INCOME TAX

FEATURES OF OUR PRESENT INCOME TAXATION

Q. What are the features of our present income taxation in

the light of R.A 8424?
A. We adopted the so-called “COMPREHENSIVE TAX
SITUS” – Comprehensive in the sense that we practically
apply all possible rules of tax situs.

Criteria used: (Code: R. P. N.)

a) Residency of taxpayer;
Situations where we utilized residency as basis:
1) We tax the income of a resident alien derived
from sources within the Philippines.
2) We also tax the income from sources within of
resident foreign corporation in the Philippines.

b) Place/Source
Used as a basis in taxing the income of a non-resident
alien individual. We can only tax his income derived from
sources within and in taxing the same, we consider the
place where the income is derived.

c) Nationality or Citizenship in the case of individual

taxpayer
We used that as a basis in imposing tax on the income of
a resident citizen. Resident citizen may be taxed from his
sources within and without. The source of income here is
immaterial what we consider is the nationality or
citizenship of the taxpayer.

Domestic corporation – we can tax its income derived from

sources within and without.

On Non-resident citizen, they can only be taxed on their

income derived from the sources within – tax situs is the
place /source of income.

Taxpayer Sources
1. RC I/O (Sec. 23 [A])
2. NRC I (Sec. 23 [B])
3. OCW I (Sec. 23 [C])
4. ALIEN I (Sec. 23 [D])
4.1 NRA-ETB
4.2 NRA-NETB
4.3 ALIEN ERA-MNC
4.4 ALIEN OBUs
4.5 ALIEN PSCS
5. Domestic Corp. I (Sec. 23 [E])
6. Foreign Corp- I (Sec. 23 [F])
RFC/NRFC
 1) A resident citizen is taxable on all income derived
from sources within and without the Philippines.

2) A non-resident citizen is taxable only on income

derived from sources within the Philippines.

3) An overseas contract worker is taxable only on

income from sources within the Philippines; a
seaman who is a citizen of the Philippines and who
receives compensation for services rendered abroad
as a member of the complement of a vessel engaged
exclusively in the international trade shall be
treated as an overseas contract worker.
4) An alien individual, whether a resident or not of
the Philippines, is taxable only on income derived
from sources within the Philippines.

5) A domestic corporation is taxable on all income

derived from sources within and without the
Philippines; and

6] A foreign corporation, whether engaged or not in

trade or business in the Philippines, is taxable only on
income derived from sources within the Philippines.

Income Taxation may be grouped into:

1) individual income taxation
2) corporate income taxation

Q. What are the basic features of individual taxation?

(S.P. F. E. M.)
A.
1) Individual income taxation adopted the Schedular
system of taxation

Schedular System of Taxation – is a system employed

where the income tax treatment varies and made to depend
on the kind or category of the taxpayer’s taxable income
(Tan vs. Del Rosario).

Characteristics of schedular system of taxation:

a) It gives or accords different tax treatment on
the income of individual taxpayer.
b) It classifies income.

Manifestations: (that under the individual taxation

we adopted the schedular system of taxation)
[C, B, P, Dp, I, R, R, D, A, Pw, P, P]

Under Sec. 32(a), income may be categorized as follows:

1) compensation income,
2) business income,
3) professional income,
4) income derived from dealings in property,
5) interest income,
 6) rent income,
7) royalties,
8) dividends,
9) annuities,
10) prizes,
11) winnings,
12) pensions, and
13) partner’s distributive share from the net income of
the general professional partnership.

 This is the manifestation that as far as

individual income taxation, the income is
categorized.

2] The tax rates are progressive in character. This is clear

under Sec. 24 (a). You will notice there that the tax base
increases as the tax rate increases.

3] Modified gross income as regards compensation

earner. Modified because in determining the taxable
compensation income, the only allowable deductions are
personal and additional exemption. You cannot deduct the
allowable deductions under Sec. 34 from gross
compensation income.
But as regards those individual taxpayers that
derived business, trade or professional income, we adopted
the net income system. This is so because under Sec. 34,
allowable deductions may be claimed by individual
taxpayers who derived business trade and professional
income.

4] We employ this “Pay as you File” system.

5] Under certain cases, we employ the “pay as you earn”

system. This applies to “income subject to withholding tax”.

Q. What are the basic features of corporate income

taxation?
A.
1] Global Concept has been adopted. >>> Global system
where the tax treatment views indifferently the tax base and
treats in common all categories of taxable income of
taxpayer (Tan vs. Del Rosario).

Characteristics of Global system of Taxation:

a) Uniform tax treatment – this is subject to diminishing
corporate tax rates of 34% (Jan. 1, 1998), 33% (Jan. 1,
1999), 32% (Jan. 1, 2000). See Chapter IV, Sec. 27).
b) Does not categorize income.
2] Corporate taxpayer, particularly domestic
corporations are entitled to deductions. So, insofar as
domestic corporation and resident foreign corporation is
concerned, we adopted here the net income tax system.
  New provisions under R.A. 8424: 10% tax on
improperly accumulated earnings of a
corporate taxpayer.

3] Pay as you file system has also been employed.

 Corporate taxpayer is allowed to adopt
calendar or fiscal year period. Corporate
taxpayer files corporate income tax return
quarterly. And it also files the so-called FINAL
ADJUSTED RETURN.
 In the case of individual taxpayer, the
payment should not be later than April 15 of
every taxable year. Individual taxpayers are
not allowed to adopt the so-called FISCAL
YEAR PERIOD.

* Individual taxpayers are allowed to adopt only the

calendar year period while corporate taxpayers have the
option either the calendar year period of the fiscal year
period.

Calendar year period – this covers the period of 12-month

commencing from Jan. 1 and ending Dec. 31.

Fiscal year period – this is also a 12-month period

commencing on any month or ending on any month other
than Dec. 31.

DEFINITION OF CERTAIN TERMS

GROSS INCOME TAXATION – is a system of taxation,

where the income is taxed at gross. The taxpayers under
this system are not entitled to any deductions.

In general, we adopted the net income taxation because

under Sec. 34, taxpayers are allowed to claim the so-called
ALLOWABLE DEDUCTIONS.

GROSS INCOME – means all income derived whatever

source, including but not limited to the following: [STP-IRR-
DAP-PS]
1. Compensation for services;
2. Gross income from trade or business or the exercise of a
profession;
3. Gains derived from dealings in property;
4. Interests;
5. Rents;
6. Royalties;
7. Dividends;
8. Annuities;
9. Prizes and winnings;
10. Pensions; and
11. Partner’s distributive share from the net income of the
general professional partnership.
NET INCOME TAXATION – income is taxed at net. The
taxpayer may claim allowable deductions.

INCOME – all wealth which flows in the taxpayer other than

a mere return of capital. It includes all income specifically
described as gain or profit including gain derived from the
sale or disposition of capital asset.

JUDICIAL DEFINITION: It also means gains derived from (1)

capital, (2) labor, or (3) both labor and capital including
gains derived from the sale or exchange of capital asset.

FOUR (4) Sources of INCOME; [ClaBS]

a. Capital
b. Labor
c. Both labor and capital
d. Sale of property

Example of income derived from capital >>> Interest Income

Example of income derived from labor >>> Compensation

Income

Example of income derived from both capital and labor >>>

Income of an independent contractor. The independent
contractor provides work force, provides capital and derives
income from such capital.

* In determining the profit from the sale of property, you

should always be guided by this formula:

Amount Received Or Realized LESS Cost of Property

= PROFIT

TAXABLE INCOME – (the old term is Net Income) – means

all pertinent items of gross income specified in the Tax Code
less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by
this Code or other special laws. (Sec. 31 of the TRA of
1997).

Shoter Version: All pertinent items of gross income less

allowable deductions.

Q. What are the advantages/disadvantages of gross income

taxation and net income taxation?
Advantages of gross income taxation:
1. It simplifies our income taxation. This is so because
since no deductions are allowed, it is very easy to tax the
income. You don’t have to find out whether deductions or
expenses are legitimate or not because they are not
deductible.
2. This will generate more revenue to the government.
3. It minimizes cost.
Disadvantages of gross income taxation:
1. As far as the taxpayer is concerned, this is inequitable
because they cannot claim the expenses, which are
incurred in connection with his trade or business or
exercise of his profession.
2. And if this is the system, in all likelihood the taxpayers
will lose interest to earn more. It will in effect reduce the
purchasing capacity of the taxpayer.
3. Since taxpayers cannot claim those legitimate expenses
as deductions, they may resort to fraudulent scheme that
will minimize their tax ability and this may be done through
the understatement of income. So, in effect, this will
encourage tax evasion.

Advantages of net income taxation:

1. As far as the taxpayer is concerned, they will consider
this as equitable and just system.
2. This will minimize tax evasion because examiners will be
employed to check whether expenses are correct or not.
3. The consequence of no. 2 is that this will generate more
revenues.

Disadvantages of net income taxation:

1. vulnerable to graft and corruption
2. vulnerable to tax evasion
3. will give rise to loss of revenues.

SOURCES/SITUS OF INCOME
An income may be an income from within or without
the Philippines. The other term for income within is Local
Income while income without is sometimes called Global
Income or Universal Income.

In determining whether an income is an income within or

without, you have to consider the classification or kind of income.

CLASSIFICATION OF INCOME: [C, B, P, I, R, R, D, A, P, P, P]

1. Compensation income from services
2. Income derived from business, trade or profession – in
this regard, the common forms of business are
merchandising business, farming business, mining
business and manufacturing business.
3. Income from sale or exchange of property (either real or
personal property)
4. Interest Income
5. Rent Income
6. Royalties
7. Dividends, which may be received from domestic or
foreign corporation
8. Annuities
9. Prizes and winnings
10. Pensions
11. Partner’s distributive share in the net income of general
professional partnership (Professional income of a partner)
* COMPENSATION INCOME
Tax Situs: Place where services are rendered. So, if services
are rendered within the Phils., that is a Local Income. If it is
a payment for services rendered outside the Phils., that is
an income without.
RC – income from within and without are taxable.
NRC – only compensation income from sources within is
taxable.
RA – same as NRC.

* BUSINESS INCOME [M3 F]

a) Merchandising Business
b) Farming Business Tax Situs: Place where
these
c) Mining Business business are
undertaken.
d) Manufacturing Business

Tax Situs:
(1) if the goods are manufactured in the Phils. And sold
within the phils. This is considered as income derived
purely within.

(2) Goods manufactured outside the Phils. and sold outside

– income derived purely without.
(3) Goods manufactured within the Phils. and sold outside
the Phils. – income partly within and partly without.

(4) Goods manufactured outside the Phils. and sold within

the Phils. – income partly within and partly without.

* INCOME FROM SALE OR EXCHANGE OF PROPERTY

 If it involves personal property, in determining
the tax situs, we have to consider the place of
sale.

 In the case of sale of transport documents, tax

situs is the place where the transport
document is sold (BOAC Case).

 If it involves real property, the tax situs is the

place or location of the real property. So, if the
property sold is situated within the Phils., the
income derived from such sale is considered
as income within.

* INTEREST INCOME
Tax Situs: RESIDENCE of the DEBTOR

Case: There was this contract regarding the construction of

ocean-going vessels. There was this issuance of letter of
credit and the payment of downpayment. All the elements
of the transactions took place in Japan. The payment was
made in Japan. The letter of credit was executed in Japan.
The delivery was made in Japan. The debtor is a domestic
corp.

Is the interest income on this loan evidenced by the

letter of credit taxable to the Japanese corp.?

HELD: NO, because the tax situs of interest income is not the
activity but the residence of the debtor. The place where the
contract of loan is executed is immaterial.

* RENT INCOME
Tax Situs: the PLACE of property subject of the contract of
lease.

* ROYALTIES
Tax Situs: the PLACE where the intangible property is USED

* DIVIDEND
a. Received from domestic corp. – this is an income purely
within.

b. Received from foreign corp. – consider the income of the

foreign corp. in the Phils. during the last preceding three (3)
taxable years;

rules:
(1) The income is purely within if the income derived from
the Phil. sources is more than 85%

(2) It is purely without if the proportion of its Phil. income to

the total income is less than 60%

(3) There should be an allocation if it is more than 50% but

not exceeding 85%

* ANNUITIES
Tax Situs: the PLACE where the contract was made

* PRIZES AND WINNINGS

 Prizes may be given on account of services
rendered – in which case, the tax situs is the
place where the services were rendered.

 If these prizes are not given on account of

services, the tax situs is the place where the
same was given.

 Tax situs of winnings is the place where the

same was given.

*PENSION
Tax Situs: PLACE where this may be given on account of
services rendered

*PROFESSIONAL INCOME OF PROFESISONAL

PARTNERS
Tax Situs: PLACE where the exercise of profession is
undertaken

GROSS INCOME
GROSS INCOME – means all income derived from whatever
source, including but not limited to the following:

INCLUSION: [code: STP-IRR-DAP-PS]

1. compensation for services
2. gross income from trade or business or the exercise of a
profession
3. gains derived from dealings in property
4. Interests
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions and
11. Partner’s distributive share from the net income of the
general professional partnership (Sec. 32 of TRA of 1997)

EXCLUSIONS [code: LAGCIRM]

1. proceeds of life insurance policy
2. amount received by the insured as return of premium
3. gifts, bequests, devises or descent
4. compensation for injuries or sickness
5. income exempt under treaty
6. retirement benefits, pensions, gratuities
and others: (F, V, R, S, S, G)
a. retirement benefits received from foreign
institution whether public or private
b. veteran’s benefits
c. retirement benefits received from private firms
whether individual or corporate
d. separation pay
e. SSS
f. GSIS
7. miscellaneous items:
a. prizes and awards given in recognition of religious,
charitable, scientific, educational, artistic, literary, or
civic achievements
CONDITIONS:
1. the recipient was selected without any action on
his part to enter the contest or proceeding
2. the recipient is not required to render substantial
future services as a condition to receiving the
prize or award
b. income derived by the government or its political
subdivisions from the exercise of any essential
governmental function or from any public utility
c. income derived from investment in the Philippines by
foreign government or financing institutions
d. prizes and awards in sports competitions
e. gain derived from the redemption of shares of stock
issued by the mutual fund company
f. contributions to GSIS, SSS, PAG-IBIG, and union dues
g. benefits in the from of 13th month pay and other
benefits
h. gain derived from the sale, exchange, retirement of
bonds debentures or other certificate of indebtedness
with a maturity of more than five (5) years. (Sec. 32 (b),
TRA of 1997)

*ALLOWABLE DEDUCTIONS

1. Optional Standard Deduction – of ten percent (10%) of the

Gross Income available only to individual other than a non-
resident alien provided he signifies in his return his
intention to elect OSD, otherwise, itemized deductions
apply. Election made shall be irrevocable for the taxable
year (Sec. 34 L)
2. Itemized Deductions – under Sec. 34 A-K, and M
3. Personal and Additional Deductions/Exemptions under
Sec. 35

* ITEMIZED DEDUCTIONS [code: ELIT-BDD-CRC]

1. expenses
2. loses
3. interest
4. taxes
5. bad debts
6. depreciation
7. depletion of oil, gas wells and mines
8. charitable and other contributions
9. research and development
10. contribution to pension trust

* NON-DEDUCTIBLE ITEMS
(Sec. 36 A)
1. Personal living or family expenses;
2. Amount paid for new buildings or permanent
improvements, or betterment to increase the value of any
property or estate;
3. Any amount expended in restoring property or in making
good the exhaustion thereof for which an allowance is or
has been made; or
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.
(Sec. 36 B) Losses from sales or exchanges of property directly
or indirectly –
1. Between members of a family (brother, sister of half or
full blood, spouse, ascendant, lineal descendants);
2. Except in case of distributions in liquidation, between an
individual and a corporation – more than 50% in value of
the outstanding stock of which is owned directly, by or for
such an individual; or
3. Except in case of distributions in liquidation, between
two corporations – more than 50% in value of the
outstanding stock of each of which is owned, directly or
indirectly, by or for same individual, if either one of such
corporation is a personal holding company or a foreign
personal holding company; or
4. Between the grantor and a fiduciary of any trust; or
5. Between fiduciary of a trust and the fiduciary of another
trust, if the same person is a grantor with respect to each
trust; or
6. Between a fiduciary of a trust and a beneficiary of such
trust.

TAXABLE INDIVIDUALS
RESIDENT CITIZENS (RC)
 Income from within and without – taxable

NON-RESIDENT CITIZENS (NRC)

 Income from within

 When an NRC returns to the Phils., his income

may also be taxed as Resident Citizen or Non-
Resident Citizen.

Illustration: A, an OCW, arrived in the Phils. sometime in

June 1998. He will be taxed as a Non-Resident Citizen
(NRC) as regards the income that he earned which covers
the period of January to June. Now as regards the income
that he will derive upon his arrival from June to December,
he will be taxed as Resident Citizen (RC).

But if he is not in the Phils. from the period of January to

December 1998, he will be taxed as NRC for the said period.

If he will return to the Phils. and stay there from January t

December 1999, he will be taxed as RC for the same period.

* NRC must prove to the satisfaction of the BIR

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

* When an NRC decides to return to the Phils., he must

prove his intention to reside here permanently.
* Now NRC includes OVERSEAS CONTACT WORKERS
(OCW), IMMIGRANTS, and those who STAY OUTSIDE the
Phils. by virtue of an employment.

RESIDENT ALIEN (RA)

1. An individual who is not a citizen of the Phils. but a
resident of the Phils.
* Includes those who consider the Phils. as a second
home.
*** Transient tourist who just sojourn, their stay is merely
temporary, thus may not be considered as RA.

* If an alien stays in the Phils. for a period of more than

one (1) year, he is considered as RA.

SPECIAL NON-RESIDENT ALIEN ENGAGED IN TRADE

OR BUSINESS (NRA-NETB)
* He must be an alien individual who is not residing in the
Phils. and not engaged in trade or business in the Phils.

* He is one whose stay in the Phis.is not more than 180 days

SPECIAL NON-RESIDENT NOT ENGAGED IN TRADE OR

BUSINESS (SNRA-NETB)
* Those employed by: (ROP)
1. Regional or Area Headquarters of Multinational
corporations;
2. Offshore Banking Units;
3. Petroleum Service Contractors

NON-RESIDENT ALIEN ENGAGED IN TRADE OR

BUSINESS (NRA-ETB)
> considered as engaged in trade or business if his stay is
more than 180 days

> We can no longer tax his income from sources without.

We can only tax his income from sources within.

ENTITLEMENT OF DEDUCTIONS

RC – entitled to deductions because the tax base is taxable

income.

Gross Income
Less: Allowable deductions
=======================
Taxable Income

NRC – entitled to deductions because the tax base is

taxable income.

RA – entitled to deductions because the tax base is taxable

income.
NRA-TB – entitled to deductions because the tax base is
gross income. Their income is subject to 25% tax rate.

SNRA-NETB – subject to 15% tax rate on their income in

the from of:
S - Salaries
H - Honoraria
O - Other
W - Wages
E - Emoluments
R - Remuneration

EXCLUSION FROM GROSS INCOME

“PROCEEDS OF LIFE INSURANCE”

Subject to tax if :
1. the insurer and insured agreed that the amount of the
proceeds shall be withheld by the insurer with the
obligation to pay interest in the same, the interest is the one
subject to tax;

2. there is transfer of the insurance policy;

Example:
A transferred to B his life insurance policy. The value
of the policy is P1 M. B paid a consideration amounting to
P300,000. B continued paying the premiums after the
transfer such that the premiums amounted to P200,000.
Upon the death of the insured, the P1 M may be received by
the heirs.

Q. Is the full amount of P1 M exempt?

A. NO, only the consideration given and the total
premiums paid may be excluded. That is, P1 M less
P500,000.

Problem:
A obtained a life insurance policy for B. B is the
president of A’s corporation. Corp. has an insurable interest
in the life of its officers, so premiums may be paid by the
employer A. Upon the death of B, his designated
beneficiaries will receive the proceeds.

a. Is the amount representing the proceeds of the life

insurance policy taxable?
b. What about the premium paid by the employer A?
Does this amount form part of the gross
compensation income?
c. Does the amount representing the proceeds of life
insurance policy from part of the estate of the
decedent?
Answers:

a. Let us first make two (2) assumptions. Let us assume

that:
1. the beneficiary designated is the employer;
2. the beneficiary designated is the heir of the
family of the insured.

The Tax Code however, makes no distinction.

Regardless of the designated beneficiary is the employer or
the heirs, or the family of the insured proceeds of life
insurance policy should always be excluded.

b. Premiums of life insurance policy paid by the

employer may form part of compensation income;
hence, taxable if the beneficiary designated are the
heirs or the family or the employees.

It is not taxable compensation income if the designated

beneficiary is the employer because that is just a mere
return of capital.

c. Proceeds of life insurance policy may be excluded from

the gross estate of the decedent under the following
cases:
1. if the beneficiary designated is a 3rd person
and the designation is irrevocable;
2. it is a proceed of a group insurance policy.

However, it is included in the gross estate of the decedent:

1. if the beneficiary designated in the estate,
executor or administrator of the estate or the
family of heirs of the decedent;
2. if the beneficiary designated is a 3rd person
and the designation is revocable [see Section
85 (e)]

As far as Sec. 85 (e) is concerned, an employer may be

considered a 3rd person.

“AMOUNT RECEIVED BY INSURED AS RETURN OF

PREMIUM”
Reason for Exclusion: It represents a mere return of capital.

The sources of this return of premium: (L.E.A.)

1. Life Insurance Policy
2. Endowment contracts
3. Annuity contracts
---Whether the premiums are returned during or at the
maturity of the term mentioned in the contract or upon
surrender of thee contract

Problem:
 A took out an endowment policy amounting to P1 M.
He paid premiums amounting to P800,000. Upon the
maturity of the policy, A received that P1M.
How much is the taxable amount?

Answer:
That is P1,000,000. – value of endowment policy
LESS: P 800,000. – representing amount of
premium

===============================================
P 200,000. – taxable amount

*“GIFTS, BEQUESTS and DEVISES”

Rationale: What is contemplated here are donations which
are purely gratuitous in character in order that it may be
excluded.

 Gifts are excluded because these are subject

to donor’s tax.
 Bequests and devises are excluded because
these may be subject to estate tax.
 What about remuneratory donations?
Remuneratory donations are subject to income
tax.
EXCEPTIONS to the Rule:>>> the income or fruit of such
money given by donation, bequests or devise, including the
income of this gift, bequest or devise in cases of transfer of
divided interest.

*“COMPENSATION FOR INJURIES OR SICKNESS”

Reason for Exclusion: This is just an indemnification for the
injuries or damages suffered. This is compensatory in
nature.

The sources are:

1. The compensation may be paid by virtue of a suit;
2. It may be paid by virtue of health insurance, accident
insurance or Workmen’s Compensation Act

But as regards damages representing loss of anticipated

income, this is the one that is taxable.

If damages are in the nature of moral, exemplary, nominal,

temperate, actual and liquidated damages, as a rule, these
may not be subject to tax.

Example:
If a person suffered injury as a result of a vehicular
accident, and an action is filed in court, the Court awards
the following:

Moral - P100,000.
Exemplary - P100,000.
Actual - P 60,000. (hospitalization expenses)
P 20,000. (repair of car)
P 60,000. (loss of income)

*** All damages awarded are tax-exempt except damages of

representing loss of income.

Question: Are damages awarded by the Court on account of

breach of contract taxable?

Answer: Qualify your answer. With regards to damages

awarded on account of loss of earnings of the contracting
party, it is taxable.

“INCOME EXEMPT UNDER TREATY”

Reason for the Exclusion: Treaty has obligatory force of
contract.

Exception: As may be provided for in the treaty.

*“RETIREMENT BENEFITS, PENSIONS, GRATUITIES

AND OTHERS”

- VETERAN’S BENEFIT
* This may be given by the US Administration.
* The recipient must be a resident veteran.

- BENEFITS GIVEN BY FOREIGN AGENCIES OR

INSTITUTIONS WHETHER PUBLIC OR PRIVATE

Giver: Foreign government agencies or institutions whether

public or private.
Recipient: Resident citizen, non-resident citizen or resident
alien.
Observation:
Non-resident citizen should not be included in the
enumeration since it is already understood that we cannot
tax his income from without. We can only tax the income of
non=-resident citizen derived from sources within.

The same is true with resident alien because we can only

tax his income from sources within.
The inclusion of NRC and RA in the enumeration are mere
surplusage.

-RETIREMENT BENEFITS RECEIVED FROM PRIVATE

FIRM WHETHER INDIVIDUAL OR CORPORATE

Recipient: Private employees or official of such private firm.

REQUISITES:
1. The private employee or official must be at least 50 years
of age at the time of his requirement;
2. He must have rendered at least 10 years of service to the
employer at the time of the retirement;
3. There must be reasonable private benefit plan –
established by the employer;
4. The reasonable private benefit plan must be approved by
the BIR.
5. Reasonable private benefit plan may be in the nature of
pension plan, profit sharing plan, stock bonus plan, or
gratuity;
6. The employer must give contribution and no amount
shall inure to the benefit of a particular employee or official.
This must be established for the common benefit of the
employees or officials;
7. This can be availed of ONCE.

* The subsequent retirement benefits received from another

private employer is no longer exempt but subject to tax.

* If the second employer is a government entity or

institution, in which case, that is exempt because the giver
here is not a private firm. The limitation applies only when
the giver of the subsequent retirement benefits is another
private employer.

-PHYSICAL DISABILITY BENEFITS

* These include death benefit, sickness benefit and other
disability benefit. Sometimes, the term used is “separation
pay”.

Giver: may either be public or private employer

*Sources of Separation Pay:

1. Death of an employee;
2. Physical disability of an employee;
3. Any other cause beyond the control of the employee or
official.

Example of no.3
a. Retrenchment of employees;
b. Installation of labor saving devises;
c. Dissolution of law firm.

>Resignation of an employee is a cause within his control.

>But, involuntary resignation is beyond the control of the
employee.
>The most important thing here is that the separation pay
was given on account of the above-mentioned sources.
>There is no requirement as to age of the employee or
official; there is also no requirement as to the length of
service of the employee or official.
>No requirement also as to the number of availment of
benefits.

-AMOUNT OF THE ACCUMULATED SICK LEAVE AND

VACATION LEAVE CREDITS
  The monetized value of these benefits may be
subject to tax if these will not form part of the
terminal leave pay.
 The monetized value of sick leave credit is
always tax exempt, if it forms part of the
terminal leave pay.
 As regards UNUSED VACATION LEAVE
CREDIT, this is exempt only if the number of
days is 10 days or less in excess of 10 days, it
is already subject to tax.
 If the unused sick leave benefit is monetized, if
the employer allow such practice, and the
same is given at the end of this year, it is
subject to withholding tax because in this
case, it does not form part of the terminal
leave pay.
 Reason for exemption of terminal leave pay:
The accumulated value of unused sick leave
and vacation leave credits included in the
terminal leave pay is exempt from income tax
because it is one received on account of a
cause beyond the control of the employee.
This terminal leave pay is usually given under
a compulsory retirement. Compulsory
retirement is a cause beyond the control ofte
employee.

*“MISCELLANEOUS ITEMS”
a. Prizes and Awards in Awards Competitions
REQUISITES:
1. Competition and tournament must be
sanctioned or approved by the National Sports
Association;
2. The competition and tournament must also be
approved by the Philippine Olympic
Committee, whether local or international;
whether held in the Phils or outside.(if not
accredited- 20% tax)

b. Prizes and Awards made primarily in

recognition of: (RCS-SALE)
Religious, Charitable, Civic Achievement, Scientific,
Athletic, Literary, Educational

Example: P1 M reward given to Mr. Advincula for his

exemplary honesty. This may be excluded from his gross
income because it is given in recognition of civic
achievement. He was (1) selected without any action on
his part to enter a contest or proceeding; and (2) he is not
required to render substantial future services as a
condition to receiving the award.

c. Income derived from public utility or from the

exercise of essential government function by the
Government or political subdivisions of the Phils.
Recipient: Government or its Political Subdivision

* Government of the Republic of the Phils or Government of

the Phils vs. National Government

Government of the Republic of the Phils. is synonymous

with Government of the Phils.
Government of the Phils. or government of the Phils. –
refers to the government corporate entity through which the
functions of the government are exercised throughout the
Phils., including save as the contrary appears from the
context, the various arms through which political authority
is made effective in the Phils., whether pertaining to the
autonomous regions, cities, provinces, municipalities,
barangays or other forms of local government. These
autonomous regions, provincial, city, municipal or
barangay subdivisions are the political subdivisions.

National government - refers to the entire machinery of

the central government. This includes the three (3) major
departments of the government: the Executive, the
Legislative and the Judiciary (Mactan Cebu International Airport
Authority vs. Marcos, Sept. 11, 1996).

 It is clear that government-owned and

controlled corporations is within the
contemplation of the term “national
government”.
 We need this distinctions because the
particular item of exclusion emphasizes the
fact that political subdivisions of the State
form part of the Government of the Phils.
 You must have noticed that there is no
provision regarding government-owned and
controlled corporations. Also, there are no
provisions on agencies or instrumentalities of
the government. The item or income here is
exempt if the recipient is either the
Government of the Republic of the Phils. or
the provincial subdivisions of the State such
as provinces, cities, etc.

* Income derived by a government-owned and controlled

corporation, agency or instrumentality of the government
may be subject to tax.

*Government-owned and controlled corporations are now

subject to corporate income tax, except:
a. SSS
b. GSIS
c. Phil. Health Insurance Corp.
d. PCSO
e. PAGCOR
Situation: A municipality derived income from holding a
fiesta.
Rule: The rule is settled that holding a town fiesta is
considered a proprietary function. Therefore, said income is
subject to tax.

Situation: A municipality derived income from the operation

of public market, electric power plant and other public
utilities.
Rule: That income is tax exempt.

d. Income derived from investment in the Phils. (1)

by foreign government or (2) financing
institutions, owned, controlled or financed by
foreign government, regional or (3) international
financing institutions established by foreign
government

REQUISITES:
1. Recipient must be:
a. foreign government;
b. financing institution owned, financed or
controlled by foreign government;
c. regional financing institution, international
financing institution established by foreign
government;
2. It must be an income derived from investment
in the Phils.

Sources of such income:

--- It may be in the nature of bonds. So, foreign government
here may be considered the creditor – possible income here
is the interest of bonds. Now, loans may be extended –
possible income here is interest on loans.

--- If a foreign government or financing institution made a

deposit in a bank, Phil. currency deposit – the income here
is the nature of interest income.

--- If a foreign government made an investment in a

domestic corporation. It may be considered a stockholder.
And a stockhlder is entitled to dividend. Hence, the
dividend income received from domestic corporation is
tax exempt.

** If the recipient of such dividend is a resident foreign

corporation that is also tax exempt. It is only subject to
tax if the recipient of such dividend is a non-resident
foreign corporation.

Case: EXIMBANK, which is a consortium of Japanese

banks, extended a loan in the amount of S20M to
Mitsubishi Metal Corp., a Japanese corporation. The same
amount was extended by Mitsubishi as a loan to Atlas
Corp., a domestic corporation.
 The contract entered into between Mitsubishi Metal
Corp. is denominated as “contract of loan and sale”. It is a
contract of loan because Mitsubishi would lend Atlas S20M.
It is a contract of sale because under the contract Atlas
bound itself to sell the concentrates (this is a mining corp.)
that may be produced by the concentrator
machine/equipment purchased through the use of the
S20M for a period of 15 years.

This being a contract of loan, Mitsubishi is entitled to

interest on loan.

ISSUE: Whether or not such interest on loan is subject to

Phil. income tax

ARGUMENTS: Mitsubishi contended that this is not taxable

because:
1. The source of S20M is a tax exempt entity (EXIMBANK is
a financing institution controlled and financed by a foreign
government); and
2. Mitsubishi is an agent of EXIMBANK, a tax exempt
entity.

HELD: There was no evidence to the effect that Mitsubishi

is an agent of EXIMBANK. It is a mere allegation that has
not been proven.

In a contract of loan, once the loan is consummated,

the amount becomes exclusive property of the borrower. It
is no longer considered the money of EXIMBANK. Hence,
the interest of such loan should be subject to tax.

The lender is not a tax exempt entity. The creditor

here is Mitsubishi and it is not a tax exempt entity. Such
being the case, tax exemption must be strictly construed
against the taxpayer and liberally in favor of the
government. When you claim exemption, you should prove
it clear and categorical terms.

* The problem may be modified by the examiner. The

examiner may clearly state the Mitsubishi is an agent of
EXIMBANK. The answer is, the interest on loan is tax
exempt. Mitsubishi then is considered as an extension of
EXIMBANK. It is as if the lender is EXIMBANK.

e. 13th month Pay and Benefits

* This applies both to private and public employees.

* Total exclusion should not exceed P30,000 subject to

increase by the Secretary of Finance upon the
recommendation of the BIR Commissioner.

f. Contributions to GSIS, SSS, MEDICARE, PAG-

IBIG, and union dues
* This is a surplusage. Even if this is not mentioned, we
cannot tax that.

g. Sale, exchange, retirement of bonds, debentures

and other certificates of indebtedness with a
maturity of more than FIVE (5) YEARS
- If maturity is less than 5 years, taxable.

Rule: Interest on bonds

1. issued by C.B - exempt
2. if issued by corp.- not exempt

Rule: Redemptions of share in mutual funds:

- only those gains derived from redemption of shares issued
by a mutual fund company are exempt
- it must emanate from a mutual fund
- If the term is not more than 5 years (5 years or less), the
gain derived from the sale, exchange and retirement of the
same, may be subject to tax.

Illustration:
If you are a creditor, you may sell these bonds,
debentures or certificates of indebtedness to another. Hindi
mo na mahintay ang maturity kasi long term. If there is a
gain on the sale of the same, it would be a tax exempt
provided that the bonds, etc., have a maturity or term of
more than 5 years.

Retirement of bonds, debenture, etc. --- Nagbayad

na ‘yung debtor. There may be gain derived from the same,
such as interest. This time, since the gain is in the nature
of interest, it is subject to tax. But, the gain derived from
the sale, exchange or retirement with a term of more than 5
years, is tax exempt. This is because exemptions are strictly
construed against the taxpayer and liberally in favor of the
government. Interests on bonds, debentures, etc. are
taxable, the provision is clear. It only covers
sale/exchange/retirement of bonds, debentures and other
certificate of indebtedness with a maturity of five years.
Strict interpretation of tax exemption.

TYPES/ CLASSIFICATION OF INCOME

1. COMPENSATION INCOME – an income derived under

an employee-
employer relationship.

This may include the following: (WEBB-DROP)

Wages, Emoluments, Bonuses, Benefits, Director’s fee,
Taxable Retirement Benefits, Other items of income of
similar nature, Taxable Pensions
* Retirement benefits may be subject to tax, if it does
not comply with the provision of Sec. 32 (b) par. 6 sub.par
a.

* Pensions may be subject to tax, if it is given not in

accordance with the conditions laid down under that
exclusion provision.

* Other items of income of similar nature may include:

(CHAMP)
Clothing allowance, Hospitalization allowance, Allowances
for Food, Medical allowance, Share from the Profit sharing
plan of the employee

* TESTS TO DETERMINE WHETHER AN INCOME IS

COMPENSATION or NOT:
 Find out whether it is received under an
employer-employee relationship.
 Any payment received under an employer-
employee relationship is compensation
income.

*TESTS TO DETERMINE THERE EXISTS AN EMPLOYER-

EMPLOYEE RELATIONSHIP: (AC-DC)
1. Appointment (selection and hiring)
2. Compensation
3. Dismissal power
4. Control test

N.B. : The name or designation of income is immaterial. The

basis of the income is immaterial and the manner by which
it is paid, is also not important. As long as it is given under
an employer-employee relationship, then that is
compensation income.

CANCELLATION OF INDEBTEDNESS – Considered as

compensation income is the indebtedness had been
cancelled in consideration of the services rendered.

*** Share of the employee from the PROFIT SHARING PLAN of

the employer- Compensation income received in
consideration of services rendered.

TAX LIABILITY OF THE EMPLOYEE PAID BY THE

EMPLOYER – Compensation income if paid under an
employer-employee relationship in consideration of services
rendered.

PREMIUMS PAID BY THE EMPLOYER ON THE

INSURANCE POLICY OF THE EMPLOYEE – Compensation
income if the beneficiary designated is the family of heirs of
the employee.
*** The basis of the income is immaterial. Even if it is paid in
piece work, fixed rate or percentage basis as long as it is
paid under an employer-employee relationship.

REQUISITES FOR TAXABILITY OF COMPENSATION

INCOME ARE: (SPR)
1. There must be services, rendered under an employer-
employee relationship.
2. If payment must be for that services rendered.
3. It must be reasonable. The compensation for services
rendered must be reasonable.

Purpose why only a reasonable amount may be taxed

as compensation income:
Take note on the part of the employer, he can claim
such compensation for services as deduction. Now, only the
amount that is reasonable under the circumstances can be
claimed as deduction. So, if the amount or the value of the
services rendered is P10,000 but the employee received
P15,000. As far as the employer is concerned, he can only
claim the reasonable amount of P10,000. In the case of an
employee, he can consider P10,000 as compensation
income. The excess of P5,000 may be treated as other
income.

*** Not all payments for services rendered are considered

compensation income. Only those paid under the employer-
employee relationship.

THE FOLLOWING ARE NOT COMPENSATION INCOME: (P

I)
1. Compensation for services rendered by independent
service contractor. This may be treated as trade or business
income.
2. Income derived by professionals from the practice of
profession under professional partnership. This is treated
as professional income.

*** Fringe benefit is considered as compensation

income. This is governed by Sec. 33, TRA 1997. This is
compensation income in the sense that this is received
under an employer-employee relatioship.

DOCTRINE OF CASH EQUIVALENT

- you may be paid in cash or in property/kind
- equivalent value of property is taxable

* DIFFERENT FORMS OF COMPENSATION INCOME:

1. Property/Kind – Fair Market Value (FMV) of the
property. If there is a price stipulated, it is the price
stipulated that will be followed in the absence of contrary
evidence.

2. Promissory Note or other evidence of Indebtedness -

 a. If it is not discounted, it is the face value of the
promissory note.
b. If it is discounted, it is the fair discounted value of
the promissory note.

3. Stock – FMV of that shares of stock

4. Cancellation of Indebtedness – Cancellation of

indebtedness has the following tax consequences:
a. It may amount to taxable compensation
income if the indebtedness has been
cancelled in consideration of the services
rendered.

b. It may amount to taxable gift or donation if

the indebtedness has been cancelled without
any consideration at all. This is not subject
to income tax but may amount to taxable gift
or donation.

c. It may amount to capital transaction if the

creditor is a corporation and the debtor is a
stockholder. If creditor corporation condoned
the indebtedness of the debtor stockholder,
that may amount to taxable capital
transaction. This is the form of direct
dividend. Now, property dividend is subject to
tax rates of 6%, 8% and 10%. Dividend
received from domestic corporation is now
subject to tax.

5. Tax liability of the Employee paid by the

employer in consideration of services rendered –
amount of tax liability

6. Premiums paid by the employer on the life

insurance policy of the employee.
a. It is a taxable compensation income if the
beneficiary designated are the heirs of the
employee or his family.

b. It is not a taxable compensation income if the

beneficiary designated is the employer
because it is just a mere return of capital.

If the designation of the employer as beneficiary

is indirect (e.g.: It is the creditor of the employer that is
designated as beneficiary), that is still not taxable
compensation income.
Example of Indirect designation of the employer as a
beneficiary:
a. Beneficiary is the wife of the President of a
close corporation.

b. If the employer may secure a loan from he

insurance policy.

Premiums will be taxed under Sec. 33 par.b no.10. it is

stated there: “Life or health insurance and other non-
life insurance premiums or similar amounts in excess
of what the law allows.

* If the payment was received by the employee when he

was no longer connected with his employer, it is still
considered compensation income. What is important
here is that it must be received during the existence of
the employer-employee relationship. Employees may
be dismissed by the employer, and they may file
complaint for illegal dismissal against the employer.
Judgment was rendered by the arbiter in favor of the
employee. All the wages supposed to be paid (e.g.
backwages) can be taxed as compensation income.
What about attorney’s fees? That is exempt.

FRINGE BENEFITS: code (HEV-HIM-EHEL)

FRINGE BENEFIT – 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 employee) such
as but not limited to the following:
1. Housing;
2. Expense account;
3 Vehicle of any kind;
4. Household personnel such as maid, driver, others;
5. Interest on loan at less than market rate to the
extent of the difference between the market rate
and the actual rate granted;
6. Membership fees, dues and other expenses borne
by the employer for the employee in social and
athletic clubs or other similar organizations;
7. Expenses for foreign travel;
8. Holiday and vacation expenses;
9. Educational assistance to the employee or his
dependents; and
10. Life or health insurance and other non-life
insurance premiums or similar amounts in excess
of what the law allows.(if contribution-exempt)

* Housing allowance may be exempt from tax if the living quarters are:
a. Provided with the premises of the employer.
 b. It must be made as a condition of employment.

 If said requisites are not present, housing

allowance may be taxed as fringe benefits.

* Meal allowance may be exempt from tax if it is provided within

the premises of the employer.

* Privilege or purchase discount are tax exempt if it does not

exceed ½ of the basic monthly salary of the employee. If it is
more than ½, the excess may be as fringe bene

* Medical or hospital allowance, clothing allowance, rice allowance

may be exempt from tax if the following requisites are present:
1. It must be of relatively small value (reasonable
amount). (RSV)
2. It must be given for the following purposes: (CHEG)
a. To promote Contentment
b. To promote Health
c. To promote Efficiency
d. To promote Goodwill

* Tax Exempt fringe benefits: (RF, DM, C, Ex, ECR)

1. Benefits given to the rank and file employees, whether
granted under a collective bargaining agreement or not.

2. “De minimis benefits” – means of small amount. These

are benefits relatively of small amount.

3. Contributions of the employer for the benefit of the

employee to retirement, insurance and hospitalization
benefits plans.

4. Fringe benefits which are authorized or exempted from

tax under special laws.

5. Those given for the convenience of the employer,

including those which are required by the nature of the
trade, business or profession of the employer
(Employer’s Convenience Rule)

De minimis benefits (of relatively small value) – limited to

facilities or privileges furnished or offered by employer to
his employees merely as a means of promoting health,
goodwill, contentment, or efficiency of employees, such as:

a. Monetized unused vacation leave credits not

exceeding ten (10) days during the year;
b. Medical cash allowance to dependents of employees
not exceeding P750 per semester of P125 per month;
c. Rice subsidy of P350 per month;
d. Uniforms;
e. Medical benefits
f. Laundry allowance of P150 per month;
g. Employee achievement awards, for length of service
 of safety achievement in the form of tangible
personal property other than cash gift certificate,
with an annual monetary value not exceeding ½
month of the basic salary of employee receiving the
award under an established written plan which does
not discriminate in favor of highly paid employees;
h. Christmas and major anniversary celebrations for
employees and their guests;
i. Company picnics and sports tournaments in the
Philippines and are participated in exclusively by
employees; and
j. Flowers, fruits, books or similar items given to
employees under special circumstances on account
of illness, marriage, birth of a baby, etc.

*Principle of Employer’s Convenience Rule:

- fringe benefits may be exempt/not subject to
tax if these are given for the benefit or
advantage of the employer.

The following are the possible fringe benefits, which may be exempt
under the Employer’s Convenience Rule: (H V H M T)
a. Housing benefit
b. Vehicle
c. Household personnel
d. Membership in a social or athletic club or similar
organization
e. Traveling expense benefit

* Housing benefit – in determining whether the same is

exempt under the employer’s convenience rule, you have to
consider the peculiar nature of the special needs of the
employer.
Requisites for exemption:
1. It must be made as a condition for employment;
2. It must be provided within the premises of the employer

*** This may apply to a supervisor of a plant or a company.

* If the housing or living quarters are provided outside the

premises of the employer, even if that is for the convenience
of the employer, this is only exempt up to 50% of the amount.
So, 50% taxable, 50% exempt.

* Vehicle – Exempt but depends upon the peculiar nature

of the special needs of the business of the employer.
Example: LBC or DHL business

* Household personnel such as maid, driver and others

– Exempt, but depends upon the peculiar nature of the
business of the employer.

* Membership in a social club, etc. – Peculiar nature

requirement.
* Traveling expense benefit – Peculiar nature
requirement. Example: Employer sent his employees abroad
to attend a particular seminar to improve their technical
know-how.

BAR QUESTION: A is a driver of Congressman Magtanggol

and he received a monthly salary of P5,000 and living
quarter allowance of P2,500.
a. Whether the P2,500 living quarter allowance is
excluded or subject to tax?
b. Assuming the employer is an obstetrician would
your answer be the same?

ANSWER:
a. That should be subject to tax.
b. It should be excluded. Reason: Convenience of the
employer’s rule.

2. GROSS INCOME FROM BUSINESS, TRADE OR

PROFESSION

BUSINESS – Any activity that entails time, attention, effort

for purposes of livelihood or profit.

 As regards construction business, the taxpayer

here must be an independent contractor. He
may report his income under the percentage of
completion method or under the so-called
completed contract method.

PROFESSIONAL INCOME – The recipient of the same must

be professionals.

 How about those who claim that they are

professionals but are not registered in the P.
R. C., can they still be tax as such?

 Yes, irrespective of whether they are licensed

or not because of the rule that gross income
derived from whatever source.

3. PASSIVE INCOME

PASSIVE INCOME – This is the income that is subject to

final tax.

Income subject to final tax are the following: (code:RPD-

WIDS)

1. Royalties

2. Prizes

3. Winnings
 4. Interests on bank deposit, deposit substitutes,
trust funds and
other similar arrangements.

5. Dividend received from domestic corporation,

mutual fund insurance company, regional
headquarters of multi-national corporation and
other corporation.

6. Share a partner in the net income after tax of a

taxable partnership, joint account, joint venture or
concessions.

*** Do not include passive income in the income of your business or

profession, or in your compensation income. This is so because
when you receive this income, the tax had already been
imposed and deducted.

RC, NRC, RA NRA-ETB NRA-

NETB
ROYALTIES 20% except in
the case of
literary
works, books Same as 25%
and musical RC, NRC,
compositions RA
which are
subject to 10%
final tax
PRIZES
exceeding
P10,000.00
If it is
P10,000.00 or
less, it is NOT 20%
subject to final 20% 25%
tax but the
same must be
included in
other income
(e.g.
compensation,
business,
professional)
WINNINGS
except PCSO & 20%
Lotto 20% 25%
INTERESTS
ON BANK 20%
DEPOSITS, 20% 25%
etc.
DIVIDENDS Subject to
RECEIVED increasing
from domestic rates of 6% if
corp., etc. received in 20% 25%
1998; 8% in
1999; and
10% in 2000.
SHARE OF A
PARTNER in
the net
income after a - do- 20%
tax of a 25%
taxable 6, 8 & 10
partnership,
etc.

Question: How do you treat that share of a professional

partner from the net income of a general-professional
partnership?

Answer: This should be taxed at the rate provided under

Sec.24, that is, 5% to 34%.

But as regards the share of a partner in the net income after

tax of a taxable or business partnership, that is one which is
subject to final tax.

PRIZES – may be exempt if given in sports competition and

if given primary in recognition of scientific, artistic, literary,
educational, religious, charitable, or civic achievement.

INTEREST
Rules
1. If it is an interest on foreign currency deposit system,
it is exempt.
If the recipient is non-resident individual (NRC, NRA-
ETB, NRA-NETB).
2. If the recipient is a resident individual (RC, RA), that
is subject to 7.5 %.
3. Interest income is also exempt if it is an interest
income on a long- term deposit or long-term
investment (this must have a term of not less than 5
years).

If the term is less than 5 years it is subject to the following rates:

1. 4 years to less than 5 years 5%
2. 3 years to less than 4 years 12%
3. Less than 3 years 20%

DIVIDEND RECEIVED FROM DOMESTIC CORPORATION

1. This is exempt from tax if the recipient is a foreign
government, financing institution, regional financing
institution, international financing institution
established by foreign government [see Sec.32 (B) (7)
 (a)].

2. It is also exempt if the recipient of such dividend is

another domestic corporation or resident foreign
corporation [see Sec. 28(A)(7)(d)]

CAPITAL GAIN DERIVED FROM SALE OF SHARES OF

STOCK

 Listed and traded through local stock exchange – this

is not subject to income tax but subject to
percentage tax of ½ of 1% of the gross selling
price.

 Not listed and traded through local stock exchange –

this is the one subject to income tax.

Not over P100,000.00 5%

Amount Over P100,000.00 10%

 If the share of stock is not listed and traded

through local stock exchange, the basis of the
tax is net capital gain. So, you should first
deduct the capital loss.

 If listed and traded through local exchange,

there is no deduction allowed because the
basis of the tax rate of ½ of 1% of the gross
selling price.

 The above-mentioned tax rates apply to all

individual taxpayers.

* CAPITAL GAIN DERIVED FROM THE SALE OF REAL

PROPERTY
- The real property involved must be considered CAPITAL
ASSET.

- The tax on capital gain derived from the sale of real

property is 6% of the gross selling price or zonal value
which ever is higher.

* CAPITAL ASSET – property held by the taxpayer whether

or not connected in his trade or business except: (code: SOUR)

1. Stock in trade or other property of any kind which

would be included in the inventory of the taxpayer
if on hand at the end of the taxable year.
2. Property primarily held for sale to customers in
the Ordinary course of trade or business.
3. Property Used in trade or business subject to
depreciation
4. Real property used in trade or business.
► The definition of capital asset says “real property held by
 the taxpayer whether or not connected with his trade or
business except real property used in trade or
business.” So, in order to be a capital asset, the real
property must be one not used in trade or business.

► That is why, the sale of residential house and lot is

subject to 6% of capital gains because it is a real
property not used in trade or business.

► But, sale of real property by a real estate dealer is not a capital

transaction because the property involved is one
primarily held for sale to customer in the ordinary
course of trade or business. That is not a capital asset
but an ordinary asset.

► This covers not only “sale” of property; it also covers

conditional sale of real property including the so-called
pacto de retro sale under Art. 1602 of the NCC, or
disposition of property located in the Phils.

► If the buyer is the government or any of its political sub-

divisions or political agencies, including government
owned and controlled corporations, the seller have the
option to avail the 6% or under Sec. 24(A), wherein the
basis under said section is taxable income so
deductions may be allowed. The cost of the property
may be deducted but when you avail of the 6%, the
basis is gross selling price or zonal value whichever is
higher.

► Is this a tax on the buyer or the seller?

It is a tax on the seller. But sometimes, through an
agreement, pwede nilang I-transfer sa buyer, and
there’s nothing that can prevent the seller from
transferring the tax to the buyer in the contract of sale.

OTHER INCOME

* OTHER INCOME includes [code: R.I.D.O.]

a. Rent income other than royalties
b. Interest income other than interest income on bank
deposit
c. Dividend income
d. Income from Other sources and this may include:
(BIT-CDC)
d.1. Bad debts recovered
d.2. Illegal gains derived from
gambling
d.3. Tax funds
d.4. Compensation for private
property expropriated by the
government for public use.
d.5. Damages
d.6. Cancellation of indebtedness
1. RENT - Compensation for the use of one’s property.
- The payment may be in cash or in kind. The property involved
is either personal or real property.

- In the case of personal intangible property, subject to final tax if

it involves intellectual property, copyright, trademarks etc.

THE FOLLOWING CONSTITUTES TAXABLE RENT INCOME:

1. The regular rent may be monthly, semi-annually or
annually

2. Additional rent income which includes:

a. Obligation of the lessor assumed by the lessee The
following are obligations which may be assumed
by the lessee: [R.I.D.I.O.]
a.1. Real property taxed on leased premises
a.2. Obligation to pay insurance premium on the
insured leased premises
a.3. If the lessor is a corp., the obligation to
distribute Dividends to its stockholders
a.4. Obligation to pay interest on the bonds issued
by the lessor.
a.5 Other obligations of the lessor which may be
assumed by the lessee.

b. Value of permanent improvements on leased premises.

This may be reported through:
b.1. Outright method at the time of permanent is
completed, he may report that as additional
rent income – FMV of the building or
permanent improvement.
b.2. Spread out method by allocating the
depreciation among throughout the remaining
term of the leased.

c. Advance rentals
c.1. If in the nature of the prepaid rentals without
restriction on the use of the amount, it is
taxable.
c.2. If it is in the nature of security deposit, it is
taxable rent income if there is a violation of
the term of the lease.
c.3. If it is in the nature of a loan to the lessor, it
is not taxable.

2. INTEREST INCOME – compensation for the use of

money.
- Whether it is an interest on loan pursuant to the
business of a taxpayer or personal transaction,
interest income, except if it is tax exempt, is always
taxable. This is so because the source of income is
immaterial, even if it is from an illegal source.

- Interest income on bank deposits is subject to final

tax.
3. DIVIDEND INCOME – amount declared, set aside and
distributed by the Board of Directors to stockholders, on
demand or a fixed period.

Classes of Dividend: [C.L.I.P.S.S.]

Cash dividend
Liquidating this is given upon liquidation of
dividend- corporate affairs
Indirect dividend - it is given in other form and this
includes cancellation of
indebtedness by the corp. of the
obligation of stockholder
Property dividend - it may be in the form of stock other
than the stock of the corp.
Stock dividend - stock issued by the giver corp.
Script dividend - It is given in the form of promissory
note or other evidence of
indebtedness.

STOCK DIVIDEND – as a rule not taxable. This is so because

there is no income here. It merely represents the transfer of
surplus account to the capital account.

EXCEPTIONS to the Rule:

Stock dividend may be subject to tax under the following exceptional
cases: [C OR D]
1. If there is a Change in the stockholders interest in
the net assets of the corp;
2. If it is one issued by Other corp. We call that
“dividend stock”
Stock dividend vs. dividend stock – Stock dividend as a
rule is not taxable whereas dividend in stock is
taxable.
3. Redemption of stock dividend;
4. If the corp. issues Different shares of stock. If the
corp. issues two different classes of shares of stock,
the dividend that may be declared thereafter is
taxable.

Example:
Outstanding stock Stock dividend Taxable
1. Preferred Common NT
2. Common Preferred NT
3. Preferred Preferred NT
4. Common Common NT
5. Preferred T
Preferred/Common
6. Common T
Preferred/Common
Disguised dividend – treasury stock dividend declared out of
the outstanding capital stock, the purpose of which is to
avoid the effect of taxation (Commissioner vs. Manning).

It is one which is made to appear as stock dividend when

the truth of the matter is that it is a dividend which is
illegally declared, such a case, since the purpose is to evade
taxation, it is taxable.

Remember, treasury shares of stock are not entitled to

dividends.

ALLOWABLE DEDUCTIONS (SEC. 34)

As regards individual taxpayers, the following may claim

allowable deductions:
1. RC
2. NRC, only those expenses incurred in the Phils.
because here, we cannot tax his income derived
from sources without.
3. RA, only those expenses incurred in the Phils.
4. NRA-ETB, but only those expenses incurred in the
Phils.
5. PP (Professional Partners under Sec. 26)

Exceptions:
1. IT earning CI – EE, ER REL
2. NRA-NTB
3. Aliens employed
A. RMC
B. OBU
C. PSC
4. NRFC
As regards corporate taxpayers, the following are entitled to
claim allowable deductions:
1. DC, which includes private educational institutions, non-
profit hospital, government-owned and controlled corps.
2. RFC

ITEMIZED DEDUCTIONS: [E,I.T,L,B,D,D,C,R,C]

1. Expenses 6. Depreciation
2. Interests 7. Depletion of oil, gas, wells and
mines
3. Taxes 8. Charitable contributions
4. Losses 9. Research & Development
5. Bad debts 10. Contribution to Pension Trust

* In the case of individual taxpayers, they may avail of the

optional standard deduction of 10% of gross income

* Corporate taxpayers are not allowed to claim 10%

optional standard deductions.

* All individual taxpayers except the NRA individual may

claim this optional standard deductions.
* Itemized deduction may apply to corporate taxpayers as well as
individual taxpayers.
* FUNDAMENTAL PRINCIPLE IN DEDUCTIONS
1. The taxpayer must prove that there is law authorizing
deductions.
2. The taxpayer must prove that he is entitled to
deductions.
*** NRFC are not entitled to claim deductions.

1. EXPENSES

ORDINARY & NECESSARY EXPENSES

When we speak of ORDINARY, this simply refers to the
expenses which are normal, usual or common to the
business, trade or profession of the taxpayer. This may not
be recurring.

Example: if an action is filed in court, it is but normal to

hire the services of a lawyer. So, the taxpayer has to pay
attorney’s fees. It is an ordinary expense under this
circumstances.

NECESSARY- It is one which is useful and appropriate in

the conduct of the taxpayer’s trade or profession.

ORDINARY & NECESSARY EXPENSES

-are those which are incurred or paid in the development,
operation management of the business, trade or profession
of the taxpayer.

EXTRA-ORDINARY EXPENSES – Not Deductible. These are

amortized or in lieu of the same, you may claim that so-
called allowance for depreciation. And if it involves
intangible asset, the word used is AMORTIZATION.

There is no hard and fast rule. An expense may

be ordinary insofar as a particular taxpayer is
concerned and it may not be an ordinary as
regards another taxpayer.

Example:
If you have business here in Manila and you also
have business in Tawi-tawi, what is the expense that you
may incur in Tawi-tawi which you may not possibly incur in
Manila?

In Tawi-tawi, you may need people to guard your

business. But here in Manila, you may need not because of
our new President-elect.

KINDS OF ORDINARY & NECESSARY EXPENSES

[C.A.R.T.E.R.S.]
1. Compensation for services rendered
2. Advertising & promotional expenses
 3. Rent expenses
4. Travelling expenses
5. Entertainment expenses
6. Repairs & maintenance expenses
7. Supplies and materials

COMMON REQUISITES FOR DEDUCTIBILITY of these ordinary &

necessary expenses: [D.I.R.]
a. Must be paid or incurred DURING the taxable year.
If you incur expenses in 1997, you cannot carry
this over to 1998. expenses incurred during a
particular year must be claimed as deductions
during this year when the same were incurred.

“PAID” – to signify the fact that the taxpayer uses

the CASH
BASIS. Under the CASH BASIS, an expense
is recognized
when it is PAID.

“INCURRED” – implies that the taxpayer employs

the ACCRUAL
BASIS. Under the ACCRUAL BASIS,
income is recognized
when earned regardless of the receipt of the
same and
the expense is recognized when incurred.

b. Must be paid or incurred in connection with the trade,

business or profession of the taxpayer.

c. Must be proven by RECEIPTS.

SPECIAL REQUISITES FOR DEDUCTIBILITY OF THESE

ORDINARY & NECESSARY EXPENSES:

1. COMPENSATION FOR SERVICES RENDERED

This must be reasonable, meaning, this must not be
ostensible.

Case 1: Partnership was sold to a corp. and it was

agreed that the partners will serve the corp. and make it
appear that they render services. So, compensation for
services was ostensibly made by the corp.

Held: These is a mere ostensible salary or payment

for services not actually rendered because that amount
really forms part of the properties purchased by the corp.

Case 2: Corporate officers succeeded in selling the

property of the corp. So, profit was derived therefrom.
Bonuses were given to these corporate officers.

Held: The rule is settled. Bonuses must be given in

good faith. There must be services rendered because
bonuses are additional compensation. In this particular
case, there was really no services rendered because that
sale was made through a broker. The corp. made it appear
that it was through the efforts of these corporate officers
that brought about a successful sale of property.

Bonuses must be given in good faith and in

determining whether bonuses will form part of the
compensation for services rendered, you have to consider the
(1) nature of the business, (2) the financial capacity of the
taxpayer and (3) the extent of the services rendered.

2. ADVERTISING AND PROMOTIONAL EXPENSES

- It must be reasonable.

Case: Sugar Dev’t. Corp paid P125,000.00 to Algue Corp.

representing promotional expenses.

Held: This is reasonable under the circumstances because

the particular budget subject for promotion involves million
of pesos. And under that circumstances, the P125,000.00 is
reasonable as this may coincide with the efforts exerted
considering that the taxpayer has no venture in that
experimental project to establish that vegetables of
investment company and this involves millions of pesos.

3. RENT EXPENSE
a. The taxpayer must NOT be the owner of the
property or he has no equitable title over the
property.
b. This is subject to withholding tax. You cannot claim
that the taxes supposed to be withheld have not
been paid or remitted to BIR.

4. TRAVELLING EXPENSES
- This must be incurred or paid while “away from home”.

- “Home” does not refer to your residence but to the station

assignment or post.

Example: From home office to branch office, the

traveling expenses incurred are deductible. And this
includes not only the transporatiotion expenses but also
meal allowance and hotel accommodations.

5. ENTERTAINMENT EXPENSES
- This must not be contrary to law, morals, good customs,
public policy or public order.

- Hence, bribes, kickbacks, and similar payments are not

deductible.
-Also, the expenses incurred by the taxpayer in entertaining
gov’t officials in 5-star hotel to gain political influence are
not deductible.
6. REPAIRS AND MAINTENANCE EXPENSES
- Only ordinary or minor repairs are deductible.

- Extra-ordinary repairs cannot be claimed as deduction and

in lieu of that, the taxpayer may not be allowed to claim
depreciation.

- If the cost of the repair increases the life of an asset for a

period of more than one (1) year, that amount is considered
extra-ordinary repair. Otherwise, it is considered ordinary
repair.

7. SUPPLIES AND MATERIALS

-This must be actually consumed during the taxable year.

- RULE ON SUBSTANTIATION simply requires that

ordinary and necessary expenses must be proven. The
proofs required include:
[N.O.R.E.D.]
a. Official receipts
b. Adequate Recourse
c. Amount of Expense
d. Date and place where such expense is paid or
incurred
e. Nature of expense

2. INTEREST

REQUISITES FOR DEDUCTIBILITY

1. This must be paid or incurred DURING the taxable
year.
2. This must be paid or incurred in connection with the
trade, business or profession of the taxpayer
3. There must be an obligation which is valid and
subsisting.
4. There must be an agreement in writing to pay
interest.

Question 1:
What about that interest on unclaimed salaries of
the employees, is that interest deductions?

Answer/Held:
NO, because there is no obligation or indebtedness.
It is the fault of the employees in case they failed to claim
their salaries.

Question 2:
What about that interest charged to the capital of the
taxpayer, is that deductible?

Answer:
Interest on cost-keeping purposes is not deductible.
This does not arise under an interest-bearing obligation.
THEORETICAL INTEREST – an interest which is computed
or calculated, not paid or incurred, for the purposes of
determining the opportunity cost of investing in a business.
This does not arise from legally demandable interest-
bearing obligation. This is not a deductible interest.

Question 3:
What about interest on preferred stock, is this
deductible?

Answer:
As a rule, interest on preferred stock is not deductible,
because there is no obligation to speak of. It is in effect an
interest on dividend. The reason why it is not deductible is
that the payment is dependent upon the profits of the corp.
It will only be paid if the corp. earn profits. And would not
be paid of the corp. incurs losses.

BUT if it is not dependent upon corporate profits or earnings,

that is deductible. If is payable on a particular on a particular
date or maturity without regard to the corporate profits, it
is deductible.

The Supreme Court mentions TWO (2) FACTORS:

1. not dependent upon corporate profits; and
2. agreement as to the date or term within which payment
will be made.

INTEREST ON GOV’T SECURITIES is now taxable.

So, if the taxpayer obtained a loan from PNB and used the
proceeds in purchasing gov’t securities, the interest is now
taxable. Likewise, the interest expense paid on that loan,
the proceeds of the same, had been use to purchase gov’t
securities is now deductible.

Q. What about an interest on a loan paid in advance, is this

deductible? Let us say that the taxpayer obtained a loan
from a bank and it is payable within 5 years. The loan
obtained is P50,000.00. Now, it was deducted in advance,
can that be claimed as deductions?

A. NO. You can only deduct the same when the installment
is due a particular year.

INTEREST EXPENSES WHICH ARE NON-DEDUCTIBLE

[PARCAPU]
1. Interest expense on PREFERRED STOCK;

2. When there is NO AGREEMENT in writing to pay

interest;

3. Interest expense on loan entered into between RELATED

TAXPAYERS.
4. Interest paid or calculated for COST-KEEPING
PURPOSES

5. Interest paid in ADVANCE

6. Interest on obligation to finance PETROLEUM

EXPLORATION

7. Interest on UNCLAIMED SALARIES of the employees

Related taxpayers:
a. members of the same family which includes:
a.1. spouses
a.2. brothers and sisters
a.3. descendants and ascendants
b. between two (2) corporations owned or controlled
by one individual. He must have a controlling
interest over these two corporations. OR, if one
corp. is considered as personal holding company
of another corp.
c. between a corp. and an individual; that individual
owns or controls more than 50% of the outstanding
capital stock of the such corp.
d. parties to a trust;
d.1. grant or fiduciary
d.2. fiduciary of one trust and fiduciary of
another trust but there is only one grantor
d.3. beneficiary and fiduciary

*Your knowledge of related taxpayers is also

important in determining whether losses are
deductible or not. If losses were incurred or paid in
connections with the transactions between these
related taxpayers, these are not deductible.

Question: How much interest expense is deductible?

Answer: The interest that may be claimed as deductions

shall be reduced
by:
a. 41% - Beginning January 1, 1998
b. 39% - Beginning January 1, 1999
c. 38% - Beginning January 1, 2000 of the
income subject to final tax.

EXAMPLE OF INCOME SUBJECT TO FINAL TAX:

1. interest on bank deposit
2. interest on deposit maintained under the foreign
currency deposit system

So, if the interest income on bank deposit amounted to

P100,000.00. And the total interest expense incurred or
paid by the taxpayer is P200,000.00. If this is incurred in
1998, 41% of P100,000.00 is P41,000.00. That
P200,000.00 interest expense incurred or paid, should be
reduced to P41% of that P100,000.00 to arrive at
P159,000.00 which is the interest that may be claimed as
deduction.
P200,000.00
- 41,000.00
-----------------------
P159,000.00

The rule has been established that TAXES are NOT

ORDINARY OBLIGATIONS. But the Supreme Court in two (2)
cases relaxed the distinction between taxes and ordinary
obligations.

1. The interest on deficiency donor’s tax is deductible. The SC

explained that taxes here are considered obligations or
indebtedness. And it ruled that we have to relax the
distinction between tax and ordinary obligation in this
respect.

2. Interest on deficiency income tax can also be claimed as

deductible interest expense because taxes here are
considered ordinary obligations.

3. TAXES

REQUISITES FOR DEDUCTIBILITY:

1. This must be paid or incurred during the taxable year.

2. This must be taxes paid or incurred in connection with

the trade, business or profession of the taxpayer.

*** Taxes that may be claimed as deductions may be

national or local taxes.

THE FOLLOWING ARE NON-DEDUCTIBLE TAXES

[S.I.N.E]
1. SPECIAL ASSESSMENT – tax imposed on the
improvement of a parcel of land

2. INCOME TAX – This includes foreign income tax. In

this regard, the so-called foreign income tax may be
claimed as a deduction from gross income or this may
be claimed as tax credit against Phil. income tax. In
the event that he claims that as tax credit, he can no
longer claim the same as deduction.

3. Taxes which are NOT CONNECTED WITH THE TRADE,

BUSINESS OR PROFESSION OF THE TAXPAYER

4. ESTATE TAX, DONOR’S TAX (see also discussion on

tax benefit rule)
TAX AS DEDUCTIONS vs. TAX CREDIT
► Taxes as deductions may be claimed as deductions
from gross income.
► Tax credit is a deduction from Phil. income tax.

► Tax as deduction includes those taxes which are paid

or incurred in connection with the trade, business or
profession of the taxpayer. However, the sources of a
tax credit is foreign income tax paid, war profit tax,
excess profit tax paid to the foreign country.

► The foreign income tax paid to the foreign country is

not always the amount that may be claimed as tax
credit because under the limitation provided under the
Tax Code, it must not be more than the ratio of foreign
income to the total income multiplied by the Phil.
income tax.

► Taxes are deductible only by the person upon whom

the tax is imposed
Except:
1. Share holder
2. corporate bonds - tax free Covenant clause

The following are entitled to claim tax credit:

1.RC 2. DC

4. LOSSES

CLASSIFICATION OF LOSSES [O. C. W. – C. S.]

1. ORDINARY LOSSES – losses sustained in the course of
trade,
business or profession of the taxpayer.

2. CAPITAL LOSSES – the assets that must be involved

there must be
capital assets

Capital Losses include the following:

a. Loss arising from failure to exercise privilege to sell
or buy property
b. Worthless securities
c. Abandonment losses in the case of natural
resources
d. Loss from wash sale

3. WAGERING OR GAMBLING LOSSES – the amount that

is deductible
must not exceed the gains.
Example:
The winnings amounted to P1,000.00 Loss is P500.
This loss is deductible.
If the winning is P500 and if the loss is P1,000. The
amount deductible is only P500 because the amount must
not exceed the gains.
 If there is no winnings and loss is P500. Deduction
losses here is ZERO.

4. CASUALTY LOSSES – this must be reported to the BIR

earlier than 30
days but not later than 45 days following the date of the
loss.

Casualty losses include:

a. Fire
b. Storm
c. Shipwreck
d. Other casualty losses
e. Robbery
f. Embezzlement
g. Theft

5. SPECIAL LOSSES – include the following:

a. loss arising from voluntary removal of buildings as an
incident to renewal or replacement

Problem:
Supposed the taxpayer had a building constructed
on a parcel of land. He owned this as well as the
building erected thereon. He had business and his
business was conducted within the premises.
Then, he decided to remove such building as to
construct a new building for new business.

Is the cost of demolition to give way to a new

building deductible loss? YES.

Suppose A purchased that parcel of land of B and

included in that sale was that of the building. A
demolish this building in order to construct a new
building. Is the cost of demolition deductible
insofar as A is concerned?

NO. That can only be claimed as deductions if the

one demolishing the same is the taxpayer. The
moment that is sold to another claim that as
deductible loss. The treatment here is, the cost of
demolition should be capitalized in the selling
price.
Exception:A may claim that as deductible loss if
this was demolished by value of a court order
because the gov’t considered this as a fire hazard,
loss of useful value of property or capital asset.

THE COMMON REQUISITES for DEDUCTIBILITY OF

LOSSES are:
1. Losses must be actually/sustained and not mere
anticipated losses;

2. Must not be compensated by insurance;

 --- If it is partly compensated, only the amount not
compensated by insurance is deductible.

3. Must be evidenced by a completed transaction.

Completed Transaction – this means that the loss

must be fixed by identifiable event.
Example: If it is a loss sustained from sale, the event
that may identify or complete the transaction is the
consummation of the contract of sale.

Suppose it is in the nature of casualty losses like fire?

The fire destroyed your property in 1995, no payment

has been made because the insurer and the insured
were still under negotiation. It was only in 1997 that
they agreed on the amount. The amount agrees upon is
P100,000. The taxpayer may claim that casualty losses
only in 1997 when payment was actually made. This is
the event that will complete the transaction.
5. BAD DEBTS

REQUISITES FOR DEDUCTIBLITY: [CU, W, TBP, VS, U]

1. Must be charged off and uncollectible within the
taxable year;
2. Must be ascertained to be worthless
3. Must arise from trade, business or profession of the
taxpayer;
4. Must be valid and subsisting indebtedness;
5. Must be uncollectible in the near future.

HOW TO PROVE THE WORTHLESSNESS OF

OBLIGATION:

According to the Supreme Court, the following STEPS must be

complied:
1. There must be a statement of account sent to the
debtor;
2. A collection letter;
3. If he failed to pay, refer the case to a lawyer;
4. If lawyer may send a demand letter to the debtor;
5. If the debtor still fails to pay the same, file an action
in court for collection.

In proving that the debtor is insolvent of bankrupt,

mere allegation of the same is not enough. You
should prove that the debtor is indeed bankrupt or
insolvent. So, you may secure a copy of that decision
by the SEC or other agency as the case may be,
declaring the debtor as bankrupt or insolvent. And
then there must be a demand letter sent to him. In
case the debtor was robbed, there must be a police
report to that effect.

The debtor may be a NRFC, so you may argue that

 he may not be sued here. According to the Supreme
Court, as a rule that is not an excuse. You should
still send a demand letter to that NRFC. In other
words, there must be diligent efforts to collect the
indebtedness and to prove that in the near future
such obligation is no longer collectible.

*** If the recovery of bad debts, resulted in a tax benefit

to the taxpayer, that is taxable. If it did not result in
any tax benefit to the taxpayer, that is not taxable.
(TAX BENEFIT RULE)

N.B. Read the case of Phil. Refining Company vs.

Commissioner, a 1989 case.

6. DEPRECIATION

The idea here is not to recover profit, but to recover the

cost of property invested in business. When the properties
are used in trade, business or profession of the taxpayer,
the law considers or recognizes the gradual loss or sale of
property.

DEPRECIATION refers to the gradual diminution of

the useful value of the property used in trade,
business or profession of the taxpayer, arising from
wear and tear or natural obsolence.

REQUISITES FOR DEDUCTIBILITY: [U P R A C ]

1. The property must be used in trade, business or
profession of the taxpayer;

2. There must be depreciable properties.

The non-depreciable properties are

a. Personal property not used in trade, business or
profession of the taxpayer;
b. Inventoriable stock and securities
c. Land
d. Mining and other natural resources

3. The allowance for depreciation must be reasonable

4. The method in computing the allowance for

depreciation must be in accordance with the method
prescribed by the Sec. of Finance upon the
recommendation of the BIR Commissioner.
This prescribed method includes:
a. Declining balance method
b. Sum of the years digit method
c. Straight line method
d. Any other method as may be prescribed by the
 Sec. of Finance upon the recommendation of the
BIR Commissioner

5. This must be charged off during the taxable year.

7. DEPLETION – natural resources

► This involves natural resources such as oil, gas wells

and mines. These are non-replaceable assets.

► The requisites for deductibility are the same as that of

depreciation except that the properties involved are
natural resources

► The idea here is not for profit but to recover the cost of
investment through this allowance for depletion.

8. CHARITABLE AND OTHER CONTRIBUTIONS

* These are fully deductible if the contributions are given to the

following: [F. A. G.]
1. Government or its political subdivisions, agencies or
instrumentalities, for the purpose of undertaking
priority projects of the government;
These priority projects include: [S.H.E.]
a. Sports development, science and invention
b. Health and human settlement
c. Educational and economic development

2. Foreign government or institution and international

civic organizations;

3. Accredited NGO

N.G.O. means non-profit domestic corporation which are

formed and organized for any of the following purposes:
[C.H.E.R.S.]
a. Research
b. Health
c. Education
d. Charitable, cultural, character building
e. Sports development and social welfare

The amount of charitable contribution that may be claimed as

deduction may be:

1. In the case of individual taxpayer:

- Not more than 10% of the net income before charitable
contribution

2. In the case of corporate taxpayer:

- Not more than 5% of the net income before the charitable
contribution
►IF the recipient of such contribution is any of the following DC
formed or organized for: [R.E.C.S.]
1. Religious purpose and rehabilitation of veterans
2. Educational purpose like educational corporations
which are not qualified as NGO
3. Charitable, cultural purpose
4. Scientific, sports development an social welfare
purpose

“10% or 5% of the net income before charitable contribution”

Example:
If an individual taxpayer has a gross income of
P100,000 and the allowable deduction, except charitable
contribution, is P50,000. The Charitable contribution is
P5,000.

Deduction first P50,000 from P100,000 and the

result is P50,000.

This P50,000 is the basis of that “10% or 5% of net

income before charitable contribution”. So, 10% of the
P50,000 is P5,000. Hence, the actual contribution of
P5,000 may be fully claimed as deduction.

But let us say, the amount of charitable contribution

is P10,000. So, he can only deduct P5,000 as charitable
contribution, and not the actual amount of P10,000
because the law imposes a limitation that the amount that
may be claimed as deduction must not be more than 10%
of net income before charitable contribution.

9. RESEARCH & DEVELOPMENT PROGRAM

This may not be claimed as deduction if the amount is:

1. Spent for the acquisition or improvements of land or
for the improvement or development of natural
resources.

2. Paid or incurred for the purpose of ascertaining the

existence, location, extent or quality of any
natural resources like deposits of ore or other
minerals including oil or gas.

10. CONTRIBUTION TO PENSION TRUSTS

REQUISITES OF DEDUCTIBILITY:
1. There must be a pension plan established by the
employer;
2. The pension must be reasonable or sound;
3. Contribution must be given by the employer to that
pension plan;
4. This must be for the benefit of the employees;
5. The plan must not be subject to the control of the
employer.
 Contribution to pension trust may refer to the current
year or past years.
CURRENT YEAR- this is considered as ordinary &
necessary expenses

Employer may also make a contribution to the pension plan

in regard to the services rendered for the past 10 years.

PERSONAL EXEMPTIONS

PERSONAL EXEMPTIONS

1. Personal and additional exemptions. (Note: Wala na

yung S.A.P.E.)

2. Premiums on health and hospital insurance

Limitations:
a. It must not be more than P2,400.00 a year. In
other words, P200.00 a month. The P2,400.00 is
the maximum amount that may be claimed as
deductions.

b. The family must have an income of not more than

P250,000.00 a year.

c. The claimant must be the spouse claiming the

additional exemption.

Premiums on life insurance policy is also included

here because it is included under the health insurance policy.

PERSONAL EXEMPTION
This is an arbitrary amount in the nature of
deductions from gross compensation income.

If the taxpayer has no compensation income, this can

be claimed as deduction from gross income from business,
trade or profession.

Personal exemption is given to approximate the

needs of the taxpayer. It is a substitute for the
disallowance of family, personal and living expenses.

KINDS OF PERSONAL EXEMPTION:

1. Basic personal exemption:

a. single or legally separated without dependent; Php20,000.00

b. head of the family; Php25,000.00

c. each married individual if both of them are earning

Compensation income Php32,000.00
(in case only one of the spouses is deriving gross
income, only such spouse shall be allowed the
personal exemptions)

2. Additional exemption
- This only applies to qualified Php8,000.00 for
dependent child and children such every qualified
as legitimate and illegitimate dependent child but
children. not to exceed 4

► Personal Exemption – only individual taxpayers,

including estate and trust, are entitled.

►In case of estate and trust – Php20,000.00

R.C. N.R.C. R.A. NRA-NTB NRA-

NETB
/subject to
the rule on
reciprocity.
/ / / But it
Personal within within must not X
Exemption exceed the
maximum
allowable
personal
exemption.
X
Additional / / Rule on
Exemption / within within reciprocity X
does not
apply.

Legend: / - available; X – not available

Head of the family – unmarried man or woman legally

separated man or woman who has the following qualified
dependents:

1. Parents - One or both parents. Must be living with

the taxpayer and dependent upon the
taxpayer for chief support.
- Parents must be natural parents.
2. Brothers or sister - To be qualified they must be:
a. Living with the taxpayer;
b. Dependent upon the taxpayer for chief
support;
c. Unmarried;
d. Not gainfully employed.
e. No more than 21 years old except if
physically or mentally incapacitated;
► must be brothers or sisters by blood
► one is enough

3. Children- Must be legitimate , illegitimate, legally

adopted or stepchildren
Conditions:
a. Living with the taxpayer;
b. Dependent upon the taxpayer for chief
support;
c. Unmarried;
d. Not gainfully employed;
e. Not more than 21 years old except if
physically or mentally incapacitated.

► Dependent is considered “living with the taxpayer”

even if the former or the latter are not physically together if
that is brought about by force of circumstances. Example if
one of the parents will have to undergo by-pass operation in
the U.S.

►Chief Support – means more than 50% of the needs of

the dependents are provided by the taxpayer.

Problem: If the child or the brother/sister got married and

then he has found to be physically or mentally
incapacitated, so bumalik si tatay at dependent sa tatay for
chief support, can he qualify as dependent?

Answer: No, physical or mental defect applies only to age

requirement. Once the child or brother/sister got married, he
is automatically disqualified as dependent.

► CHANGE OF STATUS:
1. Death of spouse during the taxable year;
2. Death of dependent during the taxable year;
3. Death of the taxpayer during the taxable year; estate of
the taxpayer may claim the basic personal exemption;
4. Additional dependent during the taxable year;
5. Taxpayer got married during the taxable year;
6. Gainful employment of the dependent during the
taxable year
7. Dependent became more than 21 years old during the
taxable year.
► Even if the above-mentioned change of status happened
during the taxable year, the taxpayer may still claim the
basic personal exemption because it is as if the change of
status happened at the end of the taxable year.

► There is a provision in the Tax Code, which is not so

clear. For purposes of head of the family, in the case of
natural children or child, there is that word
“acknowledged or recognized”.

► For purposes of the definition of head of the family, it is

clear that to qualify as dependent, the natural child or
legitimate child must be acknowledged or recognized by the
taxpayer.
► But in the definition of the dependent, dependent means
legitimate, illegitimate or legally adopted child or children.
There is no word acknowledged or recognized.

► Was this deliberately omitted by our Congressmen? Does

this imply that since they have so may illegitimate children,
they may not be required to acknowledge or recognize them
and they can claim this illegitimate child as their
dependent? This is not clear. If we will try to interpret the
law literally, there is no need of any recognition on the part
of the taxpayer.

► Is this really the intention of law?

► No. The intention of the law has always been to recognize

this illegitimate child and this is one way of compelling the
taxpayers to recognize this child.

► The President of the Republic of the Phils. cannot issue an

executive order to increase the basic personal exemption because the
provision under the Old Tax Code authorizing the President
to increase the personal and additional exemption upon the
recommendation of the Sec. of Finance has been removed
or deleted by RA 8424.

► Now, you can only increase the amount of personal and

additional exemption by legislative enactment.

NON-DEDUCTIBLE ITEMS

1. Personal, living or family expenses

2. Those which are considered capital expenses. Capital

expenditures may be one that may increase the value of
an asset.

3. Extra-ordinary repair expended to restore the property,

or making good its exhaustion. Extra-ordinary repair is
one that may prolong the life of an asset for more than
one (1) year. You cannot claim the same as deduction.
 Instead, you may claim it as allowance for depreciation.

4. Premiums paid on the life insurance policy of the officer

or employee of the employer, when the employer is
directly or indirectly designated as beneficiary.

5. Losses from sales or exchanges of property between

related taxpayers

RULES:
► Premiums paid on the insurance policy of the officer or
employee may be claimed as deduction by the employer, If
the beneficiary is the family or the heirs of the officer or the
employee.

► It is not deductible on the part of the employer, If the

beneficiary designated directly or indirectly is the employer.
If the beneficiary designated is the creditor or the heirs of the
employer, the designation is indirect; hence, that premium
is not deductible.

► On the other hand, on the part of the employees, these

premiums may be a taxable compensation income. It is
taxable compensation income on the part of the employee if
the beneficiary designated is the family of heirs of the
employee.

► Therefore, if these premiums are deductible on the part of

the employer, that is taxable on the part of the employee. If
these premiums are not deductible on the part of the
employer, that is not taxable on the part of the employee.

N.B. Personal, living and family expenses are deductible for

the simple reason that these are not connected with the
business, trade or profession of the taxpayer. In lieu of the
same, the taxpayer may claim the so-called “Personal and
Additional Exemption” in the case of individual taxpayers.