Mimeographing Machines 8.9 Posting Machines 8.10 Cash Registers 8.11 And such other similar or related equipment, as may be mutually agreed upon from time to time. 9. MAINFRAME COMPUTERS 10 MATERIALS HANDING EQUIPMENT 10.1 Forklifts 10.2 Container Vans 10.3 Conveyor Systems 10.4 Box Cars 10.5 Cranes (mounted or overhead) 10.6 Loaders with tines 10.7 Cement Mixers 10.8 And such other similar or related equipment, as may be mutually agreed upon from time to time. 11 AUXILIARY EQUIPMENT 11.1 Air-conditioning Systems 11.2 Generators and Accessories 11.3 Elevators 11.4 Escalators 11.5 Water Tanks 11.6 Water Heating Systems 11.7 Air Compressors 11.8 Cooling Tanks 11.9 Anti-Pollution Equipment 11.10 Audio-Visual Equipment 11.11 And such other similar or related equipment, as may be mutually agreed upon from time to time.

H. DEPLETION REVENUE REGULATIONS NO. 05-76

SUBJECT : Prescribing Allowable Cost Depletion Allowance Beginning Calendar Year 1975 and Fiscal Year Beginning July 1, 1975, pursuant to Section 30 (g) (1) of the National Internal Revenue Code, as amended

SECTION 2. Allowance of Deduction for Depletion. — In the case of mines, oil and gas wells and other natural deposits, there shall be allowed as deductions in computing its taxable income a reasonable allowance for depletion computed in accordance with the following sections beginning calendar year 1975 and fiscal year beginning July 1, 1975.

SECTION 3. Who May Avail of the Cost Depletion. — Annual depletion deductions are allowed only to mining entities which own an economic interest in mineral deposits. An economic interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral, in place and secures, by any form of legal relationship, such as, but not limited to, operating agreement and service contract agreement, income derived from the extraction of the mineral, to which it must look for a return of its capital. A person who has no capital investment in the mineral deposit does not possess an economic interest merely because through a contractual relation he possesses a mere economic or pecuniary advantage derived from production.

SECTION 4. Basis of Cost Depletion. — The basis upon which the cost depletion is to be allowed in respect of a property being mined shall be the adjusted cost basis of the mining property being mined as of December 31, 1974 for those on a calendar year basis and June 30, 1975 for those on a fiscal year basis beginning July 1, 1975.

For this purpose, the adjusted cost basis shall be the accumulated exploration and development expenses incurred on the mining properties as of December 31, 1974 for those on a calendar year basis and June 30, 1975 for those on a fiscal year basis beginning July 1, 1975 minus accumulated cost depletion that should have been deducted as of the same date on the same property.

Accumulated exploration expenses shall include the amount paid or incurred for the purpose of ascertaining the existence, location, extent or quality of any deposit of ore or other minerals before the beginning of the development stage of mine or deposit of a particular mining property.

Exploration expenses shall not include expenditures for improvements subject to allowances for depreciation. However, allowances for depreciation of such improvements which were used in the exploration of ores or minerals shall form part of exploration expenditures.

Development expenditures shall include all capital expenditures paid or incurred during the development stage of the mine or other natural deposits. The development stage of the mine or other natural deposit will be deemed to begin at the time when, in consideration of all the facts and circumstances (including the action of the taxpayer) deposits of ore or other minerals are shown to exist in sufficient quantity and quality in a particular area to reasonably justify commercial exploitation and actually commence commercial extraction. Development expenditures shall not include expenditures for improvements subject to allowances for depreciation. However, allowances, for depreciation of such improvements which are used in the development of ores or mineral, shall form part of development expenditures.

SECTION 5. Limitation of Cost Depletion. —

(a) The basis for cost depletion of mineral deposits does not include:

1. Amounts recoverable through depreciation, through deferred expenses and through deductions other than depletion;

2. The residual value of improvements at the end of operation.

(b) Such basis does not include exploration and development expenses incurred on mining properties or areas other than those presently being mined. These expenses shall be treated as deferred expenses (capitalized) to be taken into account as deduction in the future in the form of allowances for cost depletion if ore mineral reserves warrant commercial production or as a write-off, in case of abandonment, in the event commercial operation is not warranted as confirmed by the Bureau of Mines.

(c) The annual allowable cost depletion shall not exceed the market value as used for purposes of imposing the mining ad valorem taxes in the mine of the product thereof which has been mined and sold during the year for which the return and computation are made. Market value shall mean the actual market value of the annual gross output of the minerals or mineral extracted or produced from the particular mining property.

(d) The allowable cost depletion deduction shall be limited only to the extent of the capital invested in the particular mining property. For this purpose, capital invested in the particular mining property shall include the accumulated exploration and development expenditures and expenditures incurred on the on-going mine exploration and development on the same mining area which

1. increase the value of the mine;

2. decreases the cost of production of mineral units; or

3. restores property to its previous condition or in making good the exhaustion thereof for which an allowance is or has been made.

In fine, no further deduction for cost depletion shall be allowed when the sum of the cost depletion equals the cost of adjusted basis of the property plus allowable capital additions.

SECTION 6. Manner of Computation of Cost Depletion. — The cost depletion for taxable year beginning calendar year 1975 and fiscal year beginning July 1, 1975 shall be computed by dividing the adjusted cost basis as of December 31, 1974 of June 30, 1875, as the case may be, by the number of units of minerals remaining as of the taxable year and by multiplying the depletion unit so determined by the number of units of minerals sold within the taxable year.

In the selection of a unit of mineral for depletion, preference shall be given to the principal or customary unit or units paid for in the products sold, such as tons of ore, barrels of oil, or thousands of cubic feet of natural gas.

As used in this regulation, the phrase —

(1) "the number of units of minerals remaining as of the taxable year" is the number of units of minerals remaining at the end of the period to be recovered from the property (including units recovered but not sold) plus the "number of units sold within the taxable year";

(2) "number of units sold within the taxable year" is —

a. In the case of taxpayer reporting income on the cash basis include units for which payments were received within the taxable year although extracted or sold prior to the period and exclude units sold but not paid for in the taxable year; and

b. In the case of taxpayer reporting income on the accrual method include all units extracted and sold during the period, whether paid for or not, but does not include units with respect to depletion deductions which were allowed or allowable prior to the taxable year.

In the case of natural gas or oil wells, the taxpayer may compute the cost depletion in respect of such property for the taxable year by multiplying the adjusted cost basis of the property by a fraction, the numerator of which is equal to the number of cubic feet or barrels of oil recovered during the year and the denominator of which is equal to the

expected recoverable number of cubic feet of gas or barrels of oil at the end of the year plus the number of cubic feet of gas or barrels of oil recovered during the year.

SECTION 7. Determination of Mineral Contents of Deposits Remaining as of the Taxable Year. — The mineral contents of deposits remaining as of the taxable year pertains to the estimated mineral products reasonably known or on good evidence believed to have existed in place as of the end of the taxable year, the estimate or determination of which was made according to the method current in the industry and in the light of the most accurate and reliable information obtainable.

For purposes of computing cost depletion allowable for the taxable year, the estimated mineral products remaining as of the taxable year shall include both quantity and grade —

(a) The positive ores and mineral deposits, which include ores and minerals "blocked out" and "developed" or "assured" in the usual conventional meaning; and

(b) The probable or prospective ores and mineral deposits, which include ores or minerals that are believed to exist on the basis of good evidence although not actually known to occur on the basis of existing development. Such probable or prospective ores or minerals may be estimated:

1. As to quantity, only in case they are extensions of known deposits or are new bodies or masses whose existence is indicated by geological surveys or other evidence to a high degree of probability; and

2. As to grade, only in accordance with the best indications available as to richness.

If the quantity of recoverable units of minerals in the deposit has been previously estimated for the prior year or years, and if there has been no known change in the facts upon which the prior estimate was based, the quantity of recoverable units of mineral in the deposit as of the taxable year will be the quantity remaining from the prior estimate. However, for any taxable year for which it is ascertained, either by the taxpayer or the Commissioner of Internal Revenue, from any source, such as operations or development work prior to the close of the taxable year, that the remaining recoverable mineral units as of the taxable year are materially greater or less than the quantity remaining from the prior estimate, then the estimate of the remaining recoverable units shall be revised and the annual cost depletion allowance with respect to the property for the taxable year and for subsequent taxable years will be based upon the revised estimate until a change in the facts required another revision. Such revised estimate will not, however, change the adjusted basis for depletion.

SECTION 8. Statement to be Attached to the Return. — There shall be attached to the return of the taxpayer for such taxable year a sworn statement by a responsible officer setting forth, in complete and summary form, the pertinent information required by these regulations with respect to each such mineral property or improvement (including oil and gas properties or improvements) as enumerated hereunder:

(i) Location plan and brief description of each property;

(ii) The date of acquisition of each property and the accumulated cost to date of each property;

(iii) The accumulated cost depletion for each of the mineral property and improvements;

(iv) The estimated number of units of each kind of mineral at the end of the taxable year as estimated by the Head of the Geological and Mining Departments of the taxpayer and confirmed by the Bureau of Mines;

(v) The number of units sold and the number of units for which payment was received during the year for which the return is made;

(vi) The gross amount received from the sale of mineral;

(vii) The amount and manner of computation of depreciation for the taxable year and the amount of cost depletion for the taxable year; and

(viii) Such data as may be required by the Commissioner of Internal Revenue as the case may be.

SECTION 9. Records to be Kept. — Every taxpayer claiming and making a deduction for depletion of mineral property shall keep a separate account for each and every mining area in his books of accounts in which shall be accurately recorded the cost or other basis of such property and thereafter to be debited by any, and all capital additions. Likewise, the corresponding depletion allowance account (reserve) shall be maintained which shall be credited annually with the amounts of depletion acquired in accordance with these regulations.

In addition, the taxpayer must assemble, segregate and have readily available at his principal place of business, all the supporting data which were used in compiling the summary statement required to be attached to the income tax return to be filed as prescribed under Section 8 hereof.

SECTION 10. Basis of Depreciation of Improvements. — There shall likewise be allowed as a deduction a reasonable allowance for depreciation of improvements including, but not limited to, mining and milling equipments. Such allowance shall include wear and tear and obsolescence.

The amount of depreciation that can be claimed as expenses in cases of certain equipment is subject to the provision of Section 4 of these regulations regarding properties used in exploration and development stages.

SECTION 11. Aggregation or Combination of Separate Properties. — In the case of mining companies with several mining properties, it may aggregate into one operating unit, several mining properties for purposes of determining the adjusted cost basis recoverable thru depletion subject to the following conditions:

(a) All contiguous areas included in a single concession grant or in separate concession grants may be constituted as a single operating unit;

(b) Operating mineral interests which are geographically widespread may not be treated as parts of the same operating unit;

(c) Undeveloped operating mineral unit may be aggregated only those interests with which it will be operated as a unit when it reaches the production stage.

For purposes of these regulations, the term —

(1) Operating mineral interest means a separate mineral interest in respect of which the cost would be required to be taken into consideration of the mine, well or other natural deposit were in the production stage.

(2) Operating unit refers to the operating mineral interest which are operated together for the purpose of producing minerals. It refers to a producing unit and not to an administrative or sales organization. Among the factors which indicate that interests are operated as a unit are —

i. common field or operating unit;

ii. common supply and maintenance facilities;

iii. common processing as treatment plants; and

iv. common storage facilities.

Separate operating units shall have its own accounts to which all expenditures pertaining thereto shall be debited and the credit to such amount may either be for future depletion or write-offs as the case may be.

SECTION 12. Definition of Terms. — (a) "Mineral's" means all naturally occurring inorganic substances in solid, liquid, or any intermediate state including coal. Soil which supports organic life, sand and gravel, guano, petroleum, geothermal energy and natural gas are included in this term but are governed by special laws.

(b) "Mineral Lands" are those lands in which minerals exist in sufficient quantity and grade to justify the necessary expenditures in extracting and utilizing such minerals.

(c) "Mineral Deposit" means a natural deposit or accumulation of minerals.

(d) "Exploration" is the examination and investigation of lands supposed to contain valuable minerals, by drilling, trenching, shaft sinking, tunneling, test pitting and other means, for the purpose of probing the presence of mineral deposits and the extent thereof.

(e) "Development" refers to steps necessarily taken to reach an ore body or mineral deposit so that it can be mined.

(f) "Exploitation" means the extraction and utilization of mineral deposits.

(g) "Mining" or "to mine" means to extract, remove, utilize minerals, and includes operations necessary for that purpose.

(h) "Actual commercial production" shall mean the stage of mining operation attained by a mine in which mineral or mineral products of marketable grade and quantity have been produced and sold to local and/or foreign markets.

(i) "Mining and Milling equipments" shall mean machineries, equipment, tools for production, plants to convert mineral ores into saleable form, spare parts, supplies, materials, accessories, explosives, chemicals and transportation, and communication facilities which shall include all the items herein enumerated for commercial production which are necessary or incidental for mining, as well as for the processing of ores into marketable form and grade, and shall include those needed to explore and develop the mineral land for mining and the processing plants which may be imported and installed before the actual commercial production.

(i) "Positive ore" shall mean the full ore tonnage computed with good mining practice from dimensions revealed in outcrops, trenches, underground working and drill holes and for which the grade is computed from results of detailed sampling. The sites of inspection, sampling and measurements shall be closely spaced and the geological character were so defined that the size, shape and mineral content are well established.

(k) "Probable" or "Prospective ore "shall mean the ore for which tonnage and grade are computed partly specific measurement, samples and partly from projection for a reasonable distance on geologic evidence. The sites available for inspection, measurement and sampling are too wildly or otherwise inappropriately spaced to outline the ore completely or to establish its grade throughout.

(1) "Exploration stage" shall mean the step in exploring "new mines" or "old mines resuming operations" consisting of shallow borings, trenches, test pitting, diamond drilling and underground workings to prove the persistence and tonnage or the ore body laterally and in depth.

I. PENSION TRUSTS REVENUE REGULATION 2-40 SECTION 118. Payments to employees' pension trusts. — An employer who adopts or has adopted a reasonable pension plan, actuarially sound, and who establishes, or has established, and maintains a pension trust for the payment of reasonable pensions to his employees shall be allowed to deduct from gross income reasonable amounts paid to such trust, in accordance with the pension plan (including any reasonable amendment thereof), as follows:

(a) If the plan contemplates the payment to the trust, in advance of the time when pensions are granted, of amounts to provide for future pensions payments, then (1) reasonable amounts paid to the trust during the taxable year representing the pension liability applicable to such year, determined in accordance with the plan, shall be allowed as a deduction for such year as an ordinary and necessary business expense, and in addition (2) one-tenth of a reasonable amount transferred or paid to the trust during the taxable year to cover in whole or in part the pension liability applicable to the years prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis, shall be allowed as a deduction for the taxable year and for each of the nine succeeding taxable years.

(b) If the plan does not contemplate the payment to the trust, in advance of the time when pensions are granted, of amounts to provide for future pension payments, then (1) reasonable amounts paid to the trust during the taxable year representing the present value of the expected future payments in respect of pensions granted to employees retired during the taxable year shall be allowed as deduction for such year as an ordinary and necessary business expense, and in addition (2) one tenth of a reasonable amount transferred or paid to the trust during the taxable year to cover in whole or in part the present value of the expected future payments in respect of pensions granted to employees retired prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis, shall be allowed as a deduction for the taxable year and for each of the nine succeeding taxable years.

REPUBLIC ACT NO. 9505 - Personal Equity and Retirement Account (PERA) Act of 2008

SECTION 3. Definition of Terms. — Unless the context requires otherwise, the following terms shall have the following significance as used in this Act:

(b) "Contributor" is any person with the capacity to contract and possesses a tax identification number. The Contributor establishes and makes contributions to a PERA.

(f) "Personal Equity and Retirement Account (PERA)" refers to the voluntary retirement account established by and for the exclusive use and benefit of the Contributor for the purpose of being invested solely in PERA investment products in the Philippines. The Contributor shall retain the ownership, whether legal or beneficial, of funds placed therein, including all earnings of such funds.

(g) "PERA Investment Product" refers to a unit investment trust fund, mutual fund, annuity contract, insurance pension products, pre-need pension plan, shares of stock and other securities listed and traded in a local exchange, exchange-traded bonds or any other investment product or outlet which the concerned Regulatory Authority may allow for PERA purposes: Provided, however, That to qualify as a PERA investment product under this Act, the product must be non-speculative, readily marketable, and with a track record of regular income payments to investors.

The concerned Regulatory Authority must first approve the product before being granted tax-exempt privileges by the BIR.

(i) "Overseas Filipino" refers to (1) an individual citizen of the Philippines who is working or deriving income from abroad, including one who retained or reacquired his Philippine citizenship under Republic Act No. 9225, otherwise known as the "Citizenship Retention and Reacquisition Act of 2003"; or (2) the legitimate spouse, whether or not said spouse is of Filipino ancestry, and the children of the Filipino citizen mentioned in item (1) hereof.

SECTION 5. Maximum Annual PERA Contributions. — A Contributor may make an aggregate maximum contribution of One hundred thousand pesos (P100,000.00) or its equivalent in any convertible foreign currency at the prevailing rate at the time of the actual contribution, to his/her PERA per year: Provided, That if the Contributor is married, each of the spouses shall be entitled to make a maximum contribution of One hundred thousand pesos (P100,000.00) or its equivalent in any convertible foreign currency per year to his/her respective PERA: Provided, further, That if the Contributor is an overseas Filipino, he shall be allowed to make maximum contributions double the allowable maximum amount.

A Contributor has the option to contribute more than the maximum amount prescribed herein: Provided, That the excess shall no longer be entitled to a tax credit of five percent (5%).

The Secretary of Finance may adjust the maximum contribution from time to time, taking into consideration the present value of the said maximum contribution using the Consumer Price Index as published by the National Statistics Office, fiscal position of the government and other pertinent factors.

SECTION 6. Employer's Contribution. —- A private employer may contribute to its employee's PERA to the extent of the amount allowable to the Contributor: Provided, however, That the employer complies with the mandatory Social Security System (SSS) contribution and retirement pay under the Labor Code of the Philippines. Such contribution shall be allowed as a deduction from the employer's gross income. The Contributor, however, retains the prerogative to make investment decisions pertaining to his PERA.

SECTION 7. Separate Asset. — The PERA shall be kept separate from the other assets of an Administrator/Custodian and shall not be part of the general assets of the Administrator/Custodian for purposes of insolvency.

SECTION 8. Tax Treatment of Contributions. — The Contributor shall be given an income tax credit equivalent to five percent (5%) of the total PERA contribution: Provided, however, That in no instance can there be any refund of the said tax credit arising from the PERA contributions. If the Contributor is an overseas Filipino, he shall be entitled to claim tax credit from any tax payable to the national government under the National Internal Revenue Code of 1997, as amended.

SECTION 9. Tax Treatment of Investment Income. — All income earned from the investments and reinvestments of the maximum amount allowed herein is tax exempt.

SECTION 10. Tax Treatment of Distributions. — All distributions in accordance with Section 12 hereof are tax exempt.

SECTION 11. Termination. — Any premature termination shall be treated as an early withdrawal under Section 13 hereof: Provided, That the penalties thereunder shall not apply if the entire proceeds therefrom are immediately transferred to another PERA investment and/or another Administrator.

SECTION 12. Distributions Upon Retirement/Death. — Distributions may be made upon reaching the age of fifty-five (55) years: Provided, That the Contributor has made contributions to the PERA for at least five (5) years. The distribution shall be made in either lump sum or pension for a definite period or lifetime pension, the choice of which shall be at the option of the Contributor. The Contributor, however, has the option to continue the PERA. Complete distribution shall be made upon the death of the Contributor, irrespective of the age of the Contributor at the time of his death.

SECTION 13. Penalty on Early Withdrawal. — Any early withdrawal shall be subject to a penalty, the amount of which would be determined by the Secretary of Finance and payable to the government: Provided, That the amount of the penalty shall in no case be less than the tax incentives enjoyed by the Contributor.

No early withdrawal penalty shall be imposed on any withdrawal of any funds for the following purposes:

(a) For payment of accident or illness-related hospitalization in excess of thirty (30) days; and

(b) For payment to a Contributor who has been subsequently rendered permanently totally disabled as defined under the Employees Compensation Law, Social Security Law and Government Service Insurance System Law.

SECTION 14. Non-Assignability. — No portion of the assets of a PERA may be assigned, alienated, pledged, encumbered, attached, garnished, seized or levied upon. PERA assets shall not be considered assets of the Contributor for purposes of insolvency and estate taxes.

SECTION 16. Administration of Tax Incentives. — The BIR shall issue the implementing rules and regulations regarding all aspects of tax administration relating to PERA. The BIR shall coordinate the qualification standards of the Administrator with the Regulatory Authorities.

REVENUE REGULATION 17-2011 –IMPLEMENTING THE PERA

J. CHARITABLE AND OTHER CONTRIBUTIONS REVENUE REGULATIONS NO. 13-98

SUBJECT : Implementing Republic Act No. 8424, "An Act Amending the National Internal Revenue Code, as amended" Specifically Section 34 (H) Relative to the Deductibility of Contributions or Gifts Actually Paid or Made to Accredited Donee Institutions in Computing Taxable Income

SECTION 1. Definition of Terms. — For purposes of these Regulations, the terms herein enumerated shall have the following meanings:

a) "Non-stock, non-profit corporation or organization" — shall refer to a corporation or association/organization referred to under Section 30 (E) and (G) of the Tax Code created or organized under Philippine laws exclusively for one or more of the following purposes:

(i) religious;

(ii) charitable;

(iii) scientific;

(iv) athletic;

(v) cultural;

(vi) rehabilitation of veterans; and

(vii) social welfare

no part of the net income or asset of which shall belong to or inure to the benefit of any member, organizer, officer or any specific person.

b) "Non-government Organization (NGO)" — shall refer to a non-stock, non-profit domestic corporation or organization as defined under Section 34 (H)(2)(c) of the Tax Code organized and operated exclusively for scientific, research, educational, character-building and youth and sports development, health, social welfare, cultural or charitable purposes, or a combination thereof, no part of the net income of which inures to the benefit of any private individual.

(i) Which, not later than the fifteenth (15th) day of the third month after the close of the NGO's taxable year in which contributions are received, makes utilization directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated, unless an extended period is granted by the Secretary of Finance, upon recommendation of the Commissioner;

(ii) The level of administrative expenses of which shall, on an annual basis, not exceed thirty percent (30%) of the total expenses for the taxable year; and

(iii) The assets of which, in the event of dissolution, would be distributed to another accredited NGO organized for similar purpose or purposes, or to the State for public purpose, or purposes, or to the state for public purpose, or would be distributed by a competent court of justice to another accredited NGO to be used in such manner as in the judgment of said court shall best accomplish the general purpose for which the dissolved organization was organized.

(c) "Utilization" by an accredited NGO — shall refer to

(i) Any amount in cash or in kind, including administrative expenses, paid or utilized by an accredited NGO to accomplish one or more purposes for which it was created or organized; or

(ii) Any amount paid to acquire an asset used, or held for use, directly in carrying out one or more purposes for which the accredited NGO was created or organized; or

(iii) Any amount set aside for a specific project which comes within one or more purpose or purposes for which the accredited NGO was created, but only if at the time such amount is set aside, the accredited NGO has established to the satisfaction of the Commissioner of Internal Revenue that the amount will be utilized for a specific project within a period not to exceed five (5) years, and the project is the one which can be better accomplished by setting aside such amount than by immediate payments of funds: Provided, That, the utilization requirements prescribed under Sec. 5 of these Regulations shall be complied with; or

(iv) Any amount in cash or in kind invested in any activity related to the purpose for which it was created or organized.

(v) Any amount in cash or in kind invested in capital sustaining and generating activities, such as but not limited to, endowment funds, trust funds, money market placements, shares of stock and similar instruments: Provided, That, any income derived from these investments shall be exclusively used in activities directly related to one or more purposes for which the accredited NGO was created or organized.

(d) "Accrediting Entity" — shall refer to a non-stock, non-profit organization composed of NGO networks, duly designated by the Secretary of Finance to establish and operationalize a system of accreditation to determine the qualification of non-stock, non-profit corporations or organizations and NGOs for accreditation as qualified-donee

institutions. The Secretary of Finance and the Commissioner of Internal Revenue shall oversee, monitor and coordinate with the Accrediting Entity to ensure that the provisions of these Regulations are complied with. In this connection, the Secretary of Finance or the Commissioner of Internal Revenue or their duly authorized representative shall sit as ex-officio member of the Board of Trustees of the Accrediting entity with the right to vote. The Secretary of Finance may also designate an official of a concerned government agency, e.g. Department of Science and Technology, to assist the Board of Trustees in the accreditation of foundations.

The Secretary of Finance shall designate an entity as an Accrediting Entity provided it has a countrywide membership composed of (a) NGOs which belong to the sector that the Private Accrediting Entity intends to certify; (b) NGOs which have been in existence for at least five (5) years; and (c) NGOs not more than 50% of the members of which belong to other existing NGOs or Private Accrediting Agencies.

The Philippine Council for NGO Certification, Inc. (PCNC), a non-stock, non-profit corporation which was established by several NGO networks (e.g., Caucus of Development NGO Networks (CODE-NGO); Philippine Business for Social Progress (PBSP); Association of Foundations (AF); League of Corporate Foundations (LCF); Bishops-Businessmen's Conference for Human Development (BBC); and the National Council for Social Development Foundation (NCSD), has been duly designated by the Secretary of Finance as an Accrediting Entity pursuant to Memorandum of Agreement dated January 29, 1998 executed by and between the Secretary of Finance and PCNC's Interim Chairman.

(e) "Religious purpose" — shall refer to the promotion, propagation and accomplishment of any form of religion, creed or religious belief recognized by the Government of the Republic of the Philippines.

(f) "Charitable Activity" — shall refer to extending relief to the poor, distressed and underprivileged and shall include fighting against juvenile delinquency and community deterioration.

(g) "Scientific and research purpose" — shall refer to undertaking or assisting in pure or basic, applied and scientific research in the field of agriculture, forestry, fisheries, industry, engineering, energy development, food and nutrition, medicine, environment and biological, physical and natural sciences for the public interest.

(i) Basic research shall refer to an experimental or theoretical work undertaken primarily to acquire new knowledge of the underlying foundations of phenomena and observable facts without any particular application or use in view. It analyzes properties, structures or relationships with a view to formulating and testing hypothesis, theories or laws. The results of basic research are not generally sold but are usually published in scientific journals or circulars to interested colleagues.

(ii) Applied research shall refer to an original investigation undertaken in order to acquire new knowledge. It is directed primarily towards a specific practical aim or objective. It is undertaken either to determine possible uses for the findings of basic research or to determine new methods or ways of achieving some specific and predetermined objectives. It involves the consideration of the available knowledge and its extension in order to solve particular problems. Applied research develops ideas into operational form.

(iii) Scientific research will be regarded as carried on for public interest if the results of such research are made available to the public on a non-discriminatory basis; or if such research is performed for the Government of the Philippines or any of its agencies or political subdivisions; or if such research is directed to benefit the public.

(h) "Character building and youth and sports development (or athletic) purposes" — shall refer to and include conducting basic and applied research on youth development,

initiating and establishing youth organizations to promote and develop youth activities, including the establishment of summer camps or centers for leadership training, conducting a program on physical fitness and amateur sports development for the country; developing and maintaining recreational facilities, playgrounds and sports centers; and conducting training programs for the development of youth and athletes for national and international competitions.

(i) "Cultural activity" — shall refer to and include undertaking and/or assisting in research activities on all aspects of history, social system, customs and traditions; developing, enriching and preserving Filipino arts and culture; developing and promoting the visual and performing arts; and participating in vigorous implementation of bilingual policy through translation and wider use of technical, scientific and creative publications, development of an adaptive technical dictionary and use of Filipino as the medium of instruction.

(j) "Educational activity" — shall refer to and include the granting of scholarships to deserving students and professional chairs for the enhancement of professional courses, and instructing or training of individuals either through formal and informal methods, viz:

(i) Formal method of instruction refers to the institutionalized, chronologically graded and hierarchically structured educational system at all levels of education;

(ii) Non-formal method of instruction refers to any deliberately organized, systematic educational activity carried on outside the framework of the formal system to provide selected types of learning to particular subgroups of the population, particularly out-of-school youths and adults, for the purpose of communicating ideas, developing skills, changing attitudes or modifying behavior or improve their character and to provide them with tools necessary for the achievement of a higher standard of living. For the purpose of this section, a certification from the Technical Education and Skills Development Authority (TESDA) is required for the accreditation of the non-formal educational program which is implemented or carried out by a non-stock, non-profit corporation, organization or an NGO.

It also includes upgrading of existing facilities to support the conduct of the above activities.

(k) "Rehabilitation of veterans" — shall include services extended to Philippine veterans and members of their families because of financial difficulties and attendant problems; and services extended to disabled veterans towards productive life.

(l) "Social welfare purposes" — shall refer to and include

(i) undertaking and/or assisting in the amelioration of the living conditions of distressed citizens particularly those who are handicapped by reasons of poverty, youth, physical and mental disability, illness, old age, and natural disasters, including assistance to cultural minorities;

(ii) pursuing a program for the protection and development of children and youth, such as providing services for drop-outs, pre-school children of low-income working mothers, and physically handicapped children;

(iii) providing for the rehabilitation of the youth and disabled adults, released prisoners, drug addicts, alcoholics, mentally retarded, hansenites and similar cases; and

(iv) providing for services to squatter families and to displaced workers.

(m) "Health purposes" — shall refer to include the pursuit of any of the following:

(i) control, prevention and treatment of communicable and degenerative diseases, accidents and other health disabilities;

(ii) family planning program designed to indicate knowledge and understanding of population, human growth and development of family life;

(iii) environment sanitation, such as, public sewerage system and sanitary toilets; and

(iv) nutrition, which aims to reduce the prevalence of malnutrition and increase the energy and protein intake among households.

SECTION 2. Accreditation of non-stock, non-profit corporations/NGOs by the Accrediting Entity. —

X X X

(f) The Accrediting Entity shall issue a Certificate of Accreditation to a non-stock, non-profit corporation/NGO upon determination that it meets the criteria for accreditation; Provided, that the Certificate of Accreditation shall be valid for a maximum period of five (5) years for existing non-stock, non-profit corporations/NGOs and three (3) years for newly-organized non-stock, non-profit corporations/NGOs.

(g) The Accrediting Entity shall deny the applications of any non-stock, non-profit corporation/NGO which does not meet the criteria for accreditation. The Private Accrediting Entity shall notify the non-stock, non-profit corporation/NGO of the denial of the application, the reasons therefor, and the evaluators' recommendation in order that the non-stock, non-profit corporation/NGO may meet the criteria for accreditation. A non-stock, non-profit corporation/NGO whose application for accreditation has been denied by the Private Accrediting Entity shall have one (1) year within which to implement the evaluator's recommendations. After the one-year implementation period, the non-stock, non-profit corporation/NGO may re-apply for accreditation.

(h) The Secretary of Finance and the Commissioner of Internal Revenue shall oversee, monitor and coordinate with the Accrediting Entity to ensure that the provisions of these Regulations are complied with.

SECTION 3. Donations to Accredited Non-stock, Non-profit Corporations/NGOs. — Donations to accredited non-stock, non-profit corporations/NGOs shall be entitled to the following benefits:

(1) Limited Deductibility. — Donations, contributions or gifts actually paid or made within the taxable year to accredited non-stock, non-profit corporations shall be allowed limited deductibility in an amount not in excess of ten percent (10%) for an individual donor, and five percent (5%) for a corporate donor, of the donor's income derived from trade, business or profession as computed without the benefit of this deduction.

(2) Full Deductibility. — Donations, contributions or gifts actually paid or made within the taxable year to accredited NGOs shall be allowed full deductibility, subject to the following conditions:

(i) The accredited NGO shall make utilization directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated, not later than the fifteenth (15th) day of the third month after the close of the accredited NGOs taxable year in which contributions are received, unless an extended period is granted by the Secretary of Finance, upon recommendation of the Commissioner.

For this purpose, the term "utilization" shall have the meaning as defined under Sec. 1(c) of these Regulations.

(ii) The level of administrative expenses of the accredited NGO, shall, on an annual basis, not exceed thirty percent (30%) of the total expenses for the taxable year;

(iii) In the event of dissolution, the assets of the accredited NGO, would be distributed to another accredited NGO organized for similar purpose or purposes, or to the State for public purpose, or purposes, or to the state for public purpose, or would be distributed by a competent court of justice to another accredited NGO to be used in such manner as in the judgment of said court shall best accomplished the general purpose for which the dissolved organization was organized.

(iv) The amount of any charitable contribution of property other than money shall be based on the acquisition cost of said property

(v) All the members of the Board of Trustees of the non-stock, non-profit corporation, organization or NGO do not receive compensation or remuneration for their service to the aforementioned organization.

(3) Exemption from Donor's Tax — Donations and gifts made in favor of accredited non-stock, non-profit corporations/NGOs shall be exempt from donor's tax: Provided, however, That not more than thirty percent (30%) of the said donations and gifts for the taxable year shall be used by such accredited non-stock, non-profit corporations/NGOs institutions qualified-donee institution for administration purposes pursuant to the provisions of Section 101 (A)(3) and (B)(2) of the Tax Code .

SECTION 5. Certificate of Donations. — All accredited non-stock, non-profit corporation/NGO are required to issue a certificate of donation in such form as prescribed by the BIR, on every donation or gift they receive. Such certificate shall be accomplished by the said accredited non-stock, non-profit corporation/NGO in triplicate and distributed within thirty (30) days after the receipt of the donation, as follows:

(a) Original copy - Donor

(b) Duplicate copy - BIR

(c) Triplicate copy - Donee

SECTION 6. Notice of Donations. — The donor, on the other hand, should give a notice for every donation worth over One Million pesos (P1,000,000) to the Revenue District Officer where his place of business is located within thirty (30) days after the receipt of the Certificate of Donation attaching to the said notice the copy of the Certificate of Donation issued to him by the accredited non-stock, non-profit corporation/NGO.

SECTION 8. Substantiation Requirements. —

(a) For Donors. — Donors claiming donations and contributions to accredited non-stock, non-profit corporation/NGO as deductions from their taxable business income should submit evidences or proofs to the BIR by showing the Certificate/s of Donation and indicating therein the following:

(i) Actual receipt by the accredited non-stock, non-profit corporation/NGO of the donation or contribution and the date of receipt thereof; and

(ii) The amount of the charitable donation or contribution, if in cash; if property, whether real or personal, the acquisition cost of the said property.

On the other hand, donors claiming exemption from donor's tax on their donations and contributions to accredited non-stock, non-profit corporations/NGOs should submit evidences or proofs showing the amount of donation, if in cash; if real property, the zonal value thereof at the time of donation; and if personal property, the acquisition cost thereof, but if said personal property had already been used at the time of donation, the depreciated or book value thereof.

(b) For Accredited Non-stock, Non-profit Corporations/NGOs. — Accredited non-stock, non-profit corporations/NGOs shall, upon filing their income tax returns/annual

information returns, furnish the Revenue District Officer of the place where the said accredited non-stock, non-profit corporation/NGO is located, the following:

(i) A list of the donations and income received during the year, showing the name and address of the donors; the sources of income; the amount or market value of each donation and items of income and the disposition thereof;

(ii) A list of the activities and/or projects undertaken by the institution and the cost of each undertaking indicating in particular where and how the donations has been utilized.

(iii) A list of projects, their corresponding costs; the amount "set aside" and the status of funds balances at the end of the year;

(iv) A declaration that the utilization requirements under Section 2(c) and 8 of these Regulations have been sufficiently complied with;

(v) A declaration that no part of the net income of the accredited non-stock, non-profit corporation/NGO inures to the benefit of any private stockholder or individual; and

(vi) A declaration of the status of project implementation.

SECTION 10. Prohibited Transactions. — any accredited non-stock, non-profit corporation/NGO enjoying the benefits provided for under Sec. 4 of these Regulations is prohibited from undertaking any of the following transactions:

(a) Lending any part of its income or property without adequate security and/or a reasonable rate of interest unless the institution has a formal micro-credit or micro-finance program as approved by their Board of Trustees;

(b) Purchasing any security and/or property for more than an adequate consideration in money or money's worth;

(c) Selling any part of the security or other property for less than adequate consideration in money or money's worth;

(d) Diverting its income or transferring its property by way of lease or sale to any member of its Board of Trustees, founder/s or principal officers or any member of their families or to any corporation controlled directly or indirectly by the aforesaid individuals or their families in accordance with the attribution of stock ownership under Section 73 (A) and (B) of the Tax Code ;

(e) Using any part of its property, income or seed capital for any purpose other than that for which the corporation was created or organized; or

(f) Engaging in any activity which is contrary to law, public order or public policy.

M. ADDITIONAL REQUIREMENTS FOR DEDUCTIBILITY REVENUE MEMORANDUM ORDER NO. 38-83

Subject : Guidelines for Allowance of Deductions for Certain Income Payments Under Section 30 (1) of the Tax Code.

1. Background

1.1 Section 30 (1) of the National Internal Revenue Code, as amended by Batas Pambansa Blg. 135 , provides:

"(1) Additional requirement for deductibility of certain payments. - Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income for which depreciation or amortization may be allowed under this section and Section 29, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance with this section, Sections 54 and 93 of this Code. "

1.2 The abovequoted provisions of the Tax Code is frequently cited by Revenue Examiners in their reports of investigation to justify disallowances of certain expense and other itemized deductions for which the taxpayer is obliged to make a withholding under Sections 54 and 93 of the Code and implementing regulations. Since the amounts otherwise deductible are substantial, some taxpayers have vigorously protested the literal application of the said provision in the audit and investigation of their income tax liabilities.

1.3 In order to minimize audit controversies and to achieve uniformity in implementing the aforequoted provision of Section 30(1), this Revenue Memorandum Order is hereby issued to prescribe guidelines that shall be observed by revenue officers for allowing or disallowing items of deductions referred to in the said Section.

2. The Rationale of Section 30(1)

2.1 PD 1351 which became effective April 17, 1978 added Section 30(1) to the Code (originally as paragraph (m) of Section 30) as an additional requirement for deductibility of itemized deductions representing income payments which are subject to withholding. Batas Pambansa Blg. 125 which was approved September 7, 1979 expanded the scope of the items of deductions subject to the requirement by including amounts taken into account in computing gross income for which depreciation or amortization may be allowed. The obvious purpose of this provision is to compel compliance with the requirements of Sections 54 and 93.

2.2 Considering that the existing ad valorem (surcharges and interests), as well as the specific penalties (fine and imprisonment), are adequate to compel taxpayers/withholding agents to comply with the requirements of the withholding tax law and regulations, outright disallowance of deductions representing income payment for mere failure to withhold and remit will in effect, in case of corporations, be tantamount to the imposition of additional 25% or 35% "surcharge" (equivalent to the normal corporate tax rates).

2.3 In order to minimize the onerous effect of literal application of Section 30(1), allowance or disallowance of a deduction falling under the said paragraph of Section 30 shall be determined in accordance with the following guidelines.

3. Guidelines For Applying Section 30(1).

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

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

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

3.1/3 The withholding agent erroneously underwithheld the tax but pays during the original audit and investigation the difference in the amount supposed

to have been withheld, inclusive of surcharges, interest and penalties incident to such error.

3.2 Items of deductions disallowed due to non-compliance with Section 30 (1), the deficiency income tax assessment for which had been issued before the effectivity of this Revenue Memorandum Order may be allowed upon payment not later than May 15, 1984 of the withholding tax required and supposed to have been withheld and/or surcharges, interest and penalties. However, no refund or credit arising from such re-allowance of a previously disallowed deduction shall be granted.

N. ITEMS NOT DEDUCTIBLE REVENUE REGULATION 2-40 SECTION 119. Personal, living, and family expenses. — Personal, living, and family expenses are not deductible. Insurance paid on a dwelling owned and occupied by a taxpayer is a personal expense and not deductible. Premiums paid for life insurance by the insured are not deductible. In the case of a professional man who rents a property for residential purposes, but incidentally receives his clients, patients, or callers in connection with his professional work (his place of business being elsewhere), no part of the rent is deductible as a business expense. If however, he uses part of the house for his office, such portion of the rent as is properly attributable to such office is deductible. Where the father is legally entitled to the services of his minor children, any allowances which he gives them, whether said to be in consideration of services or otherwise, are not allowable deductions in his return of income. Alimony, and an allowance paid under a separation agreement are not deductible from gross income.

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

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

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

SECTION 122. Losses from sales or exchanges of property. — No deduction is allowed in respect of losses from sales or exchanges of property, directly or indirectly —

(a) Between members of a family. As used in Section 31, the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants;

(b) Except in the case of distributions in liquidation, between an individual and a corporation more than fifty per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;

(c) Except in the case of distributions in liquidation, between two corporations more than 50 per cent in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign personal holding company;

(d) Between a grantor and a fiduciary of any trust;

(e) Between the fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor with respect to each trust; or

(f) Between a fiduciary of a trust and a beneficiary of such trust.

Atlas Consolidated v. CIR, GR. L-26911

Doctrine: Public Relations Expense is not deductible.

Facts: Atlas is being assessed of deficiency income tax. Atlas protested the assessment asking for its reconsideration and cancellation. It is the contention of Atlas that the amount paid for as annual public relations expenses is a deductible expense from gross income under sec 30 of the NIRC. Atlas claimed that it was paid for services of a public relations firm, P.K. Macker, a reputable public relations consultant in New York, hence an ordinary and necessary business expense.

ISSUE: Whether or not the expenses paid to create a favorable image of the corporation is a deductible expense?

HELD: No, efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures. To be deductible as business expense, the following requisites are imposed: 1. the expense must be ordinary and necessary, 2. paid and incurred within the taxable year, 3. paid or incurred in carrying in a trade or business.

PART VI

I. SALE OR EXCHANGE OF PROPERTY


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

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

SECTION 133. Percentage taken into account. — In computing net income, only 50 per cent of the gain or loss recognized upon the sale or exchange for a capital asset shall be taken into account. Thus, in the case of a merchandising concern which has an "ordinary net income" (net income exclusive of net gains from the sale or exchange of capital assets) of P10,000 and a net capital gain of P5,000, the net income subject to tax will be P10,000 plus P2,500 (50 % of P5,000), of P12,500.

SECTION 134. Limitation on capital losses. — Losses from sales or exchanges of capital assets are allowed only to the extent of the gains from such sales or exchanges. If the dealings of the taxpayer in capital assets during the year result in a net capital loss, such loss cannot be deducted from his ordinary income, inasmuch as capital losses are allowable only to the extent of capital gains. In the case, for example, of a taxpayer, engaged in buying and selling goods, having an ordinary net income of P20,000, capital gains of P5,000 and capital losses of P3,000 the taxable net income is computed as follows:

Ordinary net income P20,000 Gains from sales of capital assets (as stocks or securities) P5,000 50% of such gains P2,500 Losses from sales of capital assets P3,000 50% of such losses P1,500 Net taxable capital gains 1,000 ———— Taxable net income P21,000 ======= If such taxpayer had an ordinary net income of P20,000, capital gains of P2,000 and capital losses of P7,000, the taxable net income would be computed as follows:

Ordinary net income P20,000 Losses from sales of capital assets (as stocks or securities) P7,000 50% of such losses P3,500 Gains from sales of capital assets 2,000 50% of such gains 1,000 ——— Net capital losses P2,500 Taxable net income P20,000 ====== (The net capital loss of P2,500 is not deductible in arriving at the taxable net income inasmuch as capital losses are allowed only to the extent of capital gains.)

SECTION 134-A. Capital loss carry-over-Illustration. — A, an individual has the following incomes and losses:

1946 — Net income from business 1,000 Dividends received 750 Interest earned 500 Capital gains — on capital assets held for 8 months 5,000 Capital losses — on capital assets held for 9 months 10,000 1947 — Net income from business 2,000 Interest earned 200 Capital gains — on capital assets held for 15 months 5,000 In 1946, his taxable income is computed as follows: Income from business, dividends and interest P2,250 Capital gains and losses: Capital gains P5,000 Less-Capital losses 10,000 ——— Net loss carried over to 1947 (P5,000) ——— Net income subject to tax P2,250 In 1947, his taxable income is computed as follows: Income from business and interest P2,200 Capital gains and losses: Capital gains P5,000 ——— One-half P2,500 ——— Less-Capital loss carried over (#) 2,250 Net capital gain 250 ——— Net income subject to tax P2,450 ====== # The net capital loss of P5,000 sustained in 1946 and carried over in 1947 is reduced to P2,250 for the reason that the net income from business and other sources (not including capital gain), for the year 1946 is only P2,250.

If a bank or trust company incorporated under the laws of the Philippines or of the United States, a substantial part of whose business is the receipt of deposits, sells any bond, debenture, note, or 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 limitation contained in Section 34(c) and shall not be included in determining the applicability of such limitation to other losses.

SECTION 135. Gains and losses from short sales. — For income tax purposes, a short sale is not deemed to be consummated until the delivery of property to cover the short sale. If the short sale is made through a broker and the broker borrows property to make delivery, the short sale is not deemed to be consummated until the obligation of the seller created by the short sale is finally discharged by delivery of property to the brokers to replace the property borrowed by such broker.

I.A.1. DEFITION OF CAPITAL 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 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.

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 as ordinary 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. IHCDAS

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 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 times determine 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.

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.

For example, real properties forming part of the inventory of a real estate dealer, which are foreclosed, shall, for purposes of determining the applicable tax on such foreclosure sale, be treated as ordinary assets. On the other hand, the nature of such real property in the hands of the foreclosure buyer shall be determined in accordance with the rules stated in sub-paragraph (f) hereof.

SECTION 4. Applicable Taxes on Sale, Exchange or Other Disposition of Real Property. — Gains/Income derived from sale, exchange, or other disposition of real properties shall, unless otherwise exempt, be subject to applicable taxes imposed under the Code, depending on whether the subject properties are classified as capital assets or ordinary assets.

a. In the case of individual citizens (including estates and trusts), resident aliens, and non-resident aliens engaged in trade or business in the Philippines.

(i) Capital gains presumed to have been realized from the sale, exchange, or other disposition of real property located in the Philippines, classified as capital assets, shall be subject to the six percent (6%) capital gains tax imposed under Sec. 24(D)(1) or 25(A)(3) of the Code, as the case may be, based on the gross selling price or current fair market value as determined in accordance with Sec. 6(E) of the Code, whichever is higher, provided, that if the buyer is the Government or any of its political subdivisions or agencies or a government-owned-or-controlled corporation, the tax liability shall, at the option of the individual seller (including estate or trust), be computed on the basis of either the six percent (6%) capital gains tax under Sec. 24(D)(1)/25(A)(3) or the graduated tax rates under Sec. 24(A)(1)(c) or 25(A)(1) , all of the Code.

(ii) The sale of real property located in the Philippines, classified as ordinary assets, shall be subject to the creditable withholding tax (expanded) under Sec. 2.57.2(J) of Rev. Regs. No. 2-98, as amended, based on the gross selling price or current fair market value as determined in accordance with Section 6(E) of the Code, whichever is higher, and consequently, to the ordinary income tax imposed under Sec. 24(A)(1)(c) or 25(A)(1) of the Code, as the case may be, based on net taxable income.

b. In the case of non-resident aliens not engaged in trade or business in the Philippines. — Capital gains presumed to have been realized by non-resident aliens not engaged in trade or business in the Philippines on the sale of real property located in the Philippines shall be subject to the six percent (6%) capital gains tax imposed under Sec. 25(B), in relation to Sec. 24(D)(1), of the Code, based on the gross selling price or current fair market value as determined in accordance with Sec. 6(E) of the Code, whichever is higher.

c. In the case of domestic corporations. —

(i) Capital gains presumed to have been realized from the sale, exchange or disposition of lands and/or buildings located in the Philippines, which are classified as capital assets, shall be subject to a capital gains tax of six percent (6%) based on the gross selling price or current fair market value as determined in accordance with Sec. 6(E) of the Code, whichever is higher, of such land and/or buildings pursuant to Sec. 27(D)(5) of the Code.

(ii) The sale of land and/or building classified as ordinary asset and other real property (other than land and/or building treated as capital asset), regardless of the classification thereof, all of which are located in the Philippines, shall be subject to the creditable withholding tax (expanded) under Sec. 2.57.2(J) of Rev. Regs. No. 2-98, as amended, and consequently, to the ordinary income tax under Sec. 27(A) of the Code. In lieu of the ordinary income tax, however, domestic corporations may become subject to the minimum corporate income tax (MCIT) under Sec. 27(E) of the Code, whichever is applicable.

d. In the case of resident foreign corporations. — Real property located in the Philippines, regardless of classification, sold by a resident foreign corporation shall be subject to the creditable withholding tax (expanded) under Sec. 2.57.2(J) of Rev. Regs. No. 2-98, as amended, and consequently, to the ordinary income tax under Sec. 28(A)(1) or to the MCIT under Sec. 28(A)(2), both of the Code, whichever is applicable.

e. In the case of non-resident foreign corporations. — The gain from the sale of real property located in the Philippines by a non-resident foreign corporation shall be subject to the final withholding tax at the rate of thirty-two percent (32%) imposed under Sec. 2.57.1(I) of Rev. Regs. No. 2-98, as amended, in relation to Sec. 28(B)(1) of the Code.

f. Income on sale of real property not located in the Philippines. — Gain realized from the sale, exchange, or other disposition of real property not located in the Philippines, regardless of classification, by resident citizens or domestic corporations shall be subject to the income tax imposed in Sec. 24(A)(1), or Sec. 27(A) or (E) of the Code, as the case may be. Such income/gain shall be exempt pursuant to Sec. 23(B) , (D) and (F) of the Code, as the case may be, in the case of non-resident citizens, alien individuals and foreign corporations,

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 dealer’s 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? ORDINARY INCOME.

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.

I.B. DETERMINATION OF GAIN OR LOSS FROM SALE OR TRANSFER OF PROPERTY


SECTION 136. Basis for determining gain or loss from sale of property. — For the purpose of ascertaining the gain or loss from the sale or exchange of property, the basis is the cost of such property, or in the case of property which should be included in the inventory, its latest inventory value. But in the case of property acquired before March 1, 1913, when its fair market value as of that date is in excess of its cost, the gain to be included in gross income is the excess of the amount realized therefor over such fair market value. (See illustration I, Section 137 of these regulations). Also in the case of property acquired before March 1, 1913, when its fair market value as of that date is lower than its cost the deductible loss is the excess of such fair market value over the amount realized therefor. (See Illustration II, Id.). No gain or loss is recognized in the case of

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

SECTION 137. Illustrations of the computation of gain or loss from the sale or exchange of property acquired prior to March 1, 1913. — To avoid complexity no adjustment has been made in these examples for depreciation or depletion.

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

ILLUSTRATION I

Fair Market

Cost Value Sale Price Taxable gain

Mar. 1, 1913

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

Excess of amount realized over fair

market value as of March 1, 1913.

Gain attributed to the period prior

to March 1, 1913 not taxable.

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

ILLUSTRATION II

Fair Market


Mar. 1, 1913

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

Excess of fair market value over

amount realized. Loss attributable to

the period prior to March 1, 1913, not

deductible.

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

ILLUSTRATION III

Fair Market


Mar. 1, 1913

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

Reason: A gain on whole transaction,

which gain is attributed to period prior

to March 1,1913.

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

ILLUSTRATION IV

Fair Market


Mar. 1, 1913

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

Reason: A loss on whole transaction,

which loss is attributable to period

prior to March 1, 1913.

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

ILLUSTRATION V

Fair Market


Mar. 1, 1913

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

Reason: Gain on whole transaction,

all of which is attributable to period

subsequent to March 1, 1913.

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

ILLUSTRATION VI

Fair Market


Mar. 1, 1913

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

Reason: Loss on whole transaction, all

of which is attributable to period

subsequent to March 1, 1913. Only

actual loss sustained deductible.

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

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

SECTION 140. Exchange of property. — Gain or loss arising from the acquisition and subsequent disposition of property is realized only when as the result of a transaction between the owner and another person the property is converted into other property (a) that is essentially different from the property disposed of, and (b) that has a market value. The requirement that the property received in exchange must be "essentially different from the property disposed of" implies that there must be a change in substance and not merely a change in form. By way of illustration, if a taxpayer owning ten shares of stock exchanges his stock certificate for a voting trust certificate, no income is realized. The term "market value" means the fair value of the property in money as between one who wishes to purchase and one who wishes to sell. It is not, however, what can be obtained for the property when the owner is under peculiar compulsion to sell or the purchaser to buy; nor is it a purely speculative value which an owner could not reasonably expect to obtain for the property although he might possibly be fortunate enough to do so. "Market value" is the price at which a seller willing to sell at a fair price and a buyer willing to buy at a fair price, both having reasonable knowledge of the facts, will trade. Evidence as to the assets and liabilities of a corporation and as to its earnings may furnish definite indications of the market value of its stock.

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

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

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

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

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

3. TAX-FREE EXCHANGE OF PROPERTY

i. MERGER OR CONSOLIDATION


Gentlemen :

This refers to your letter dated August 4, 1987 requesting 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 stockholders shall receive the equivalent amount in DFI shares of stock or P163,384.95 DFI shares with a par value of P100.00 per share; that considering that 809,750 shares of EFI with a par value of P10.00 per share are issued and outstanding, one (1) DFI share shall be issued for approximately 4.9561EFI shares; that Ignacio shall receive 114,369.41 DFI shares for his 566,825 EFI shares, while PPC shall receive 40,015.48 DFI shares for its 242,925 EFI shares (including the four (4) qualifying shares in the names of its four (4) nominees; that in order to avoid fractional shares, Ignacio and PPC agree that the latter shall waive in favor of the former its fractional share, with the additional payment by Ignacio of P5.00 to complete one (1) whole share, that the Articles of Incorporation of DFI shall simultaneously be amended to increase its authorized capital stock by P40 million, or from P10 million to P50 million, and at least 25% of which increase or P16,338,500.00 equivalent to 163,385 shares shall be issued as aforementioned in exchange for the 809,750 outstanding shares of EFI worth of P16,338,495.00 and the additional payment in cash of P5.00 as aforementioned, that after the effective date of the merger, all EFI stockholders will become DFI stockholders, and that simultaneous with the merger the Articles of Incorporation of the surviving corporation, DFI shall be amended and its name shall be Evergreen Farms, Inc. immediately after the effectivity of the merger.

In reply thereto, I have the honor to inform you that the above reorganization is a merger within the contemplation of Section 35(c)(2) and (5(b) of the Tax Code because a corporation (DFI) acquired all of the properties of another corporation (EFI) solely for stocks, the transaction undertaken being for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation.

Accordingly, the transfer by EFI of all its assets and liabilities to DFI solely, in exchange for the latter's shares of stock shall not give rise to the recognition of gain or loss pursuant to Section 35(c)(2) of the Tax Code. No gain or loss shall be recognized to EFI upon the distribution of DFI shares to EFI stockholders in complete redemption of their stocks under Section 35(c)(2) of the Tax Code. No gain or loss shall be recognized to EFI stockholders upon the exchange of their stocks solely for DFI stocks under Section 35(c)(2) of the Tax Code.

The basis of the assets received by DFI shall be the same as it would be in the hands of EFI. The basis of DFI stocks received by the stockholders of EFI shall be the same as the basis of the EFI stocks surrendered in exchange therefor.

If the total liabilities to be assumed by DFI upon effective merger date exceed the historical or original acquisition cost (cost basis) of the assets transferred by EFI, the excess shall be recognized as gain of EFI. (Sec. 35(c)(4)(b), Tax Code, as amended by P.D. No. 1773)

It is understood, however, that upon the subsequent sale or exchange of the assets or shares of stocks acquired by the parties, the gain derived from such sale or exchange shall be subject to income tax.

The abovementioned transactions shall not be subject to the gift tax as there is no intention to donate on the part of any of the parties.

COMMISSIONER v. RUFINO, L-33665-68

Facts: The private respondents were the majority stockholders of the defunct Eastern Theatrical Co. It had an original capital stock of P500,000.00, which was increased in 1949 to P2,000,000.00, divided into 200,000 shares at P10.00 per share, and was organized to engage in the business of operating theaters, opera houses, places of amusement and other related business enterprises, more particularly the Lyric and Capitol Theaters in Manila. The President of this corporation (hereinafter referred to as the Old Corporation) during the year in question was Ernesto D. Rufino.

They are also the majority and controlling stockholders of another corporation, the Eastern Theatrical, Inc. This corporation is engaged in the same kind of business as the Old Corporation. The General-Manager of this corporation (hereinafter referred to as the New Corporation) at the time was Vicente A. Rufino.

In a special meeting of stockholders of the Old Corporation on December 17, 1958, to provide for the continuation of its business after the end of its corporate life, and upon the recommendation of its board of directors, a resolution was passed authorizing the Old Corporation to merge with the New Corporation by transferring all its business, assets, goodwill, and liabilities to the latter, which in exchange would issue and distribute to the shareholders of the Old Corporation one share for each share held by them in the said Corporation.

It was expressly declared that the merger of the Old Corporation with the New Corporation was necessary to continue the exhibition of moving pictures at the Lyric and Capitol Theaters even after the expiration of the corporate existence of the former, in view of its pending booking contracts, not to mention its collective bargaining agreements with its employees.

The aforesaid transfer was eventually made by the Old Corporation to the New Corporation, which continued the operation of the Lyric and Capitol Theaters and assumed all the obligations and liabilities of the Old Corporation beginning January 1, 1959.

The Bureau of Internal Revenue examined later, resulting in the petitioner declaring that the merger of the aforesaid corporations was not undertaken for a bona fide business purpose but merely to avoid liability for the capital gains tax on the exchange of the old for the new shares of stock. Accordingly, he imposed the deficiency assessments against the private respondents.

Held: The Court of Tax Appeals did not err in finding that no taxable gain was derived by the private respondents from the questioned transaction. There was a valid merger although the actual transfer of the properties subject of the Deed of Assignment was not made on the date of the merger. The Court finds no impediment to the exchange of property for stock between the two corporations being considered to have been effected on the date of the merger. That, in fact, was the intention, and the reason why the Deed of Assignment was made retroactive to January 1, 1959. Such retroaction provided in effect that all transactions set forth in the merger agreement shall be deemed to be taking place simultaneously on January 1. 1959, when the Deed of Assignment became operative. The certificates of stock subsequently delivered by the New Corporation to the private respondents were only evidence of the ownership of such stocks. Although these certificates could be issued to them only after the approval by the SEC of the increase in capitalization of the New Corporation, the title thereto, legally speaking, was transferred to them on the date the merger took effect, in accordance with the Deed of Assignment. Our ruling then is that the merger in question involved a pooling of resources aimed at the continuation and expansion of business and so came under the latter and intendment of the National Internal Revenue code, as amended by the above-cited law, exempting from the capital gains tax exchanges of property effected under lawful corporate combinations.

The basis consideration, of course, is the purpose of the merger, as this would determine whether the exchange of properties involved therein shall be subject or not to the capital gains tax. The criterion laid down by the law is that the merger "must be undertaken for a bona fide" business purpose and not solely for the purpose of escaping the burden of taxation."

iii. TRANSFER OF PROPERTY FOR SHARES OF STOCK

REVENUE MEMORANDUM RULING NO. 01-01

SUBJECT : Tax Consequences of Tax-Free Exchange of Property for Shares of Stock of a Controlled Corporation Pursuant to Section 40(C)(2) of the National Internal Revenue Code of 1997

This Revenue Memorandum Ruling shall apply solely and exclusively to, and may be relied upon only in situations in which the facts are substantially similar to the facts stated below, but subject to the principles of substance over form.

I. FACTS

1. A domestic corporation (the "Transferor") owns certain property, consisting, for example, of the following:

1.1 Land encumbered by a real estate mortgage (REM);

1.2 Buildings;

1.3 100 shares of stock in G Corporation with a par value of P10 per share;

1.4 50 shares of stock in D Corporation without par value;

1.5 Unsecured receivables;

1.6 Loans to Q ("Borrower/Mortgagor"), secured by a real estate mortgage;

1.7 Cash.

2. X Corporation (the "Transferee") is a domestic corporation.

3. The Transferor transfers the property to the Transferee. In exchange, the Transferee issues shares to the Transferor out of the unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock. The Transferor does not receive any money or property other than the aforementioned shares of the transferee.

4. The property transferred by the Transferor-corporation constitutes less than 80% of the Transferor's assets, including cash.

5. In addition to the transfer of the property, the Transferee assumes liabilities of the Transferor. However, the sum total of the amount of liabilities assumed, plus the amount of the encumbrance or REM on the Land (as stated in Section 40(C)(4) of the Tax Code of 1997 — "liabilities to which the property is subject") do not exceed the basis of the property transferred.

6. The shares are neither issued in payment for services, nor for settlement of an outstanding liability that arises from the performance of services rendered by the Transferor to the Transferee.

7. As a result of the above-mentioned transfer, the Transferor acquires at least 51% of the total outstanding capital stock of the Transferee entitled to vote. HTAEIS

II TAX CONSEQUENCES

1. Income tax. The Transferor shall not recognize any gain or loss on the transfer of the property to the Transferee. Consequently, the Transferor will not be subject to capital

gains tax, income tax, or to creditable withholding tax on the transfer of such property to the Transferee. Neither may the transferor recognize a loss, if any, incurred on the transfer. The last paragraph of Section 40(C)(2) and (6)(c) of the Tax Code of 1997 state:

"No gain or loss shall also be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four (4) persons, gains control of said corporation: Provided, That stocks issued for services shall not be considered as issued in return for property."

"(c) The term "control", when used in this Section, shall mean 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."

In addition, the assumption of liabilities or the transfer of property that is subject to a liability does not affect the non-recognition of gain or loss under Section 40(C)(2) of the Tax Code of 1997, since in this case, the total amount of such liabilities does not exceed the basis of the property transferred. Section 40(C)(4) of the Tax Code of 1997 states:

"(4) Assumption of liability. —

(a) If the taxpayer, in connection with the exchanges described in the foregoing exceptions, receives stock or securities which would be permitted to be received without the recognition of the gain if it were the sole consideration, and as a part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property, subject to a liability, then such assumption or acquisition shall not be treated as money and/or other property, and shall not prevent the exchange from being within the exceptions.

(b) If the amount of the liabilities assumed plus the amount of the liabilities to which the property is subject exceed the total amount of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be."

In addition, the Transferee is not subject to income tax on its receipt of the property as contribution to its capital, even if the value of such property exceeds the par value or stated value of the shares issued to the Transferor. Section 55 of Revenue Regulations No. 2 ("Income Tax Regulations") states:

"Section 55. Acquisition or disposition by a corporation of its own capital stock. — . . . . The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than the par or stated value of such stock.

xxx xxx xxx"

However, stocks shall not be issued for a consideration less than par or issued price thereof. (Section 62, Corporation Code of the Philippines)

2. Donor's tax. The Transferor is not subject to donor's tax, regardless of whether the value of the property transferred exceeds the par/stated value of the Transferee shares issued to the Transferor, there being no intent to donate on the part of the Transferor.

3. Value added tax. The Transferor is not subject to value-added tax ("VAT") on the transfer of the property if it is not engaged in a business that is subject to the VAT under Title IV of the Tax Code of 1997. Even if the Transferor is engaged in an activity that is subject to VAT, it is nonetheless not subject to VAT on the transfer of the property to the Transferee, since the Transferor gains control of the Transferee. Section 4.100-5(b)(1) of Revenue Regulations No. 7-95, as amended states:

"(b) Not subject to output tax. — The VAT shall not apply to goods or properties existing as of the occurrence of the following:

1) Change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholders, Example: transfer of property to a corporation in exchange for its shares of stock under Section 34(c)(2) and (6)(c) of the Code [now 40(C)(2) and (6)(c) of the Tax Code of 1997].

4. Documentary stamp tax.

5. Time of Payment of Taxes.

III ADDITIONAL FACTS AND VARIATIONS NOT AFFECTING TAX CONSEQUENCES

The following additional facts or variations will not affect the tax consequences of the transaction, as described above:

1. In no. 1 of "I. Facts" stated above, if the total number of Transferors does not exceed five persons, whether such persons are natural persons or juridical persons.

2. In no. 7 of "I. Facts" stated above, the tax consequences are not affected by whether the Transferor is/was a shareholder prior to the transaction, or that, prior to the transaction, the Transferor already possessed control of the Transferee by owning 51% or more of the total outstanding capital stock of the Transferee entitled to vote. In such a case, the Transferor is deemed to have acquired "further control" of the Transferee, which places the transaction within the purview of Section 40(C)(2) of the Tax Code of 1997.

However, a Transferor who, prior to the transaction was an existing shareholder of the Transferee, but who owned less than 51% of the voting stocks of the Transferee (even if it, together with not more than four (4) persons, owned more than 51% of all classes of stocks entitled to vote of the Transferee) cannot be deemed to have gained control or further control of the Transferee if, after a transaction in which it is the sole transferor, it still owned by itself less than 51% of the voting stocks of the Transferee. For instance, assume in the above facts that, prior to the transfer, the Transferor, together with Stockholders E, B, M and R, owned 100% of the voting stocks of the Transferee. However, by itself the Transferor owned only 32% of the voting stocks of the Transferee (the balance of the 68% voting stocks being owned by Stockholders E, B, M and R). The Transferor transfers property to the Transferee in exchange for shares of stock. After this exchange, the Transferor owned, including the initial 32%, a total of 49% — or less than 51% — of the voting stocks of the Transferee. In this situation, the Transferor is not deemed to have gained control or further control of the Transferee.

NOTE: SEE CONSEQUENCE OF NEW SC DECISION ON THIS. FILINVEST CASE

IV FURTHER CLARIFICATION OF FACTS AND TAX CONSEQUENCES

1. No. 1 of "I. Facts" mentions "property". For purposes of Section 40(C)(2) of the Tax Code of 1997, this term excludes services, accounts receivable for services rendered by the Transferor for the Transferee, cash and the conversion of debt into equity.

2. No. 3 of "I. Facts" mentions the issuance of the Transferee's shares from the "unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock". This statement of fact excludes the following, which if present, would give rise to a different tax consequence treated elsewhere other than in this Revenue Memorandum Ruling —

2.1 The issuance of treasury shares, which have previously been issued but were subsequently re-acquired by the Transferee and have not been retired.

2.2 Settlement of subscription receivables Therefore, the tax consequences described above shall not apply to the extent that the property is transferred in payment for the unpaid balance of the subscription to shares.

3. No. 4 of "I. Facts" mentions the property transferred constituting "less than 80% of the Transferor's assets, Including cash". This requirement is necessary to distinguish this transaction from a de facto merger as described in Section 40(C)(6)(b) of the Tax Code of 1997 in relation to BIR Circular No. V-253 dated July 16, 1957, the tax consequences of which will be discussed in a different Revenue Memorandum Ruling.

4. No. 5 of "I. Facts" mentions the term "adjusted basis of the property", as well as the fact that such liabilities assumed and to which the property is subject "do(es) not exceed the adjusted basis of the property transferred". These terms are clarified as follows:

4.1 The basis or "original basis" of the property is its "historical cost". "Historical cost" is the value of the property as determined pursuant to Section 40(B) of the Tax Code of 1997. The term "adjusted basis" is the value of the property as determined pursuant to the said Section, modified by adjustments to the historical cost. For example, the "adjusted basis" of a property acquired by purchase is the historical cost (acquisition cost) of such property increased by, among others, the amount of improvements that materially add to the value of the property or appreciably prolong its life and decreased by accumulated depreciation. "Adjusted basis" excludes re-appraisal surplus, whether or not recorded in the books of the Transferor.

4.2 "Property" does not include services or accounts receivable for services rendered by the Transferor to the Transferee, cash, or the conversion of debt into equity. Therefore, in determining whether liabilities assumed and to which the property is subject "do(es) not exceed the adjusted basis of the property transferred", the value of services rendered, cash and the conversion of debt into equity will be excluded from the computation of "adjusted basis of the property transferred".

5. The term "adjusted basis" should be distinguished from the term "substituted basis", since they are not necessarily synonymous. The terms "original basis" and "adjusted basis" are used in reference to the value of the property before it was transferred by the Transferor; whereas, the term "substituted basis" is used in reference to both the value of the property in the hands of the Transferee after its transfer and the shares received by the Transferor from the Transferee. The term "substituted basis" is significant in determining the tax basis of the aforementioned property or shares for purposes of computing the gain or loss on the subsequent disposition of such property or shares. The following rules will apply in determining substituted basis:

5.1 In general, the substituted basis of the Transferee's shares received by the Transferor for purposes of computing gain or loss on the subsequent disposition of such shares by the Transferor is equal to the Transferor's basis in the property at the time of the transfer (that is, "historical cost/original basis" or "adjusted basis", as the case may be) decreased by (1) the money received by the Transferor, and (2) the fair market value of the other property received by the Transferor, and increased by (a) the amount treated as dividend of the shareholder and (b) the amount of any gain that was recognized on the exchange. If, as in this case, the Transferee assumed liabilities of the Transferor and/or acquired property of the Transferor that is subject to liabilities, the amount of liabilities shall be treated as money for purposes of determining the substituted basis. In the particular facts covered by this Revenue Memorandum Ruling, the substituted basis of the Transferee's shares acquired by the Transferor is the historical cost/original basis or adjusted basis of the properties mentioned in no. 1 of "I. Facts" (excluding cash), less the total of (a) the amount of liabilities assumed by the Transferee and (b) the amount of real estate mortgage on the Land.

Section 40(C)(5)(a) of the Tax Code of 1997 states:

"(5) Basis. —

(a) The basis of the stock or securities received by the transferor upon the exchange specified in the above exception shall be the same as the basis of the property, stock or securities exchanged, decreased by (1) the money received, and (2) the fair market value of the other property received, and increased by (a) the amount treated as dividend of the shareholder and (b) the amount of any gain that was recognized on the exchange; Provided, That the property received as "boot" shall have as basis its fair market value; provided, further, that 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 the liability) shall, for purposes of this paragraph, be treated as money received by the transferor on the exchange; provided, finally, that if the transferor receives several kinds of stock or securities, the Commissioner is hereby authorized to allocate the basis among the several classes of stocks or securities."

5.2 On the other hand, the substituted basis of the property in the hands of the Transferee for purposes of computing gain or loss on the subsequent disposition of such property by the Transferee is the Transferor's original or adjusted basis in such property at the time of transfer plus the gain recognized to the transferor on the exchange. Section 40(C)(5)(b) of the Tax Code of 1997 states:

"The basis of the property transferred in the hands of the transferee shall be 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."

In the particular facts of this Revenue Memorandum Ruling, there are no circumstances under which the Transferor recognizes gain. Thus, in this case, the substituted basis of the property in the hands of the Transferee is equal to the Transferor's original or adjusted basis in such property at the time of the transfer.

6. No. 7 of "I. Facts" mentions that the Transferor acquires "at least 51% of the total outstanding capital stock of the Transferee entitled to vote". Shares of stock "entitled to vote" excludes those shares that have been denied voting rights in the Transferee's Articles of Incorporation, in accordance with the provisions of Batas Pambansa Blg. 68 ("The Corporation Code of the Philippines" or the "Corporation Code") (although the Corporation Code may retain the right of holders of preferred shares to vote in certain instances specified in the Code).

For instance, assume in the above Facts, that the Transferee has an authorized capital stock of P32,550,000.00 divided into 265,000 common shares and 2,990,000 preferred non-voting shares with a par value of P10.00 per share. Only common shares have voting rights. The stockholders of the Transferee before the transfer are the following:

Stockholders Common Preferred Transferor 135,490 9 B 10 8 C 64,000 651,244 D 64,000 651,246 E 1,497 530,340 F 1 1 G 1 1 H 1 1 ———— ———— TOTAL 265,000 1,832,850 ======== ========

The Transferee increases its authorized capital stock by increasing only the number of its common shares. Out of this increase, the Transferor subscribes to 298,450 common shares for a total subscription price of P2,984,500.00, which subscription is paid in property.

As a result of the subscription the Transferor gains control of the Transferee by owning 77.01% (433,940/563,450 common shares) of the latter's outstanding shares of stock that are entitled to vote, to wit:

Stockholders Common Preferred Transferor 433,940 9 B 10 8 C 64,000 651,244 D 64,000 651,246 E 1,497 530,340 F 1 1 G 1 1 H 1 1 ———— ———— TOTAL 563,450 1,832,850 ======== ======= 7. If the Transferor is a Philippine branch of a foreign corporation, and the branch is incorporated into the Transferee corporation (such that the branch will no longer exist after the incorporation of the Transferee) directly owned by the head office, in addition to the tax consequences described above, the branch will be subject to the 15% branch profits remittance tax to the extent that there are unremitted branch profits at the time of transfer (Section 28(A)(5), Tax Code of 1997), since the transaction will be considered a constructive remittance of branch profits to the head office which is converted into equity of the Transferee corporation. The 15% rate may be reduced under applicable provisions of the various tax treaties to which the Philippines is a signatory.

iv. ADMINISTRATIVE REQUIREMENTS IN CASE OF TAX-FREE EXCHANGE


SUBJECT : Guidelines Implementing Revenue Regulations No. 18-2001 on the Monitoring of the Basis of the Property Transferred and Shares of Stock Received Pursuant to Section 40(C)(2) of the Tax Code of 1997, Revising and Updating the Requirements and Conditions Precedent to the Non-Recognition of Gain or Loss in Transactions Falling Thereunder, and Prescribing the Forms Therefor.

I. DOCUMENTATION REQUIREMENTS

A. BIR Certification/Ruling —

Any application to be filed with the Law Division for a BIR Certification/Ruling on the tax consequence of the exchange of properties described hereunder shall be made in a form which the BIR will provide for the purpose under the cover of a transmittal letter providing a brief overview of the transaction that contains all the material facts of the exchange transaction, and shall be accompanied by three (3) copies of each of the following documents:

(1) In the case of transfer of property to a controlled corporation/partnership —

(a) Deed of Transfer/Assignment/Exchange;

(b) Duly registered Articles of Incorporation or Partnership with SEC of the transferor corporation and transferee corporation/partnership, and By-Laws;

(c) Copies of the Transfer Certificates of Title/Condominium Certificates of Title/Certificates of Stock to the properties to be transferred pursuant to the tax-free exchange, as certified by the appropriate Registrar of Deeds or Corporate Secretary, as the case may be;

(d) Copies of the latest Tax Declaration of the properties to be transferred pursuant to the tax-free exchange, as certified by the appropriate local government unit's Assessor. It is understood that any improvement is separately

declared and therefore, covered by a Tax Declaration distinct from the Tax Declaration on the land. Further, if the tax declaration was issued three (3) or more years prior to the exchange transaction, the Transferor shall include in the certification by the local government unit's Assessor that such declaration is the latest tax declaration covering the real property;

(e) Certification of the fair market value or zonal value of the real property involved in the exchange. The zonal value shall be certified, as a general rule, by the Chief, Asset Valuation Division at the 10th Floor, BIR National Office. However, the Revenue District Officer or the Revenue Regional Director can also issue the certification whenever access to the latest schedule of zonal values is electronically available to them.

(f) Sworn certification by the individual transferor or in the case of a juridical person, by the Chief Financial Officer or his equivalent as to the basis of the property to be transferred. The original or adjusted basis, as the case may be, of each real property/share of stock/or other property transferred must be itemized in the certification, instead of a single lump sum in order to enable the Registrar of Deeds or the corporate secretary, as the case may be, to annotate the substituted basis on the reverse side of the Transfer/Condominium Certificate of Title to the real property involved or of the Certificate of Stock, and in order to facilitate the determination of gain or loss from a subsequent disposition of real properties/shares of stock and other properties received in the exchange.

(g) Sworn statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the properties acquired in the exchange is subject. The proper officer to issue the statement shall be the Chief Financial Officer or his equivalent and confirmed by the President or the Chief Executive Officer or Country Chairman or their equivalent;

(h) Audited Financial Statements of Transferor-corporation, as of the transaction date.

(2) In the case of Merger or Consolidation —

(a) The documents stated in (1) above;

(b) Plan of Corporate Merger or Consolidation;

(c) Statement of the amount and nature of the assets to be transferred by the absorbed corporation to the surviving/consolidated corporation.

(d) Articles of Incorporation duly registered with SEC of the merged or consolidated corporation; and

(e) Audited Financial Statements duly submitted or to be submitted to the SEC in connection with the application for merger or consolidation.

The material facts in the submitted documents, including an analysis of their bearing on the issues and a specification of the applicable provisions thereof, must be stated also in the covering letter.

B. No Application/Request for Certification-Ruling will be processed unless the foregoing requirements are complied with in all respects.

C. In the case of executed and/or completed transactions, either original executed and notarized copies or certified true copies of the above-mentioned documents must be submitted, together with proof of payment of the applicable documentary stamp taxes on the transactions. In the case of issuance of shares/unit of participation by the transferee, the due dates for the payment of the corresponding documentary stamp tax prescribed under Revenue Memorandum Order No. 8-98 dated February 10, 1998, as amended by

Revenue Regulations No. 6-2001 and 12-2001 dated July 31, 2001 and September 7, 2001, respectively, shall apply.

D. Records to be kept and information to be filed. —

The parties to the transaction shall comply with the pertinent provisions of Revenue Regulations No. 18-2001 dated November 13, 2001, regarding the records to be kept and information to be filed in connection with the tax-free exchange, provided that, any violation thereof, including the failure of the parties to present proof of annotation of the substituted basis within the period provided in Section 7 of such Regulations shall be referred to the Prosecution Division for appropriate action.

III. PROCESSING AND CERTIFICATION FEE

The taxpayer/applicant shall pay the applicable processing and certification fee as provided in Revenue Regulations No. 18-2001 dated November 13, 2001, before filing of the request for certification-ruling. The applicant must submit proof of payment of the processing and certification fee, with the original presented, upon filing of the application for certification-ruling with the Law Division. Otherwise, the application shall not be accepted for processing.

The processing and certification fee shall accordingly be adjusted if additional transfer certificates of title/condominium certificates of title/certificates of stock are submitted for processing.

IV. DECLARATION UNDER OATH

Declarations in the application and joint certification form, the documents to be submitted, and the facts represented in support of the requested certification-ruling, including the covering letter, shall be sworn under oath, under penalties of perjury, by the taxpayer himself, or, in the case of a juridical person, by the Chief Financial Officer or his equivalent who has personal knowledge of the facts to be true, correct and complete. Actual submission of the application/request and follow-up thereof may be done by an authorized representative, clothed with a special power of attorney, and subject to the provisions of Revenue Regulations No. 15-99 dated July 16, 1999 on accreditation of tax agents.

V. ISSUANCE OF CERTIFICATE AUTHORIZING REGISTRATION (CAR)/TAX CLEARANCE (TCL)

The CAR/TCL for the real property or share of stock/unit of participation/interest involved in the exchange shall be issued by the Revenue District Officer (RDO) or by the Authorized Internal Revenue Officer (AIRO), on the basis of the certification-ruling issued by the Commissioner or his duly authorized representative to the effect that the transaction qualifies as a tax-free exchange or corporate reorganization under Section 40(C)(2) of the Tax Code of 1997. The necessary proof of payment of appropriate documentary stamp taxes must also be presented.

The CAR/TCL to be issued shall specify, among others, that the transaction involved is a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997; the date of exchange; the original or adjusted basis as represented by the taxpayer, and substituted basis of the properties as stated in the certification or ruling issued by the Bureau of Internal Revenue.

VI. REPEALING CLAUSE. —

The provisions of Revenue Memorandum Order No. 26-92 dated May 28, 1992, and all other rules, orders or portions thereof that are contrary to or inconsistent with the provisions of this Order are hereby modified and/or repealed accordingly.

REVENUE MEMORANDUM RULING NO. 01-02

SUBJECT : Tax Consequences of De Facto Merger Pursuant to Section 40(C)(2) and (6)(b) of the National Internal Revenue Code of 1997

I. FACTS

1. A domestic corporation (the "Transferor") owns certain property, consisting, for example, of the following:

1.1 Land encumbered by a real estate mortgage (REM);

1.2 Buildings;

1.3 100 shares of stock in G Corporation with a par value of P10 per share;

1.4 50 shares of stock in D Corporation without par value;

1.5 Unsecured receivables;

1.6 Loans to Q ("Borrower/Mortgagor"), secured by a real estate mortgage;

1.7 Cash.

2. The property transferred by the Transferor constitutes at least 80% of the Transferor's assets, including cash.

3. The Transferor transfers the property to the Transferee. In exchange, the Transferee issues shares to the Transferor out of the unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock. The Transferor does not receive any money or property other than the aforementioned shares of the transferee.

4. In addition to the transfer of the property, the Transferee assumes liabilities of the Transferor. However, the sum total of the amount of liabilities assumed, plus the amount of the encumbrance or REM on the Land (as stated in Section 40(C)(4) of the Tax Code of 1997 — "liabilities to which the property is subject") do not exceed the basis of the property transferred.

II. GENERAL PRINCIPLES

1. A de facto merger involves the acquisition by one corporation of all or substantially all the properties of another solely for stock. Section 40(C)(6)(b) of the Tax Code of 1997 states:

"The term "merger" or "consolidation," when used in this Section, shall be understood to mean: (i) the ordinary merger or consolidation; or (ii) the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock: Provided, That for a transaction to be regarded as a merger or consolidation within the purview of this Section, it must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation: Provided, further, That 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 transactions shall be treated as a single unit: Provided, finally, That 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." (Emphasis supplied)

The phrase "substantially all the properties of another corporation" is defined in BIR General Circular No V-253 dated July 16, 1957 to mean "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'.

To constitute a de facto merger, the following elements must concur: (1) there must be a transfer of all or substantially all of the properties of the transferor corporation solely for stock, and (2) it must be undertaken for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation.

One basic difference between a de facto merger and a statutory merger is that the Transferor is not automatically dissolved in the case of the former. Likewise, there is no automatic transfer to the Transferee of all the rights, privileges, and liabilities of the Transferor. It is, in fact, in procedure, similar to a transfer to a controlled corporation under the same Section 40(C)(2) of the Tax Code of 1997, except that at least 80% of the Transferor's assets, including cash, are transferred to the Transferee, with the element of permanence and not merely momentary holding. However, a de facto merger and a transfer to a controlled corporation are different in that, (1) the Transferor in a de facto merger is a corporation, while in a transfer to a controlled corporation, the Transferors may either be a corporation or an individual, and (2) in a de facto merger, there is no requirement that the transferor gains control (that is, 51% of the total voting powers of all classes of stocks of the Transferee entitled to vote) of the Transferee as a prerequisite to enjoying the benefit of non-recognition of gain or loss. What is essential in a de facto merger is that the Transferee acquires all or substantially all of the properties of the Transferor.

III. TAX CONSEQUENCES

1. Income tax. The Transferor shall not recognize any gain or loss on the transfer of the property to the Transferee. Consequently, the Transferor will not be subject to capital gains tax, income tax, nor to creditable withholding tax on the transfer of such property to the Transferee. Neither may the Transferor recognize a loss, if any, incurred on the transfer.

In addition, the assumption of liabilities or the transfer of property that is subject to a liability does not affect the non-recognition of gain or loss under Section 40(C)(2) of the Tax Code of 1997, since in this case, the total amount of such liabilities does not exceed the basis of the property transferred. Section 40(C)(4) of the Tax Code of 1997 states:

"(4) Assumption of liability. —

(a) If the taxpayer, in connection with the exchanges described in the foregoing exceptions, receives stocks or securities which would be permitted to be received without the recognition of the gain if it were the sole consideration, and as a part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property, subject to a liability, then such assumption or acquisition shall not be treated as money and/or other property, and shall not prevent the exchange from being within the exceptions.

(b) If the amount of the liabilities assumed plus the amount of the liabilities to which the property is subject exceed the total amount of the adjusted basis of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be."

Moreover, the Transferee is not subject to income tax on its receipt of the property as contribution to its capital, even if the value of such property exceeds the par value or stated value of the shares issued to the Transferor: Section 55 of Revenue Regulations No. 2 ("Income Tax Regulations") states:

"Section 55. Acquisition or disposition by a corporation of its own capital stock. — . . . The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than the par or stated value of such stock.

xxx xxx xxx"

However, stocks shall not be issued for a consideration less than par or issued price thereof. (Section 62, Corporation Code of the Philippines)

2. Donor's tax. The Transferor is not subject to donor's tax, regardless of whether the value of the property transferred exceeds the par/stated value of the Transferee shares issued to the Transferor, there being no intent to donate on the part of the Transferor.

3. Value-added tax. The Transferor is not subject to value-added tax ("VAT") on the transfer of the property if it is not engaged in a business that is subject to the VAT under Title IV of the Tax Code of 1997. Even if the Transferor is engaged in an activity that is subject to VAT, it is nonetheless not subject to VAT on the transfer of the property to the Transferee. Section 4.100-5(b)(1) & (3) of Revenue Regulations No. 7-95, as amended states:

"(b) Not subject to output tax. — The VAT shall not apply to goods or properties existing as of the occurrence of the following:

1) Change of control of a corporation by the acquisition of the controlling interest of such corporation by another stockholder or group of stockholders. Example: transfer of property to a corporation in exchange for its shares of stock under Section 34(c)(2) and (6)(c) of the Code [now 40(C)(2) and (6)(c) of the Tax Code of 1997].

xxx xxx xxx

3) Merger or consolidation of corporations. The unused input tax of the dissolved corporation as of the date of merger or consolidation shall be absorbed by the surviving or new corporation."

Thus, since a de facto merger is considered within the definition of a merger under Section 40(C)(6) of the Tax Code of 1997, the transfer of the property by the Transferor to the Transferee shall not be subject to VAT. However, the second sentence of Section 4.100-5(b)(3), supra, is inapplicable in de facto mergers, and therefore, the Transferor's unused input tax cannot be absorbed by or transferred to the Transferee. The above sentence contemplates only a statutory merger or consolidation that, by operation of law, results in a "dissolved corporation" and a "surviving or new corporation". Furthermore, pursuant to Section 80 of the Corporation Code of the Philippines, the unused input tax, being an asset, is transferred in statutory merger by operation of law.

4. Documentary stamp tax. The documentary stamp tax consequences of the

5. Time of payment of Documentary Stamp Taxes. The time for the payment of the documentary stamp tax liabilities, whether the taxpayer is an e-filer or not, shall be as follows:

IV. ADDITIONAL FACTS AND VARIATIONS NOT AFFECTING TAX CONSEQUENCES

The following additional facts or variations will not affect the tax consequences of the transaction, as described above:

1. In no. 1 of "I. Facts" stated above, the total number of Transferors in a de facto merger is not relevant in determining whether it qualifies for non-recognition of gain or loss. However, non-recognition of gain or loss will apply to the Transferors that meet the requirements for a de facto merger described in "II. General Principles".

2. In no. 3 of "I. Facts" stated above, the shares issued by the Transferee may either be voting or non-voting stocks since the voting requirement applies only to a transfer to a controlled corporation, pursuant to Section 40(C)(2) in relation to 40(C)(6)(c) of the Tax Code of 1997.

3. The tax consequences are not affected by whether the Transferor is/was a shareholder prior to the transaction.

4. Paragraph IV(4) & (5) of Revenue Memorandum Ruling 1-2001 dated November 29, 2001, which discuss the tax basis of property and shares involved in a merger, consolidation or transfer to a controlled corporation, are hereby reproduced and adopted by reference in this Revenue Memorandum Ruling.

V. FURTHER CLARIFICATION OF FACTS AND TAX CONSEQUENCES

1. No. 1 of "I. Facts" mentions "property". For purposes of Section 40(C)(2) of the Tax Code of 1997, this term excludes services, accounts receivable for services rendered by the Transferor for the Transferee, cash and the conversion of debt into equity.

2. No. 2 of "I. Facts" mentions the property transferred constituting "at least 80% of the Transferor's assets, including cash". This distinguishes this transaction from a transfer to a controlled corporation as described in Section 40(C)(2) of the Tax Code of 1997 and Revenue Memorandum Ruling No. 1-2001 dated November 29, 2001.

3. No. 3 of "I. Facts" mentions the issuance of the Transferee's shares from the "unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock". This statement of fact excludes the following, which if present, would give rise to a different tax consequence treated elsewhere other than in this Revenue Memorandum Ruling —

3.1 The issuance of treasury shares, which have previously been issued but were subsequently re-acquired by the Transferee and have not been retired.

3.2 Settlement of subscription receivables. Therefore, the tax consequences described above shall not apply to the extent that the property is transferred in payment for the unpaid balance of the subscription to shares.

I.B.4. COST OF BASIS IN TAX-FREE EXCHANGES


SECTION 2. Basis. — A. Substituted Basis of Stock or Securities Received by the Transferor. — The substituted basis of the stock or securities received by the transferor on a tax-free exchange shall be as follows:

1. The original basis of the property, stock or securities to be transferred;

2. Less: (a) money received, if any, and (b) the fair market value of the other property received, if any;

3. Plus: (a) the amount treated as dividend of the shareholder, if any, and (b) the amount of any gain that was recognized on the exchange, if any.

However, the property received as 'boot' shall have as basis its fair market value. The term "boot" refers to the money received and other property received in excess of the stock or securities received by the transferor on a tax-free exchange.

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

Finally, if the transferor receives several kinds of stock or securities, the Commissioner is authorized to allocate the basis among the several classes of stocks or securities.

B. Substituted Basis of the Transferred Property in the Hands of the Transferee. The substituted basis of the property transferred in the hands of the transferee shall be as follows:

(a) the original basis in the hands of the transferor;

(b) Plus: the amount of the gain recognized to the transferor on the transfer.

C. The Original Basis of Property to be Transferred. The original basis of the property to be transferred shall be the following, as may be appropriate:

(a) The cost of the property, if acquired by purchase on or after March 1, 1913;

(b) The fair market price or value as of the moment of death of the decedent, if acquired by inheritance;

(c) The basis in the hands of the donor or the last preceding owner by whom the property was not acquired by gift, if the property was acquired by donation.

If the basis, however, is greater than the fair market value of the property at the time of donation, then, for purposes of determining loss, the basis shall be such fair market value; or,

(d) The amount paid by the transferee for the property, if the property was acquired for less than an adequate consideration in money or money's worth.

(e) The adjusted basis of (a) to (d) above, if the acquisition cost of the property is increased by the amount of improvements that materially add to the value of the property or appreciably prolong its life less accumulated depreciation.

(f) The substituted basis, if the property was acquired in a previous tax-free exchange under Section 40(C)(2) of the Tax Code of 1997.

D. Basis for Determining Gain or Loss on a Subsequent Sale or Disposition of Property Subject of the Tax-free Exchange.

The substituted basis as defined in Section 40(C)(5) of the Tax Code of 1997, and implemented in Section 2.A and 2.B above, shall be the basis for determining gain or loss on a subsequent sale or disposition of property subject of the tax-free exchange.

SECTION 4. Information to be Contained in Certification/Ruling by the Bureau of Internal Revenue. — All certifications or rulings issued by the Bureau of Internal Revenue confirming that an exchange of property for shares complies with the provisions of Section 40(C)(2) of the Tax Code of 1997 shall include a statement on the substituted basis of the property transferred.

SECTION 5. Conditions for the Issuance of Certificate Authorizing Registration (CAR) or Tax Clearance (TCL). — The CAR/TCL for the real property or share of stock/unit of participation/interest involved in the exchange shall be issued by the Revenue District Officer/Authorized Internal Revenue Officer on the basis of the certification or ruling to be issued in triplicate by the Commissioner or his duly authorized representative to the effect that the transaction qualifies as a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997.

The CAR/TCL to be issued shall specify, among others, that the transaction involved is a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997; the date of exchange; and the substituted basis of the properties as stated in the certification or ruling issued by the Bureau of Internal Revenue.


SUBJECT : Guidelines Implementing Revenue Regulations No. 18-2001 on the Monitoring of the Basis of the Property Transferred and Shares of Stock Received Pursuant to Section 40(C)(2) of the Tax Code of 1997, Revising and Updating the Requirements and Conditions Precedent to the Non-Recognition of Gain or Loss in Transactions Falling Thereunder, and Prescribing the Forms Therefor.

In order to facilitate the monitoring of the basis of properties transferred and shares received in an exchange transaction, and in the determination of whether a transaction involving the transfer of properties by individual/s or corporation/s in exchange for shares of stock of another corporation or unit of participation in a partnership, as well as a transaction involving a merger or consolidation, is a tax-free exchange that falls under Section 40(C)(2), in relation to Section 40(6)(b) and (c) of the Tax Code of 1997, the requirements hereunder stated must be complied with by both .transferor(s)/absorbed corporation and transferee/surviving/consolidated corporation.

The procedures outlined hereunder implement and complement Revenue Regulations No. 18-2001 dated November 13, 2001, and shall be observed in the monitoring and investigation of the basis of such properties transferred pursuant to a tax-free exchange, to ascertain compliance with the conditions set forth in the Certification/Ruling issued by this Office, and in the consequent assessment of tax liabilities if any, due upon subsequent disposition of the properties involved in the exchange.

I. DOCUMENTATION REQUIREMENTS

A. BIR Certification/Ruling —

B. No Application/Request for Certification-Ruling will be processed unless the foregoing requirements are complied with in all respects.

C. In the case of executed and/or completed transactions, either original executed and notarized copies or certified true copies of the above-mentioned documents must be submitted, together with proof of payment of the applicable documentary stamp taxes on the transactions. In the case of issuance of shares/unit of participation by the transferee, the due dates for the payment of the corresponding documentary stamp tax prescribed under Revenue Memorandum Order No. 8-98 dated February 10, 1998, as amended by Revenue Regulations No. 6-2001 and 12-2001 dated July 31, 2001 and September 7, 2001, respectively, shall apply.

D. Records to be kept and information to be filed. —

The parties to the transaction shall comply with the pertinent provisions of Revenue Regulations No. 18-2001 dated November 13, 2001, regarding the records to be kept and information to be filed in connection with the tax-free exchange, provided that, any violation thereof, including the failure of the parties to present proof of annotation of the substituted basis within the period provided in Section 7 of such Regulations shall be referred to the Prosecution Division for appropriate action.

II. FORM OF REQUEST FOR RULING AND CERTIFICATION

III. PROCESSING AND CERTIFICATION FEE

IV. DECLARATION UNDER OATH

Declarations in the application and joint certification form, the documents to be submitted, and the facts represented in support of the requested certification-ruling, including the covering letter, shall be sworn under oath, under penalties of perjury, by the taxpayer himself, or, in the case of a juridical person, by the Chief Financial Officer or his equivalent who has personal knowledge of the facts to be true, correct and complete. Actual submission of the application/request and follow-up thereof may be done by an authorized representative, clothed with a special power of attorney, and subject to the provisions of Revenue Regulations No. 15-99 dated July 16, 1999 on accreditation of tax agents.

V. ISSUANCE OF CERTIFICATE AUTHORIZING REGISTRATION (CAR)/TAX CLEARANCE (TCL)

The CAR/TCL for the real property or share of stock/unit of participation/interest involved in the exchange shall be issued by the Revenue District Officer (RDO) or by the Authorized Internal Revenue Officer (AIRO), on the basis of the certification-ruling issued by the Commissioner or his duly authorized representative to the effect that the transaction qualifies as a tax-free exchange or corporate reorganization under Section 40(C)(2) of the Tax Code of 1997. The necessary proof of payment of appropriate documentary stamp taxes must also be presented.

The CAR/TCL to be issued shall specify, among others, that the transaction involved is a tax-free exchange under Section 40(C)(2) of the Tax Code of 1997; the date of exchange; the original or adjusted basis as represented by the taxpayer, and substituted basis of the properties as stated in the certification or ruling issued by the Bureau of Internal Revenue.

7. PAYMENT OF CGT AND DST ON EXTRA-JUDICIAL FORECLOSURE


SUBJECT : Further Amending Revenue Memorandum Order No. 29-86 dated September 3, 1986, as Amended by Revenue Memorandum Order No. 16-88 dated April 18, 1988, as Further Amended by Revenue Memorandum Order No. 27-89 dated April 18, 1989, and as Last Amended by Revenue Memorandum Order No. 6-92 dated January 15, 1992 Relative to the Payment of Capital Gains Tax and Documentary Stamp Tax on Extra-Judicial Foreclosure Sale of Capital Assets Initiated by Banks, Finance and Insurance Companies

SECTION 2. Foreclosure of Mortgage Provision Under Presidential Decree No. 1529 , Otherwise Known as "Property Registration Decree". — Section 63 of P.D. No. 1529, otherwise known as the "Property Registration Decree" provides as follows:

"SEC. 63. Foreclosure of Mortgage. — (a) If the mortgage was foreclosed judicially, a certified copy of the final order of the court confirming the sale shall be registered with the Register of Deeds. If no right of redemption exists, the certificate of title of the mortgagor shall be cancelled, and a new certificate issued in the name of the purchaser.

"Where the right of redemption exists, the certificate of title of the mortgagor SHALL NOT BE CANCELLED, but the certificate of sale and the order confirming the sale shall be registered by a BRIEF MEMORANDUM thereof made by the Register of Deeds upon the certificate of title. In the event the property is redeemed, the certificate or deed of redemption shall be filed with the Register of Deeds, and a brief memorandum thereof shall be made by the Register of Deeds on the certificate of title of the mortgagor.

"If the property is not redeemed, the final deed of sale executed by the sheriff in favor of the purchaser at a foreclosure sale shall be registered with the Register of Deeds; whereupon the title of the mortgagor shall be cancelled, and a new certificate issued in the name of the purchaser.

"(b) If the mortgage was foreclosed extrajudicially, a certificate of sale executed by the officer who conducted the sale shall be filed with the Register of Deeds who shall make a brief memorandum thereof on the certificate of title.

"In the event of redemption by the mortgagor, the same rule provided for in the second paragraph of this section shall apply.

"In case of non-redemption, the purchaser at foreclosure sale shall file with the Register of Deeds, either a final deed of sale executed by the person authorized by virtue of the power of attorney embodied in the deed of mortgage, or his sworn statement attesting to the fact of non-redemption; whereupon, the Register

of Deeds shall issue a new certificate in favor of the purchaser after the owner's duplicate of the certificate has been previously delivered and cancelled."

It is clear from the above provision of the "Property Registration Decree" that where the right of redemption of the mortgagor exists, the certificate of title of the mortgagor shall not be cancelled yet even if the property had already been subjected to foreclosure sale, BUT INSTEAD only a brief memorandum shall be annotated at the back of the certificate of title, and the cancellation of the title and the subsequent issuance of a new title in favor of the purchaser/highest bidder depends on whether the mortgagor shall redeem or not the mortgaged property within one year from the issuance of the certificate of sale. Thus, no transfer of title to the highest bidder can be effected yet until and after the lapse of the one-year period from the issuance of the said certificate of sale.

SECTION 3. Capital Gains Tax. —

(1) In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. A certification to that effect or the deed of redemption shall be filed with the Revenue District Office having jurisdiction over the place where the property is located which certification or deed shall likewise be filed with the Register of Deeds and a brief memorandum thereof shall be made by the Register of Deeds on the Certificate of Title of the mortgagor.

(2) In case of non-redemption, the capital gains tax on the foreclosure sale imposed under Secs. 24(D)(1) and 27(D)(5) of the Tax Code of 1997 shall become due based on the bid price of the highest bidder but only upon the expiration of the one-year period of redemption provided for under Sec. 6 of Act No. 3135 , as amended by Act No. 4118 , and shall be paid within thirty (30) days from the expiration of the said one-year redemption period.

SECTION 4. Documentary Stamp Tax. —

(1) In case the mortgagor exercises his right of redemption, the transaction shall only be subject to the P15.00 documentary stamp tax imposed under Sec. 188 of the Tax Code of 1997 because no land or realty was sold or transferred for a consideration.

(2) In case of non-redemption, the corresponding documentary stamp tax shall be levied, collected and paid by the person making, signing, issuing, accepting, or transferring the real property wherever the document is made, signed, issued, accepted or transferred where the property is situated in the Philippines; Provided, That whenever one party to the taxable document enjoys exemption from the tax, the other party thereto who is not exempt shall be the one directly liable for the tax. The tax return prescribed under the Code shall be filed within ten (10) days after the close of the month following the lapse of the one-year redemption period, and the tax due under Sec. 196 of the Tax Code of 1997 shall be paid based on the bid price at the same time the aforesaid return is filed.

I.D. EXEMPTION FROM CGT OF CERTAIN INDIVIDUALS


SUBJECT : Exemption of Certain Individuals from the Capital Gains Tax on the Sale, Exchange or Disposition of a Principal Residence under Certain Conditions

SECTION 2. Definition of Terms. — For purposes of these Regulations, the following items shall have the following meaning:

(1) "Natural person" — shall refer to a citizen or resident alien individual taxable under Sec. 24 of the Code. It does not include an estate or a trust, the provision of Sec. 60 of the Code to the contrary notwithstanding.

RR 14-2000 AMENDMENT (2) Principal Residence. — (a) The term "Principal Residence" shall refer to the dwelling house, including the land on which it is situated, where the husband and wife or an unmarried individual, whether or not qualified as head of family, and members of his family reside. Actual occupancy of such principal residence shall not be considered interrupted or abandoned by reason of the individual's temporary absence therefrom due to travel or studies or work abroad or such other similar circumstances. Such principal residence must be characterized by permanency in that it must be the dwelling house in which, whenever absent, the said individual intends to return.

"(b) Where ownership of the land and the dwelling house thereon belongs to different persons, e.g., where the land is leased to the dwelling house owner, only the dwelling house shall be treated as Principal Residence of the dwelling house owner. Thus, if the said land and the dwelling house thereon be jointly sold or disposed by the said owners, only the-sale or disposition of the dwelling house shall be entitled to the benefit of exemption from the capital gains tax herein prescribed: Provided, however, that where both the owner of the land and owner of the dwelling house actually reside in the said dwelling house, then both the said land and dwelling house shall be treated as their Principal Residence (e.g., owner of the land is the parent while owner of the house is his child, or vice versa).

"(c) Where the land and the dwelling house thereon be owned by several co-owners, e.g., inherited by two or more heirs through hereditary succession, and where the said property is actually used as Principal Residence by one or more of the said co-owners, including the members of .his/their family, the said property shall be treated as the Principal Residence of the co-owner/s actually occupying and using the same as his/their Principal Residence but to the extent of his/their proportionate share in the value of the principal residence. Conversely, the capital gains tax exemption benefit herein prescribed shall not apply in respect of the other co-owners who do not actually use and occupy the same as their Principal Residence.

"(d) The residential address shown in the latest income tax return filed by the vendor/transferor immediately preceding the date of sale of the said real property shall be treated, for purposes of these Regulations, as a conclusive presumption about his true residential address, the certification of the Barangay Chairman, or Building Administrator (in case of a condominium unit), to the contrary notwithstanding, in accordance with the doctrine of admission against interest or the principle of estoppel (e.g., if the property was sold on May 1, 2000, the vendor's annual income tax return for the year 1999, which he filed on or before April 15, 2000, showing his residential address, shall be treated as a conclusive presumption that his true residential address is that which is shown in his aforesaid income tax return). If the vendor is exempt from filing any tax return, in which case, he has no tax record immediately prior to the sale of his property, then the aforementioned certification from the Barangay Chairman or Building Administrator, as the case may be, shall suffice."

(3) "Fully Utilized" — shall mean that the taxpayer has actually commenced with the construction of his new principal residence or has actually entered into a contract for the purchase of his new principal residence within eighteen (18) calendar months from the date of sale, exchange or disposition thereof, with the intention of using the entire proceeds of sale for the acquisition or construction of his new principal residence. Provided, that any expense paid for by the seller in effecting the sale, i.e., documentary stamp tax, transfer fees, broker's commission, if any, shall be considered as part of the amount utilized.

SECTION 3.. RR 14-00 AMENDMENT "SEC. 3. Conditions for Exemption. — The general provisions of the Code to the contrary notwithstanding, capital gains presumed to have been realized from the sale, exchange or disposition by a natural person of his

Principal Residence shall not be imposed with six percent (6%) capital gains tax, subject to compliance with the following:

"(1) Escrow Agreement. — The six percent (6%) capital gains tax otherwise due on the presumed capital gains derived from the sale, exchange or disposition of his Principal Residence shall be deposited in cash or manager's check in interest-bearing account with an Authorized Agent Bank (AAB) under an Escrow Agreement (ANNEX A hereof) between the concerned Revenue District Officer, the Seller/Transferor and the AAB to the effect that the amount so deposited, including its interest yield, shall only be released to such Seller/Transferor upon certification by the said RDO that the proceeds of sale or disposition thereof has, in fact, been utilized in the acquisition or construction of the Seller/Transferor's new Principal Residence within eighteen (18) calendar months from date of the said sale or disposition. The date of sale or disposition of a property refers to the date of notarization of the document evidencing the transfer of said property. In general, the term "Escrow" means "A scroll, writing or deed, delivered by the grantor, promisor or obligor into the hands of a third person, to be held by the latter until the happening of a contingency or performance of a condition, and then by him delivered to the grantee, promisee or obligee."

"(2) Capital Gains Tax Return. — The Seller/Transferor shall file, in duplicate, his Capital Gains Tax Return (BIR FORM No. 1706) covering the sale or disposition of his Principal Residence with the concerned .Revenue District Office within thirty (30) days from date of its sale or disposition: Provided, however, that the Seller/Transferor shall not be required to pay any capital gains tax during the 18-month period on the sale of his principal residence duly established as such. Provided, further, that for purposes of the capital gains tax otherwise due on the sale, exchange or disposition of the said Principal Residence, the execution of the Escrow Agreement referred to in the immediately preceding Section 3 (1) hereof shall be considered sufficient.

"The following shall be submitted with the Capital Gains Tax Return herein required to be filed:

(a) Proof of payment of the documentary stamp tax imposed under Sec. 196 of the Tax Code of 1997 on the deed of sale or conveyance of the said "Principal Residence;"

(b) A sworn statement from the Barangay Chairman that the taxpayer's Principal Residence is located within the jurisdiction of that Barangay and that the same has been his residence immediately prior to the date of its sale or disposition: Provided, however, that if the taxpayer's Principal Residence sold or disposed is a condominium unit, in lieu of the said Barangay Chairman, the certification shall be issued by the Building Administrator of the Condominium building.

(c) A duplicate original copy of the Deed of Conveyance of his Principal Residence;

(d) A certified xerox copy of the Transfer Certificate of Title (TCT) or Condominium Certificate of Title (CCT), in case of a condominium unit, covering the Principal Residence sold or disposed;

(e) A certified xerox copy of the latest Tax Declaration covering the said Principal Residence (land and improvement); and

(f) If the building or improvement thereon has been constructed on or after the year 1990, the Building Permit or Occupancy Permit issued by the concerned city or municipality, showing the amount of the construction cost thereof.

"(3) Post Reporting Requirement. — The proceeds from the sale, exchange or disposition of his old Principal Residence must be fully utilized in acquiring or constructing his new Principal Residence within eighteen (18) calendar months from date of its sale, exchange or disposition. in order to show proof that positive action was undertaken to

utilize the proceeds for the acquisition or construction of his new Principal Residence within the 18-month reglementary period, he shall submit to the RDO concerned, within thirty (30) days from the lapse of the said period, the following documents:

(a) A sworn statement that the total proceeds from the sale or disposition of his old Principal Residence has been actually utilized in the acquisition or construction of his new Principal Residence or, if the construction of his new Principal Residence is still in progress, a sworn statement that such amount shall be fully utilized to procure the necessary materials and pay for the cost of labor and other expenses for the construction thereof;

(b) A certified statement from his architect or engineer, or both, showing the cost of materials and labor for the construction of his new Principal Residence;

(c) A certified copy of the Building Permit issued by the Office of the Building Official of the City or Municipality where his new Principal Residence shall be constructed as well as xerox copies of documents (e.g., building specification plan, construction plans, or construction cost estimates) submitted with his application for the said Building Permit on which computation of the amount of the building license fee has been based;

(d) In case his new Principal Residence is acquired by purchase, a duplicate original copy of the Deed of Absolute Sale covering the purchase of his new Principal Residence.

"(4) Release from the Escrow Agreement. — Upon a showing, based on the foregoing documents, that the proceeds of sale, exchange or disposition of his old Principal Residence have already been fully utilized in the acquisition or construction of his new Principal Residence, the concerned Revenue District Officer shall, within fifteen (15) days from date of submission by the Seller/Transferor of the foregoing documents, release the Escrow on the aforesaid bank deposit in favor of the Seller/Transferor (ANNEX B hereof).

"(5) Limitation on Tax Exemption Privilege. — The tax exemption herein granted may be availed of only once every ten (10) years;

"(6) Cost Basis of the New "Principal Residence". — The historical cost or adjusted cost basis of his old Principal Residence sold, exchanged or disposed shall be carried over to the cost basis of his new Principal Residence; and

"(7) Assessment for Deficiency Capital Gains Tax; Application of the Escrowed Bank Deposit Against the Deficiency Tax. — If the Seller/Transferor fails to submit documentary evidence within thirty (30) days after the lapse of the aforesaid 18-month period, showing that he has utilized the proceeds of sale, exchange or disposition of his old Principal Residence to acquire or construct his new Principal Residence, it shall be presumed that he did not, in fact, utilize the aforesaid proceeds of sale for the construction or acquisition of his new Principal Residence, in which case, he shall be treated deficient in the payment of his capital gains tax from the sale or disposition of his aforesaid Principal Residence, and shall be accordingly be assessed for deficiency capital gains tax, inclusive of the 20% interest per annum, pursuant to the provisions of Section 228 of the Code, as implemented by Revenue Regulations No. 12-99 , in relation to Section 249 of the said Code.

Pursuant to the provisions of Revenue Regulations No. 12-99, the taxpayer shall be issued with the required Post Reporting Notice informing him, in writing, of the aforementioned facts, in order that he may present his side of the case through informal conference, and the required Preliminary Assessment Notice, before issuance of the Formal Assessment Notice. If, at this point in time, the escrowed tax money is still in the custody of the Depository Bank, the full amount thereof, including its interest earnings, shall be applied in computing for the taxpayer's deficiency capital gains tax. Upon the time that the said deficiency tax assessment has become final and executory, the deposit in escrow, inclusive of its interest earnings, shall be forfeited and applied against the

taxpayer's deficiency capital gains tax liability. The depository Bank shall forthwith be informed of this action, and shall, upon demand in writing, by the Commissioner or his duly authorized representative (ANNEX C hereof), turn over the money for application in payment of the taxpayer's deficiency tax liability. If the same is insufficient to cover the entire amount assessed, the seller/transferor shall remain liable for the remaining balance of the assessment. On the other hand, the excess of the deposit in escrow, if any, shall forthwith be returned to the Seller/Transferor, by the Bank, upon written authorization from the Commissioner or his duly authorized representative.

"(8) Partial Utilization of the Proceeds of Sales Exchange or Disposition. — If there is no full utilization of the proceeds of sale, exchange or disposition of his old Principal Residence for the acquisition or construction of his new Principal Residence, he shall be liable for deficiency capital gains tax, inclusive of 20% interest per annum, computed from the 31st day after the date of sale or disposition of the said old Principal Residence."

SECTION 4. Determination of Capital Gains Tax Due if the Proceeds of Sale, Exchange or Disposition of his Principal Residence has not Been Fully Utilized. — In a case where the entire proceeds of sale is not utilized for the purchase or construction of a new principal residence, the capital gains tax shall attach. In computing the capital gains tax due on the sale of the principal residence, we follow the following steps:

(1) Determine the percentage (%) of non-utilization applying the formula:

Unutilized Portion of GSP

-------------------------- = Percentage (%) of Non-Utilization

GSP

(2) Multiply the % of non-utilization by the GSP or FMV, whichever is higher.

(3) Multiply the product in item (2) above by the rate of six percent (6%).

If the seller fails to utilize the proceeds of sale or disposition in full or in part within the 18-month reglementary period, his right of exemption from the capital gains tax did not arise to the extent of the unutilized amount, in which event, the tax due thereon shall immediately become due and demandable on the 31st day after the date of the sale, exchange or disposition of principal residence. As such, he shall file his capital gains tax return covering the sale, exchange or disposition of his principal residence and pay the deficiency capital gains tax inclusive of the twenty five percent (25%) surcharge for late payment of the tax plus twenty percent (20%) delinquency interest per annum incident to such late payment computed on the basis of the basic tax assessed. The interest shall be imposed from the thirty-first (31st) day after the date of the sale of principal residence until the date of payment, provided, that the date of sale shall mean the date of notarization of the document of sale, exchange, or disposition of principal residence.

Illustrations:

(1) In case the proceeds from the sale, exchange or disposition of his principal residence has been fully utilized to acquire his new principal residence. — Assume that Mr. Arnold Buendia acquired his principal residence in 1986 at a cost of P1,000,000.00. He sold the said property on January 1, 1998, with a fair market value of P5,000,000.00, for a consideration of P4,000,000.00. Within the 18-month reglementary period, he purchased his new principal residence at a cost of P7,000,000.00.

Computations:

Historical cost of old principal residence P1,000,000.00

Gross selling price (GSP) P4,000,000.00

Fair market value (FMV) of old principal residence

at the time of sale P5,000,000.00

Cost to acquire new principal residence P7,000,000.00

(a) To compute for the capital gains tax due. — In this case, Mr. Buendia shall be exempt from the capital gains tax otherwise due from him since the entire proceeds of the sale has been fully utilized to acquire his new principal residence.

(b) To compute for the basis of the new principal residence. — The historical cost or adjusted cost basis of his old principal residence shall be carried over to the cost basis of his new principal residence, computed as follows:


Add: Additional cost to acquire new principal

residence

Cost to acquire his new principal residence P7,000,000.00

Less: GSP of his old principal residence (4,000,000.00) 3,000,000.00

----------------- ----------------

Adjusted Cost Basis of New Principal Residence P4,000,000.00

==========

(2) In case the fair market value of the old principal residence is equal to the cost to acquire the new principal residence. — Using the above illustration, if for example, instead of P7,000,000.00, Mr. Buendia was able to acquire his new principal residence at a cost of P4,000,000.00, which is equal to the gross selling price of his old principal residence. Cdpr

(a) To compute for the capital gains tax due. — In this case, Mr. Buendia is still exempt from the payment of the capital gains tax otherwise due from him because there has been full utilization of the proceeds from the sale of his old principal residence within the 18-month reglementary period.

(b) To compute for the basis of his new principal residence. — Since the fair market value of his old principal residence is equal to the cost to acquire his new principal residence, the historical cost of his old principal residence shall be the basis of his new principal residence, computed as follows:

Historical cost of his old principal residence P1,000,000.00


residence:


Less: GSP of old principal residence (4,000,000.00) -

----------------- ----------------


==========

(3) In case the proceeds from the sale of his old principal residence has not been fully utilized to acquire his new principal residence. — If Mr. Buendia acquired his new principal residence within the 18-month reglementary period but did not, however, utilize

the entire proceeds of the sale in acquiring his new principal residence because he only used P3,000,000 thereof in acquiring his new principal residence, that portion of the gross selling price not utilized in the acquisition or construction of his new principal residence shall be subject to capital gains tax.

Computations:


Gross selling price (GSP) P4,000,000.00

Fair market value (FMV) of old principal residence P5,000,000.00


(a) To compute for the capital gains tax due. — To compute for the capital gains tax due, the following formula shall be used in determining capital gains tax due on the taxable portion pertaining to the unutilized amount of the proceeds of sale:

Unutilized Portion of GSP of Old Principal Residence (GSP or FMV of Old Principal ----------------------------------------- x Residence, whichever is higher) x CGT GSP of Old Principal Residence = (P4,000,000 - P3,000,000) ------------------------------- x P5,000,000 x 6% P4,000,000 = P1,000,000 ------------------------------- x P5,000,000 x 6% P4,000,000 = 25% x P5,000,000 x 6% = P75,000.00 ======== The capital gains tax due from Mr. Buendia for the said unutilized portion shall be P75,000 out of the total of P300,000 capital gains tax otherwise due from the sale of his old principal residence (i.e., P5,000,000 x 6% = P300,000). However, he shall be exempt from capital gains tax to the extent allocable to that portion which he actually utilized to acquire his new principal residence (i.e., capital gains tax portion of P225,000), as shown below:

Fair market value of the principal residence sold P5,000,000

-------------

Capital gains tax otherwise due thereon (6%) P300,000

Capital gains tax allocable to the unutilized portion 75,000

-------------

Amount of exempt capital gains tax allocable to the utilized

portion of proceeds from sale (P3,000,000/P4,000,000 = 75% P225,000

times P300,000) ========

(b) To compute for the basis of the new principal residence. — In this case, since the entire proceeds was not utilized to acquire the new principal residence, the cost basis to be carried over to his new principal residence shall be equivalent to the proportion of the utilized amount over the GSP applied on the historical cost, computed as follows:

Historical cost of old principal residence P1,000,000

Less: Portion of historical cost pertaining to the tax

paid unutilized amount (25%) (250,000)

-------------

Adjusted Cost Basis of New Principal Residence P750,000

========

or another way for computing the adjusted cost basis of the new principal residence is by using this formula:

Utilized Amount of GSP -------------------------- x Historical Cost = Amount to be Carried Over GSP of Old of Old Principal to the Cost Basis of New Principal Residence Residence Principal Residence applied as follows: (P4,000,000 - P1,000,000) -------------------------------- x P1,000,000 = P750,000 P4,000,000 =======

SECTION 5. Disposition of the Principal Residence in Exchange for Property Other than Cash. — (1) If the individual taxpayer's principal residence is disposed in exchange for a condominium unit, the disposition of the taxpayer's principal residence shall not be subjected to the capital gains tax herein prescribed, provided that the said condominium unit received in the exchange shall be used by the taxpayer-transferor as his new principal residence. In this particular case, the exempt provision of Sec. 24(D)(2) of the 1997 Tax Code shall only apply to the transferor of the principal residence and not to the transferee who shall be subject to the capital gains tax in case his/its condominium unit is treated as capital asset or to the income tax which shall be withheld in accordance with Sec. 2.57.2(J) of Revenue Regulations No. 2-98, as amended, in case the condominium unit is treated as an ordinary asset. However, if the condominium unit is similarly treated by an individual owner as his principal residence, then the same shall also be covered by the exempt provision under Sec. 24(D)(2) of the same Code.

Example: Mr. Buendia assigned and conveyed his principal residence to ABC Realty Corporation in exchange for a condominium unit which Mr. Buendia will use as his new principal residence. Thus, Mr. Buendia is exempt the from imposition of capital gains tax on the exchange of his new principal residence while ABC Realty Corporation, on the other hand, shall be subject to income tax, on its exchange of the condominium unit.

(2) If the said taxpayer's principal residence is disposed of in exchange for a parcel of land and such land received in the exchange shall be used for the construction of his new principal residence, no income tax or capital gains tax shall be imposed upon the owner of the principal residence. However, the owner of the land shall be subject to capital gains tax or to income tax, as the case may be.

(3) If in the acquisition of his new principal residence, the taxpayer exchanged his old principal residence plus cash or other property, the unutilized portion subject to capital gains tax shall be determined by the difference between the total consideration made on the conveyance of old principal residence transferred (FMV of old principal residence + cash or FMV of other property) and the total consideration received (FMV of new principal residence) for such exchange.

Example: Mr. Buendia assigned and conveyed his principal residence with fair market value of P4,000,000 and in addition paid P2,000,000 to acquire as new principal residence the principal residence of Mr. Yabut. Mr. Yabut, on the other hand, conveyed his principal residence to Mr. Buendia with fair market value of P5,000,000, with the intention of making the property received from Mr. Buendia as his new principal residence. The

historical cost of the old principal residence of Mr. Buendia is P1,000,000 while the historical cost of the old principal residence of Mr. Yabut is P500,000.

(a) Computation of capital gains tax due on the exchange of property by Mr. Buendia — No capital gains tax is due from Mr. Buendia for the reason that there has been full utilization of the value of his old principal residence exchanged where in addition to fair market value of his old principal residence of P4,000,000, he still paid cash of P2,000,000 to acquire as his new principal residence the old principal residence of Mr. Yabut valued at P5,000,000.

(b) Computation of cost basis of the new principal residence of Mr. Buendia —

Historical cost of his old principal residence P1,000,000.00


residence:


Less: FMV of old principal residence at the time of (4,000,000.00) 2,000,000.00

exchange ----------------- ----------------


==========

(c) Computation of capital gains tax due from Mr. Yabut — Mr. Yabut shall be liable to capital gains tax to the extent of the unutilized portion of the total value of consideration received in the exchange which is computed as follows:

= (P6,000,000 - P5,000,000)

------------------------------- x P6,000,000 x 6%

P6,000,000

= P1,000,000

------------------------------- x P6,000,000 x 6%

P6,000,000

= P60,000.00

========

(d) Computation of the adjusted cost basis of the new principal residence of Mr. Yabut — In computing for the adjusted cost basis of the new principal residence of Mr. Yabut, only that portion of historical cost corresponding to the unutilized portion of the value received shall be considered. In this case, the adjusted cost basis of the new principal residence is computed as follows:

= P5,000,000

-------------- x P500,000

P6,000,000

= P416,667

=======

In order to avail of the tax exemption from capital gains tax with respect to such exchanges, the aforesaid taxpayer is nevertheless required to acquire his new principal residence within the eighteen (18) month reglementary period, otherwise, he shall be liable to pay the capital gains tax on the disposition of his principal residence.

In all cases of exchange of principal residence for another real property, the liability of documentary stamp tax provided under Sec. 196 of the 1997 Code shall accrue to both parties involved in the exchange.

I.F. TAXATION OF SHARES OF STOCK


SUBJECT : Consolidated Regulations Prescribing the Rules on the Taxation of Sale, Barter, Exchange or Other Disposition of Shares of Stock Held as Capital Assets

SECTION 2. Definition of Terms. — For purposes of these Regulations, the following definitions of words and phrases are hereby adopted:

(a) "Stock Classified as Capital Assets" means all stocks and securities held by taxpayers other than dealers in securities.

(b) "Dealer in securities" means a merchant of stocks or securities, whether an individual, partnership or corporation, with an established place of business, regularly engaged in the purchase of securities and the resale thereof to customers; that is, one who, as merchant, buys securities and re-sells them to customers with a view to the gains and profits that may be derived therefrom. "Dealer in securities" means any person who buys and sells securities for his/her own account in the ordinary course of business (Sec. 3.4, SRC).

(c) "Shares of Stock" shall include shares of stock of a corporation; warrants and/or options to purchase shares of stock; as well as units of participation in a partnership (except general professional partnerships), joint stock companies, joint accounts, joint ventures taxable as corporations, associations, and recreation or amusement clubs (such as golf, polo or similar clubs); and mutual fund certificates.

(d) "Option" refers to an option to acquire stock or an option to acquire such an option and each one of a series of options to acquire stock. "Options" are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying security at a predetermined price, called the exercise or strike price, on or before a predetermined date, called the expiry date, which can only be extended by the Commission upon stockholders' approval. (SRC Rule 3 (1) (F) (1))

(e) "Shareholder" shall include holders of a share/s of stock, warrants and/or options to purchase shares of stock of a corporation, as well as a holder of a unit of participation in a partnership (except general professional partnerships), in a joint stock company, a joint account, a taxable joint venture, a member of an association, recreation or amusement club (such as golf, polo or similar clubs) and a holder of a mutual fund certificate, a member in an association, joint stock company or insurance company.

(f) "Stockbroker" includes all persons whose business it is, for other brokers, to negotiate purchases or sales of stocks, or engaged in the business of effecting transactions in securities for the account of others but does not include a bank or underwriters for one or more investment companies as defined in the Investment Company Act. "Broker" is a person engaged in the business of buying and selling securities for the account of others. (Sec. 3.3, SRC)

(g) "Local Stock Exchange" refers to any domestic organization, association, or group of persons, whether incorporated or unincorporated, licensed or unlicensed, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of stocks, and includes the market place and the market facilities maintained by such exchange. "Exchange" is an organized domestic marketplace or

facility that brings together buyers and sellers and executes trades of securities and/or commodities, duly registered with the Securities and Exchange Commission. (Sec. 3.7, SRC)

(h) "Gross selling price" refers to the total amount of money or its equivalent which the purchaser pays the seller as consideration for the shares of stock.

(i) "Gross value in money" means the "fair market value". In the case of shares traded thru the stock exchange, "fair market value" shall consist of the actual selling price at which the transaction was executed in the trading system and/or facilities of the Local Stock Exchange.

(j) "Initial Public Offering (IPO)" refers to a public offering of shares of stock made for the first time in the Local Stock Exchange.

(k) "Primary Offering" refers to the original sale made to the investing public by the issuer corporation of its unissued Shares of Stock.

(l) "Secondary Offering" refers to an offer for sale to the investing public by the existing shareholders of their securities which is conducted during an IPO or a follow-on/follow-through offering.

(m) "Follow-on/Follow-through Offering of Shares" refers to an offering of shares to the investing public subsequent to an IPO.

(n) "Shares Listed and Traded through the Local Stock Exchange", for purposes of these Regulations, refers to all sales, trades or transactions of listed Shares of Stock executed through the trading system and/or facilities of the Local Stock Exchange. This term includes block sale or other types of sales, trades or transactions in the Local Stock Exchange and executed through the trading system and/or facilities of the Local Stock Exchange in accordance with the rules of the Local Stock Exchange as approved by the Securities and Exchange Commission.

(o) "Net Capital Gain" means the excess of the gains from sales or exchanges of capital assets over the losses from such sales or exchanges.

(p) "Net Capital Loss" means the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges.

(q) "Closely-held Corporation" means corporation at least fifty percent (50%) in value of the outstanding capital stock or at least fifty percent (50%) of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than twenty (20) individuals.

Rules in Determining Whether the Corporation is a Closely-Held Corporation insofar as such Determination is based on Stock Ownership:

(q.1) Stock not owned by individuals. — Stock owned directly or indirectly by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries.

(q.2) Family and partnership ownerships. — An individual shall be considered as owning the stock owned, directly or indirectly, by or for family, or by or for his partner. For purposes of this paragraph, the family of an individual includes only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.

(q.3) Option. — If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option and each one of a series of options shall be considered as an option to acquire such stock.

(q.4) Constructive ownership as actual ownership. — Stock constructively-owned by reason of the application of paragraph (q.1) or (q.3) shall, for purposes of applying paragraph (q.1) or (q.2), be treated as actually owned by such person; but stock constructively owned by the individual by reason of the application of paragraph (q.2) hereof shall not be treated as owned by him for purposes of again applying such paragraph in order to make another constructive owner of such stock.

(r) "Family of an individual" includes only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal descendants.

(s) "Mutual Fund Company" means an open-end and close-end investment company as defined under the Investment Company Act.

(t) "Acquired" as used in Sec. 7 (c.6) of these Regulations when dealing with wash sales of shares of stock, means acquired by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law, and comprehends cases where the taxpayer has entered into a contract or option within the sixty-one-day period to acquire by purchase or by such an exchange.

(u) "Capital Asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business of a character which is subject to the allowance for depreciation provided in Subsection (F) of Section 34 of the Tax Code, as amended, or real property used in trade or business of the taxpayer.

(v) "Book Value per Share" refers to the value per share computed by dividing the total Stockholders' Equity of a corporation or net assets of the company by the number of outstanding shares or units of participation in a company. In case there are preferred shares as well as common shares, the book value per common share is computed by deducting the liquidation value of the preferred shares from the total equity of the corporation and dividing the result by the number of common shares outstanding as of balance sheet date. The liquidation value of the preferred shares is equal to the redemption price as of balance sheet date, including any premium and cumulative preferred dividends in arrears.

(w) "Treasury Shares" are shares of stock which have been issued and fully paid for, but subsequently reacquired by the issuing corporation by purchase, redemption which is not for cancellation, donation or through some other lawful means. Such shares may again be disposed of for a reasonable price fixed by the board of directors.

(x) "Redeemed Shares" are shares bought back by the issuing corporation for the purpose of retirement or cancellation.

(y) "Acquisition Cost" shall include the purchase price, tax assumed and the commission paid.

(z) "Shares Considered as Worthless" refers to shares when offered for sale or requested for share redemption, no amount can be realized by the owner of the share.

SECTION 3. Persons Liable to the Tax. — The following sellers or transferors of stock are liable to the tax provided for in Sec. 5 of these Regulations:

(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 estates, trusts, trust funds and pension funds, among others.

SECTION 4. Persons Not Liable to the Tax. — The taxes imposed herein shall not apply to the following:

(a) Dealers in securities;

(b) Investors in shares of stock in a mutual fund company, as defined in Section 22 (BB) of the Tax Code, as amended, and Sec. 2 (s) of these Regulations, in connection with the gains realized by said investor upon redemption of said shares of stock in a mutual fund company; and

(c) All other persons, whether natural or juridical, who are specifically exempt from national internal revenue taxes under existing investment incentives and other special laws.

SECTION 5. Sale, Barter or Exchange of Shares of Stock Listed and Traded Through the Local Stock Exchange. — There shall be levied, assessed and collected on every sale, barter, exchange or other disposition of Shares of Stock Listed and Traded through the Local Stock Exchange other than the sale by a dealer of securities, under the following rules:

(a) Tax Rate. — A stock transaction tax at the rate of one-half of one percent (1/2 of 1%) based on the amount determined in subsection (b) hereunder.

(b) Tax Base. — Gross selling price 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.

SECTION 6. Sale, Barter or Exchange, or Issuance of Shares of Stock Through IPO. — There shall be levied, assessed and collected on every sale, barter, exchange or other disposition through initial public offering (IPO) of shares of stock in closely held corporations, as defined in Sec. 2 (q) hereof, under the following rules:

(a) Tax Rates. — A tax at the rates provided hereunder shall be imposed based on subsection (b) hereof in accordance with the proportion of shares of stock sold, bartered, exchanged or otherwise disposed to the total outstanding shares of stock after the listing in the Local Stock Exchange:

Proportion of Disposed Shares to Outstanding Shares Tax Rate

Up to twenty-five percent (25%) 4%

Over twenty-five percent (25%) but not over

thirty three and one-third percent (33 1/3%) 2%

Over thirty-three and one third percent (33 1/3%) 1%

(b) Tax Base. — Gross selling price or gross value in money of the shares of stock sold, bartered, exchanged or otherwise disposed of.

(c) Determination of the Persons Liable to Pay the Tax. —

(c.1) Primary Offering. — The tax herein imposed shall be paid by the issuer corporation with respect to the Shares of Stock corresponding to the Primary Offering.

(c.2) Secondary Offering. — The tax herein imposed shall be paid by the selling shareholder(s) with respect to the Shares of Stock corresponding to the Secondary Offering.

(c.3) Illustration. — RFB Corporation, a closely-held corporation, has an authorized capital stock of 100,000,000 shares with par value of Php1.00/share as of January 1, 2008.

Of the 100,000,000 authorized shares, 25,000,000 thereof is subscribed and fully paid up by the following stockholders:

Mr. Estoy B. Zabala 5,000,000

Mrs. Rowena V. Posadas 5,000,000

Mr. Conrado G. Cruz 5,000,000

Mr. Benedict O. Sison 5,000,000

Mrs. Linda O. Evangelista 5,000,000

–––––––––

Total Shares Outstanding 25,000,000

========

RFB Corporation finally decides to conduct an IPO and initially offers 25,000,000 of its unissued shares to the investing public. After the IPO in March 2008, RFB Corporation's total issued shares increased from 25,000,000 to 50,000,000 shares.

At the IPO, one of the existing stockholders, Mrs. Linda O. Evangelista, has likewise decided to sell her entire 5,000,000 shares to the public. Thus, 25,000,000 shares have been offered in the primary offering and 5,000,000 shares in the secondary offering.

Computation of the percentage to be used. —

(i) Total Number of Shares Outstanding

Number of Shares issued by RFB prior to IPO 25,000,000 shares

Add: Number of Additional Shares Through

Primary Offering for IPO 25,000,000 shares

––––––––––

Total Shares Outstanding after Listing at the

Stock Exchange or IPO 50,000,000 shares

=========

(ii) Computation of Percentage Ratio to the Total Outstanding Shares

(ii.a) For Primary Offering:

Number of Shares offered by

RFB Corporation to the public 25,000,000 shares

Divide by the number of shares outstanding

after the Listing at the Stock Exchange 50,000,000 shares

–––––––––

Ratio of Percentage 50%

–––

Percentage Ratio is 50% which is over 33 1/3% so the Rate of Tax to be used for Primary Offering (IPO) of shares is 1%.

(ii.b) For Secondary Offering:

Number of Shares offered by existing

Stockholder of RFB Corporation to the

public 5,000,000 shares

Divide by the number of shares outstanding

after the Listing at the Stock Exchange 50,000,000 shares

––––––––––

Ratio of Percentage 10%

–––

Percentage Ratio is 10% which is under 25% so the Rate of Tax to be used for Secondary Offering (IPO) of shares is 4%.

(iii) Computation of the Tax

(iii.a) RFB Corporation newly issued shares

(25,000,000 shares x Php1.50/share x 1%) = Php375,000

(iii.b) Mrs. Linda O. Evangelista's shares

(5,000,000 shares x Php1.50/share x 4%) = Php300,000

If in June 2008, RFB Corporation again decides to increase capitalization by offering another 30,000,000 of unissued shares to the public at Php2.00/share consequently bringing the total issued shares to 80,000,000 shares, such follow-on/follow-through sale which are shares issued subsequent to IPO shall no longer be taxed pursuant to Section 6 hereof. The transaction, however, is subject to Documentary Stamp Tax similar to the transaction covered by Primary Offering as well as Secondary Offering of shares of stock. DcCASI

Nonetheless, in case another existing shareholder decides to offer his existing shares to the public subsequent to IPO, as in the above illustration, if Mr. Benedict O. Sison ever decides to sell his 5,000,000 shares to the public at Php2.00 per share (for the Php10,000,000 he received as consideration for the shares he sold), he shall be taxed pursuant to Section 127 (A) of the Tax Code as implemented by Sec. 5 of these Regulations which is 1/2 of 1% of the gross selling price or PhpP50,000 (i.e., 5,000,000 shares x Php2.00/share = Php10,000,000 x 1/2 of 1%).

SECTION 7. Sale, Barter or Exchange of Shares of Stock Not Traded Through a Local Stock Exchange Pursuant to Secs. 24 (C), 25 (A)(3), 25 (B), 27 (D) (2), 28 (A) (7) (C), 28 (B) (5) (C) of The Tax Code, as Amended. —

(a) Tax Rate. — The provisions of Sec. 39 (B) of the Tax Code, as amended, notwithstanding, a final tax at the rates prescribed below is hereby imposed on the sale, barter or exchange of shares of stock not traded through the Local Stock Exchange pursuant to Secs. 24 (C), 25 (A) (3), 25 (B), 27 (D) (2), 28 (A) (7) (c), 28 (b) (5) (c) of the said Tax Code, as amended. cIETHa

Amount of Capital Gain Tax Rate

Not over Php100,000 5%

On any amount in excess of Php100,000 10%

(b) Tax Base. — The tax imposed in Subsection (a) above shall be upon the net capital gains realized during the taxable year from the sale, barter, exchange or disposition of shares of stock, except shares sold or disposed of through the Local Stock Exchange which is covered by the provisions of Secs. 5 and 6 above.

(c) Determination of Amount and Recognition of Gain or Loss. —

(c.1) Determination of Selling Price. — In determining the selling price, the following rules shall apply:

(c.1.1) In the case of cash sale, the selling price shall be the total consideration per deed of sale.

(c.1.2) If the total consideration of the sale or disposition consists partly in money and partly in kind, the selling price shall be sum of money and the fair market value of the property received.

(c.1.3) In the case of exchange, the selling price shall be the fair market value of the property received.

(c.1.4) In case the fair market value of the shares of stock sold, bartered, or exchanged is greater than the amount of money and/or fair market value of the property received, the excess of the fair market value of the shares of stock sold, bartered or exchanged over the amount of money and the fair market value of the property, if any, received as consideration shall be deemed a gift subject to the donor's tax under Sec. 100 of the Tax Code, as amended.

(c.2) Definition of "fair market value" of the Shares of Stock. — For purposes of this Section, "fair market value" of the shares of stock sold shall be:

(c.2.1) In the case of listed shares which were sold, transferred, or exchanged outside of the trading system and/or facilities of the Local Stock Exchange, the closing price on the day when the shares are sold, transferred, or exchanged. When no sale is made in the Local Stock Exchange on the day when the listed shares are sold, transferred, or exchanged, the closing price on the day nearest to the date of sale, transfer or exchange of the shares shall be the fair market value.

(c.2.2) In the case of shares of stock not listed and traded in the local stock exchanges, the book value of the shares of stock as shown in the financial statements duly certified by an independent certified public accountant nearest to the date of sale shall be the fair market value.

Illustrations. —

(i) Assume that Ms. Girl Cantillep sold on October 31, 2008, 100 shares of stock of "A Corporation". The corporation's accounting period consistently employed in keeping its books of accounts is on a calendar year basis. In this case, the book value of the shares of stock of "A Corporation" shall be determined based on its audited financial statements for the calendar year 2007 since its audited financial statements for the calendar year 2008 is yet nonexistent as of the date of sale.

(ii) Assume that Ms. Mape Sison sold on March 31, 2008, 100 shares of stock of "B Corporation". The corporation likewise uses calendar year basis accounting period. In this case, the books of accounts of "B Corporation" have already been closed and adjusted for Calendar Year 2007, but the independent

Certified Public Accountant has yet to issue the audited financial statements for said calendar year 2007 which financial statements together with the annual income tax returns are due to be filed on or before April 15, 2008.

In this particular case, the book value of the shares of stock of "B Corporation" shall tentatively be based on the financial statements for Calendar Year 2007 yet to be audited and not on the audited financial statements of Calendar Year 2006. Once the 2007 audited financial statements have been issued, adjustment to the book value shall be made for the difference.

(c.2.3) In the case of a unit of participation in any association, recreation or amusement club (such as golf, polo, or similar clubs), the fair market value thereof shall be its selling price or the bid price nearest to the date of sale as published in any newspaper or publication of general circulation, whichever is higher.

(c.3) Determination of Gain or Loss from Sale or Disposition of Shares of Stock. — The gain from the sale or other disposition of shares of stock 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 (other than money) received, if any.

(c.3.1) Basis for Determining Gain or Loss from Sale or Disposition of Shares of Stock. — Gain or loss from the sale, barter or exchange of property, for a valuable consideration, shall be determined by deducting from the amount of consideration contracted to be paid, the vendor/transferor's basis for the property sold or disposed plus expenses of sale/disposition, if any.

">(c.3.1.1) Acquired by Purchase. — If the property is acquired by purchase, the basis is the cost of such property.

"> Determination of the Cost. — The cost basis for determining the capital gains or losses for shares of stock acquired through purchase shall be governed by the following rules:

">(i) If the shares of stock can be identified, then the cost shall be the actual purchase price plus all costs of acquisition, such as commissions, documentary stamp taxes, transfer fees, etc.

">(ii) If the shares of stock cannot be properly identified, then the cost to be assigned shall be computed on the basis of the first-in first-out (FIFO) method.

">(iii) If books of accounts are maintained by the seller where every transaction of a particular stock is recorded, then the moving average method shall be applied rather than the FIFO method.

">(iv) In general, stock dividend received shall be assigned with a cost basis which shall be determined by allocating the cost of the original shares of stock to the total number shares held after receipt of stock dividends (i.e., the original shares plus the shares of stock received as stock dividends).

"> Illustration of cost allocated to stock dividends declared. — Five (5) shares of stock in XYX Company were acquired at a total cost of Php1,000.00 or at two hundred pesos per share (Php200/share). XYX Company declared and issued five (5) shares of stock as stock dividend. In this case, the cost basis for each of the ten (10) shares of stock shall be computed by dividing the cost basis of the original shares by ten (10) shares, or one thousand pesos (Php1,000.00)

divided by ten (10) shares equals one hundred pesos (Php100.00) per share. ECTIHa

">(c.3.1.2) Acquired by Devise, Bequest or Inheritance. — If the property was acquired by devise, bequest or inheritance, the basis shall be the fair market value of such property at the time of death of the decedent.

"> The term "property acquired by bequest, devise or inheritance" as used herein means acquisition through testamentary or intestate succession and includes, among others:

">(i) Property interests that the taxpayer received as a result of a transfer, or creation of a trust, in contemplation of or intended to take effect in possession or enjoyment at or after death; and

">(ii) Such property interests as the taxpayer has received as the result of the exercise by a person of a general power of appointment by will or by deed executed in contemplation of or intended to take effect in possession or enjoyment at or after death, otherwise known as a donation mortis causa or a donation in contemplation of death.

">(c.3.1.3) Acquired by Gift. — If the property was acquired by gift, the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift, except that if such basis is greater than the fair market value of the property at the time of the gift, then for the purpose of determining the loss, the basis shall be such fair market value.

"> Illustration. — Assume that "Mr. Era" bought shares of stock in 1970 at a cost of Php100,000. He donated these shares to "Mr. Aio" on January 1, 1998, during which time, the said shares has a fair market value of Php1,000,000 and on the basis of such fair market value, "Mr. Era" paid the corresponding donor's tax. "Mr. Aio", the donee, sold the shares on January 1, 1999 for a consideration of PhP2,000,000. In this case, the basis of "Mr. Aio" in computing his gain from the sale shall be at the historical cost basis thereof in the hands of "Mr. Era", the donor, or at Php100,000. The gain from the sale in the hands of "Mr. Aio" is Php1,900,000 (i.e., selling price of Php2,000,000 less historical cost thereof in the hands of "Mr. Era" the donor, at Php100,000 equals gain from the sale made by "Mr. Aio" in the amount of Php1,900,000).

">(c.3.1.4) Acquired for Inadequate Consideration. — If the property was acquired for less than an adequate consideration in money or money's worth, the basis of such property is the amount paid by the transferee for the property.

"> Illustration. — Assume that "Mr. Esq" sold to "Mr. Nma", shares of stock for a consideration of Php1,000,000. At the time of the sale, its fair market value is Php3,000,000. If "Mr. Nma" later on sells this property and he is taxable on his gain derived from the sale, his gain from the sale shall be determined by deducting from the amount of consideration received his purchase price thereof at Php1,000,000. However, at the time of sale by "Mr. Esq" to "Mr. Nma", the former should pay Capital Gains Tax and Documentary Stamp Tax on the over-the-counter sale transactions of shares and at the same time Donor's Tax on the indirect gift which is the difference between fair market value of shares/stocks sold and the actual consideration for the sold shares of stock. HEISca

(c.3.2) Rules on Substituted Basis in cases of Tax-Free Exchanges of Shares of Stock under Section 40 (C) (2) of the Tax Code, as Amended. —

(c.3.2.1) Substituted Basis of Stock or Securities Received by the Transferor. — The substituted basis of the stock or securities received by the transferor on a tax-free exchange shall be as follows:

(i) The original basis of the property, stock or securities transferred;

(ii) Less: (a) money received, if any, and (b) the fair market value of the other property received, if any;

(iii) Plus: (a) the amount treated as dividend of the shareholder, if any, and (b) the amount of any gain that was recognized on the exchange, if any. However, the property received as 'boot' shall have as basis its fair market value. The term "boot" refers to the money received and other property received in excess of the stock or securities received by the transferor on a tax-free exchange. SICaDA

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

Finally, if the transferor receives several kinds of stock or securities, the Commissioner is authorized to allocate the basis among the several classes of stocks or securities.

(c.3.2.2) Substituted Basis of the Transferred Property in the Hands of the Transferee. — The substituted basis of the property transferred in the hands of the transferee shall be as follows:

(i) The original basis in the hands of the transferor;

(ii) Plus: the amount of the gain recognized to the transferor on the transfer.

(c.3.2.3) The Original Basis of Property to be Transferred. — The original basis of the property to be transferred shall be the following, as may be appropriate:

(i) The cost of the property, if acquired by purchase on or after March 1, 1913;

(ii) The fair market price or value as of the moment of death of the decedent, if acquired by inheritance;

(iii) The basis in the hands of the donor or the last preceding owner by whom the property was not acquired by gift, if the property was acquired by donation. If the basis, however, is greater than the fair market value of the property at the time of donation, then, for purposes of determining loss, the basis shall be such fair market value; or, aHTDAc

(iv) The amount paid by the transferee for the property, if the property was acquired for less than an adequate consideration in money or money's worth.

(v) The adjusted basis of (i) to (iv) above, if the acquisition cost of the property is increased by the amount of improvements that materially add to the value of the property or appreciably prolong its life less accumulated depreciation.

(vi) The substituted basis, if the property was acquired in a previous tax-free exchange under Section 40 (C) (2) of the Tax Code, as amended.

(c.3.2.4) Basis for Determining Gain or Loss on a Subsequent Sale or Disposition of Property Subject of the Tax-free Exchange. — The substituted basis as defined in Section 40 (C) (5) of the Tax Code as amended, and implemented in Section (c.3.2.1) and (c.3.2.2) above, shall be the basis for determining gain or loss on a subsequent sale or disposition of property subject of the tax-free exchange.

(c.4) Limitation of Capital Losses. — 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.

(c.5) Shares of Stock Becoming Worthless. — Losses from shares of stock, held as capital asset, which have become worthless during the taxable year shall be treated as capital loss as of the end of the year. However, this loss is not deductible against the capital gains realized from the sale, barter, exchange or other forms of disposition of shares of stock during the taxable year, but must be claimed against other capital gains to the extent provided for under Section 34 of the Tax Code, as amended. For the 5% and 10% net capital gains tax to apply, there must be an actual disposition of shares of stock held as capital asset, and the capital gain and capital loss used as the basis in determining net capital gain, must be derived and incurred respectively, from a sale, barter, exchange or other disposition of shares of stock.

(c.6) Losses from Wash Sales of Shares of Stock. — The following rules shall apply with respect to losses from wash sales of shares of stock:

(c.6.1) A taxpayer cannot deduct any loss claimed to have been sustained from the sale or other disposition of stock, if, within a period beginning thirty (30) days before the date of such sale or disposition and ending thirty (30) days after such date (referred to in this section as the sixty-one (61)-day period), he has acquired (by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock. However, this prohibition does not apply in the case of a dealer in stock if the sale or other disposition of stock is made in the ordinary course of the business of such dealer.

(c.6.2) Where more than one loss is claimed to have been sustained within the taxable year from the sale or other disposition of stock or securities, the provisions of this Section shall be applied to the losses in the order in which the stock the disposition of which resulted in the respective losses were disposed of (beginning with the earliest disposition). If the order of disposition of stock disposed of at a loss on the same day cannot be determined, the stock or securities will be considered to have been disposed of in the order in which they were originally acquired (beginning with earliest acquisition).

(c.6.3) Where the amount of stock or securities acquired within the sixty-one (61)-day period is less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the loss from the sale or other disposition of which is not deductible shall be those with which the stock or securities acquired are matched in accordance with this rule: The stock or securities sold will be matched in accordance with the order of their acquisition (beginning with the earliest acquisition) with an equal number of the shares of stock or securities sold or otherwise disposed of.

(c.6.4) Where the amount of stock or securities acquired within the sixty-one day period is not less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the acquisition of which resulted in the non-deductibility of the loss shall be those with which the stock or securities disposed of are matched in accordance with this rule: The stock or securities sold or otherwise disposed of will be matched with an equal number of the shares of stock or securities acquired in accordance with the order of acquisition (beginning with the earliest acquisition) of the stock or securities acquired.

(c.6.5) The acquisition of any share of stock or any security which results in the non-deductibility of a loss under the provisions of this Section shall be disregarded in determining the deductibility of any other loss.

(c.6.6) As provided in Sec. 2 of these Regulations, the word "acquired" as used in this Section means acquired by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law, and comprehends cases where the taxpayer has entered into a contract or option within the sixty-one-day period to acquire by purchase or by such an exchange the subject shares of stock.

Examples of losses from wash sales of stock or securities. —

(i) On December 1, 2000, Ms. Rose Miranda whose taxable year is the calendar year, purchased 100 shares of common stock of M company for Php10,000. On December 15, 2000, she purchased 100 additional shares for Php9,000. On January 2, 2001, she sold the 100 shares purchased on December 1, 2000 for Php9,000. Because of the provisions of this Section, no loss from the sale is allowable as deduction. HDTSIE

(ii) Ms. Karren Punzalan, whose taxable year is the calendar year, had the following stock transactions:

• On September 21, 2000, purchased 100 shares of the common stock of M Company for Php5,000 or at Php50.00/share.

• On December 21, 2000, she purchased 50 shares of substantially identical stock for Php2,750 or at Php55/share. IDSaEA

• On December 26, 2000, she purchased 25 additional shares of such stock for Php1,125 or at Php45/share.

• On January 2, 2001, she sold for Php4,000 the 100 shares purchased on September 21, 2000 or at Php40.00/share.

Computation of the Indicated Loss

Proceeds from sale of 100 shares Php4,000

Cost of shares bought on September 21, 2000 5,000

–––––––––

Indicated Loss from the sale (Php1,000)

========

Computation of Non-deductible Loss due to the Sixty-one Day Period of Purchase of Substantially Identical Shares. —

Number of Shares Purchased Within the 61-day

period 75 shares

x Cost/share for shares bought on

September 21, 2000 Php50.00/share

––––––––––––

Amount Php3,750.00

Less: Proceeds from Sale on January 2, 2001

for 75 shares (i.e. 75 x P40/share) 3,000.00

–––––––––

Non-Deductible Loss Php750.00

========

The loss on the sale of the remaining 25 shares (Php1,250 less Php1,000 or Php250) is deductible subject to the limitations provided in items (c.6.3) above and (c.4) above.

(iii) Ms. Ding Cruz, whose taxable year is the calendar year, had the following stock transactions:

• On September 15, 2000, purchased 100 shares of the stock of M Company for Php5,000.

• On February 1, 2001, she sold these shares for Php4,000.

• On each of the four days from February 15, 2001 to February 18, 2001, she purchased 50 shares per day of substantially identical stock for Php2,000 per purchase.

There is an indicated loss of P1,000 from the sale of the 100 shares on February 1, 2001, but since within the sixty-one-day period she purchased not less than 100 shares of substantially identical stock, the loss is not deductible. The particular shares of stock, the purchase of which resulted in the nondeductibility of the loss are the first 100 shares purchased within such period, that is, the 50 shares purchased on February 15, 2001, and the next 50 shares purchased on February 16, 2001.

SECTION 8. Taxation of Surrender of Shares by the Investor Upon Dissolution of the Corporation and Liquidation of Assets and Liabilities of Said Corporation. — Upon surrender by the investor of the shares in exchange for cash and property distributed by the issuing corporation upon its dissolution and liquidation of all assets and liabilities, the investor shall recognize either capital gain or capital loss upon such surrender of shares computed by comparing the cash and fair market value of property received against the cost of the investment in shares. The difference between the sum of the cash and the fair market value of property received and the cost of the investment in shares shall represent the capital gain or capital loss from the investment, whichever is applicable. If the investor is an individual, the rule on holding period shall apply and the percentage of taxable capital gain or deductible capital loss shall depend on the number of months or years the shares are held by the investor. Section 39 of the Tax Code, as amended, shall herein apply in all possible situations.

The capital gain or loss derived therefrom shall be subject to the regular income tax rates imposed under the Tax Code, as amended, on individual taxpayers or to the corporate income tax rate, in case of corporations.

SECTION 9. Taxation of Shares Redeemed for Cancellation or Retirement. — When preferred shares are redeemed at a time when the issuing corporation is still in its "going-concern" and is not contemplating in dissolving or liquidating its assets and liabilities, capital gain or capital loss upon redemption shall be recognized on the basis of the difference between the amount/value received at the time of redemption and the cost of the preferred shares.

Similarly, the capital gain or loss derived shall be subject to the regular income tax rates imposed under the Tax Code, as amended, on individual taxpayers or to the corporate income tax rate, in case of corporations.

This section, however, does not cover situations where a corporation voluntarily buys back its own shares, in which it becomes treasury shares. In such cases, the stock transaction tax under Sec. 127 (A) of the Tax Code shall apply if the shares are listed and executed through the trading system and/or facilities of the Local Stock Exchange. Otherwise, if the shares are not listed and traded through the Local Stock Exchange, it is subject to the 5% and 10% net capital gains tax.

SECTION 10. Time of Payment of Tax and Manner of Filing Returns. — The tax imposed under Section 5 of these Regulations shall be collected as follows:

(a) Tax on Sale of Shares of Stock Listed and Traded through the Local Stock Exchange. — The stock broker who effected the sale has the duty to collect the tax from the seller upon issuance of the confirmation of sale, issue the corresponding official receipt thereof and remit the same to the collecting bank/officer of the Revenue District Officers (RDO) where the broker is registered within five (5) banking days from the date of collection thereof and to submit on Mondays of each week to the secretary of the Local Stock Exchange, of which he is a member, a true and complete return, which shall contain a declaration, that he made under the penalties of perjury, of all the transactions effected through him during the preceding week and of taxes collected by him and turned over to the concerned RDO. The secretary of the Local Stock Exchange shall reconcile the records of the Local Stock Exchange with the weekly reports of stockbrokers and in turn transmit to the RDO, on or before the 15th day of the following month, a consolidated return of all transactions effected during the preceding month through the Local Stock Exchange.

(b) Tax on Shares of Stock Sold or Exchanged through IPO. — The corporate issuer in Primary Offering shall file the return and pay the corresponding tax to the RDO which has jurisdiction over said corporate issuer within thirty (30) days from the date of listing of the shares of stock in the Local Stock Exchange. The return shall be accompanied with a copy of the instrument of sale.

In the case of shares of stock sold or exchanged through Secondary Offering at the time of listing at the Local Stock Exchange of shares of closely-held corporations, the provisions of subsection (a) of this Section shall apply as to the time and manner of the payment of the tax on the sale thereof.

(c) Tax on Shares of Stock Not Traded through the Local Stock Exchange. — Persons deriving capital gains from the sale or exchange of listed shares of stock not traded through the Local Stock Exchange as prescribed by these regulations shall file a return within thirty (30) days after each transaction and a final consolidated return of all transactions during the taxable year on or before the fifteenth (15th) day of the fourth (4th) month following the close of the taxable year.

In the case of an individual taxpayer, the filing of the final consolidated return of all transactions shall be during the calendar year. However, for corporate taxpayers, the filing of the final consolidated return of all transactions shall be in accordance with the accounting period employed by such taxpayer which may either be calendar or fiscal year basis.

SECTION 11. Effect of Non-Payment of Tax. — No sale, exchange, transfer or similar transaction intended to convey ownership of, or title to any share of stock shall be registered in the books of the corporation unless the receipts of payment of the tax herein imposed is filed with and recorded by the stock transfer agent or secretary of the corporation. It shall be the duty of the aforesaid persons to inform the Bureau of Internal Revenue in case of non-payment of tax. Any stock transfer agent or secretary of the corporation or the stockbroker, who caused the registration of transfer of ownership or title on any share of stock in violation of the aforementioned requirements shall be punished in accordance with the provisions of Title X, Chapters I and II of the Tax Code, as amended.

SECTION 12. Penalties. — In addition to the civil and criminal liabilities of the taxpayer, for violation of the provisions of these Regulations, the following administrative penalties prescribed under Secs. 248 and 249 of the same Tax Code shall be imposed, which shall be collected at the same time, in the same manner and as part of the tax.

(a) Surcharges. —

(a.1) There shall be imposed, in addition to the tax required to be paid, a penalty equivalent to twenty-five percent (25%) of the amount due, in the following cases:

(a.1.1) Failure to file any return and pay the tax due thereon as required by the provisions of the Tax Code, as amended, and these Regulations, on the date prescribed;

(a.1.2) Unless otherwise authorized by the Commissioner, filing a return with an internal revenue officer other than those with whom the return is required to be filed; or

(a.1.3) Failure to pay the deficiency tax within the time prescribed for its payment in the notice of assessment; or

(a.1.4) Failure to pay the full or part of the amount of the tax shown on any return required to be filed under the provisions of the Tax Code, as amended, and these Regulations, on or before the date prescribed for its payment.

(a.2) In case of willful neglect to file the return within the period prescribed by the Tax Code or these Regulations, or in case a false or fraudulent return is willfully made, the penalty to be imposed shall be fifty percent (50%) of the tax or of the deficiency tax, in case any payment has been made on the basis of such return before the discovery of the falsity or fraud. ASEIDH

(b) Interest. — There shall be assessed and collected on any unpaid amount of tax, interest at the rate of twenty percent (20%) per annum.

(c) Deficiency Interest. — Any deficiency in the tax due shall be subjected to interest at the rate of twenty percent (20%), which interest shall be assessed and collected from the date prescribed for its payment until the full payment thereof.

(d) Delinquency Interest. — In case of failure to pay the amount of the tax due on the return required to be filed, or a deficiency tax, or any surcharge or interest thereon on the due date appearing in the notice and demand of the Commissioner of Internal Revenue, there shall be assessed and collected on the unpaid amount, interest at the rate of twenty percent (20%) per annum until the amount is fully paid, which interest shall form part of the tax.

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