PM Reyes Notes on Taxation 1 - Income Tax (Updated 14 January 2013)

PM REYES NOTES ON TAXATION I: INCOME TAX

PM REYES NOTES ON TAXATION I: INCOME TAX (Updated 14 January 2013) BY PIERRE MARTIN DE LEON REYES This reviewer is a compilation of personal notes in Taxation One and notes and lectures from Atty. Gruba and Atty. Montero. References have also been made to the following books: DE LEON & DE LEON, JR. THE FUNDAMENTALS OF TAXATION (2012); DE LEON & DE LEON, JR. COMPREHENSIVE REVIEW OF TAXATION (2010); VITUG & ACOSTA. TAX LAW AND JURISPRUDENCE (2006); DOMONDON, TAXATION VOLUME II: INCOME TAX (2009); CO-UNTIAN, JR. TAX DIGEST (2009); MAMALATEO, PHILIPPINE INCOME TAX (2010); MAMALATEO, REVIEWER ON TAXATION (2008). This reviewer is best used with SACADALAN-CASASOLA, NIRC AND OTHER LAWS (2012). Possessors are granted the right to reproduce and distribute this reviewer as well as the right to convert the work to any medium for the purpose of preservation and/or continued distribution provided that the authors name remains clearly associated with the work and that no alterations of the form and content are made.

Page | 1 In general Q1. What is an income? Income means the gain derived from capital, from labor, or from both combined, including profits gained from dealings in property or as well as any asset clearly realized whether earned or not. It refers to all wealth which flows into the taxpayer other than as a mere return on capital. (RR No.2) Q2. What is an income tax? Income Tax is a tax on the net income or the entire income received or realized in one taxable year. It is levied upon corporate and individual incomes in excess of specified amounts, less certain deductions and/or specified exemptions permitted by law. The final tax on certain passive incomes and withholding tax on income are embraced within the term. In CONWI V. CTA [AUGUST 31, 1992], the Supreme Court defined income tax as an amount of money coming to a person or corporation within a specified time, whether as payment for services, interest, or profit from investment. As stated by the Supreme Court in REPUBLIC OF THE PHILIPPINES VS. MANILA ELECTRIC COMPANY [NOVEMBER 15, 2002], income tax is imposed on an individual or entity as a form of excise tax or a tax on the privilege of earning income. In exchange for the protection extended by the State to the taxpayer, the government collects taxes as a source of revenue to finance its activities. Q3. When is income taxable? (or what are the

elements of a taxable income?) Income, gain or profit is subject to income tax when the following conditions are present:

1. There is income, gain or profit1 2. The income, gain or profit is received or realized

during the taxable year;2 (known as the realization concept) and

3. The income, gain or profit is not exempt from income tax.3

Q3.1. What is the difference between

income and capital? Income is distinct from capital. Income means all the wealth which flows into the taxpayer other than a mere return on capital while capital is a fund or property existing at one distinct point in time while income denotes a flow of wealth during a definite period of time. Income is gain derived and severed from capital. (see CHAMBER OF REAL ESTATE AND BUILDERS ASSOCIATION, INC. V. ROMULO [MARCH 9, 2010]). Income as contrasted with capital or property is to be the test. The essential difference between capital and income is that capital is a fund; income is a flow. A fund of property existing at an instant of time is called capital. A flow of services rendered by that capital by the payment of money from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time is called an income. Capital is wealth, while income is the service of wealth. A tax on income is not a tax on property. "Income," as here used, can be defined as "profits or gains." (see MADRIGAL VS. RAFFERTY [AUGUST 7, 1918]).

Q3.1.1 Are stock dividends income or capital?

Generally, stock dividends represent capital and do not constitute as income to its recipient. Mere issuance thereof is not yet subject to income tax as they are nothing but an enrichment through increase in value of capital investment. Such are considered

1 As opposed to mere reimbursements or return on capital. 2 As opposed to the common examples of unrealized forex gains or mere revaluation increments. 3 Examples of those exempt from income tax: de minimis benefits and professional fees of GPPs.

Napoleon-III(supports Fisher v. Trinidad)

Napoleon-III(e.g. no reimbursement medrep)

Napoleon-III4. Complete Dominion (CIR v. Glenshaw Glass Co.)

Napoleon-IIIUnder realization there must be:1) change in substance2) transaction with a 3rd party

Napoleon-IIIBaseball Example: No Income because there is really no realization because there is no business transaction with a 3rd party. This militates agianst administrative convenience.

Napoleon-III

Napoleon-IIIBallpen example:w/ name income to finderw/o name no income to finder*Treasure Trove Test

Napoleon-IIIIncome from capital & labor? Is this a requisite for what constitutes income? NO. Because it can also arise from WINDFALL.(See CIR v. Glenshaw & Murphy v. IRS)

Does it have to be severed from the capital before it is considered as income? NO. (Hevering v. Bruun)

Napoleon-IIINOTE: Inter-corporate dividends are subject to 0% tax.

Napoleon-IIIGross Income (less) Deductions = Taxable Income

Napoleon-III


PIERRE MARTIN DE LEON REYES 2

unrealized gain and cannot be subjected to income tax until that gain has been realized. As explained by the Supreme Court in FISHER V. TRINIDAD [OCTOBER 30, 1922], when a corporation issues stock dividends, it shows that the corporations accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution. The stockholder receives nothing out of the corporate assets for his separate use and benefit but a representation of his increased interest in the capital of the corporation. The capital still belongs to the corporation as there is no separation of interest. However, stock dividends constitute as income if a corporation redeems stock issued so as to make a distribution.4 This is essentially equivalent to the distribution of a taxable dividend the amount so distributed in the redemption considered as taxable income. (see COMMISSIONER VS. MANNING [AUGUST 7, 1975])

Q3.2. Are money received as damages income?

Yes. In COMMISSIONER V. GLENSHAW GLASS CO. [348 U.S. 426], Glenshaw Co was engaged in a proracted litigation with Hartford-Empire Co where the former demanded exemplary damages for fraud and treble damages for injury to its business by reason of the latters violation of federal antitrust laws. The parties settled. Glenshaw did not report the money received as damages from the settlement in its income tax return. The Commissioner assessed Glenshaw for the deficiency. Glenshaw contended that punitive damages, as windfalls flowing from culpable conduct of third parties are not taxable income. The US Supreme Court held that money received as damages must be reported as they constitute income. The mere fact that such payments were extracted from wrongdoers cannot detract from their character as taxable income. The Court also stated that punitive damages cannot be classified as gifts. In MURPHY V. IRS [493 F.3d 170], the US Court of Appeals (District of Columbia), held that the amount received as compensatory damages for emotional distress and loss of reputation constitutes taxable income.

4 The exception to the rule that stock dividends do not constitute income shall be discussed more extensively later. Knowing that there is an exception exists will suffice for now.

Q3.3. What is the constructive receipt doctrine?

The constructive receipt doctrine provides than an item is treated as income when it is credited to the account of the, or made unconditionally available to the taxpayer; no physical possession is required. Income is received not only when it is actually handed to a taxpayer but also when it is merely constructively received by him. In LIMPAN INVESTMENT V. CIR [JULY 26, 1966], the lessees opted to deposit their payments when the lessor refused to accept the same in 1957. The lessor did not report these payments in his 1957 income tax return. The Supreme Court held that the failure to report the said rental income is unjustified as, when the payments were deposited, the lessor was deemed to have constructive received such rentals. Overview of the Philippine Income Tax System Q4. What are the features of the Philippine tax

system?

The Philippine tax system is: 1. Direct5 2. Progressive6 3. Semi-schedular, semi-global

Q4.1. What are the kinds of income tax

systems?

The types of income tax systems adopted are as follows: 1. Global Tax System where the taxpayer is

required to lump up all items of income earned during a taxable period and pay under a single set of income tax rates on these different items of income. (Simply put, varying taxes are imposed on passive income)

2. Schedular Tax System where there are different tax treatments of different types of income so that a separate tax return is required to be filed for each type of income and the tax is computed on a per return or per schedule basis.

5 Direct taxes are those taxes wherein both the tax liability as well as the impact or burden of the tax falls on the same person 6 Progressive taxes are those taxes imposed where the tax rate increases as the tax base increases

Napoleon-IIIThe holder of stock dividend was not any poorer or richer when he received stock dividends (realization). There is also the idea of severance from capital which was been modified by Helvering v. Bruun.

Napoleon-IIIStock dividends cannot comply with the requirement of wherewithal (i.e. the capacity to pay. By taxing stock dividends, it is like asking the stockholder to sell his stock dividends to the BIR.

Napoleon-IIIYou have to be liquid to be taxed. You cant pay stocks/chickens to the BIR. This is why realization is a requisite for income. WHEN YOU REALIZE it is a different question.

Napoleon-IIISegues into the 3rd requisite. There may be an instance whereby those not considered as income will be such because the law says they are.

Tax Benefit Rule - if unable to collect, you may report it as loss. But if after such report, you receive payment for the debt, it becomes income in your hands. In contrast, if you receive it before loss report, its neutral.

Napoleon-IIIReceipt of stock dividends does not give rise to income



(Simply put, one rate for all types of gross income).

3. Semi-Schedular or Semi-Global Tax System where the tax system is either (a) global (e.g. taxpayer with compensation income not subject to final withholding tax or business or professional income or mixed income compensation and business or professional income) or (b) schedular (e.g. taxpayer with compensation, capital gains, passive income, or other income subject to final withholding tax) or (c) both global and schedular may be applied depending on the nature of the income realized by the taxpayer during the year. Q4.2. How do you distinguish

schedular treatment from global treatment as used in income taxation?

Under the schedular tax system, the various types of income (i.e. compensation; business/professional income) are classified accordingly and are accorded different tax treatments, in accordance with schedules characterized by graduated tax rates. Since these types of income are treated separately, the allowable deductions shall likewise vary for each type of income. On the other hand, under the global tax system, all income received by the taxpayer are grouped together, without any distinction as to type or nature of the income, and after deducting therefrom expenses and other allowable deductions, are subjected to tax at a graduated or fixed rate (see TAN VS. DEL ROSARIO [OCTOBER 3, 1994]).

Q4.3. What are the types of Philippine Income Tax (under Title II of the NIRC)?

The types of Income tax under Title II of the NIRC are: 1. Graduated income tax on individuals 2. Normal corporate income tax on corporations 3. Minimum corporate income tax on corporations 4. Special income tax on certain corporations (e.g.

private educational institutions, FCDUs, and international carriers)

5. Capital gains tax on sale or exchange of unlisted shares of stock of a domestic corporation classified as a capital asset

6. Capital gains tax on sale or exchange of real property located in the Philippines and classified as a capital asset

7. Final withholding tax on certain passive investment incomes

8. Fringe benefit tax 9. Branch profit remittance tax; and 10. Tax on improperly accumulated earnings. Definition of Terms Q5. Define the following terms: In Section 22(A) to (I), (Z), (GG), and (HH), Tax Code: Person An individual, a trust, estate or

corporation Corporation Includes partnerships, no matter

how created or organized, joint-stock companies, joint accounts, associations, or insurance companies but does not include general professional partnerships and a joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum and other energy operations pursuant to an operating agreement under a service contract with the Government

General Professional Partnerships (GPPs)

Partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business

Domestic (Corporation)

When applied to a corporation, means created or organized in the Philippines or under its laws

Foreign (Corporation)

When applied to a corporation, means a corporation which is not domestic

Nonresident citizen

The term means a citizen of the Philippines: 1. who establishes to the

satisfaction of the Commissioner the fact of his physical presence abroad with intention to reside therein



2. who leaves the Philippines during the taxable year to reside abroad either as an immigrant or for employment on a permanent basis

3. 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. who has been previously considered a non-resident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines with respect to his income derived from sources abroad until date of his arrival in the Philippines

Resident alien An individual whose residence is

within the Philippines and who is not a citizen thereof

Nonresident alien

An individual whose residence is not within the Philippines and who is not a citizen thereof

Resident foreign corporation

A foreign corporation engaged in trade or business within the Philippines

Nonresident foreign corporation

A foreign corporation not engaged in trade or business within the Philippines

Ordinary Income

Includes any gain from the sale or exchange of property which is not a capital asset or property described in Section 39(A)(1)7

Statutory Minimum Wage

Refers to the rate fixed by the Regional Tripartite Wage and Productivity Boar, as defined by the Bureau of Labor and Employment Statistics (BLES) of DOLE.

Minimum Wage earner

A worker in the private sector paid the statutory minimum wage or to an employee in the public sector with compensation income of not more than the statutory minimum wage in the non-agricultural sector where he/she is assigned

7 which defines what capital assets are and those which are not.

In Section 31, 35(B), and 39(A), Tax Code: Taxable Income

the pertinent items of gross income specified in the NIRC less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by the NIRC or other special laws

Dependent 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

Capital Assets property held by the taxpayer (whether or not connected with his trade or business, EXCEPT: 1. Stock in trade of the

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

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

3. Property used in trade or business of a character that is subject to allowance for depreciation

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

Net Capital Gain

the excess of the gains from sales or exchanges of capital assets over the losses from such sales or exchanges

Net Capital loss

the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges

Napoleon-IIISEC Reg.

Napoleon-IIIBranch not a separate entity from the head office; mere extension; you secure a registration establishing the branch. For tax purposes is a resident foreign corp.

Napoleon-IIISubsidiary organized as a separate entity from the parent corp; relationship is based on equity (shareholding); considered as domestic corp. even if wholly owned by a foreign corporation.

Napoleon-IIITokyo Shipping case

Napoleon-IIIDiff. bet. RC & NRC is based on the physical presence and on the nature of the stay.

Napoleon-IIIIncome - Exclusions = Gross income - Deductions/Exemptions = Net Taxable Income

Napoleon-IIINot subject to Income Tax



Q6. What are the kinds of income taxpayers?8 The kinds of income taxpayers under Title II of the NIRC are:

A. Individuals 1. Citizens (Section 24, NIRC)

a. Resident Citizens b. Nonresident Citizens

2. Aliens a. Resident Aliens (Section 24, NIRC) b. Nonresident Aliens (Section 25,

NIRC) i. Engaged in trade or business in

the Philippines ii. Not engaged in trade or business

in the Philippines 3. Estates and Trusts (Section 60, NIRC)

a. Revocable trust b. Irrevocable trust

B. Corporations 1. Domestic Corporations (Section 27,

NIRC) 2. Foreign Corporations (Section 28, NIRC)

a. Resident foreign corporations b. Nonresident foreign corporations

3. Partnerships a. Taxable partnership (Section 73(D),

NIRC) b. Exempt partnership

i. General Professional Partnership (Section 26, NIRC)

ii. Joint venture or consortium undertaking construction activity or engaged in petroleum operations with operating contract with the government

Resident citizens and resident aliens Q7. Who are citizens of the Philippines?9 The following are considered citizens of the Philippines: 8 Before proceeding to income proper, it is important to know the different kinds of taxpayers first. This is because in analyzing any problem involving income taxation, the first thing to do is to determine who the taxpayer is. The only two exceptions where knowing the taxpayer is immaterial are where the transaction involves sales of shares of stock of a domestic corporation because it is subject to 1% of stock transaction tax or 5%/10% capital gains tax on net capital gain whether the seller is an individual, citizen or alien or a corporation, domestic or foreign and (2) where the real property sold is a capital asset located in the Philippines which is subject to 6% capital gains tax. 9 To determine if the taxpayer is a resident citizen, just refer to the enumeration of what constitutes a non-resident citizen.

1. Those who are citizens of the Philippines at

the time of the adoption of the Constitution 2. Those whose fathers or mothers are citizens

of the Philippines 3. Those born before January 17, 1973 of

Filipino mothers, who elect Philippine Citizenship upon reaching the age of majority; and

4. Those who are naturalized in accordance with law

Q8. Who is a non-resident alien? A non-resident alien is an individual whose residence is within the Philippines and who is not a citizen thereof.

Q8.1. How is the residency of an alien determined?

An alien is considered a non-resident if he stays here for a definite short period of time. An alien will be considered a resident if the stay here is either: 1. definite and extended; 2. indefinite In GARRISON V. CA [JULY 19, 1990], in resolving the contention of US nationals that they cannot be considered resident aliens as they intend to go back to the US on termination of their employment in the Philippines, the Supreme Court held that what the law requires is merely physical or bodily presence in a given place for a period of time, not the intention to make it a permanent place of abode. The Supreme Court further held that, as laid clearly in RR No. 2, whether an alien 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 as a transient. If he lives in the Philippines and has no definite intention as to his stay, he is a resident.10 One who comes to the Philippines for a definite purpose, which in its nature may be promptly accomplished, is a transient.11 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 the

10 In other words, stay is indefinite. 11 In other words, the stay is for a definite short period of time.

Napoleon-III



Philippines his temporary home, he becomes a resident, although he intends to return to his domicile abroad.12

Q8.2. When is the residence of an alien considered lost?

RR 2 provides that 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. Non-resident citizens Q9. Who is a non-resident citizen? The term non-resident citizen means a citizen of the Philippines:

1. who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with intention to reside therein

2. who is an one who leaves the Philippines during the taxable year to reside abroad either as an immigrant or for employment on a permanent basis

3. who is one 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. who has been previously considered a non-resident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines with respect to his income derived from sources abroad until date of his arrival in the Philippines

(See Section 22E, NIRC and Section 2, RR No. 01-79 [January 8, 1979])

Q9.1. Should a non-resident citizen file an income tax return or information return covering his income earned abroad?

No. Previously, under RR No. 01-79, non-resident citizens were required to do so. In RR No. 9-99, non-resident citizens were required to file an information 12 In other words, the stay is definite but extended.

return. However, under RR 05-01 [July 31, 2001], non-resident citizens are no longer required to file the same on their income derived from sources outside the Philippines.

Q9.2. What is meant by the phrase most of the time as used in determining whether a citizen who derives income from abroad and is physically present abroad is a non-resident?

RR No. 01-79 states that to be 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. Note: As can be seen from the wording of RR No. 01-79, most of the time applies to a contract worker. In BIR Ruling 33-00 [September 5, 2000], however, the CIR held that for overseas contract workers, the time spent abroad is not material as all that is required is for the workers employment contract to pass through and be registered with the POEA.

Q9.3. If a natural-born Philippine citizen who became a citizen of the United States is later on granted Philippine dual citizenship under RA 9225, is he required to pay taxes for income earned in the United States?

No. In BIR Ruling DA-095-05 [March 29, 2005], the CIR held that such a person would be a non-resident citizen, and hence, will not be required to pay Philippine tax for income earned in the United States. Non-resident aliens engaged in business in the Philippines Q10. Who is a non-resident alien? A non-resident alien is an individual: 1. whose residence is not within the Philippines; and 2. who is not a citizen thereof

Napoleon-IIIHow to Determine if NRA or RARelevant factors:(1) Duration & (2) Certainty/DefinitieShort-Definite NRAShort-Indefinite ResidentLong-Definite Resident (e.g. Normal Black)Long-Indefinite Resident

Napoleon-IIIThe moment you leave the Phils. you are considered an NRC whether or not you prove the requisites.

Napoleon-III

Napoleon-IIIThe 183 day qualification is only to qualify the most of the time requirementBUT this is not solely controlling. RATHER Section 22.

Napoleon-IIIThis applies to a citizen who needs to be abroad for the most time but not a contract worker.

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FreeTextDual Citizens are treated as non-resident citizens of the Philippines

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Q10.1. How do you determine if a non-resident alien is engaged in trade or business?

Once a taxpayer is determined to be a non-resident alien, the test to determine whether the alien is a non-resident alien engaged in trade or business is whether his total aggregate stay for a taxable year exceeds 180 days. Corporations Q11. Differentiate the kinds of corporate

taxpayers. A corporation is itself a taxpaying entity and speaking generally, for purposes of income tax, corporations are classified into (a) domestic corporations and (b) foreign corporations. Foreign corporations are further classified into (1) resident foreign corporations and (2) non-resident foreign corporations. A domestic corporation is one created or organized in the Philippines or under its laws. A foreign corporation is one created or organized under the laws of a foreign country. A resident foreign corporation is a foreign corporation engaged in trade or business within the Philippines or having an office or place of business therein. A non- resident foreign corporation is a foreign corporation not engaged in trade or business within the Philippines and not having any office or place of business therein. A domestic corporation is taxed on its income from sources within and without the Philippines, but a foreign corporation is taxed only on its income from sources within the Philippines. However, while a foreign corporation doing business in the Philippines is taxable on income solely from sources within the Philippines, it is permitted to deductions from gross income but only to the extent connected with income earned in the Philippines. On the other hand, foreign corporations not doing business in the Philippines are taxable on income from all sources within the Philippines, as interest, dividends, rents, salaries, wages, premiums, annuities Compensations, remunerations, emoluments, or other fixed or determinable annual or periodical or casual gains, profits and income and capital gains.

(see N.V. REEDERIJ AMSTERDAM VS. CIR [JUNE 23, 1988]) Q12. Is a partnership liable for income tax? Yes. The term corporations includes partnerships, no matter how created or organized.

Q12.1. Is a GPP13 liable for income tax? No. A GPP is not considered a taxable entity for income tax purposes. Section 26 of the NIRC provides that persons engaging in business as partners in a GPP shall be liable for income tax only in their separate and individual capacities computed on their respective distributive shares of the partnership profit.

Q12.2. Distinguish between a GPP and an ordinary business partnership.

A general professional partnership, unlike an ordinary business partnership (which is treated as a corporation for income tax purposes and so subject to the corporate income tax), is not itself an income taxpayer. The income tax is imposed not on the professional partnership, which is tax exempt, but on the partners themselves in their individual capacity computed on their distributive shares of partnership profits (see CARAG, CABALLES, JAMORA AND SOMERA LAW OFFICES VS. DEL ROSARIO [OCTOBER 3, 1994])

Q12.2.1. A and B, co-owners, bought 3 parcels of land in one transaction and bought 2 more parcels of land in another. They decided to sell the 3 parcels to C and the 2 parcels to D. They realized a net profit gain and paid CGT. CIR assessed them for deficiency corporate income tax. Is the co-ownership taxable as a corporation?

No. A Co-Ownership who own properties which produce income should not automatically be considered partners of an unregistered partnership, or a corporation, within the purview of the income tax law. The essential elements of a partnership are two, namely: (a) an agreement to contribute money, 13 General professional partnership (GPP) are partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business.

Napoleon-IIIOnce clasisified as NRA (S-D), further:< 180 days Not engaged in business. Back&Forth accumulated to 180> 180 days Engaged in business.

Napoleon-IIIDiff. bet. Co-Ownership and Unregistered Partnership:Common FundIntent to divide profitsHabituality

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property or industry to a common fund; and (b) intent to divide the profits among the contracting parties. Here, there is no evidence that petitioners entered into an agreement to contribute money, property or industry to a common fund, and that they intended to divide the profits among themselves. The sharing of returns does not in itself establish a partnership whether or not the persons sharing therein have a joint or common right or interest in the property. There must be a clear intent to form a partnership, the existence of a juridical personality different from the individual partners, and the freedom of each party to transfer or assign the whole property. (see OBILLOS v. CIR [OCTOBER 29, 1985] and PASCUAL V. CIR [OCTOBER 18, 1988]).

Q12.2.2. A group of insurance companies in the Philippines decided to form a pool and entered into a reinsurance treaty with a non-resident reinsurance company. Is such a pool subject to corporate taxes and withholding taxes on dividends paid to the non-resident reinsurance company?

Yes. Where several local insurance ceding companies enter into a Pool Agreement or an association that would handle all the insurance businesses covered under their quota-share reinsurance treaty and surplus reinsurance treaty with a non-resident foreign reinsurance company, the resulting pool having a common fund, and functions through an executive board and its work is indispensable, beneficial and economically useful to the business of the ceding companies and the foreign firm, such circumstances indicate a partnership or an association taxable as a corporation (see AFISCO INSURANCE CORPORATION VS. CIR [JANUARY 25, 1999])

Q12.2.3. A and B inherited properties. They did not partition the same and instead invested them to a common fund and divide the profits therefrom. Should they be classified as an unregistered partnership subject to corporate income tax?

Yes. The income from inherited properties may be considered as individual income of the respective

heirs only as long as the inheritance or estate is no distributed, or, at least, partitioned. But the moment their respective known shares are used as part of the common assets of heirs to be used in making profits, it is but proper that the income from such shares should be considered as part of the taxable income of an unregistered partnership. (see ONA V. CIR [MAY 25, 1972]).

Q12.3. Are joint ventures taxable? Generally, yes. However, a joint venture or consortium undertaking construction projects or engaged in petroleum operations with an operating contract with the government are not liable for income tax.

Q12.3.1. What are the requirements in order for a joint venture formed for construction purposes be not liable for income tax?

In RR No. 010-12 [JUNE 1, 2012], a joint venture or consortium formed for the purpose of undertaking construction projects which is not considered as a taxable corporation should be: 1. For the undertaking of a construction project; 2. Should involve joining or pooling of resources by

licensed local contractors, licensed by the Philippine Contractors Accreditation Board (PCAB) of the DTI;

3. The local contractors are engaged in construction business;

4. The joint venture itself must likewise be duly licensed as such by the PCAB

Absent one of the requirements, the joint venture formed for construction purposes shall be considered a taxable corporation.

Q12.3.2. May joint ventures involving foreign contractors be treated as a non-taxable corporation?

Yes, provided that the member foreign contractor is: 1. covered by a special license as contractor by the

PCAB; and 2. construction project is certified by the appropriate

government office as a foreign financed/internationally-funded project and that international bidding is allowed under the bilateral agreement between the Philippine government; and foreign/international financing institution.

Napoleon-III

Napoleon-IIIThis was made by the BIR because they cant amend the NIRC. The RR requires that both parties in the JV must be both contractors

Napoleon-IIIIn order to still fall w/in the NIRC, they form a separate entity altogether (instead of JV) so that the distribution of units is merely dividends and not taxable.

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Q12.3.3. Two local contractors entered

into a joint development agreement to construct a residential subdivision. One local contractor shall contribute the parcel of land while the other shall contribute the construction and development of the parcel of land into a subdivision. Each shall receive an allocation of saleable house and lot units from the project. Is the joint venture liable for income tax?

No. In BIR Ruling No. 108-2010 [October 19, 2010],14 involving a joint venture between Avida and Aurora, the CIR held that the joint development agreement between the two is not subject to income tax because joint ventures formed by local contractors for construction purposes are deemed as not falling under the definition of a taxable corporation. Income15 Statutory Inclusions Q13. What are deemed included in (gross)

income? All income derived from whatever source, including, but not limited to, the following items:

1. Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions and similar items;

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

3. Gains derived from dealings in property 4. Interests 5. Rents 6. Royalties 7. Dividends

14 It is also important to note in this BIR Ruling that the CIR held that the allocation of saleable units does not constitute as a taxable event as no income is actually realized by Avida or Aurora. 15 Previously, we looked into the types of taxpayers. Now, before proceeding to general principles and source of income rules, let us look into what is included in the term income; and what is excluded therefrom.

8. Annuities 9. Prizes and winnings 10. Pensions; and 11. Partners distributive share from the net

income of the GPP (see Section 32(A), NIRC)16

Q13.1. Is the enumeration provided in Section 32(A) exclusive?

No. Section 32(A) does not intend the enumeration to be exclusive. It merely directs that the types of income listed therein be treated as income from sources within the Philippines (see CIR VS. AMERICAN AIRLINES [DECEMBER 19, 1989]) Compensation for services

Q13.2. If an employer pays the income taxes assessable against an employee, is the payment by the employer taxable income on the part of the employee?

Yes. In OLD COLONY TRUST CO. V. COMMISSIONER [279 U.S. 716], the US Supreme Court held that the payment of the tax by the employer was in consideration of services rendered by the employee. The payment constituted income to the employee. The Court also added that it cannot be argued that the payment was a gift. The payment for services, even though voluntary, was nevertheless compensation for services rendered. Rents

Q13.3. Are improvements made by lessees taxable as income on the part of the lessor?

Yes, provided the such buildings or improvements are not subject to the removal by the lessee. The lessor may either: (1) report the improvements as income at the time when such improvements are completed based on its fair market value; or (2) spread the life of the lease the estimated depreciate value of the improvements at termination of the lease

16 The above answer is the definition of gross income. This will be discusses in greater detail later. For now, we focus on determining what is considered income and what is not considered income or excluded therefrom.

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Napoleon-IIISection 78: specific types of payment that are not considered as taxable income (e.g. domestic labor)

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and report as income for each year of the lease an aliquot part thereof (Section 49, RR No. 2)

Q13.3.1. Should the improvement be capable of being separated from the land in order to be considered a taxable gain?

No. The US Supreme Court in HELVERING V. BRUUN [309 US 461] stated that it is not necessary to recognition of taxable gain that the lessor be able to sever the improvement begetting the gain from his original capital. Dividends

Q13.4. What are dividends? The term dividends means any distribution made by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, whether in money or in other property.17

Q13.5. Are property dividends taxable? Yes. As provided in Section 251, RR No. 2, dividends paid in securities or other property (other than its own stock), in which the earnings of a corporation have been invested, are income to the recipients to the amount of the full market value of such property when receivable by individual stockholders.

Q13.6. Are stock dividends subject to income tax?

No. As discussed earlier, a stock dividend only represents the transfer of surplus to capital account and, as such, is not subject to income tax.

Q13.6.1. What is the exception to the rule that stock dividends are not subject to income tax?

Stock dividends constitute as income if a corporation redeems stock issued so as to make a distribution. This is essentially equivalent to the distribution of a taxable dividend the amount so distributed in the redemption considered as taxable income. (see 17 If in money, it is called a cash dividend. If it is in property, it is called a property dividend.

COMMISSIONER VS. MANNING [AUGUST 7, 1975]) The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the stockholder's separate property. Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption. (see CIR VS. CA [JANUARY 20, 1999]) As provided in Section 252, RR No. 2: A stock dividend constitutes income if its gives the shareholder an interest different from that which is former stock holdings represented. A stock dividend does not constitute income if the new shares confer no different rights or interests that did the old.

Q13.7. Are liquidating dividends subject to income tax?

Yes. Where a corporation distributes all of its property or assets in complete liquidation or dissolution,18 the gain realized from the transaction by the stockholder, whether individual or corporate, is taxable income or a deductible loss,19 as the case may be.20 From whatever source

Q13.8. What is meant by the phrase all income derived from whatever source"

The phrase all income derived from whatever source encompasses all accessions to wealth, clearly realized, and over which the taxpayers have complete dominion. A gain constitutes taxable income when its recipient has such control over it that as a practical matter, he derives readily realizable economic value from it. 18 There must be a bona fide plan of liquidation involving the transfer of all assets. 19 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. 20 Previously, the CIR has ruled in BIR RULING 039-02 [NOVEMBER 11, 2002] and other previous rulings that the transfer by a liquidating corporation of its remaining assets to its stockholders and the receipt of the shares surrendered by the shareholder are not subject to income tax. However, in BIR RULING 479-11 [DECEMBER 5, 2011], the CIR reversed and set aside the above-cited ruling and all previous rulings to that effect. The rule now is that they are subject to income tax.

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Napoleon-IIIMere issuance/declaration of stock dividends are doesnt result to income

Napoleon-IIISD issued bought by the company ultimately the stockholder received cash. Except that it was declared tax-free. not legit bus. purpose

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Q13.8.1. Is an unlawful gain subject to income tax?

Yes. In JAMES V. US [366 US 213], the Supreme Court ruled that embezzled money constitutes gross income. It opined that unlawful, as well, as lawful gain are comprehended within the term gross income. The Court has given a liberal construction to gross income in recognition of the intent of Congress to tax all gains except those specifically exempted.

Q13.8.2. May cancellation or forgiveness of indebtedness amount to a gain subject to income tax?

Yes. 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. (see Section 50, RR No. 2).21

Q13.8.3. Should taxes previously claimed and allowed as deductions but subsequently refunded or granted as tax credit be considered part of gross income?

Yes. RMC No. 13-80 [April 10, 1980] provides that taxes previously claimed and allowed as deductions but subsequently refunded or granted as tax credit should be declared as part of the gross income of the taxpayer in the year of receipt of the refund or tax credit. However, taxes which are not allowable as deductions, when refunded or credited, are not declarable for income tax purposes.22 Inventories

Q13.9. Explain the use of inventories to determine the income of a taxpayer.

For certain businesses, the use of inventories may be deemed necessary in order to determine clearly the

21 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. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. 22 The enumeration of taxes not allowable as deductions will be provided later.

income of a taxpayer. If such is the determination, the taxpayer shall take inventories upon such basis as the Secretary of Finance, upon recommendation of the CIR, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

Q13.9.1. Is there a particular method of valuing inventory that a taxpayer should follow?

No. The taxpayer may choose the method of valuding its inventory for any taxable year, and such method should be used in all subsequent years unless: 1. With the approval of the CIR, a change to a

different method is authorized; or 2. The CIR finds that the nature of the stock on

hand is such that inventory ains should be considered realized for tax purposes and therefore it is necessary to modify the valuation method.23

Thus, in BIR RULING DA-128-08 [AUGUST 11, 2008], Pilipinas Shell requested to change its valuation method from the Weighted Average Method (WAVE) to the First-In-First-Out (FIFO) to conform with the adoption by a new computerized accounting system based on the Global Systems Application and Product Data Processing (GSAP) by its parent company and its affiliates, including Pilipinas Shell. They system uses FIFO. The CIR approved the shift to FIFO noting that the WAVE method is no longer compatible with the new accounting system to be introduced and to be consistent with the inventory method used by its parents company and affiliates all over the world. Exclusions Q14. What are exclusions? The term exclusions refers to items that are not included in the determination of gross income because: 1. They represent return of capital or are not

income, gain or profit (e.g. life insurance) 2. They are subject to another kind of internal

revenue tax (e.g. gifts, bequests, devices) 3. They are income, gain or profits that are

expressly exempt from income tax under the

23 The CIR shall not exercise this authority more often than every 3 years.

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Napoleon-IIIValidity of the element of complete dominion.

Tax you paid for embezzled income is non-refundable.

Napoleon-IIIGambler lost 3.4M but was only required to pay 0.5M. Is there taxable income in his hands? The US-SC is not income.

Napoleon-IIIFor discharge of debt to be applicable:(1) liability(2) debtors holds property. (e.g. the chips dont represent property. It is only an accounting mechanism)

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Constitution, tax treaty, Tax Code, or general or special law. (e.g. PEZA)

Q15. What are deemed excluded from

(gross) income? As provided in Section 32(B), NIRC, the following items shall not be included in gross income and shall be exempt from income tax 1. Proceeds of life insurance,24 payable upon the

death of the insured to the heirs or beneficiaries, but not the interest payments thereon if such amounts are held by the insurer under an agreement to pay interest.

2. Amounts received by the insured as return of premiums paid under life insurance, endowment or annuity contracts, either during the term or at the maturity of the contract or upon the surrender thereof.

3. Gifts, bequests, and devises25 but not the income from such property; if the amount received is on account of services rendered whether constituting a demandable debt or not such as remuneratory donations or the use or opportunity or use of capital, the receipt is income.

4. Compensation for injuries or sickness whether by suit or agreement including amounts received through accident or health insurance or under the Workmens compensation Act, but not damages or compensation recovered for loss of profit in loss or damage to property which would be taxable

5. Income exempt under treaty binding upon the Government of the Philippines.

6. Certain retirement benefits, pensions, gratuities, more particularly:

a. Retirement benefits received under RA

7641 and those received by officials and employees of private firms, whether individual or corporate, in accordance with a reasonable private benefit plan26 maintained by the employer provided:

24 It is considered as indemnity rather than income 25 They are instead subject to estate or gift taxes (see PIROVANO VS. COMMISSIONER [JULY 31, 1965]) 26 Reasonable private benefit plan means a pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the

i. that the retiring official or employee has

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

ii. That the benefits granted shall be availed of by an official or employee only once.

b. Any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death sickness or other physical disability or for any cause beyond the control of the said official or employee.

c. The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other similar benefits received by resident or 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 laws of the United States administered by the United States Veterans Administration.

e. Benefits received from or enjoyed under the Social Security System in accordance with the provisions of Republic Act No. 8282.

f. Benefits received from the GSIS under Republic Act No. 8291, including retirement gratuity received by government officials and employees.

7. Miscellaneous items, likewise exempt,

including: a. Income of foreign governments or

financing institutions owned, controlled or enjoying refinancing from such foreign

benefit of some or all of his officials or employees, wherein contributions are made by such employer for the officials or employees, or both, for the purpose of distributing to such officials and employees the earnings and principal of the fund thus accumulated, and wherein its 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.

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governments and of international or regional financial institutions established by foreign governments from their passive investments in the Philippines

b. Income of the Philippine government and its political subdivisions derived from public utilities or in the exercise of essential governmental functions

c. Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement but only if: i. The recipient was selected without

any action on his part to enter the contest or proceedings; and

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

d. All prizes and wards granted to athletes in local and international sports competitions whether held in the Philippines or abroad.

e. Gross benefits received by officials and employees of public and private entities provided, however, that the total exclusion shall not exceed P30,000 which shall cover: i. Benefits received by officials and

employees of the national and local government pursuant to RA 6686

ii. Benefits received by employees pursuant to PD 851

iii. Benefits received by officials and employees not covered by PD 851

iv. Other benefits such as productivity incentives and Christmas bonus provided that the ceiling of P30,000 may be increased through the rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner, after considering, among others, the effect on the same of the inflation rate at the end of the taxable year.

f. GSIS, SSS, Medicare and Pag-ibig contributions and union dues of individuals

g. Gains from the sale of bonds, debentures or other certificate of indebtedness with a maturity of more than 5 years

h. Gains from the redemption of shares of stock in a mutual fund company

Also, under Section 33(C), NIRC, the following fringe benefits27 are not taxable: 1. Fringe benefits authorized and exempted from

tax under special laws; 2. Contributions of the employer for the benefit of

the employee to retirement, insurance and hospitalization plans;

3. Benefits given to rank and file employees, whether granted under a CBA or not;

4. De minimis benefits. Retirement benefits

Q15.1. What are the requirements to exempt retirement benefits from income tax?

For the retirement benefits to be exempt from income tax, the taxpayer is burdened to prove the concurrence of the following elements:

1. a reasonable private benefit plan is maintained by the employer;

2. the retiring official or employee has been in the service of the same employer for at least ten (10) years;

3. the retiring official or employee is not less than fifty (50) years of age at the time of his retirement; and

4. the benefit had been availed of only once 5. The retirement plan must be submitted to

and approved by the BIR (see INTERCONTINENTAL BROADCASTING CORPORATION VS. AMARILLA [OCTOBER 29, 2006])

Q15.2. An employer maintains an

employees trust to provide retirement, pension, disability benefits to its employees. The trust made investments and earned therefrom interest income. Is it proper to subject the interest income to withholding tax?

No. As held by the Supreme Court in CIR V. CA & GCL RETIREMENT PLAN [MARCH 23, 1992], said retirement benefits received by officials and 27 Fringe benefits means any goods, service or other benefit furnished or granted in cash or in kind by an employer to an individual employee (except rank and file employees). This will discussed more later.

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employees of private firms in accordance with a reasonable private benefit plan maintained by the employer shall be exempt from all taxes

Q15.3. A government employee, retired from service. Upon retirement, he received, among other benefits, terminal leave pay which the CIR withheld a portion allegedly representing income tax thereon. Is terminal leave pay considered part of gross income of the recipient?

No. In COMMISSIONER OF INTERNAL REVENUE VS. CA & EFREN CASTANEDA [OCTOBER 17, 1991], the Supreme Court held that terminal leave pay received by a government official or employee is not subject to withholding (income) tax. The rationale behind the employees entitlement to an exemption from withholding tax on his terminal leave is that commutation of leave credits, more commonly known as terminal leave, is applied for by an officer or employee who retires, resigns or is separated from the service through no fault of his own. In the exercise of sound personnel policy, the Government encourages unused leaves to be accumulated. Terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits. In fine, not being part of the gross salary or income of a government official or employee but a retirement benefit, terminal leave pay is not subject to income tax. (see RE: REQUEST OF ATTY. BERNANDINO ZIALCITA [OCTOBER 18, 1990]).

Q15.4. Are contributions to SSS, GSIS, PHIC and Pag-Ibig in excess of the mandatory contributions subject to income tax?

Yes. Previously, SSS, GSIS, PHIC and Pag-Ibig contributions in excess of the mandatory contributions were considered exempt from income tax. However, because it was deemed to have been abused and the excess contributions are being made as a form of investment, RMC No. 027-11 [JULY 1, 2011] now considers the excess contributions as not excludible from gross income and not exempt from income and withholding tax.

Income derived by foreign government

Q15.5. A domestic corporation entered into a loan and sales contract with a foreign corporation where the latter shall extend a loan to the former and the former shall sell to the latter all copper concentrates to be produced from the machine to be purchased using the loaned amount. The foreign corporation applied for the loan from one of its government financing institutions. Is the interest income from the loans automatically exempt from withholding tax?

No. As held in CIR V. MITSUBISHI METAL CORPORATION [JANUARY 22, 1990], the burden of proof rests upon the party claiming an exemption to prove that it is in fact covered by the exemption. In the said case, the Supreme Court found that the foreign government financing institution had nothing to do with the sales and loans agreement. It is the foreign corporation, not the foreign government financing institution that is the sole creditor of the domestic corporation. De Minimis/PERA

Q15.6. What are de minimis benefits? As defined by RR 3-98 [MAY 21, 1998], de minimis benefits are benefits of relatively small value offered or furnished by the employer to his/her employees as a means of promoting the health, goodwill, contentment, efficiency of his/her employees. These benefits are exempt from the withholding tax on compensation income, and consequently from income tax, regardless of whether or not the recipients of the benefits are managerial or rank-and-file employees.

Q15.6.1. What are deemed de minimis benefits?

As provided in RR No. 005-11 [March 16, 2011], as amended recently by RR No. 008-12 [MAY 11, 2012], the following shall be considered de minimis benefits not subject to income tax as well as withholding tax on compensation income of both managerial and rank and file employees:

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1. Monetized unused vacation leave credits of private employees not exceeding ten (10) days during the year;28

2. Monetized value of vacation and sick leave credits paid to government officials and employees;29

3. Medical cash allowance to dependents of employees, not exceeding P750 per employee per semester or P125 per month; 30

4. Rice subsidy of P1,500 or one (1) sack of 50 kg. rice per month amounting to not more than P1,500;31

5. Uniform and clothing allowance not exceeding P5,000 per annum;32

6. Actual medical assistance, e.g. medical allowance to cover medical and healthcare needs, annual medical check-up, maternity assistance, and routine consultations, not exceeding P10,000 per annum;33

7. Laundry allowance not exceeding P300 per month;34

8. Employees achievement awards, e.g. for length of service or safety achievement, with an annual monetary value not exceeding P10,000;35

9. Gifts given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum;36

10. Daily meal allowance for overtime work and night/graveyard shift not exceeding 25% of the basic minimum wage per region basis.37

Q15.6.2. Is the enumeration of de

minimis benefits exclusive?

28 This was included in RR 3-98 and in RR 8-00 [August 21, 2000] but referred to employees in general. RR No. 005-11 [March 16, 2011] specifically provided private employees. 29 Introduced by RR 10-00 [December 14, 2000] 30 Provided under RR 3-98 and RR 8-00 [August 21, 2000] 31 Under RR 3-98, the amount was P350. RR 8-00 [August 21, 2000] increased this to P1,000 and added the alternative 1 sack of 50kg of rice. This was increased by RR 5-2008 [APRIL 17, 2008] to P1,500. 32 RR 3-98 did not provide for an amount. RR 8-00 [August 21, 2000] provided for an amount of P3,000. RR No. 005-11 [March 16, 2011] provided for an amount of P4,000. This was again increased by RR No. 008-12 [MAY 11, 2012] to P5,000. 33 RR 3-98 simply said medical benefits with no corresponding amount. RR 8-00 [August 21, 2000] provided the amount of P10,000 as the ceiling. 34 RR 3-98 provided for an amount of P150. RR 8-00 [August 21, 2000] increased it to P300. 35 RR 3-98 provided for a ceiling of month of the basic salary of the employee. RR 8-00 [August 21, 2000] changed the ceiling amount to P10,000. 36 RR 3-98 did not provide for a ceiling amount. RR 8-00 [August 21, 2000] introduced the P5,000 ceiling. 37 Introduced by RR 8-00 [August 21, 2000].

Yes. As provided in RR No. 005-11 [March 16, 2011], all other benefits given by employers which are not included in the enumeration shall not be considered de minimis benefits, and, hence, shall be subject to income tax as well as withholding tax on compensation income.

Q15.7. Is income earned by a contributor from the investments and reinvestments of his Personal Equity and Retirement Act (PERA) assets subject to income tax?

No. As provided in RR No 017-11 [OCTOBER 27, 2011], implementing the tax provisions of RA 9505, otherwise known as the Personal Equity and Retirement Account (PERA) Act of 2008, investment income of a contributor consisting of all income earned from the investments and reinvestments of his PERA assets in the maximum amount allowed shall be exempt from the following taxes as may be applicable: 1. Final withholding tax on interest from any

currency bank deposit, yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements, including a depository bank under the EFCDS;

2. Capital gains tax on the sale, exchange, retirement or maturity of bonds, debentures or other certificates of indebtedness;

3. 10% tax on cash and/or property dividends actually or constructively received from a domestic corporation, including a mutual fund company;

4. Capital gains tax on the sale, barter, exchange, or other disposition of shares of stock in a domestic corporation;

5. Regular income tax. General Principles Q16. What are the general principles of

income taxation in the Philippines (Section 23, Title II, NIRC)?

Except as otherwise provided in this Code, the general principles are: Resident Citizen

taxable on all income derived from sources within and outside the Philippines

Non-Resident Citizen

taxable only on income derived from sources within the

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Philippines [By definition of a non-resident citizen, this applies to an overseas contract worker (a citizen working and deriving income from abroad)]

Alien (whether resident or non-resident)

taxable only on income derived from sources within the Philippines

Domestic corporation

taxable on all income derived from sources within and outside the Philippines

Foreign corporation

taxable only on income derived from sources within the Philippines (This applies whether the foreign corporation is engaged or not in trade or business in the Philippines)

Simply put, only resident citizens and domestic corporations are taxable on their worldwide income while the other types of individual and corporate taxpayers are taxable only on income derived from sources within the Philippines. Additionally, it must be noted that only a non-resident alien not engaged in trade or business in the Philippines and non-resident foreign corporations are taxed on gross income while all other types of taxpayers are subject to tax on net income (i.e. may claim deductions). Source of Income Rules38 Q17. What is meant by source of income? The source of an income is the property, activity or service that produced the income. It is the physical source where the income came from. (see CIR VS. BAIER-NICKEL [AUGUST 29, 2006]). Q18. What are the source of income rules in

the Philippines? (Section 42, Title II, NIRC)

38 For the source of income rules, my reference IS MICHAEL J. MCINTYRE, INTERNATIONAL TAX: TEXT, CASES, PROBLEMS, AND QUESTIONS (2013). Most, if not all, of our tax books fail to sufficiently explain source of income rules and, thus, recourse to a foreign material is warranted. The rules are applicable as they are based on the US Tax Code, of which our own tax laws are modeled after.

Interests The source of an interest payment is the place of residence of the person obligated to make that payment (residence-of-the-obligor rule). It is income within the Philippines if the residence of the obligor is in the Philippines. It is income without the Philippines if the residence of the obligor is abroad.

Dividends Generally, a dividend has its source in the country where the corporation paying the dividend is incorporated. Thus, if the dividend is received from a domestic corporation, it is income within the Philippines. If the dividend is from the foreign corporation, it is income without the Philippines. The exception to the general rule that dividends paid by a foreign corporation are from sources without the Philippines is when a foreign corporation derives 50 percent of its gross income from sources within the Philippines for a three-year period ending with the close of its taxable year preceding the declaration of its dividends

Services Income from services is sourced in the country where the services are performed. Thus, it is income within the Philippines if the service is performed in the Philippines. It is income without the Philippines if it is performed abroad.

Rents and Royalties

The rental income and royalty income derived from the use of property has its source in the country where the property is used. For tangible property, the place of use is the place where the tangible property is actually located.

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Napoleon-IIIWhether resident or non-resident foreign corporation

Napoleon-IIIRoyalties income from intangible prop.

Rents income from tangible prop.

Napoleon-IIIYou need to first know what type of income you have, then the source and whether it would be taxable in the PH or not.

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Thus, it is income within the Philippines if rents and royalties are derived from property located in the Philippines For intangible property, the country of use is the country that protects the owner of that property against its unauthorized use by other persons.39 Thus, it is income within the Philippines if it is used in the Philippines and the unauthorized use of such intangible property is protected by Philippine law.

Sale of Real Property

Income from the sale of real property is sourced in the country where the real property is located. Thus, it is income within the Philippines if the real property is located in the Philippines. It is income without if the real property is located abroad.

Sale of Personal Property

The income from the sale of personal property has its source in the country where the personal property is sold.40 Thus, if the personal property is sold in the Philippines, it is income within the Philippines. If sold abroad, it is income without the Philippines. Note that gains from sale of shares of stock of a domestic corporation are treated as derived entirely from sources within the Philippines regardless of where the said shares are sold.

39 This is the generally accepted rule. 40 In the US, the rule is that income from sale of personal property is sourced in the country where the seller is resident (residence-of-the-seller rule)

Q18.1. In CIR v. MARUBENI [DECEMBER 18, 2001], assuming that Marubeni was disqualified from availing of the income tax amnesty, would the income from the services rendered in connection with the turn-key projects constitute as income from Philippine sources?

The answer is both yes and no. The answer is yes with regard to those services performed in the Philippines. The answer is, however, no with regard to those services rendered in Japan. Such services were rendered outside the taxing jurisdiction and thus constitute as income without the Philippines. Marubeni, being a foreign corporation, is taxable only on income within the Philippines and, hence, income from services rendered in the Philippines.

Q18.2. ABC Airways is a foreign airline.41 While it did not carry passengers and/or cargo to or from the Philippines, ABC maintains a general sales agent of its tickets in the Philippines. Is the sale of the tickets taxable as income from sources within the Philippines?

Yes. For the source of income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In ABCs case, the sale of tickets in the Philippines is the activity that produces the income. The tickets exchanged hands here in the country and the payments for fares were also made with Philippine currency. The site of the source of payments is the Philippines. The absence of flight operations to and from the Philippines is not determinative of the source of income/site of income taxation for the test of taxability is the source. (see CIR VS. JAPAN AIRLINES [MARCH 6, 1991]; CIR VS. BOAC [APRIL 30, 1987])

Q18.3. XYZ entered into reinsurance contracts with foreign insurance companies not doing business in

41 It is a resident foreign corporation. In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character. ABC maintained a general sales agent and it was engaged in selling or issuing tickets, which is considered the main lifeblood of an airline.

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Napoleon-IIIThe execution/signing of the contract is insignificant to determining where the sale of the property would be taxed.

Napoleon-IIIRoyalties you pay depending on where the capital in used. So if you use the intellectual property (construct the design) here, then you have to pay taxes here.

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the Philippines. XYZ was to cede portions of premiums underwritten in the Philippines to the foreign corporations in consideration for the assumption of risk. Is the cession of the premiums taxable as income from sources within the Philippines?

Yes. Sources means the activity, property, or service giving rise to the income. The original insurance undertakings took place in the Philippines. It is not required that the foreign corporation be engaged in business in the Philippines. What is controlling is no the place of business, but the place of activity that created the income. Thus, the income is subject to income tax. (see PHILIPPINE GUARANTY V. CIR [APRIL 30, 1965] and HOWDEN & CO. V. CIR [APRIL 14, 1965]).

Q18.4. ABC, a domestic corporation, entered into a Management Service Agreement with XYZ, a non-resident foreign corporation under which the latter shall provide services for ABCs US branch and advice on ABCs corporate structure, all performed abroad. Is the compensation for services taxable as income from sources within the Philippines?

Yes. The services covered by the management service agreement fall under the meaning of royalties. It is immaterial if the non-resident foreign corporation has no properties in the Philippines. The test of taxability is the source and the source of an income is that activity which produced the income. It is not the presence of any property from which one derives rentals and royalties that is controlling,42 but rather as expressed under the expanded meaning of royalties, it includes royalties for the supply of scientific, technical, industrial, or commercial, knowledge or information; and the technical advice, assistance or services rendered in connection with the technical management and administration of any scientific, industrial or commercial undertaking, venture, project or scheme. (see PHILAMLIFE V. CTA [CA-GR SP. NO. 31283, APRIL 25, 1995]). 42 This confirms the acceptance of the Philippine taxing jurisdiction of the rule that as to intangible property, the country of use is the country that protects the owner of that property against its unauthorized use by other persons.

Q18.5. A, a non-resident citizen, was

engaged by a domestic corporation as a commission agent. A will receive a sales commission on all sales actually concluded. A argues that the income is not taxable as A does not reside in the Philippines and that the place of payment of the income is outside the Philippines. Is As contention correct?

No. The source of an income is the property, activity or service that produced the income. With respect of rendition of labor or personal service, as in the instant case, it is the place where the labor or service is performed that determines the source of income. There is therefore no merit in As interpretation which equates source of income in labor or personal service with the residence of the payor or the place of payment of the income. (see CIR VS. BAIER-NICKEL [AUGUST 29, 2006])43

Q18.6. Quill Corp is an office supply retailer with no physical presence in North Dakota but it has a licensed computer software program that its customers in North Dakota use for checking Quills current inventories and for placing orders directly. North Dakota attempted to impose a use tax44 on Quill. Is Quill liable for the tax?

Yes. In QUILL CORP V. NORTH DAKOTA [504 US 298, MAY 26, 1992], the US Supreme Court ruled that there must be physical presence in a state for the corporation to be liable for sales and use taxes. It applied its ruling in NATIONAL BELLAS HESS V. DEPARTMENT OF REVENUE OF ILLINOIS [386 US 753] where it held that a seller whose only connection with customers in the State is by common carrier or the mail lacked the requisite minimum contacts with the 43 Note that in this case, Baier-Nickel argued that the services were done in Germany. However, she failed to prove hat such was the fact. Thus, the services were deemed performed in the Philippines, and, as such, is subject to income tax. 44 A use tax is a type of excised tax levied in the United States upon otherwise "tax free" tangible personal property purchased by a resident of the assessing state for use, storage or consumption of goods in that state (not for resale), regardless of where the purchase took place.

Napoleon-III

Napoleon-III

Napoleon-IIIPhilamlife discusses the difference between royalties and services.

Napoleon-IIIWhat she failed to do was prove that the sale was consummated in Germany

Napoleon-IIIEven in PH tax treaties, the corp has to have physical presence to be taxable by the locality.

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State. Thus, such vendors are free from state-imposed duties to collect sales and use taxes. Nevertheless, the US Supreme Court opined that if interstate commerce would be subject to intolerable or undesirable burdens because of this, Congress has the power to legislate make such vendors liable for sales and use taxes.45

Q18.7. Vodafone International Holdings (VIH), a corporation in the Netherlands, acquired a controlling interest of CGP holdings, a company in the Cayman Islands. By virtue of this controlling interest, VIH acquired a 52% stake in Hutchinson Essar Limited (HEL)46 in India from Hutchinson Telecom International Limited (HTIL). Simply stated, VIH acquired control over CGP and its subsidiaries, including HEL. The Indian tax authorities contended that the transfer of shares was subject to income tax. VIH argues that the transfer of shares took place outside the Indian taxing jurisdiction, and, hence, is not taxable. Which contention is correct?

The contention of VIH was held to be correct. In VODAFONE INTERNATIONAL HOLDINGS B.V. V. UNION OF INDIA (SUPREME COURT OF INDIA, CIVIL APPEAL NO. 733 OF 2012, JANUARY 20, 2012),47 the Indian Supreme Court ruled that VIH had no liability to withhold tax as the transaction was between two non-residents with no taxable presence in India. Under Section 9(1) of the Income Tax Act of India, all income accruing or arising, whether directly or

45 Note that, as of this updated version, the BIR plans to impose a sales tax on online retailers in the opinion that such sellers are no different from merchants who sell their goods in physical stores. A RR on the matter is forthcoming. 46 HEL was an Indian joint venture between HTIL, a corporation in Hong Kong, and Essar, an Indian corporation. 47 It is also important to note, that in this case, the Indian Supreme Court stated that, on the context of taxation of a holding company structure, the corporate veil may be lifted only if it is established that the transaction was a sham or there was abuse. In this case, the shares of CGP were transferred only for a commercial benefit and not with the object of tax evasion. The structure was in existence over a decade, it was not created or used as an instrument for tax avoidance, VIH was not a short-time investor and it did not introduce any new practice to grant itself a controlling interest.

indirectly through transfer of capital assets situated in India shall be deemed to accrue or arise in India.48 The Supreme Court stated that the section clearly applied to a transfer of capital asset situated in India and could not be expanded to cover indirect transfers of capital assets or property situated in India. The words directly or indirectly go with the income and not with the transfer of a capital asset.49

Q18.8. Is the gross income of branches of foreign corporations generated from solicitation of orders from local importers where the branches merely relay to its head office abroad said purchase orders and where the head office is the entity which actually consummates the sale liable for income tax?

Yes. By virtue of RAMO No. 1-86 [April 25, 1986], an income tax is imposed on the gross income generated from constructive trading and commission income derived from brokering activities of Philippine branches of foreign corporations engaged in trading activities. RAMO No. 01-95 [March 21, 1995] expanded RAMO No. 1-86 to cover taxation of Philippine branches of foreign corporations engaged in soliciting orders, purchases, service contracts, trading, construction and other activities.

Q18.9. ABC, a multinational company, claimed as deduction from gross income its share of the overhead expenses of its foreign head office. Can these overhead expenses of the foreign head office be deducted from the gross income of the Philippine branch?

It depends. Either it can be deducted in full or partly. Where an expense is clearly related to the production of Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, 48 The Indian taxing authorities argued that this was a look-through provision a look through provision so that if there was a transfer, of a capital asset, situated in India, it meant income from capital gains accruing or arising outside India would be fictionally deemed to accrue or arise in India. 49 The Indian Supreme Court also noted that the existence of the Direct Tax Code Bill of 2010 which expressly stated that income accuring even from indirect transfer of capital assets situated in India would be deemed to accrue in India but this is not yet in force.

Napoleon-III

Napoleon-IIIWhat has to be the subject is the stocks of the company and not the company itself.

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rental of office building in the Philippines), that expense can be deducted from the gross income acquired in the Philippines without resorting to apportionment. However, where there are items included in the overhead expenses incurred by the parent company, all of which cannot be definitely allocated or identified with the operations of the Philippine branch, the company may claim as its deductible share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross income, worldwide, of the multinational corporation. (see COMMISSIONER VS. CTA & SMITH KLINE [JANUARY 17, 1984]; see also RAMO 4-86 [April 5, 1986]) Deductions Q19. What are the kinds of deductions? 1. Deductions from compensation income

refers to the personal and additional exemptions in Section 35, NIRC and premium payments on health and/or hospitalization insurance which are allowed to be deducted by an individual taxpayer who receives income for personal services rendered under an employer-employee relationship

2. Deductions from business and/or professional income refers to the itemized deductions in Section 34 (A) to (M) including those deductible from compensation income, which a self-employed individual or professional engaged in the practice of a profession may deduct.

3. Deductions from corporate income refers to the itemized deductions in Section 34 (A) to (J) which corporations (including partnerships other than GPPs) engaged in trade or business are authorized to claim

4. Special deductions refer to the deductions

allowed in addition to the itemized deductions allowable to corporations which may be availed of by insurance companies and proprietary educational institutions and non-profit hospitals as well as estates and trusts.

Q19.1. Who can avail of the deductions

provided for under the law? All taxpayers except:

1. Nonresident aliens not engaged in trade or business; and

2. Nonresident foreign corporations or those corporations not engaged in trade or business in the Philippines

With respect to the itemized deductions, they cannot be availed by citizens and resident aliens whose income is purely compensation income from which only the personal and additional exemptions and premium payments on health and hospitalization insurance are deductible. Sections 34 and 35, Tax Code Q20. What are the allowable and itemized

deductions under the Tax Code? The allowable and itemized deductions include:

1. Business Expenses (Expenses in connection with taxpayers trade, business or profession)

2. Interest on Indebtedness 3. Taxes in connection with taxpayers

business, trade or profession [except income taxes, estate and donors taxes, special assessments, and foreign income taxes (unless the taxpayer does not make use of the tax credit privilege)]

4. Losses 5. Bad debts 6. Deprecia

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PM Reyes Notes on Taxation 1 - Income Tax (Updated 14 January 2013)

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