PM REYES NOTES ON INCOME TAXUnder the global tax system, all types of income arelumped together and taxed at graduated rates as asingle taxable income

PM REYES NOTES ON TAXATION I:
INCOME TAX
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. M ANILA 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 profit

2. The income, gain or profit is received or realized
2
during the taxable year; (known as the
realization concept) and
3. The income, gain or profit is not exempt from
3
income tax.
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 [M ARCH 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
M ADRIGAL 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
As opposed to mere reimbursements or return on capital.

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.
2
PM REYES NOTES ON TAXATION I: INCOME TAX (Updated 14 January 2013)

BY PIERRE M ARTIN 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

INCOME TAX
unrealized gain and cannot be subjected to income
tax until that gain has been realized.
Q3.3. What is the constructive receipt

doctrine?
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.
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.
However, stock dividends constitute as income if a

corporation redeems stock issued so as to make a
4
distribution. 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. M ANNING [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.
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:
5
1. Direct
6
2. Progressive
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
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.
PIERRE MARTIN DE LEON REYES
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

INCOME TAX
(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?
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
Corporation
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
General
Professional
Partnerships
(GPPs)
Domestic
(Corporation)
Foreign
(Corporation)
Nonresident
citizen
An individual, a trust, estate or

corporation
Includes partnerships, no matter
how created or organized, jointstock 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
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
When applied to a corporation,
means created or organized in
the Philippines or under its laws
When applied to a corporation,
means a corporation which is
not domestic
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

INCOME TAX
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
Nonresident
alien
Resident
foreign
corporation
Nonresident
foreign
corporation
Ordinary
Income
Statutory
Minimum
Wage
Minimum
Wage earner
An individual whose residence is

within the Philippines and who is
not a citizen thereof
An individual whose residence is
not within the Philippines and
who is not a citizen thereof
A foreign corporation engaged in
trade or business within the
Philippines
A foreign corporation not
engaged in trade or business
within the Philippines
Includes any gain from the sale
or exchange of property which is
not a capital asset or property
7
described in Section 39(A)(1)
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.
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
In Section 31, 35(B), and 39(A), Tax Code:

Taxable
Income
Dependent
Capital Assets
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
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
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
Net
Gain
Capital
Net
loss
Capital
4. Real property used in trade

or business of the taxpayer
the excess of the gains from
sales or exchanges of capital
assets over the losses from such
sales or exchanges
the excess of the losses from
assets over the gains from such
sales or exchanges
which defines what capital assets are and those which are not.

INCOME TAX
Q6.What are the kinds of income taxpayers?8
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
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
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.
Resident citizens and resident aliens

Q7.Who are citizens of the Philippines?9
The following
Philippines:
are
considered
citizens
of
the
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.
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
10
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
11
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 the
10
11
In other words, stay is indefinite.

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

INCOME TAX
Philippines his temporary home, he becomes a
resident, although he intends to return to his domicile
12
abroad.
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 nonresident 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. 0179 [January 8, 1979])
Q9.1. Should a non-resident citizen file

an
income
tax
return
or
information return covering his
income earned abroad?
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
No. Previously, under RR No. 01-79, non-resident

citizens were required to do so. In RR No. 9-99, nonresident citizens were required to file an information
12
In other words, the stay is definite but extended.

INCOME TAX
Q10.1. How do you determine if a nonresident 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.

INCOME TAX
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 nonresident
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])
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 [M AY
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.
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.
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
What are the requirements in

order for a joint venture
formed
for
construction
purposes be not liable for
income tax?
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.

INCOME TAX
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?
8.
9.
10.
11.
Annuities
Prizes and winnings
Pensions; and
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])
No. In BIR Ruling No. 108-2010 [October 19,

14
2010], 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.
Compensation for services
Income15
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.
Statutory Inclusions
Q13.
What are deemed included in (gross)

income?
All income derived from whatever source, including,

but not limited to, the following items:
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?
Rents
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
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
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.
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.

INCOME TAX
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,
17
whether in money or in other property.
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
18
dissolution, the gain realized from the transaction
by the stockholder, whether individual or corporate, is
19
taxable income or a deductible loss, as the case
20
may be.
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 abovecited ruling and all previous rulings to that effect. The rule now is
that they are subject to income tax.
10

INCOME TAX
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
21
Section 50, RR No. 2).
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
22
declarable for income tax purposes.
Inventories
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
23
method.
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?
Q13.9. Explain the use of inventories to

determine the income of a
taxpayer.
The term exclusions refers to items that are not

included in the determination of gross income
because:
For certain businesses, the use of inventories may be

deemed necessary in order to determine clearly the
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
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.
23
The CIR shall not exercise this authority more often than every 3
years.
11

INCOME TAX
Constitution, tax treaty, Tax Code, or general or
special law. (e.g. PEZA)
Q15.
What are deemed excluded

(gross) income?
24
1. Proceeds of life insurance, 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.
25
3. Gifts, bequests, and devises 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.
It is considered as indemnity rather than income

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
25
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.
pensions,
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
26
reasonable private benefit plan maintained
by the employer provided:
24
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
from
As provided in Section 32(B), NIRC, the following

items shall not be included in gross income and shall
be exempt from income tax
6. Certain
retirement
benefits,
gratuities, more particularly:
i.
7. Miscellaneous
including:
items,
likewise
exempt,
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.
12

INCOME TAX
b.
c.
d.
e.
f.
g.
h.
governments and of international or

regional financial institutions established
by foreign governments from their
passive investments in the Philippines
Income of the Philippine government
and its political subdivisions derived
from public utilities or in the exercise of
essential governmental functions
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
All prizes and wards granted to
athletes in local and international sports
competitions whether held in the
Philippines or abroad.
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.
GSIS, SSS, Medicare and Pag-ibig
contributions and union dues of
individuals
Gains from the sale of bonds,
debentures or other certificate of
indebtedness with a maturity of more
than 5 years
Gains from the redemption of shares
of stock in a mutual fund company
Also, under Section 33(C), NIRC, the following fringe

27
benefits 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 [M ARCH 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.
13

INCOME TAX
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-andfile 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 [M AY 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:
14

INCOME TAX
1. Monetized unused vacation leave credits of
private employees not exceeding ten (10) days
28
during the year;
2. Monetized value of vacation and sick leave
credits paid to government officials and
29
employees;
3. Medical cash allowance to dependents of
employees, not exceeding P750 per employee
30
per semester or P125 per month;
4. Rice subsidy of P1,500 or one (1) sack of 50 kg.
rice per month amounting to not more than
31
P1,500;
5. Uniform and clothing allowance not exceeding
32
P5,000 per annum;
6. Actual medical assistance, e.g. medical
allowance to cover medical and healthcare
needs, annual medical check-up, maternity
assistance, and routine consultations, not
33
exceeding P10,000 per annum;
7. Laundry allowance not exceeding P300 per
34
month;
8. Employees achievement awards, e.g. for length
of service or safety achievement, with an annual
35
monetary value not exceeding P10,000;
9. Gifts given during Christmas and major
anniversary celebrations not exceeding P5,000
36
per employee per annum;
10. Daily meal allowance for overtime work and
night/graveyard shift not exceeding 25% of the
37
basic minimum wage per region basis.
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
Non-Resident
Citizen
taxable on all income derived

from sources within and outside
the Philippines
taxable only on income derived
from
sources
within
the
15

INCOME TAX
Alien (whether
resident
or
non-resident)
Domestic
corporation
Foreign
corporation
Philippines
[By definition of a non-resident
citizen, this applies to an
overseas contract worker (a
citizen working and deriving
income from abroad)]
from
sources
within
the
Philippines
taxable on all income derived
from sources within and outside
the Philippines
from
sources
within
the
Philippines
(This applies whether the foreign
corporation is engaged or not in
trade or business in the
Philippines)
Interests
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.
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.
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
Additionally, it must be noted that only a nonresident 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

Services
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)
The source of an interest payment is

the place of residence of the person
obligated to make that payment
(residence-of-the-obligor rule).
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.
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.
For tangible property, the place of

use is the place where the tangible
property is actually located.
16

INCOME TAX
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?

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
39
persons.
Sale
of
Real
Property
Sale
of
Personal
Property

Philippines if it is used in the
Philippines and the unauthorized
use of such intangible property is
protected by Philippine law.
Income from the sale of real
property is sourced in the country
where the real property is located.
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?

Philippines if the real property is
located in the Philippines. It is
income without if the real property is
located abroad.
The income from the sale of
personal property has its source in
the country where the personal
40
property is sold.
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.
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
39
This is the generally accepted rule.

In the US, the rule is that income from sale of personal property
is sourced in the country where the seller is resident (residenceof-the-seller rule)
40
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.
17

INCOME TAX
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
42
derives rentals and royalties that is controlling, 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
43
CIR VS. BAIER-NICKEL [AUGUST 29, 2006])
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,
M AY 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.
18

INCOME TAX
State. Thus, such vendors are free from stateimposed 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
45
for sales and use taxes.
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?
indirectly through transfer of capital assets situated in

48
India shall be deemed to accrue or arise in India.
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
49
not with the transfer of a capital asset.
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.
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.
47
733 OF 2012, JANUARY 20, 2012),
the Indian
Supreme Court ruled that VIH had no liability to
withhold tax as the transaction was between two nonresidents 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.
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 lookthrough 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.
19

INCOME TAX
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])
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
Deductions
Q20. What are the allowable and itemized

deductions under the Tax Code?
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
Q19. What are the kinds of deductions?

The allowable and itemized deductions include:
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
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. Depreciation
7. Depletion
8. Charitable and other contributions
9. Research and development expenditures
10. Contributions to pension trusts
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:
Business expenses
Q21. What are the requisites for deductibility
of business expenses?50
The requisites are:
1. The expense must be ordinary and
necessary
2. Paid or incurred during the taxable year
3. In carrying on the trade or business of the
taxpayer
4. Reasonable in amount
5. Substantiated by sufficient evidence
50
This is the general rule which is to be followed for all business

expenses. The enumeration provided in certain business expenses
provide for additional requisites.
20

INCOME TAX
3. Reasonable allowance for rentals and or
other payments required for the continued
use or premium of the property for the
purpose of the trade or business and to
which property the taxpayer has not taken or
is not taking title or in which he has no
51
equity.
4. Reasonable allowance for entertainment,
amusement and recreation expenses
provided that they are connected to the
development and operation of the trade,
business or profession and that it is not
contrary to law, morals, public policy or public
order.
6. Must not be against law, morals, public

policy, or public order
Q21.1. What is meant by ordinary and

necessary expenses?
An expense is 'ordinary' when it connotes a
payment which is normal in relation to the business of
the taxpayer and the surrounding circumstances.
An expense will be considered 'necessary' where
the expenditure is appropriate and helpful in the
development of the taxpayer's business
Q21.2. What is meant by paid or incurred

during the taxable year?
Paid or incurred during the taxable year means that
the deduction shall be taken for the taxable year in
which paid or accrued or paid or incurred dependent
on the accounting method in which net income is
computed
Q21.2.1.
ABC Corp failed to claim

expenses for professional
services that accrued in past
years. May ABC Corp still
claim these expenses as
deductions?
No. In COMMISSIONER OF INTERNAL REVENUE VS.

ISABELA CULTURAL CORPORATION (FEBRUARY 12,
2007), Isabela Corp failed to claim the expenses for
professional services that accrued in 1984 and 1985
during the said years. Instead, it sought to claim them
as deductions during the taxable year of 1986. The
Supreme Court held that one of the requisites for the
deductibility of a business expenses is that it must
have been paid or incurred during the taxable year.
Hence, the professional fees should have been
claimed as deductions during the years where they
were paid or incurred.
Q21.4. Is the enumeration of business

expenses provided in the Tax
Code exclusive?
No. A taxpayer is entitled to deduct the ordinary and
necessary expenses paid in carrying on his business
from his gross income from whatever source.
Q21.4.1.
1. Republic Act 10028 (Expanded Breastfeeding

Promotion Act)
The law provides that the expenses incurred by a
private health and non-health facility, establishment
or institution, in complying with the provisions of this
Act, shall be deductible expenses for income tax
purposes up to twice the actual amount incurred
provided:
1. That the deduction shall apply for the taxable
period when the expenses were incurred
2. That all health and non-health facilities,
establishments and institutions shall comply
with the provisions of this Act within six (6)
months after its approval
3. That such facilities, establishments or
institutions shall secure a "Working MotherBaby-Friendly
Certificate"
from
the
Department of Health to be filed with the
Bureau of Internal Revenue, before they can
avail of the incentive.
Q21.3. What are the types of business

expenses specifically included in
the Tax Code as deductions?
As provided in Section 34(A)(1)(a), these are:
1. Reasonable allowance for salaries or other
compensation
for
personal
services
actually rendered to the taxpayer
2. Reasonable allowance for travel expenses
in the pursuit of trade, business or profession
Name some special laws

which provide for deductible
business expenses.
2. Republic Act
Development Act)
51
8502
(Jewelry
Industry
In the latter case, he may claim depreciation allowance
21

INCOME TAX
The law provides for a deduction from taxable income
of fifty percent (50%) of expenses incurred in training
schemes in connection with the Act and which shall
be deductible during the financial year the expenses
were incurred.
3. Republic Act 8525 (Adopt a school act)
The law provides for a deduction from the gross
income equivalent to fifty percent (50%) of expenses
incurred in connection with the said act.
4. Republic Act 9999 (Free Legal Assistance Act)
The law provides that a lawyer or professional
partnerships rendering actual free legal services, as
defined by the Supreme Court, shall be entitled to an
allowable deduction from the gross income, the
amount that could have been collected for the actual
free legal services rendered or up to ten percent
(10%) of the gross income derived from the actual
performance of the legal profession, whichever is
lower
Q21.4.2.
Name
some
revenue
regulations
implementing
special laws which provide for
deductible business expenses.
1. RR 1-2009 [December 9, 2008]
arguing that the advertising expenses are not

business expenses but capital expenditures.
The Supreme Court ruled in favor of the CIR.
Advertising is generally of two kinds: (1) advertising
to stimulate the current sale of merchandise or use of
services and (2) advertising designed to stimulate
the future sale of merchandise or use of services.
The second type involves expenditures incurred, in
whole or in part, to create or maintain some form of
goodwill for the taxpayers trade or business or for
the industry or profession of which the taxpayer is a
member. If the expenditures are for the advertising of
the first kind, then, except as to the question of the
reasonableness of amount, there is no doubt such
expenditures are deductible as business expenses.
If, however, the expenditures are for advertising of
the second kind, then normally they should be spread
out over a reasonable period of time The protection
of brand franchise is analogous to the maintenance
of goodwill or title to ones property. This is a capital
expenditure which should be spread out over a
reasonable period of time. This was akin to the
acquisition of capital assets and therefore expenses
related thereto were not to be considered as
business expenses but as capital expenditures. The
advertising expense incurred by General Foods fall
under the second type.
Q21.4.4.
The RR provides that sales discounts given to

persons with disabilities shall be deductible from
gross income subject to certain conditions.
ABC Corporation paid a PR

firm to campaign for the sale
of ABCs additional capital
stock. Is the compensation
paid to the PR firm deductible
as a business expense?
2. RR 7-2010 [July 20, 2010]

The RR provides that discounts given to senior
citizens on certain goods and services shall be
deductible from gross income. Also, private
establishments employing senior citizens shall be
entitled to additional deductions from gross income
equivalent to fifteen (15%) of the total amount paid as
salaries and wages to senior citizens.
Q21.4.3.
Are advertising expenses

deductible
from
gross
income?
It depends on the nature of the advertising expense.

In COMMISSIONER OF INTERNAL REVENUE VS. GENERAL
FOODS (PHILS.) INC. [APRIL 24, 2003], General Foods
claimed as deductions its advertising expenses for its
product Tang. The CIR disallowed the deduction
No. In ATLAS CONSOLIDATED MINING & DEVELOPMENT

CORPORATION VS. COMMISSIONER OF INTERNAL
REVENUE (JANUARY 27, 1981), the Supreme Court
held that this is not deductible because it is a capital
expenditure. Expenses relating to the recapitalization
and reorganization of the corporation, promotion
expenses and commission or fees for the sale of
stock reorganization are capital expenditures.
Q21.4.5.
Are
litigation
deductible as a
expense?
expenses
business
No. As held in ATLAS CONSOLIDATED MINING &

DEVELOPMENT CORPORATION VS. COMMISSIONER OF
INTERNAL REVENUE (JANUARY 27, 1981), litigation
expenses incurred in defense or protection of title are
capital in nature and not deductible.
22

INCOME TAX
Q21.4.6.
A, a hotel owner, claimed as

deduction
promotion
expenses incurred by his wife
for the promotion of the hotel.
Half of the said expenses were
disallowed
as
deductions
because on the finding that his
wife went abroad on a
combined
business
and
medical
trip.
Is
the
disallowance proper?
Commission. The Supreme Court held that the police

protection fees were not deductible as they are illegal
since it was consideration for the performance of
functions required of policemen by law. As to the gifts
and parties, they were deemed excessive
considering that the purpose of the exhibition was for
a charitable cause.
Yes. In ZAMORA VS. COLLECTOR OF INTERNAL

REVENUE [MAY 31, 1963], Zamora, a hotel owner,
The test of deductibility in the case of compensation

payments is whether they are reasonable and
payments purely for the personal services actually
rendered.
claimed as deduction promotion expenses incurred

by his wife for the promotion of the hotel. On appeal,
the CTA only allowed 50% of the promotional
expenses as deductions because it was found in the
Central Bank dollar allocation that his wife went
abroad on a combined business and medical trip.
The Supreme Court stated that promotional
expenses are deductible but must be substantiated.
When some of the representation expenses claimed
by the taxpayer were evidenced by vouchers or chits,
but others were without vouchers or chits, documents
or supporting papers; that there is no more than oral
proof to the effect that payments have been made for
representation expenses allegedly made by the
taxpayer and about the general nature of such
alleged expenses; that accordingly, it is not possible
to determine the actual amount covered by
supporting papers and the amount without supporting
papers, the court should determine from all available
data,
the
amount
properly deductible
as
representation expenses. In view of this, the
Supreme Court held CTA did not commit error in
allowing as promotion expenses in As income tax
returns at merely one-half.
Q21.4.7.
Are police protection fees and

gifts for an exhibition for
charitable
purposes
deductible as a business
expense?
No. In CALANOC VS. COLLECTOR OF INTERNAL

REVENUE [NOVEMBER 29, 1961], at issue in this case
is the deductibility of the expenses incurred for police
protection and for gifts and parties in connection with
the boxing and wrestling exhibition that Calanoc
financed and promoted whose proceeds would be
given to the orphans and destitute children of the
Child Welfare Workers Club of the Social Welfare
Q21.5. What is the rule on the

deductibility
of
compensation
payments?
Q21.5.1.
A, an experience realtor, was

paid supervision fees in the
amount of P100,000 annually
by XYZ Corporation for a
three-year project, an amount
when combined with his salary
and bonuses is double the
XYZs
income.
Are
the
supervision fees deductible?
No. In C.M. HOSKINS & CO., INC. VS. COMMISSIONER OF

INTERNAL REVENUE [NOVEMBER 28, 1969], Hoskins &
Co. claimed as deductions the payment of P100,000
to its founder and controlling stockholder, Hoskins
representing 50% of the 8% supervision fees the
company received as managing agent for Paradise
Farms. In this case, the Supreme Court held that
such was not deductible for failing to pass the
reasonableness test. If allowed, Hoskin would be
receiving on his salary, bonus, and supervision fees
at total of P185,000 which is double the companys
reported net income. The Supreme Court stated that
if it was a one-time payment, it could have been
deducted since Hoskin was an experienced realtor.
However, the P100,000 supervision fee was being
paid every year (for three years) for the entire
duration of the companys project with Paradise
Farms.
Q21.6. Are salaries deductible?

Yes provided that they comply with the following
requisites:
1. The expense must be both ordinary and
necessary
2. The salaries must be paid or incurred within
the taxable year
23

INCOME TAX
3. The salaries must be incurred in carrying on
a trade or business
4. The salaries must be for personal services
actually rendered
5. The salaries must be reasonable in amount.
Q21.7. Are
bonuses
to
employees
allowable deductions from gross
income?
Yes provided that:
1. They are made in good faith
2. They are given for personal services actually
rendered
3. They do not exceed a reasonable
compensation for the services rendered
when added to the stipulated salaries.
Q21.7.1.
Can a bonus given to

corporate officers be deducted
from gross income from the
sale of one of its properties on
the
representation
that
corporate officers, by virtue of
their positions, contributed to
the consummation of the sale?
No. In AGUINALDO INDUSTRIES CORPORATION VS.

COMMISSIONER OF INTERNAL REVENUE [FEBRUARY 25,
1982], Aguinaldo Industries sought to claim as
deductions the bonuses given to its corporate officers
from the sale of one of its properties.The Supreme
Court held that the said bonuses cannot be deducted
because there is no evidence that the said officers
did any work which would be the basis of the grant of
the bonuses. One of the requisites for the
deductibility of bonuses is that they are given for
personal services actually rendered.
Q21.7.2.
ABC Corporation claimed as

deductions bonuses it gave to
its non-resident president and
vice-president
and
the
bonuses it gave to its resident
officers and employees. The
company gave its resident
officers and employees much
more. The deductions for
bonuses given to resident
officers and employees were
disallowed for being excessive
and for no special reason. Is
the disallowance proper?
It would depend on the nature, extent, and quality of

the services actually rendered by the resident officers
and employees. In KUENZLE & STREIFF, INC. VS.
COLLECTOR OF INTERNAL REVENUE [OCTOBER 20,
1959], the Supreme Court held that the bonuses to
its resident officers and employees were reasonable
taking into account the situation at the time when the
services were rendered: unsettling conditions after
the war, the imposition of controls on exports and
imports, and he use of foreign exchange which
resulted in diminution of the amount of business.
Q21.8. What are some factors that may be

considered in determining the
reasonableness
of
the
compensation paid for services?
They are:
1.
2.
3.
4.
5.
6.
7.
8.
The payment must be made in good faith

The character of the taxpayers business
The volume and amount of its net earnings
The locality in which the business is in
The type and extent of the services rendered
The salary policy of the corporation
The size of the particular business
The employees qualifications and business
venture
9. The general economic conditions
There is no fixed test in determining the
reasonableness of a given bonus as compensation.
This depends on many factors and the situation must
be considered as a whole.
Q21.9. What is the rule on the

deductibility of representation or
entertainment, amusement and
recreation expenses?
Such expenses must:
1. be directly related to or in furtherance of the
conduct of the trade, business or exercise of
the profession
2. not be contrary to law, morals, public policy
or public order
3. not exceed such ceilings prescribed by the
Secretary of Finance.
Q21.9.1.
Is
there
a
ceiling
on
entertainment,
amusement
and recreational expenses?
Yes. RR 10-2002 [JULY 10, 2002] provides that

sellers of goods or properties are allowed to deduct
24

INCOME TAX
0.5% of their net sales as representation expenses
while sellers of services are granted 1% of their net
revenues as representation expenses. However,
when supporting documents reflect a lower amount,
then such lower amount shall be used.
not precluded thereby from claiming said interest

payment as deduction under Section 34(B) of the
same Code. It is a well-settled rule that tax
obligations constitute indebtedness for purposes of
deduction from gross income of the amount of
interest paid on indebtedness.
Q24.2. Are there any additional

requisites provided for revenue
regulations for the deductibility
of interest expenses?
Interest (as amended by Republic Act 9337)

Q22. How is interest defined under the Tax
Code?
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 borrowers use of money during
the term of the loan, as well as for his detention of
money after the due date for its repayment.
Q23. What is indebtedness?

Indebtedness is something owned by one who is
unconditionally obligated or bound to pay
Q24. What are the requisites for the

deductibility of interest expenses from
gross income?
The requisites are:
1. There must be indebtedness
2. The indebtedness must be connected with
the taxpayers trade, business or exercise of
profession
3. The interest must be legally due
4. The interest expense must have been paid or
incurred during the taxable year.
5. The interest must have been stipulated in
writing
Q24.1. Do tax obligations constitute

indebtedness?
Yes. In COMMISSIONER OF INTERNAL REVENUE VS. VDA.
DE PRIETO [SEPTEMBER 30, 1960], Vda. de Prieto
conveyed real property by way of gifts to her four
children. She was assessed for donors gift taxes
including interests due thereon. She claimed as
deduction the total interest on account of the
delinquency. She contends that the interests due
from her tax obligations are deductible from gross
income.
The Supreme Court held that although interest
payment for delinquent taxes is not deductible as tax
under Section 34(C) of the Tax Code, the taxpayer is
Yes. RR 13-2000 [NOVEMBER 20, 2000] provides

three more, namely:
1. the interest payment arrangement must not be
between related taxpayers
2. the interest must not be incurred to finance
petroleum operations
3. 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
The RR also provides for a limitation in that 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
38% of the interest income earned which had been
52
subject to final withholding taxes.
Q24.3. What are the rules on the

deductibility
of
Interest
expenses?
The general rule is that the amount of interest
expense paid or incurred within a taxable year on
indebtedness in connection with the taxpayers trade,
business or exercise of profession shall be allowed
as a deduction from the taxpayers gross income
provided that the taxpayers otherwise allowable
deduction for interest expense shall be reduced by
38% of the interest income subject to final tax.
The exceptions (where interest expense is not
deductible from gross income) are:
1. If within the taxable year an individual
reporting income on the cash basis incurs an
indebtedness on which an interest is paid in
advance through discount or otherwise.
Such interest shall be allowed as a deduction
in the year the indebtedness is paid. If the
52
This will be further discussed under tax arbitrage.
25

INCOME TAX
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.
2. If both the taxpayer and the person to whom
the payment has been made or is to be made
are related persons specified under
Section 36(B).
3. If the indebtedness is used to finance
petroleum exploration.
Q24.4.1.
Enumerate the cases when no

deduction is allowed because
the loan is between related
taxpayers.
1. Between members of the family

2. Between an individual and a corporation
where the individual paid interest on a loan
granted by the corporation more than 50% of
the capital stock of which is owned by the
individual
3. Between two corporations where one
corporation owns more than 50% of the
53
other
4. Between a grantor and fiduciary of a trust
5. Between the fiduciary of a trust and the
fiduciary of another trust with the same
grantor
6. Between a fiduciary of a trust and a
beneficiary of such trust
Q25. May the taxpayer choose to treat

interest
expense
as
capital
expenditure?
Yes. Section 34(B)(3) provides that at the option of
the taxpayer, interest incurred to acquire property
used in trade, business or exercise of a profession
may be allowed as a deduction or treated as a capital
expenditure.
However, should the taxpayer elect to deduct the
interest payments against its gross income, the
taxpayer cannot at the same time capitalize the
interest payments because that would constitute
double tax benefits which is not authorized by law
In PAPER INDUSTRIES CORPORATION OF THE
PHILIPPINES VS. COURT OF APPEALS [DECEMBER

1, 1995], Paper Industries claimed as deductions
against gross income interest payments on loans for
the purchase of machinery and equipment. The CIR
disallowed the deduction on the ground that because
the loans had been incurred for the purchase of
machinery and equipment, the interest payments on
the said loans should have been capitalized instead
and claimed as a depreciation deduction taking into
account the adjusted basis of the machinery and
equipment (original acquisition cost plus interest
charges) over the useful life of such assets.
The Supreme Court ruled that Paper Industries is
entitled to its claimed deduction for interest payments
on loans for, among other things, the purchase of
machinery and equipment. The general rule is that
interest expenses are deductible against gross
income and this certainly includes interest paid under
loans incurred in connection with the carrying on of
the business of the taxpayer. In this case, the CIR
does not dispute that the interest payments were
made on loans incurred in connection with the
carrying on of the registered operations of Paper
Industries, i.e., the financing of the purchase of
machinery and equipment actually used in the
registered operations of Paper Industries. Neither
does the CIR deny that such interest payments
were legally due and demandable under the terms of
such loans, and in fact paid by Paper Indusries
during the tax year. The CIR has been unable to
point to any provision of the Tax Code or any other
Statute that requires the disallowance of the interest
payments made by Paper Industries. The general
rule that interest payments on a legally demandable
loan are deductible from gross income must be
applied.
Interest arbitrage
Q26. What is interest arbitrage?
Interest arbitrage results in the reduction of the
interest expense by a percentage of the interest
income subject to final tax. It is also defined as a
circumstance which is presumed to exist because by
putting excess funds in deposits/securities subject to
20% withholding, taxpayers are able to avoid the
32% tax which will happen if the same funds are
invested in revenue-generating activities.
53
The case of a parent company-subsidiary loan will not be

disallowed because it does not refer to a case of a commonlyowned entity (commonly owned at 50%) but one where one entity
owns the other.
Another illustration of this is when a taxpayer borrows

money from the bank (interest payments on which
26

INCOME TAX
can then be claimed as expense and thus a 32%
benefit) then deposits it in a bank (and subsequently
suffers only a 20% final withholding tax) thus
benefiting by 12% representing the difference the
32% deduction and the 20% withholding tax. It does
not matter if the taxpayer actually intended to save
taxes.
claimed are connected with income from sources

within the Philippines.
Also, to be deductible, the taxes must be imposed by
law on, and payable by the taxpayer. Thus, a VAT is
not deductible by the customer upon whom the
burden of the tax is shifted by the seller (on whom the
tax is imposed by law).
In BIR RULING NO. 006-00 [JANUARY 5, 2000],

PNB requested the BIR to exclude the interest
income derived by it from treasury bonds in the
determination of the interest expense not allowable
as deduction as gross income. PNB argues that the
said bonds were given by the Government for
payment for its liabilities to PNB and hence, it has not
engaged in a tax arbitrage scheme.
Although as a general rule, the amount of interest
expense paid or incurred by a taxpayer within a
taxable year on indebtedness in connection with his
trade, business or exercise of profession shall be
allowed as a deduction from his gross income, the
said interest expense, however, shall be reduced if
the taxpayer has derived certain interest income
which had been subject to final withholding tax. The
CIR ruled that this limitation on the deductibility of
interest expenses applies whether or not a tax
arbitrage scheme was entered into by the taxpayer.
Taxes
Q27. Are all taxes deductible from gross
income?
No. Section 34(C)(1) provides that all taxes, national
or local, paid or accrued during the taxable year in
connection with the trade or business or
profession of the taxpayer are deductible from
gross income except:
Q27.1. May a resident alien deduct from

their gross income income taxes
they paid to their government?
Generally, the answer is no. In COMMISSIONER OF
54
INTERNAL REVENUE VS. LEDNICKY [JULY 31, 1964],
US citizens residing in the Philippines who derives
income wholly from sources within the Philippines,
sought to deduct from their gross income the income
taxes they have paid to the US government.
The Supreme Court held that to allow an alien
resident to deduct from his gross income whatever
taxes he pays to his own government is incompatible
with the status of the Philippines as a sovereign
state. This is because the foreign government will
have the power to reduce the tax income of the
Philippine government simply by increasing their tax
rates.
Also important is this case is the statement made by
the court on the exception: a taxpayer may only be
allowed to deduct from his gross income, taxes paid
to a foreign country when such taxpayer is entitled to
a foreign tax credit and he does not choose to
exercise such right. The right to deduct foreign tax
paid is only an alternative to the taxpayers right to
the foreign tax credit.
Q28. What is the rule on credit for taxes?

1. Philippine income tax
2. Foreign income taxes unless the taxpayer
does not make use of the tax credit privilege
under Section 34(C)(3)
3. Estate and donors taxes
4. Taxes assessed against local benefits of a
kind tending to increase the value of the
property assessed (special assessments)
5. VAT
In the case of nonresident alien individual or a
foreign corporation, deduction is only allowed if and
to the extent that the taxes for which deduction is
If the taxpayer signifies in his return his desire to

claim a credit for taxes, the basis of such credit, in
the case of a resident citizen of the Philippines, and
in the case of a domestic corporation is as follows:
a. The amount of income taxes paid or incurred
during the taxable year to any foreign country
b. An individuals proportionate share of any
such taxes of which he is a partner or of an
54
Note that at the time this case was decided, resident aliens were
still allowed to claim a tax credit. The present rule is that only
resident citizens and domestic corporations can claim a tax credit.
Also, in this case, their net income for foreign sources was zero
and, thus, there was no need to apply the tax credit.
27

INCOME TAX
estate or trust of which he is a beneficiary
paid or accrued during the taxable year to a
foreign country if his distributive share of the
income of such partnership or trust is
reported for taxation under Title II.
Only those subject to tax on worldwide income
(resident citizen and domestic corporations) may
avail of tax credits because they pay taxes for foreign
sources income twice (in the Philippines and abroad)
and the tax credit is meant to lessen the impact of
double taxation,
Q28.1. What are the limitations on credit

for foreign taxes?
The amount of the credit shall be subject to the
following limitations:
1.
2.
The amount of the credit in respect to the tax

paid or incurred to any country shall not
exceed the same proportion of the tax
against which such credit is taken, which the
taxpayers taxable income from sources
within such country under this Title bears to
his entire taxable income for the same
taxable year.
The total amount of the credit shall not
exceed the same proportion of the tax
against which such credit is taken, which the
taxpayers taxable income from sources
without the Philippines taxable under this
Title bears to his entire taxable income for
the same taxable year.
In mathematical terms, this can be expressed as:
2. Those incurred in any transaction entered

into for profit, although not connected with
the trade or business
3. Casualty losses that arise from fire, storm,
shipwreck, or other casualty, or from theft or
robbery, even though not connected with the
trade or business of the taxpayer.
Q30. What are the conditions for deductibility

of losses?
In order that losses may be allowed as deductions,
the following conditions must concur:
1. The losses must actually be sustained and
charged off within the taxable year
2. Evidenced by a closed and completed
transaction
3. Loss is not compensated by insurance or
otherwise
4. In the case of an individual, the loss must have
been incurred in the business, trade or profession
of the taxpayer or incurred in any transaction
entered into for profit though not connected with
his trade or business
5. In the case of casualty loss, declaration of loss is
filed within 45 days from the occurrence of the
casualty loss
Q30.1. How shall the amount of the loss

deductible be determined?
The amount of loss deductible is limited to the
difference between the value of the property
immediately preceding the loss and its value
immediately thereafter but shall not exceed an
amount equal of the cost or other adjusted basis of
the property, or depreciated cost reduced by any
55
insurance or other compensation received.
Thus, the tax payable is whichever comes out from

this formula or the actual foreign taxes paid,
whichever is lower.
Losses
Q30.2. What are the special rules on

losses?
Certain special rules on losses are:
1. Losses are deductible only by the person
sustaining them. They are purely personal
and cannot be used as deductions by
another
Q29. How are losses classified under the Tax

Code?
Losses are generally classified into:
55
1. Those incurred in a trade or business for

profit
For example, you purchased a piece of machinery for the value

of 200,000 to be depreciated for 20 years. On the 10th year, it was
lost due to fire and for the loss, you received P50,000 from your
insurance. How much can you deduct? Get the depreciated cost
which is now 100,000 and deduct the insurance received. The
amount that can be deducted is then 50,000.
28

INCOME TAX
2. Net Operating Loss Carry Over (NOLCO)
can be availed of by any taxpayer engaged in
trade, business, or practice of profession.
Net Operating loss of business for any
taxable year, which refers to the excess of
allowable deduction over gross income, can
be carried over as deduction for the next
three consecutive taxable years immediately
following the year of such loss.
NOLCO shall be allowed only if there has
been no substantial change in the
ownership of the business or enterprise.
3. Capital losses may not be deducted from
ordinary gains; such capita losses may only
be deducted from capital gains unless a final
tax on the capital transaction is imposed.
4. Losses from wagering transaction shall be
allowed only to the extent of the gains from
such transactions.
5. In the case of petroleum operations which
are
abandoned,
wholly
or
partially,
accumulated exploration and development
expenditures to a certain extent may be
allowed as deduction as abandonment
losses.
6. Losses on account of the shrinkage in value
of securities or shares of stock are not
deductible until after the loss would have
been actually sustained by the disposition of
the said securities. When, however, such
securities become worthless during the
taxable year and are capital assets the loss
thereform shall be considered as a loss from
the sale or exchange on the last day of such
taxable year, of capital assets.
7. Voluntary advances to a corporation made
without expectation of repayment do no
warrant, upon on-payment, a deduction for
losses
8. Losses from investments are not deductible
as ordinary losses or as bad debts from other
income. Shares of stock becoming worthless
in the hands of an investor are capital assets,
as such capital losses are allowed to be
deducted only to the extent of capital gains.
Q30.3. What is the rule with respect to

loss resulting from shrinkage in
the value of the stock
A person cannot deduct from gross income any

amount claimed as a loss merely on account of
shrinkage in value of such stock through fluctuations
of the market or otherwise.
Q30.4. What is the rule with respect to

loss
resulting
from
stocks
becoming worthless?
If the securities become worthless during the taxable
year and are capital assets, 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.
Q30.5. What are the substantiation

requirements for losses arising
from casualty, robbery, theft, or
embezzlement?
Generally, under RR 12-77 [OCTOBER 6, 1977], the
substantiation requirements are:
1. A declaration of loss filed with the CIR or his
deputies within a certain period as prescribed
in the RR after the occurrence of the
casualty, robbery, theft, or embezzlement
2. Proof of the elements of the loss claimed
RMO 31-2009 [OCTOBER 16, 2009] provides for

policies and guidelines for the reporting of casualty
losses.
Section 38, Tax Code

Q31. Define Wash sale.
Wash sale is a sale or other disposition of stock or
securities where substantially identical securities are
acquired or purchased within a 61-day period,
beginning 30 days before the sale and ending 30
days after the sale.
Q31.1. Are losses

deductible?
from
wash
sales
No. This is an exception to the general rule that

losses from sales or exchanges of stock or securities
are deductible as losses from sales or exchange of
property.
This will not apply to a loss incurred by a dealer in
securities.
29

INCOME TAX
NOLCO
Q32. What is a net operating loss?
Net Operating loss refers to the excess of allowable
deduction over gross income of a business for any
taxable year.
Q32.1. What are the rules on the carryover of net operation loss by a
taxpayer?
1. The net operating loss of the business or
enterprise for any taxable year immediately
preceding the current taxable year, which had not
been previously offset as deduction from gross
income shall be carried over as a deduction from
gross income for the next 3 consecutive taxable
years immediately following the year of such loss
2. Any net loss incurred in a taxable year during
which the taxpayer was exempt from income tax
shall not be allowed as a deduction
3. 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
(a) not less than 75% in nominal value of
outstanding issued shares, if the business is in
the name of a corporation is held by or on behalf
of the same persons; or
(b) Not less than 75% of the paid-up capital of the
corporation. If the business is in the name of a
corporation is held by or on behalf of the same
persons.
Q32.2. XYZ entered into a merger

agreement with ABC. Under this
agreement, the rights, properties,
privileges, powers and franchises
of the said ABC were to be
transferred,
assigned
and
conveyed to XYZ as the surviving
corporation. Before merger, the
company had over preceding
years accumulated losses. XYZ
claimed these losses as a
deduction against its gross
income. Should the deduction be
allowed?
No. In PAPER INDUSTRIES CORPORATION OF THE

PHILIPPINES VS. COURT OF APPEALS [DECEMBER 1,
1995], the Supreme Court ruled that the deduction
was improper. 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 merger,
consolidation or any form of business combination of
such taxpayer with another person. To allow the
deduction claimed by the surviving corporation would
be to permit one corporation or enterprise to benefit
from the operating losses accumulated by another
corporation or enterprise.
Q32.3. If a corporation has paid its MCIT,

will the three-year reglementary
period on the carry-over of NOLCO
continue to run?
Yes. RR 14-01 [AUGUST 27, 2001] provides that that
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
MCIT computation
Q32.4. If several corporations enter an

agreement to integrate their
respective businesses, can each
of the corporations continue to
carry-over their respective net
operating losses?
It depends on the nature of the integration plan. In
BIR RULING 30-00 [AUGUST 10, 2000], three cement
companies (Republic, Fortune and Blue Circle)
sought the opinion of the CIR on the tax implications
of their integration plan. With regard to NOLCO, the
CIR held that since, under the plan, the corporation
are not dissolved but merely integrated for a specific
bona fide purpose, the net operation losses of each
of the cement corporations are preserved after the
proposed share swap and may be carried over and
claimed as a deduction from their respective gross
income because there is no substantial change in the
ownership of either of the three cement companies.
Forex losses
Q33. Are
foreign
deductible?
exchange
losses
No. In BIR RULING 206-90 [OCTOBER 30, 1990] and

BIR RULING NO. 144-85 [AUGUST 26, 1985], the CIR
30

INCOME TAX
held that, with regard to foreign exchange losses, the
annual increase in value of an asset is not taxable
income because such increase has not yet been
realized, The increase in value 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. The same conclusion obtains to losses.
The annual decline in the value of property is not
normally allowable as a deduction. Hence, to be
allowable the loss must be realized.
Bad Debts
Q34. What are bad debts?
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 form uncollectable amounts of
income from goods sold or services rendered.
Q34.1. How do you distinguish bad debts

from loss?
Voluntary cancellation or forgiveness of a debt does
not give rise to a deductible loss. However, if the debt
is actually worthless, there may be a bad debt
deduction. That deduction would be allowed because
the debt was worthless, not because it was forgiven.
Q34.2. What are the conditions for bad

debts to be deductible?
As provided in RR 5-99 [March 10, 1999], 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 taxpayers
trade, business or practice of profession
3. The same must not be sustained in a transaction
entered into between related parties
4. The same must actually be charged-off within the
taxable year
5. The same must be actually ascertained to be
worthless and uncollectible as of the end of the
taxable year.
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.
2. 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
In both cases, requisites nos. 1-4 should still be
complied with,
Q34.3. What is meant by actually

ascertained to be worthless?
The phrase means that a debt is not worthless simply
because it is of doubtful value or difficult to collect.
Conclusive evidence must be presented to show that
the taxpayers receivable from a debtor has definitely
become worthless.
Q34.4. What is meant

charged off?
by
actually
The phrase means that the amount of money lent by

the taxpayer to his debtor has been recorded in his
books of account as a receivable that has actually
become worthless of as of the end of the taxable
year, that the said receivable has been cancelled and
written-off from the said taxpayers books of account.
Q34.5. ABC mining entered into a

management contract with XYZ
mining. ABC made advances of
cash and property. However,
XYZs mine suffered continuing
losses which led to ABC;s
withdrawal as manager and
cessation of mine operations. ABC
and XYZ entered into two
compromises: the first involved
alleged indebtedness by XYZ from
the advances of ABC and the
second involved long-term loans
guaranteed
by
ABC.
ABC
deducted the amounts as bad
debt. Is the deduction proper?
RR 5-99 [March 10, 1999] provides for two

exceptions to requisite no. 5, namely:
1. The BSP, through the Monetary Board, shall
ascertain the worthlessness and uncollectibility of
No.
In
PHILEX
MINING
CORPORATION
VS.
COMMISSIONER OF INTERNAL REVENUE [APRIL 16,
2008], the Supreme Court held that Philex cannot
deduct the amounts as bad debt. The agreement
31

INCOME TAX
provided for a distribution of assets of the mine upon
termination, a provision that is more consistent with a
partnership than a creditor-debtor relationship. In this
connection, there is no contractual basis for the
execution of the two compromise agreements in
which Baguio Gold recognized a debt in favor of
Philex. Philexs advances should be treated as
investments in a partnership. The advances were not
"debts" of Baguio Gold to Philex inasmuch as the
latter was under no unconditional obligation to return
the same to the former.
As for the amounts that Philex paid as guarantor to
Baguio Golds creditors, the debts were not yet due
and demandable at the time that Philex paid the
same. Philex cannot claim the advances as a bad
debt deduction from its gross income. Deductions for
income tax purposes partake of the nature of tax
exemptions and are strictly construed against the
taxpayer, who must prove by convincing evidence
that he is entitled to the deduction claimed. In this
case, Philex failed to substantiate its assertion that
the advances were subsisting debts of Baguio Gold
that could be deducted from its gross income.
Consequently, it could not claim the advances as a
valid bad debt deduction.
Q34.6. Is the declaration by the taxpayer

that a debt is worthless sufficient
for it to claim a bad debt
deduction?
No. In PHILIPPINE REFINING COMPANY VS. COURT OF
APPEALS [M AY 8, 1996], at issue was PRCs (now
Unilever) claimed of bad debt deduction. On appeal,
the CTA disallowed the same as there was no iota of
documentary evidence to prove the worthlessness of
the debts sought to be deducted. The Supreme Court
stated that before a debt can be considered
worthless, the taxpayer must also show that it is
indeed uncollectible even in the future. PRC here
failed to prove the worthlessness of the amounts
receivable.
Q34.7. ABC, an investment company

made advances to XYZ under an
agreement that a portion of its net
profits would go to ABC. XYZ
suffered substantial losses but
continued to operate. ABC made a
partial write-off of the losses and
deducted the amount in its return.
Is the deduction proper?
No. In FERNANDEZ HERMANOS, INC. VS. COMMISSIONER

OF INTERNAL REVENUE [SEPTEMBER 30, 1969], the
Supreme Court held that the deduction was improper.
The Court opined that assuming that in this case
there was a valid and subsisting debt and that the
debtor was incapable of paying the debt, the debt is
still not deductible as a worthless debt because the
debtor was still in operation. It has been held that if
the debtor corporation, although losing money or
insolvent, was still operating at the end of the taxable
year, the debt is not considered worthless and
therefore not deductible.
Q34.8. What is the Tax Benefit Rule?

Under the Tax Benefit Rule or Equitable Doctrine
of Tax Benefit, the recovery of amounts deducted in
previous years shall be included as part of the gross
income in the year of recovery to the extent of the
income tax benefit of said deduction.
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 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 if the said bad debt
written-off, then his subsequent recovery shall be
treated as a mere recovery or a return of capital,
hence, not treated as receipt of realized taxable
income.
Depreciation
Q35. What is depreciation?
Depreciation is the gradual diminution in the useful
56
value of tangible property resulting from wear and
tear and normal obsolescense.
The term is also applied to amortization of the value
57
of intangible assets, the use of which in the trade or
business is definitely limited in duration.
Q35.1. What is the

depreciation?
rationale
behind
Depreciation commences with the acquisition of the

property and its owner is not bound to see his
property gradually waste, without making provision
56
Not all tangible property can be depreciated. Land, for example,

cannot be depreciated because its value continues to increase.
57
Like those with limited duration
32

INCOME TAX
out of earnings for its replacement. It is entitled to see
to it that from earnings the value of the property
invested is kept unimpaired so that at the end of any
given term of years, the original investment remains
as it was in the beginning
Q35.2. What are the requisites for the

deductibility of a depreciation
expense?
1. The allowance for depreciation must be
reasonable
2. It must be for property used in the trade,
business, or profession
3. It must be charged off during the taxable
year; and
4. A statement on the allowance must be
attached to the return
Q35.3. Can an asset be depreciated
beyond its acquisition cost?
No. In BASILAN ESTATES, INC. VS. COMMISSIONER OF
INTERNAL REVENUE [SEPTEMBER 5, 1967], Basilan
Estates claimed deductions for the depreciation of its
assets up to 1949 on the basis of their acquisition
cost. In 1950, however, it changed the depreciable
value of the assets by increasing it to conform with
the increase in cost of their replacement. Accordingly,
in 1950 to 1953, the company deducted from gross
income the value of the depreciation based on this
reappraised value.
The Supreme Court held that such value cannot be
deducted from gross income as it was beyond the
acquisition cost. Depreciation as a deduction is
allowed so that the owner of the assets can set aside
some money to buy a replacement or, in other words,
to gradually recover the acquisition cost. The income
tax law does not authorize the depreciation of an
asset beyond its acquisition cost. The reason is that
deductions from gross income are privileges, not
matters of right. More importantly, the recovery, free
of income tax, of an amount more than the invested
capital in an asset will run counter to the purpose of a
depreciation allowance. For then, the taxpayer can
not only recover the acquisition cost, but also make
some profit.
Recovery in due time through
depreciation of investment made is the philosophy
behind depreciation allowance; the idea of profit on
the investment made has never been the underlying
reason for the allowance of a deduction for
depreciation.
Q35.4. The BIR found that ABC claimed

excessive depreciation of its
buildings. In its defense, ABC
Limpan argued that that some of
its buildings are old and out of
style; hence, they are entitled to
higher rates of depreciation than
those adopted by the BIR in its
assessment. On appeal, the CTA
found that the depreciation was
excessive. Should the findings of
the CTA be affirmed?
Yes provided there no arbitrariness and abuse of
discretion on the part of the CTA. In LIMPAN
INVESTMENT CORPORATION VS. COMMISSIONER OF
INTERNAL REVENUE [JULY 26, 1966], the Supreme
Court opined that depreciation is a question of fact
and is not measured by theoretical yardstick, but
should be determined by a consideration of actual
facts. The findings of the tax court in this respect
should not be disturbed when not shown to be
arbitrary or in abuse of discretion. Limpan has not
shown any arbitrariness or abuse of discretion on the
part of the CTA. In fact, the CTA applied rates of
depreciation in accordance with Bulletin F of the US
Federal Internal Revenue Service, which the
Supreme Court, has pronounced as having strong
persuasive effect.
Q35.5. What are the special rules on

deductibility of depreciation on
vehicle expenses?
RR 12-2012 [OCTOBER 12, 2012] provides for the
following rules:
1. Only one vehicle for land transport is allowed for
the use of an official or employee
2. The value of which should not exceed
P2,400,000
3. It must be substantiated with sufficient evidence,
such as official receipts or other adequate
records; and
4. There is a direct connection or relation of the
vehicle to the development, management,
operation, and/or conduct of the trade or
business or profession of the taxpayer
Generally, no deduction in the gross income shall be
allowed for depreciation of the following:
33

INCOME TAX
1. Yachts, helicopters, airplanes, and/or aircrafts;
and
2. Land vehicles with a value of more than
P2,400,000
Exception: the taxpayer is in the business of transport
operations or lease of transportation equipment and
the vehicles purchased are used in such operations.
In addition, the following shall be disallowed as
deductions in the gross income:
1. All maintenance expenses on account of nondepreciable vehicles;
2. Input taxes on the purchase of non-depreciable
vehicles and all input taxes on maintenance
expenses.
Depletion
Q36. What is depletion?
Depletion is the exhaustion of natural resources like
mines and opil and gas wells as a result of production
or severance from such mines or wells.
Q36.1. Who may avail of the cost of

depletion?
Annual depletion deductions are allowed only to
persons who own an economic interest in the
property that are entitled to depletion allowance.

depletion and depreciation?
Both depletion and depreciation are predicated on
the same basic premise of avoiding a tax on capital.
The allowance for depletion is based on the theory
that the extraction of minerals gradually exhausts the
capital investment in the mineral deposit. The
purpose of the depletion deduction is to permit the
owner of a capital interest in mineral in place to make
a tax-free recovery of that depleting capital asset. A
depletion is based upon the concept of the
exhaustion of a natural resource whereas
depreciation is based upon the concept of the
exhaustion of the property, not otherwise a natural
resource, used in a trade or business or held for the
production of income. Thus, depletion and
depreciation are made applicable to different types of
assets. And a taxpayer may not deduct that which the
Code allows as a deduction of another.
Q36.3. What is the rule on depletion?

A reasonable allowance for depletion or amortization,
under a cost depletion method, shall be allowed for
oil and gas wells and mines. The allowance is
deductible from the net taxable income. However,
when the allowance for depletion has equal the
capital invested, no further allowance shall be
granted
In CONSOLIDATED MINES, INC. VS. COURT OF TAX

APPEALS [AUGUST 29, 1974], the BIR among other
disallowances claimed that the depletion expense
deductions of Consolidated Mines have been
overcharged. Thus, Consolidated was assessed for
income tax deficiency. The CIR and Consolidated
differed with regard to the cost of the mining property
as well as the estimated ore deposit. On appeal to
the CTA, the CTA ruled in favor of the CIR on the
issue of depletion deductions. Consolidated
contested the rate of mine depletion adopted by the
CTA in arriving at its conclusion.
In depletion, evidence must be shown to show the
produce mined and for how much they were sold
during the year for which the return or computation
were made. This is necessary in order to determine
the amount of depletion that can be legally deducted
from gross income. Given the evidence presented,
the Supreme Court held that the CIR was correct as
to the cost of the mining property but both the CIR
and Consolidated were wrong as to estimated ore
deposit.
Charitable and other contributions

Q37. What are the conditions for deductibility
of charitable contributions?
The requisites are:
1. Actually paid or made to the Philippine
Government or any political subdivision
thereof, or any of the domestic corporation or
association specified in the Tax Code
2. Made within the taxable year
3. Not exceeding 10% (individuals) or 5%
(corporations) of the taxpayers taxable
income before charitable contributions
4. Evidenced by adequate receipts or records
34

INCOME TAX
Q37.1. What contributions are deductible
in full?
Donations to the following institutions are deductible
in full:
1. Donations to the Government, its entities,
political subdivisions or fully owned
corporations exclusively for undertaking
priority activities in accordance with the
national priority plan to be determined by
NEDA
2. Donations to foreign institutions or
international organizations pursuant to
agreements, treaties entered into by
Government or special laws
3. Donations to accredited Non-Government
Organizations
(non-profit
domestic
58
corporation)
Q37.2. When are donations subject to

limitations?
When the donation is made to:
1. The government for public purposes
2. Accredited
domestic
corporations
for
religious, charitable, scientific, etc. purposes
3. Social welfare institutions
4. NGOs (not accredited)
The limitations are 10% of net income for individual
taxpayers and 5% of net income for corporate
taxpayers.
Q37.3. What
is
a
organization?
Is an
international
NGO
qualified
to
be
granted
accreditation?
58
NGOs are accredited by the PCNC (Philippine Council for NGO

Certification)
Research and Development

Q38. What is the rule on the deductibility of
expenses
for
research
and
development?
A taxpayer may treat research or development
expenditures which are paid or incurred by him
during the taxable year in connection with his trade,
business, or profession as ordinary and necessary
expenses which are not chargeable to capital
account. The expenditures so treated shall be
allowed as deduction during the taxable year when
paid or incurred.
Q38.1. When
is
the
inapplicable?
above
rule
The rule does not apply to:

1. Any expenditure for the acquisition or
improvement of land, or for the improvement
of property to be used in connection with
research and development of a character
which is subject to depreciation and depletion
2. Any expenditure paid or incurred for the
purpose of ascertaining the existence,
location, extent, quality of any deposit of ore
or other mineral, including oil or gas.
non-government
A non-government organization shall refer to a

non-stock, non-profit domestic corporation
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.
Q37.3.1.
No. In BIR RULING 19-01 [M AY 10, 2001], at issue

was whether or not international organizations with
home offices based abroad are qualified to be
granted done institution status (accreditations as
NGO), the CIR ruled that a non-stock, non-profit
corporation or organization must be created or
organized under Philippine laws and that an NGO
must be a non-profit domestic corporation, a foreign
corporation whether resident or non-resident cannot
be accredited as a done institution.
In 3M PHILIPPINES, INC. VS. COMMISSIONER OF

59
INTERNAL REVENUE [SEPTEMBER 26, 1988],
3M
Philippines, a subsidiary of 3M (nonresident foreign
corporation based in the US), claimed as deductions
the entire amount paid by 3M Philippines to 3M for
royalties and technical services. The Supreme Court
ruled that the entire amount is not deductible.
Improper payments of royalty are not deductible as
legitimate business expenses. Proper reference must
be given to CB Circular 393 which provides that
59
Note, however, that during this time, there was a 5% threshold

for royalty payments.
35

INCOME TAX
royalties shall be paid only on commodities
manufactured by the licensee under the royalty
agreement. In this case, there were some finished
products imported by the licensee from the licensor.
No royalty is payable on the wholesale price of such
imported finished products.
Q38.2. May the taxpayer elect to

amortize/capitalize its research
and development expenses?60
Yes. The taxpayer may elect to amortize the following
research and development expenditures:
1. Paid or incurred by the taxpayer in connection
with his trade, business, or profession
2. Not treated as research and development
expenses (not capitalized)
3. Chargeable to capital account but not chargeable
to property of a character which is subject to
depreciation or depletion.
Additional requirements for deductibility

Q39. What are the additional requirements
for deductibility of deductions?
Q40. What is meant by Optional Standard

deduction?
Section 34(L) provides that in lieu of the itemized
deductions, an individual subject to tax excluding a
nonresident alien may elect a standard deduction
of not exceeding 40% of his gross sales or gross
receipts, as the case may be. In the case of a
domestic corporation and a resident foreign
corporation, it may elect a standard deduction in an
amount not exceeding 40% of its gross income.
A non-resident alien (whether engaged or not) and a
non-resident foreign corporation cannot claim OSD.
The election to use OSD when made in the return
shall be irrevocable for the taxable year for which the
return is made.
Q40.1. What are the rules in the

determination of the amount of
OSD?
RR 16-2008 [NOVEMBER 26, 2008] provides for the
following rules:
Any amount paid or payable which is otherwise

deductible from or taken into account in computing
gross income or for which depreciation or
amortization may be allowed 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 BIR in accordance with:
1. For individuals
a. If on accrual basis of accounting, the OSD
shall be based on gross sales
b. If on cash basis of accounting, the OSD shall
be based on gross receipts
c. Cost of sales and cost of services are not
allowed to be deducted for purposes of
determining the basis of the OSD
1. Section 34, Section 58 (on returns and payment of

taxes withheld at source); and
2. For corporations
a. It shall be based on gross income
2. Section 81 (on filing of return and payment of taxes

withheld) .
Q40.2. What are the rules in the

determination of the amount of
OSD of GPPs?
RMO 38-83 [NOVEMBER 14, 1983] provides for the

guidelines for allowance of deductions for certain
income payments.
RR 2-2010 [FEBRUARY 18, 2010] amended Sections

6 to 7 of RR 16-2008 with respect to the
determination of the OSD of GPPs.
Optional Standard Deduction

Section 34 (L), Tax Code as amended by Republic
Act 9504
60
This is similar to interest expense where you can capitalized.
A GPP is not subject to income tax but the partners

shall be liable to pay income tax on their separate
and individual capabilities for their respective
distributive share in the net income of the GPP.
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. The
36

INCOME TAX
GPP may claim itemized deductions or in lieu thereof
may opt to avail of the OSD allowed to corporations.
The net income determined by either claiming the
itemized deductions or OSD from the GPPs gross
income is the distributable net income from which the
share of each partner is determined.
If the GPP availed of the itemized deductions in
computing its net income, a partner may still claim
itemized deductions from his share in the net income
of the partnership.
However, if the GPP availed of the OSD in computing
its net income, the partner can no longer claim further
deduction from his share in the said net income.
Premium payments on health and/or

hospitalization insurance
Q41. May a taxpayer deduct from his gross
income premium payments for health
and hospitalization insurance?
Yes. An individual taxpayer can claim as deduction
from his gross income the premium payment for
health and/or hospitalization insurance for an amount
not exceeding P2,400 per family during the taxable
year provided the gross family income does not
exceed P250,000 for the taxable year. Only one
spouse claiming the additional exemption for
dependents shall be entitled to this deduction.
Non-deductible expenses
Section 36, Tax Code
Q42. What items are not deductible from

gross income?
No deduction shall in any case be allowed in respect
to:
1. Personal, living or family expenses
61
3. Any amount expended in restoring property

or in making good the exhaustion thereof for
which an allowance is or has been made
(capitalized interest)
4. Premiums paid on any life insurance
policy covering the life of any officer or
employee or of any person financially
interested in any trade or business carried on
by the taxpayer, individual, or corporate
when the taxpayer is directly or indirectly a
beneficiary under such policy
5. Losses from sales or exchanges of property
directly or indirectly between related
persons
a. Between members of a family
b. Between
an
individual
and
a
corporation more than 50% in value of
the outstanding stock of which is owned
by such individual (except in the case of
distributions in liquidation)
c. Between two corporations more than
50% in value of the outstanding stock of
each of which is owned by the same
individual if either one of the companies
is a holding company
d. Between the 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
f.
Between a fiduciary of a trust and a
beneficiary of such trust.
Section 119-122, RR 2 reiterates the enumeration

provided above.
Q42.1. Are
margin
fees
business expenses?
deductible
2. Any amount paid out for new buildings or

for
permanent
improvements
or
betterments made to increase the value of
any
property
or
estate.
(Capital
expenditures)
No. In ESSO STANDARD EASTERN, INC. VS.

COMMISSIONER OF INTERNAL REVENUE [JULY 7, 1989],
Esso made profit remittances to its New York Head
Office. Esso claims that the margin fees it paid to the
Central Bank on the remittances are ordinary and
necessary expenses and should be deducted from its
gross income.
They are not deductible because the taxpayer is already given a

personal exemption of P50,000 regardless of status and gender,
plus an additional exemption of P25,000 foe each dependent, not
exceeding 4, as defined by law
The Supreme Court held that margin fees are not

necessary and ordinary expenses. The margin fees
are not expenses in connection with the production or
earning of petitioner's incomes in the Philippines..
61
37

INCOME TAX
Since the margin fees in question were incurred for
the remittance of funds to petitioner's Head Office in
New York, which is a separate and distinct income
taxpayer from the branch in the Philippines, for its
disposal abroad, it can never be said therefore that
the margin fees were appropriate and helpful in the
development of petitioner's business in the
Philippines exclusively or were incurred for purposes
proper to the conduct of the affairs of petitioner's
branch in the Philippines exclusively or for the
purpose of realizing a profit or of minimizing a loss in
the Philippines exclusively
Determining Net Income Tax Payable62

Section 31, 32(A), NIRC
Q43. What is taxable income?

As defined in Section 31, the term taxable income
means the pertinent items of gross income specified
in this Code, less the deductions and/or personal and
additional exemptions, if any, authorized for such
types of income by this Code or other special laws.
Q44. What is gross income?
Q45. Is income subject to final tax included

in the taxpayers taxable income?
No. Under the Tax Code, "taxable income" does not
include passive income subjected to final withholding
taxes. The definition of gross income is broad enough
to include all passive incomes subject to specific
rates or final taxes. However, since these passive
incomes are already subject to different rates and
taxed finally at source, they are no longer included in
the computation of gross income, which determines
taxable income (see CIR VS. PHILIPPINE AIRLINES
[OCTOBER 9, 2006]).
Such income is no longer returnable, meaning it will
no longer be declared as income in the income tax
return and, hence, will not be subject to the schedular
income tax rates on individuals or the corporate
income tax rate.
Q46. How is net

determined?
income
tax
payable
In all cases, other than when a final tax is imposed or

when the gross compensation income tax system
applies, the income tax is imposed on the net taxable
income computed as follows:
As provided in Section 32(A), gross income means

all income derived from whatever source, including,
but not limited to, the following items:
(1) All income minus exclusions equals gross

income;
(2) Gross income less allowable deductions
equals net income (in case of corporations,
63
this is already the taxable net income)
(3) Net income less personal and additional
exemptions (when applicable) equals
taxable net income
(4) Taxable net income times income tax rates
(on the graduated basis) equals net income
tax due
(5) Income tax less creditable withholding tax
and/or tax credit equals net income tax
payable.
1. Compensation for services in whatever form

paid, including, but not limited to fees,
salaries, wages, commissions and similar
items;
2. Gross income derived from the conduct of
trade or business or the exercise of a
profession;
3. Gains derived from dealings in property
4. Interests
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions; and
11. Partners distributive share from the net
income of the GPP
62
The next three parts will be on Individuals, Corporations, and

Withholding Tax. This part provides the key terms and an overview
of how net income tax payable for individuals and corporations are
determined.
63
Simply multiply it with the corporate income tax rate.
38

INCOME TAX
Further, their holiday pay, overtime pay, night shift
differential pay, and hazard pay received by them
shall likewise be exempt from income tax.
Individuals
Ordinary and Passive Income
Q47. Differentiate ordinary
passive income.
income
from
Ordinary income is income other than capital gain

and those incomes which fall under the category of
passive income.
On the other hand, if the income is generated in the
active pursuit and performance of the corporations
primary purposes, the same is not passive income.
Generally, passive income is income generated by
the taxpayers assets. These assets can be in the
form of real properties that return rental income,
shares of stock in a corporation that earn dividends
or interest income received from savings.
Q47.1. What is the income tax rate

imposed on ordinary income?
It shall be subject to the graduated income tax with
64
rates from 5% to 32%.
In relation to Section 23 of the NIRC, the taxable
income derived for each taxable year:
1. From all sources within and without the
Philippines by resident citizens;
2. From all sources within the Philippines only
by a non-resident citizen including overseas
contract workers;
3. From all sources within the Philippines only,
by a resident alien or a non-resident alien
engaged in trade or business in the
65
Philippines;
shall be subject to the graduated income tax in
accordance with the following schedule provided
under Section 24 (see Tax Rates Table annexed to
this reviewer)
Q47.1.1.
Is the income of minimum

wage earners be subject to the
graduated income tax rates?
No. Minimum wage earners shall be exempt from the

payment of income tax on their taxable income.
64
For ordinary income over P10,000 but not over P30,000 and
upper brackets, a fixed amount is added to the taxable amount
subject to the graduated income tax rate.
65
Only difference really is the source of income
Q47.2. What is the income tax rate

imposed on passive income?
Passive incomes are subject to different final taxes.
As stated earlier, since they are already subject to
different rates and taxed finally at source, they are no
longer included in the computation of gross income,
which determines taxable income.
Q47.3. What are the incomes subject to

final tax rates?
As a general rule, income, gain or profit derived by
an individual during the taxable year shall be subject
to the graduated income tax rates.
As exceptions, certain incomes subject to tax are
not subject to the graduated tax rates and are instead
subject to final tax rates. They are:
1. Tax on certain passive income under
Section 24(B)
a. Interests, royalties, prizes and other
winnings under Section 24(B)(1)
b. Cash and/or property dividends under
Section 24(B)(2)
2. Capital gains from sale of shares of stock not
traded in the Stock exchange under Section
24(C)
3. Capital gains from sale of real property under
Section 24(D)
4. Compensation income of alien and Filipino
employees of
a. Regional or area headquarters and
regional operating headquarters of MNCs
under Section 25(C)
b. Offshore Banking Units under Section
25(D)
c. Foreign petroleum service contractors
and sub-contractors under Section 25(E)
Q47.3.1.
What is the proper tax

treatment
on
individual
taxpayers of income derived
from royalties, prizes and
other winnings?
Royalties (except books, literary works, musical

compositions), prizes amount to more than P10,000
and other winnings (except PCSO and Lotto)
39

INCOME TAX
Q47.3.4.
Final tax in case of citizens (whether resident or
nonresident), resident aliens and non-resident aliens
engaged in trade or business is 20%.
In case of non-resident aliens not engaged in trade or
business, the amount received shall form part of their
gross income subject to a flat 25%. (see Section
25(B))
As provided in RR 14-2012 [NOVEMBER 7, 2012]:

1. Interest from Philippine currency bank
deposits and yield from deposit substitute
and from trust funds or similar
arrangements
Exceptions:
1. For royalties from books, literary works, musical
compositions, the final tax is 10%.
2. Prizes amounting to P10,000 or less shall form
part of ordinary taxable income and, subject, to the
graduated income tax rates.

treatment
on
individual
from interests
Final tax in case of citizens, resident aliens and nonresident aliens engaged in trade or business is
66
20%.
In case of non-resident aliens not engaged in trade or
business, the amount received shall form part of their
67
gross income subject to flat 25% income tax.
3. PCSO and Lotto Winnings are tax-exempt.
Q47.3.2.

treatment
on
individual
from dividends?
Dividends from domestic corporations and shares in

net profits of taxable partnerships received by
citizens (whether resident or nonresident) or resident
aliens are subject to 10%.
2. Interest income derived from government

debt instruments and securities
They are considered deposit substitutes.
same tax treatment as above is applied.
3. Interest derived from long
deposits or investments
What are deposit substitutes?

An alternative form of obtaining
funds from the public (the term
public means borrowing from 20 or
more individual or corporate
lenders at any one time), other
than
deposits,
through
the
issuance,
endorsement,
or
acceptance of debt instruments for
the borrowers own account for
purposes
of
re-lending
or
purchasing receivables and other
similar obligations, or financing
their own needs or the needs of
their agent or dealer
long-term
a. Depositor is an individual citizen (resident or

non-resident), a resident alien or a
nonresident alien engaged in trade or
business in the Philippines;
b. The long-term deposit or investment
certificates under name of the individual;
c. The long-term deposits or investments must
be in the form of savings, common or
individual trust funds, deposit substitutes, etc
evidences by certificates in the BSPprescribed form
d. The long-term deposits or investments must
be issued by banks only;
e. The long-term deposits or investments must
have a maturity period of not less than 5
years
As for non-resident aliens not engaged in trade or

business, it shall form part of their taxable gross
income subject to flat rate of 25%.
Deposit
substitutes
The
They are exempt from tax, provided the following

requisites are met:
In the case of non-resident aliens engaged in trade or

business, it is 20%.
Q47.3.3.
68
66
Same rate applies to domestic and resident foreign corporations.

A non-resident foreign corporation is subject to a FWT of 30%.
Irrespective of the number of lenders at the time of origination if
such debt instrument and securities are to be traded or exchanged
in the secondary market.
67
68
40

INCOME TAX
f.
The long-term deposits or investments must

be in the denominations of P10,000 and
other BSP-prescribed denominations
g. The long-term deposits or investments
should not be pre-terminated.
h. Except those specifically exempted by law,
any other income such as gains from trading,
foreign exchange gain shall not be covered
by income tax exemption.
If the deposit or investment is pre-terminated, a final
tax shall be imposed on the entire income.
Four years to less than five year 5%.
Three years to less than four years 12%
If less than three years 20%.
4. Interest income derived from a depository
bank under the expanded foreign
currency deposit system (EFCDS)
banks, the interest income shall be subject to

10%
6. Interest income
instruments
Q48. Define the following terms.

Section 22(Z) and 39(A) Tax Code
Ordinary
Income
Ordinary loss
Capital Assets
a. The interest income must be derived by

residents. Interest income from foreign currency
loans granted by such depository banks under
the EFCDS other than OBUs shall be subject to a
final tax of 10%.
b. Any income of non-residents, whether individuals
or corporations, shall be tax-exempt.
5. Interest income derived from offshore
banking units of OBUs
69
Domestic and resident foreign corporations are also subject to

the final tax of 7.5%. Nonresident foreign corporations are exempt.
other
Capital Gains Tax70
Derived by FCDUs:
a. Income derived by OBUs from foreign currency

transactions with nonresidents, other OBUs, and
local commercial banks are tax-exempt.
b. If the foreign currency transactions are with
residents other than OBUs and local commercial
all
Any other debt instrument not within the coverage of

deposit substitutes shall be subjected to a creditable
withholding tax of 20%.
Derived from FCDUs:

a. The interest income must be derived by
residents. If the interest income is derived by a
resident individual taxpayer, it shall be subject to
69
a final tax of 7 %.
b. Any income of non-residents, whether individuals
or corporations, shall be tax-exempt.
c. If the bank account is jointly in the name of a
non-resident and a resident, 50% shall be treated
as exempt and the remaining 50% shall be
subject to the final tax of 7 .
derived
Net
Gain
Capital
Net
Loss
Capital
Any gain from the sale or

exchange of property which is not
a capital asset or property
described in Section 39(A)(1)
(which defines what capital assets
are and those which are not)
Includes any loss from the sale or
exchange of property which is not
a capital asset
Means property held by the
taxpayer
(whether
or
not
connected with his trade or
business) but does not include:
1. Stock in trade of the taxpayer
or other property of a kind
which would properly be
include 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 the trade or
business of a character which
is subject to the allowance for
depreciation
4. Real property used in trade or
business of the taxpayer
Means the excess of the gains
from sales of exchanges of capital
sales or exchanges
Means the excess of the losses
from sales or exchanges of capital
70
This will be discussed in greater detail in the section on Capital

Gains and Losses.
41

INCOME TAX
Q49.2. What capital gains are subject to
capital gains tax?

sales or exchanges
Section 22(T) to (X), Tax Code
Securities
Dealer
securities
in
Bank
Non-bank
financial
institution
Quasi-banking
activities
Means share of stock n a

corporation and rights to subscribe
for or to receive such shares
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
Every banking institution as
defined in RA 337 as amended by
RA 8791 (General Banking Act of
2000)
A financial intermediary as defined
in RA 337 as amended by RA
8791 (General Banking Act of
2000) authorized by the BSP to
perform quasi-banking activities
Means borrowing funds from 20 or
more personal or corporate
lenders at any one time, through
the issuance, endorsement, or
acceptance of debt instruments of
any kind other than deposits for
the borrowers own account or
through the issuance of certificates
of
assignments
or
similar
instruments, with recourse, or of
purchase agreements for purposes
of
re-lending
or
purchasing
receivables and other similar
obligations
Q49. What is a capital gains tax?

A capital gains tax is a tax on capital gains, the profit
realized from the sale of capital assets.
Q49.1. If the asset sold is not a capital

asset, what tax will be imposed?
If the asset is an ordinary asset, any gain from the
sale thereof shall form part of the ordinary income
which shall be subject either to graduated income tax
rates (if individual) or corporate income tax (if
corporation).
1. Capital gains from the sale of shares of stock no

trade in the stock exchange
2. Capital gains from the sale of real property
Q49.3. From the above transactions, who

are the individual taxpayers whose
transactions would be subject to
capital gains tax?
The capital gains tax shall be imposed on such
transactions by any individual taxpayer, whether
71
citizen or alien.
Q49.4. Is the capital gain from the sale or

exchange of a capital asset always
taxable in full?
No. In the case of a taxpayer other than a
corporation, the following percentages of the gain
upon the sale or exchange of a capital asset shall be
taken into account in computing net capital gain:
1. 100% if the capital asset has been held for not
more than 12 months
2. 50% if the capital asset has been held for more
than 12 months
Capital Gains Tax with respect to shares

of stock
Q50. What are stocks classified as capital
assets?
Stocks classified as capital assets mean all stocks
and securities held by taxpayers other than dealers in
securities.
Q51. What is the rule on capital gains from

sales of shares of stock?
Capital gains tax shall be imposed upon the net
capital gains realized during the taxable year from the
sale, barter, exchange or other disposition of shares
of stock in a domestic corporation except shares,
sold or disposed through the stock exchange.
The final tax imposed shall be:
71
Note that any corporate taxpayer, domestic or foreign as well as

all other taxpayers may be subjected to pay capital gains tax on
stock or real property transactions
42

INCOME TAX
Capital gains not over P100,000 5%
Capital gains over P100,000 10%
from said transactions (see COMPAGNIE FINANCIERE

SUCRES ET DENREES VS. CIR [AUGUST 28, 2006])
The tax base shall only be the gain on the sale and
such sale will always be subject to capital gains tax
without any exemption.
The capital gains tax must be paid within 30 days
following each sale or disposition. In case of
installment sale, the return shall be filed within 30
days following the receipt of the first down payment
and within 30 days following the subsequent
installment payments.
(See RR 06-2008 [APRIL 22, 2008])
Q51.1. If the share of stock is traded

through the stock exchange, what
tax is applicable?
A percentage tax of of 1% is imposed on the gross
selling price of shares of stock if they are listed and
sold, exchanged or transferred through the facilities
of the local stock exchange.(see Section 127(A) and
RR 06-2008 [APRIL 22, 2008])
However, even if trade through the stock exchange, a
sale of shares by companies not complying with the
10% minimum public float shall be subject to capital
gain tax (see RR 16-2012 [November 7, 2012])
Q51.2. What are exempted from capital

gains tax on stock transactions?
1. Gains derived by dealers in securities
2. Gains from sales of stock to the extent invested
in new shares of stocks in banks, financial
intermediaries, and corporations organized
primarily to hold equities in banks
3. All other gains which hare specifically exempt
from income tax under existing investment
incentives and other special laws.
Q51.3. Is an assignment of deposits on

stock subscriptions subject to
capital gains tax?
YES. The assignment of the deposits on stock
subscriptions results in a net gain. A tax on the profit
of sale on net capital gain is the very essence of the
net capital gains tax law. To hold otherwise will
ineluctably deprive the government of its due and
unduly set free from tax liability persons who profited
Q51.4. What is the effect of non-payment

of capital gains tax on stock
transactions?
As provided in Section 11 of RR 06-2008, 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.
RMC 37-2012 [AUGUST 3, 2012] clarified RR 06-2008
in stating that a Certificate Authorizing Registration
[CAR] is still necessary before any transfer of shares
of stock not traded in the Stock Exchange may be
transferred in the books of a corporation.
Capital Gains Tax with

disposition of real property
respect
to
Q52. What is the rule on capital gains from

dispositions of real property?
The rate of 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 by the
CIR, whichever is higher.
The tax base shall be the entire selling price.

The capital gains tax must be paid within 30 days
following each sale or disposition. In case of
installment sale, the return shall be filed within 30
days following the receipt of the first down payment
and within 30 days following the subsequent
installment payments.
Q52.1. What is the special rule for

disposition of real property made
by
an
individual
to
the
government?
As provided in RR 8-98, in case of disposition of
real
property
made
by an
individual
43
to
the

INCOME TAX
government or to any of its political subdivisions or
agencies or to government-owned or controlled
corporations, the seller may elect to:
1. compute the tax on the gain derived from such
sale under the normal income tax rates; or
2. under a final capital gains tax of 6%.
Q52.2. What are the conditions for the

exemption of capital gains tax on
the sale by a natural person of his
principal residence?
computed from the 31st day after the date of sale

or disposition of the said old principal residence.
Q52.3. Who is liable to pay the capital

gains tax?
The seller is liable to pay the capital gains tax. As
provided in RR NO. 8-98 [AUGUST 25, 1998], the
capital gains tax return will be filed by the seller within
30 days following each sale or disposition of real
property.
Q52.3.1.
As provided in RR 13-99 [JULY 26, 1999], as

72
amended by RR 14-2000 [NOVEMBER 20, 2000]:
1. The 6% capital gains tax otherwise due shall be
deposited in cash or managers check in an
interest-bearing account with an authorized agent
bank under an Escrow Agreement.
2. He shall file his Capital Gains Tax Return
3. The proceeds from the sale, exchange or
disposition must be fully utilized in acquiring or
constructing his new principal residence within 18
calendar months from date of its sale. To ensure
compliance, he must within 30 days from the
lapse of the said period the required documents
to prove full utilization.
4. Upon a showing that the proceeds of the sale,
exchange or disposition have been fully utilized,
the escrow on the bank deposit shall be released.
5. The tax exemption may be availed of only once
every 10 years
6. The historical cost or adjusted basis of his old
principal residence sold, exchanged disposed
shall be carried over to the cost basis of his new
principal residence
7. If he fails to submit the required documents within
30 days after the lapse of the 18-month period, it
shall be presumed that he did not fully utilize the
proceeds of the sale, exchange or disposition of
his old principal residence, and shall be assessed
deficiency capital gains tax. The escrow shall be
73
applied in payment of this.
8. If there is no full utilization of the proceeds of
sale, exchange or disposition of his old principal
residence, he shall be liable for deficiency capital
gains tax, inclusive of 20% interest per annum,
72
RR 14-2000 added the escrow agreement requirement and

conditions relating thereto.
73
If the same is insufficient to cover the entire amount assessed,
he shall remain liable for the remaining balance of the assessment.
The excess of the deposit in escrow, if any, shall be returned to
him.
Can the buyer pay the capital

gains tax?
Yes. The buyer can retain the amount for the capital
74
gains tax and pay it upon authority of the seller, or
the seller can pay the tax, depending on the
agreement of the parties.
Q52.4. Is the payment of the capital gains

tax a pre-requisite to the transfer
of ownership to the buyer?
No. Payment of the capital gains tax, however, is not
a pre-requisite to the transfer of ownership to the
buyer. The transfer of ownership takes effect upon
the signing and notarization of the deed of absolute
sale. (see Chua v. CA [APRIL 9, 2003])
Q52.5. If a mortgagee foreclosed the

mortgaged property but the
mortgagor exercises his right of
redemption within the applicable
period, will capital gains tax still
be imposed on the foreclosure
sale?
RR 4-99 [M ARCH 9, 1999] provides that in case the
mortgagor exercises his right of redemption within
75
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. If the
mortgagor does not exercise his right of redemption,
74
The buyer has more interest in having the capital gains tax paid
immediately since this is a pre-requisite to the issuance of a new
Torrens title in his name.
75
Note Section 47 of the General Banking Act, judicial persons
whose property is being sold pursuant to an extrajudicial
foreclosure shall have the right to redeem the property until, but
not after, the registration of the certificate of foreclosure sale with
the Register of Deeds which in no case shall be more than 3
months after foreclosure
44

INCOME TAX
capital gains tax on the foreclosure sale shall become
due.
Q52.5.1. ABC Company took out a loan
from XYZ bank and mortgaged
one of its properties as
collateral. ABC was unable to
pay so XYZ extrajudicially
foreclosed the property and
bought it. Before the expiration
of the one-year redemption
76
period, the mortgagor notified
the bank of its intention to
redeem the property. Is XYZ
liable to pay the capital gains tax
as a result of the foreclosure
sale?
No. In foreclosure sale, there is no actual transfer of
the mortgaged real property until after the expiration
of the one-year period and title is consolidated in the
name of the mortgagee in case of non-redemption.
This is because before the period expires there is yet
no transfer of title and no profit or gain is realized by
the mortgagor.
Q52.6. If title to property is transferred to

one spouse as a result of a court
decision in an annulment case, is
the transfer subject to capital
gains tax?
No. In BIR Ruling DA-029-08 [JANUARY 23, 2008],
title to a house and lot was transferred to the
husband by virtue of a decision of the court declaring
his marriage with his wife null and void. In BIR
Ruling DA 287-07 [M AY 8, 2007], title to a
condominium unit was transferred to the wife as a
result of an agreement to distribute communal
property executed in the course of annulment
proceedings. In both BIR Rulings, the CIR held that
the transfer of the title of the subject properties are
not subject to capital gains tax, as such transfers are
equivalent to a conveyance but without monetary
consideration, made in accordance with the Court's
Decision granting parties agreement for the
distribution of communal property.
OCWs/Senior Citizens/Disabled
76
The foreclosure sale in the case on which the question is based

took place prior to the effectivity of the Act.
Q53. What are the requirements for OCWs

and seafarers or seamen to be
considered
OCWs
for
taxation
purposes?
To be considered as an OCW, they must be duly
registered as such with the POEA with a valid
Overseas Employment Certificate (OEC). In the case
of seafarers or seamen, they must be duly registered
with the POEA with a valid OEC and with a valid
Seafarers Identification Record Book or Seamans
book issued by the MARINA. (see RR NO. 001-11
[FEBRUARY 24, 2011]).
Q53.1. What is the tax treatment of OCWs

for purposes of income tax?
An OCWs income arising out of his overseas
employment is exempt from income tax. If he has
income earnings from business activities or
properties within the Philippines, such income
earnings are subject to Philippine income tax.
Q53.2. Are OCWs and seafarers exempt

from the 7.5% final tax on interest
income from a depository bank
under the EFCDS?
No, because OCW and seamen are non-residents.
As such, they are exempt from the final tax. To avail
of the tax exemption, they must present proof of nonresidency such as their OEC or Seamans book.
However, if the account is jointly in the name of the
OCW and an individual living in the Philippines, half
of the interest income will be treated as tax-exempt
and the remaining half shall be subject to the final
tax. (see RR NO. 001-11 [FEBRUARY 24, 2011]).
Q54. What is the tax treatment of senior

citizens for purposes of income tax?
Generally, qualified senior citizens deriving returnable
income during the taxable year, whether from
compensation or otherwise, are required to file their
income tax return and pay the tax.
However, he shall be exempt under the following
cases:
1. The returnable income is in the nature of
compensation income but he qualifies as a
minimum wage earner; and
2. If the aggregate amount of gross income earned
by the Senior Citizen during the taxable year
45

INCOME TAX
does not exceed the amount of his personal
exemptions (basic and additional)
Note that the exemption of senior citizens from
income tax does not extend to all types of income
earned during the taxable year such as those subject
to final taxes. (see RR No. 007-10 [JULY 20, 2010].)
Q54.1. Is the 20% sales discount granted

by establishments to qualified
senior citizens considered a tax
credit or a tax deduction?
In M.E. HOLDING CORPORATION V. COURT OF APPEALS
[M ARCH 3, 2008], the Supreme Court noted that
under RA 9257 or the Expanded Senior Citizens Act
of 2003, starting taxable year 2004, the 20% sales
discount shall be treated as a tax deduction and no
longer as a tax credit.
Q54.1.1.
What is the difference between

a tax credit and tax deduction?
A tax credit is a peso-for-peso deduction from the

taxpayers tax liability or a full recovery while a tax
deduction only benefits the taxpayer to the extent of a
percentage of the amount granted as a discount.
(See CARLOS SUPERDRUG CORP. V. DSQS [JUNE 29,
2007] and M.E. HOLDING CORPORATION V. COURT OF
APPEALS [M ARCH 3, 2008])
Q55. Can a benefactor77 of a PWD whose civil

status is single avail of the head of
family status to be entitled to personal
exemption?
It is no longer necessary. RA 9442, which amends
RA 7277 or the Magna Carta for Persons with
Disability, provides that a benefactor of a PWD
whose civil status is single shall be considered as
head of family and, as such, shall be entitled to
personal exemption. However, the terms head of
family and his/her dependents for purposes of
availing personal exemption have been eliminated in
view of an amendment brought about by RA 9504.
The rule is that individual taxpayers regardless of
status are entitled to the personal exemption. [see
RR NO. 001-09 [DECEMBER 9, 2008].
Personal
PERA
and
additional
77
Exemptions/
A benefactor refers to any person, whether related or not to the

person with disability, who takes care of him/her as a dependent
Q56. What is the rationale behind personal

and additional exemptions under the
Tax Code?
Exemptions are fixed at arbitrary amounts intended to
substitute for the disallowance of personal or living
expenses as deductible items from the taxable
income of certain individual taxpayers. The amounts
represent roughly the equivalent of the taxpayers
minimum
subsistence
and
those
of
his
dependents.(see PANSACOLA V. CIR [NOVEMBER 16,
2006])
Q56.1. Which
kinds
of
individual
taxpayers can avail of personal
and additional exemptions?
Citizens and resident aliens are allowed personal
and additional exemptions; nonresident aliens
engaged in trade or business in the Philippines
are entitled to personal exemptions only by way of
78
reciprocity but not to additional exemptions.
Q56.2. How should these exemptions be

credited?
These exemptions must first be credited against
gross compensation income; the excess, if any, can
be used to offset taxable net income.
Q57. What is personal exemption allowed to

individual taxpayers?
79
All individual taxpayers, regardless of status, shall

be allowed a basic personal exemption of P50,000.
78
Thus, for a nonresident alien, his entitltment to personal and

additional exemption depends on whether he is engaged in trade
or business and his country of residence allows exemption to
Filipinos. If not engaged, he will not be allowed the exemption.
Note as well that employees of ROHQs, OBUs, and FCDUs are
not entitled to personal and additional exemptions as they are
subject to tax on gross income without the benefit of deductions/
exemptions.
79
Note that, previously, the amount of personal exemption
depended on the status of the individual taxpayer. It was P20,000
for single individuals, P32,000 for legally married and P25,000 for
head of a family. As amended by RA 9504, all individuals,
regardless of status, are entitlted to a basic personal exemption of
P50,000.
46

INCOME TAX
Q57.1. What is the
individuals?
rule
for
married
In the case of married individuals where only one

spouse is deriving gross income, only such spouse
shall be allowed the personal exemption.
Yes. RA 10165 or The Foster Care Act of 2012

amended the NIRC to include a foster child in the
term dependent. Thus, foster parents may claim an
addition exemption of P25,000 for each dependent
(which includes the foster child) not exceeding 4.
Q58. What are the additional exemptions

allowed to individual taxpayers?
Q58.2. What is the rule for spouses and

legally separated spouses?
There shall be allowed an additional exemption of

80
P25,000 for each dependent not exceeding four.
The additional exemption for dependents can be

claimed by only one of the spouses. In the case of
legally separated spouses, additional exemptions
may be claimed only by the spouse who has custody
of the child or children.
Q58.1. Who is a dependent under the

Tax Code?
81
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 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.
Q54.1.2.
Are
illegitimate
considered
for
exemptions?
children
additional
Yes. By express wording of the law, a dependent

includes an illegitimate child.
Q54.1.3.
May parents and siblings be

considered
as
additional
exemptions?
No. parents and siblings are considered dependents

only for purposes of qualifying an individual to
become head of a family but not for purposes of
additional exemptions.
Q54.1.4.
Are senior citizens supported

and living with a taxpayer
considered as additional tax
exemptions?
No. The word dependent does not include senior

citizens.
Q54.1.5.
Is a foster child considered a

dependent?
Q59. What is the status-at-the-end-of-theyear rule or the change-of-status

rule with respect to personal and
additional exemptions?
This means that whatever is the status of the
taxpayer at the end of the calendar year shall be
used for purposes of determining his personal and
additional exemptions.
As held in PANSACOLA V. CIR [NOVEMBER 16, 2006],
what the law should consider for the purpose of
determining the tax due from an individual taxpayer is
his status and qualified dependents at the close of
the taxable year and not at the time the return is filed
and the tax due thereon is paid.
A change of status of the taxpayer during the taxable
82
year generally benefits, but does not prejudice him.
In the following cases, the rule is applied as follows:
1. If the taxpayer marries or should have additional
dependents during the taxable year, he may
claim the corresponding additional exemption in
full for such year.
2. If the taxpayer dies during the taxable year, his
estate may still claim the personal and additional
exemptions for himself and his dependents as if
he died at the close of such year.
3. If the spouse or any of the dependents dies or if
any such dependent marries, becomes 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 oth e
dependents died, or if such dependents married,
80
Previously, the amount was P8,000.

Note that Illegitimate children are included in the definition of
dependents and in the entitlement for additional exemption.
81
82
The rule of thumb is that which will be beneficial to the taxpayer.
47

INCOME TAX
became 21 years old or became gainfully
employed at the close of such year.
Q60. What is the tax treatment of PERA

investment income with respect to
income tax?
The 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 income tax
provided that:
1. Each of the investment products must be
approved by the concerned regulatory authority
2. Non-income taxes, if applicable, relating to the
above investment income, shall remain
imposable.
Q62. May GPPs claim OSD?

Yes. RR 2-2010 [FEBRUARY 18, 2010] provides for
the rules in the determination of the OSD of GPPs.
Refer to Q40.1.
Corporations
Q63. Define taxable income and gross
income for purposes of corporate
income taxes.
Taxable
Income
Partnerships (GPPs)83
Q61. What is the tax treatment of a GPP?
The GPP as an entity is not liable for income tax.
However, the persons engaging in business as
partners in a GPP shall be liable for income tax only
in their separate and individual capacities for their
respective distributive share in the net income of the
GPP.
Q61.1. How is the distributive share of the

partners computed?
The net income of the GPP shall be computed in the
same manner as a corporation. Each partner shall
report as gross income his distributive share, actually
or constructively received, in the net income of the
partnership.
Q61.2. When is the net income of a

partnership deemed constructively
received by partners?
The taxable income declared by a partnership which
is subject to corporate income tax, after deducting the
said corporate income tax, shall be deemed to have
been actually or constructively received by the
partners in the same taxable year and shall be taxed
to them in their individual capacity, whether actually
distributed or not.
Gross Income
means the pertinent items of gross

income specified in the Code, less
the deductions and/or personal
and additional exemptions, if any
authorized for such types of
income by the Code or other
special laws. For corporations,
taxable income would mean net
income. Net income and taxable
income is used interchangeably
when it comes to corporations.
Shall mean gross sales less sales
returns, discounts, allowances and
cost of goods sold.
Q63.1. Why is the distinction of the two

relevant for purposes of corporate
income tax?
1. For domestic corporations and resident foreign
corporations, Regular Corporate Income Tax
(RCIT) is imposed on taxable income. For nonresident foreign corporations, RCIT is imposed
on its gross income.
2. When applicable, MCIT is imposed on the gross
income of domestic and resident foreign
corporations.
Domestic Corporations
Ordinary Income
Q64. What is the regular corporate income
tax imposed on corporations?
The rate of RCIT imposed on corporations is 30%.
84
83
Previously, we have said that a partnership is liable for income

tax as the term corporations includes partnerships no matter how
created or organized except GPPs. In this, GPPs will be discussed
instead.
84
Note that it was 35% effective November 1, 2005 but on January

1, 2009, the effective rate is now 30%.
48

INCOME TAX
For domestic corporations:
1. The rate is imposed on taxable income from
sources within and without the Philippines.
2. Different rates of tax apply on certain passive
incomes.
As a general rule, all domestic corporations are

subject to the RCIT. As exceptions, certain domestic
corporations are subject to final tax rates. They are:
1. Proprietary education
institutions
and
hospitals
2. Foreign currency deposit unit of a local
universal or commercial bank
3. Firms that are taxed under a special income
tax regime
4. Private educational institutions
5. Hospitals
For resident foreign corporations:

1. The rate is imposed on taxable income from
2. Different rates of tax apply on certain passive
incomes.
For nonresident foreign corporations:
1. The rate is imposed on gross income from all
2. The gross income includes those income sourced
from certain passive incomes including capital
gains.
3. However, capital gains from sales of shares of
stock not traded in the stock exchange are, not
included in the gross income as well as interest
from foreign loans and intercorporate dividends
which are subject to final tax rates.
Q67. Are GOCCs

income tax?
subject
to
corporate
As a general rule, yes. As provided under Section

27(C), the provisions of special or general laws to the
contrary notwithstanding, all corporations, agencies
or instrumentalities owned or controlled by the
Government, except the GSIS, SSS, Philhealth,
and the PCSO, shall pay such rate of tax upon their
taxable income as imposed by this section upon
corporations or associations engaged in a similar
business, industry or activity.
Passive Income
Q65. May the President allow domestic and
resident foreign corporations the option
to be taxed on their gross income?
Yes. As provided under Section 27(A)(1) and
Section
28(A)(1),
the
President
upon
recommendation of the Secretary of Finance may
allow domestic and resident foreign corporations the
option to be taxed at 15% of gross income after the
following conditions have been satisfied:
1. a tax effort ratio of 20% of the GNP
2. a ratio of 40% of income tax collection to total
tax revenues
3. a VAT tax effort of 4% of GNP
4. a 0.9% ratio of Consolidated Public Sector
Financial Position (CPSFP) to GNP
Q68. What are some of the certain passive

incomes received by corporations?
1. Interests from Deposits and Yield or any other
Monetary Benefit from Deposit Substitutes and
from Trust Funds and Similar Arrangements and
Royalties
2. Income derived under the Expanded Foreign
Currency Deposit System
3. Intercorporate Dividends
4. Capital gains from sale of shares of stock not
traded in the Stock exchange under
85
5. Capital gains from sale of real property
This option is available to firms whose ratio of cost of

sales to gross sales or receipts from all sources does
not exceed 55%. Upon election of the gross income
tax option, it shall be irrevocable for 3 consecutive
taxable years during which the corporation is
qualified.
Q66. What domestic corporations are subject

to preferential tax rates?
85
Note that this is not considered a passive income for foreign

corporations, whether resident or nonresident. The simple reason
is because of the prohibition imposed by the Constitution on
foreign ownership of lands.
49

INCOME TAX
Q68.1. What is the tax treatment on
corporations of income derived
from dividends?
1. If the dividends
corporation:
are
from
domestic
Domestic and resident foreign corporations are taxexempt as they are treated as inter-corporate
dividends. However, for resident foreign corporations,
they are subject to the 15% branch profit remittance
tax.
For non-resident foreign corporations, the dividend is
subject to:
1. Tax treaty rate, if applicable
2. 15% if no tax treaty but satisfies the tax-sparing
provision
3. 30% if no tax treaty and does not comply with the
tax-sparing provision
2. If the dividends are from a foreign corporation:
The income shall form part of the gross income of the
corporation but the situs of the income becomes
material except for a domestic corporation which is
taxed on worldwide income.

corporations of interest income
from Deposits and Yield or any
other Monetary Benefit from
Deposit Substitutes and from
Trust
Funds
and
Similar
Arrangements and Royalties?
1. Domestic and resident foreign corporations are
subject to a final tax of 20%.
2. Subject to a final withholding tax of 30% if
received by a foreign nonresident corporation,
unless the interest income is from foreign loans
contracted on or before August 1, 1986, in which
case it is subject to a FWT of 20%

corporations of income derived
under the EFCDS?
1. Domestic and resident foreign corporations are
subject to a final tax of 7.5%. Any income of nonresidents, whether individuals or corporations,
shall be tax-exempt.
2. Income derived by a depository bank under the

EFCDS from foreign currency transactions with
non-residents, OBUs in the Philippines, local
commercial banks, including branches of foreign
banks and other depository banks under the
EFCDS shall be exempt from all taxes.
3. Interest income from foreign currency loans
granted by such depository banks under the
EFCDS other than OBUs shall be subject to a
final tax of 10%.
Capital Gains Tax86

Q69. Is the assignment and delivery of the
developed units to joint owners in a
Build-To-Own (BTO) scheme subject to
capital gains tax?
In a BTO, the developer makes it appear that it
merely manages the construction of the condominium
project, and that the funds as contributed by the
individual investors are pooled in a bank with the
developer, as project manager, receiving a project
management fee, In that scheme, it is claimed that
the assignment and delivery to the individual
investors of the developed units is not taxable as it is
merely a transfer of property held in trust by the
Trustee for the individual trustors. Previous BIR
rulings have exempted the assignment from capital
gains tax. In In BIR RULING DA-455-07 [AUGUST 17,
2007], the conveyance of the condominium units by
the trustee to the individual trustors pursuant to the
terms of the BTO contract and without consideration
was held not subject to capital gains tax. However, in
RMC NO. 055-10 [JUNE 28, 2010], the CIR nullified all
BIR Rulings exempting the scheme from capital gains
tax. Thus, the present rule is that the assignment and
delivery in BTO schemes are subject to capital gains
tax.
Resident Foreign Corporations
In general
Q70. What is the difference between a branch
and a subsidiary?
For purposes of taxation, a subsidiary is considered a
domestic corporation while a branch is a resident
foreign corporation.
86
Same rates and rules as in the case of individual taxpayers.

Refer to that discussion in the reviewer.
50

INCOME TAX
Q71. What resident foreign corporations are
subject to preferential tax rates?
taxed on the income they derive from Philippine

sources.
As a general rule, all resident foreign corporations

are subject to the RCIT. As exceptions, certain
resident foreign corporations are subject to final
rates. They are:
For an international air carrier, Gross Philippine

Billings refers to the amount of gross revenue derived
from carriage of persons, excess baggage, cargo and
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 ticket or
passage document.
1. Regional or area headquarters (RHQ) (a branch

established in the Philippines by MNCs and
which does not earn or derive income from the
87
Philippines and whose role is supervisory)
2. Representative office (a branch in the Philippines
of a MNC whose activities are limited to
information dissemination, product promotion)
88
3. International carriers by air or water
89
4. Offshore Banking Units
5. Foreign Currency deposit Unit (FCDU) in the
90
Philippines of a foreign bank
91
6. Regional Operating Headquarters (ROHQ)
7. Branch of foreign corporation with respect to
profit remittances to head office.
8. Branch of foreign corporations registered with
PEZA, SBMA, CDA, CDJHA.
9. Qualified service contractor or subcontractor
engaged in petroleum operations in the
Philippines
International Carrier
Q72. For purposes of income taxation, what
is an international carrier?
An International 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 (see RR NO. 15-2002)
Q73. What is Gross Philippine Billings?

The 2.5% tax on gross Philippine billings is an
income tax levied on the presumed gain of the airline
and shipping companies. It ensures that they are
For International Shipping, Gross Philippine Billings

means gross revenue whether for passenger, cargo
or mail originating from the Philippines up to final
destination, regardless of the place of sale or
payments of the passage or freight documents
Q73.1. ABC Shipping is a foreign

corporation. XYZ chartered one of
ABCs ships to load raw sugar in
the Philippines. Upon arriving at
the port, the vessel found no sugar
for loading. The ship sailed back
without carrying any sugar. Is ABC
Shipping
liable
for
gross
Philippine billings tax?
No. A resident foreign corporation engaged in the
transport of cargo is liable for taxes depending on the
amount of income it derives from sources within the
Philippines. ABC derived no receipt from its charter
agreement with XYZ. The vessel arrived in the port
on but found no raw sugar to load and returned
without any cargo laden on board (see CIR vs.
Tokyo Shipping [M AY 26, 1995])
Q73.2. What is the tax treatment of an

international air carrier with flights
originating from Philippine ports?
RR No. 15-2002 provides that such an international
air carrier, irrespective of the place where passage
documents are sold or issued, is subject to the Gross
Philippine Billings tax unless subject to a different tax
rate under the applicable tax treaty to which the
Philippines is a signatory.
87
They are tax-exempt.

An international carrier doing business in the Philippines shall
pay a tax of 2.5% on its Gross Philippine Billings
89
Income derived by OBUs from foreign currency transactions with
nonresidents, other OBUs, and local commercial banks are taxexempt.If the foreign currency transactions are with residents other
than OBUs and local commercial banks, the interest income shall
be subject to 10%
90
See Q68.3.
91
They shall pay a tax of 10% of their taxable income
88
Q73.3. What is the tax treatment of

foreign airline companies who do
not have flights from or passing
through
any
point
in
the
Philippines but have a branch
51

INCOME TAX
office or a sales agent in the
Philippines which sells tickets?
(see CIR V. BOAC [APRIL 30, 1987], AIR NEW

ZEALAND V. CIR [CTA CASE, JANUARY 30, 2008] and
UNITED AIRLINES V. CIR [SEPTEMBER 29, 2010])
RR No. 15-2002 provides that such off-line airline is

not considered engaged in business as an
international air carrier and is, therefore, not subject
to the Gross Philippine billings tax.
OBUs/FCDUs92
However, the sale of tickets is taxable as income

from sources within the Philippines.
Q74. What is a branch profit remittance tax?
Q73.4. ABC Airlines is an off-line

international
carrier
selling
passage documents through an
independent sales agent in the
Philippines. Is ABC engaged in
trade
or
business
in
the
Philippines and, as such, subject
to the corporate income tax on
resident foreign corporations?
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.
Here, ABC maintained a general sales agent and it
was engaged in selling or issuing tickets, which is
considered the main lifeblood of an airline.
The absence of flight operations to and from the
Philippines is not determinative of the source of
income for purposes of ascertaining income tax
liability. It is sufficient that the income is derived from
activity within the Philippine territory. 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.
If an international air carrier maintains flights to and
from the Philippines, it shall be taxed at the rate of
2.5% of its Gross Philippine billings, while
international air carriers that do not have flights to
and from the Philippines but nonetheless earn
income from other activities in the country will be
taxed at the corporate income tax rate. Here, ABC
earns income from the sale of tickets.
Branch Profit Remittance Tax
Any profit remitted by a branch to its head office shall

be subject to a tax of 15% which shall be based on
the total profits applied or earmarked for remittance
without any deduction for the tax component thereof
except those activities which are registered with the
PEZA.
Q74.1. What is the purpose of the branch

profit remittance tax?
The purpose of a branch profit remittance tax is to
equalize the tax burden on foreign corporations
maintaining on one hand, local branch offices, and
organizing, on the other hand, a subsidiary domestic
corporation where at least majority of all the latters
stocks are owned by such foreign corporations.
As explained in the case of BANK OF AMERICA VS.
COURT OF APPEALS [JULY 21, 1994], prior to
amendment, local branches were made to pay only
the usual corporate income tax of 25% to 35% then
on net income applicable to resident foreign
corporations while Philippine subsidiary corporations
were subject to the same rate on their net income but
their dividend payments were additionally subjected
to a 15% withholding tax. Thus to eliminate this
unequal tax treatment, a branch profit remittance tax
was imposed on local branches on their remittance of
profits abroad.
Q74.2. What is the correct tax base for

computing the branch profit
remittance tax? Is it the profit
actually remitted or the amount
actually applied for?
The correct tax base is the amount actually applied
for by the branch with the Central Bank as profit to be
remitted abroad.
In BANK OF AMERICA VS. COURT OF APPEALS [JULY 21,
1994], the Supreme Court held that the the tax base
92
Refer to questions on the tax treatment of interest income

derived from transactions with OBUs and FCDUs as provided in
RR 14-2012.
52

INCOME TAX
upon which the 15% which the 15% branch profits
remittance tax shall be imposed is the profit actually
remitted abroad and not the total branch profits out of
which the remittance is to be made. We note,
however, that the applicable law for the branch profit
remittance tax specifies the tax base to be on the
profit remitted abroad.
In COMPANIA GENERAL V. CIR [CTA CASE NO. 4141
AUGUST 23, 1993], Compania General contended that
the correct tax base for computing the branch profit
remittance tax is the profit actually remitted abroad
given its reliance on previous BIR rulings and the
case of CIR v. Burroughs. On the other hand, the CIR
contends that, because of RMC Circular No. 8-82
[March 17, 1982], the tax base should be the amount
actually applied for by the branch with the Central
Bank of the Philippines as profit to be remitted
abroad. The CTA ruled in favour of the CIR as the
branch profit remittance taxes were paid after the
effectivity of RMC No. 8-82.
Q74.3. Norway and the Philippines

entered into a tax treaty. Article 25
of the Convention provides for
equal treatment between nationals
of the two countries and as
between a Norwegian enterprise in
the Philippines and a domestic
enterprise. Det Norske Philippines,
a local branch of De Norske, a
Norwegian enterprise, invokes
Article 25 for the non-imposition of
the branch profits remittance tax.
Is its contention valid?
No. In ITAD BIR RULING NO. 018-09 [JUNE 23, 2009],
the CIR ruled that the principle of equal treatment in
Article 25 does not prevent the imposition of the
branch profit remittance tax. First, the principle of
equal treatment is limited to nationals of the
Philippines and of Norway who are both residents of
the Philippines. While indeed Det Norske is a national
of Norway, it is not a resident of the Philippines.
Second, while the treaty lays down a principle of
equal treatment between a Norwegian enterprise in
the Philippines and a domestic enterprise, as long as
the aggregate taxes imposed by the Philippines on
such Norwegian enterprise is not greater than the
taxes imposed by the Philippines on a domestic
enterprise, it cannot be considered that such
Norwegian enterprise is treated less favourably in the
Philippines than the domestic enterprise.
Regional
ROHQs
or
Area
Headquarters
and
Q75. Define regional or area headquarters

and a regional operating headquarters.
Regional
or
area
headquarters
(RHQs)
Regional
Operating
Headquarters
(ROHQs)
Shall mean a branch established in

the Philippines by MNCs and
which headquarters do not earn or
derive income from the Philippines
and which act as supervisory,
communications and coordinating
center
for
their
affiliates,
subsidiaries, or branches in the
Asia-Pacific Region and other
foreign markets
Shall mean a branch established in
the Philippines by multinational
companies which are engaged in
any of the following services:
general administration; business
planning
and
coordination;
sourcing and procurement of raw
materials
and
components;
corporate
finance
advisory
services; marketing control and
sales promotion; training and
personal management; logistic
services;
research
and
development services and product
development; technical support
and maintenance; data processing
and
communications;
and
business development
Q75.1. What is the tax treatment of RHQs

and ROHQs?
RHQs are not subject to income tax while ROHQs
shall pay a tax of 10% of their taxable income
Q75.2. What is the tax treatment of the

income
derived
by
alien
individuals and qualified Filipino
personnel employed by RHQs and
ROHQs?
A FWT of 15% shall be withheld from the gross
income derived by every alien individual occupying
managerial and technical positions in RHQs and
ROHQs and representative offices established in the
Philippines multinational companies as salaries,
wages, annuities, compensation, remuneration, and
other emoluments, such as honoraria and
53

INCOME TAX
allowances, except income which is subject to fringe
benefits tax, from such regional or area headquarters
and regional operating headquarters.
The same tax treatment shall apply to Filipinos
employed and occupying the same positions as those
aliens employed by RHQs and ROHQs of
multinational companies, regardless of whether or not
there is an alien executive occupying the same
position. (see RR 11-2010 [October 26, 2010])
Q75.2.1.
Can the Filipino employee opt

to be taxed at the regular
income tax rate?
Yes, such Filipinos employed by RHQs and ROHQs

in a managerial or technical position shall have the
option to be taxed at either 15% of gross income or at
the regular rate on their taxable income in
accordance with the Tax Code if the RHQ or ROHQ
93
is governed by Book III of E.O. 226, as amended by
R.A. No. 8756. (see RR 11-2010 [October 26, 2010])
Q75.2.2.
If the Filipino is not a

managerial
or
technical
employee, can he avail of the
15% final income tax rate?
No. As clarified by RR 11-2010 [October 26, 2010],

all other employees other than those in managerial or
technical positions are considered as regular
employees who are subject to the regular income tax
rate on their taxable compensation income.
Q75.2.3.
What are the requirements in

order for a Filipino to be
deemed
occupying
a
managerial
or
technical
position the same as that of an
alien employed in an ROHQs
or RHQ?
1. Position and Function Test The employee

must occupy a managerial position or technical
position AND must actually be exercising such
managerial or technical functions pertaining to
said position;
2. Compensation Threshold Test In order to be
considered a managerial or technical employee
for income tax purposes, the employee must
have received, or is due to receive under a
contract of employment, a gross annual taxable
93
Book III of EO 226 (or the Omnibus Investments Code) refers to

Incentives to MNCs establishing RHQs and ROHQs in the
Philippines
compensation of at least PhP975,000.00

9495
(whether or not this is actually received);
3. Exclusivity Test The Filipino managerial or
technical employee must be exclusively working
for the RHQ or ROHQ as a regular employee and
not just a consultant or contractual personnel.
Exclusivity means having just one employer at a
time.
Nonresident Foreign Corporations

In general
Q76. XYZ Corporation is a domestic
corporation which entered into a
license
agreement
with
ABC
Corporation, a non-resident foreign
corporation based in the US pursuant to
which the former was granted the right
to use trademark, patents and
technology owned by the latter. For
such use, XYZ paid royalties to ABC
and subjected the same to the 25%
withholding tax on royalty payments.
XYZ claimed for a refund and argues
that the withholding tax should only be
10% pursuant to the most-favoured
nation clause of the RP-US Tax Treaty
in relation to the RP-West Germany Tax
Treaty. Is XYZs contention correct?
No. In CIR V. S.C. JOHNSON AND SONS, INC. [JUNE 25,
1999], the Supreme Court held that the concessional
tax rate of 10% provided for in the RP-Germany Tax
Treaty could not apply to taxes imposed upon
royalties in the RP-US Tax Treaty since the two taxes
imposed under the two tax treaties are not paid under
similar circumstances and do not contain similar
provisions on tax crediting. It is not proved that the
RP-US Tax Treaty grants similar tax reliefs to
residents of the US in respect of the taxes imposable
upon royalties earned from sources within the
Philippines as those allowed to their German
counterparts. Further, the RP-Germany Tax Treaty
allows for crediting against German income and
94
If there is a change in compensation as a consequence of which,

such employee subsequently receiving less than the compensation
threshold, the employee shall be subject to the regular income tax
rate for the calendar year when the change becomes effective.
95
Beginning December 31, 2013 and on December 31 every three
years thereafter, the compensation threshold shall be adjusted to
its present value using the Philippine Consumer Price Index (CPI),
as published by the National Statistics Office.
54

INCOME TAX
corporate tax of 20% of the gross amount of royalties
paid under the law of the Philippines. On the other
hand, the RP-US Tax Treaty does not provide for the
similar crediting of 20% of the gross amount of
royalties paid. The similarity in the circumstances of
payment of taxes is a condition for the enjoyment of
most favored nation treatment precisely to
underscore the need for equality of treatment. since
the RP-US Tax Treaty does not give a matching tax
credit of 20 percent for the taxes paid to the
Philippines on royalties as allowed under the RPWest Germany Tax Treaty, XYZ cannot be deemed
entitled to the 10 percent rate granted under the latter
treaty for the reason that there is no payment of taxes
on royalties under similar circumstances.
Q77. ABC Corporation, a foreign corporation

in Japan and licensed to do engage in
business in the Philippines (hence, a
resident foreign corporation) has equity
investments in XYZ Company, a
domestic corporation. XYZ declared
and paid cash dividends to ABC. XYZ
directly remitted the cash dividends to
ABCs head office in Japan (hence, a
non-resident foreign corporation) net
not only of the 10% final dividend tax
but also of the withheld 15% profit
remittance tax based on the remittable
amount after deducting the final
withholding tax of 10%. ABC argues
that following the principal-agent
relationship theory, ABC is a resident
foreign corporation subject only to the
10 % intercorporate final tax on
dividends received from a domestic
corporation. Is ABC correct?
No. The general rule that a foreign corporation is the
same juridical entity as its branch office in the
Philippines cannot apply here. This rule is based on
the premise that the business of the foreign
corporation is conducted through its branch office,
following the principal agent relationship theory. It is
understood that the branch becomes its agent here.
So that when the foreign corporation transacts
business in the Philippines independently of its
branch, the principal-agent relationship is set aside.
The transaction becomes one of the foreign
corporation, not of the branch. Consequently, the
taxpayer is the foreign corporation, not the branch or
the resident foreign corporation. Corollarily, if the
business transaction is conducted through the branch
office, the latter becomes the taxpayer, and not the

foreign corporation. (see MARUBENI CORPORATION VS.
CIR [SEPTEMBER 14, 1989]).
Q78. XYZ is a foreign shipping company. It

does not have a branch office in the
Philippines and it made only two calls
in Philippine ports. What kind of foreign
corporation is XYZ?
XYZ is a foreign corporation not authorized or
licensed to do business in the Philippines. In order
that a foreign corporation may be considered
engaged in trade or business, its business
transactions must be continuous. A casual
business activity in the Philippines by a foreign
corporation does not amount to engaging in trade
or business in the Philippines for income tax
purposes. Accordingly, its taxable income for
purposes of our income tax law consists of its gross
income from all sources within the Philippines. (see
N.V. REEDERIJ AMSTERDAM VS. CIR [JUNE 23,
1988])
Special nonresident foreign corporations

Q79. Enumerate
the
non-resident
foreign
corporations whose income is subject to
preferential tax rates.
As a general rule, the gross income of a non-resident

foreign corporation is subject to the flat rate tax of
30%. As exceptions, the following are subject to final
tax rates and final withholding taxes:
1. Income of a non-resident cinematographic film
96
owner, lessor or distributor
2. Income of a non-resident owner or lessor of
97
vessels chartered by Philippine nationals
3. Income of a non-resident owner of aircraft,
98
machineries and other equipment
96
Such corporation shall pay a tax of 25% of its gross income from
97
Such corporation shall be subject to a tax of 4.5% of gross
rentals, lease or charter fees from leases or charters to Filipino
citizens or corporations, as approved by the Marina
98
Such corporations shall be subject to a tax of 7.5% of gross
rentals of fees
55

INCOME TAX
Tax on Certain Incomes of Non-resident
Foreign Corporations
Q80. Enumerate the incomes of non-resident
foreign
corporations
subject
to
preferential tax rates
1. Interest income on foreign loans contract on or
after August 1, 1986.
2. Intercorporate dividends received from a
domestic corporation
3. Income covered by Tax Treaties

interest income on foreign loans
from a non-resident foreign
corporation?
If the foreign loan is contracted on or after August 1,
1986, it shall be subject to a FWT at the rate of 20%.

dividends
received
from
a
domestic corporation by a nonresident foreign corporation?
exempted or reduced are considered as having been

fully paid.
In the Philippines, the 15% tax on dividends received
by a non-resident foreign corporation from a domestic
corporation is imposed subject to the condition that
the country in which the nonresident foreign
corporation is domiciled shall allow a credit against
the tax due from the nonresident foreign corporation
taxes deemed to have been paid in the Philippines
equivalent to 15%, which represents the different
between the regular income tax of 30% and the 15%
100
tax on dividends.
Q80.2.2.
Illustrate the application of the

tax-sparing
provision
by
101
providing an example.
1. "X" Foreign Corp. Tax Liability with no preferential

rates
"X" Foreign Corporation income
102
Foreign Tax rate (50%)
103
RP Tax Rate (30%)
Foreign Tax Credit
104
"X" tax payable to Foreign
"X" tax payable to RP
400
200
120
120
80
120
For non-resident foreign corporations, the dividend is

subject to:
Here, the total tax payable of the foreign corporation

is 200.
1. Tax treaty rate, if applicable

2. 15% if no tax treaty but satisfies the tax-sparing
provision
3. 30% if no tax treaty and does not comply with the
tax-sparing provision
2. "X" Foreign Corp. Tax Liability with Preferential

Rate and without Tax Sparing
Q80.2.1.
What
is
provision?
tax-sparing
As explained in the case of CIR V. PROCTER &

GAMBLE PHILIPPINES [DECEMBER 2, 1999]: A more
general way of mitigating the impact of double
taxation is to recognize the foreign tax as a tax credit.
However, the principal defect of the tax credit system
is when low tax rates or special tax concessions are
granted in a country for the obvious reason of
encouraging foreign investments. For instance, if the
usual tax rate is 35 percent but a concession rate
accrues to the country of the investor rather than to
99
the investor himself. To obviate this, a tax sparing
provision may be stipulated. With tax sparing, taxes
99
This means that, at the end of the day, the foreign investor
would be paying the same total amount of taxes due to the foreign
country and the Philippines.

RP Tax Rate (15%)
Foreign Tax Credit
400
200
60
60
140
60
Here, the total tax payable of the foreign corporation

is still the same at 200.
100
Note that previously, it was 20% which represents the

difference between the RCIT of 35% and the 15% tax on
dividends.
101
The example provided in the case of CIR v. Procter & Gamble
uses the old rates. This example modifies the example provided in
the case and uses the current rates effective January 1, 2009.
Note that the foreign tax rate and the foreign corporation income
are hypothetical.
102
Income (400) x Foreign Tax Rate (50%) = 200
103
Income (400) x RP Tax Rate (30%) = 120
104
[Income (400) x Foreign Tax Rate (50%)] Foreign Tax Credit
(120) = 80
56

INCOME TAX
3. "X" Foreign Corp. Tax Liability with Preferential
Rate and with Tax Sparing
RP Tax Rate (15%)
Foreign Tax Credit
400
200
60
105
120
80
60
The CTA, applying the ruling in CIR V. PROCTER &

GAMBLE PHILIPPINES [DECEMBER 2, 1999], concluded
that if the country of domicile of the recipient
corporation allows a credit against the tax imposable
106
by it an amount equivalent to 20% of the dividends
remitted from a Philippine domestic corporation to
corporations domiciled therein, the dividends remitted
are subject to FWT at the preferential rate of 15% in
accordance with Section 28 (b)(5)(b) of the Tax Code
of 1997, as amended.
The total tax payable of the foreign corporation is

now 140.
Q80.2.3.
Is it required that the foreign

country must give a deemed
paid tax credit for the
dividend tax waived by the
Philippines making applicable
the preferred dividend tax rate
of 15%?
As ruled in CIR V. PROCTER & GAMBLE PHILIPPINES

[DECEMBER 2, 1999], the Tax Code does not require
that the foreign countrys tax laws deemed the
parent-corporation to have paid the dividend tax
waived by the Philippines. The Code only requires
that the foreign country shall allow the corporation a
deemed paid tax credit in an amount equivalent to
the percentage points waived by the Philippines.
Q80.2.4.
When does a non-resident

foreign corporation become
entitled to the 15% FWT?
In INTERPUBLIC GROUP OF COMPANIES, INC. VS.

COMMISSIONER OF INTERNAL REVENUE [CTA CASE NO.
7796 DATED FEBRUARY 21, 2011], a US Corporation,
who owns 30% of the total and outstanding voting
capital stock of a Philippine advertising company filed
a claim for the refund or issuance of a TCC for
overpaid FWT on dividends withheld and remitted by
the Philippine company. In the administrative claim,
the US corporation alleged that, as a non-resident
foreign corporation, it may avail of the preferential
FWT rate of 15% on cash dividends received from a
domestic corporation during the taxable year 2006.
The CIR, in response, raised the question of whether
the US corporation is entitled to the FWT at the rate
of 15% or the rate of 20% in accordance with the RPUS Tax Treaty.
105
The additional 60 will be considered as tax deemed paid or also

known as the phantom tax. It is the foreign jurisdiction that will
allow the deemed paid tax credit.
Q80.2.5.
Is there a need for a prior

ruling from the BIR in order to
avail of the benefit?
In INTERPUBLIC GROUP OF COMPANIES, INC. VS.

COMMISSIONER OF INTERNAL REVENUE [CTA CASE NO.
7796 DATED FEBRUARY 21, 2011], the CIR also
contended that the US companys transactions were
bereft of any tax treaty relief application with the
International Tax Affairs Division (ITAD). On this
point, the CTA ruled that the same is not
107
necessary.
Q80.2.6.
If the foreign country does not

impose a tax on the dividend,
is the dividend received by the
non-resident
foreign
corporation subject to the 15%
FWT?
Yes. In BIR RULING DA-145-07 [M ARCH 8, 2007], SM

Investments asked for the BIRs opinion on whether
the cash dividends declared by them to Asia
Opportunities Limited, a corporation organized and
existing under the laws of the British Virgin Islands
are subject to 15% FWT. The CIR noted that the
International Business Companies Ordinance of the
Territory of the British Virgin Islands does not impose
any tax on dividends from foreign sources, which
logically would include those received from Philippine
corporations. As such, the dividend is subject only to
the FWT of 15%.
Q80.3. To avail the benefits of a tax treaty

provision, must it be preceded by
an application for a tax treaty relief
with the International Tax Affairs
Division (ITAD)?
106
Now, 15% effective January 1, 2009.

This is subject to debate. This case implies that the benefit is
automatic without need for a TTRA.
107
57

INCOME TAX
Yes. As provided in RMO 072-10 [AUGUST 25, 2010],
the ITAD is the sole office charged with the receiving
of tax treaty relief applications (TTRA). All tax treaty
relief applications relative to the implementation and
interpretation of the provisions of Philippine tax
treaties shall only be submitted to and received by
the International Tax Affairs Division (ITAD). All
rulings relative to the application, implementation and
interpretation of the provisions of Philippine tax
treaties shall emanate from ITAD.
In MIRANT V. CIR [CTA CASE NO. 7796, FEBRUARY 21,
2011], Mirant made income payments to VHL
enterprises, a US nonresident foreign corporation
and to WES World, a UK nonresident foreign
corporation. It accordingly withheld the tax due on
these interest payments. Thereafter, Mirant filed for a
refund contending that the two foreign corporations
have created permanent establishments in the
Philippines and thus making applicable the lower
withholding tax rate under the RP-UK and RP-US tax
treaties. The CTA noted that under those treaties,
VHL and WES World, while not having a fixed place
of
business
have
established
permanent
establishments in the Philippines because they have
furnished services through their employees or other
personnel for a period or periods the aggregate of
which is more than 183 days in a twelve-month
period."
However, under RMO 01-2000, it is provided that the
availment of a tax treaty provision must be preceded
by an application for a tax treaty relief with its
International Tax Affairs Division (ITAD). A foreign
corporation wishing to avail of the benefits of the tax
treaty should invoke the provisions of the tax treaty
and prove that indeed the provisions of the tax treaty
applies to it, before the benefits may be extended to
such corporation.The CTA noted that Mirant did not
make such application. Thus, the CTA finally held
that the income payments of Mirant to VHL and WES,
which are both non-resident foreign corporations, are
108109
subject to the final tax of 32%.
Q80.4. What is the meaning of mostfavoured nation (MFN) and how is

it applied to applications for tax
treaty reliefs?
108
Note that the applicable tax rate is now 30%.

Note, however, that in INTERPUBLIC GROUP OF COMPANIES, INC.
VS. COMMISSIONER OF INTERNAL REVENUE [CTA CASE NO. 7796
DATED FEBRUARY 21, 2011], the CTA, by way of obiter, stated that,
even with respect to the applicability of the 20% FWT under the
RP-US Tax Treaty, a tax treaty relief application is not made a
condition precedent by law.
109
The most-favoured nation simply means that a

country which is the recipient of this treatment must,
receive equal advantages as the "most favoured
nation" by the country granting such treatment. Most
tax treaties would have a MFN clause making a
benefit which is more advantageous accorded to one
country demandable.
In ITAD RULING 102-02 [M AY 28, 2002], Energizer
Philippines claims that its royalty payments to
Eveready Battery are subject to the preferential tax
rate of 15% pursuant to the MFN clause of the RPUS Tax Treaty in relation to the RP-Netherlands Tax
Treaty. The CIR applied the ruling in CIR V. S.C.
JOHNSON AND SONS, INC. [JUNE 25, 1999], where the
Supreme Court interpreted the MFN clause, or the
phrase paid under similar circumstances as
referring to the manner of payment of taxes and not
the subject matter of the tax which is royalties. The
CIR found that the RP-US and RP-Netherland tax
treaties show a similarity on the manner of payment
of taxes, that is, the allowable foreign tax credit on
both treaties is the amount actually paid in the
Philippines. Thus, the royalty payments by Energizer
to Eveready are subject to the preferential tax rate of
15% of the gross amount of royalties pursuant to the
"most-favored-nation" provision of the RP-US tax
treaty in relation to the RP-Netherlands tax.
Withholding Tax
In general
Q81. What is the withholding tax system?
The withholding tax system is a procedure through
which taxes (including income taxes) are collected.
Q81.1. Who is the withholding agent?

The withholding agent is the one who has control,
custody, or receipt of the funds that is subject to
income tax and to be withheld and remitted to the
BIR. The withholding agent holds the amount
withheld from the income of another person in trust
for the government until paid.
The duty to withhold is different from the duty to pay
income tax. The obligation to withhold is imposed
upon the buyer-payor of income but the burden of tax
is really upon the seller-income earner.
The obligation to withhold is compulsory as it makes
such withholding agent personally liable for payment
58

INCOME TAX
of the tax. Such liability of the withholding agent is
direct and independent from the liability of the income
recipient.
Q81.2. Who are required by law to

withhold on income payments?
1. Agents or employees of withholding agents
2. Persons having control of the payment and
claiming the expense
3. Payor having control of the payment where
payment is made thru brokers
Q81.3. When does the

withhold arise?
obligation
to
Either when:
1. It is paid
2. It becomes payable (i.e. it is legally due,
demandable, or enforceable)
3. It is accrued as an asset or expense
In FILIPINAS SYNTHETIC FIBER CORPORATION V. CA
[OCTOBER 12, 1999], the Supreme Court stated that
the Tax Code is silent as to when the duty to withhold
taxes arises. In this case, to determine when the duty
to withhold the taxes arose, the Court inquired into
the nature of accrual method of accounting, the
procedure used by the taxpayer, and to the modus
vivendi of withholding tax at source come. It noted
that under the accrual basis method of accounting,
income is reportable when all the events have
occurred that fix the taxpayers right to receive the
income and the amount can be determined with
reasonable accuracy. Such method is allowed by law
in reporting incomes.
Q81.4. May a withholding agent file a

claim for tax refund?
Generally, the person entitled to claim a tax refund is
the taxpayer. However, if the taxpayer does not file
the claim, the withholding agent may file the same. In
CIR V. SMART COMMUNICATIONS [AUGUST 25, 2010], it
was submitted that rule allowing the withholding
agent to file the claim is applicable only when the
withholding agent and the taxpayer are related
parties. The Supreme Court disagreed and stated
that such relationship is not required. A withholding
agent has a legal right to file a claim for refund. First,
he is considered a taxpayer under the Tax Code as
he is personally liable for the withholding tax as well
as for deficiency assessments, surcharges, and
penalties, should the amount withheld be finally found
to be less than the amount that should have been

withheld. Second, as an agent of the taxpayer, his
authority to file the income tax return and remit the
tax withheld to the government includes the authority
to file a claim for refund and to bring an action for
recovery of such claim.
Q81.5. Is the withholding agent who filed

the claim for tax refund obliged to
remit the same to the taxpayer?
Yes. In CIR V. SMART COMMUNICATIONS
[AUGUST 25, 2010], the Supreme Court ruled
that while the withholding agent has the right to
recover the taxes erroneously or illegally
collected, he nevertheless has the obligation to
remit the same to the principal taxpayer under
the principle of unjust enrichment.
Q81.6. What are the three categories of
income subject to withholding
tax?
Under Section 57 of the Tax Code, the types of
income subject to withholding tax are divided into
three categories:
1. withholding of final tax on certain incomes;
2. withholding of creditable tax at source and
3. tax-free covenant bonds.
Q81.7. What are the three

withholding tax?
types
of
1. Final withholding tax (FWT)

2. Creditable Withholding Tax (WT)
3. Withholding Tax on Wages
Q82. Differentiate final withholding tax (FWT)

from creditable withholding tax (CWT).
The differences are as follows:
FWT
The amount of income
tax withheld by the
withholding
agent
is
constituted as a full and
final payment of the
income tax due from the
payee on the said
income.
The liability for payment
CWT
Taxes withheld on certain
income payments are
intended to equal or at
least approximate the tax
due of the payee on said
income.
Payee
of
income
59
is

INCOME TAX
of the tax rests primarily
on the payor as a
withholding agent.
The
payee
is
not
required to file an income
tax
return
for
the
particular income.
required to report the

income and/or pay the
difference between the
tax withheld and the tax
due on the income. The
payee also has the right
to ask for a refund if the
tax withheld is more than
the tax due.
The income recipient is
still required to file an
income tax return, as
prescribed in Sec. 51
and Sec. 52 of the NIRC.
(see Section 2.57(A) and (B), RR 2-98 [April 17,

1998] and CHAMBER OF REAL ESTATE AND BUILDERS
ASSOCIATION, INC. V. ROMULO [M ARCH 9, 2010])
Final Withholding Tax at Source

Q83. What is meant by withholding tax at
source?
Since the withholding taxes are deducted by the
withholding agent when the income payments are
paid or payable, they are described as withholding
taxes-at-source. This means that the income tax of
the recipient of income is withheld and deducted at
the source and at the time of accrual or payment of
the expense by the withholding agent-payer of
income.
Q83.1. What are the four general types of

income payments subject to FWT?
1. Passive Incomes
2. Income payments to entities where their gross
income is subject to tax (i.e. non-resident aliens
not engaged in trade or business, non-resident
foreign corporations, special aliens)
3. Fringe Benefits
4. Informers Reward to Persons Instrumental in the
Discovery of the Violations of the Tax Code.
(see Section 2.57.1, RR 2-98 [April 17, 1998])
Creditable Withholding Tax

Q84. What is meant by creditable withholding
tax?
Under the CWT tax system, taxes withheld on certain

payments are but intended to approximate the tax
due from the payee. The withheld taxes remitted to
the BIR are treated as deposits or advances on the
actual tax liability of the taxpayer, subject to
adjustment at the proper time when the actual tax
liability can be fully and finally determined.
Q84.1. What are the three general types of

creditable withholding taxes?
The three types of creditable withholding taxes are:
1. Expanded withholding tax on certain income
payments made by private persons to resident
taxpayers (e.g. professional fees, income
payments to brokers, income payments to
partners of GPPs, etc)
2. Withholding tax on compensation income for
services done in the Philippines
3. Withholding tax on money payments made by the
government
Q84.2. What is the rule on creditable

withholding of income payments
to medical petitioners as laid down
in RR 13-98 [August 14, 1998]?
It shall be presumed that the hospital or clinic has
collected the professional fee of the said medical
practitioner and shall, accordingly, be liable for the
withholding of the tax vis-a-vis each and every patient
admitted into the hospital or clinic under the care of
the said medical practitioner.
However, the withholding tax shall not apply
whenever there is proof that no professional fee has
in fact been charged by the medical practitioner and
paid by his patient,
Return and Payment of Tax Withheld at

Source
Q85. Who is obliged to file the return and pay
the tax withheld?
The withholding agent shall file the return and pay the
tax:
1. FWT - within 25 days from the close of each
calendar quarter for FWT
2. CWT - not later than the last day of the month
following the close of the quarter during which
withholding was made. (see Section 58(A), Tax
Code)
60

INCOME TAX
Q85.1. What are the other obligations of
the withholding agent with respect
to the return and payment of the
tax withheld?
1. He shall furnish the recipient of the income a
written statement showing the income or other
payments made by him during such quarter or
year, and the amount of the tax deducted and
withheld therefrom.
2. He shall submit an annual information return
containing the list of payees and income
payments, amount of taxes withheld for each
payee and other pertinent information. (see
Section 58(B) and (C), Tax Code)
Q85.2. Since
CWT
is
but
an
approximation, what happens if
there is excess payment or
deficiency in payment?
2. Compensation income of government employees

with salary grades 1 to 3.
Q87. Who is obliged to deduct, withhold, file

the return and pay the tax upon wages?
Every employer making payment of wages shall
deduct and withhold upon such wages the applicable
110
tax except in the case of minimum wage earners.
(see Section 79(A), Tax Code)
The return shall be filed and the payment made
within 25 days from the close of each calendar
quarter (see Section 81, Tax Code)
However, if the employer is the Government or any
political subdivision, agency, or instrumentality, the
return of the amount deducted and withheld upon any
wage shall be made:
The excess of the amount of tax so withheld over the

tax due on his return shall be refunded.
1. by the officer or employee having control over the

payment of such wage, or
2. by any officer duly designated for the purpose
(see Section 82, Tax Code)
If the income tax collected at source is less than the

tax due on his return, the difference shall be paid.
(see Section 58(D), Tax Code)
Q87.1. What are the other obligations of

the employer with respect to the
withholding of tax on wages?
Q85.3. What is the effect of non-payment

of CWT to the transfer of real
property?
1. Every employer shall furnish to each such

employee a written statement confirming wages
paid by the employer during the calendar year
and the amount of tax deducted and withheld
No registration of any document transferring real

property shall be effected by the Register of Deeds
unless the CIR or his duly authorized representative
has certified that such transfer has been reported and
the capital gains or CWT, if any, has been paid. (see
Section 58(E), Tax Code)
Withholding on Wages
2. Every employer shall submit to the CIR an annual

information return containing a list of employees,
the total amount of compensation income of each
employee, the total amount of taxes,
accompanied by copies of the written statements,
and other information as may be deemed
necessary.
Q87.2. Who is liable if there is a failure to

withhold and remit the correct
amount of tax?
Q86. What income payments are exempted

from the requirement of withholding tax
on compensation?
As provided in SECTION 2.78, RR 2-98 [APRIL 17,
1998], as amended by RR 1-2006 [DECEMBER 29,
2005]:
The employer shall be liable. If he fails to withhold

and remit the correct amount, such tax shall be
collected from him together with penalties or
additions to the tax otherwise applicable (see
Section 80(A), Tax Code)
1. Compensation income of individuals that do not

exceed the statutory minimum wage or P5,000
pesos per month, whichever is higher.
110
Minimum wage earners are exempt from income tax.
61

INCOME TAX
Q87.3. What is the consequence if the
employer fails to deduct and
withhold the tax but the tax
against which such tax may be
credited is paid (the tax is paid by
the recipient)/employee)?
If the employer fails to deduct and withhold the tax
and thereafter the tax against which such tax may be
credited is paid, the tax so required to be deducted
and withheld shall not be collected from the
employer. The employer shall not be relieved of
liability for any penalty for non-compliance (see
Q87.4. What is the rule when there is an

overpayment of tax withheld on
wages by the employer?
If the overpayment was not deduced and withheld by
the employer, he shall be given a refund or credit.
If the overpayment was deducted and withheld by the
employer, the employee shall be allowed a credit.
Q87.5. How can employees avail of

personal
and
additional
exemptions given that
their
compensation is subjected to
withholding?
On or before the date of commencement of
employment with the employer, the employee shall
submit to the employer a signed withholding
exemption certificate relating to the personal and
additional exemptions to which he is entitled.
If there is a change of status, he may file a new
exemption certificate within 10 days from such
change. (see Section 79(D)(2), Tax Code)
Q87.6. What is the consequence if an

employee fails or refuses to file an
exemption certificate or wilfully
supplies false or inaccurate
information?
The tax shall be collected from the employee
including penalties or additions to the tax. Further,
excess taxes withheld by the employer shall not be
refunded to the employee but shall be forfeited to the
government
Q87.7. What is the withholding treatment

when the husband and the wife
each are recipients of wages?
1. The husband shall be deemed the head of the
family and proper claimant of the additional
exemption unless he explicitly waives this right in
favor of his wife
2. Taxes shall be withheld from the wages of the
wife with the schedule for zero exemption
Q88. Are
backwages,
allowances
and
benefits awarded in a labor dispute
subject to withholding tax?
Yes. Backwages, allowances, and benefits awarded
in a labor dispute constitute remunerations for
services that would have been performed by the
employee in the year when actually received, or
during the period of his dismissal from the service
which was subsequently ruled to be illegal. The said
back wages, allowances and benefits are subject to
withholding tax on wages. (see RMC 39-2012
[August 3, 2012])
Q88.1. Who should withhold the tax due

thereon?
The employers are mandated to withhold taxes on
wages and this includes those backwages,
allowances, and benefits awarded in a labor dispute.
Q88.2. If the backwages, allowances,

disputes are received by virtue of
a labor dispute award through
garnishment of debts due to the
employer and other credits to
which the employer is entitled to
subject to withholding tax?
In RMC 39-2012 [August 3, 2012], the CIR
answered this question in the affirmative. Persons
having control of the payment of wages or salaries
are authorized to deduct and withhold upon such
wages or salaries the withholding tax due thereon. In
this case, the garnishees are the persons owning
debts due to the employer or in possession or control
of credits to which the employer are entitled.
Accordingly, they are in control of the payment of
backwages, allowances and benefits. Thus, in order
to ensure the collection of the appropriate withholding
taxes on wages, garnishees of a judgment award in a
labor dispute are constituted as withholding agents
62

INCOME TAX
with the duty of deducting the corresponding
withholding tax on wages due thereon in an amount
equivalent to five percent (5%) of the portion of the
judgment award representing the taxable backwages,
allowances and benefits.
Withholding
Agencies
Tax
by
Government
Q89. What income payments made by the

government are subject to withholding?
Income payments, except any single purchase which
is P10,000 and below, which are made by a
government office, national or local, including
111
GOCCs,
on their purchases of goods from local
suppliers shall be subject to a withholding tax of 1%.
(see Section 2.57.2(N), RR 2-98 [April 17, 1998])
Special Rules
Minimum Corporate Income Tax
Q90. What is the minimum corporate income
tax (MICT?)
A minimum corporate income tax of 2% of gross
income shall be imposed on a domestic
corporation and resident foreign corporation
beginning on the fourth taxable year immediately
following the year in which such corporation
commenced its business operations when:
1. the MCIT is greater than the RCIT for the taxable
year.
2. such operation has zero or negative taxable
income
(see Section 27(E), Section 28(A)(2), Tax Code and
RR 9-98 [August 5, 1998], as amended by RR 122007 [October 10, 2007])
Q90.1. What is the purpose of MCIT?

As held in the case of CHAMBER OF REAL ESTATE AND
2010]), the primary purpose of any legitimate
business is to earn a profit. Continued and repeated
losses after operations of a corporation or consistent
reports of minimal net income render its financial
statements and its tax payments suspect. For sure,
111
A GOCC which is listed as one of the top 5,000 corporations

shall withhold the tax in its capacity as a GOCC rather than as one
of the top 5,000 corporations.
certain tax avoidance schemes resorted to by

corporations are allowed in our jurisdiction. The MCIT
serves to put a cap on such tax shelters. As a tax on
gross income, it prevents tax evasion and minimizes
tax
avoidance
schemes
achieved
through
sophisticated and artful manipulations of deductions
and other stratagems. Since the tax base was
broader, the tax rate was lowered.
Q90.2. Is MCIT a tax on capital and an

additional tax imposition?
The Supreme Court in CHAMBER OF REAL ESTATE AND
2010] answered this in the negative. The MCIT is
imposed on gross income which is arrived at by
deducting the capital spent by the corporation in the
sale of its goods, i.e. the cost of goods and other
direct expenses from gross sales. Thus, the capital is
not being taxed. Furthermore, the MCIT is not an
additional tax imposition. It is imposed in lieu of the
RCIT.

RCIT and MCIT?
The tax base of RCIT is taxable income while the tax
base of MCIT is gross income.
In COMMISSIONER VS. PAL [JULY 7, 2009], PAL under
PD 1590 (its franchise) was liable only for basic
corporate income tax or franchise tax, whichever is
lower and this is in lieu of all other taxes, except real
property. The CIR contends that PAL is subject to
MCIT while it was the contention of PAL that the
MCIT was included in the in lieu of all other taxes
provision. The Supreme Court noted there is a
distinction between taxable income, which is the
basis for basic corporate income tax; and gross
income, which is the basis for the MCIT under
Section 27(E). The two terms have their respective
technical meanings, and cannot be used
interchangeably. Hence, the basic corporate income
tax cannot cover MCIT since the basis for the first is
the annual net taxable income; while the basis for the
second is gross. Thus, MCIT is included in all other
taxes from which PAL is exempted.
Q90.4. For purposes of MCIT, what is

gross income?
As provided in RR 9-98 [August 5, 1998], as
amended by RR 12-2007 [October 10, 2007]:
63

INCOME TAX
For purposes of MCIT, the term "gross income"
means gross sales less sales returns, discounts, and
allowances and cost of goods sold, in case of sale of
goods, or gross revenue less sales returns,
discounts, allowances and cost of services/direct
cost, in case of sale of services.
Note that cost of goods sold shall include all
business expenses directly incurred to produce the
merchandise to bring them to their present location
and use while cost of services shall mean all direct
costs and expenses necessarily incurred to provide
112
the services required by the customs and clients.
As noted by the Supreme Court in COMMISSIONER VS.
PAL
[JULY
7,
2009],
inclusions
and
exclusions/deductions from gross income for MCIT
purposes are limited to those directly arising from the
conduct of the taxpayers business. It is thus more
limited than the gross income used in the
computation of basic corporate income tax.
Q90.4.1.
What if apart from the income

from core business activities,
other items of gross income
are realized or earned by the
corporation, are these items
included as part of gross
income?
Yes. If apart from deriving income from these core

business activities there are other items of gross
income realized or earned by the taxpayer during the
taxable period which are subject to the normal
corporate income tax, the same items must be
included as part of the taxpayer's gross income for
113
computing MCIT.
Q90.5. Explain the carrying forward of

excess MCIT against normal
income tax.
Any excess MCIT against the normal income tax is
creditable within the next three (3) years from
payment thereof. To illustrate:
Year
RCIT
MCIT
112
Excess
MCIT
against
RCIT
This only shows that deductions are not taken into account in
MCIT.
113
This means that the term "gross income" will also include all
items of gross income enumerated under Section 32(A) of the Tax
Code, as amended, except income exempt from income tax and
income subject to final withholding tax
1998
50,000
1999
60,000
2000
100,000 (tax
to
be
115
paid)
75,000 (tax
to
be
114
paid)
100,000 (tax
to be paid)
60,000
25,000
40,000
In the year 2000, since the RCIT is greater than

MCIT, the firm will have to pay the RCIT of P100,000.
To this amount, the corporation can credit the excess
MCIT is has so far which totals 65,000. The amount
of income tax payable now becomes 35,000. Note
that with respect to the excess MCIT of 25,000, that
can be claimed as tax credit against the normal
income tax up to the year 2001 or three years from
payment of the MCIT in 1998 and only when the
RCIT is greater than MCIT. You cannot credit the
MCIT against the MCIT or other losses.
Q90.6. Can the imposition of MCIT be

suspended?
Yes, the Secretary of Finance can suspend its
imposition on any corporation which suffers losses on
116
account of prolonged labor dispute, or because of
117
force majeure,
or because of legitimate business
118
reverses.
Improperly Accumulated Earnings Tax

(IAET)
Q91. What is an improperly accumulated
earnings tax?
This is the income tax imposed on a corporation if its
earnings and profits are accumulated (undistributed)
instead of being divided and distributed to its
stockholders.
An improperly accumulated earnings tax (IAET) equal
to 10% is imposed for each taxable year on the
114
This is the tax to be paid because MCIT > RCIT

This Is the tax to be paid because MICT < RCIT
Defined as losses arising from a strike staged by the employees
which lasted for more than six (6) months within a taxable period
and which has caused the temporary shutdown of business
operations.
117
It means a cause due to an irresistible force as by "Act of God"
like lightning, earthquake, storm, flood and the like. This term shall
also include armed conflicts like war or insurgency.
118
It shall include substantial losses sustained due to fire, robbery,
theft or embezzlement, or for other economic reason as
determined by the Secretary of Finance.
115
116
64

INCOME TAX
improperly accumulated taxable income of each
corporation.
It is imposed on domestic corporations which are
119
classified as closely-held corporations.
Q91.1. Define improperly accumulated

taxable income.
The term improperly accumulated taxable income
means taxable income adjusted by:
1.
2.
3.
4.
Income exempt from tax

Income excluded from gross income
Income subject to final tax; and
The amount of net operating loss carry-over
deducted; and
5. Reduced by the sum of:
a. dividends actually or constructively paid; and
b. income tax paid for the taxable year
c. amount reserved for the reasonable needs of
120
the business
In relation to 5(c), RMC 35-2011 [March 14, 2011]
states that the amount that may be retained, taking
into consideration the reasonable needs of the
business shall be 100% of the paid-up capital or the
amount contributed to the corporation representing
the par value of the shares of stock. Any excess
121
capital over and above the par shall be excluded.
Q91.2. What is the purpose and nature of

IAET?
The imposition of IAET discouraged tax avoidance
through corporate surplus accumulation. When
corporations do not declare dividends, income taxes
are not paid on the undeclared dividends received by
the shareholders. The tax on improper accumulation
of surplus is essentially a penalty tax designed to
compel corporations to distribute earnings so that the
said earnings by shareholders could, in turn, be taxed
(see CYNAMID PHILIPPINES INC VS. CA [JANUARY 20,
2000])
119
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.
120
Added by RR 2-01.
121
For example, if only Dec 31, 2010, you have a paid-up capital of
100,000. You can only retain up to 100,000. A subsequent infusion
of capital of 500,000 a week later cannot be considered.
The IAET is being imposed in the nature of a penalty

to the corporation for the improper accumulation of its
earnings, and as a form of deterrent to the avoidance
of tax upon shareholders who are supposed to pay
dividends tax on the earnings distributed to them by
the corporation (see RR 2-01 [FEBRUARY 12, 2001]).
Q91.3. What corporations are subject to

IAET?
As a general rule, the IAET shall apply to every
corporation formed or availed for the purpose of
avoiding the income tax with respect to its
shareholders or the shareholders of any other
corporation, by permitting earnings and profits
accumulate instead of being divided or distributed.
As exceptions, the IAET shall not apply to:
1. Publicly-held corporations
2. Banks and other non-bank financial
intermediaries; and
3. Insurance companies
4. GPPs
5. Non-taxable joint ventures
6. Enterprises registered under SEZs (see RR
2-01 [FEBRUARY 12, 2001]).
Q91.4. What is the main factor to consider

in holding a corporation liable for
IAET?
The touchstone of the liability is the purpose behind
the accumulation of the income and not the
consequences of the accumulation. Thus, if the
failure to pay dividends is due to some other causes,
such as the use of undistributed earnings and profits
for the reasonable needs of the business, such
purpose would not generally make the accumulated
or undistributed earnings subject to the tax. However,
if there is a determination that a corporation has
accumulated income beyond the reasonable needs of
the business, the 10% improperly accumulated
earnings tax shall be imposed. [see RR 2-01
[FEBRUARY 12, 2001]).
Q91.5. What circumstances are indicative

of a purpose to avoid the income
tax with respect to shareholders?
The fact that any 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. (see Section 29(C)(1),
Tax Code)
65

INCOME TAX
Moreover, the fact that the earnings or profits of a
corporation are permitted to accumulate beyond the
reasonable needs (including reasonably anticipated
needs) of the business shall be determinative of the
purpose to avoid the tax upon its shareholders or
members unless the corporation, by the clear
preponderance of evidence shall prove the contrary
(see Section 29(C)(2), Tax Code)
In CIR v. TUASON [M AY 15, 1989], the CIR assessed
Tuason, Inc. for IAET. The CIR presumed that when
Tuason, Inc. accumulated profits, the purpose was to
avoid the income tax on its shareholders on the
finding that it was a mere holding or investment
company. Tuason contended it was for the purpose
of expanding their business as a real estate broker.
The Supreme Court ruled that Tuason was liable for
IAET. Tuason was a mere holding company as it was
not involved itself in the development of the
subdivisions but merely subdivided its own lots and
sold them for bigger profits. It derived its income from
interest, dividends, and rental from the sale of realty.
The touchstone of liability is the purpose behind the
accumulation of the income and not the
consequences of the accumulation. The company's
failure to distribute dividends to its stockholders was
clearly for reasons other than the reasonable needs
of the business.
Q91.6. What is the Immediacy Test?

The Immediacy Test is used to determine the
reasonable needs of business in order to justify an
accumulation of earnings. Under this test, the term
"reasonable needs of the business" are hereby
construed to mean the immediate needs of the
business, including reasonably anticipated needs.
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.
In M ANILA WINE MERCHANTS V. CIR [FEBRUARY 20,
1984], Manila Wine Merchants (MWM) invested in
several companies and bought shares in Wack Wack
Golf and Country Club and likewise acquired US
Treasury Bills. CIR found that MWM had
unreasonably accumulated a surplus. On appeal, the
CTA ruled that the purchase of shares were
harmless. However, the CTA also ruled that the
purchase of US Treasury Bills was in no way related
to the business of importing and selling wines and
ordered MWM to pay IAET on the said treasury bills.

One of the contentions of MWM was that it will be
used to aid its importations The Supreme Court ruled
against MWM. It noted that the bonds were bought in
1951 and until 1961; it was never used to aid MWMs
importations. To justify an accumulation of earnings
and profits for the reasonably anticipated future
needs, such accumulation must be used within a
reasonable time after the close of the taxable year.
In CYNAMID V. CA [JANUARY 20, 2000], Cynamid
argued that the increase of working capital by a
corporation justifies accumulating income. It invoked
the Bardahl Formula which allowed retention, as
working capital reserve, sufficient amounts of liquid
assets to carry the company though one operating
cycle and pay all of its current liabilities and any
extraordinary expenses reasonably anticipated. The
Supreme Court ruled that, as stressed by American
authorities, the formula is used only for administrative
convenience and not a precise rule. The Court found
that in companies where the formula was applied,
they had operating cycles shorten than that of
Cynamid. The ratio of current assets to current
liabilities should be used to determine the sufficiency
of working capital which ideally should be 2:1.
Cyanamids ratio is 2.21:1 and, thus, there was no
need to infuse working capital.
Q91.7. In determining if profits are

reasonably
accumulated
for
business needs, the intention of
the taxpayer is reckoned at what
time?
It is reckoned at the time of accumulation. In M ANILA
WINE MERCHANTS V. CIR [FEBRUARY 20, 1984], one of
the contentions of MWM was that it held on to said
bonds for several years to wait for 60% of its stock to
be owned by Filipinos so it can purchase its own lot
and building. The Supreme Court stated that to
determine if profits are reasonably accumulated for
business needs, the controlling intention is that
manifested at the time of accumulation and not later
ones. The second reason given by MWM was too
indefinite and was a mere afterthought.
Q91.8. Are there ways by which to avoid

liability from IAET?
Yes, when the accumulation is justified by
reasonable needs of the business such as:
1. Accumulation up to 100% of the paid-up capital
66

INCOME TAX
2. For definite corporate expansion projects or
programs
3. For buildings, plants or equipment acquisitions
4. For compliance with a loan covenant or preexisting obligation under a legitimate business
agreement
5. When there is a legal prohibition for its
distribution
6. In the case of Philippine subsidiaries of foreign
corporations, undistributed earnings intended or
reserved for investments within the Philippines
Q91.9. Abbot-Phils,
a
domestic
corporation, is a wholly owned
subsidiary of Abbot-US, a nonresident
foreign
corporation.
Abbot-Phils claims that by virtue
of this, it is exempt from the IAET.
Is this contention correct?
Yes. In BIR RULING 25-02 [JUNE 25, 2002], the CIR
ruled that Abbot-Phils was exempt from IAET. Since
Abbott-Phils. is a wholly-owned subsidiary of AbbottUS, such shares will be considered as being owned
proportionately by the Abbott-US shareholders. The
ownership of a domestic corporation for purposes of
determining whether it is a closely held corporation or
a publicly held corporation is ultimately traced to the
individual shareholders of the parent company. Thus,
where at least 50% of the outstanding capital stock or
at least 50% of the total combined voting power of all
classes of stock entitled to vote in a corporation is
owned directly or indirectly by at least 21 or more
individuals, the corporation is considered publiclyheld corporation. As of the year-end 2000, Abbott-US
had 101,272 shareholders holding a combined
1,545,934,133 shares of common stock and the
twenty largest shareholders of Abbott-US as of
September 30, 2001 own an aggregate of 30.1
percent of Abbott-US' issued and outstanding shares.
Thus, Abbot-Phils is a publicly-held corporation
exempt from IAET.
Fringe Benefit Tax

Q92. What is a fringe benefit tax?
The State imposes a final tax of 32% effective
January 1, 2000 on the grossed-up monetary value
of fringe benefit furnished or granted to the
employee except rank and file employees by the
employer, whether an individual, professional
partnership or a corporation regardless of whether
the corporation is taxable or not, or the government

and its instrumentalities except when:
1. The fringe benefit is required by the nature of or
necessary to the trade, business or profession of
the employer; or
2. When the fringe benefit is for the convenience or
advantage of the employer
(see Section 33, Tax Code and RR 3-98 [JANUARY
1, 1998])
Q92.1. What is a fringe benefit?

As defined by Section 33(B), the term fringe
benefit means any good, service or other benefit
furnished or granted in cash or in kind by an
employer to an individual employee (except rank and
file employees as defined herein) such as, but not
limited to, the following:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Housing;
Expense account;
Vehicle of any kind;
Household personnel, such as maid, driver and
others;
Interest on loan at less than market rate to the
extent of the difference between the market rate
and actual rate granted;
Membership fees, dues and other expenses
borne by the employer for the employee in social
and athletic clubs or other similar organizations;
Expenses for foreign travel;
Holiday and vacation expenses;
Educational assistance to the employee or his
dependents; and
Life or health insurance and other non-life
insurance premiums or similar amounts in excess
of what the law allows.
Q92.2. What is the rationale behind the

Fringe Benefits Tax?
As a general rule, the income recipient is the person
liable to pay the income tax. In order to improve
collection of income on the compensation income of
employees, the State requires the employer to
withhold the tax upon payment of the compensation
income. However, it has been observed that many of
the fringe benefits paid by the employer to his
employees are not subjected to income tax and
withholding tax on compensation. To plug this
loophole, RA 8424 was passed. It imposed a fringe
benefits tax on the fringe benefits received by
67

INCOME TAX
supervisory and managerial employees. The law
mandates that the employer shall assume the fringe
benefits tax imposed on the taxable fringe benefits of
122
123
the managerial
or supervisory employees,
but
allows the employer to deduct such fringe benefit tax
as a business expense from its gross income.
However, the fringe benefits of rank-and-file
124
employees are treated as part of his compensation
income, which must be withheld and deducted by his
employer from the compensation income of the
employee.
Q92.3. What is meant by grossed-up

monetary value of the fringe
benefit?
As defined in RR 3-98 [JANUARY 1, 1998], the
grossed-up monetary value of the fringe benefit
represents the whole amount of income received by
the employee which includes the net amount of
money or net monetary value of property which has
been received plus the amount of the fringe benefit
tax thereon otherwise due from the employee, but
paid by the employer for and in behalf of his
125
employee.
Q92.3.1.
How
is
the
grossed-up
monetary value of the fringe
benefit determined?
Q92.4. Are all fringe benefits subject to

FBT?
No. The following fringe benefits are not taxable:
1. Fringe benefits exempted by law
2. Benefits required by the business or for the
convenience of the employer
3. Benefits given to the rank and file employees;
and
126
4. De minimis benefits
Transfer Pricing
Q93. What is transfer pricing?
It is the power of the CIR to distribute, apportion,
allocate, and shift income and expenses between
related taxpayers to reflect their true taxable income
or to prevent evasion of taxes.
At present, the Philippines does not have any
guidelines on transfer pricing unlike in other
jurisdictions. RMC 026-08 [March 24, 2008] states
that while the BIR is still revising the final draft of the
RR on transfer pricing, the BIR as a matter of policy
subscribes to the OECD Transfer Pricing Guidelines
in the interim.
Q93.1. GSK purchase a pharmaceutical

ingredient from Adechsa, a related
non-residency
company
for
between $1,512 and $1,651 per kg.
During the same period, two
Canadian
pharmaceutical
companies purchase the same
ingredient for between $194 and
$304 per kg from arms length
suppliers. Canadas minister for
internal revenue reassessed GSK
because the prices it paid for the
ingredient were greater than an
amount that would have been
reasonable in the circumstances
had they been dealing at arms
length. GSK argues the License
and Supply Agreement it entered
with
Adechsa
should
be
considered in determining if it is
an arms length transaction. Is
GSKs contention correct?
It is determined by dividing the actual monetary value

of the fringe benefit by 68% (effective January 1,
2000.)
Q92.3.2.
Is the above formula absolute?
No. In the case of non-resident aliens not engaged in

trade or business and alien and Filipino individuals
employed in RHQs, ROHQs of MNCs, OBUs and
petroleum subcontractors, the grossed-up value of
the fringe benefit shall be determined by dividing the
actual monetary value of the fringe benefit by the
difference between one hundred percent (100%) and
under their respective rates of income tax.
122
A managerial employee refers to one who is vested with powers

or prerogatives to lay down and execute management policies
and/or to hire, transfer, suspend, lay-off, recall, discharge, assign
or discipline employees
123
A supervisory employee is one who, in the interest of the
employer, effectively recommends such managerial actions if the
exercise of such authority is not merely routinary or clerical in
nature but requires the use of independent judgment.
124
A rank-and-file employee means all employees who are holding
neither managerial or supervisory position
125
The purpose of getting the grossed-up monetary value is to
preserve the benefit to the employer as a whole.
126
For the discussion of this, see Q15.6
68

INCOME TAX
Q93.1.1.
Yes. As held by the Supreme Court of Canada in HM
V. GLAXOSMITHKLINE [2012 SCC 52, OCTOBER 18,
2012], a proper application of the arms length
principle requires that regard be had for the
economically relevant characteristics of the arms
length and non-arms length circumstances to ensure
they are sufficiently comparable. The economically
relevant characteristics of the situations being
compared may make it necessary to consider other
transactions that impact the transfer price under
consideration. Such circumstances will include
agreements that may confer rights and benefits in
addition to the purchase of property where those
agreements are linked to the purchasing agreement.
The objective is to determine what an arms length
purchaser would pay for the property and the rights
and benefits together where the rights and benefits
are linked to the price paid for the property. In this
case, GSK was paying for at least some of the rights
and benefits under the Licence Agreement as part of
the purchase prices for ranitidine from Adechsa. As
such, the Licence Agreement could not be ignored in
determining the reasonable amount paid to Adechsa
which applies not only to payment for goods but also
to payment for services.
Q93.2. What is the arms length

bargaining standard with respect
to the determination of the taxable
income on inter-company loans or
advances in relation to transfer
pricing?
RMC 026-08 [M ARCH 24, 2008] adopts the arms
length standard as the ultimate test for determining
the fairness of related party transactions. The
standard to be applied in every case is that of an
uncontrolled taxpayer dealing at arms length with
another uncontrolled taxpayer.
Thus, where a member of a group of controlled
entities makes a loan or advances directly or
indirectly or becomes a creditor of another member of
such group and charges no interest, or chargest
interest at a rate which is not equal to an arms-length
127
rate, the CIR may make appropriate allocations to
reflect an arms length interest rate for use of such
loan or advance.
Filinvest
Development
Corporation (FDC) extended
advances in favour of its
affiliate. The BIR assesses
FDC for deficiency income by
unilaterally imputing an arms
length interest rate on its
advances. FDC disputes this
by saying the CIR lacks
authority to impute theoretical
interest and the rule is that
interests cannot be demanded
in the absence of a stipulation
to that effect. Is FDCs
contention correct?
Yes. According to the case of CIR V. FILINVEST

DEVELOPMENT CORPORATION [JULY 19, 2011], Despite
the seemingly broad power of the CIR to distribute,
apportion and allocate gross income under Section
50, the same does not include the power to impute
theoretical interest even with regard to controlled
taxpayers transactions. This is true even if the CIR is
able to prove that the interest expense was in fact
claimed by FDC. The term in the definition of gross
income that even those income from whatever
source derived is covered still requires that there
must be actual or at least probable receipt or
realization of the time of gross income sought to be
apportioned, distributed or reallocated. Finally, under
the Civil Code, no interest shall be due unless
128
expressly stipulated in writing.
Q93.3. Is transfer pricing applicable only

to taxable entities
No. Section 50 does not apply only to taxable
entities. Reallocation may also apply to tax-exempt
organizations. (see RMC 026-08 [M ARCH 24, 2008])
Special Entities
Proprietary Educational Institutions and
Hospitals
Q94. What is the tax treatment of proprietary
education institutions and hospitals
which are non-profit?
127
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.
128
The case would have been decided differently if we had an RR

on Transfer Pricing.
69

INCOME TAX
Section 27(B) of the Tax Code provides that they
shall pay a tax of 10% on their taxable income
except:
1. Certain passive incomes subject to final tax
2. If the gross income from unrelated trade,
129
business, or other activity exceeds 50% of
the total gross income derived by such
130
proprietary educational institution
and
hospital which are non-profit from all sources,
the tax shall be imposed on the entire taxable
income.
Q94.1. What is meant by the terms

proprietary and non-profit?
Proprietary means private while non-profit means no
net income or asset accrues to or benefits any
member or specific person, with all the net income or
asset devoted to the institutions purposes and all its
activities.
As noted by the Supreme Court IN CIR V. ST. LUKES
MEDICAL CENTER [SEPTEMBER 26, 2012], non-profit
does not necessarily mean charitable.
Q94.2. St. Lukes Medical Center is a

hospital organized as a non-stock
and non-profit corporation. It
admits both paying and nonpaying patients. The CIR claimed
that St. Lukes was liable for
income tax at 10% as provided
under Section 27(B)131 of the NIRC.
St. Lukes argues that it is a nonstock, non-profit institution for
charitable and social welfare
purposes exempt from income tax
under Section 30(E) and (G) of the
NIRC.132 Decide.
129
Means any trade, business, or other activity, the conduct of

which is not substantially related to the exercise or performance by
such educational institution or hospital of its primary purpose or
function.
130
Is any private schoolm maintained and administered by private
individuals or groups with an issued permit to operation from the
Department of Education or CHED, or TESDA, as the case may be
131
Section 27(B) provides that proprietary educational institutions
and hospitals which are non-profit shal pay a tax of ten percent
(10%) on their taxable income
132
Section 30(E), NIRC provides that a non-stock corporation or
association organized and operated exclusively for charitable
purposes is exempt from income tax while Section 30(G) provides
that a civic league or organization not organized for profit but
operated exclusively for the promotion of social welfare is likewise
exempt.
In CIR V. ST. LUKES MEDICAL CENTER [SEPTEMBER 26,

2012], the Supreme Court ruled that St. Lukes
cannot claim full tax exemption under Section 30
because it has paying patients and this is
notwithstanding the fact that it is a non-profit hospital.
For Section 27(B) to apply, the hospital must be nonprofit which means that no net income or asset
accrues to or benefits any member or specific person
and all the activities of the hospital are non-profit. On
the other hand, Section 30(E) and (G), while
providing for an exemption is qualified by the last
paragraph which, in turn, provides that activities
conducted for profit shall be taxable. Section 30(E)
and (G) requires that an institution be operated
exclusively for charitable purposes to be completely
exempt from income tax. In this case, however, St.
Lukes is not operated exclusively for charitable
purposes insofar as its revenues from paying patients
are concerned. Such revenue is subject to income
tax at 10% under Section 27(B).
Q94.3. Reconcile the tax treatment of

proprietary
educational
institutions and hospitals which
are non-profit under Section 27(B)
and
non-stock,
non-profit
charitable
institutions
under
Section 30(E) and (G).
To be exempt from income taxes, Section 30(E)
requires that the charitable institution must be
organized and operated exclusively for charitable
purpose. It is nevertheless allowed to engage in
activities conducted for profit without losing its taxexempt status for its not-for-profit activities. The
consequence, however, is that such income from
activities conducted for profit, regardless of the
disposition made of such income, shall be subject to
tax.
For proprietary educational institutions and hospitals
which are non-profit, to avail of the preferential tax
rate, no net income or asset accrues to or benefits
any member or specific person, with all the net
income or asset devoted to the institutions purposes
and all its activities.
Thus, in CIR V. ST. LUKES MEDICAL CENTER
[SEPTEMBER 26, 2012], while the St. Lukes did not
qualify as a non-profit, non-stock charitable institution
under Section 30(E) as it was not operated
exclusively for charitable purposes, it remains to be a
proprietary non-profit hospital under Section 27(E) as
long as it does not distribute any of its profits to its
70

INCOME TAX
members and such profits are reinvested pursuant to
its corporate purposes. St. Lukes, as a proprietary
non-profit hospital, is entitled to the preferential tax
rate of 10% on its net income from its for-profit
activities.
GOCCs
Q95. Are
GOCCs,
agencies
and
instrumentalities owned and control by
the government liable to pay income
tax?
All corporations, agencies, or instrumentalities owned
or controlled by the government shall pay such rate
of tax upon their taxable income except:
1.
2.
3.
4.
5.
GSIS
SSS
Phil Health
133
Local Water Districts
PCSO
(see Section 27(C), Tax Code)
Q95.1. Is RA 9337 constitutional insofar

as it excluded PAGCOR from the
enumeration of GOCCs exempt
from the payment of corporate
income tax?
Yes. In PAGCOR V. BIR [M ARCH 15, 2011], the
Supreme Court held that the original exemption of
PAGCOR from corporate income tax was not made
pursuant to a valid classification based on substantial
distinction so that the law may operate only on some
and not on all. Instead, the same was merely granted
to the acquiescence of the House Committee on
Ways and Means to the request of PAGCOR. The
argument that the withdrawal of the exemption
violates the non-impairment clause will not hold since
any franchise is subject to amendment, alteration or
134
repeal by Congress.
133
Inserted by RA 10026.
The Court, however, made clear that PAGCOR remains to be
exempt from indirect taxes.
134
Exempt Corporations
Q96. What are the exempt corporations
enumerated in Section 30 of the Tax
Code?
1. Labor, agricultural or horticultural organization
not organized principally for profit
2. Mutual savings bank not having a capital stock
represented by shares and cooperative bank
without capital stock organized and operated for
mutual purposes and without profit
3. A beneficiary society, order or association,
operating for the exclusive benefit of the
members such as a fraternal organization
operating under the lodge system, or a mutual
aid association or a non-stock corporation
organized by employees providing for the
payment of life, sickness, accident, or other
benefits exclusively to the members of such
society, order, or association, or non-stock
corporation or their dependents
4. Cemetery company owned and operated
exclusively for the benefit of its members
5. Non-stock corporation or association organized
and operated exclusively for religious, charitable,
scientific, athletic, or cultural purposes, or for the
rehabilitation of veterans, no part of its net
income or asset shall belong to or inure to the
benefit of any member, organizer, officer or any
specific person
6. Business league, chamber of commerce, or
board of trade, not organized for profit and no
part of the net income of which inures to the
benefit of any private stockholder or individual
7. Civil league or organization not organized for
profit but operated exclusively for the promotion
of social welfare
8. A non-stock and non-profit educational institution
9. Government educational institution
10. Farmers or mutual typhoon or fire insurance
company, mutual ditch or irrigation company,
mutual or cooperative telephone company or like
organizstion of a purely local character, the
income of which consists solely of assessments,
dues, and fees collected from members for the
sole purpose of meeting its expenses; and
11. Farmers, fruit growers, or like association
organized and operated as a sales agent for the
purpose of marketing the products of its
members and turning back to them the proceeds
of sales, less the necessary selling expenses on
the basis of the quantity of produce finished by
them.
71

INCOME TAX
Q96.1.1.
Q96.1. Are recreational

from income tax?
clubs
exempt
No. As clarified by RMC 35-2012 [AUGUST 3, 2012],

clubs which are organized and operated exclusively
for pleasure, recreation, and other non-profit
purposes (hereinafter referred to as "recreational
clubs") are not exempt from income tax. The
provision in the National Internal Revenue Code of
1977 which granted income tax exemption to such
recreational clubs was omitted in the current list of
tax exempt corporations under National Internal
Revenue Code of 1997, as amended.
No. In CIR V. G. SINCO EDUCATIONAL CORP [OCTOBER

23, 1956], the Supreme Court held that the amount of
fees charged by the school depends upon the policy
and a given administration at a given time and is not
conclusive of the purposes of the institution. It does
not in itself make a school a profit-making enterprise.
Q96.1.2.
Q96.2. A credit cooperative was assessed

deficiency withholding tax on
interest from savings and time
deposits of its members. The CTA
ruled
against
the
credit
cooperative
stating
that
withholding
tax
on
income
payments subject to FWT includes
said interests as interests from
similar arrangements. Is CTAs
ratio correct?
No. Since interest from any Philippine currency bank
deposit yield or any other monetary benefit from
deposit substitutes are paid by banks, other entities
such as cooperative are not required to withhold the
corresponding tax on the interest from savings and
time deposits of its members. The fact that similar
arrangements is preceded by banking terms means
that those subject to withholding must have deposit
peculiarities. This is also consistent with the
preferential treatment accorded to members of
cooperatives who are exempt in the same way as the
cooperative themselves. (see DUMAGUETE CREDIT
COOPERATIVE V. CIR [JANUARY 22, 2010]).
Q96.3. Are
all
the
activities
of
corporations enumerated in Q90
exempt from tax?
No. Notwithstanding that they are exempt
corporations, the income of whatever kind and
character of the organizations mentioned above from
any of their properties, real or personal, or form any
of their activities conducted for profit regardless of the
disposition made of such income shall be subject to
tax imposed under the Code.
If a non-stock, non-profit
educational
institution
charges tuition and other fees
for the different services it
renders, does the institution
lose its tax-exempt status?
What is the difference in tax

treatment on interest income
from currency bank deposits
and yield, etc and on interest
income from a depository
bank under the EFCDS of nonstock, non-profit corporations
and
non-stock,
non-profit
educational institutions?
As provided in RMC 76-03 [November 14, 2003]:

For non-stock non profit corporation, their interest
income from currency bank deposits and yield or any
other monetary benefit from deposit substitute
instruments and from trust funds and similar
arrangement, and royalties derived from sources
within the Philippines are subject to the 20% final
withholding tax and interest income derived by them
from a depository bank under the expanded foreign
currency deposit system shall be subject to 71/2%
final withholding tax.
Unlike non-stock, non-profit corporations, their
interest income from currency bank deposits and
yield from deposit substitute instruments used
actually, directly and exclusively in pursuance of their
purposes as an educational institution, are exempt
from the 20% final tax and 7 % tax on interest
income under the expanded foreign currency deposit
system imposed provided they submit on an annual
basis submit to the Revenue District Office
concerned an annual information return and duly
audited financial statement together with the
following:
1. Certification from their depository banks as to the
amount of interest income earned from passive
investment not subject to the 20% final
withholding tax and 7 % tax on interest income
72

INCOME TAX
under the expanded foreign currency deposit
system.
2. Certification of actual utilization of the said
income; and
3. Board Resolution by the school administration on
proposed projects to be funded out of the money
deposited in banks or placed in money markets,
on or before the 14th day of the fourth month
following the end of its taxable year.
Q96.4. Enumerate some special laws

granting exempt status to certain
types of corporations
1. Executive Order 226 (Article 39) or the
Omnibus Investment Code
thereof, 5% of the gross income earned by all

business enterprises within the ECOZON
shall be paid and remitted as follows:
i. 3% to the National Government
ii. 2% to the Treasurers office of the
municipality of city where the enterprise is
located.
3. RA 9178 or the Barangay Micro Business
Enterprises Act
All BMBEs shall be exempt from tax for income
arising from the operations of the enterprise.
4. RA 9593 (Section 4 & 86, 88) or Tourism

Act
Registered Enterprises are granted an Income Tax

Holiday as follows:
a. New enterprises in Greenfield and Brownfield

137
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
138
the expiration of the first six (6) years.
b. 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.
c. 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
139
upgrade of facilities.
d. 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
a. For six (6) years from commercial operation

for pioneer firms and four (4) years for nonpioneer firms, new registered firms shall be
fully exempt from income taxes levied by the
National Government. This tax exemption will
be extended for another year in each of the
following cases:
i. the project meets the prescribed ration of
capital equipment to number of workers set
by the BOI
ii. utilization of indigenous raw materials at
rates set by the BOI
iii. the net foreign exchange savings or
135
earnings amount
b. 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
136
Government.
2. RA 7916 (Sections 23 to 25) or the Special
Economic Zone Act
137
a. 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
A Greenfield Tourism Zone refers to a new or pioneer

development, as determined by the TIEZA (Tourism Infrastructure
and Enterprise Zone Authority) while a Brownfield Tourism Zone
refers to an area with existing infrastructure or development as
determined by the TIEZA.
138
135
No registered pioneer firm may avail of this incentive for a

period exceeding eight (8) years.
136
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.
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.
139
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.
73

INCOME TAX
enterprise shall pay a tax of five percent (5%)
on its gross income earned, which shall be
distributed as follows:
i. 1/3 to be proportionally allocated among
affected LGUs
ii. 1/3 to the National Government; and
iii. 1/3 to the TIEZA
5. RA 9856 or the Real Estate Investment

Trust (REIT) Act
140
A REIT
shall be subject to income tax on its
taxable net income defined in the Act as the pertinent
items of gross income less all allowable deductions,
less the dividends distributed by the REIT out of its
141
distributable income. In no case, shall the REIT be
subject to MCIT.
Note, however, that if the REIT (1) fails to maintain its
status as a public company as defined in the Act; (2)
fails to maintain the listed status of the investor
securities on the Exchange; and (3) fails to distribute
at least 90% of its distributable income, the income
tax shall be imposed on taxable net income not as
defined in the Act but as defined in the Tax Code.
Capital
assets/income
Assets/income
v.
Ordinary
Q97.1. What are capital assets?

The term capital assets means 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
(see Section 39 Tax Code, and Section 132, RR 2)
(see RR 13-2011 [JULY 25, 2011])

Q97.1.1.
Capital Gains and Losses

Q97. What is the importance of knowing if an
asset/income is capital or ordinary
The tax treatment will vary depend on the nature of
the asset. For example, if real property is a capital
asset, the gain from the sale thereof shall be subject
to the final capital gains tax of 6%. If it is an ordinary
asset, any gain from the sale thereof shall form part
of the ordinary income which shall be subject either
to graduated income tax rates (if an individual) or
corporate income tax (if a corporation).
140
A REIT is a stock corporation established principally for the

purpose of owning income - generating real estate assets.
141
Dividends are allowed deductions.
A inherited from his father an

agricultural land. He had the
land surveyed and subdivided
into lots. Improvements, such
as good roads, concrete
gutters, drainage and lighting
system, were introduced to
make the lots saleable. Soon
after, the lots were sold to the
public at a profit. The Revenue
examiner adjudged A as
engaged in business as real
estate dealers and required
him to pay the real estate
dealers tax and assessed a
deficiency income tax on
profits derived from the sale of
the lots based on the rates for
ordinary income and not as
capital gains at capital gain
rates.
Is
the
Revenue
Examiner correct?
Yes. The statutory definition of capital assets is

negative in nature. If the asset is not among the
exceptions, it is a capital asset; conversely, assets
falling within the exceptions are ordinary assets. And
74

INCOME TAX
necessarily, any gain resulting from the sale or
exchange of an asset is a capital gain or an ordinary
gain depending on the kind of asset involved in the
transaction. In this case, the activities of A 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. A did
not sell the land in the condition in which he acquired
it. In the course of selling the subdivided lots, A
engaged in the real estate business and accordingly,
the gains from the sale of the lots are ordinary
income taxable in full (see CALASANZ VS.
COMMISSIONER [OCTOBER 9, 1986])
Q97.2. What are ordinary assets?

The statutory definition of capital assets is negative in
nature. If the asset is not among the exceptions, it is
a capital asset; conversely, assets falling within the
exceptions are ordinary assets
Q97.2.1.
Y inherited from his mother

several tracts of land. When
his mother was still alive,
these lands were subdivided
into lots and leased. Y sold the
leased lots to the occupants
except for one lot which
needed filling because of low
elevation. Said lot was filled
and subdivided into smaller
lots and sold to the public. Y
reported his income from the
sales as long-term capital
gains. The CIR denied this and
ruled that Y was engaged in
the business of leasing the
lots and the subsequent sale
are sales of real property used
in trade or business of the
taxpayer. Is the CIR correct?
Yes. In this case, the properties should be regarded

as ordinary assets. When Y obtained by inheritance
the parcels in question, transferred to him was not
merely the duty to respect the terms of any contract
thereon, but as well the correlative right to receive
and enjoy the fruits of the business and property
which the decedent had established and maintained.
Under the circumstances, Ys sales of the several lots
forming part of his rental business cannot be
characterized as other than sales of ordinary assets.
The sales concluded on installment basis of the
subdivided lots comprising the last lot do not deserve
a different characterization for tax purposes. The

following circumstances in combination show
unequivocally that the petitioner was, at the time
material to this case, engaged in the real estate
business (see TUASON VS. LINGAD [JULY 31, 1974])
Q97.3. What is the tax consequence if the

property is sold by a sellercorporation engaged in real estate
business?
142
It depends. In BIR RULING 27-02 [JULY 15, 2002],

the CIR was asked to rule on the tax consequences
of certain transactions involving a seller that is
engaged n real estate business but without any
specification as to whether the property is capital or
ordinary. The CIR stated that it is necessary to first
determine the character of the real property being
sold.
If the real property is a land or building which is not

actually used in the business of the seller-corporation
and is treated as a capital asset, , then a final tax of
six percent (6%) shall be imposed on the gain
presumed to have been realized on its sale,
exchange or disposition of such land or building
based on the gross selling price or fair market value,
whichever is higher of such land and/or building. This
rule applies, whether or not the seller-corporation is
engaged in real estate business.
If the real property being sold is an ordinary asset,
withholding tax rates shall apply. The rate of
withholding tax will depend on whether, first, the
seller is exempt or taxable; second, whether the
seller is habitually engaged in real estate business or
not; and third, if the seller is habitually engaged in
real estate business, the gross selling price.
Q97.4. Is an equity investment a capital

asset?
Yes. As ruled by the Supreme Court in CHINABANK V.
CA [JULY 19, 2000], an equity investment is a capital,
not ordinary, asset of the investor the sale or
exchange of which results in either a capital gain or a
capital loss.
142
This ruling also stated that registration with the HLURB or

HUDCC shall be sufficient for a seller/transferor to be considered
as habitually engaged in the real estate business. If the
seller/transferor is not registered with HLURB or HUDCC, he/it
may prove that he/it is engaged in the real estate business by
offering other satisfactory evidence
75

INCOME TAX
Net capital gain, net capital loss
Q97.5. Define net capital gain and net

capital loss.
Net
Gain
Capital
Net
loss
Capital
the excess of the gains from

sales or exchanges
the excess of the losses from
sales or exchanges
Percentage taken into account

Q97.6. Is the capital gain from the sale
or exchange of a capital asset
always taxable in full?
No. In the case of a taxpayer other than a
143
corporation,
the following percentages of the gain
upon the sale or exchange of a capital asset shall be
taken into account in computing net capital gain:
1. 100% if the capital asset has been held for not
more than 12 months
2. 50% if the capital asset has been held for more
than 12 months
Limitations on capital loss

Q97.7. What is the allowable extent of
losses from sales or exchanges of
capitals assets?
Losses from sales of exchanges of capital assets
shall be allowed to be deducted only to the extent of
the gains from such sales or exchanges.
In CHINABANK V. CA [JULY 19, 2000], Chinabank
made a 53% equity investment in the First CBC
Capital (Asia) Ltd, a Hong Kong subsidiary. First CBC
became insolvent. With BSP approval, Chinabank
wrote-off the investment in its ITR as a bad debt or as
an ordinary loss deductible from its gross income.
The BIR disallowed the deduction on the basis that
the debt was not worthless. The Supreme Court ruled
that the equity investment is not indebtedness in the
first place but rather capital, not an ordinary, asset.
Shares of stock would be ordinary assets only to
143
The holding period is material only if the capital asset is sold by

an individual. This does not apply to corporations.
a dealer in securities or a person engaged in the

purchase and sale of, or an active trader (for his own
account) in, securities. In the hands, however, of
another who holds the shares of stock by way of an
investment, the shares to him would be capital
assets. When the shares held by such investor
become worthless, the loss is deemed to be a loss
from the sale or exchange of capital assets.
The Court further stated that assuming that the equity
investment of CBC has indeed become "worthless,"
the loss sustained is a capital, not an ordinary, loss.
The rule thus is that capital loss can be deducted
only from capital gains. The capital loss sustained by
CBC can only be deducted from capital gains if any
derived by it during the same taxable year that the
securities have become "worthless.
Determination of Gains or Loss from Sale

or Transfer of Property
Computation of Gain or Loss
Q98. How is gain or loss from the sale or
other
disposition
of
property
computed?
The gain from the sale or other disposition of
property shall be the excess of the amount realized
therefrom over the basis or adjusted basis for
determining gain.
The loss shall be the excess of the basis or adjusted
basis for determining loss over the amount realized.
Q98.1. Define amount realized

Amount
realized
the sum of the money received

plus the fair market value of te
property (other than money
received).
Q98.2. When is gain or loss realized?

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 that:
1. is essentially different from the property disposed
of, and
2. has a market value.
76

INCOME TAX
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
144
form.
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
Basis
of
Stocks
and
Securities
acquired
in
Wash Sales
Cost or basis for determining gain or

loss
Q99. Define basis
Basis
1. The cost thereof in the case of

property acquired on or after
March 1, 1913, if such property
was acquired by purchase;
[see Section40(B) Tax Code

and RR-2]
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. [see Section 143,
RR 2]
Exchange
of
Exchanges)
Property
(Tax-Free
Definitions
2. The FMV as of the date of
acquisition if the same was
acquired by inheritance
3. If the property was acquired
by gift, the basis shall be the
same as if it would be in the
hands of the donor or the last
preceding owner by whom it was
not acquired by gift except if
such basis is greater than FMV
of the property at the time of the
gift then, for purpose of
determining loss, the basis shall
be such FMV;
4. If the property was acquired
for less than an adequate
consideration in money or
moneys worth, the basis of such
property is the amount paid by
the transferee for the property
5. The basis as defined in
paragraph (C)(5) of Section 40 if
the property was acquired in a
transaction where the gain or
loss is not recognized under
paragraph (C)(2) of Section
145
40.
Q100. For purposes of Section 40, define the

following terms:
Securities
Merger
or
Consolidation
Means bonds and debentures

but not notes of whatever class
or duration
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.
For a transaction to be regarded
as a merger or consolidation
under Section 40:
1. It must be undertaken for a
bona fide business purpose and
not solely for escaping the
burden of taxation
2. In determining if a bona fide
transaction exists, the whole
transaction
or
series
of
transactions shall be treated as
a single unit and every step of
the
transaction
shall
be
considered
144
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.
145
This refers to the basis used in tax-free exchanges
3.In determine if the property

transferred
constitutes
a
77

INCOME TAX
Control
substantial
portion
of
the
property of the transferor,
property shall be taken to
include cash assets
Means ownership or stocks in a
corporaion possessing at least
51% of the total voting power of
all classes of stock entitled to
vote
Q101. What are considered

exchanges?
as
tax-free
As a general rule, the entire amount of the gain or

loss shall be recognized upon the sale or exchange
of property
The exceptions (tax free exchanges) are:
1. No gain or loss shall be recognized if in
pursuance of a plan of merger or
consolidation:
a. A corporation which is a party to a
merger or consolidation exchanges
property solely for stock in a corporation,
which is a party to the merger or
consolidation
b. A shareholder exchanges stock in a
corporation, which is a party to a merger
or consolidation solely for the stock of
another corporation also a party to a
merger or consolidation
c. A security holder of a corporation, which
is a party to a merger or consolidation,
exchanges his securities in such
corporation, solely for stock or securities
in another corporation, a party to the
merger or consolidation
2. No gain or loss shall be recognized if
property is transferred to a corporation by
a person in exchange for stock or unit of
participation in such a corporation of
which as a result of such exchange, said
person, alone or together with others, not
exceeding four (4) persons gains control of
said corporation provided that stocks issued
for services shall not be considered as
issued in return for property.
Merger or Consolidation
Q101.1. A,
B,
C
were
majority
stockholders of ABC Theatrical
Co. They were also majority

stockholders of XYZ Theatrical
Co which was engaged in the
same business. ABC and XYZ
agreed to merge. Under the
agreement,
all
business,
property, assets and goodwill of
ABC will be transferred to XYZ in
exchange for XYZ stocks for
each stock held in ABC. Is the
exchange subject to capital
gains tax?
No. As held in CIR v. RUFINO [FEBRUARY 27, 1987], It
is well established that where stocks for stocks were
exchanged, and distributed to the stockholders of the
corporations, parties to the merger or consolidation,
pursuant to a plan of reorganization, such exchange
is exempt from capital gains tax. The basic
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." It is clear, in fact, that the purpose of the
merger was to continue the business of the Old
Corporation, whose corporate life was about to
expire, through the New Corporation to which all the
assets and obligations of the former had been
transferred. The exemption from the tax of the gain
derived from exchanges of stock solely for stock of
another corporation was intended to encourage
corporations in pooling, combining or expanding their
resources conducive to the economic development of
the country. The merger in question involved a
pooling of resources aimed at the continuation and
expansion of business and so came under the letter
and intendment of the NIRC exempting from the
capital gains tax exchanges of property.
Transfer of property for shares of stock

Q101.2. Filinvest
Development
Corporation (FDC), a holding
company, is the owner of 80% of
the outstanding shares of
Filinvest Alabang, Inc. (FAI) and
67.42% of the outstanding
shares of Filinvest Land, Inc.
(FLI). FDC and FAI entered into a
Deed of Exchange with FLI
78

INCOME TAX
whereby the former both transfer
in favor of the latter parcels of
land in exchange for shares of
stock of FLI. The CIR argues that
the taxable gain should be
recognized for the exchange as
FDCs controlling interest in FLI
was decreased as a result of the
exchange.
Is
the
CIRs
contention correct?
stocks entitled to vote. In determining the 51% stock

ownership, only those persons who transferred
property for stock in the same transaction may be
counted up to a maximum of five.
No. The Supreme Court in CIR V. FILINVEST

DEVELOPMENT CORPORATION (JULY 19, 2011] stated
that the requisites for the non-recognition of gain or
loss of a transfer of property for shares of stock are
as follows: (a) the transferee is a corporation; (b) the
transferee exchanges its shares of stock for
property/ies of the transferor; (c) the transfer is made
by a person, acting alone or together with others, not
exceeding four persons; and, (d) as a result of the
exchange the transferor, alone or together with
others, not exceeding four, gains control of the
transferee. Rather than isolating FDC, the shares
issued to FDC should be appreciated in combination
with the new shares issued to FAI. Together, FDC
and FAIs shares add to 70.99% of FLIs shares.
Since the term "control" is clearly defined as
"ownership of stocks in a corporation possessing at
least fifty-one percent of the total voting power of
classes of stocks entitled to one vote, the exchange
of property for stocks between FDC-FAI and FLI
clearly qualify as a tax-free transaction.
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.
(see RMC 1-02 [April 25, 2002])
Q101.3. ABC is a domestic corporation.

Shareholders transferred their
real property in exchange for
more shares in the corporation.
In effect, they gained control of
more than 51% of the shares of
the corporation entitled to vote.
Is the exchange tax-exempt?
146
It depends. In BIR Ruling 274-87,

the CIR ruled
that no gain or loss would be recognized if property is
transferred to a corporation by a person in exchange
for stock in such a corporation of which as a result of
such exchange, said person alone or together with
others, not exceeding four persons, gains control of
said corporation. The term "control" shall mean
ownership of stocks in a corporation possessing at
least 51% of the total voting power of all classes of
146
Transfer of substantially all the assets

Q101.4. What is a de facto merger?
To constitute a de facto merger, the following
elements must concur:
Q101.5. What is meant by substantially

all?
As provided by RR 2, "substantially all" means 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
Q101.6. What
are
the
differences
between a de facto merger and a
statutory (ordinary) merger?
In a de facto merger, the Transferor is not
automatically dissolved unlike in the case of a
statutory merger. Likewise, there is no automatic
transfer to the Transferee of all the rights, privileges,
and liabilities of the Transferor in the case of de facto
merger.
Q101.7. What are the similarities and

differences between a de facto
merger and a transfer of property
for shares under Section 40(C)(2)
of the Tax Code?
De facto merger is 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.
Note that in this BIR Ruling, there were 6 transferors,
79

INCOME TAX
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 nonrecognition 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.
(see RMC 1-02 [April 25, 2002])
Administrative Requirements in case of

tax-free exchanges
Q101.8. What are the administrative
requirements in case of tax-free
exchanges?
1. The parties who are applying for confirmation that
the transaction is indeed a tax-free exchange
shall submit the following:
a. A sworn certification on the basis of the
property to be transferred
b. Certified true copies of the TCT and/or CCT
of real properties transferred
c. Certified true copies of the corresponding
latest Tax Declaration of the real properties
to be transferred
d. Certified true copies of the certificates of
stocks evidencing shares of stocks to be
transferred
e. Certified true copy of the inventory of other
property/ies to be transferred/
2. The BIR shall issue a certification or ruling
confirming that an exchange of property for
shares complies with the requisites for it to be
tax-free. The certification or ruling shall contain
the substituted basis of the properties.
3. The Certificate Authorizing Registration (CAR) or
Tax Clearance (TCL) shall be issued by the
RDO/Authorized Internal Revenue Officer on the
basis of the BIR certification or ruling
4. The information that the transaction is a tax-free
exchange and the substituted basis of the
properties shall be annotated in the TCT and/or
CCT.
5. The applicant/taxpayer shall pay the processing
and certification fee of P5,000 for each
application not involving more than 10 real

properties and/or certificates of stock. An
additional P100 shall be paid for every TCT/CCT
and/or certificate of stock in excess of 10.
6. Every official, agent, or employee of the Registry
of Deeds and corporate secretary or the duly
authorized officer of the corporation who fails to
annotate the information shall be subject to a
penalty.
Exchange not solely in kind

Q101.9. What is the effect if the tax-free
exchange is not solely in kind?
1. If an individual, shareholder, security holder
or corporation receives money and/or
property in addition to the stock, the gain, but
not the loss, shall be recognized but in
amount not in excess of the sum of the
money and the fair market value of such
other property received.
2. As to the shareholder, if the money and/or
property has the effect of a distribution of a
taxable dividend, there shall be taxed an
amount of the gain recognized not in excess
of his proportionate share of the undistributed
earnings and profits of the corporation; the
remainder, if any, shall be treated as capital
gain.
3. If the transferor corporation receives money
and/or property in addition to the stock, then:
a. If the corporation distributes it in
pursuance of the plan of merger or
consolidation,
no
gain
shall
be
recognized
b. If the corporation does not distribute it,
the gain, if any, but not the loss shall be
recognized but not in an amount not in
excess of the sum of such money and
the fair market value of the property so
received.
Assumption
Exchanges
of
Liability
in
Tax-Free
Q101.10. What is the effect of the

assumption of the transferee of
the liabilities of the transferor
in addition to the transfer of
property?
80

INCOME TAX
Section 40(C)(4) provides that if the taxpayer
receives the stock as if it were the sole consideration,
and, as part of the consideration, another party to the
exchange assumes a liability of the taxpayer or
acquires property subject to a liability, such
assumption or acquisition shall not be treated as
money and/or property and shall not prevent the
exchange from being tax-free.
However, if the amount of liabilities assumed plus the
amount of liabilities to which the property is subjected
to exceed the total adjusted basis of the property,
then such excess shall be considered either a capital
gain or ordinary gain, as the case may be.
Q101.11. What is the cost or basis in taxfree exchanges?

The basis of the stock or securities shall be the same
as the basis of the property, stock, or securities
exchanged:
1. minus the money received
2. minus the fair market value of the property
received
3. plus the amount treated as dividend of the
shareholder
4. plus the amount of any gain that was
recognized on the exchange.
Note that the assumption or acquisition of liability
shall be treated as money and/or property received if
as part of the consideration to the transferor, the
transferee of the property assumes a liability of the
transferor or acquires from the latter property subject
to a liability.
The basis of the property transferred in the hands of
the transferee shall be the same as it would be in the
hands of the transferor increased by the amount of
the gain recognized to the transferor on the transfer.
Business Purpose
Q101.12. A owns all the stock of ABC
Corp. ABC Corp. had 1,000
shares of XYZ Corp. A formed
a new corporation called DEF
Corp. A had ABC transfer all
1,000 XYZ shares to DEF. She
then
dissolved
DEF
and
liquidated the assets (the XYZ
shares). A then sold the XYZ
shares
and
paid
the
corresponding CGT based on a
lower cost basis. Is the transfer
valid?
.
No. As held in GREGORY V. HELVERING [293 US 465,

JANUARY 7, 1935], a transfer of assets by one
corporation to another must have a business
purpose. Here, it was a mere device which followed
the form of a corporate reorganization to conceal its
real character which was a transfer of stock of XYZ
shares to A.
Rulings
Q101.13. Is there a prescriptive period
for
rulings
issued
in
connection
to
tax-free
exchanges?
Yes. RMC 40-2012 [August 3, 2012] provides that
rulings issued under Section 40 (C) (2) of the NIRC,
as amended, shall be valid only for ninety (90) days
counted from the date of receipt of the ruling by any
of the parties to the exchange transaction. The
properties and shares of stocks involved in the
transfer should be conveyed to the transferee/s and
transferor/s, respectively, within this period.
Losses from Wash Sales of Stocks or

Securities
Q101.14. What is a Wash sale?
Wash sale is a sale or other disposition of stock or
securities where substantially identical securities are
acquired or purchased within a 61-day period,
beginning 30 days before the sale and ending 30
days after the sale.
Q101.15. Are losses from wash sales

deductible?
No. This is an exception to the general rule that
losses from sales or exchanges of stock or securities
are deductible as losses from sales or exchange of
property.
This will not apply to a loss incurred by a dealer in
securities. A loss incurred by a dealer in securities
with respect to a transaction made in the ordinary
course of the business of such dealer is deductible.
81

INCOME TAX
Example:
A, whose taxable year is the calendar year, on
December 1, 2012, purchased 100 shares of
common stock in the ABC Company for P100,000
and on December 15, 2012, purchased 100
additional shares for P80,000. On January 2, 2012,
he sold the 100 shares purchased on December 1,
2012, for P80,000. Because of the provisions of
Section 38, no loss from the sale is allowable as a
deduction.
(see Section 38, Tax Code and Section 131, RR 2)
Administrative Provisions
Accounting Methods
Q102. What are accounting methods that
may be used by taxpayers?
The methods are:
1. Cash Method a method of accounting
whereby all items of gross income received
during the year shall be accounted for in
such taxable year and that only expenses
actually paid shall be claimed as deductions
during the year
2. Accrual Method method of accounting for
income in the period it is earned, regardless
of whether it has been received or not.
Expenses are accounted for in the period
they are incurred and not in the period they
are paid.
3. Installment Method method of accounting
considered appropriate when collections of
the proceeds of sales and incomes extend
over relatively long periods of time and there
is strong possibility that full collection will not
be paid. As customers make installment
payments, the seller recognizes the gross
profit on sale in proportion to the cash
collected during the year. (see Section 49,
Tax Code)
4. Percentage of Completion Method
method of accounting applicable in the case
of a building, installation or construction
contract covering a period in excess of one
year, whereby gross income derived from
such contract may be reported upon the
basis of percentage of completion. (see

Section 48, Tax Code)
5. Crop Year Basis method of accounting
applicable only for farmers engaged in the
production of crops which take more than a
year from the time of planting to the process
of gathering and disposal of the harvest.
Expenses paid or incurred are deductible in
the year the gross income from the sale of
the crops is realized.
Hybrid Method
Q102.1. Can
a
taxpayer
use
a
combination of two or more
methods of accounting?
No. The rule is that a taxpayer may use any one
method of accounting but not a combination of two or
more methods of accounting for each type of
business during the taxable year. The use of a hybrid
method of accounting is not allowed (see
CONSOLIDATED MINES VS. CTA [AUGUST 29, 1974])
Percentage of Completion Method

Q102.2. Can gross income be instead
reported when the long term
contract is finally completed?
Yes. Section, 44, RR 2 provides that 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.
Installment Basis
Q102.3. A sold lots to ABC Corp and was
paid less than 25%, the balance
was covered by 4 checks. On the
same day, the checks were
discounted (exchange for cash
at an amount lower than face
value) also ABC Corp. A reported
82

INCOME TAX
as income for the year of the sale
for the year of the sale only the
cash amount received from sale
and
excluded
the
amount
received from the discounted
checks.
The
balance
was
reported as income only in the
next four years. A argues that
initial
payment
excludes
evidence of indebtedness. Is As
contention correct?
Yes, but this applies only to corporate taxpayers. If

the corporate taxpayer wishes to change his
accounting period from fiscal to calendar year, from
calendar year to fiscal year, or from one fiscal year to
another, the net income shall, with the approval of the
CIR, be computed on the basis of such new
accounting period. (see Section 46, Tax Code)
Yes. As held in BANAS V. CA [FEBRUARY 10, 2000],

The transaction remains to be an instalment (not
cash) sale as the law expressly excludes evidence of
indebtedness in the determination of how much was
paid for the year. However, even if the proceeds of
discounted note is not considered as part of the initial
payment, the income realized from the discounting
itself is still a separate taxable income in the year it
was converted into cash because it was at this year
that there was actual gain on the discounted notes.
Q103.3. When are items of gross income

included?
Accounting Period
Q103. What is the general rule for computing
the taxpayers taxable income?
The taxable income shall be computed upon the
basis of the taxpayers annual accounting period
fiscal year or calendar year as the case may be.

fiscal year and calendar year?
Calendar year is an accounting period which starts
from January 1 and ends on December 31 while
Fiscal year is an accounting period of 12 months
ending on the last day of any month other than
December 31.
Income tax returns, whether individuals or for
corporations, are required to be made and their
income computed for each calendar year. However,
corporations may with the approval of the CIR, file
their returns and compute their income on the basis
of a fiscal year. (see Section 43, Tax Code)
Change of Accounting Period

Q103.2. Can a taxpayer change
accounting period?
his
The corporation must file the corresponding final or

adjustment return (see Section 47, Tax Code)
Allocation of Income and Deductions
The amount of all items of gross income shall be

included in the gross income for the taxable year in
which received by the taxpayer unless under the
accounting method such amounts are to be properly
accounted for as for a different period. (see Section
44, Tax Code)
Q103.4. When is the period for which

deductions and credits are
taken?
The deductions shall be taken for the taxable year in
which paid or accrued or paid or incurred
dependent upon the accounting method used unless
in order to clearly reflect the income the deductions
should be taken as of a different period. (see Section
45, Tax Code)
Q103.5. When is the CIR authorized to

allocate income and deductions?
(Transfer pricing)
CIR to authorized to distribute, apportion, allocate,
and shift income and expenses between related
taxpayers to reflect their true taxable income or to
prevent evasion of taxes.
Returns and Payments of Taxes

Q104. Enumerate the BIR forms used in
income tax filing.
1. BIR Form 1700: Annual ITR for Individuals
Earning Purely Compensation Income
2. BIR Form 1702: Annual ITR for SelfEmployed Individuals, Estates and Trusts;
3. BIR Form 1702: Annual ITR for Corporation,
Partnership
and
Other
Non-Individual
83

INCOME TAX
Taxpayer. (see RR 019-11 [DECEMBER 9,
2011])
3. An individual whose sole income has been

subjected to final withholding tax
Individual Return
4. An individual who is exempt from income
tax
Who are required to pay

Q105. Who are required to file an income tax
return?
The following individuals are required to file an
income tax return:
1. Resident citizen
2. Nonresident citizen, on his income from
3. Resident alien, on income derived from
4. Nonresident alien engaged in trade or
business or in the exercise of profession in
the Philippines (see Section 51, Tax Code)
Those not required to pay

Q106. Who are not required to file an income
tax return?
A: The following individuals are not required to file an
income tax return:
5. Minimum wage workers
Where to file
Q107. Where will the income tax return be
filed?
The return shall be filed with the
1.
2.
3.
4.
authorized agent bank

Revenue District Officer
Collection Agent
duly authorized Treasurer of the city or
municipality in which such person has his legal
residence or principal place of business in the
Philippines
5. if there be no legal residence or place of
business in the Philippines, with the Office of the
Commissioner. (see Section 51, Tax Code).
When to file
Q108. When is the income tax return filed?
1. An individual whose gross income does not

exceed his total personal and additional
exemptions for dependents under Section
35.
However, a citizen of the Philippines and any
alien individual engaged in business or
practice of profession within the Philippines
shall file an income tax return, regardless of
the amount of gross income.
2. An individual with respect to pure
compensation
income
derived
from
sources within the Philippines (substituted
filing)
However, (1) an individual deriving
compensation concurrently from two or more
employers at any time during the taxable
year shall file an income tax return and (2) an
individual whose compensation income
derived from sources within the Philippines
exceeds P60,000 shall also file an income
tax return
The following rules shall govern the time of filing of

income tax returns:
1. The return of any individual shall be filed on
or before April 15 of each year covering
income for the preceding taxable year.
2. Individuals subject to tax on capital gains
;
a. From the sale or exchange of shares of
stock not traded thru a local stock
exchange shall file a return within thirty
(30) days after each transaction and a
final consolidated return on or before
April 15 of year covering all stock
transactions of the preceding taxable
year; and
b. From the sale or disposition of real
property shall file a return within thirty
(30) days following each sale or other
disposition.
84

INCOME TAX
3. Married individuals who do not derive income
purely from compensation, shall file a return
for the taxable year to include the income of
both spouses, but where it is impracticable
for the spouses to file one return, each
spouse may file a separate return of income.
4. The income of unmarried minors derived
from property received from a living parent
shall be included in the return of the parent,
except:
a. when the donor's tax has been paid on
such property, or
b. when the transfer of such property is
exempt from donors tax.
5. If the taxpayer is unable to make his own
return, the return may be made by his duly
authorized agent or representative or by the
guardian or other person charged with the
care of his person or property.
Where to pay
before April 15 of the same taxable year. (see

Q110.1. When should the estimated tax

be paid?
The estimated tax due with respect to his declared
income shall be paid in four (4) instalments. The first
shall be paid at the time of te declaration and the
second and third shall be paid on August 15 and
November 15 of the current year, respectively. The
fourth instalment shall be paid on or before April 15 of
the following calendar year when the final adjusted
income tax return is to be filed. (see Section 74(B),
Tax Code)
Corporation Returns
Q111. Who are required to file a corporate
return?
Every corporation, except foreign corporations not
engaged in trade or business in the Philippines, shall
render, in duplicate, a true and accurate quarterly
income tax return and final or adjustment return.
Q109. Where is the income tax paid?

1. At the nearest Authorized Agent Bank (AAB)
of the Revenue District Office where the
taxpayer is registered.
2. In places where there are no AABs, to the
Revenue
Collection
Officer
or
duly
Authorized City or Municipal Treasurer
located within the Revenue District Office
where the taxpayer is registered.
Quarterly Income Tax

Q110. When should income tax be declared
for individuals?
147
Individuals subject to income tax, who is receiving

148
self-employment income, whether it constitutes the
sole source of his income or in combination with
salaries, wages, and other fixed or determinable
income, shall make and file a declaration of his
estimated income for the current taxable year on or
147
Nonresident citizens, with respect to income without the

Philippines and nonresident aliens not engaged in trade or
business, are not required to make a declaration.
148
Consists of earnings derived by the individual from the practice
of profession or conduct of trade or business carried on by him as
a sole proprietor or by a partnership of which he is a member.
The return shall be filed by the president, vicepresident or other principal officer, and shall be sworn
to by such officer and by the treasurer or assistant
treasurer.
Quarterly Income Tax

Q112. When should corporate income tax be
declared and paid?
Every corporation shall file a quarterly summary
declaration of its gross income and deductions on a
cumulative basis for the preceding quarter or
quarters, upon which the income tax shall be levied,
collected and paid.
The tax so computed shall be decreased by the
amount of tax previously paid or assessed during the
preceding quarters and shall be paid not later than 60
days from the close of each of each of the first three
quarters of the taxable year, whether calendar or
fiscal year (see Section 75, Tax Code)
Final Adjustment Return

Q113. What are the options available to the
corporation when the sum of the
quarterly tax payments made during
85

INCOME TAX
Prior Years Excess Credits in
the Final Adjustment Return?
the taxable year is not equal to the

total tax due on the entire taxable
income of that year?
The corporation shall either
1. Pay the balance of tax still due
2. Carry-over the excess credit
3. Be credited or refunded with the excess
amount paid
Q113.1. Differentiate a tax credit from a

tax refund
In a tax refund, any tax on income that is paid in
excess of the amount due the government is
refunded. In a tax credit, the refundable amount is
applied against the estimated quarterly income tax
liabilities of the succeeding taxable year
Q113.2. Are the options to file a tax

refund and to avail of tax credit
alternative remedies?
Yes. As held in PHILAM ASSET M ANAGEMENT V. CIR
[DECEMBER 14, 2005], these two options are
alternative. The choice of one precludes the other.
One cannot get a tax refund and a tax credit at the
same time for the same excess income taxes paid.
Q113.2.1. If the corporate taxpayer fails

to signify his intention in the
Final Adjustment Return, is it
barred from making a valid
request for refund should it
choose this option later on?
No. As held in PHILAM ASSET M ANAGEMENT V. CIR
[DECEMBER 14, 2005], failure to indicate a choice will
not bar a valid request for a refund, should this option
be chosen by the taxpayer later on.
Q113.3. What is the irrevocability rule?

No. Once the option to carry-over the excess and
apply the excess quarterly income tax against income
tax due for the taxable quarters of the succeeding
taxable years has been made, such option shall be
considered irrevocable for that taxable period and no
application for cash refund or issuance of a tax credit
certificate shall be allowed. (see Section 76, Tax
Code and SYSTRA PHILIPPINES V. CIR [SEPTEMBER 21,
2007])
Q113.4. What is the implication when a

corporation fills out the portion
As held in PHILAM ASSET M ANAGEMENT V. CIR

[DECEMBER 14, 2005], the fact that the corporation
filled out the portion prior years excess credits in
the Final Adjustment Return means that it
categorically availed itself of the carry-over option. If
an application for tax refund has been or will be filed,
that portion should necessarily be blank.
Where to file
Q114. Where should the quarterly income
tax declaration and final adjustment
return be filed?
They shall be filed with the
1.
2.
3.
4.
Authorized agent bank

Revenue District Officer
Collection Agent
Duly authorized Treasurer of the city or
municipality having jurisdiction over the location
of the principal office of the corporation filing the
return or place where its main books of accounts
and other data from which the return is prepared
(see Section 77, Tax Code)
When to file
Q115. When should the quarterly income tax
declaration and final adjustment
return be filed?
The corporate quarterly declaration shall be filed
within 60 days following the close of each of the first
here quarters of the taxable year.
The final adjustment return shall be filed on or before
th
th
April 15, or on on or before the 15 day of the 4
month following the close of the fiscal year, as the
case may be.
When to pay
Q116. When should the income tax due be
paid?
The income due on the corporate quarterly returns
and final adjustment income tax returns shall be paid
at the time the declaration or return is filed.
86

INCOME TAX
Capital gains on shares of stock
Return of GPPs
Q117. When should the return for capital

gains on shares of stock be filed?
Q119. Is a GPP required to file a return?
Every corporation deriving capital gains from the sale

or exchange of shares of stock not traded thru a local
stock exchange shall file a return within 30 days after
each transaction and a final consolidated return of all
transactions during the taxable year on or before the
th
th
15 day of the 4 month following the close of the
taxable year.
Return of corporations contemplating

dissolution/reorganization
Q118. If a corporation plans to dissolve or
reorganize, what are its obligations
with respect to returns and payments
of taxes?
Yes. RR 2 provides that all corporations,
contemplating dissolution or retiring from business
without formal dissolution shall, within 30 days after
the approval of such resolution authorizing their
dissolution, and within the same period after their
retirement from business, file their income tax returns
covering the profit earned or business done by them
from the beginning of the year up to the date of such
dissolution or retirement and pay the corresponding
income tax due thereon upon demand by the CIR.
In BPI V. CIR [CA-G.R. SP. NO. 38304, APRIL 14,
2000], by virtue of a merger, BPI became the
successor-in-interest of FEBTC on July 1, 1985. On
April 10, 1986, FEBTC filed its final income tax return
with the BIR showing, among others, a refundable
amount of P174,065.77. BPI filed a claim for refund
of this amount. The BIR and CTA stated that the
claim for refund has already prescribed because the
return should have been filed by FEBTC within 30
days from SEC's approval of the Articles of Merger.
BPI contended that the said return should have been
filed on the 15th day of the 4th month following the
close of FBTC's taxable year. The CA agreed with
the BIR and CTA. Section 78 of the Tax Code and
Section 224 of RR 2 required FEBTC as a dissolving
corporation to file its income tax return within 30 days
after the cessation of its business or 30 days after the
approval of the merger on July 1, 1985 or up to July
31, 1985. Thus, the claim for refund has already
prescribed.
Yes. Although
a GPP is not a taxable entity, it is

required to file a return of its income setting forth the
items of gross income and deductions, and the
names, taxpayer identification numbers (TIN),
addresses and shares of each of the partners. (see
SECTION 55, Tax Code).
Return of Receivers,
Bankruptcy or Assignees
Trustees
in
Q120. Who shall make the return if the

property or business of a corporation
is being operated by receivers,
trustees or assignees?
If receivers, trustees in bankruptcy or assignees are
operating the corporation, such receivers, trustees
or assignees shall make the returns of net income
as and for such corporation and the tax due shall be
assessed and collected in the same manner as if
assessed directly against the corporation.
Others not captured

Q121. How shall the tax upon gains, profits,
and income not falling and not
returned
and
paid
under
the
provisions on returns and payment of
tax be assessed?
They shall be assessed by personal return. The rule
is that all gains, profits, and income of a taxable
class, shall be charged and assessed with the
corresponding tax and the said tax shall be paid by
the owners of such gain, profits or income or the
proper person having receipt, custody, or control or
disposal of the same
Other income tax requirements

Q122. Enumerate the other income tax
requirements under Section 67-72 of
the Tax Code
1. All persons, corporations, duly registered general
co-partnerships undertaking for profit or
otherwise the collection of foreign payments of
interests or dividends shall obtain a license from
the CIR. (see Section 67, Tax Code)
87

INCOME TAX
co-partnerships making income payments to
another are required to render a true and
accurate return to the CIR setting forth the
amount of such gains, profits and income and the
name and address of the recipient of such
payments. (see Section 68, Tax Code)
co-partnerships, doing business as a broker,
shall render a correct return showing the names
of customers for whom such persons,
corporations, duly registered general copartnerships transacted business with. (see
4. Any attorney, accountant fiduciary, bank, trust
company, financial institution or other person,
who aids, assists, counsels or advises in, or with
respect, to the formation, organization or
reorganization of any foreign corporation shall
within 30 days thereafter file a return with the
CIR. (see Section 70, Tax Code)
5. After the assessment shall have been made,
returns, including corrections thereto made by the
CIR, shall be filed in the Office of the CIR and
shall constitute public records and be open to
149
inspection upon order of the President
(see
6. When an assessment is made in case of any list,
statement or return, which in the opinion of the
CIR was false or fraudulent or contained any
understatement or undervaluation, no tax
collected under such assessment shall be
recovered by any suit unless the said list,
statement or return was not false nor fraudulent
and did not contain any understatement or
150
undervaluation. (see Section 72, Tax Code)
cargo revenue and paid a lower income tax thereon,

and that its underpayment of the income tax on cargo
revenue is even higher than the income tax it paid on
passenger revenue subject of the refund, such that
refund cannot be granted.
In UNITED AIRLINES V. CIR [SEPTEMBER 29, 2010], the

CTA found that United Airlines underpaid its Gross
Philippine Billings because United made erroneous
deductions from its gross cargo revenues in the ITR.
United questioned the proprietary of the CTAs
determination. The Supreme Court held that under
Section 72 of the Tax Code, the CTA can make a
valid finding that the taxpayer made erroneous
deductions on its gross cargo revenue, that because
of such erroneous deductions, it reported a lower
149
RA 10021 or the Exchange of Information on Tax Matters Act of

2009 provides that income tax returns of specific taxpayers subject
of a request for exchange of information by a foreign tax authority
pursuant to an international convention or agreement on tax
matters to which the Philippines is a signatory or a party of, shall
be open to inspection upon order of the President
150
This provision does not apply to statement or returns made or to
be made in good faith regarding annual depreciation of oil or gas
wells and mines
88

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PM REYES NOTES ON INCOME TAXUnder the global tax system, all types of income arelumped together and taxed at graduated rates as asingle taxable income

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PM REYES NOTES ON TAXATION I:

Q2.What is an income tax?

Q3.When is income taxable? (or what are the

1. There is income, gain or profit

Q3.1. What is the difference between

Q3.1.1 Are stock dividends income or

As opposed to mere reimbursements or return on capital.

PM REYES NOTES ON TAXATION I: INCOME TAX (Updated 14 January 2013)

PM REYES NOTES ON TAXATION I:

Q3.3. What is the constructive receipt

As explained by the Supreme Court in FISHER V.

The constructive receipt doctrine provides than an

However, stock dividends constitute as income if a

Q3.2. Are money received as damages

Income is received not only when it is actually

Overview of the Philippine Income Tax

Q4.1. What are the kinds of income tax

The exception to the rule that stock dividends do not constitute

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PM REYES NOTES ON TAXATION I:

6. Capital gains tax on sale or exchange of real

Under the schedular tax system, the various types of

Q4.3. What are the types of Philippine

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An individual, a trust, estate or

PM REYES NOTES ON TAXATION I:

An individual whose residence is

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

the pertinent items of gross

4. Real property used in trade

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PM REYES NOTES ON TAXATION I:

The kinds of income taxpayers under Title II of the

Q8.Who is a non-resident alien?

Q8.1. How is the residency of an alien

Resident citizens and resident aliens

Before proceeding to income proper, it is important to know the

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The Supreme Court further held that, as laid clearly in

In other words, stay is indefinite.

PM REYES NOTES ON TAXATION I:

Q8.2. When is the residence of an alien

Q9.1. Should a non-resident citizen file

return. However, under RR 05-01 [July 31, 2001],

Q9.2. What is meant by the phrase

Q9.3. If a natural-born Philippine citizen

Non-resident aliens engaged in business

Who is a non-resident alien?

A non-resident alien is an individual:

No. Previously, under RR No. 01-79, non-resident

In other words, the stay is definite but extended.

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PM REYES NOTES ON TAXATION I:

Differentiate the kinds of corporate

A corporation is itself a taxpaying entity and speaking

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(see N.V. REEDERIJ AMSTERDAM VS. CIR [JUNE 23,

Is a partnership liable for income tax?

Yes. The term corporations includes partnerships,

Q12.1. Is a GPP13 liable for income tax?

Q12.2. Distinguish between a GPP and an

A and B, co-owners, bought 3

No. A Co-Ownership who own properties which