Revenue Regulations 02-40 Page 1 of 39

REVENUE REGULATIONS NO. 02-40 90,000 100,000 10,000 50% 5,000 37,080
February 10, 1940 100,000 120,000 20,000 52% 10,400 47,480
120,000 140,000 20,000 53% 10,600 58,080
INCOME TAX REGULATIONS 140,000 160,000 20,000 54% 10,800 68,880
160,000 200,000 40,000 55% 22,000 90,880
SECTION 1. Scope. — In accordance with the provisions of Sections 4 (I) and 338 of Commonwealth Act 200,000 250,000 50,000 56% 28,000 118,880
No. 466, otherwise known as the National Internal Revenue Code, the following regulations affecting Sections 250,000 300,000 50,000 57% 28,500 147,380
19 to 84 of the same Code relating to the income tax are hereby promulgated to supersede all circulars, 300,000 400,000 100,000 58% 58,000 205,380
precedents, rulings, and regulations heretofore published on the same subject, and they shall be known as 400,000 500,000 100,000 59% 59,000 264,380
Revenue Regulations No. 2, or the Income Tax Regulations: 500,000 - - 60% - -
Note: Taxable income is arrived at after deducting personal and additional exemptions to which taxpayer is
(Only the section numbers of the Code are given below as their texts will be found in the same Code. They entitled.
serve as captions of the pertinent provisions of the Regulations.) (Section 22 of the Code)
(Section 20 of the Code)
SECTION 5. Definition. — A "non-resident alien individual" means an individual —
SECTION 2. Application of title. — Section 20 provides that the provisions of Title II of the National (a) Whose residence is not within the Philippines; and
Internal Revenue Code shall apply only to income received from January 1, 1939. (b) Who is not a citizen of the Philippines.
(Section 21 of the Code)
An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the
SECTION 3. Persons considered citizens of the Philippines. — The following shall be considered citizens of Philippines for purposes of the income tax. Whether he is a transient or not is determined by his intentions
the Philippines: with regard to the length and nature of his stay. A mere floating intention indefinite as to time, to return to
(1) Those who were citizens of the Philippines at the time of the adoption of the Constitution of the another country is not sufficient to constitute him a transient. If he lives in the Philippines and has no definite
Philippines. intention as to his stay, he is a resident. One who comes to the Philippines for a definite purpose which in its
(2) Those born in the Philippines of foreign parents who, before the adoption of the Constitution, had been nature may be promptly accomplished is a transient. But if his purpose is of such a nature that an extended
elected to public office in the Philippines. stay may be necessary for its accomplishment, and to that end the alien makes his home temporarily in the
(3) Those whose fathers are citizens of the Philippines. Philippines, he becomes a resident, though it may be his intention at all times to return to his domicile abroad
(4) Those whose mothers are citizens of the Philippines and, upon reaching the age of majority, elect when the purpose for which he came has been consummated or abandoned.
Philippine citizenship.
(5) Those who are naturalized in accordance with law. (Sec. 1, Article IV, Constitution of the Philippines.) SECTION 6. Loss of residence by alien. — An alien who has acquired residence in the Philippines retains his
Philippine citizenship may be lost or reacquired in the manner provided by law. A foreigner who has come to status as a resident until he abandons the same and actually departs from the Philippines. An intention to
reside in the Philippines and has filed his petition to acquire Philippine citizenship but has not yet received the change his residence does not change his status as a resident alien to that of a nonresident alien. Thus an alien
requisite naturalization certificate still remains an alien. who has acquired a residence in the Philippines is taxable as a resident for the remainder of his stay in the
Philippines.
SECTION 4. Tax on citizens and residents. — Section 21 imposes progressive rates of income taxes on
citizens and residents, starting from 3 per cent upon the amount by which the net income does not exceed SECTION 7. Taxation of aliens in general. — For purposes of income tax, alien individuals are divided
P2,000 and rising gradually to 60 per cent upon the amount by which the net income exceeds P500,000. generally into two classes, namely, resident aliens and non-resident aliens. Resident aliens are taxable in the
(Conforms with amendments by R.A. 2343, effective June 20, 1959.) same manner as citizens of the Philippines, that is, a resident alien is taxable on income derived from all
The following is a table, showing the rates of income tax under Section 21, as amended by Section 1 of R.A. No. sources including sources without the Philippines. Non-resident aliens are taxable only on income from sources
2343, applicable to income received from Jan. 1, 1959 and for fiscal periods ending after June 30, 1959: within the Philippines.

1 2 3 4 5 6 SECTION 8. Taxation of non-resident aliens; classification. — Non-resident alien individuals are divided
Exceeding Not Bracket Rate Tax on Each Cumulative into two classes: (1) Those engaged in trade or business within the Philippines, and (2) those not engaged in
Exceeding of Tax Bracket Amount of Tax trade or business within the Philippines. Non-resident aliens falling within the first class are subject to the
P- P2,000 2,000 3% P60 P60 graduated rates established in Section 21 with respect to their net income from sources within the Philippines.
2,000 4,000 2,000 6% 120 180 Non-resident aliens falling within the second class are subject to a flat rate of 20 per cent on their total income
4,000 6,000 2,000 9% 180 360 from sources within the Philippines, if such total income does not exceed P23,800, otherwise, the graduated
6,000 8,000 2,000 16% 320 680 rates established in Section 21 will apply to the total income if it exceeds P23,800. (Conforms with
8,000 10,000 2,000 20% 400 1,080 amendments by R.A. 2343, effective June 20, 1959.)
10,000 20,000 10,000 24% 2,400 3,480
20,000 30,000 10,000 30% 3,000 6,480 The phrase "engaged in trade or business within the Philippines" includes the performance of personal services
30,000 40,000 10,000 36% 3,600 10,080 within the Philippines. Whether a non-resident alien has an "office or place of business," however, implies a
40,000 50,000 10,000 40% 4,000 14,080 place for the regular transaction of business and does not include a place where casual or incidental
50,000 60,000 10,000 42% 4,200 18,280 transactions might be, or are, effected. Neither the beneficiary nor the grantor of a trust, whether revocable or
60,000 70,000 10,000 44% 4,400 22,680 irrevocable, is deemed to be engaged in trade or business in the Philippines or to have an office or place of
70,000 80,000 10,000 46% 4,600 27,280 business therein, merely because the trustee is engaged in trade or business in the Philippines or has an office
80,000 90,000 10,000 48% 4,800 32,080 or place of business therein. (Test of "office or place of business" was deleted by R.A. 2343.)
Revenue Regulations 02-40
(Section 23 of the Code)
SECTION 9. Personal exemption. — Personal exemption is an arbitrary amount allowed for personal, living,
or family expenses of the taxpayer. It is allowed to citizens of the Philippines, to resident aliens, and to non-
resident aliens in certain cases. The procedure of arriving at the tax due after giving effect to the exemptions
allowable is set forth in Section 4 of these regulations. EHcaDT
SECTION 10. Personal exemption of single individuals. — A single individual is entitled to a personal
exemption of P1,800.
SECTION 11. Personal exemption of married persons and heads of family. — A married person is entitled to
a personal exemption of P3,000. Only one exemption of P3,000 is allowed with respect to the aggregate
income of both husband and wife. (Conforms with amendments by R.A. 2343, effective June 20, 1959.)
A head of family is an individual who actually supports and maintains in one household one or more
individuals, who are closely connected with him by blood relationship, relationship by marriage, or by
adoption, and whose right to exercise family control and provide for these dependent individuals is based upon
some moral or legal obligation. In the absence of continuous actual residence together, whether or not a
person with dependent relatives is a head of a family within the meaning of the statute must depend on the
character of the separation. If a father is absent on business, or a child or other dependent is away at school or
on a visit, the common home being still maintained, the additional exemption applies. If, moreover, through
force of circumstances a parent is obliged to maintain his dependent children with relatives or in a boarding
house while he lives elsewhere, the additional exemption may still apply. If, however, without necessity, the
dependent continuously makes his home elsewhere, his benefactor is not the head of a family, irrespective of
the question of support. A resident alien with children abroad is not thereby entitled to credit as the head of a
family. Chief support means principal or main support. Partial support not amounting to chief support will not
entitle the taxpayer to claim exemption as a head of a family.
Under the law the following persons are entitled to P3,000 exemption: (a) a married man; (b) a married
woman; and (c) an unmarried man or woman with one or both parents, or one or more brothers or sisters, or
one or more legitimate, recognized natural, or adopted children living with and dependent upon him or her for
their chief support, where such brothers, sisters, or children are not more than 23 years of age, unmarried and
not gainfully employed or where such children are incapable of self-support because mentally or physically
defective. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
SECTION 12. Additional exemption for dependents. — The taxpayer is entitled to an additional exemption
of P1,000 for each legitimate, recognized natural, or adopted child wholly dependent upon and living with such
person, if such dependent is not more than 23 years of age, unmarried and not gainfully employed or incapable
of self-support because mentally or physically defective, provided that the person claiming additional
exemption is a head of family. The children with respect to whom additional exemption is claimed must be
wholly dependent upon the taxpayer for support. (Conforms with amendments by R A. 2343, effv. June 20,
1959.)
SECTION 13. Change of status. — If the status of the taxpayer, insofar as it affects the personal and
additional exemptions, changes during the taxable year by reason of his death, the amount of the personal and
additional exemptions shall be apportioned, in accordance with the number of months before and after such
change. For the purpose of such apportionment, a fractional part of a month shall be disregarded unless it
amounts to more than half a month in which case it shall be considered as one month. (Conforms with
amendment by R.A. 590, effv. Sept. 22, 1950.)
SECTION 14. Personal exemption of non-resident aliens. — A non-resident alien is entitled to a personal
exemption in an amount equal to the exemptions allowed by the income tax law in the country of which he is a
citizen or subject to citizens of the Philippines. The exemption allowed to non-resident aliens is a reciprocal
one; that is, it is only allowed if the country of said non-resident aliens allows similar exemptions to Filipinos
not residing in such country but deriving income from sources therein. If the country of which the non-resident
alien is a citizen or subject does not have any income tax law, such non-resident alien will not be entitled to
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personal exemption.
(Section 24 of the Code)
SECTION 15. Income tax on corporations. — The law imposes an annual income tax of 22 per centum upon
that portion of the net income of every corporation not in excess of P100,000 and 30 per cent on the excess.
The term "corporation" includes partnership no matter how created or organized, joint-stock companies, joint-
account (cuentas en participacion), association, or insurance companies but does not include duly registered
general co-partnership (companias colectivas). The tax is upon net income, which is undetermined by
subtracting from the gross income, as defined in the law, the allowable deductions. (Conforms with
amendments by R.A. 2343, effv. June 20, 1959.)
SECTION 16. Corporations liable to tax. — Every corporation, domestic or foreign, not otherwise exempt
from tax under Title II or any other law, is liable to tax. A domestic corporation is taxed on its income from
sources within and without the Philippines, but a foreign corporation is taxed only on its income form sources
within the Philippines.
The tax imposed by law on corporations is not imposed only upon such corporations as are organized and
operated for profit. Any corporation, firm or association, no matter how created or organized, or what the
purpose of its organization may be, is subject to the tax, except as provided in Section 27, relative to
exemptions from tax on corporations. A corporation is not exempt simply and only because it is primarily not
organized and operated for profit.
SECTION 17. Dividends received by a corporation from a domestic corporation. — Dividends received by a
domestic or resident foreign corporation from a domestic corporation subject to tax are taxable only to the
extent of 25 per cent thereof. All other classes of income (except net capital gains, Section 34) of corporations
are taxable in full. Likewise dividends from a foreign corporation, whether resident or non-resident, are taxable
in full. (See Sections 250 to 256 of these regulations relative to taxation of dividends and other distributions.)
SECTION 17-A. Tax on life insurance companies. — Every life insurance company organized in or existing
under the laws of the Philippines, or foreign life insurance company authorized to carry on business in the
Philippines are taxable on their total net investment income derived from interest, dividends and rents from all
sources whether within or without the Philippines, to the flat rate of 6-1/2%. However, purely cooperative
insurance companies or associations which are conducted by the members thereof with the money collected
from among themselves and solely for their own protection and not for profit are exempt from income tax.
The total net investment income of domestic life insurance companies means the gross investment income
received during the taxable year from rents, dividends and interest less deductions for real estate expenses,
depreciation, interest paid within the taxable year on its indebtedness except on indebtedness incurred to
purchase or carry obligation the interest upon which is wholly exempt from taxation under existing laws, and
such investment expenses paid during the taxable year as are ordinary and necessary in the conduct of its
investment. The total net investment income of foreign life insurance companies doing business here is that
portion of their gross world investment income which bears the same ratio to such income as their total
Philippines reserve (whether kept in the Philippines or abroad) bears to their total world reserve less that
portion of their total world investment expenses which bears the same ratio to such expenses as their total
Philippine investment income bears to their total world investment income. The following equation simplifies
this formula:
PGI = PR/WR x WGI
PIE = PGI/WGI x WIE
PGI - PIE = PNI
Legend:
PGI is Philippine Gross Investment Income
PNI is Philippine Net Investment Income
PR is Total Philippine Reserve
WR is Total World Reserve
WGI is World Gross Investment Income
Revenue Regulations 02-40
PGI is Philippine Gross Investment Income
WIE is Total World Investment Expenses
PIE is Philippine Investment Expense
In both cases, the deductible expenses must be connected with the investment income subjected to tax. For
the proper determination of the income tax liability of resident foreign life insurance companies, they should
submit the necessary financial statement reflecting the nature of the investment income and corresponding
expenses. These financial statements must be duly certified by an independent certified public accountant and
authenticated by a Philippine consular official.
Foreign life insurance companies not doing business in the Philippines are subject to the normal income tax on
their income received from sources within the Philippines. They are subject to tax at the rate of 30% like any
other foreign corporation.
Domestic life insurance companies and foreign life insurance companies doing business in the Philippines are
not allowed to deduct from their gross income the net additions, if any, required by law to be made within the
year to reserve funds and the sums other than dividends paid within the year on policy and annuity contracts.
(Proposed by the BIR. If adopted, this will supersede Sec. 124 of existing regulations.)
(Section 25 of the Code)
SECTION 18. Taxation of corporation formed or utilized for avoidance of tax. — Section 25 imposes for each
year, in addition to the tax imposed by Section 24 a tax of 25 per cent on the undistributed portion of the
profits or surplus of a corporation which is formed or availed of for the purpose of preventing the imposition of
the tax upon its shareholders or members or the shareholders or members of any other corporation through
the medium of permitting gains or profits to accumulate instead of dividing or distributing them. However,
banks, insurance companies, personal holding companies and foreign personal holding companies as defined in
Chapter VIII, are excepted from taxation under Section 25. The tax imposed by Section 25 applies whether the
avoidance was accomplished through the formation or use of only one corporation or a chain of corporations.
For example, if the capital stock of the M Corporation is held by the N Corporation so that the dividend
distributions of the M Corporation would not be returned as income subject to the tax on individuals until
distributed in turn by the N Corporation to its individual shareholders, nevertheless the tax imposed by Section
25 applies to the M Corporation, if that corporation is formed or availed of for the purpose of preventing the
imposition of the tax upon the individual shareholders of the N Corporation. A foreign corporation, whether
resident or non-resident, is subject to the tax provided for under Section 25 in the same manner and under the
same circumstances as a domestic corporation.
SECTION 19. Purpose to avoid tax; evidence; burden of proof; definitions of holding or investment
company. — The Collector of Internal Revenue's determination that a corporation was formed or availed of for
the purpose of avoiding the tax on its shareholders or members is subject to disproof by competent evidence.
The existence or non-existence of the purpose may be indicated by circumstances other than the evidence
specified in Section 25(b), and whether or not such purpose was present depends upon the particular
circumstances of each case. In other words, a corporation is subject to taxation under Section 25 if it is formed
or availed of for the purpose of preventing the imposition of the progressive rates of tax upon shareholders
through the medium of permitting earnings or profits to accumulate, even though the corporation is not a
mere holding or investment company 50 per cent or more of the outstanding stock of which is owned directly
or indirectly by one person, and does not have an unreasonable accumulation of earnings or profits; and on
the other hand, the fact that a corporation is such a company or has an accumulation is not absolutely
conclusive against it if, by clear and convincing evidence, the taxpayer satisfies the Commissioner of Internal
Revenue that the corporation was neither formed nor availed of for the purpose of avoiding the tax on
individuals. All the other circumstances which might be construed as evidence of the purpose to avoid the tax
on shareholders cannot be outlined, but among other things the following will be considered: (1) Dealings
between the corporation and its shareholders, such as withdrawal by the shareholders as personal loans or the
expenditure of funds by corporation for the personal benefit of the shareholders, and (2) the investment by the
corporation of undistributed earnings in assets having no reasonable connection with the business. The mere
fact that the corporation distributed a large part of its earnings for the year in question does not necessarily
prove that earnings were not permitted to accumulate beyond reasonable needs or that the corporation was
not formed or availed of to avoid the tax upon shareholders.
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If the Commissioner of Internal Revenue determined that the corporation was formed or availed of for the
purpose of avoiding the progressive rates of tax on individuals through the medium of permitting earnings or
profits to accumulate, and the taxpayer contests such determination of fact by litigation, the burden of proving
the determination wrong by a preponderance of evidence, together with the corresponding burden of first
going forward with evidence, is on the taxpayer under principles applicable to income tax cases generally, and
this is so even though the corporation is not a mere holding or investment company and does not have an
unreasonable accumulation of earnings or profits. However, if the corporation is a mere holding or investment
company, then the law gives further weight to the presumption of correctness already arising from the
Commissioner of Internal Revenue's determination by expressly providing an additional presumption of the
existence of a purpose to avoid the tax upon shareholders, while if earnings or profits are permitted to
accumulate beyond the reasonable needs of the business then the law adds still more weight to the
Commissioner of Internal Revenue's determination by providing that irrespective of whether or not the
corporation is a mere holding or investment company, the existence of such an accumulation is determinative
of the purpose to avoid the tax upon shareholders unless the taxpayer proves the contrary by such a clear
preponderance of all the evidence that the absence of such a purpose is unmistakable.
SECTION 20. Holding and investment companies. — A corporation having practically no activities except
holding property, and collecting the income therefrom or investing therein, shall be considered a holding
company within the meaning of Section 25. If the activities further include, or consist substantially of, buying
and selling stocks, securities, real estate, or other investment property (whether upon an outright or a marginal
basis) so that the income is derived not only from the investment yield but also from profits upon market
fluctuations, the corporation shall be considered an investment company within the meaning of Section 25.
SECTION 21. Unreasonable accumulation of profits. — An accumulation of earnings or profits (including the
undistributed earnings or profits of prior years) is unreasonable if it is not required for the purposes of the
business, considering all the circumstances of the case. It is not intended, however, to prevent accumulations
of surplus for the reasonable needs of the business if the purpose is not to prevent the imposition of the tax
upon shareholders. No attempt is here made to enumerate all the ways in which earnings or profits of a
corporation may be accumulated for the reasonable needs of the business. Undistributed income is properly
accumulated if retained for working capital needed by the business; or if invested in additions to plant
reasonably required by the business; or if in accordance with contract obligations placed to the credit of a
sinking fund for the purpose of retiring bonds issued by the corporation. The nature of the investment of
earnings or profits is immaterial if they are not in fact needed in the business. Among other things, the nature
of the business, the financial condition of the corporation at the close of the taxable year, and the use of the
undistributed earnings or profits will be considered in determining the reasonableness of the accumulations.
The business of a corporation is not merely that which it has previously carried on, but includes in general any
line of business which it may undertake. However, a radical change of business when a considerable surplus
has been accumulated may afford evidence of a purpose to avoid the tax. If one corporation owns the stock of
another corporation in the same or a related line of business and in effect operates the other corporation, the
business of the latter may be considered in substance although not in legal form the business of the first
corporation. Earnings or profits of the first corporation put into the second through the purchase of stock or
otherwise may, therefore, if a subsidiary relationship is established, constitute employment of the income in its
own business. Investment by a corporation of its income in stock and securities of another corporation is not of
itself to be regarded as employment of the income in its business. The business of one corporation may not be
regarded as including the business of another unless the other corporation is a mere instrumentality of the
first; to establish this it is ordinarily essential that the first corporation own all or substantially all of the stock of
the second.
The Commissioner of Internal Revenue may require any corporation to furnish a statement of its accumulated
earnings and profits, the name and address of, and number of share held by each of its shareholders or
members, and the amounts that would be payable to each, if the income of the corporation were distributed.
(Section 26 of the Code)
SECTION 22. General co-partnerships. — General co-partnerships, when duly registered, are not subject to
Revenue Regulations 02-40
income tax, but are required to file returns of their income on B.I.R. Form No. 17.04 for the purpose of
furnishing information as to the share in the gains or profits which each partner shall include in his individual
return. Individuals carrying on business in general co-partnership are, however, taxable upon their distributive
shares of the net income of such partnership, whether distributed or not, and are required to include such
distributive shares in their individual returns. The returns of duly registered general co-partnerships should be
rendered on or before April 15 of each year or within sixty days after the end of their fiscal year depending on
whether their books are kept on the calendar or on the fiscal year basis. (Conforms with amendments by R.A.
2343, effv. June 20, 1959.)
SECTION 23. Distributive shares of partners. — The distributive share of the net profit of a general co-
partnership must be included in the individual returns of the partners. But where the result of partnership
operation is a loss, the loss will be divisible by the partners in the same proportion as the net income would
have been divisible (or, if the partnership agreement provides for the division of a loss in a manner different
from the division of a gain, in the manner so provided) and may be taken by the individual partners in their
respective returns of income.
(Section 27 of the Code)
SECTION 24. Proof of exemption. — In order to establish its exemption, and thus be relieved of the duty of
filing returns of income and paying the tax, it is necessary that every organization claiming exemption file an
affidavit with the Commissioner of Internal Revenue, showing the character of the organization, the purpose
for which it was organized, its actual activities, the sources of its income and its disposition, whether or not any
of its income is credited to surplus or inures or may inure to the benefit of any private shareholder or
individual, and in general, all facts relating to its operations which affect its right to exemption. To such affidavit
should be attached a copy of the charter or articles of incorporation, the by-laws of the organization, and the
latest financial statement showing the assets, liabilities, receipts, and disbursement of the organization.
Upon receipt of the affidavit and other papers by the Commissioner of Internal Revenue, the organization will
be informed whether or not it is exempt. When an organization has established its right to exemption, it need
not thereafter make and file a return of income as required under Section 46 of the Tax Code. However, the
organization should file on or before April 15 of each year, an annual information return under oath, stating its
gross income and expenses incurred during the preceding year, and a certificate showing that there has not
been any substantial change in its By-Laws, Articles of Incorporation, manner of operation and activities as well
as sources and disposition of income. (As amended by Revenue Regulations No. 7-64, approved November 25,
1964.)
SECTION 25. Agricultural and horticultural organizations. — The organizations contemplated by subsection
(a) of Section 27 of the Code as entitled to exemption from income taxation are those which (1) have no net
income inuring to the benefit of any member; (2) are educational or instructive in character; and (3) have as
their objects the betterment of the conditions of those engaged in such pursuits, the improvement of the
grade of their products, and the development of a higher degree of efficiency in their respective occupations.
Organizations such as provincial fairs and like associations of a quasi-public character, which are designed to
encourage the development of better agricultural and horticultural products through a system of awards,
prizes, or premiums, and whose income derived from gate receipts, entry fees, donations, etc., is used
exclusively to meet the necessary expenses of upkeep and operation, are thus exempt. On the other hand,
associations which have for their purpose, for example, the holding of periodical race meets, the profits from
which may inure to the benefit of their shareholders, are not exempt. Similarly, corporations engaged in
growing agricultural or horticultural products or raising live stock or similar products for profits are not exempt
from tax under this paragraph.
SECTION 26. Mutual savings bank. — In order that a corporation may be entitled to exemption as a mutual
savings bank, it must appear that it is an organization (1) which has no capital stock represented by shares, and
(2) whose earnings less only the expenses of operation, are distributable wholly among the depositors. If it
appears that the organization has shareholders who participate in the profits, the organization will not be
exempt from income tax.
SECTION 27. Fraternal beneficiary societies. — A fraternal beneficiary society is exempt from tax only if
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operated under the "lodge system", or for the exclusive benefit of the members of a society so operating.
"Operating under the lodge system" means carrying on its activities under a form of organization that
comprises local branches, chartered by a parent organization and largely self-governing, called lodges,
chapters, or the like. In order to be exempt, it is also necessary that the society should have an established
system for payment to its members or their dependents of life, sick, accident, or other benefits.
SECTION 28. Building and loan associations. — (Now subject to tax, as amended by Sec. 4, R.A. 82.)
SECTION 29. Cemetery companies. — A cemetery company may be entitled to exemption, (1) if it is owned
by and operated exclusively for the benefit of its lot owners, or (2) if it is not operated for profit. Any cemetery
corporation chartered solely for burial purposes and not permitted by its charter to engage in any business not
necessarily incident to that purpose, is exempt from income tax, provided that no part of its net earnings
inures to the benefit of any private shareholder or individual. A cemetery company which fulfills the other
requirement of the statute may be exempt, even though it issues preferred stock entitling the holders to
dividend at a fixed rate, provided that its articles of incorporation require (a) that the preferred stock shall be
retired at par as soon as sufficient funds are realized from sales, and (b) that all funds not required for the
payment of dividends upon or for the retirement of preferred stock shall be used by the company for the care
and improvement of the cemetery property.
A cemetery company having a capital stock represented by shares, or which is operated for profit or for the
benefit of persons other than its members, does not come within the exempted class.
SECTION 30. Religious, charitable, scientific, athletic, cultural, and educational corporations. — A
corporation falling among those enumerated in subsection (e) of Section 27 is exempt from tax on its income
(other than income of whatever kind and character from its properties, real or personal) if such corporation
meets two tests: (a) It must be organized and operated for one or more of the specified purposes; and (b) no
part of its net income must inure to the benefit of private stockholders or individuals.
The income of such corporation which is considered as income from their properties, real or personal,
generally consists of income from corporate dividends, rentals received from their properties, interests
received from such capital loaned to other persons, income from agricultural lands owned by such
corporations, profits from the sale of property, real or personal, and other similar income. ASIETa
Income not derived from their properties, real or personal, are exempt. For example, in the case of a religious
corporation, income from the conduct of strictly religious activities, such as fees received for administering
baptismals, solemnizing marriages, attending burials, holding masses, and other like income, is exempt. In the
case of an educational corporation, income from the holding of an educational fair or exhibit is exempt.
However, if such exempt income is invested by the corporation, the income from such investment, as interests
from the capital where the capital has been loaned or dividends on stock where the capital has been invested
in shares of stock, will constitute taxable income. Donations and other similar contributions received by such
corporation from other persons are exempt.
The clause "except income expressly exempt by this Title" appearing in subsection (e) of Section 27 refers to
those classes of income which, in accordance with subsection (b) of Section 29, are exempt from taxation
under Title II.
Charitable corporations include an association for the relief of the families of clergymen, even though the latter
make a contribution to the fund established for this purpose; or for furnishing the services of trained nurses to
persons unable to pay for them; or for aiding the general body of litigants by improving the efficient
administration of justice. Educational corporations may include associations whose sole purpose is the
instruction of the public. But associations formed to disseminate controversial or partisan propaganda are not
educational within the meaning of the law. Scientific corporations include an association for the scientific study
of law with a view to improving its administration.
It does not prevent exemption that private individuals, for whose benefit a charity is organized, receive the
income of the corporation or association. The law refers to individuals having a personal and private interest in
Revenue Regulations 02-40
the activities of the corporation, such as stockholders. If, however, a corporation issues "voting shares", which
entitle the holders upon the dissolution of the corporation to receive the proceeds of its property, including
accumulated income, the right to exemption ceases to exist, even though the by-laws provide that the
shareholders shall not receive any dividend or other return upon their shares.
SECTION 31. Business leagues. — A business league is an association of persons having some common
business interest, which limits its activities to work for such common interest and does not engage in a regular
business of a kind ordinarily carried on for profit. Its work need not be similar to that of a chamber of
commerce or board of trade. If it engages in a regular business of a kind ordinarily carried on for profit, the fact
that the business is conducted on a cooperative basis or produces only sufficient income to be self-sustaining,
is not ground for exemption. An association engaged in furnishing information to prospective investors, to
enable them to make sound investments, is not exempt, since its members have no common business interest,
even though all of its income is devoted to the purpose stated. A clearing house association, not organized for
profit, no part of the net income of which inures to any private shareholder or individual, is exempt provided
its activities are limited to the exchange of checks, and similar work for the common benefit of its members. An
association of persons who are engaged in the transportation business, whether by land or water, which is
designed to promote the legitimate objects of such business, and all of the income of which is derived from
membership dues and is expended for office expenses is exempt from tax.
SECTION 32. Civic leagues. — Civic leagues entitled to exemption comprise those not organized for profit
but operated exclusively for purposes beneficial to the community as a whole. In general, organizations
engaged in promoting the welfare of mankind are exempt from tax.
SECTION 33. Social clubs. — The exemption applies to practically all social and recreation clubs which are
supported by membership fees, dues, and assessments. If a club, by reason of the comprehensive powers
granted in the charter, engages in business or in agriculture or horticulture, for profit, such club is not
organized and operated exclusively for pleasure, recreation, or social purposes, and any profit realized from
such activities is subject to tax.
SECTION 34. Mutual insurance companies and like organizations. — It is necessary to exemption that the
income of the company be derived solely from assessments, dues, and fees collected from members. If income
is received from other sources, the corporation is not exempt. Income, however, from sources other than those
specified does not prevent exemption where its receipt is a mere incident of the business of the company. Thus
the receipt of interest upon a working bank balance, or of the proceeds of the sale of badges, office supplies,
or equipment, will not defeat the exemption. The same is true of the receipt of interest upon Government
bonds, where they were purchased and were afterwards sold. Where, however, such bonds are bought as a
permanent investment, the receipt of the interest destroys the exemption. The receipt of what is, in substance,
an entrance fee, charged by a mutual fire insurance company as a condition of membership, does not render
the company taxable, although this fee is called a premium. If an organization issues policies for stipulated cash
premiums, or if it requires advance deposits to cover the cost of the insurance and maintains investments from
which income is derived, it is not entitled to exemption. On the other hand, an organization may be entitled to
exemption, although it makes advance assessment for the sole purpose of meeting future losses and expenses,
provided that the balance of such assessments remaining on hand at the end of the year is retained to meet
losses and expenses or is returned to members. An organization of a purely local character is one whose
business activities are confined to a particular community, place, or district, irrespective, however, of political
subdivisions.
SECTION 35. Farmers' cooperative marketing and purchasing association. — Cooperative associations,
acting as sales agents for farmers or others, in order to come within the exemption must establish that for their
own account they have no net income. Cooperative dairy companies, which are engaged in collecting milk and
disposing of it or the products thereof and distributing the proceeds, less necessary operating expenses,
among their members upon the basis of the quantity of milk or of butter fat in the milk furnished by such
members are exempt from the tax. If the proceeds of the business are distributed in any other way than on
such a proportionate basis, the company will be subject to tax. A farmers' association is not exempt from
taxation where in accounting to farmers furnishing produce for the proceeds of sales it deducts more than the
necessary selling expenses incurred. Cooperative associations acting as purchasing agents are not expressly
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exempt from tax, but rebates made to purchasers, whether or not members of the association, in proportion to
their purchases may be excluded from gross income in computing the net income subject to tax. Any profits
made from non-members and distributed to members in the guise of rebates are, of course, subject to tax.
Cooperative marketing associations duly incorporated under Act No. 3425, known as the Cooperative
Marketing Law are exempt from income tax. (See also R.A. 702 exempting cooperative marketing associations.)
(Section 28 of the Code)
SECTION 36. Meaning of net income. — The tax imposed by law is upon income. In the computation of the
tax, various classes of income must be considered: (a) Income, in the broad sense, meaning all wealth which
flows into the tax-payer other than as a mere return of capital. It includes the forms of income specifically
described as gains and profits, including gains derived from the sale or other disposition of capital assets.
Income cannot be determined merely by reckoning cash receipts, for the statute recognizes as income
determining factor other items, among which are inventories, accounts receivable, property exhaustion, and
accounts payable for expenses incurred. (b) Gross income, meaning income (in the broad sense) less income
which is by statutory provision or otherwise exempt from the tax imposed by law. (c) Net income, meaning
gross income less statutory deductions. The statutory deductions are, in general, though not exclusively,
expenditures other than capital expenditures, connected with production of income. (d) In the case of a
taxpayer other than a corporation as defined in Section 84 (b) of the Code, net income means gross income
less exemptions. Ordinarily the net income is to be computed in accordance with the method of accounting
regularly employed in keeping the books of the taxpayer.
SECTION 37. Computation of net income. — Net income must be computed with respect to a fixed period.
That period is twelve months ending December 31st of every year except in the case of a corporation filing
returns on a fiscal year basis in which case net income will be computed on the basis of such fiscal year. Items
of income and of expenditures, which as gross income and deductions, are elements in the computation of net
income, need not be in the form of cash. It is sufficient that such items may be appraised in terms of money.
The time as of which any item of gross income or any deduction is to be accounted for must be determined in
the light of the fundamental rule that the computation shall be made in such a manner as would clearly reflect
the taxpayer's income. If the method of accounting regularly employed by him in keeping his books clearly
reflects his income, it is to be followed with respect to the time as of which items of gross income and
deductions are to be accounted for, otherwise the computation of net income shall be made in such manner as
in the opinion of the Commissioner of Internal Revenue would clearly reflect it.
SECTION 38. Bases of computation. — Approved standard methods of accounting will be ordinarily
regarded as clearly reflecting income. A method of accounting will not, however, be regarded as clearly
reflecting income unless all items of gross income and all deductions are treated with reasonable consistency.
All items of gross income shall be included in the gross income for the taxable year in which they are received
by the taxpayer and deductions taken accordingly, unless in order clearly to reflect income such amounts are to
be properly accounted for as of a different period. For instance, in any case in which it is necessary to use an
inventory, no accounting in regard to purchases and sales will correctly reflect income except an accrual
method. A taxpayer is deemed to have received items of gross income which have been credited to or set apart
for him without restriction. On the other hand, appreciation in value of property is not even an accrual of
income to a taxpayer prior to the realization of such appreciation through sale or conversion of the property.
(For methods of accounting and determination of accounting period, see Sections 166 to 169 of these
regulations.)
(Section 29(a) of the Code)
SECTION 39. What gross income includes. — Gross income includes, in general, compensation for personal
and professional services, business income, profits from sales of and dealings in property, interests, rents,
dividends, and gains, profits, and income derived from any source whatever, unless exempt from tax by law. In
general, income is the gain derived from capital, from labor, or from both combined, provided it be understood
to include profit gained through a sale or conversion of capital assets. Profit of citizens, resident aliens, or
domestic corporations derived from sales in foreign commerce must be included in their gross income. Income
may be in the form of cash or of property.
Revenue Regulations 02-40
For the treatment of dividends for purposes of the tax, see Sections 250 to 256 of these regulations. For the
treatment of capital gains, see Sections 132 to 135 of these regulations.
SECTION 40. Compensation for personal services. — Where no determination of compensation is had until
the completion of the services, the amount received is ordinarily income for the taxable year of its
determination, if the return is rendered on the accrual basis; or, for the taxable year in which received, if the
return is rendered on a receipts and disbursements basis. Commissions paid salesman, compensation for
services on the basis of a percentage of profits, commissions on insurance premiums, tips, and pensions or
retiring allowances paid by private persons or by the Government of the United States or of the Philippines
(except pensions exempt by law from tax) are income to the recipients; as are also marriage fees, baptismal
offerings, sums paid for saying masses for the dead, and other contributions received by a clergyman,
evangelists, or religious worker for services rendered. However, so-called pensions awarded by one to whom
no services have been rendered are mere gifts or gratuities and are not taxable.
SECTION 41. Compensation paid other than in cash. — Where services are paid for with something other
than money, the fair market value of the thing taken in payment is the amount to be included as income. If the
services were rendered at a stipulated price, in the absence of evidence to the contrary, such price will be
presumed to be the fair value of the compensation received. Compensation paid an employee of a corporation
in its stock is to be treated as if the corporation sold the stock for its market value and paid the employee in
cash. When living quarters are furnished in addition to cash salary, the rental value of such quarters should be
reported as income.
SECTION 42. Compensation paid in promissory notes. — Promissory notes or other evidence of
indebtedness received in payment for services, and not merely as security for such payment, constitute income
to the amount of their fair market value. A taxpayer receiving as compensation a note regarded as good for its
face value at maturity, but not bearing interest, shall treat as income as of the time of receipt the fair
discounted value of the note at that time. Thus, if it appears that such a note is or could be discounted on a 6
per cent basis, the recipient shall include such note in his gross income to the amount of its face value less
discount computed at the prevailing rate for such transactions.
If the payment due on a note so accounted for are met as they become due, there should be included as
income in respect of each such payment so much thereof as represents recovery for the discount originally
deducted.
SECTION 43. Gross income from business. — In the case of a manufacturing, merchandising, or mining
business, "gross income" means the total sales, less the cost of goods sold, plus any income from investments
and from incidental or outside operations or sources. In determining the gross income, subtractions should not
be made for depreciation, depletion, selling expenses or losses, or for items not ordinarily used in computing
the cost of goods sold.
SECTION 44. Long term contracts. — Income from long-term contracts is taxable for the period in which the
income is determined, such determination depending upon the nature and terms of the particular contract. As
used herein the term "long-term" contracts means building, installation, or construction contracts covering a
period in excess of one year. Persons whose income is derived in whole or in par from such contracts may, as to
such income, prepare their returns upon the following bases:
(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion.
In such case there should accompany the return certificate of architects, or engineers showing the percentage
of completion during the taxable year of the entire work performed under contract. There should be deducted
from such gross income all expenditures made during the taxable year on account of the contract, account
being taken of the material and supplies on hand at the beginning and end of the taxable period for use in
connection with the work under the contract but not yet so applied. If upon completion of a contract, it is
found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the
Commissioner of Internal Revenue may permit or require an amended return.
(b) Gross income may be reported in the taxable year in which the contract is finally completed and accepted
Page 6 of 39
if the taxpayer elects as a consistent practice to so treat such income, provided such method clearly reflects
the net income. If this method is adopted there should be deducted from gross income all expenditures during
the life of the contract which are properly allocated thereto, taking into consideration any material and
supplies charged to the work under the contract but remaining on hand at the time of the completion.
Where a taxpayer has filed his return in accordance with the method of accounting regularly employed by him
in keeping his books and such method clearly reflects the income, he will not be required to change to either of
the methods above set forth. If a taxpayer desires to change his method of accounting in accordance with
paragraphs (a) and (b) above, a statement showing the composition of all items appearing upon his balance
sheet and used in connection with the method of accounting formerly employed by him, should accompany his
return.
SECTION 45. Gross income of farmers. — A farmer reporting on the basis of receipts and disbursements (in
which no inventory to determine profits is used) shall include in his gross income for the taxable year (1) the
amount of cash or the value of merchandise or other property received from the sale of live stock and produce
which were raised during the taxable year or prior years, (2) the profit from the sale of any live stock or other
items which were purchased, and (3) gross income from all other sources. The profit from the sale of live stock
or other items which were purchased is to be ascertained by deducting the cost from the sales price in the year
in which the sale occurs, except that in the case of the sale of animals purchased as draft or work animals, or
solely for breeding or dairy purposes and not for resale, the profit shall be the amount of any excess of the
sales prices over the amount representing the difference between the cost and the depreciation theretofore
sustained and allowed as a deduction in computing net income.
In the case of a farmer reporting on the accrual basis (in which an inventory is used to determine profits), his
gross profits are ascertained by adding to the inventory value of live stock and products on hand at the end of
the year the amount received from the sale of live stock products, and miscellaneous receipts for hire of teams,
machinery, and the like, during the year, and deducting from this sum the inventory value of live stock and
products on hand at the beginning of the year and the cost of live stock and products purchased during the
year. In such cases all live stock raised or purchased for sale shall be included in the inventory at their proper
valuation determined in accordance with the method authorized and adopted for the purpose. Also, live stock
acquired for drafts, breeding, or dairy purposes and not for sale may be included in the inventory, instead of
being treated as capital assets subject to depreciation, provided such practice is followed consistently by the
taxpayer. In case of the sale of any live stock included in an inventory their cost must not be taken as an
additional deduction in the return of income, as such deduction will be reflected in the inventory.
In every case of the sale of machinery, farm equipment, or other capital assets (which are not to be included in
an inventory if one is used to determine profits) any excess over the cost thereof less the amount of
depreciation theretofore sustained and allowed as a deduction in computing net income, shall be included as
gross income. Where farm produce is exchanged for merchandise, groceries, or the like, the market value of
the article received in exchange is to be included in gross income. Rents received in crop shares shall be
returned as of the year in which the crop shares are reduced to money or a money equivalent. Proceeds of
insurance, such as fire and typhoon insurance on growing crops, should be included in gross income to the
amount received in cash or its equivalent for the crop injured or destroyed. If a farmer is engaged in producing
crops which take more than a year from the time of planting to the time of gathering and disposing, the
income therefrom may be computed upon the crop basis; but in any such cases the entire cost of producing
the crop must be taken as a deduction in the year in which the gross income from the crop is realized. EaICAD
As herein used the term "farm" embrace the farm in the ordinarily accepted sense, and includes stock, dairy,
poultry, fruit, and truck farms, also plantations, ranches, and all land used for farming operations. All
individuals, partnerships, or corporations that cultivate, operate, or manage farms for gain or profit either as
owners, or tenants, are designated farmers. A person cultivating or operating a farm for recreation or pleasure,
the result of which is a continual loss from year to year, is not regarded as a farmer.
SECTION 46. Sale of patents and copyrights. — A taxpayer disposing of patents or copyrights by sale should
determine the profit or loss arising therefrom by computing the difference between the selling price and the
cost. The taxable income in the case of patents or copyrights acquired prior to March 1, 1913, should be
ascertained in accordance with the provisions of section 136 of these regulations. The profit or loss thus
Revenue Regulations 02-40
ascertained should be increased or decreased, as the case may be, by the amounts deducted on account of
depreciation of such patent or copyrights since March 1, 1913, or since the date of acquisition if subsequent
thereto.
SECTION 47. Sale of goodwill. — Gain or loss from a sale of goodwill results only when the business, or a
part of it, to which the goodwill attaches is sold, in which case the gain or loss will be determined by comparing
the sale price with the cost or other basis of the assets, including goodwill. If specific payment was not made
for goodwill acquired after March 1, 1913, there can be no deductible loss with respect thereto, but gain may
be realized from the sale of goodwill built up through expenditures which have been currently deducted. It is
immaterial that goodwill may never have been carried on the books as an asset but the burden of proof is on
the taxpayer to establish the cost or fair market value on March 1, 1913, of the goodwill sold.
SECTION 48. Annuities and insurance policies. — Annuities paid by religious, charitable, and educational
corporations under an annuity contract are subject to tax to the extent that the aggregate amount of the
payments to the annuitant exceeds the amounts paid by him as consideration for the contract. An annuity
charged upon devised land is taxable to a donee-annuitant, whether paid by the devisee out of the rents of the
land or from other sources. The devisee is not required to return as gross income the amount of rent paid to
the annuitant, and he is not entitled to deduct from his gross income any sums paid to the annuitant. Amounts
received by an insured as a return of premiums paid by him under life insurance, endowment, or annuity
contracts, such as the so-called "dividends" of a mutual insurance company, which may be credited against the
current premium, are not subject to tax. Distributions on paid-up policies which are made out of earnings of
the insurance company subject to tax are in the nature of corporate dividends and should be included in the
taxable income of the individual, without any credit for the amount of tax paid by the corporation at source.
SECTION 49. Improvements by lessees. — When buildings are erected or improvements made by a lessee
in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal
by the lessee, the lessor may at his option report the income therefrom upon either of the following bases;
(a) The lessor may report as income at the time when such buildings or improvements are completed the fair
market value of such buildings or improvements subject to the lease.
(b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or
improvements at the termination of the lease and report as income for each year of the lease an aliquot
part thereof.
If for any other reason than a bona fide purchase from the lessee by the lessor the lease is terminated, so that
the lessor comes into possession or control of the property prior to the time originally fixed for the termination
of the lease, the lessor receives additional income for the year in which the lease is so terminated to the extent
that the value of such buildings or improvements when he became entitled to such possession exceeds the
amount already reported as income on account of the erection of such buildings or improvements. No
appreciation in value due to causes other than the premature termination of the lease shall be included.
Conversely, if the building or improvements are destroyed prior to the expiration of the lease, the lessor is
entitled to deduct as a loss for the year when such destruction takes place the amount previously reported as
income because of the erection of such buildings or improvements, less any salvage value subject to the lease
to the extent that such loss was not compensated for by insurance. If the buildings or improvements destroyed
were acquired prior to March 1, 1913, the deduction shall be based on the cost or the value subject to the
lease to the extent that such loss was not compensated for by insurance. HSaCcE
SECTION 50. Forgiveness of indebtedness. — The cancellation and forgiveness of indebtedness may
amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If, for
example, an individual performs services for a creditor, who, in consideration thereof cancels the debt, income
to that amount is realized by the debtor as compensation for his services. If, however, a creditor merely desires
to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift
from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which
a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend.
SECTION 51. When income is to be reported. — Gains, profits, and income are to be included in the gross
Page 7 of 39
income for the taxable year in which they are received by the taxpayer, unless they are included when they
accrue to him in accordance with the approved method of accounting followed by him. If a person sues in one
year on a pecuniary claim or for property, and money or property is recovered on a judgment therefore in a
later year, income is realized in that year, assuming that the money or property would have been income in the
earlier year if then received. This is true of a recovery for patent infringement. Bad debts or accounts charged
off subsequent to March 1, 1913, because of the fact that they were determined to be worthless, which are
subsequently recovered, whether or not by suit, constitute income for the year in which recovered, regardless
of the date when amounts were charged off.
SECTION 52. Income constructively received. — Income which is credited to the account of or set apart for
a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so
credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the
income must be credited to the taxpayer without any substantial limitation or restriction as to the time or
manner of payment or condition upon which payment is to be made. A book entry, if made, should indicate an
absolute transfer from one account to another. If the income is not credited, but is set apart, such income must
be unqualifiedly subject to the demand of the taxpayer. Where a corporation contingently credits its
employees with bonus stock, but the stock is not available to such employees until some future date, the mere
crediting on the books of the corporation does not constitute receipt.
SECTION 53. Examples of constructive receipt. — When interest coupons have matured and are payable,
but have not been cashed, such interest payment though not collected when due and payable, is nevertheless
available to the taxpayer and should therefore be included in his gross income for the year during which the
coupons matured. This is true if the coupons are exchanged for other property instead of eventually being
cashed. Defaulted coupons are income for the year in which paid. The distributive share of the profits of a
partner in a general co-partnership duly registered is regarded as received by him, although not distributed.
Interest credited on savings bank deposits, even though the bank nominally has a rule, seldom or never
enforced, that it may require so many days' notice in advance of cashing depositors' checks, is income to the
depositor when credited. An amount credited to shareholders of a building and loan association, when such
credit passes without restriction to the shareholder, has taxable status as income for the year of the credit.
When the amount of such accumulations has not become available to the shareholder until the maturity of a
share, the amount of any share in excess of the aggregate amount paid in by the shareholder is income for the
year of maturity of the share.
SECTION 54. Creation of corporate sinking fund. — If a corporation in order solely to secure payment of its
bonds or other indebtedness, places property in trust, or sets aside certain amounts in a sinking fund under
the control of a trustee who may be authorized to invest and reinvest such sums from time to time, the
property or fund thus set aside by the corporation and held by the trustee is an asset of the corporation, and
any gain arising therefrom is income of the corporation and shall be included as such in its annual return.
SECTION 55. Acquisition or disposition by a corporation of its own capital stock. — Whether the acquisition
or disposition by a corporation of share of its own capital stock gives rise to taxable gain or deductible loss
depends upon the real nature of the transaction, which is to be ascertained from all its facts and
circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their
original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price
be in excess of, or less than, the par or stated value of such stock.
But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain
or loss is to be computed in the same manner as though the corporation were dealing in the shares of another.
So also if the corporation receives its own stock as consideration upon the sale of property by it, or in
satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though
the payment had been made in any other property. Any gain derived from such transaction is subject to tax,
and any loss sustained is allowable as deduction where permitted by the provisions of Title II.
SECTION 56. Contributions by shareholders. — Where a corporation requires additional funds for
conducting its business and obtains such needed money through voluntary pro rata payments by its
shareholders, the amounts so received being credited to its surplus account or to a special capital account, will
Revenue Regulations 02-40
not be considered income, although there is no increase in the outstanding shares of stock of the corporation.
The payments in such circumstances are in the nature of voluntary assessments upon, and represent an
additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an
addition to and as a part of the operating capital of the company.
SECTION 57. Sale and retirement of corporate bonds. — (1) (a) If bonds are issued by a corporation at their
face value, the corporation realizes no gain or loss. (b) If thereafter the corporation purchases and retires any
of such bonds at a price in excess of the issuing price or face value, the excess of the purchase price over the
issuing price or face value is a deductible expense for the taxable year. (c) If, however, the corporation
purchases and retires any of such bonds at a price less than the issuing price or face value, the excess of the
issuing price or face value over the purchase price is gain or income for the taxable year.
(2) (a) If bonds are issued by a corporation at a premium, the net amount of such premium is gain or income
which should be prorated or amortized over the life of the bond. (b) If thereafter the corporation purchases
and retires any of such bonds at a price in excess of the issuing price minus any amount of premium already
returned as income, the excess of the purchase price over the issuing price minus any amount of premium
already returned as income (or over the face value plus any amount of premiums not yet returned as income)
is a deductible expenses for the taxable year. (c) If, however, the corporation purchases and retires any of such
bonds at a price less than the issuing price minus any amount of premium already returned as income, the
excess of the issuing price minus any amount of premium already returned as income (or of the face value plus
any amount of premium not yet returned as income) over the purchase price is gain or income for the taxable
year.
(3) (a) If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and
should be prorated or amortized over the life of the bonds. (b) If thereafter the corporation purchases and
retires any of such bonds at a price in excess of the issuing price plus any amount of discount already deducted,
the excess of the purchase price over the issuing price plus any amount of discount already deducted (or over
the face value minus any amount of discount not yet deducted), is a deductible expense for the taxable year.
(c) If, however, the corporation purchases and retires any of such bonds at a price less than the issuing price
plus any amount of discount already deducted, the excess of the issuing price plus any amount of discount
already deducted (or of the face value minus any amount of discount not yet deducted) over the purchase
price is gain or income for the taxable year.
SECTION 58. Income of corporation from leased property. — Where a corporation has leased its property in
consideration that the lessee shall pay in lieu of other rental an amount equivalent to a certain rate of dividend
on the lessor's capital stock or the interest on the lessor's outstanding indebtedness, together with taxes,
insurance or other fixed charges, such payments shall be considered rental payments and shall be returned by
the lessor corporation as income, notwithstanding the fact that the dividends and interest are paid by the
lessee directly to the shareholders and bondholders of the lessor. The fact that a corporation has conveyed or
let its property and has parted with its management and control, or has ceased to engage in the business for
which it was originally organized, will not relieve it from liability to the tax. While the payments made by the
lessee directly to the bondholders or shareholders of the lessor are rentals as to both the lessee and lessor
(rentals paid in one case and rentals received in the other), to the bondholders and the shareholders, such
amounts are interest and dividend payments received as from the lessor and as such shall be accounted for in
their returns.
SECTION 59. Gross income of a corporation in liquidation. — When a corporation is dissolved, its affairs are
usually wound up by a receiver or trustee in dissolution. The corporate existence is continued for the purpose
of liquidating the assets and paying the debts, and such receiver or trustee stands in the stead of the
corporation for such purposes. Any sales of property by them are to be treated as if made by the corporation
for the purpose of ascertaining the gain or loss.
SECTION 60. Gross income of foreign corporations. — The gross income of a foreign corporation subject to
tax consists of its gross income from sources within the Philippines. Gross income from sources within the
Philippines, as applied to foreign corporations, shall include interest received on bonds, notes, or other
interest-bearing obligations issued by residents, corporate or otherwise, as well as income derived from
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dividends on the capital stock or from the net earnings of domestic or resident foreign corporations, joint stock
companies, associations, or insurance companies, dividends from other foreign corporations to the extent
provided in Section 37 of the Code, and likewise income from rentals and royalties from all sources within the
Philippines.
(Section 29(b) of the Code)
SECTION 61. Exclusions from gross income. — The term "gross income" as used in the Act does not include
those items of income exempted by statute or by fundamental law. Such tax-free income should not be
included in the income tax return unless information regarding it is specifically called for. The exclusion of such
income should not be confused with the reduction of gross income by the application of allowable deductions.
SECTION 62. Proceeds of insurance. — The proceeds of life-insurance policies, paid by reason of the death
of an insured to his estate or to any beneficiary (individual, partnership, or corporation, but not a transferee for
a valuable consideration), directly or in trust, are excluded from the gross income of the beneficiary. It is
immaterial whether the proceeds are received in a single sum or in installments. If, however, such proceeds are
held by the insurer under an agreement to pay interest thereon, the interest payments must be included in
gross income. Amounts received (other than amounts paid by reason of the death of the insured and interest
payments on such amounts) under a life insurance, endowment, or annuity contract are excluded from gross
income but, if such amounts (when added to amounts received before the taxable year under such contract)
exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the
excess shall be included in gross income. However, in the case of a transfer for a valuable consideration, by
assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein, only the
actual value of such consideration and the amount of the premiums and other sums subsequently paid by the
transferee are exempt from taxation.
SECTION 63. Amounts received as compensation for injuries or sickness. — The amounts received by an
insured or his estate or beneficiaries through accident or health insurance or under workmen's compensation
acts as compensation for personal injuries or sickness are excluded from the gross income of the insured, his
estate, and other beneficiaries. Any damages recovered by suit or agreement on account of such injuries or
sickness are similarly excluded from the gross income of the individual injured or sick, if living, or of his estate
or other beneficiaries entitled to receive such damages, if dead.
SECTION 64. Gifts and bequests. — Property received as a gift or received under a will or testament or
through legal succession, is exempt from the income tax, although the income therefrom or income derived
from its investment, sale, or otherwise is not. An amount of principal paid under a marriage settlement is a gift.
Neither alimony nor an allowance based on a separation agreement is taxable income.
(Section 30(a) of the Code)
SECTION 65. Business expenses. — Business expenses deductible from gross income include the ordinary
and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business. The cost
of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from
gross sales is computing gross income. Among the items included in business expenses are management
expenses, commissions, labor, supplies, incidental repairs, operating expenses of transportation, equipment
used in the trade or business, traveling expenses while away from home solely in the pursuit of a trade or
business, advertising and other selling expenses, together with insurance premiums against fire, storm, theft,
accident, or other similar losses in the case of a business, and rental for the use of business property. A
taxpayer is entitled to deduct the necessary expenses paid in carrying on his business from his gross income
from whatever source.
SECTION 66. Traveling expenses. — Traveling expenses as ordinarily understood, include transportation
expenses and meals and lodging. If the trip is undertaken for other than business purposes, the transportation
expenses are personal expenses, and the meals and lodging are living expenses, and therefore, not deductible.
If the trip is solely on business, the reasonable and necessary traveling expenses, including transportation
expenses, meals and lodging, become business instead of personal expenses.
(a) If, then, an individual, whose business requires him to travel receives a salary as full compensation for his
Revenue Regulations 02-40
services, without reimbursement for traveling expenses, or is employed on a commission basis with no
expense allowance, his traveling expenses, including the entire amount expended far meals and lodging,
are deductible from gross income.
(b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall include in gross
income, the amount so repaid and may deduct such expenses. aDcHIC
(c) If an individual receives a salary and also an allowance for meals and lodging, as for example, a per diem
allowance in lieu of subsistence, the amount of the allowance should be included in gross income and the
cost of such meals and lodging may be deducted therefrom.
A payment for the use of a sample room at a hotel for the display of goods is a business expense. Only
such expenses as are reasonable and necessary in the conduct of the business and directly attributable to it
may be deducted. A taxpayer claiming the benefit of the deductions referred to herein must attach to his
return a statement showing (1) the nature of the business in which he is engaged; (2) the number of days away
from home during the taxable year on account of business; (3) the total amount of expenses incident to meals
and lodging while absent from home and business during the taxable year; (4) the total amount of other
expenses incident to travel and claimed as a deduction.
Claim for the deductions referred to herein must be substantiated, when required by the Commissioner
of Internal Revenue by record showing in detail the amount and nature of the expenses incurred.
SECTION 67. Cost of materials. — Taxpayers carrying materials and supplies on hand should include in
expenses the charges for materials and supplies only to the amount that they are actually consumed and used
in operation during the year for which the return is made, provided that the cost of such materials and supplies
has not been deducted in determining the net income for any previous year. If a taxpayer carries incidental
materials or supplies on hand for which no record of consumption is kept or of which physical inventories at
the beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his
expenses and deduct from gross income the total cost of such supplies and materials as were purchased during
the year for which the return is made, provided the net income is clearly reflected by this method.
SECTION 68. Repairs. — The cost of incidental repairs which neither materially add to the value of the
property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be
deducted as expense, provided the plant or property account is not increased by the amount of such
expenditure. Repairs in the nature of replacement, to the extent that they arrest deterioration and appreciably
prolong the life of the property should be charged against the depreciation reserves if such account is kept.
SECTION 69. Professional expenses. — A professional may claim as deductions the cost of supplies used by
him in the practice of his profession, expenses paid in the operation and repair of transportation equipment
used in making professional calls, dues to professional societies and subscriptions to professional journals, the
rent paid for office rooms, the expenses of the fuel, light, water, telephone, etc.; used in such offices, and the
hire of office assistants. Amounts currently expended for books, furnitures, and professional instruments and
equipment, the useful life of which is short, may be deducted. But amounts expended for books, furniture, and
professional instruments and equipment of a permanent character are not allowable as deductions. SEHTIc
SECTION 70. Compensation for personal services. — Among the ordinary and necessary expenses paid or
incurred in carrying on any trade or business may be included a reasonable allowance for salaries or other
compensation for personal services actually rendered. The test of deductibility in the case of compensation
payments is whether they are reasonable and are, in fact, payments purely for service. This test and its
practical application may be further stated and illustrated as follows:
(1) Any amount paid in the form of compensation, but not in fact as the purchase price of services, is
not deductible. (a) An ostensible salary paid by a corporation may be a distribution of dividend on
stock. This is likely to occur in the case of a corporation having few shareholders, practically all of
whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar
services, and the excessive payment correspond or bear a close relationship to the stockholdings of
the officers or employees, it would seem likely that the salaries are not paid wholly for services
rendered, but that the excessive payments are a distribution of earnings upon the stock. (b) An
Page 9 of 39
ostensible salary may be in part payment for property. This may occur, for example, where a
partnership sells out to a corporation, the former partners agreeing to continue in the service of the
corporation. In such a case it may be found that the salaries of the former partners are not merely
for services, but in part constitute payment for the transfers of their business.
(2)
(2) The form or method of fixing compensation is not decisive as to deductibility. While any form of
contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does
not follow that payments on a contingent basis are to be treated fundamentally on any basis different
from that applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid
pursuant to a free bargain between the employer and the individual made before the services are
rendered, not influenced by any consideration on the part of the employer other than that of securing on
fair and advantageous terms the services of the individual, it should be allowed as a deduction even
though in the actual working out of the contract it may prove to be greater than the amount which would
ordinarily be paid.
(3) In any event the allowance for compensation paid may not exceed what is reasonable in all the
circumstances. It is in general just to assume that reasonable and true compensation is only such amount
as would ordinarily be paid for like services by like enterprises in like circumstances. The circumstances to
be taken into consideration are those existing at the date when the contract for services was made, not
those existing at the date when the contract is questioned.
SECTION 71. Treatment of excessive compensation. — The income tax liability of the recipient in respect of
an amount ostensibly paid to him as compensation, but not allowed to be deducted as such by the payer, will
depend upon the circumstances of each case. Thus, in the case of excessive payments by corporations, if such
payments correspond or bear a close relationship to stockholdings, and are found to be distribution of earnings
or profits, the excessive payments will be treated as dividend. If such payments constitute payment for
property, they should be treated by the payer as a capital expenditure and by the recipient as part of the
purchase price. HSCcTD
SECTION 72. Bonuses to employees. — Bonuses to employees will constitute allowable deductions from
gross income when such payments are made in good faith and as additional compensation for the services
actually rendered by the employees, provided such payment, when added to the stipulated salaries, do not
exceed a reasonable compensation for the service rendered. It is immaterial whether such bonuses are paid in
cash or in kind or partly in cash and partly in kind. Donations made to employees and others, which do not
have in them the element of compensation or are in excess of reasonable compensation for services, are not
deductible from gross income.
SECTION 73. Pensions, compensation for injuries. — Amounts paid for pensions to retired employees or to
their families or others dependent upon them, or on account of injuries received by employees, and lump-sum
amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary
expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. When
the amount of the salary of an officer or employee is paid for a limited period after his death to his widow or
heirs, in recognition of the services rendered by the individual, such payments may be deducted. Salaries paid
by employers to employees who are absent in the military, naval or other service of the Government, but who
intend to return at the conclusion of such service, are allowable deductions. (See Section 118 of these
regulations, relative to pension trust.)
SECTION 74. Rentals. — Where a leasehold is acquired for business purposes for a specified sum, the
purchaser may take as a deduction in his return an aliquot part of such sum each year, based on the number of
years the lease has to run. Taxes paid by a tenant to or for a landlord for business property are additional rent
and constitute a deductible item to the tenant and taxable income to the landlord, the amount of the tax being
deductible by the latter. The cost borne by a lessee in erecting buildings or making permanent improvements
on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In
order to return to such taxpayer his investment of capital, an annual deduction may be made from gross
income of an amount equal to the cost of such improvements divided by the number of years remaining of the
term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term
of lease is greater than the probable life of the buildings erected, or of the improvements made, this deduction
Revenue Regulations 02-40
shall take the form of an allowance for depreciation.
SECTION 75. Expenses of farmers. — A farmer who operates a farm for profit is entitled to deduct from
gross income as necessary expenses all amounts actually expended in the carrying on of the business of
farming. The cost of ordinary tools of short life or small cost, such as hand tools, including shovels, rakes, etc.,
may be included. The cost of feeding and raising livestock may be treated as an expense deduction, in so far as
such cost represents actual outlay, but not including the value of farm produce grown upon the farm or the
labor of the taxpayer. Where a farmer is engaged in producing crops which take more than a year from the
time of planting to the process of gathering and disposal, expenses deducted may be determined upon the
crop basis, and such deductions must be taken in the year in which the gross income from the crop has been
realized. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not
an allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and
ranches, prior to the time when the productive state is reached may be regarded as investments of capital.
Amounts expended in purchasing work, breeding or dairy animals are regarded as investments of capital, and
may be depreciated unless such animals are included in an inventory in accordance with Section 149 of these
regulations. The purchase price of transportation equipment even when wholly used in carrying on farm
operations, is not deductible but is regarded as an investment of capital. The cost of gasoline or fuel, repairs,
and upkeep of the transportation equipment if used wholly in the business of farming is deductible as an
expense; if used partly for business purposes and partly for the pleasure or convenience of the taxpayer or his
family, such cost may be apportioned according to the extent of the use for purposes of business and pleasure
or convenience, and only the proportion of such cost justly attributable to business purposes is deductible as a
necessary expense. If a farm is operated for recreation or pleasure and not on a commercial basis, and if the
expenses incurred in connection with the farm are in excess of the receipt therefrom, the entire receipts from
the sale of products may be ignored in rendering a return of income, and the expenses incurred, being
regarded as personal expenses, will not constitute allowable deduction.
SECTION 76. When charges are deductible. — Each year's return, so far as practicable, both as to gross
income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every
reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit
of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all
authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses,
interests, taxes, or other charges, he can not deduct them from the income of the next or any succeeding year.
If it is recognized, however, that particularly in a going business of any magnitude there are certain overlapping
items both of income and deduction, and so long as these overlapping items do not materially distort the
income, they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them
into his accounts. Judgments or other binding judicial adjudication, on account of damages for patent
infringement, personal injuries, or other cause, are deductible from gross income when the claim is so
adjudicated or paid, unless taken under other methods of accounting which clearly reflect the correct
deduction, less any amount of such damages as may have been compensated for by insurance or otherwise: If
subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior
taxable year which has not been deducted from gross income, he may render an amended return for such
preceding taxable year including such amount of loss in the deduction from gross income and may in proper
cases file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original
return. A loss from theft or embezzlement occurring in one year and discovered in another is ordinarily
deductible for the year in which sustained.
SECTION 77. Expenses allowable to non-resident aliens and foreign corporations. — The expenses
allowable to a non-resident alien or a foreign corporation consist of only such expenses as are incurred in
carrying on any business or trade conducted within the Philippines exclusively.
(Section 30(b) of the Code)
SECTION 78. Interest. — Interest paid or accrued within the taxable year on indebtedness may be deducted
from gross income, except that interest on indebtedness incurred or continued to purchase bonds and other
securities, the interest upon which is exempt from tax, is not deductible. Interest paid by the taxpayer on a
mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly
liable upon the bond or not secured by such mortgage, may be deducted as interest on his indebtedness.
Page 10 of 39
In the case of a non-resident alien individual or foreign corporation, the allowable deduction will be the
proportion of such interest which the amount of gross income from sources within the Philippines bears to the
amount of gross income from all sources within and without this country; however, to avail of this deduction,
such non-resident alien individual or foreign corporation shall include in the return all the information
necessary for its calculation.
Interest paid by a corporation on scrip dividends is an allowable deduction. So-called interest on preferred
stock, which is in reality a dividend thereon, can not be deducted in computing net income. In the case of
banks and loan or trust companies, interest paid within the year on deposits or on moneys received for
investment and secured by interest-bearing certificates of indebted issued by such hank or loan or trust
company may be deducted from gross income.
SECTION 79. Interest on capital. — Interest calculated for cost-keeping or other purposes on account of
capital or surplus invested in the business, which does not represent a charge arising under an interest-bearing
obligation, is not allowable deduction from gross income.
(Section 30(c) of the Code)
SECTION 80. Taxes in general. — As a general rule, taxes are deductible with the exception of those with
respect to which the law does not permit deduction. However, in the case of a non-resident alien individual
and a foreign corporation, deduction is allowed only if and to the extent that the taxes for which deduction is
claimed are connected with income from sources within the Philippines.
Import duties paid to the proper customs officers, and business, occupation, license, privilege, excise and
stamp taxes and any other taxes of every name or nature paid directly to the Government of the Philippines or
to any political subdivision thereof, are deductible. The word "taxes" means taxes proper and no deductions
should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage
is not a tax. Automobile registration fees are considered taxes. Taxes are deductible as such only by the person
upon whom they are imposed. Thus the merchants' sales tax imposed by law upon sales is not deductible by
the individual purchaser even though the tax may be billed to him as a separate item.
In computing the net income of an individual no deduction is allowed for the taxes imposed upon his interest
as shareholder of a bank or other corporation, which are paid by the corporation without reimbursement from
the taxpayer. The amount so paid should not be included in the income of the shareholder.
In the case of corporate bonds or other obligations containing a tax-free covenant clause the corporation
paying a tax or any part of it, for someone else pursuant to its agreement is not entitled to deduct such
payment from gross income on any ground.
SECTION 81. Income tax imposed by the Government of the Philippines. — The law does not permit the
deduction of the income tax paid to or accrued in favor of the Government of the Philippines, and in no case
may the taxpayer avail of such deduction.
SECTION 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country. —
Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country (including the
United States and possessions thereof) are allowed as deductions only if the taxpayer does not signify in his
return his desire to have to any extent the benefits of the provisions of law allowing credits against the tax for
taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income
from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to
such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed
as deduction.
SECTION 83. Estate, inheritance, and gift taxes: taxes assessed against local benefits. — Estate, inheritance,
and gift taxes are not deductible.
So-called taxes, more properly assessments, paid for local benefits, such as street, sidewalk, and other like
Revenue Regulations 02-40
improvements, imposed because of and measured by some benefit inuring directly to the property against
which the assessment is levied, do not constitute an allowable deduction from gross income. A tax is
considered assessed against local benefits when the property subject to the tax is limited to the property
benefited. Special assessments are not deductible, even though an incidental benefit may inure to the public
welfare. The taxes deductible are those levied for the general public welfare, by the proper taxing authorities at
a like rate against all property in the territory over which such authorities have jurisdiction. When assessments
are made for the purpose of maintenance or repair of local benefits, the taxpayer may deduct assessments
paid as an expense incurred in business, if the payment of such assessments is necessary to the conduct of his
business. When the assessments are made for the purpose of constructing local benefits, the payments by the
taxpayer are in the nature of capital expenditures and are not deductible. Where assessments are made for the
purpose of both construction and maintenance or repairs, the burden is on the taxpayer to show the allocation
of the amounts assessed to the different purposes. If the allocation can not be made, none of the amounts so
paid is deductible.
SECTION 84. Analysis of credit for taxes: — If the taxpayer signifies in his return his desire to claim a credit
for taxes, the basis of such credit, in the case of a citizen of the Philippines, whether resident or non-resident,
and in the case of a domestic corporation, is as follows: (a) The amount of any income, war-profits, and excess-
profits taxes paid or accrued during the taxable year to any foreign country; and (b) an individual's
proportionate share of any such taxes of which he is a partner or of an estate or trust of which he is a
beneficiary paid or accrued during the taxable year to a foreign country if his distributive share of the income
of such partnership or trust is reported for taxation under Title II of the Code.
In the case of an alien resident of the Philippines who signifies in his return his desire to claim a credit for such
taxes the basis of the credit is as follows: (a) The amount of any such taxes paid or accrued during the taxable
year to any foreign country if the foreign country of which such alien resident is a citizen or subject, in imposing
such taxes, allows a similar credit to citizens of the Philippines residing in such country; and (b) his
proportionate share of any such taxes of a partnership of which he is a partner or an estate or trust of which he
is a beneficiary paid or accrued during the taxable year to any foreign country if his distributive share of the net
income of such partnership or trust is reported for taxation under Title II of the Code, and if the foreign country
of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of
the Philippines residing in such country.
If a taxpayer signifies in his return his desire to claim credit for taxes, such action will be considered to apply to
income, war-profits, and excess-profits taxes paid to all foreign countries (including the United States and
possessions thereof), and no portion of any such taxes shall be allowed as a deduction from gross income.
SECTION 85. Meaning of terms. — The "amount of any income, war-profits, and excess-profits taxes paid or
accrued during the taxable year" means taxes proper (no credit being given for amounts representing interest
or penalties) paid or accrued during the taxable year on behalf of the taxpayer claiming credit. "Foreign
country" means any foreign state or political subdivision thereof, or any foreign political entity, which levies
and collects income, war-profits, or excess-profits taxes, and includes the United States or any political
subdivision thereof.
SECTION 86. Conditions of allowance of credits. — If the taxpayer signifies in his return his desire to claim
credit for income, war-profits, or excess-profits taxes paid other than to the Philippines, the income tax return
must be accompanied by the appropriate form prescribed by the Commissioner of Internal Revenue. The form
must be carefully filled in with all the information there called for and with the calculations of credits there
indicated, and must be duly signed and sworn to or affirmed. If credit is sought for taxes already paid the form
must have attached to it the receipt for each such tax payment. If credit is sought for taxes accrued, the form
must have attached to it the return on which each such accrued tax was based. This receipt or return so
attached must be either the original, a duplicate original, a duly certified or authenticated copy, or a sworn
copy. In case only a sworn copy of a receipt or return is attached, there must be kept readily available for
comparison on request the original, a duplicate original, or a duly certified or authenticated copy. If the receipt
of the return is in a foreign language, a certified translation thereof must be furnished by the taxpayer. Any
additional information necessary for the determination of the amount of income derived from sources without
the Philippines and from each foreign country shall, upon the request of the Commissioner of Internal
Page 11 of 39
Revenue, be furnished by the taxpayer.
In the case of a credit sought for a tax accrued but not paid, the Commissioner of Internal Revenue may in
addition require as a condition precedent to the allowance of credit a bond from the taxpayer. It shall be in
such sum as the Commissioner of Internal Revenue may prescribe, and shall be conditioned for the payment by
the taxpayer of any amount of tax found due upon any redetermination of the tax made necessary by such
credit proving incorrect, with such further conditions as the Commissioner of Internal Revenue may require.
This bond shall be executed by the taxpayer, or the agent or representative of the taxpayer, as principal, and by
sureties satisfactory to and approved by the Commissioner of Internal Revenue.
If it is the desire of the taxpayer to claim as a credit and not as a deduction accrued income, war-profits, and
excess profits taxes imposed by the authority of any foreign country or possession of the United States but at
the time the return is made it is impossible to estimate the amount of such taxes that may have accrued for the
period for which the return is made, the form required under this section may be filed at a later date but a
credit cannot be allowed for such taxes unless the taxpayer signifies in his return his desire to have to any
extent the benefits of Section 30(c) (3) to (9).
SECTION 87. Redetermination of tax when credit proves incorrect. — In case credit has been given for taxes
accrued, or a proportionate share thereof, and the amount that is actually paid on account of such taxes, or a
proportionate share thereof, is not the same as the amount of such credit, or in case any tax payment credited
is refunded in whole or in part, the taxpayer shall immediately notify the Commissioner of Internal Revenue.
The Commissioner of Internal Revenue will thereupon redetermine the amount of the tax of such taxpayer for
the year or years for which such incorrect credit was granted. The amount of tax, if any, due upon such
redetermination shall be paid by the taxpayer upon notice and demand by the Commissioner of Internal
Revenue. The amount of tax, if any, shown by such redetermination to have been overpaid shall be credited or
refunded to the taxpayer in accordance with the provisions of Section 309 of the Code.
SECTION 88. Countries which do or do not satisfy the similar credit requirements. — A country satisfies the
similar credit requirement of Section 30(c)(3)(B), as to income tax paid to such country, either by allowing to
citizens of the Philippines residing in such country a credit for the amount of income taxes paid to the
Philippines. A country does not satisfy the similar credit requirement of Section (30)(c)(3)(B) if it does not allow
any credit to citizens of the Philippines residing in such country for the amount of income taxes paid to the
Philippines, or if such country does not impose any income taxes. If the country of which a resident alien is a
citizen or subject does not allow to a Filipino citizen residing in such country a credit for taxes paid by such
citizen to another foreign country, no credit is allowed to such resident alien for taxes paid by him to such
foreign country.
SECTION 89. When credit for taxes may be taken. — The credit for taxes provided by Section (30)(c)(3) to
(9) may ordinarily be taken either in the return for the year in which the taxes accrued or in which the taxes
were paid, dependent upon whether the accounts of the taxpayer are kept and his returns filed upon the
accrual basis or upon the cash receipts and disbursements basis. Section 30(c)(6) allows the taxpayer, at his
option and irrespective of the method of accounting employed in keeping his books, to take such credit for
taxes as may be allowable in the return for the year in which the taxes accrued. An election thus made must be
followed in returns for all subsequent years, and no portion of any such taxes will be allowed as a deduction
from gross income.
SECTION 90. Domestic corporation owning a majority of the stock of foreign corporation. — In the case of a
domestic corporation which owns a majority of the voting stock of a foreign corporation from which it receives
dividends in any taxable rear, the credit for foreign taxes includes not only the income, war profits and excess-
profits taxes paid or accrued during the taxable year to any foreign country by such domestic corporation, but
also income, war-profits and excess-profits taxes deemed to have been paid determined by taking the same
proportion of any income, war-profits, and excess-profits taxes paid or accrued by such controlled foreign
corporation to any foreign country upon or with respect to the accumulated profits of such foreign corporation
from which such dividends were paid, which the amount of any such dividends received bears to the amount
of such accumulated profits. The amount of taxes deemed to have been paid is limited, however, to an amount
of the tax against which the credit for foreign taxes is taken, which the amount of such dividends bears to the
Revenue Regulations 02-40
amount of the entire net income of the domestic corporation in which such dividends are included. If dividends
are received from more than one controlled foreign corporation, the limitation is to be computed separately
for the dividends received from each controlled foreign corporation. If the credit for foreign taxes includes
taxes deemed to have been paid, the taxpayer must furnish the same information with respect to the taxes
deemed to have been paid as it is required to furnish with respect to the taxes actually paid or accrued by it.
Taxes paid or accrued by a controlled foreign corporation are deemed to have been paid by the domestic
corporation for purposes of credit only. cSTHAC
SECTION 91. Non-resident aliens and foreign corporations not allowed credits against the tax. — Non-
resident aliens and foreign corporations may not claim credits against the tax from taxes of foreign countries.
SECTION 92. Limitation on credit for foreign taxes. — The amount of credit for foreign taxes shall be subject
to the following limitations:
(a) The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the same
proportion of the tax against which such credit is taken, which the taxpayer's net income from sources
within such country taxable under Title II bears to his entire net income for the same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax against which such credit
is taken, which the taxpayer's net income from sources without the Philippines taxable under Title II bears to
his entire net income for the same taxable year.
(Section 30(d) of the Code)
SECTION 93. Losses by individuals. — Losses sustained by individuals during the year not compensated for
by insurance or otherwise are fully deductible (except by non-resident aliens) —
(a) If incurred in a taxpayer's trade; or
(b) If incurred in any transaction entered into for profits; or
(c) Of property not connected with the trade or business if arising from fires, storm, shipwreck, or other
casualty, or from robbery, theft or embezzlement. No loss shall, however, be allowed as a deduction if at
the time of filing of the return, such loss has been claimed as deduction for estate or inheritance tax
purposes in the estate or inheritance tax return.
SECTION 94. Losses by corporations. — Domestic corporations may deduct losses actually sustained and
charged off within the year and not compensated for by insurance or otherwise.
SECTION 95. Losses by non-resident alien and foreign corporation. — Non-resident aliens and foreign
corporations are allowed only losses sustained in business or trade conducted within the Philippines, losses of
property within the Philippines arising from fires, storms, shipwreck, or other casualty and from robbery, theft,
or embezzlement, and losses actually sustained in transactions entered into for profit in the Philippines,
although not connected with their trade or business, not compensated by insurance or otherwise.
SECTION 96. Losses generally. — Losses must usually be evidenced by closed and completed transactions.
Proper adjustment must be made in each case for expenditures or items of loss properly chargeable to capital
account, and for depreciation, obsolescence, amortization, or depletion. Moreover, the amount of the loss
must be reduced by the amount of any insurance or other compensation received, and by the salvage value, if
any, of the property. A loss on the sale of residential property is not deductible unless the property was
purchased or constructed by the taxpayer with a view to its subsequent sale for pecuniary profit. No loss is
sustained by the transfer of property by gift or death. Losses sustained in illegal transactions are not
deductible. EAISDH
SECTION 97. Voluntary removal of buildings. — Loss due to the voluntary removal or demolition of old
buildings, the scrapping of old machinery, equipment, etc., incident to renewals and replacements will be
deductible from gross income. When a taxpayer buys real estate upon which is located a building, which he
proceeds to raze with a view to erecting thereon another building, it will be considered that the taxpayer has
sustained no deductible expense on account of the cost of such removal, the value of the real estate, exclusive
of old improvements, being presumably equal to the purchase price of the land and building plus the cost of
removing the useless building.
Page 12 of 39
SECTION 98. Loss of useful value. — When through some change in business conditions, the usefulness in
the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the
business or discards such assets permanently from use of such business, he may claim as deduction the actual
loss sustained. In determinating the amount of the loss, adjustment must be made, however, for
improvements, depreciation and the salvage value of the property. This exception to the rule requiring a sale or
other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of
which the property has been prematurely discarded, as, for example, where an increase in the cost or change
in the manufacture of any product makes it necessary to abandon such manufacture, to which special
machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable
use of the property impossible. This exception does not extend to a case where the useful life of property
terminates solely as a result of those gradual processes for which depreciation allowance are authorized. It
does not apply to inventories or to other than capital assets. The exception applies to buildings only when they
are permanently abandoned or permanently devoted to a radically different use, and to machinery only when
its use as such is permanently abandoned. Any loss to be deductible under this exception must be charged off
in the books and fully explained in returns of income.
SECTION 99. Shrinkage in value of stocks. — A person possessing stock of a corporation can not deduct
from gross income any amount claimed as a loss merely on account of shrinkage in value of such stock through
fluctuation of the market or otherwise. The loss allowable in such case is that actually suffered when the stock
is disposed of. If stock of a corporation becomes worthless, its cost or other basis determined in accordance
with these regulations may be deducted by the owner in the taxable year in which the stock became worthless,
provided a satisfactory showing of its worthlessness be made, as in the case of bad debts.
SECTION 100. Losses of farmers. — Losses incurred in the operation of farms as business enterprises are
deductible from gross income. If farm products are held for favorable markets, no deduction on account of
shrinkage in weight or physical value or by deterioration in storage shall be allowed, except as such shrinkage
may be reflected in an inventory if used to determine profits. The total loss by storm, flood, or fire of a
prospective crop is not a deductible loss in computing net income. A farmer engaged in raising and selling
stock, cattle, sheep, horses, etc., is not entitled to claim as a loss the value of animals that perish from among
those animals that were raised on the farm, except as such loss is reflected in an inventory if used. If livestock
has been purchased after March 1, 1913, for any purpose, and afterwards dies from disease, exposure, or
injury, or is killed by order of the authorities, the actual purchase price of such stock, less any depreciation
allowable as a deduction in computing net income, with respect to such perished, livestock, and also any
insurance or indemnity recovered, may be deducted as a loss. The actual cost of other property (with proper
adjustment for depreciation), which is destroyed by order of the authorities, may in like manner be claimed as
a loss; but if reimbursement is made in whole or in part on account of stock killed or property destroyed, the
amount received shall be reported as income for the year in which reimbursement is made. The cost of any
feed, pasturage, or care which has been deducted as an expense of operation shall not be included as part of
the cost of the stock for the purpose of ascertaining the amount of a deductible loss. If gross income is
ascertained by inventories, no deduction can be made for livestock or products lost during the year, whether
purchased for resale, produced on the farm, as such losses will be reflected in the inventory by reducing the
amount of livestock or products on hand at the close of the year. If an individual owns and operates a farm, in
addition to being engaged in another trade, business or calling, and sustains a loss from such operation of the
farm, then the amount of loss sustained may be deducted from gross income received from all sources,
provided the farm is not operated for recreation or pleasure. IEaCDH
SECTION 101. Capital losses; losses on wash sales of stock or securities. — Losses on sales or exchanges of
capital assets are allowed to the extent provided in section 34 of the Code. If any securities which are capital
assets become worthless during the taxable year, the loss resulting therefrom shall be considered as a loss
from the sale or exchange, on the last day of such taxable year, of capital assets. Losses on "wash sales" of
stock or securities are treated in section 33 of the Code.
(Section 30 (e) of the Code)
SECTION 102. Bad debts. — Where all the surrounding circumstances indicate that a debt is worthless, and
the debt is charged off on the books of the taxpayer within the year, the same may be allowed as a deduction
in computing net income. There should accompany the return a statement showing the propriety of any
Revenue Regulations 02-40
deduction claimed for bad debts. Before a taxpayer may charge off and deduct a debt, he must ascertain and
be able to demonstrate, with a reasonable degree of certainty, the uncollectibility of the debt. Any amount
subsequently received on account of a bad debt previously charged off and allowed as a deduction for income
tax purposes, must he included in gross income for the taxable year in which received. In determining whether
a debt is worthless the Commissioner of Internal Revenue will consider all pertinent evidence, including the
value of the collateral, if any, securing the debt and the financial condition of the debtor.
Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action
to enforce payment would in all pro-ability not result in the satisfaction of execution on a judgment, a showing
of those facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction.
Bankruptcy is generally an indication of the worthlessness of at least a part of an unsecured and unpreferred
debt. Actual determination of worthlessness in bankruptcy is sometimes possible before and at other times
only when a settlement in bankruptcy shall have been had. Where a taxpayer ascertained a debt to be
worthless and charged it off in one year, the mere fact that bankruptcy proceedings instituted against the
debtor are terminated in a later year, confirming the conclusion that the debt is worthless, will not authorize
shifting the deduction to such later year. If a taxpayer computes his income upon the basis of valuing his notes
or accounts receivable at their fair market value when received, which may be less than their face value, the
amount deductible for bad debts in any case is limited to such original valuation.
SECTION 103. Examples of bad debts. — Worthless debts arising from unpaid wages, salaries, rents, and
similar items of taxable income will not be allowed as a deduction unless the income such items represent has
been included in the return of income for the year in which the deduction as a bad debt is sought to be made
or in a previous year. Only the difference between the amount received in distribution of the assets of a
bankrupt and the amount of the claim may be deducted as a bad debt. The difference between the amount
received by a creditor of a decedent in distribution of the assets of the decedent's estate and the amount of his
claim may be considered a worthless debt. A purchaser of accounts receivable which can not be collected and
are consequently charged off the hooks as bad debt is entitled to deduct them, the amount of deduction to be
based upon the price he paid for them and not upon their face value.
Where under foreclosure of a mortgage, the mortgagee buys the mortgaged property and credits the
indebtedness with the purchase price, the difference between the purchase price and the indebtedness will
not be allowable as a deduction for a bad debt, for the property which was security for the debt stands in the
place of the debt. The determination of loss in such case is deferred until the disposal of the property.
SECTION 104. Securities becoming worthless. — If any securities which are capital assets are ascertained to
be worthless and charged off within the taxable year, the loss resulting therefrom shall, except in the case of a
bank or trust company incorporated under the laws of the Philippines or of the United States a substantial part
of whose business is the receipt of deposits, be considered as a loss from the sale or exchange, on the last day
of such taxable year, of capital assets.
(Section 30(f) of the Code)
SECTION 105. Depreciation. — A reasonable allowance for the exhaustion, wear and tear, and obsolescence
of property used in the trade or business may be deducted from gross income. For convenience such an
allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in
market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such
depreciation of any property used in the trade or business is that amount which should be set aside for the
taxable year in accordance with a reasonable consistent plan whereby the aggregate of the amount so set
aside, plus the salvage value, will, at the end of the useful life of the property in business, equal the basis of the
property. Due regard must also be given to expenditures for current upkeep.
SECTION 106. Depreciable property. — The necessity for a depreciation allowance arises from the fact that
certain property used in the business gradually approaches a point where its usefulness is exhausted. The
allowances should be confined to property of this nature. In the case of tangible property, it applies to that
which is subject to wear and tear, to decay or decline from natural causes, to exhaustion and to obsolescence
due to the normal progress of the art, as where machinery or other property must be replaced by a new
invention, or due to the inadequacy of the property to the growing needs of the business. It does not apply to
Page 13 of 39
inventories or to stock in trade, nor to land apart from the improvements or physical development added to it.
It does not apply to bodies of minerals which through the process of removal suffer depletion. Property kept in
repair may, nevertheless, be the subject of a depreciation allowance. The deduction of an allowance for
depreciation is limited to property used in the taxpayer's trade or business. No such allowance may be made in
respect to automobiles or other transportation equipment used solely for the pleasure, a building used by the
taxpayer solely as his residence, nor in respect of furniture or furnishings therein, personal effects, or clothing;
but properties and costumes used exclusively in a business, such as theatrical business, may be the subject of a
depreciation allowance.
SECTION 107. Depreciation of intangible property. — Intangibles, the use of which in the trade or business is
definitely limited in duration, may be the subject of a depreciation allowance. Examples are patents,
copyrights, and franchises. Intangibles, the use of which in the business or trade is not so limited, will not
usually be a proper subject of such an allowance. If however, an intangible asset acquired through capital
outlay is known from experience to be of value in the business for only a limited period, the length of which
can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a
depreciation allowance, provided the facts are fully shown in the return or prior thereto to the satisfaction of
the Commissioner of Internal Revenue.
SECTION 108. Capital sum recoverable through depreciation allowances. — The capital sum to be replaced
by depreciation allowances is the cost or other basis of the property in respect of which the allowance is made.
To this amount should be added from time to time the cost of improvements, additions, and betterment and
from it should be deducted from time to time the amount of any definite loss or damage sustained by the
property through casualty, as distinguished from the gradual exhaustion of its utility which is the basis of the
depreciation allowance. Where the lessee of real property erects buildings, or makes permanent
improvements which become part of the realty and income has been returned by the lessor as a result thereof,
as provided in Section 49 of these regulations, the capital sum to be replaced by depreciation allowance is the
same as though no such buildings had been erected or such improvements made. No depreciation deduction
will be allowed in the case of property which has been amortized to its scrap value and is no longer in use.
AaSCTD
SECTION 109. Method of computing depreciation allowance. — The capital sum to be replaced should be
charged off over the useful life of the property, either in equal annual installments or in accordance with any
other recognized trade practice, such as an apportionment of the capital sum over units of production.
Whatever plan or method of apportionment is adopted must be reasonable and must have due regard to
operating conditions during the taxable period. While the burden of proof must rest upon the taxpayer to
sustain the deductions taken by him, such deductions must not be disallowed unless shown by clear and
convincing evidence to be unreasonable. The reasonableness of any claim for depreciation shall be determined
upon the conditions known to exist at the end of the period for which the return is made. If it develops that
the useful life of the property will be longer or shorter than the useful life as originally estimated under all the
then known facts, the portion of the cost or other basis of the property not already provided for through
depreciation allowances should be spread over the remaining useful life of the property as reestimated in the
light of the subsequent facts, and depreciation deductions taken accordingly.
SECTION 110. Obsolescence. — With respect to physical property the whole or any portion of which is
clearly shown by the taxpayer as being affected by economic conditions that will result in its being abandoned
at a future date prior to the end of its normal useful life, so that depreciation deductions alone are insufficient
to return the cost (or other basis) at the end of its economic term of usefulness, a reasonable deduction for
obsolescence, in addition to depreciation, may be allowed in accordance with the facts obtaining with respect
to each item of property concerning which a claim for obsolescence is made. No deductions for obsolescence
will be permitted merely because, in the opinion of a taxpayer, the property may become obsolete at some
later date. This allowance will be confined to such portion of the property on which obsolescence is definitely
shown to be sustained and can not be held applicable to an entire property unless all portions thereof are
affected by the conditions to which obsolescence is found to be due.
SECTION 111. Depreciation of patent or copyright. — In computing depreciation allowance in the case of a
patent or copyright, the capital sum to be replaced is the cost or other basis of the patent or copyright. The
Revenue Regulations 02-40
allowance should be computed by an apportionment of the cost or other basis of the patent or copyright over
the life of the patent or copyright since its grant, or since its acquisition by the taxpayer, or since March 1,
1913, as the case may be. If the patent or copyright was acquired from the Government, its cost consists of the
various Government fees, cost of drawings, experimental models, attorney's fees, development or
experimental expenses, etc., actually paid. Depreciation of a patent can be taken on the basis of the fair market
value as of March 1, 1913, only when affirmative and satisfactory evidence of such value is offered. Such
evidence should whenever practicable be submitted with the return. If the patent becomes obsolete prior to
its expiration, such proportion of the amount on which its depreciation may be based as the number of years
of its remaining life bears to the whole number of years intervening between the basic date when it legally
expires may be deducted, if permission to do so is specifically secured from the Commissioner of Internal
Revenue. Owing to the difficulty of allocating to a particular year the obsolescence of a patent, such permission
will be granted only if affirmative and satisfactory evidence that the patent became obsolete in the year for
which the return is made is submitted to the Commissioner of Internal Revenue. The fact that depreciation has
not been taken in prior years does not entitle the taxpayer to deduct in any taxable year a greater amount for
depreciation than would otherwise be allowable. AcDHCS
SECTION 112. Depreciation of drawings and models. — Where a taxpayer has incurred expenditures in his
business for designs, drawings, patterns, models, or work of an experimental nature calculated to result in
improvement of his facilities or his product, if the period of usefulness of any such asset may be estimated
from experience with reasonable accuracy, it may be the subject of depreciation allowances spread over such
estimated period of usefulness. The facts must be fully shown in the return or prior thereto to the satisfaction
of the Commissioner of Internal Revenue. Except for such depreciation allowances no deduction shall be made
by the taxpayer against any sum so set up as an asset except on the sale or other disposition of such asset at a
loss or on proof of a total loss thereof.
SECTION 113. Charging off depreciation. — A depreciation allowance, in order to constitute an allowable
deduction from gross income, must be charged off. The particular manner in which it shall be charged off is not
material, except that the amount measuring a reasonable allowance for depreciation must be either deducted
directly from the book value of the assets or preferably credited to a depreciation reserve account, which must
be reflected in the annual balance sheet. The allowances should be computed and charged off with express
reference to specific items, units, or groups of property, each item or unit being considered separately or
specifically included in a group with others to which the same factors apply. The taxpayer should keep such
records to each item or unit of depreciable property as will permit the ready verification of the factors used in
computing the allowance for each year for each item, unit, or group.
SECTION 114. Depreciation in the case of farmers. — A reasonable allowance for depreciation may be
claimed on farm buildings (other than a dwelling occupied by the owner), farm machinery, and other physical
property. A reasonable allowance for depreciation may also be claimed on live stock acquired for work,
breeding, or dairy purposes, unless they are included in an inventory used to determine profits in accordance
with these regulations. Such depreciation should be based on the cost or other basis and the estimated life of
the live stock. If such live stock be included in an inventory no depreciation thereof will be allowed, as the
corresponding reduction in their value will be reflected in the inventory.
SECTION 115. Statement to be attached to return. — To each return in which depreciation charges are
claimed, there should be attached a statement showing the item, unit, or group of depreciable property, the
cost price or its market value as of March 1, 1913, if acquired prior to that date, the rate of charge, amount
previously deducted, and the amount claimed in the return. These data must agree with those appearing in the
books of the taxpayer.
(Section 30(g) of the Code)
SECTION 115-A-1. General Circular V-332, January 6, 1961 — Who is entitled to deduct depletion. — In order to
be entitled to percentage depletion allowance, the taxpayer must have an economic interest in the property. To
acquire an economic interest, the taxpayer must have a capital investment in the property and not a mere
economic advantage. The taxpayer must have acquired at least, by investment, any interest in oil or gas or
mineral in place, and secures, by any form of legal relationship, income derived from the extraction of the oil,
gas or mineral, to which he must look for a return of his capital. Thus the parties entitled to share in oil or
Page 14 of 39
mineral extracted, or the gross proceeds therefrom (including the parties to a lease providing for royalty
payments of stated amounts per unit mined) have economic interests in the oil or minerals in place. That is,
they, as owners of the rights in oil or other mineral in place, share the income from production, and the
depletion allowances thereon are regarded as designed to permit tax-free recovery of at least their capital
investments in such property rights.
SECTION 115-A-2. Basis for depletion. — On oil or gas wells the percentage depletion allowance is fixed at 27
1/2% of gross income while on mines, the percentage depletion allowance varies in accordance with the class
of minerals. The gross income basis is the amount remaining after deducting therefrom rents or royalties paid
or incurred by the taxpayer in respect to the property. In both cases, the total percentage depletion allowance
shall in no case exceed 50% of the net income or profit.
Illustration
Subject: Oil and gas wells (1) (2)
Gross income after deducting rents and royalties P100.00 P100.00
27 1/2% thereof 27.50 27.50
Net income or net profit 50.00 70.00
50°/ of net income or net profit 25.00 35.00
Allowance depletion 25.00 27.50
Under column (1) P25.00 is the allowance depletion because the allowable percentage cannot exceed 50% of
the net profit or net income. Under column (2), the allowable depletion is P27.50 because it does not exceed
50% of either the net income or net profit.
SECTION 115-A-3. Definition of terms. — For purposes of the depletion allowance for oil and gas wells and
mines, the following terms and phrases shall have the meaning indicated:
(a) Gross income. — Gross income means the "gross income from the property". The gross income in the
case of gas and oil wells is the amount for which the taxpayer sells the oil and gas in the immediate vicinity of
the well. If the oil and gas are not sold on the property but are manufactured or converted into a refined
product prior to sale, the gross income from the property shall be assumed to be equivalent to the
representative market or field price (as of the date of sale) of the oil and gas before conversion or
transportation.
"Gross income from the property" means, in the case of mines, the gross income from mining. The gross
income from mining consists of the proceeds from the sales of ores or minerals extracted from the mining
property. Where ores are sent abroad where the ordinary treatment processes are applied or where they are
refined and where they are sold, the actual cost of ocean freight as well as insurance, should be deducted from
the actual selling price for gross income purposes. Also where minerals or mineral products are sold or
consigned abroad by the lessee or owner of the mine under C.I.F. terms, the actual cost of ocean freight and
insurance should be deducted. ECDHIc
(b) Mining. — The term "mining" includes not merely the extraction of the ores or minerals from the ground
but also the ordinary treatment process normally applied by mine owners or operators in order to obtain the
commercially marketable mineral product or products, and so much of the transportation of ores or minerals
(whether or not by common carrier) from the point of extraction from the ground to the plants or mills in
which the ordinary treatment processes are applied thereto as is not in excess of 50 miles unless the
Commissioner of Internal Revenue finds that the physical and other requirements are such that the ore or
mineral must be transported a greater distance to such plants or mills.
(c) Extraction of the ores or minerals from the ground. — The term "extraction of the ores or minerals from
the ground" includes the extraction by mine owners or operators of ores or minerals from the waste or residue
of prior mining. Thus income derived from the working over of tailings, piles or culm banks is included in
determining "gross income from the property". The length of time between the prior mining and extraction of
ores or minerals from the waste or residue of such mining is immaterial. Whether the waste or residue results
from the application of ordinary treatment processes or from the process of removal from the ground, income
derived therefrom is within the term "gross income from the property". To be included in "gross income from
the property", income derived from the extraction of ores or minerals from the waste or residue of prior
Revenue Regulations 02-40
mining must come from such extraction by the mine owner or operator himself.
(d) Ordinary treatment processes. — The term "ordinary treatment processes" includes the following:
(1) In the case of coal-cleaning, breaking, sizing, dust-allaying, treating to prevent freezing, and loading for
shipment;
(2) In the case of sulfur recovered by the Frasch process — pumping to vats, cooling, breaking, and loading
for shipment;
(3) In the case of iron ore, bauxite, ball and sagger clay, rock asphalt, and minerals which are customarily sold
in the form of a crude mineral product — sorting, concentrating; and sintering to bring to shipping grade
and form, and loading for shipment;
(4) In the case of lead, zinc, copper, gold, silver, or fluorspar ores, potash, and ores which are not customarily
sold in the form of the crude mineral product-crushing, grinding, and beneficiation by concentration
(gravity, flotation, amalgamation, electrostatic, or magnetic) cyanidation, leaching, crystallization,
precipitation (but not including as an ordinary treatment process electrolytic deposition, roasting,
thermal or electric smelting, or refining), or by substantially equivalent processes, or extraction of the
product or products from the ore, including the furnacing of quicksilver ores; and
(5) The pulverization of talc, the burning of magnesite, and the sintering and modulizing of phosphate rock.
(e) Net income or net profit. — "Net income" or "net profit" means the taxpayer's taxable income from the
property. Net income or net profit (computed without allowance for depletion) means the "gross income from
the property" less the allowable deductions attributable to the mineral property upon which the depletion is
claimed and the allowable deductions attributable to the treatment processes insofar as they relate to the
product of such property, including overhead and operating expenses, development costs properly charged to
expense, depreciation, taxes, losses sustained, etc. Deductions not directly attributable to particular properties
or processes shall be fairly allocated.
(f) Property. — For the purpose of computing the depletion allowance in the case of mines and wells, the
term "property" means each separate interest owned by the taxpayer in each mineral deposit in each separate
tract or parcel of land.
If a taxpayer owns two or more separate operating mineral interests which constitute part or all of an
operating unit, he may elect to form (a) one aggregation of, and to treat as one property, any two or more of
such interests and (b) to treat as a separate property each such interest which he does not elect to include
within the aggregation referred to in (a). Separate operating mineral interests which constitute part or all of an
operating unit may be aggregated whether or not they are included in contiguous tracts or parcels. A taxpayer
may not elect to form more than one aggregation of operating mineral interests within any one operating unit.
Such election may be made by the taxpayer by the giving of notice of such election to the Commissioner of
Internal Revenue not later than the time prescribed for filing of the return and any such election so made shall
be binding upon the taxpayer for all subsequent taxable years, except that the Commissioner of Internal
Revenue may consent to a different treatment of the interest with respect to which the election has been
made.
SECTION 115-A-4. Depletion deductible by non-resident aliens or foreign corporations. — A non-resident alien
individual or a foreign corporation is entitled to an allowance for depletion of oil and gas wells or mines located
in the Philippines. (Gen. Cir. V-332 implements Sec. 30(g), Tax Code, as amended by R.A. 2698)
(Section 30(h) of the Code)
SECTION 116. When contributions or gifts may be deducted. — Contributions or gifts within the taxable year
are deductible to an aggregate amount not in excess of 6 per centum, in the case of an individual, and 3 per
centum, in the case of a corporation, of the taxpayer's taxable net income, if actually paid or made to or for the
use of the Government of the Philippines or any political subdivision thereof for exclusively public purposes or
to domestic corporations or associations organized and operated exclusively for religious, charitable, scientific,
athletic, cultural or educational purposes, or to societies for the prevention of cruelty to children or animals,
provided that no part of the net income of which inures to the benefit of any private stockholders or individual.
In connection with claims for deductions, there shall be stated on returns of income the name and address of
Page 15 of 39
each organization to which a gift was made and the approximate date and the amount of the gift in each case.
Where the gift is other than money, the basis for calculation of the amount thereof shall be the fair market
value of the property at the time of the gift. Contributions or gifts paid or made to corporations or associations
specified in the law will only be allowed as deduction when the taxpayer attaches to his return the receipt duly
signed by the responsible officer of the corporations or associations to which the contributions or gifts has
been paid or made. If desired, said receipt will be returned to the taxpayer after they have served their
purpose.
(Section 30(i) of the Code)
SECTION 117. Allowance of deductions and credits. — Unless a non-resident alien individual shall file or
cause to be filed with the Commissioner of Internal Revenue, a true and accurate return of income from all
sources, corporate, or otherwise, within the Philippines, regardless of amount, the tax shall be collected on the
basis of the gross income (not the net income) from sources within the Philippines. In case of failure to file
such return, the Commissioner of Internal Revenue will cause a return of income to be made and include
therein the income of such non-resident alien from all source concerning which he has information, and he will
assess the tax and collect it from one or more of the sources of income of such non-resident alien within the
Philippines, without allowance for deductions or credit. (Cf. effect of Sec. 22(b) as amended by R.A. 2343.)
(Section 30(j) of the Code)
SECTION 118. Payments to employees' pension trusts. — An employer who adopts or has adopted a
reasonable pension plan, actuarially sound, and who establishes, or has established, and maintains a pension
trust for the payment of reasonable pensions to his employees shall be allowed to deduct from gross income
reasonable amounts paid to such trust, in accordance with the pension plan (including any reasonable
amendment thereof), as follows:
(a) If the plan contemplates the payment to the trust, in advance of the time when pensions are granted, of
amounts to provide for future pensions payments, then (1) reasonable amounts paid to the trust during the
taxable year representing the pension liability applicable to such year, determined in accordance with the plan,
shall be allowed as a deduction for such year as an ordinary and necessary business expense, and in addition
(2) one-tenth of a reasonable amount transferred or paid to the trust during the taxable year to cover in whole
or in part the pension liability applicable to the years prior to the taxable year, or so transferred or paid to place
the trust on a sound financial basis, shall be allowed as a deduction for the taxable year and for each of the
nine succeeding taxable years.
(b) If the plan does not contemplate the payment to the trust, in advance of the time when pensions are
granted, of amounts to provide for future pension payments, then (1) reasonable amounts paid to the trust
during the taxable year representing the present value of the expected future payments in respect of pensions
granted to employees retired during the taxable year shall be allowed as deduction for such year as an ordinary
and necessary business expense, and in addition (2) one tenth of a reasonable amount transferred or paid to
the trust during the taxable year to cover in whole or in part the present value of the expected future
payments in respect of pensions granted to employees retired prior to the taxable year, or so transferred or
paid to place the trust on a sound financial basis, shall be allowed as a deduction for the taxable year and for
each of the nine succeeding taxable years.
(Section 30(k) of the Code)
SECTION 118-A. Optional standard deduction. — In lieu of the deductions allowed under this section an
individual, other than a non-resident alien, may elect a standard deduction. Such optional standard deduction
shall be in the amount of one thousand pesos or in an amount equal to ten per centum of his gross income,
whichever is the lesser. Unless the taxpayer signifies in his return his intention to elect the optional standard
deduction he shall be considered as having availed himself of the deductions allowed in the preceding
subsection. The Secretary of Finance shall prescribe the manner of the election. Such election when made in
the return shall be irrevocable for the taxable year for which the return is made.
(Section 31 of the Code)
SECTION 119. Personal, living, and family expenses. — Personal, living, and family expenses are not
deductible. Insurance paid on a dwelling owned and occupied by a taxpayer is a personal expense and not
Revenue Regulations 02-40
deductible. Premiums paid for life insurance by the insured are not deductible. In the case of a professional
man who rents a property for residential purposes, but incidentally receives his clients, patients, or callers in
connection with his professional work (his place of business being elsewhere), no part of the rent is deductible
as a business expense. If however, he uses part of the house for his office, such portion of the rent as is
properly attributable to such office is deductible. Where the father is legally entitled to the services of his
minor children, any allowances which he gives them, whether said to be in consideration of services or
otherwise, are not allowable deductions in his return of income. Alimony, and an allowance paid under a
separation agreement are not deductible from gross income.
SECTION 120. Capital expenditures. — No deduction from gross income may be made for any amounts paid
out for new buildings or for permanent improvements or betterments made to increase the value of the
taxpayer's property, or for any amount expended in restoring property or in making good the exhaustion
thereof for which an allowance for depreciation or depletion or other allowance is or has been made. Amounts
expended for securing a copyright and plates, which remain the property of the person making the payments,
are investments of capital. The cost of defending or perfecting title to property constitutes a part of the cost of
the property and is not a deductible expense. The amount expended for architect's services is part of the cost
of the building. Commissions paid in purchasing securities are a part of the cost of such securities.
Commissions paid in selling securities are an offset against the selling price. Expenses of the administration of
an estate, such as court costs, attorney's fees, and executor's commissions, are chargeable against the "corpus"
of the estate and are not allowable deductions. Amounts to be assessed and paid under an agreement
between bondholders or shareholders of a corporation, to be used in a reorganization of the corporation, are
investments of capital and not deductible for any purpose in return of income. DaACIH
In the case of a corporation, expenses for organization, such as incorporation fees, attorney's fees and
accountants' charges, are ordinarily capital expenditures; but where such expenditures are limited to purely
incidental expenses, a taxpayer may charge such items against income in the year in which they are incurred. A
holding company which guarantees dividends at a specified rate on the stock of a subsidiary corporation for
the purpose of securing new capital for the subsidiary and increasing the value of its stockholdings in the
subsidiary may not deduct amounts paid in carrying out this guaranty in computing its net income, but such
payments may be added to the cost of its stock in the subsidiary.
SECTION 121. Premiums on life insurance of employees. — Any amounts paid for premiums on any life
insurance policy covering the life of an officer or employee or of any person financially interested in the
business of the taxpayer when the taxpayer is directly or indirectly a beneficiary under such policy are not
deductible.
SECTION 122. Losses from sales or exchanges of property. — No deduction is allowed in respect of losses
from sales or exchanges of property, directly or indirectly —
(a) Between members of a family. As used in Section 31, the family of an individual shall include only his
brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants;
(b) Except in the case of distributions in liquidation, between an individual and a corporation more than fifty
per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
(c) Except in the case of distributions in liquidation, between two corporations more than 50 per cent in
value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if
either one of such corporations with respect to the taxable year of the corporation preceding the date of the
sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign
personal holding company;
(d) Between a grantor and a fiduciary of any trust;
(e) Between the fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor with
respect to each trust; or
(f) Between a fiduciary of a trust and a beneficiary of such trust.
(Section 32 of the Code)
SECTION 123. Gross income of insurance companies. — In general, the gross income of insurance companies
consists of their total revenue from the operation of the business and of their income from all other sources
Page 16 of 39
within the taxable year, except as otherwise provided by the statute. Gross income includes net premiums (that
is, gross premium less returned premiums on policies not taken), investment income, profits from the sale of
assets, and all gains, profits, and income reported to the Insurance Commissioner, except income specifically
exempt from tax. A net decrease in reserve funds required by law within the taxable year must be included in
the gross income to the extent that such funds are released to the general uses of the company and increase
its free assets. Any net decrease in reserves shall be added to the gross income, unless the company shall show
that such decrease resulted from the application of reserves to the purposes for which they were established.
SECTION 124. Gross income of life insurance companies. — A life insurance company shall not include in
gross income such portion of any actual premiums received from any individual policyholder as is paid back or
credited to or treated as an abatement of premium of such policyholder within the taxable year. (a) "Paid back"
means paid in cash. (b) "Credited to" means held to the credit of, including dividends applied to pay renewal
premiums, to purchase additional paid-up insurance or annuities, or to shorten the endowment or premium-
paying period. It does not include dividends provisionally ascertained and apportioned upon deferred
dividends policies. Dividends provisionally ascertained, apportioned, or credited on deferred dividends policies
can not be excluded or deducted from gross income for the reason that the assured has no vested or
enforceable right in them and can not at the time of the ascertainment, apportionment, or credit, not until the
maturity of the policy, avail himself of such dividends; and in the event of the death of the assured prior to the
expiration of the deferred dividend period, the amount so ascertained, apportioned, or credited lapses. (c)
"Treated as an abatement of premium" means of the premium for the taxable year. Where the dividend paid
back is in excess of the premium received from the policyholder within the taxable year there may be excluded
from gross income only the amount of such premium received, and where no premium is received from the
policyholder within the taxable year the company is not entitled to exclude from its premiums received from
other policyholders an amount in respect to such dividend payment. (See changes in Sec. 24(b), Tax Code.)
SECTION 125. Gross income of mutual insurance companies. — The gross income of mutual insurance
companies (other than life) consists of their total revenue from the operation of the business and of their
income from all other sources within the taxable year, except as otherwise provided by the statute. Premiums
received by mutual marine insurance companies which are paid out for reinsurance should be eliminated from
gross income and the payments for reinsurance, from disbursement. Deposit premiums on perpetual risks
received and returned by mutual fire insurance companies should be treated in the same manner, as no
reserve will be recognized covering liability for such deposits. The earnings on such deposits, including such
portion, if any, of the premium deposits as are not returned to the policyholders upon cancellation of the
policies, must be included in the gross income.
SECTION 126. Deductions allowed insurance companies. — Insurance companies are entitled to the same
deductions from gross income as other corporations, and also to the deduction of the net addition required by
law to be made within the taxable year to reserve funds and of the sums other than dividends paid with the
taxable year on policy and annuity contracts. "Paid" includes "accrued" or "incurred" (construed according to
the method of accounting upon the basis of which the net income is computed) during the taxable year, but
does not include any estimate for losses incurred but not reported during the taxable year. As payments on
policies there should be reported all death, disability and other policy claims (other than dividends as above
specified) paid within the year, including fire, accident and liability losses, matured endowments, annuities,
payments on installment policies and surrender values actually paid.
SECTION 127. Special deductions allowed mutual insurance companies. — Mutual insurance companies
(other than mutual life and mutual marine insurance companies), which require their members to make
premium deposits to provide for losses and expenses, are allowed to deduct from gross income the aggregate
amount of premium deposits returned to their policyholders or retained for the payment of losses, expenses,
and reinsurance reserves. In determining the amount of premium deposits retained by a mutual fire or mutual
casualty insurance company for the payment of losses, expenses, and reinsurance reserves, it will be presumed
that losses and expenses have been paid out of earnings and profits other than premiums to the extent of such
earnings and profits. If, however, any portion of such amount is applied during. the taxable year to the
payment of losses, expenses, or reinsurance reserves, or which a separate allowance is taken, then such
portion is not deductible; and if any portion of such amount for which an allowance is taken is subsequently
applied to the payment of expenses, losses, or reinsurance reserves, then such payment can not be separately
Revenue Regulations 02-40
deducted. The amount of premium deposits retained for the payment of expenses and losses and the amount
of such expenses and losses, may not both be deducted. A company which invests part of the premium
deposits so retained by it in interest-bearing securities may, nevertheless, deduct such part, but not the
interest received on such securities. A mutual fire insurance company which has a guaranty capital is taxed like
other mutual fire insurance companies. A stock fire insurance company operated on the mutual plan to the
extent of paying dividends to certain classes of policyholders, may make a return on the same basis as a mutual
fire insurance company with respect to its business conducted on the mutual plan.
SECTION 128. Special deductions allowed mutual marine insurance companies. — Mutual marine insurance
companies should include in gross income the gross premiums collected and received by them less amounts
paid for reinsurance. They may deduct from gross income amounts repaid to policyholders on account of
premiums previously paid by them together with the interest actually paid upon such amounts between the
date of ascertainment and the date of payment thereof. The remainder of the premiums accordingly forms
part of the net income of the company, except to the extent that it is subject to then deductions allowed such
insurance companies and other corporations.
SECTION 129. Net addition to reserve funds. — All policy premiums on which net addition to reserve is
computed, must be included in gross income. Insurance companies may deduct from gross income the net
addition required by law to be made within the taxable year to reserve funds. When the reserve at the end of
the year is less than at the beginning of the year there is a "released reserve", and the amount so released
must be included in gross income. In the case of assessment insurance companies, whether domestic or
foreign, the actual deposit of sums with the officers of the Government of the Philippines, pursuant to law, as
addition to guaranty or reserve funds shall be treated as being payments required by law to reserve funds. In
the case of life insurance companies, the net addition to the "reinsurance reserve" and the "reserve for
supplementary contracts", and in the case of fire, marine, accident, liability, and other insurance companies,
the net addition to the "unearned premium reserves", and only such other reserves as are specifically required
by the statute will be allowed as deductions. ADEacC
SECTION 130. Copy of report to Insurance Commissioner to be furnished the Commissioner of Internal
Revenue. — To facilitate the auditing of income tax returns, insurance companies shall submit to the
Commissioner of Internal Revenue together with returns of income, wherever possible a copy of their annual
report to the Insurance Commissioner.
(Section 33 of the Code)
SECTION 131. Losses from wash sales of stock or securities. — (a) A taxpayer cannot deduct any loss claimed
to have been sustained from the sale or other disposition of stock or securities, if, within a period beginning
thirty days before the date of such sale or disposition and ending thirty days after such date (referred to in this
section as the sixty-one-day period), he has acquired (by purchase or by an exchange upon which the entire
amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire,
substantially identical stock or securities. However, this prohibition does not apply in the case of a dealer in
stock or securities if the sale or other disposition of stock or securities is made in the ordinary course of its
business as such dealer.
(b) Where more than one loss is claimed to have been sustained within the taxable year from the sale or
other disposition of stock or securities, the provisions of this section shall be applied to the losses in the order
in which the stock or securities the disposition of which resulted in the respective losses were disposed of
(beginning with the earliest disposition). If the order of disposition of stock or securities disposed of at a loss
on the same day cannot be determined, the stock or securities will be considered to have been disposed of in
the order in which they were originally acquired (beginning with earliest acquisition).
(c) Where the amount of stock or securities acquired within the sixty-one day period is less than the amount
of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the loss
from the sale or other disposition of which is not deductible shall be those with which the stock or securities
acquired are matched in accordance with the following rule:
The stock or securities acquired will be matched in accordance with the order of their acquisition (beginning
Page 17 of 39
with the earliest acquisition) with an equal number of the shares of stock or securities sold or otherwise
disposed of.
(d) Where the amount of stock or securities acquired within the sixty- one-day period is not less than the
amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the
acquisition of which resulted in the nondeductibility of the loss shall be those with which the stock or
securities disposed of are matched in accordance with the following rule:
The stock or securities sold or otherwise disposed of will be matched with an equal number of the shares of
stock or securities acquired in accordance with the order of acquisition (beginning with the earliest acquisition)
of the stock or securities acquired.
(e) The acquisition of any security which results in the non-deductibility of a loss under the provisions of this
section shall be disregarded in determining the deductibility of any other loss.
(f) The word "acquired" as used in this section means acquired by purchase or by an exchange upon which
the entire amount of gain or loss was recognized by law, and comprehends cases where the taxpayer has
entered into a contract or option within the sixty-one-day period to acquire by purchase or by such an
exchange.
EXAMPLE (1): A, whose taxable year is the calendar year, on December 1, 1939, purchased 100 shares of
common stock in the M Company for P10,000 and on December 15, 1939, purchased 100 additional shares for
P9,000. On January 2, 1940, he sold the 100 shares purchased on December 1, 1939, for P9,000. Because of
the provisions of Section 33 no loss from the sale is allowable as a deduction.
EXAMPLE (2): A, whose taxable year is the calendar year, on September 21, 1939, purchased 100 shares of the
common stock of the M Company for P5,000. On December 21, 1939, he purchased 50 shares of substantially
identical stock for P2,750, and on December 26, 1939, he purchased 25 additional shares of such stock for
P1,125. On January 2, 1940, he sold for P4,000 the 100 shares purchased on September 21, 1939. There is an
indicated loss of P1,000 on the sale of the 100 shares. Since within the sixty-one-day period A purchased 75
shares of substantially identical stock, the loss on the sale of 75 of the shares (P3,750 less P3,000, or P750) is
not allowable as a deduction because of the provisions of Section 33. The loss on the sale of the remaining 25
shares (P1,250 less P1,000, or P250) is deductible subject to the limitations provided in Sections 31(b) and 34.
The basis of the 50 shares purchased December 21, 1939, the acquisition of which resulted in the non-
deductibility of the loss (P500) sustained on 50 of the 100 shares sold on January 2, 1940, is P2,500 (the cost of
50 of the shares sold on January 2, 1940), plus P750 [the difference between the purchase price of the 50
shares acquired on December 21, 1939, (P2,750) and the selling price of 50 of the shares sold on January 2,
1940 (P2,000)], or P3,250. Similarly the basis of the 25 shares purchased on December 26, 1939, the
acquisition of which resulted in the nondeductibility of the loss (P250) sustained on 25 of the shares sold on
January 2, 1940, is P1,250 plus P125, or P1,375. (See Section 143 of these regulations.)
EXAMPLE (3): A, whose taxable year is the calendar year, on September 15, 1938, purchased 100 shares of the
stock of the M Company for P5,000. He sold these shares on February 1, 1940, for P4,000. On each of the four
days from February 15, 1940, to February 18, 1940, he purchased 50 shares of substantially identical stock for
P2,000. There is an indicated loss of P1,000 from the sale of the 100 shares on February 1, 1940, but since
within the sixty-one-day period A purchased not less than 100 shares of substantially identical stock, the loss is
not deductible. The particular shares of stock the purchase of which resulted in the nondeductibility of the loss
are the first 100 shares purchased within such period, that is, the 50 shares purchased on February 15, 1940,
and the 50 shares purchased on February 16, 1940.
(Section 34 of the Code)
SECTION 132. Definition of "capital assets." — The law provides that the term "capital assets" shall be held
to mean property held by the taxpayer (whether or not connected with his trade or business), but does not
include stock in trade of the taxpayer or other property of a kind which would properly be included in the
inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily
for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business,
Revenue Regulations 02-40 Page 18 of 39

of a character which is subject to the allowance for depreciation provided in subsection (f) of Section 30 of the SECTION 134-A. Capital loss carry-over-Illustration. — A, an individual has the following incomes and losses:
Code. The term "capital asset" includes all classes of property not specifically excluded by Section 30(a). 1946 — Net income from business 1,000
Dividends received 750
The exclusion from the term "capital assets" of property used in the trade or business of a taxpayer of a Interest earned 500
character which is subject to the allowance for depreciation provided in Section 30(f) of the Code is limited to Capital gains — on capital assets held for 8 months 5,000
property used by the taxpayer in the trade or business at the time of the sale or exchange. It has no application Capital losses — on capital assets held for 9 months 10,000
to gains or losses arising from the sale of real property used in the trade or business to the extent that such 1947 — Net income from business 2,000
gain or loss is allocable to the land, as distinguished from depreciable improvements upon the land. To such Interest earned 200
gain or loss allocable to the land, the limitations of Section 34(b) and (c) apply (such limitation may be Capital gains — on capital assets held for 15 months 5,000
inapplicable to a dealer in real estate, but, if so, it is because he holds the land primarily for sale to customers In 1946, his taxable income is computed as follows:
in the ordinary course of his trade or business, not because land is subject to a depreciation allowance). Gains Income from business, dividends and interest P2,250
or losses from the sale or exchange of property used in the trade or business of the taxpayer of a character Capital gains and losses:
which is subject to the allowance for depreciation provided in Section 30(f) of the Code, will not be subject to Capital gains P5,000
the percentage provisions of Section 34(b) and losses from such transactions will not be subject to the Less-Capital losses 10,000
limitation of losses provided in Section 30(c). (Real property used in taxpayer's trade or business is no longer ———
capital asset per Am. R.A. 82.) Net loss carried over to 1947 (P5,000)
———
SECTION 133. Percentage taken into account. — In computing net income, only 50 per cent of the gain or Net income subject to tax P2,250
loss recognized upon the sale or exchange for a capital asset shall be taken into account. Thus, in the case of a In 1947, his taxable income is computed as follows:
merchandising concern which has an "ordinary net income" (net income exclusive of net gains from the sale or Income from business and interest P2,200
exchange of capital assets) of P10,000 and a net capital gain of P5,000, the net income subject to tax will be Capital gains and losses:
P10,000 plus P2,500 (50 % of P5,000), of P12,500. Capital gains P5,000
———
SECTION 134. Limitation on capital losses. — Losses from sales or exchanges of capital assets are allowed One-half P2,500
only to the extent of the gains from such sales or exchanges. If the dealings of the taxpayer in capital assets ———
during the year result in a net capital loss, such loss cannot be deducted from his ordinary income, inasmuch as Less-Capital loss carried over (#) 2,250
capital losses are allowable only to the extent of capital gains. In the case, for example, of a taxpayer, engaged Net capital gain 250
in buying and selling goods, having an ordinary net income of P20,000, capital gains of P5,000 and capital ———
losses of P3,000 the taxable net income is computed as follows: Net income subject to tax P2,450
======
Ordinary net income P20,000 # The net capital loss of P5,000 sustained in 1946 and carried over in 1947 is reduced to P2,250 for the reason
that the net income from business and other sources (not including capital gain), for the year 1946 is only
Gains from sales of capital assets P2,250.
(as stocks or securities) P5,000
50% of such gains P2,500 If a bank or trust company incorporated under the laws of the Philippines or of the United States, a substantial
Losses from sales of capital assets P3,000 part of whose business is the receipt of deposits, sells any bond, debenture, note, or certificate or other
50% of such losses P1,500 evidence of indebtedness issued by any corporation (including one issued by a government or political
Net taxable capital gains 1,000 subdivision thereof), with interest coupons or in registered form, any loss resulting from such sale shall not be
———— subject to the limitation contained in Section 34(c) and shall not be included in determining the applicability of
Taxable net income P21,000 such limitation to other losses.
=======
If such taxpayer had an ordinary net income of P20,000, capital gains of P2,000 and capital losses of P7,000, SECTION 135. Gains and losses from short sales. — For income tax purposes, a short sale is not deemed to
the taxable net income would be computed as follows: be consummated until the delivery of property to cover the short sale. If the short sale is made through a
Ordinary net income P20,000 broker and the broker borrows property to make delivery, the short sale is not deemed to be consummated
Losses from sales of capital assets until the obligation of the seller created by the short sale is finally discharged by delivery of property to the
(as stocks or securities) P7,000 brokers to replace the property borrowed by such broker.
50% of such losses P3,500 (Section 35 of the Code)
Gains from sales of capital assets 2,000
50% of such gains 1,000 SECTION 136. Basis for determining gain or loss from sale of property. — For the purpose of ascertaining the
——— gain or loss from the sale or exchange of property, the basis is the cost of such property, or in the case of
Net capital losses P2,500 property which should be included in the inventory, its latest inventory value. But in the case of property
Taxable net income P20,000 acquired before March 1, 1913, when its fair market value as of that date is in excess of its cost, the gain to be
====== included in gross income is the excess of the amount realized therefor over such fair market value. (See
(The net capital loss of P2,500 is not deductible in arriving at the taxable net income inasmuch as capital losses illustration I, Section 137 of these regulations). Also in the case of property acquired before March 1, 1913,
are allowed only to the extent of capital gains.) when its fair market value as of that date is lower than its cost the deductible loss is the excess of such fair
market value over the amount realized therefor. (See Illustration II, Id.). No gain or loss is recognized in the case
Revenue Regulations 02-40 Page 19 of 39

of property sold or exchanged (a) at more than cost but less than its fair market value as of March 1, 1913 (See which gain is attributed to period prior
Illustration III, Id.), or (b) at less than cost but at more than its fair market value as of March 1, 1913. (See to March 1,1913.
Illustration IV, Id., Id., Id.) In any case proper adjustment must be made in computing gain or loss from the No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or disposed of at
exchange or sale of property for any depreciation or depletion sustained and allowable as deduction in less than cost but at more than its fair market value as of that date.
computing net income; the amount of depreciation previously charged off by the taxpayer shall be deemed to
be true depreciation sustained unless shown by clear and convincing evidence to be incorrect. What the fair ILLUSTRATION IV
market value of property was as of March 1, 1913, is a question of fact to be established by evidence which will Fair Market
reasonably and adequately make it appear. The nature and extent of the sales and the circumstances under Cost ValueSale Price Taxable gain
which they were made should be considered. Prices received at forced sales or for small lots of property may Mar. 1, 1913
be and often are no real indication of the value of the amount of property in question. For instance, sales from P20,000 P6,000 P10,000 No taxable gain or deductible
time to time of a small number of shares of stock is little indication of the value of a large or controlling interest loss.
in the corporation. If the taxpayer can not determine the cost of securities purchased prior to March 1, 1913, Reason: A loss on whole transaction,
because of the loss, destruction, or failure to keep records, the value of the securities at the date of which loss is attributable to period
approximate date of acquisition may be used in determining the cost basis for purposes of computing the gain prior to March 1, 1913.
or loss from the sale of the securities. When the date or approximate date of acquisition is unknown, no Where the cost is equal to or greater than the fair market value as of March 1, 1913, and the selling price
general rule can be stated for determining the cost value of such securities. Each case must be considered exceeds the cost, the gain to be included in gross income is the excess of the selling price over the cost.
separately upon its own facts.
ILLUSTRATION V
SECTION 137. Illustrations of the computation of gain or loss from the sale or exchange of property acquired Fair Market
prior to March 1, 1913. — To avoid complexity no adjustment has been made in these examples for Cost ValueSale Price Taxable gain
depreciation or depletion. Mar. 1, 1913
P20,000 P10,000 P40,000 P20,000
In the case of property acquired before March 1, 1913, when its fair market value as of that date is in excess of Reason: Gain on whole transaction,
its cost, the taxable gain is the excess of the amount realized therefor over such fair market value. all of which is attributable to period
subsequent to March 1, 1913.
ILLUSTRATION I Where the fair market value as of March 1, 1913, is equal to or greater than the cost and the selling price is less
Fair Market than the cost, the deductible loss is the amount by which the cost exceeds the selling price.
Cost ValueSale Price Taxable gain
Mar. 1, 1913 ILLUSTRATION VI
P20,000 P30,000 P40,000 P10,000 Fair Market
Excess of amount realized over fair Cost ValueSale Price Taxable gain
market value as of March 1, 1913. Mar. 1, 1913
Gain attributed to the period prior P20,000 P30,000 P10,000 P10,000
to March 1, 1913 not taxable. Reason: Loss on whole transaction, all
In the case of property acquired before March 1, 1913, when its fair market value as of that date is lower than of which is attributable to period
its cost, the deductible loss is the excess of such fair market value over the amount realized therefor. subsequent to March 1, 1913. Only
actual loss sustained deductible.
ILLUSTRATION II
Fair Market SECTION 138. Sale of property acquired by gift. — In computing the gain or loss from the sale or other
Cost ValueSale Price Taxable gain disposition of property acquired by gift, the basis shall be the selling price and the fair market value of the
Mar. 1, 1913 property at the time the gift was made, or its fair market value as of March 1, 1913, if acquired prior thereto,
P20,000 P10,000 P6,000 P4,000 determined in accordance with the next two preceding sections. In the case of gifts made on or after July 1,
Excess of fair market value over 1939, the value taken as a basis for gift tax purposes shall be considered as the fair market value in computing
amount realized. Loss attributable to gain or loss from the sale or other disposition of the property.
the period prior to March 1, 1913, not
deductible. SECTION 139. Sale of property acquired by devise, bequests, or inheritance. — In computing the gain or loss
No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or disposed of at from the sale or other disposition of property acquired by devise, bequest, or inheritance, the basis shall be
more than cost but at less than its fair market value as of that date. the fair market price or value of such property at the time of the death of the decedent. The term "property
acquired by bequest, devise, or inheritance" as used herein includes (a) such property interests as the taxpayer
ILLUSTRATION III has received as the result of a transfer, or creation of a trust, in contemplation of or intended to take effect in
Fair Market possession or enjoyment at or after death, and (b) such property interest as the taxpayer has received as the
Cost ValueSale Price Taxable gain result of the exercise by a person of a general power of appointment (1) by will, or (2) by deed executed in
Mar. 1, 1913 contemplation of or intended to take effect in possession or enjoyment at or after death. In the case of
P20,000 P60,000 P40,000 No taxable gain or deductible property acquired by gift, bequest, devise, or inheritance, prior to March 1, 1913, the taxable gain or
loss. deductible loss from the sale or other disposition thereof shall be computed in accordance with sections 136
Reason: A gain on whole transaction, and 137 of these regulations. In the case of property acquired by bequest, devise or inheritance, its value as
Revenue Regulations 02-40
appraised for the purpose of the inheritance tax shall be deemed to be its fair market value when acquired.
SECTION 140. Exchange of property. — Gain or loss arising from the acquisition and subsequent disposition
of property is realized only when as the result of a transaction between the owner and another person the
property is converted into other property (a) that is essentially different from the property disposed of, and (b)
that has a market value. The requirement that the property received in exchange must be "essentially different
from the property disposed of" implies that there must be a change in substance and not merely a change in
form. By way of illustration, if a taxpayer owning ten shares of stock exchanges his stock certificate for a voting
trust certificate, no income is realized. The term "market value" means the fair value of the property in money
as between one who wishes to purchase and one who wishes to sell. It is not, however, what can be obtained
for the property when the owner is under peculiar compulsion to sell or the purchaser to buy; nor is it a purely
speculative value which an owner could not reasonably expect to obtain for the property although he might
possibly be fortunate enough to do so. "Market value" is the price at which a seller willing to sell at a fair price
and a buyer willing to buy at a fair price, both having reasonable knowledge of the facts, will trade. Evidence as
to the assets and liabilities of a corporation and as to its earnings may furnish definite indications of the market
value of its stock.
SECTION 141. Determination of gain or loss from the exchange of property. — The amount of income
derived or loss sustained from an exchange of property is the difference between the market value at the time
of the exchange of the property received in exchange and the original cost, or other basis, of the property
exchange. If the property exchanged was acquired prior to March 1, 1913, see Sections 136 and 137 of these
regulations.
SECTION 142. Readjustment of interest in a registered copartnership. — When a partner retires from a duly
registered copartnership, or the partnership is dissolved, he realizes a gain or loss measured by the difference
between the price received for his interest and the cost to him of his interest in the partnership including in
such cost the amount of his share in any undistributed partnership net income earned since he became a
partner on which the income tax has been paid. However, if such interest in the partnership was acquired prior
to March 1, 1913, both the cost as hereinbefore provided and the amount of such interest as of date, plus the
amount of the shares in any undistributed partnership net income earned since March 1, 1913, on which the
income tax has been paid, shall be ascertained and the taxable gain derived or the deductible loss sustained
shall be computed as provided in Sections 136 and 137 of these regulations. If the partnership distributes its
assets in kind and not in cash, the partner realizes gain or suffers loss according to the market value of the
property received in liquidation. Whenever a new partner is admitted, to a partnership, or any existing
partnership is reorganized, the facts as to such change or reorganization should be fully set forth in the next
return of income, in order that the Commissioner of Internal Revenue may determine whether any gain or loss
has been realized by any partner.
SECTION 143. Basis of stock or securities acquired in "wash sales". — In the sale or other disposition of
stocks or securities the acquisition of which (or the contract or option to acquire which) resulted in the non
deductibility of the loss from the sale or other disposition of substantially identical stock or securities the basis
shall be the basis of the substantially identical stock so sold or disposed of, increased or decreased, as the case
may be, by the difference, if any, between the price at which the stock or securities was acquired and the price
at which such substantially identical stock or securities were sold or otherwise disposed of. The application of
this rule may be illustrated by the following examples:
EXAMPLE (1): A purchased a share of common stock of the X Corporation for P100 in 1936, which he sold
January 15, 1940, for P80.00. On February 1, 1940, he purchased a share of common stock of the same
corporation for P90.00. No loss from the sale is recognized under Section 33 of the Code. The basis of the new
share is P110; that is, the basis of the old share (P100) increased by P10, excess of the price at which the new
share was acquired (P90) over the price at which the old share was sold (P80).
EXAMPLE (2): A purchased a share of common stock of the X corporation for P100 in 1936, which he sold
January 15, 1940, for P80. On January 1, 1940, he purchased a share of common stock of the same corporation
for P70. No loss from the sale is recognized under Section 33 of the Code. The basis of the new share is P90;
that is, the basis of the old share (P100) decreased by P10, the excess of the price at which the old share was
Page 20 of 39
sold (P80) over the price at which the new share was acquired (P70). (See Section 131 of these regulations).
SECTION 143-A. Excerpts from B.I.R. General Circular No. V-253 publishing Republic Act No. 1921 amending
Section 35 of the Code, particularly subsection (c) thereof:
Features of the Amendment
1. Before and after the amendment. — Under the provisions of subsection (c) of Section 35 of the National
Internal Revenue Code, before its amendment by Republic Act No. 1921, when property is exchanged for
another property, the property received in exchange shall, for the purpose of determining gain or loss, be
treated as the equivalent of cash to the amount of its fair market value.
Paragraph 1 of subsection (c) of section 35 of the Tax Code after the amendment states the general rule that
upon the sale or exchange of property, the entire amount of gain or loss as the case may be, is recognized,
while paragraphs 2 and 3 give the exceptions where gain or loss is not recognized, or gain is recognized only in
part.
2. Exceptions to the rule recognizing gain or loss in exchanges of property solely in kind. — Under paragraph
2 of subsection (c) of Section 35 of the Tax Code after its amendment by Republic Act No. 1921, no gain
or loss shall be recognized in the following cases of exchanges made in pursuance of a plan of merger or
consolidation:
(a) By a corporation: If a corporation, a party to a merger or consolidation, in pursuance of such plan of
merger or consolidation, exchanges property solely for stock in another corporation, a party to the merger or
consolidation.
(b) By a shareholder: A shareholder who exchanges his stock in a corporation which is a party to the merger
or consolidation solely for stock of another corporation, also a party to the merger or consolidation.
(c) By a security holder: A security holder of a corporation which is a party to the merger or consolidation,
who exchanges his securities in such corporation solely for stock or securities in another corporation, a party to
the merger or consolidation.
3. Recognition of gain in part but not loss, where exchanges are not solely in kind.
(a) By a shareholder or security holder. — If in connection with an exchange made by a shareholder or
security holder described in the above exceptions, he receives not only stock or securities, permitted to be
received without recognition of loss or gain, but also money and/or other property, then the gain, if any, to the
recipient shall be recognized, but in an amount not in excess of the sum of money and the fair market value of
such other property. The loss, if any, to the shareholder or security holder from such an exchange is not to be
recognized to any extent. However, if the distribution of such other property and/or money to a shareholder in
the course of a merger or consolidation has the effect of the distribution of a taxable dividend, there shall be
taxed to the distributee as a taxable dividend such an amount of the gain recognized on the exchange as is not
in excess of the distributee's ratable share of the undistributed earnings and profits of the corporation, and as
a capital gain, the remainder, if any, of the gain so recognized.
Example: A, in connection with a merger or consolidation in 1957 exchanges a share of stock in the X
Corporation (a party to the merger or consolidation) purchased in 1939 at a cost of P100 for a share of stock of
the Y Corporation (also a party to the merger or consolidation), which has a fair market value of P90, plus P20
in cash. The gain from the transaction is P10 and is recognized and taxed as a gain from the exchange of
property. However, if the share of stock received had a fair market value of P70, the loss from the transaction
of P10 would not be recognized.
(b) By a corporation. — If, in pursuance of a plan of merger or consolidation above described, the transferor
corporation receives not only stock permitted to be received without the recognition of gain or loss, but also
money and/or other property, then, if such money and/or other property received by the corporation is
distributed by it pursuant to the plan of merger or consolidation, no gain to the said corporation will be
recognized. If the other property and/or money received by the corporation is not distributed by it pursuant to
the plan of merger and consolidation, the gain, if any, to the corporation from the exchange will be recognized
in an amount not in excess of the sum of money and the fair market value of the other property so received
which is not distributed. In either case no loss from the exchange will be recognized.
Revenue Regulations 02-40
4. Assumption of liability. — Where upon an exchange described in the foregoing exceptions, a taxpayer
receives stock or securities which would be permitted to be received without the recognition of gain if it were
the sole consideration, and as part of the consideration, another party to the exchange assumes a liability of
the taxpayer, or acquires from the taxpayer property subject to a liability, such assumption or acquisition shall
not be considered as money and/or other property, and shall not prevent the exchange from being within the
exceptions. Accordingly, the assumption of the aforesaid liabilities is not to be treated as other property or
money for the purpose of determining the amount of realized gain.
5. Basis of stock or securities for the purpose of determining gain or loss upon subsequent sale.
(a) By the transferor corporation, or its shareholder or security holder. — The basis of the stock or securities
received by the transferor corporation or its shareholder or security holder upon the exchange specified in the
above exceptions shall be the same as the basis of the property, stock or securities exchanged decreased by
the money received and the fair market value of the other property received, and increased by the amount
treated as dividend of the shareholder and the amount of any gain that was recognized on the exchange. The
other property or "boot" received in exchange shall have as basis its fair market value.
Examples:
1. A purchased a share of stock in the X Corporation in 1939 for P100. Pursuant to a plan of merger or
consolidation, A in 1957 exchanged his share for one share in the Y Corporation, worth P90 and P30 in cash. A
realized a gain of P20 upon the exchange. The basis of the share of stock in the Y Corporation is P90, that is, the
basis of the share in the X Corporation (P100) less the amount of money received by A (P30) plus the amount
of the gain recognized on the exchange (P20).
2. A purchased a share of stock in the X Corporation in 1939 for P100. Upon a merger or consolidation of
the X Corporation in 1957, A received in place of his stock in the X Corporation a share of stock in the Y
Corporation worth P60, a Treasury Bond worth P50, and in addition P20 in cash. A realized a gain of P30 upon
the exchange. The basis of the property received in exchange is the basis of the old stock decreased in the
amount of money received (P20) and increased in the amount of gain that was recognized (P30), which results
in a basis for the property received of P110. This basis of P110 is apportioned between the Treasury Bond and
the share of stock, the basis of the Treasury Bond being its fair market value at the date of the exchange, P50,
and of the share of stock, the remainder, P60.
(b) By the transferee. — The basis of the property transferred in the hands of the transferee shall be the
same as it would be in the hands of the transferor, increased by the amount of the gain recognized to the
transferor on the transfer.
(c) If corporation shareholder or security holder received several kinds of stock or securities. — When
securities of a single class were exchanged for new securities of different classes where no gain or loss was
recognized, the proper method of apportionment is to allocate to each class of new securities that proportion
of the original basis which the market value of the particular class bears to the market value of all securities
received on the date of the exchange, for purposes of determining the gain or loss on the subsequent sale of
any of the new securities. For example, if 100 shares of common stock par value P100, are exchanged for 50
shares of preferred and 50 shares of common each of P100 par value, and the cost of the old stock was P250
per share, or P25,000, but the market value of the preferred stock on the date of the exchange was P110 per
share, or P5,500 for the 50 shares, and the market value of the common was P440 per share or P22,000 for the
50 shares of common, one-fifth of the original cost, or P5,000, would be regarded as the cost of the preferred
and four-fifths, or P20,000 as the cost of the common.
As previously shown cash "boot" operates in the first instance to reduce basis. Then to this result must be
added the gain recognized. The remainder is to be allocated between the several types of stock and securities
permitted to be received without the recognition of gain or loss. To illustrate: The taxpayer in a nontaxable
exchange trades A stock which cost P100 for one share of common stock and one share of preferred stock of B
corporation, together worth P100 (P100 each), and P50 cash. The basis for the share of B common stock will
therefore be P50 (1/2 of P100) and the B preferred stock will likewise take a P50 basis.
Page 21 of 39
6. Definitions:
(a) The term "securities" means bonds and debentures but not "notes" of whatever class or duration.
(b) The term "merger" or "consolidation" shall be understood to mean the ordinary merger or consolidation,
or the acquisition by one corporation of all or substantially all the properties of another corporation solely for
stock. In order that a transaction may be regarded as a merger or consolidation within the purview of the
amendment, it must be undertaken for a bona fide business purpose and not solely for the purpose of
escaping the burden on taxation. In determining whether a bona fide business purpose exists, each and every
step of the transaction shall be considered and the whole transaction or series of transactions shall be treated
as a single unit. The term "property" shall be taken to include the cash assets of the transferor for purpose of
determining whether the property transferred constitutes a substantial portion of the property of the
transferor. "Substantially all" as used under this amendment means the acquisition by one corporation of at
least 80% of the assets, including cash, of another corporation, which has the element of permanence and not
merely momentary holding.
(Section 36 of the Code)
SECTION 144. Need of inventories. — In order to reflect the net income correctly, inventories at the
beginning and end of each year are necessary in every case in which the production, purchase or sale of
merchandise is an income producing factor. The inventory should include raw materials and supplies on hand
that have been acquired for sale, consumption, or use in productive processes together with all finished or
partly finished goods. Only merchandise title to which is vested in the taxpayer should be included in his
inventory. Accordingly the seller should include in his inventory goods under contract for sale but not yet
segregated and applied to the contract and goods out upon consignment, but should exclude from inventory
goods sold, title to which has passed to the purchaser. A purchaser should include in inventory merchandise
purchased, title to which has passed to him although such merchandise is in transit or for other reasons has
not been reduced to physical possession, but should not include goods ordered for future delivery transfer of
title to which has not yet been effected.
SECTION 145. Valuation of inventories. — The law provides two tests to which each inventory must conform.
— (1) It must conform as nearly as possible to the best accounting practice in the trade or business, and (2) it
must clearly reflect the income. It follows, therefore, that inventory rules can not be uniform but must give
effect to trade customs which come within the scope of the best accounting practice in the particular trade or
business. In order to clearly reflect income, the inventory practice of a taxpayer should be consistent from year
to year, and greater weight is to be given to consistency than to any particular method of inventory or basis of
valuation, as long as the method or basis used is substantially in accord with these regulations. An inventory
that can be used under the best accounting practice in a balance sheet showing the financial position of the
taxpayer is, as a general rule, regarded as clearly reflecting his income.
The bases of valuation most commonly used by business concerns and which meet the requirements of the
Income Tax Law are (a) cost price or (b) cost or market price, whichever is the lower. Any goods in an inventory
which are unsalable at normal prices or unusable in the normal way because of damage, imperfections, shop
wear, changes of style, odd or broken lots, or other similar causes, including second hand goods taken in
exchange, should be valued at "bona fide" selling prices whether basis (a) or (b) is used, or if such goods consist
of raw materials or partly finished goods held for use or consumption, they should be valued upon a
reasonable basis, taking into consideration the usability and the condition of the goods, but in no case shall
such value be less than the scrap value. "Bona fide" selling price means actual offerings of goods during a
period ending not later than thirty days after inventory date. The burden of proof will rest upon the taxpayer to
show that such exceptional goods as are valued upon such selling bases come within the classifications
indicated above, and he shall maintain such records of the disposition of the goods as will enable a verification
of the inventory to be made.
In respect to normal goods, whichever basis (a) or (b) is adopted must be applied with reasonable consistency
to the entire inventory. Taxpayers were given the option to adopt either basis (a) or (b) for their 1921
inventories, and the basis adopted for that year is controlling and a change can now be made after permission
is secured from the Commissioner of Internal Revenue. Goods taken in the inventory which have been so
intermingled that they can not be identified with specific invoices will be deemed to be either (a) the goods
most recently purchased or produced and the cost thereof will be the actual cost of the goods purchased or
Revenue Regulations 02-40
produced during the period in which the quantity of goods in the inventory has been acquired, or (b) where
the taxpayer maintains book inventories in accordance with a sound accounting system in which the respective
inventory accounts are charged with the actual cost of the goods purchased or produced and credited with the
value of the goods used, transferred, or sold, calculated upon the basis of the actual cost of the goods acquired
during the taxable year (including the inventory at the beginning of the year) the net value as shown by such
inventory accounts will be deemed to be the cost of the goods on hand. The balances shown by such
inventories should be verified by physical inventories at reasonable intervals and adjusted to conform
therewith.
Inventories should be recorded in a legible manner, properly computed and summarized, and should be
preserved as a part of the accounting record of the taxpayer. The inventories of taxpayers on whatever basis
taken will be subject to investigation by the Commissioner of Internal Revenue and the taxpayer must satisfy
the Commissioner of Internal Revenue of the correctness of the price adopted.
The following methods, among others, that are sometimes used in taking or valuing inventories, are not in
accord with these regulations and therefore their use for income tax purposes is prohibited, viz.:
(1) Deducting from the inventory a reserve for price changes, or an estimated depreciation in the value
thereof.
(2) Taking work in process, or other parts of the inventory, at a nominal price or at less than its proper value.
(3) Omitting portions of the stock on hand.
(4) Using a constant price or nominal value for a so called normal quantity of materials or goods in stock.
(5) Including stock in transit, either shipped to or from the taxpayer, the title to which is not vested in the
taxpayer.
SECTION 146. Inventories at cost price. — Cost means:
(1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of such goods.
(2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade
or other discounts, except strictly cash discounts, approximating a fair interest rate, which may be deducted or
not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be
added transportation or other necessary charges incurred in acquiring possession of the goods.
(3) In the case of merchandise produced by the taxpayer since the beginning of the taxable year, (a) the cost
of raw materials and supplies entering into or consumed in connection with the products; (b) expenditures for
direct labor; (c) indirect expenses incident to and necessary for the production of the particular article,
including therein a reasonable proportion of management expenses, but not including any cost of selling or
return on capital whether by way of interest or profit.
(4) In any industry in which the usual rules for computation of cost of production are inapplicable, costs may
be approximated upon such basis as may be reasonable and in conformity with established trade practice in
the particular industry. Among such cases are: (a) Farmers and raisers of 1ivestock; (b) miners and
manufacturers who by a single process or uniform series of processes derive a product of two or more kinds,
size or grade, the unit cost of which is substantially alike; and (c) retail merchants who use what is known as
the "retail method" in ascertaining approximate cost. cCaSHA
SECTION 147. Inventories at market price. — Under ordinary circumstances, and for normal goods in an
inventory "market price" means the current bid price prevailing at the date of the inventory for the particular
merchandise in the volume in which usually purchased by the taxpayer and is applicable in the cases (a) of
goods purchased and on hand, and (b) of basic elements of cost (materials, labor, and burden) in goods in
process of manufacture and in finished goods on hand; exclusive, however, of goods on hand or in process of
manufacture for delivery upon firm sales contracts (i.e., those not legally subject to cancellation by either
party) at fixed prices entered into before the date of the inventory, which goods must be inventoried at cost.
Where no open market exists or where quotations are nominal due to stagnant market condition, the taxpayer
must use such evidence of a fair market price at the date or dates nearest the inventory as may be available,
such as specific purchase or sales by the taxpayer or others in reasonable volume and made in good faith, or
compensation paid for cancellation of contracts for purchase commitments. Where the taxpayer in the regular
course of business has offered for sale such merchandise at prices lower than the current price as above
defined, the inventory may be value at such prices and the correctness of prices will be determined by
reference to the actual sales of the taxpayer for a reasonable period before and after the date of the inventory.
Page 22 of 39
Prices which vary materially from the actual prices so ascertained will not be accepted as reflecting the market
price.
SECTION 148. Inventories by dealers in securities. — A dealer in securities who in his books of account
regularly inventories unsold securities on hand either —
(a) At cost;
(b) At, cost or market, whichever is lower; or
(c) At market value.
may make his return upon the basis upon which his accounts are kept; provided that a description of the
method employed shall be included in or attached to the return, that all the securities must be inventoried by
the same method, and that such method must be adhered to in subsequent years, unless another method be
authorized by the Commissioner of Internal Revenue. A dealer in securities in whose books of accounts
separate computations of the gain or loss from the sale of the various lots of securities sold are made on the
basis of the cost of each lot shall be regarded, for the purposes of this section, as regularly inventorying his
securities at cost. For the purposes of this rule a dealer in securities is a merchant of securities, whether an
individual, partnership; or corporation, with an established place of business, regularly engaged in the
purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells
them to customers with a view to the gains and profits that may be derived therefrom. If such business is
simply a branch of the activities carried on by such person, the securities inventoried as here provided may
include only those held for purposes of resale and not for investment. Taxpayers who buy and sell or hold
securities for investment or speculation, irrespective of whether such buying or selling constitutes the carrying
on of a trade or business, and officers of corporations and members of partnerships who in their individual
capacities buy and sell securities, are not dealers in securities within the meaning of this rule.
SECTION 149. Inventories of livestock raisers and other farmers. —
(1) Farmers may change the basis of their returns from that of receipts and disbursements to that of an
inventory basis, which necessitates the use of opening and closing inventories for the year in which the change
is made. There should be included in the opening inventory all farm products (including livestock) purchased or
raised which were on hand at the date of the inventory, but inventories must not include real estate, buildings,
permanent improvements, or any other fixed assets.
(2) Because of the difficulty of ascertaining actual cost of livestock and other farm products, farmers who
render their returns upon an inventory basis may at their option value their inventories for the current taxable
year according to the "farm-price method" which provides for the valuation of inventories at market price less
cost of marketing. If the use of the "farm-price method" of valuing inventories for any taxable year involves a
change in method of pricing inventories from that employed in prior years, the opening inventory for the
taxable year in which the change is made should be brought in at the same value as the closing inventory for
the preceding taxable year. If such valuation of the opening inventory for the taxable year in which the change
is made results in an abnormally large income for that year, there may be submitted with the return for such
taxable year an adjustment statement for the preceding year based on the "farm-price method" of valuing
inventories; upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at the
rate of tax in effect for such preceding year.
(3) Where returns have been made in which the taxable net income has been computed upon incomplete
inventories, the abnormality should be corrected by submitting with the return for the current taxable year a
statement for the preceding year in which such adjustments shall be made as are necessary to bring the closing
inventory for the preceding year into agreement with opening complete inventory for the current taxable year.
SECTION 150. Inventories of miners and manufacturers. — A taxpayer engaged in mining or manufacturing
who by a single process or uniform series of processes derives a product of two or more kinds, sizes or grades,
the unit cost of which is substantially alike, and who in conformity to a recognized trade practice allocates an
amount of cost to each kind, size, or grade of product which in the aggregate will absorb the total cost of
production, may use such allocated cost a the basis for pricing inventories, provided such allocation bears a
reasonable relation to the respective selling values of the different kinds of products.
Revenue Regulations 02-40
SECTION 151. Inventories of retail merchants. — Retail merchants who employ what is known as the "retail
method" of pricing inventories may make their returns upon that basis, provided that the use of such method,
is designated upon the returns, that accurate accounts are kept and that such method is consistently adhered
to unless a change is authorized by the Commissioner of Internal Revenue. Under this method the goods in the
inventory are ordinarily priced at the selling prices and the total retail value of the goods in each department or
of each class of goods is reduced to approximate cost by deducting the percentage which represents the
difference between the retail selling value and the purchase price. This percentage is determined by
departments of a store or by classes of goods, and should represent as accurately as may be the amounts
added to the cost prices of the goods to cover selling and other expenses of doing business and for the margin
of profit. In computing the percentage above mentioned, proper adjustment should be made for all mark-ups
and mark-downs.
A taxpayer maintaining more than one department in his store or dealing in classes of goods carrying different
percentages of gross profit should not use a percentage of profit based upon an average of his entire business
but should compute and use in valuing his inventory the proper percentages for the respective departments or
classes of goods.
(Section 37 of the Code)
SECTION 152. Income from sources within the Philippines. — The law divides the income of taxpayers into
three classes:
(1) Income which is derived in full from sources within the Philippines;
(2) Income which is derived in full from sources without the Philippines; and
(3) Income which is derived partly from sources within and partly from sources without the Philippines.
Non-resident alien individuals and foreign corporations are taxable only upon income from sources within the
Philippines. Citizens and residents of the Philippines and domestic corporations are taxable upon income
derived from sources both within and without the Philippines. EAcTDH
The taxable income from sources within the Philippines includes that derived in full from sources within the
Philippines and that portion of the income which is derived partly from sources within and partly from sources
without the Philippines which is allocated or apportioned to sources within the Philippines.
SECTION 153. Interest. — Interest on bonds or notes or other interest bearing obligations of residents,
corporate or otherwise, constitutes income from sources within the Philippines.
SECTION 154. Dividends. — Gross income from sources within the Philippines includes dividends, as defined
by Section 83 of the Code:
(a) From a domestic corporation; and
(b) From a foreign corporation unless less than 50 per cent of its gross income for the three-year period
ending with the close of its taxable year preceding the declaration of such dividends, or for such part of such
period as it has been in existence, was derived from sources within the Philippines; but only in an amount
which bears the same ratio to such dividends as the gross income of the corporation for such period derived
from sources within the Philippines bears to its gross income from all sources.
Dividends will be treated as an income from sources within the Philippines unless the taxpayer submits
sufficient data to establish to the satisfaction of the Commissioner of Internal Revenue that they should be
excluded from gross income under Section 37(a)(2)(B).
SECTION 155. Compensation for labor or personal services. — Gross income from sources within the
Philippines includes compensation for labor or personal services performed within the Philippines regardless of
the residence of the payor, of the place in which the contract for service was made, or of the place of payment.
If a specific amount is paid for labor or personal services performed in the Philippines, such amount shall be
included in the gross income. If no accurate allocation or segregation of compensation for labor or personal
services performed in the Philippines can be made, or when such labor or service is performed partly within
and partly without the Philippines, the amount to be included in the gross income shall be determined by an
apportionment of the time basis, i.e., there shall be included in the gross income an amount which bears the
same relation to the total compensation as the number of days of performance of the labor or services within
Page 23 of 39
the Philippines bears to the total number of days performance of labor or services for which the payment is
made. Wages received for services rendered inside the territorial limits of the Philippines and wages of an alien
seaman earned on a coastwise vessel are to be regarded as from sources within the Philippines.
SECTION 156. Rentals and royalties. — Gross income from sources within the Philippines includes rentals or
royalties from property located within the Philippines or from any interest in such property, including rentals or
royalties for the use of or the privilege of using in the Philippines, patents, copyrights, secret processes and
formulas, goodwill, trademarks, trade brands, franchises, and other like property. The income arising from the
rental of property whether tangible or intangible located within the Philippines, or from the use of property,
whether tangible or intangible, located within the Philippines, is from sources within the Philippines.
SECTION 157. Sale of real property. — Gross income from sources within the Philippines includes gain,
computed under the provisions of Section 35, derived from the sale or other disposition of real property
located in the Philippines. For the treatment of capital gains and losses, see Sections 132 to 135 of these
regulations.
SECTION 158. Income from sources without the Philippines. — Gross income from sources without the
Philippines includes:
(1) Interest other than that specified in Section 37(a)(1), as being derived from sources within the
Philippines;
(2) Dividends other than those derived from sources within the Philippines as provided in Section 37(a)(2);
(3) Compensation for labor or personal services performed without the Philippines;
(4) Rentals or royalties derived from property without the Philippines or from any interest in such property,
including rentals or royalties for the use of or for the privilege of using without the Philippines, patents,
copyrights, secret processes and formulas, goodwill, trade-marks, trade brands, franchises, and other like
property; and
(5) Gain derived from the sale of real property located without the Philippines. AEIDTc
SECTION 159. Sale of personal property. — Income derived from the purchase and sale of personal property
shall be treated as derived entirely from the country in which sold. The world "sold" includes "exchanged". The
"country in which sold" ordinarily means the place where the property is marketed. This section does not apply
to income from the sale of personal property produced (in whole or in part) by the taxpayer within and sold
without the Philippines or produced (in whole or in part) by the taxpayer without and sold within the
Philippines. (See Section 162 of these regulations.)
SECTION 160. Apportionment of deductions. — From the items specified in Section 37(a) as being derived
specifically from sources within the Philippines there shall be deducted the expenses, losses, and other
deductions properly apportioned or allocated thereto and a ratable part of any other expenses, losses or
deductions which can not definitely be allocated to some item or class of gross income. The remainder shall be
included in full as net income from sources within the Philippines. The ratable part is based upon the ratio of
gross income from sources within the Philippines to the total gross income.
EXAMPLE: A non-resident alien individual whose taxable year is the calendar year, derived gross income from
all sources for 1939 of P180,000, including therein:
Interest on bonds of a domestic corporation P9,000
Dividends on stock of domestic corporation 4,000
Royalty for the use of patents within the Philippines 12,000
Gain from sale of real property located within the Philippines 11,000
————
Total P36,000
that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of the gross
income was from sources without the Philippines, determined under Section 37(c).
The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount of P8,000 is
properly allocated to income from sources within the Philippines and the amount of P40,000 is properly
Revenue Regulations 02-40
allocated to income from sources without the Philippines.
The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A ratable part
thereof, based upon the relation of gross income from sources within the Philippines to the total gross income,
shall be deducted in computing net income from sources within the Philippines. Thus, there are deducted from
the P36,000 of gross income from sources within the Philippines expenses amounting to P14,000 (representing
P8,000 properly apportioned to the income from sources within the Philippines and P6,000, a ratable part
(one-fifth) of the expenses which could not be allocated to any item or class of gross income). The remainder,
P22,000, is the net income from sources within the Philippines.
SECTION 161. Other income from sources within the Philippines. — Items of gross income other than those
specified in Section 37(a) and (c) shall be allocated or apportioned to sources within or without the Philippines,
as provided in Section (37)(e).
The income derived from the ownership or operation of any farm, mine, oil or gas well, other natural deposit,
or timber, located within the Philippines, and from the sale by the producer of the products thereof within or
without the Philippines, shall ordinarily be included in gross income from sources within the Philippines. If,
however, it is shown to the satisfaction of the Commissioner of Internal Revenue that due to the peculiar
conditions of productions and sale in a specific case or for other reasons all of such gross income should not be
allocated to sources within the Philippines and to sources without the Philippines shall be made as provided in
Section 162 of these regulations.
Where items of gross income are separately allocated to sources within the Philippines, there shall be
deducted therefrom, in computing net income, the expenses, losses, and other deductions properly
apportioned or allocated thereto and a ratable part of other expenses, losses, or other deductions which
cannot definitely be allocated to some item or class of gross income.
SECTION 162. Income from the sale of personal property derived from sources partly within and partly
without the Philippines. — Items of gross income not allocated by Sections 152 to 159 or 161 of these
regulations to sources from within or without the Philippines shall (unless unmistakably from a source within
or a source without the Philippines) be treated as derived from sources partly within and partly without the
Philippines.
The portion of such income derived from sources partly within the Philippines and partly within a foreign
country which is attributable to sources within the Philippines shall be determined according to the following
rules and cases:
PERSONAL PROPERTY PRODUCED AND SOLD: — Gross income derived from the sale of personal property
produced (in whole or in part) by the taxpayer within the Philippines and sold within a foreign country, or
produced (in whole or in part) by the taxpayer within a foreign country and sold within the Philippines shall be
treated as derived partly from sources within the Philippines and partly from sources within a foreign country
under one of the cases below. As used herein the word "produced" includes created, fabricated, manufactured,
extracted, processed, cured, or aged.
CASE 1. Where the manufacturer or producer regularly sells a part of his output to wholly independent
distributors or other selling concerns in such a way as to establish fairly an independent factory or production
price — or shows to the satisfaction of the Commissioner of Internal Revenue that such an independent factory
or production price has been otherwise established — unaffected by considerations of tax liability, and the
selling or distributing branch or department of the business is located in a different country from that in which
the factory is located or the production carried on, the net income attributable to sources within the
Philippines shall be computed by an accounting which treats the products as sold by the factory or productive
department of the business to the distributing or selling department at the independent factory price as
established. In all such cases the basis of the accounting shall be fully explained in a statement attached to the
return.
CASE 2. Where an independent factory or production price has not been established as provided under Case
Page 24 of 39
1, the net income shall first be computed by deducting from the gross income derived from the sale of
personal property produced (in whole or in part) by the taxpayer within the Philippines and sold within a
foreign country or produced (in whole or in part) by the taxpayer within a foreign country and sold within the
Philippines, the expenses, losses, or other deductions properly apportioned or allocated thereto and a ratable
part of any expenses, losses, or other deductions which can not definitely be allocated to some item or class of
gross income. Of the amount of net income so determined, one-half shall be apportioned in accordance with
the value of the taxpayer's property within the Philippines and within the foreign country, the portion
attributable to sources within the Philippines being determined by multiplying such one half by a fraction the
numerator of which consists of the value of the taxpayer's property within the Philippines, and the
denominator of which consists of the value of the taxpayer's property both within the Philippines and within
the foreign country. The remaining one-half of such net income shall be apportioned in accordance with the
gross sales of the taxpayer within the Philippines and within the foreign country, the portion attributable to
sources within the Philippines being determined by multiplying such one-half by a fraction the numerator of
which consists of the taxpayer's gross sales for the taxable year or period within the Philippines, and the
denominator of which consists of the taxpayer's gross sales for the taxable year, or period both within the
Philippines and within the foreign country. The "gross sales of the taxpayer within the Philippines" means the
gross sales made during the taxable year which were principally secured, negotiated, or effected by employees,
agents, offices, or branches of the taxpayer's business resident or located in the Philippines. The term "gross
sales" as used in this paragraph refers only to the sales of personal property produced (in whole or in part) by
the taxpayer within the Philippines and sold within a foreign country or produced (in whole or in part) by the
taxpayer within a foreign country and sold within the Philippines, and the term "property" includes only the
property held or used to produce income which is derived from such sales. Such property should be taken at its
actual value, which in the case of property valued or appraised for purposes of inventory, depreciation,
depletion, or other purposes of taxation shall be the highest amount at which so valued or appraised, and
which in other cases shall be deemed to be its book value in the absence of affirmative evidence showing such
value to be greater or less than the actual value. The average value during the taxable year or period shall be
employed. The average value of property as above prescribed at the beginning and end of the taxable year or
period ordinarily may be used, unless by reason of material changes during the taxable year or period such
average does not fairly represent the average for such year or period, in which event the average shall be
determined upon a monthly or daily basis. Bills and accounts receivable shall (unless satisfactory reason for a
different treatment is shown) be assigned or allocated to the Philippines when the debtor resides in the
Philippines. HCIaDT
CASE 3. Applications for permission to base the return upon the taxpayer's books of account will be
considered by the Commissioner of Internal Revenue in the case of any taxpayer who, in good faith and
unaffected by considerations of tax liability, regularly employs in his books of account a detailed allocation of
receipts and expenditures which reflects more clearly than the processes or formulas herein prescribed, the
income derived from sources within the Philippines.
SECTION 163. Foreign steamship companies. — The returns of foreign steamship companies whose vessels
touch ports of the Philippines should include as gross income, the total receipts of all out-going business
whether freight or passengers. With the gross income thus ascertained, the ratio existing between it and the
gross income from all parts, both within and without the Philippines of all vessels, whether touching ports of
the Philippines or not, should be determined as the basis upon which allowable deductions may be computed,
the principle being that allowable deductions shall be computed upon a basis which recognizes that the
income arising and accruing from business done if any from this country shall bear its share, and no more, of
expense, incident to the earning or creation of such income, in the ratio that the gross income arising in and
from this country bears to the entire gross income arising from business done both within and without this
country. In other words, the net income of a foreign steamship company doing business in or from this country
is ascertained for the purpose of the income tax, by deducting from the gross receipts from outgoing business
such a portion of the aggregate expenses, losses, etc., as such receipts bear to the aggregate receipts from all
ports of all vessels, including in each case incoming of a nonshipping character but incidental, to the shipping
business such as dividends from investments, interests on deposits, etc. For example —
Given
(a) Gross receipts from outgoing freights and passengers
Revenue Regulations 02-40 Page 25 of 39

from P.I. ports P20,000 shall be separately computed therefrom.

(b) Gross receipts from outgoing freights and passengers (Section 38 of the Code)
from all ports other than those of P. I 200,000
(c) Interests and other nonshipping income received by P.I. SECTION 166. General rule. — The method of accounting regularly employed by the taxpayer in keeping his
office 5,000 books, if such method clearly reflects his income is to be followed with respect to the time as of which items of
(d) Interests, dividends, and other nonshipping income received gross income and deductions are to be accounted for. If the taxpayer does not regularly employ a method of
by all offices other than those in P.I. 50,000 accounting which clearly reflects his income, the computation shall be made in such manner as in the opinion
(e) Total expenses and deductions of the company as a whole, of the Commissioner of Internal Revenue clearly reflects it. (See Section 137 of these regulations for
including those incurred by P.I. office 150,000 computation of net income, and Section 38 for bases of computation. For the use of inventories, see Sections
Computation of P.I. Net Income 144 to 151 of these regulations.)
(f) P.I. Gross Income:
Freights and passengers P20,000 SECTION 167. Methods of accounting. — It is recognized that no uniform method of accounting can be
Interest and other income 5,000 prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms and systems
——— of accounting as are in his judgment best suited to his purpose. Each taxpayer is required by law to make a
Total 25,000 return of his true income. He must, therefore, maintain such accounting records as will enable him to do so.
(g) P.I. expenses: Any approved standard method of accounting which reflects taxpayer's income may be adopted. Among the
P.I. gross income essentials are the following:
—————————— x World's expenses, or (1) In all cases in which the production, purchase, or sale of merchandise of any kind is an income producing
World's gross income factor, inventories of the merchandise on hand (including finished goods, work in process, raw materials, and
20,000 plus 5,000 supplies) should be taken at the beginning and end of the year and used in computing the net income of the
—————————————————— x 150,000, or year in accordance with Sections 144 to 151 of these regulations;
200,000 plus 20,000 plus 50,000 plus 5,000 (2) Expenditures made during the year should be properly classified as between capital and income; that is
25,000 to say, expenditures for items of plant, equipment, etc., which have a useful life extending substantially beyond
————— x 150,000 = 13,636 the year should be charged to a capital account and not to an expense account; and
275,000 (3) In any case in which the cost of capital assets is being recovered through deductions for wear and tear,
(h) P.I. net income: depletion, or obsolescence, any expenditure (other than ordinary repairs) made to restore the property or
P.I. gross income less P.I. expenses, or prolong its useful life should be added to the property account or charged against the appropriate reserve and
P25,000 less P13,636 = P11,364 not to current expenses.

SECTION 164. Telegraph and cable service. — A foreign corporation carrying on the business of transmission
of telegraph or cable messages between points in the Philippines and points outside the Philippines derives
income partly from sources within and partly from sources without the Philippines.
(1) GROSS INCOME. — The gross income from sources within the Philippines derived from such services shall
be determined by adding (a) its gross revenues derived from messages originating in the Philippines and (b)
amounts collected abroad on collect messages originating in the Philippines and deducting from such sum
amounts paid or accrued for transmission of messages beyond the company's own circuit. Amounts received
by the company in the Philippines with respect to collect messages originating without the Philippines shall be
excluded from gross income.
(2) NET INCOME. — In computing net income from sources within the Philippines there shall be allowed as
deductions from gross income determined in accordance with paragraph (1): (a) all expenses incurred in the
Philippines (not including any general overhead expenses), incident to the carrying on of the business in the
Philippines; (b) all direct expenses incurred abroad in the transmission of messages originating in the
Philippines (not including any general overhead expenses or maintenance, repairs, and depreciation of cable
and not including any amount already deducted in computing gross income); (c) depreciation of property
(other than cables) located in the Philippines and used in the trade or business therein; and (d) a proportionate
part of the general overhead expenses [not including any items incurred abroad corresponding to those
enumerated in (a), (b), and (c)], and of maintenance, repairs, and depreciation of cables of the entire cable
system of the enterprise based on the ratio which the number of words originating in the Philippines bears to
the total words transmitted by the enterprise.
SECTION 165. Computation of income. — If a taxpayer has gross income from sources within or without the
Philippines as defined by Section 37 (a) or (c) together with gross income derived partly from sources within
and partly from sources without the Philippines, the amounts thereof, together with the expenses and
investment applicable thereto, shall be segregated, and the net income from sources within the Philippines
SECTION 168. Changes in accounting methods. — The true income, computed under the law shall in all cases
be entered in the return. If for any reason the basis of reporting income subject to tax is changed, the taxpayer
shall attach to his return a separate statement setting forth for the taxable year and for the preceding year the
classes of items differently treated under the two systems, specifying in particular all amounts duplicated or
entirely omitted as the result of such change.
A taxpayer who changes the method of accounting employed in keeping his book shall, before computing his
income upon such new method for purposes of taxation, secure the consent of the Commissioner of Internal
Revenue. For the purposes of this action, a change in the method of accounting employed in keeping books
means any change in the accounting treatment of items of income or deductions, such as a change from cash
receipts and disbursements method to the accrual method, or vice versa; a change involving the basis of
valuation employed in the computation of inventories (see Sections 144 to 151 of these regulations); a change
from the cash or accrual method to the long-term contract method, or vice versa; a change in the long-term
contract method from the percentage of completion basis to the completed contract basis or vice versa (see
Section 44 of these regulations); or a change involving the adoption of, or a change in the use of, any other
specialized basis of computing net income such as the crop basis. Application for permission to change the
method of accounting employed and the basis upon which the return is made shall be filed within 90 days after
the beginning of the taxable year to be covered by the return. The application shall be accompanied by a
statement specifying all amounts which would be duplicated or entirely omitted as a result of the proposed
change. Permission to change the method of accounting will not be granted unless the taxpayer and the
Commissioner of Internal Revenue agree to the terms and conditions under which the change will be effected.
SECTION 169. Accounting period. — Income tax returns, whether for individuals or for corporations,
associations, or partnerships, are required to be made and their income computed for each calendar year
ending on December 31st of every year. However, corporations, associations, or partnerships may with the
approval of the Commissioner of Internal Revenue first secured, file their returns and compute their income on
the basis of a fiscal year which means an accounting period of twelve months ending on the last day of any
Revenue Regulations 02-40
month other than December. But in no instance shall individual taxpayers be authorized to establish a fiscal
year as basis for filing their returns and computing their income. (For authority to file on fiscal year basis see
Section 172 of these regulations.)
(Section 39 of the Code)
SECTION 170. When included in gross income. — Except as otherwise provided in Section 39 in the case of
the death of a taxpayer, gains, profits, and income are to be included in the gross income for the taxable year in
which they are received by the taxpayer, unless they are included as of a different period in accordance with
the approved method of accounting followed by him. If a taxpayer has died there shall also be included in
computing net income for the taxable period in which he died amounts accrued up to the date of his death if
not otherwise properly includible in respect of such period or a prior period, regardless of the fact that the
decedent may have kept his books and made his returns on the basis of cash receipts and disbursements.
(For income not reduced to possession but considered as constructively received and for examples of
constructive receipt, see Sections 52 and 53 of these regulations. For the treatment of income from long-term
contracts, see Section 44 of these regulations.)
(Section 40 of the Code)
SECTION 171. "Paid or incurred" and "paid or accrued". — (a) The terms "paid or incurred" and "paid or
accrued" will be construed according to the method of accounting upon the basis of which the net income is
computed by the taxpayer. The deductions and credits must be taken for the taxable year in which "paid or
accrued" or "paid or incurred", unless in order clearly to reflect the income such deductions or credits should
be taken as of a different period. If a taxpayer desires to claim a deduction or a credit as of a period other than
the period in which it was "paid or accrued" or "paid or incurred", he shall attach to his return a statement
setting forth his request for consideration of the case by the Commissioner of Internal Revenue together with a
complete statement of the facts upon which he relies. However, in his income tax return he shall take the
deduction or credit only for the taxable period in which it was actually "paid or incurred", or "paid or accrued",
as the case may be. Upon the audit of the return, the Commissioner of Internal Revenue will decide whether
the case is within the exception provided by the law, and the taxpayer will be advised as to the period for
which the deduction or credit is properly allowable.
(b) The provisions of paragraph (a) of this section in general are not applicable with respect to the taxable
period during which the taxpayer dies. In such case there shall also be allowed as deductions and credits for
such taxable period amounts accrued up to the date of his death if not otherwise allowable with respect to
such period or a prior period, regardless of the fact that the decedent was required to keep his books and make
his returns on the basis of cash receipts and disbursements. (See also Section 76 of these regulations.)
(Section 41 of the Code)
SECTION 172. Change of accounting period. — If a corporation, including a duly registered general co-
partnership, desires to change its accounting period from fiscal year to calendar year or from calendar year to
fiscal year, or from one fiscal year to another, it shall at any time not less than thirty days prior to the date fixed
in Section 46(b) of the Code for the filing of its return on the basis of its original accounting period submit a
written application to the Commissioner of Internal Revenue designating the proposed date for the closing of
its new taxable year, together with a statement of the date on which the books of account were opened and
closed each year for the past three years, the date on which the taxable year began and ended as shown on the
returns filed for the past three years, and the reasons why the change in accounting period is desired. (See also
Section 46(d) of the Code.)
(Section 42 of the Code)
SECTION 173. Returns for periods of less than twelve months. — No return can be made for a period of more
than twelve months. A separate return for a fractional part of a year is therefore required whenever there is a
change, with the approval of the Commissioner of Internal Revenue, in the basis of computing net income from
one taxable year to another taxable year. The periods to be covered by such separate returns in the several
cases are stated in Section 42(a). The requirements with respect to the filing of a separate return and the
payment of tax for a part of a year are the same as for the filing of a return and the payment of tax for a full
taxable year closing at the same time. DAETcC
(Section 43 of the Code)
Page 26 of 39
SECTION 174. Sale of personal property on installment plan. — Dealers in personal property ordinarily sell
either for cash or on the personal credit of the purchaser or on the installment plan. Dealers who sell on the
installment plan usually adopt one of four ways of protecting themselves in case of default —
(a) By an agreement that title is to remain in the vendor until the purchaser has completely performed his
part of the transaction;
(b) By a form of contract in which title is conveyed to the purchaser immediately, but subject to a lien for the
unpaid portion of the selling price;
(c) By a present transfer of title to the purchaser, who at the same time executes a reconveyance in the form
of a chattel mortgage to the vendor; or
(d) By conveyance to a trustee pending performance of the contract and subject to its provisions.
The general purpose and effect being the same in all of these cases, the same rule is uniformly applicable. The
general rule prescribed is that a person who regularly sells or otherwise disposes of personal property on the
installment plan, whether or not title remains in the vendor until the property is fully paid for, may return as
income therefrom in any taxable year that proportion of the installment payments actually received in that
year which the total or gross profit (that is, sales less cost of goods sold) realized or to be realized when the
property is paid for, bears to the total contract price. Thus the income of a dealer in personal property on the
installment plan may be ascertained by taking as income that proportion of the total payments received in the
taxable year from installment sales (such payments being allocated to the year against the sales of which they
apply) which the total or gross profit realized or to be realized on the total installment sales made during each
year bears to the total contract price of all such sales made during that respective year. No payments received
in the taxable year shall be excluded in computing the amount of income to be returned on the ground that
they were received under a sale the total profit from which was returned as income during a taxable year or
years prior to the change by the taxpayer to the installment basis of returning income. Deductible items are
not to be allocated to the years in which the profits from the sales of a particular year are to be returned as
income, but must be deducted for the taxable year in which the items are "paid or incurred" or "paid or
accrued", as provided by Section 40 and 84(q) of the Code. A dealer who desires to compute his income on the
installment basis shall maintain books of account in such a manner as to enable an accurate computation to be
made on such basis in accordance with the provisions of this section.
The income from a casual sale or other casual disposition of personal property (other than property of a kind
which should properly be included in inventory) may be reported on the installment basis only if (1) the sale
price exceeds P1,000 and (2) the initial payments do not exceed 25 per cent of the selling price.
If for any reason the purchaser defaults in any of his payments, and the vendor returning income on the
installment basis repossesses the property sold whether title thereto had been retained by the vendor or
transferred to the purchaser, gain or loss for the year in which the repossession occurs is to be computed upon
any installment obligations of the purchaser which are satisfied or discharged upon the repossession or are
applied by the vendor to the purchase or bid price of the property. Such gain or loss is to be measured by the
difference between the fair market value of the property repossessed and the basis in the hands of the vendor
of the obligations of the purchaser which are so satisfied, discharged, or applied, with proper adjustment for
any other amounts realized or costs incurred in connection with the repossession. The basis in the hands of the
vendor of the obligations of the purchaser satisfied, discharged, or applied upon the repossession of the
property shall be the excess of the face value of such obligations over an amount equal to the income which
would be returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on
account of any portion of the obligations of the purchaser which are treated by the vendor as not having been
satisfied, discharged, or applied upon the repossession, unless it is clearly shown that after the property was
repossessed the purchaser remained liable for such portion; and in no event shall the amount of the deduction
exceed the basis in the hands of the vendor of the portion of the obligations with respect to which the
purchaser remained liable after the repossession. If the property repossessed is bid in by the vendor at a lawful
public auction or judicial sale, the fair market value of the property shall be presumed to be the purchase or
bid price thereof in the absence of clear and convincing proof to the contrary. The property repossessed shall
be carried on the books of the vendor at its fair market value at the time of the repossession.
If the vendor chooses as a matter of consistent practice to return the income from installment sales on the
straight accrual or cash receipts and disbursement basis, such a course is permissible.
Revenue Regulations 02-40
SECTION 175. Sale of real property involving deferred payments. — Under Section 43 deferred-payment
sales of real property include (a) agreements to purchase and sale which contemplate that a conveyance is not
to be made at the outset, but only after all or a substantial portion of the selling price has been paid, and (b)
sales in which there is an immediate transfer of title, the vendor being protected by a mortgage or other lien as
to deferred payments. Such sales either under (a) or (b), fall into two classes when considered with respect to
the terms of sale, as follows:
(1) Sales of property on the installment plan, that is, sales in which the payments received in cash or
property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is
made do not exceed 25 per cent of the selling price.
(2) Deferred-payment sales not on the installment plan, that is sales in which the payments received in cash
or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is
made exceed 25 per cent of the selling price.
In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken subject
to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the
"selling price" but the amount of the mortgage, to the extent that it does not exceed the basis to the vendor of
the property sold, shall not be considered as a part of the "initial payments" or of the "total contract price", as
those terms are used in Section 43 of the Code, in Sections 174 and 176 of these regulations, and in this
section. The term "initial payments" does not include amounts received by the vendor in the year of sale from
the disposition to a third person of notes given by the vendee as part of the purchase price which are due and
payable in subsequent years. Commissions and other selling expenses paid or incurred by the vendor are not to
be deducted or taken into account in determining the amount of the "initial payments," the "total contract
price", or "the selling price". The term "initial payments" contemplates at least one other payment in addition
to the initial payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no
payment during the first year, the income may not be returned on the installment basis. Income may not be
returned on the installment basis where no payment in cash or property, other than evidences of indebtedness
of the purchaser, is received during the first year, the purchaser having promised to make two or more
payments, in later years.
SECTION 176. Sale of real property on installment plan. — In transactions included in class (1) in the
preceding section the vendor may return as income from such transactions in any taxable year that proportion
of the installment payments actually received in that year which the total profit realized or to be realized when
the property is paid for bears to the total contract price.
If the purchaser defaults in any of his payments, and the vendor returning income on the installment basis
reacquires the property sold, whether title thereto had been retained by the vendor or transferred to the
purchaser, gain or loss for the year in which the reacquisition occurs is to be computed upon any installment
obligations of the purchaser which are satisfied or discharged upon the reacquisition or are applied by the
vendor to the purchase or bid price of the property. Such gain or loss is to be measured by the difference
between the fair market value of the property acquired (including the fair market value of any fixed
improvements placed on the property by the purchaser) and the basis in the hands of the vendor of the
obligations of the purchaser which are so satisfied, discharged, or applied, with proper adjustment for any
other amounts realized or costs incurred in connection with the reacquisition. The basis in the hands of the
vendor of the obligations of the purchaser satisfied, discharged, or applied upon the reacquisition of the
property will be the excess of the face value of such obligations over an amount equal to the income which
would be returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on
account of any portion of the obligations of the purchaser which are treated by the vendor as not having been
satisfied, discharged, or applied upon the reacquisition of the property, unless it is clearly shown that after the
property was reacquired the purchaser remained liable for such portion; and in no event shall the amount of
the deduction exceed the basis in the hands of the vendor of the portion of the obligations with respect to
which the purchaser remained liable after the acquisition. If the property reacquired is bid in by the vendor at
a foreclosure sale, the fair market value of the property shall be presumed to be the purchase or bid price
thereof in the absence of clear and convincing proof to the contrary. If the property reacquired is subsequently
sold, the basis for determining gain or loss is the fair market value of the property at the date of reacquisition
(including the fair market value of any fixed improvements placed on the property by the purchaser).
If the vendor chooses as a matter of consistent practice to turn the income from installment sales on the
Page 27 of 39
straight accrual or cash receipts and disbursements basis, such a course is permissible, and the sales will be
treated as deferred-payment sales not on the installment plan.
SECTION 177. Deferred-payment sale of real property not on installment plan. — In transactions included in
class (2) in Section 175 of these regulations, the obligations of the purchaser received by the vendor are to be
considered as the equivalent of cash.
If the vendor has retained title to the property and the purchaser defaults in any of his payments, and the
vendor repossesses the property, the difference between (1) the entire amount of the payments actually
received on the contract and retained by the vendor plus the fair-market value at the time of repossession of
fixed improvements placed on the property by the purchaser and (2) the sum of the profits previously returned
as income in connection therewith and an amount representing what would have been a proper adjustment
for exhaustion, wear and tear, obsolescence, amortization, and depletion of the property during the period the
property was in the hands of the purchaser had the sale not been made will constitute gain or loss, as the case
may be to the vendor for the year in which the property is repossessed, and the basis of the property in the
hands of the vendor will be the original basis at the time of the sale plus the fair market value at the time of
repossession, of fixed improvements placed on the property by the purchaser. If the vendor has previously
transferred title to the purchaser, and the purchaser defaults in any of his payments and the vendor reacquired
the property, such reacquisition shall be regarded as a transfer by the vendor, in exchange for the property for
such of the purchaser's obligations as are applied by the vendor to the purchase or bid price of the property.
Such an exchange will be regarded as having resulted in the realization by the vendor of gain or loss, as the
case may be for the year of reacquisition, measured by the difference between the fair market value of the
property including fixed improvements placed by the purchaser on the property, and the amount of the
obligations of the purchaser which were applied by the vendor to the purchase or bid price of the property.
The fair market value of the property reacquired shall be presumed to be the amount for which it is bid in by
the vendor in the absence of clear and convincing proof to the contrary. If the property reacquired is
subsequently sold the basis for determining gain or loss is the fair market value of the property at the date of
reacquisition including the fair market value of the fixed improvements placed on the property by the
purchaser.
SECTION 178. Sale of real estate in lots. — Where a tract of land is purchased with a view to dividing it into
lots or parcels of ground to be sold as such, the entire fair market value as of March 1, 1913, or the cost, if
acquired subsequently to that date, shall be equitably apportioned to the several lots or parcels and made a
matter of record on the books of the taxpayer, to the end that any gain derived from the sale of any such lots
or parcels may be returned as income for the year in which the sale was made. This rule contemplates that
there will be a measure of gain or loss on every lot or parcel sold, and not that the capital invested in the entire
tract shall be extinguished before any taxable income shall be returned. The sale of each lot or parcel will be
treated as a separate transaction and the gain or loss will be accounted for accordingly.
SECTION 178(a). In all cases where a taxpayer sells during the year real or personal property on the installment
basis, there should be attached to the income tax return a statement of each sale made during the year
containing the following information:
(a) Name of buyer
(b) Address of buyer
(c) Date of sale
(d) Selling price
(e) Payments received during the year corresponding to each sale.
(This new section has been inserted in Revenue Regulations No. 2 by Revenue Regulations No. 8-65 dated June
1, 1965. Took effect upon their promulgation in the Official Gazette on September 27, 1965).
(Section 44 of the Code)
SECTION 179. Determination of the taxable net income of a controlled taxpayer. — (A) DEFINITIONS. —
When used in this section —
(1) The term "organization" includes any organization of any kind, whether it be a sole proprietorship, a
partnership, a trust, an estate, or a corporation or association, irrespective of the place where organized,
where operated, or where its trade or business is conducted, and regardless of whether domestic or foreign,
Revenue Regulations 02-40
whether exempt or taxable, or whether affiliated or not.
(2) The terms "trade" or "business" include any trade or business activity of any kind, regardless of whether
or where organized, whether owned individually or otherwise, and regardless of the place where carried on.
(3) The term "controlled" includes any kind of control, direct or indirect, whether legally enforceable, and
however exercisable or exercised. It is the reality of the control which is decisive, not its form or the mode of its
exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.
(4) The term "controlled taxpayer" means any one of two or more organizations, trades, or businesses
owned or controlled directly or indirectly by the same interests. aCHDST
(5) The terms "group" and "group of controlled taxpayers" mean the organizations, trades, or businesses
owned or controlled by the same interests.
(6) The term "true net income" means, in the case of a controlled taxpayer, the net income (or, as the case
may be, any item or element affecting net income) which would have resulted to the controlled taxpayer, had it
in the conduct of its affairs (or, as the case may be, in the particular contract, transaction, arrangement, or
other act) dealt with the other member or members of the group at arm's length. It does not mean the
income, the deductions, or the item or element of either, resulting to the controlled taxpayer by reason of the
particular contract, transaction, or arrangement, the controlled taxpayer, or the interests controlling it, chose
to make (even though such contract, transaction, or arrangement be legally binding upon the parties thereto).
(b) SCOPE AND PURPOSE. — The purpose of Section 44 is to place a controlled taxpayer on a tax parity with
an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled taxpayer, the true net
income from the property and business of a controlled taxpayer. The interests controlling a group of controlled
taxpayers are assumed to have complete power to cause each controlled taxpayer so to conduct its affairs that
its transactions and accounting record truly reflect the net income from the property and business of each of
the controlled taxpayers. If, however, this has not been done, and the taxable net incomes are thereby
understated, the statute contemplates that the Commissioner of Internal Revenue shall intervene, and, by
making such distributions, apportionments, or allocations as he may deem necessary of gross income or
deductions, or of any item or element affecting net income, between/or among the controlled taxpayers
constituting the group, shall determine the true net income of each controlled taxpayer dealing at arm's length
with another uncontrolled taxpayer. The standard to be applied in every case is that of an uncontrolled
taxpayer. Section 44 grants no right to a controlled taxpayer to apply its provisions at will, nor does it grant any
right to compel the Commissioner of Internal Revenue to apply such provisions.
(c) APPLICATION. — Transactions between the controlled taxpayer and another will be subjected to special
scrutiny to ascertain whether the common control is being used to reduce, avoid, or escape taxes. In
determining the true net income of a controlled taxpayer, the Commissioner of Internal Revenue is not
restricted to the case of improper accounting, to the case of a fraudulent, colorable, or sham transaction, or to
the case of a device designed to reduce or avoid tax by shifting or distorting income or deductions. The
authority to determine true net income extends to any case in which either by inadvertence or design the
taxable net income in whole or in part, of a controlled taxpayer, is other than it would have been had the
taxpayer in the conduct of his affairs been an uncontrolled taxpayer dealing at arm's length with another
uncontrolled taxpayer.
(Section 45 of the Code)
SECTION 180. Individual returns. — Returns, in duplicate, are required of: (a) Every citizen or resident alien
having a gross income of P1,800 or more for the taxable year; (b) every non-resident alien having income from
sources within the Philippines irrespective of amount; and (c) guardians, trustees, executors, administrators,
receivers, conservators, and all others acting in any fiduciary capacity, when, for the taxable year, the gross
income of the person, trust, or estate for whom or which they act reaches P1,800. (See Section 214 of these
regulations.)
For each calendar year, every person whether married or single, having a gross income from all sources of
P1,800 or over, including dividends, excepting stock dividends, must make a return of income although the tax
has been paid at source and the return shows no tax liability. Whether or not an individual is the head of a
family or has dependents is immaterial in determining his liability to render a return. The husband shall include
in his return the income derived not only from his services, labor, or industry or the income derived from the
conjugal partnership but also the income of the wife derived from her industry or labor as well as that derived
from her separate, data, or paraphernal property. Where, however, the filing of one consolidated return is
Page 28 of 39
impracticable, married persons may file separate returns but the incomes declared in such returns will be
consolidated and the tax computed on such consolidated income.
The law requires that the income of unmarried minors derived from property received from a living parent
shall be included in the return of the parent, except (1) when the gift tax imposed under Chapter II of Title III of
the Code has been paid on such property, or (2) where the transfer of such property is exempt from the gift
tax.
A signature affixed to a return is presumed to be genuine.
SECTION 181. When and where to file individual returns. — The return must be filed with the Commissioner
of Internal Revenue, provincial revenue agent, or treasurer of the province, city or municipality in which the
taxpayer has his legal residence or principal place of business, on or before April 15th of the year following that
for which the return is filed.
When the last due date for filing return falls on Sunday or a legal holiday, the last due date will be held to be
the day following such Sunday or legal holiday, or if placed on the mails, it should be posted in ample time to
reach the Commissioner of Internal Revenue, provincial revenue agent or treasurer of the province, city, or
municipality in which the taxpayer has his legal residence or principal place of business, under ordinary
handling of mail, on or before the date on which the return is required to be filed. When question is raised as
to whether or not the return was posted in ample time to reach the proper official, the envelope in which the
return was transmitted and the return should be submitted to the Commissioner of Internal Revenue with such
comment and recommendation as the receiving officer may consider proper to make.
SECTION 182. Persons under disability. — If the taxpayer is unable to make his own return, on account of
minority, illness, absence or non-residence, the return may be made by his duly authorized agent or
representative or by the guardian or other person charged with the care of his person or property, the principal
and his representative or guardian assuming the responsibility of making the return and incurring penalties
provided for erroneous, false, or fraudulent returns.
SECTION 183. Form of return. — Individual returns shall be prepared on B.I.R. Form No. 17.01. The forms
may be had from the office of the Commissioner of Internal Revenue in Manila, or in the office of the provincial
treasurers or their deputies.
A taxpayer will not be excused from making a return by the fact that no return form has been furnished him.
Taxpayers not supplied with the proper forms should make application therefor to the Commissioner of
Internal Revenue or to the provincial treasurers, or their deputies in ample time to have their returns prepared,
verified, and filed with the proper official on or before the due date. Each taxpayer should carefully prepare his
return so as to fully and clearly set forth the data therein called for. Imperfect or incorrect returns will not be
accepted as meeting the requirements of the statute. (There are now BIR Provincial Revenue Officers.)
(Section 46 of the Code)
SECTION 184. Corporation returns. — Corporations are required to make returns of income in duplicate,
regardless of the amount of their net income.
A corporation claiming exemption from tax and from the filing of returns must establish its right to exemption
in accordance with the procedure set forth in Section 24 of these regulations, otherwise it will be amenable to
the penalties for failure to file returns.
In the case of ordinary corporations, partnerships, and joint accounts (cuentas en participacion), the return
shall be on the form prescribed for corporations (B.I.R Form No. 17.02), and the returns of insurance
companies, on the prescribed form (B.I.R. Form No. 17.03). A corporation having an existence during any
portion of a taxable year is required to make a return. A corporation which has received a charter, but has
never perfected its organization, and which has transacted no business and had no income from any source,
may upon presentation of the facts to the Commissioner of Internal Revenue be relieved from the necessity of
making a return so long as it remains in an unorganized condition. In the absence of a proper showing to the
Commissioner of Internal Revenue such corporation must file the necessary return.
Revenue Regulations 02-40
A corporation desiring to change its accounting period from calendar year to fiscal year must comply with the
procedure set forth in Section 172 of these regulations relative to the change in accounting period of
corporations.
SECTION 185. Returns of insurance companies. — Insurance companies transacting business in the
Philippines or deriving income from sources therein are required to file returns of income. The return shall be
made on the prescribed form (B.I.R. Form No. 17.03).
SECTION 186. Returns of foreign corporations. — Every foreign corporation having income from sources
within the Philippines must make a return of income on the form prescribed for corporation (B.I.R. Form No.
17.02). If such a corporation has no office or place of business in this country, but has a resident agent therein,
the latter shall make the return. Although the foreign corporation is not engaged in business in this country
and has no office, branch, or agency in the Philippines, it is required to make a return if it has received income
from sources within the Philippines.
SECTION 187. Time and place for filing corporate returns. — Returns of corporations, associations, or
partnerships must be filed on or before the fifteenth day of April in each year or on or before the 15th day of
the fourth month following the close of a duly designated fiscal year. The return, if placed in the mails, should
be posted in ample time to reach the Commissioner of Internal Revenue, provincial, revenue agent, or
treasurer of the province, city or municipality in which is located the principal office of the corporation where
its books of account and other data are kept, on or before the last due date for the filing of the return. When
the last due date falls on Sunday or a legal holiday, the returns may be filed without penalty on the next
succeeding business day. (Conforms with Am. by R.A. 2343.)
(Section 47 of the Code)
SECTION 188. Extension of time for filing returns. — The Commissioner of Internal Revenue may, in
meritorious cases, grant a reasonable extension of time for filing returns of income. Requests for such
extension of time must be submitted before the last day of the period for filing returns. Absence or sickness is
considered as reasonable cause, whereas, inability to close the books or to gather information required due to
various circumstances will be subject to careful investigations before the request for extension is favorably
considered.
(Section 48 of the Code)
SECTION 189. Returns by receiver. — Receivers, trustees in dissolution, trustees in bankruptcy, and
assignees, operating the property or business of corporations, partnerships, or associations must make returns
of income for such corporations, partnerships or associations covering each year or part of the year during
which they are in control. Notwithstanding that the powers and functions of a corporation are suspended and
that the property and business are for the time being in the custody of the receiver, trustee, or assignee,
subject to the order of the court, such receiver, trustee, or assignee stands in the place of the corporate
officers and is required to perform all the duties and assume all the liabilities which would devolve upon the
officers of the corporation were they in control. A receiver in charge of only part of the property of a
corporation, however, as a receiver in mortgage foreclosure proceedings involving merely a small portion of its
property, need not make a return of income.
(Section 49 of the Code)
SECTION 190. Returns of duly registered general co-partnerships. — Duly registered general copartnerships
are required to render, in duplicate, a return of their earnings, profits and income, setting forth the items of the
gross income and the deductions allowable, and the names and addresses of the individuals who would be
entitled to the net earnings, profits, and income, if distributed. (See sections 22 and 23 of these regulations.)
(Section 50 of the Code)
SECTION 191. Verification of returns. — All income tax returns must be verified by the oath or affirmation of
the person rendering them. Oath may be taken before any officer authorized to administer oaths or if desired,
before the Commissioner of Internal Revenue or any internal-revenue officer especially deputized by him or
authorized by law to administer oaths, free of charge.
Page 29 of 39
SECTION 192. Discovery of understatement of income. — If the amount of income declared in a return has
been found to be understated, the Commissioner of Internal Revenue or any internal-revenue officer shall
notify the taxpayer of such fact, and the taxpayer may, if he so desires, under a sworn statement, present
testimony to the contrary and disprove the findings made.
(Section 51 of the Code)
SECTION 193. Assessment of tax. — All income tax returns filed with the provincial revenue agents or with
the treasurers of provinces, cities, or municipalities must be stamped with the date of their receipt and
immediately forwarded to the Commissioner of Internal Revenue. All assessments of income tax shall be made
by the Commissioner of Internal Revenue and all taxpayers shall be notified of the amount for which they are
respectively liable on or before the first day of May of each successive year. In the case of a corporation filing
returns on the basis of a fiscal year, it shall be notified of the amount for which it is liable on or before the first
day of the fifth month following the close of its fiscal year. (See changes made by R.A. 2343, effv. June 20, 1959,
introducing here self assessment.)
SECTION 194. Payment of tax. — The total amount of tax assessed shall be paid on or before the fifteenth
day of April following the close of the calendar year by the person subject to tax, and in the case of a
corporation, by the president, vice-president, or other responsible officer thereof. In the case of corporations
filing returns on the basis of a fiscal year, the total amount of tax shall be paid on or before the fifteenth day of
the fourth month following the close of the fiscal year. (Conforms with amendments by R.A. 2343, effv. June
20, 1959.)
Where the tax assessed against the taxpayer is in excess of P500, the taxpayer may elect to pay the tax in two
equal installments. The first installment shall be paid on or before the date prescribed in section 51 (a) and the
second installment on or before the fifteenth day of July following the close of the calendar year or on or
before the fifteenth day of the seventh month following the close of the fiscal year, as the case may be. Upon
failure to pay any installment on the date fixed for its payment, the whole amount of the tax unpaid becomes
due and payable, together with the delinquency penalties. (Conforms with amendments by R.A. 2343, effv.
June 20, 1959.)
SECTION 195. Commissioner's authority to make returns. — In cases wherein taxpayers have neglected or
refused to make return, and in cases wherein returns are found, upon examination or otherwise, to be
erroneous, false, or fraudulent, the Commissioner of Internal Revenue shall upon discovery thereof, make a
return upon the best evidence obtainable, and the tax so discovered to be due, together with the penalties
prescribed, shall be assessed and the amount thereof shall be paid immediately upon notice and demand.
SECTION 196. Surcharge and interest in case of delinquency. — Upon failure to pay any tax or installment
thereof, of any deficiency tax, when the same is due, a penalty of 5 per cent of the amount of tax unpaid, and
interest at the rate of 1 per cent per month upon the said tax from the time the same became due until paid,
shall be added to the amount of such tax. (See Sec. 51(b) to (e) as amended by R.A. 2343, effv. June 20, 1959.)
(Section 52 of the Code)
SECTION 197. Receipts for income tax payments. — It shall be the duty of the collecting officer to
acknowledge the receipt of the payment of income tax due from each taxpayer by issuing the requisite
Revenue Official Receipt (B.I.R. Form No. 25.24).
(Section 53 of the Code)
SECTION 198. Withholding tax at source. — Withholding is required (a) of a tax of 20 per centum in the case
of fixed or determinable annual or periodical income, including dividends or net gains or net profits received
from corporations, partnerships or associations, payable to non-resident alien individuals not engaged in trade
or business and not having an office or place of business in the Philippines; and (b) of a tax of 20 per centum in
the case of interest upon bonds, obligations or securities issued by domestic or resident foreign corporations,
containing a so-called tax-free covenant clause, payable either to citizens or aliens, residents or non-residents,
where the owner of such interest income does not file with the withholding agent a signed notice on B.I.R.
Form No. 17.13 claiming the benefit of personal exemption. Subject to the exception just mentioned,
Revenue Regulations 02-40
withholding taxes takes place in all cases of payments of interest upon tax-free covenant bonds or other
securities regardless of the place where such bonds or securities are issued or marketed and the interest
thereupon paid. Bonds issued under a trust deed containing a tax-free covenant are treated as if they contain
such a covenant.
SECTION 199. Fixed or determinable annual or periodical income. — Only fixed or determinable annual or
periodical income is subject to withholding. The statute specifically includes in such income, interests,
dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, and emoluments, but
other kinds of income may be included, as for instance, royalties.
Income is fixed when it is to be paid in amounts definitely pre-determined. On the other hand, it is
determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained.
The income need not be paid annually if it is paid periodically; that is to say, from time to time, whether or not
at regular intervals. That the length of time during which the payments are to be made may be increased or
diminished in accordance with some one's will or with the happening of an event does not make the payments
any the less determinable or periodical. A salesman working by the month for a commission on sales which is
paid or credited monthly receives determinable periodical income. The income derived from the sale in the
Philippines of property whether real or personal, is not fixed or determinable annual or periodical income.
Dividends from every domestic corporation are subject to the withholding provisions of the law. Dividends
from a foreign corporation are subject to withholding if (1) such foreign corporation is engaged in trade or
business within the Philippines or has an office or place of business therein, and (2) more than 85 per cent of
its gross income for the three-year period ending with the close of its taxable year preceding the declaration of
such dividends (or for such part of such period as the corporation has been in existence) was derived from
sources within the Philippines. In case the owners of any securities are not known to the withholding agent,
the latter should deduct and withhold a tax of 20 per cent on the interest on such securities.
SECTION 200. Payments to non-resident alien individuals. — The law requires withholding of the tax on
income payable to a non-resident alien individual not engaged in trade or business in the Philippines and not
having an office or place of business therein. A non-resident alien individual is presumed not to be engaged in
trade or business in the Philippines and not to have an office or place of business therein, unless the
withholding agent has definite knowledge that such resident is engaged in trade or business in the Philippines
and of the name and address of his resident agent in this country, or unless the withholding agent definitely
knows that such non-resident has an office or place of business in the Philippines and of the location of such
office or place of business. An individual whose address is without the Philippines is presumed to be a non-
resident alien, unless the withholding agent has definite knowledge that such person is either a citizen or a
resident of the Philippines. An individual whose address is within the Philippines, may be presumed to be a
resident of the Philippines, unless the withholding agent has reason to believe that such individual, not being a
citizen of the Philippines, has not established residence in this country.
In case of doubt, a withholding agent may always protect himself by withholding the tax due, and promptly
causing a query to be addressed to the Commissioner of Internal Revenue for the determination of whether or
not the income paid to an individual is not subject to withholding. In case the Commissioner of Internal
Revenue decides that the income paid to an individual is not subject to withholding the withholding agent may
thereupon remit the amount of tax withheld.
SECTION 201. Exception from withholding. — Withholding of a tax on interests upon bonds or other
obligations containing a tax-free covenant clause shall not be required in the case of a citizen or resident alien
individual if he files with the withholding agent when presenting interest coupons for payment, not later than
February 1 following the taxable year, an ownership and exemption certificate on the requisite form (B.I.R.
Form No. 17.13) claiming a personal exemption or credits for dependents. The withholding agent shall forward
such certificate to the Commissioner of Internal Revenue with a letter of transmittal. The income of domestic
and resident foreign corporations is free from withholding.
SECTION 202. Ownership certificates for interest coupons. — The owners, except domestic and resident
foreign corporations, of bonds or other obligations containing a tax-free covenants clause, issued by a domestic
Page 30 of 39
or resident foreign corporation, when presenting interest coupons for payment, shall file a certificate of
ownership on B.I.R. Form No. 17.13, for each issue of bonds, showing the name and address of the debtor
corporation, the name and address of the owner of the bonds, the nature of the obligations, the amount of
interest and its due date, and the amount of any tax withheld. In the case of corporate bonds or similar
obligations not containing a tax-free covenant clause, no ownership certificates are required. But ownership
certificates are required in the case of such bonds if the owner is unknown to the withholding agent.
Ownership certificates need not be filed in the case of interest payments on bond or similar obligations of the
United States or of the Government of the Philippines or of any political subdivision thereof.
Where in connection with the sale of its property payment of the bonds or other obligations of a corporation is
assumed by the assignee, such assignee, whether an individual, partnership, corporation, province, city or
municipality, must deduct and withhold such taxes as would have been required to be withheld by the assignor
had not such sales and transfer been made.
SECTION 203. Return and payment of tax withheld. — (a) Every withholding agent shall make an annual
return in duplicate, on B.I.R. Form No. 17.43 of the tax withheld from interest on corporate bonds or other
obligations on or before the 15th day of April of each year for the preceding calendar year. (b) Every person
required to deduct and withhold any tax from income other than such bond interest shall make an annual
return thereon, in duplicate, on B.I.R. Form No. 17.43 on or before April 15 of each year for each non-resident
alien individual not engaged in trade or business within the Philippines and not having any office or place of
business therein, to whom income other than bond interest was paid during the previous taxable year. The
entire amount of the income from which the tax was withheld shall be included in gross income without
deduction for such payment of the tax. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
The tax due on withholding income tax returns are payable at the same time and in the same manner as taxes
due on individual returns.
SECTION 204. Income of recipient. — Income upon which the tax is required to be withheld at source shall
nevertheless be included in the return of the recipient of such income. However, the amount of tax withheld
shall be credited against the amount of income tax due on such return, and the amount, if any, by which the
tax withheld at source exceeds the tax due on the return shall be refunded in accordance with the provisions of
Section 309 of the Code.
(Section 54 of the Code)
SECTION 205. Withholding of tax on income of nonresident foreign corporations, firms, etc. — All persons,
corporations, partnerships, and associations, having the control, receipt, custody, disposal, or payment of
interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments,
or other fixed or determinable annual or periodical gains, profits, and income received or obtained from
sources within the Philippines by a non-resident alien firm, copartnership, corporation, association, trust
company, trustee, and insurance company, not engaged in business or trade within the Philippines and not
having an office or place of business therein, are required to withhold a tax of 30 per cent thereon, file the
requisite withholding return on the prescribed form (B.I.R. Form No. 17.43), and pay the tax withheld, in
accordance with the provisions of sections 198 to 204 of these regulations. The withholding provisions of the
law are likewise applicable to the income derived from interest upon bonds, mortgages, or deeds of trust, or
other interest-bearing obligations of a domestic or resident foreign corporation, firm or association, whether or
not the bonds and other such obligations, or securities contain the so-called tax-free covenant clause, and
regardless of the place where such bonds, obligations, or securities are issued, negotiated, or marketed and
the interest thereon paid, in case where such interest-income is received or obtained by, or paid to, a non-
resident alien firm, corporation, association, trust company, or trustee, not engaged in business or trade within
the Philippines and not having an office or place of business therein. (Conforms with amendments by R.A.
2343, effv. June 20, 1959.)
A foreign corporation is presumed not to be engaged in trade or business within the Philippines and not to
have office or place of business therein, unless the withholding agent has definite knowledge that such foreign
corporation is in fact engaged in trade or business in the Philippines and of the name and address of its
resident agent, or unless the withholding agent has definite knowledge that such foreign corporation has a
Revenue Regulations 02-40
branch office or business in this country and of the location of such branch office or place of business.
(Section 55 of the Code)
SECTION 206. Income tax not otherwise collectible from taxpayer chargeable to his representative. — It is
the intent and purpose of the law to charge and collect income tax imposed under Title II of the Code on all
gains, profits, and income of a taxable class, and the tax is required to be paid by the owner of such gains,
profits. and income or by the proper representative having the receipt, custody, control, or disposal of the
same. Thus, where a non-resident has charged a resident, under a power of attorney, to sell in his behalf
property, real or personal in the Philippines, the proper tax due may be collected from the owner of the gains
or profits or from the representative who had the receipt, custody, control or disposal of such gains, profits, or
income, as the personal liability of such representative.
(Sections 56 to 60 of the Code)
SECTION 207. Estates and trusts. — "Fiduciary" is a term which applies to all persons or corporations that
occupy positions of peculiar confidence towards others, such as trustees, executors, or administrators; and a
fiduciary, for income tax purposes, is any person or corporation that holds in trust an estate of another person
or persons. In order that a fiduciary relationship may exist, it is necessary that a legal trust be created.
In general, the income of a trust for the taxable year which is to be distributed to the beneficiaries must be
returned by and will be taxed to the respective beneficiaries, but the income of a trust which is to be
accumulated or held for future distribution, whether consisting of ordinary income or gain from the sale of
assets included in the corpus of the trust, must be returned by and will be taxed to the trustee. Three
exceptions to this general rule are found in the law: (1) in the case of revocable trust (Section 59); (2) in the
case of a trust the income of which, in whole or in part, may be held or distributed for the benefit of the
grantor (Section 60); and (3) in the case of a trust administered in a foreign country [Section 57(c)]. In the first
case, the income from such part of the trust estate title to which may be revested in the grantor should be
included in the grantor's return. In the second case, part of the income of the trust, which may be held or
distributed for the benefit of the grantor, should be included in the grantor's return. In the third case, the
trustee is not entitled to the deductions mentioned in subsections (a) and (b) of Section 57 and the net income
of the trust undiminished by any amounts distributed, paid or credited to beneficiaries will be taxed to the
trustees; however, the income included in the return of the trustees is not to be included in computing the
income of the beneficiaries.
SECTION 208. Consolidation of incomes of two or more trusts. — Section 56(b)(2) expressly requires the
consolidation of the income of two or more trusts where the creator of the trust in each instance is the same
person and the beneficiary in each instance is the same. The tax due on the consolidated income will be
collected from the trustees in proportion to the net income of the of the respective trusts. (See Section 215 of
these regulations.)
SECTION 209. Estates and trusts taxed to fiduciary. — In the case of a decedent's estate the settlement of
which is the object of testamentary or intestate proceedings, the fiduciary, executor, or administrator is
required to file an annual return for the estate up to the final settlement thereof. In the same manner, the
fiduciary is required to file a yearly return covering the income of a trust, whether created by will or deed, for
accumulation of income, whether for unascertained persons or persons with contingent interests or otherwise.
In both cases the income of the estate or trust is taxed to the fiduciary. Where under the terms of a will or
deed, the trustee, may in his discretion, distribute the income or accumulate it, the income is taxed to the
trustee, irrespective of the exercise of his discretion. The imposition of the tax is not affected by the fact that
an ultimate beneficiary may be a person exempt from tax.
SECTION 210. Estate and trust taxed to beneficiaries. — In the case of (a) a trust the income of which is to be
distributed annually or regularly; (b) an estate of a decedent the settlement of which is not the object of
judicial testamentary or intestate proceedings; and (c) properties held under a co-ownership or tenancy in
common, the income is taxable directly to the beneficiary or beneficiaries. Each beneficiary must include in his
return his distributive share of the net income of the trust, estate, or co-ownership. In the case of trusts which
are in whole or in part subject to revocation by the grantor, or which are for the benefit of the grantor, the
income of the trust is to be included in computing the net income of the grantor.
Page 31 of 39
SECTION 211. Decedent's estate administration. — The "period of administration or settlement of the
estate" is the period required by the executor or administrator to perform the ordinary duties pertaining to
administration, in particular, the collection of assets and the payment of debts and legacies. Estates during the
period of administration have but one beneficiary and that beneficiary is the estate.
No taxable income is realized from the passage of property to the executor or administrator on the death of
the decedent, even though it may have appreciated in value since the decedent acquired it. In the event of
delivery of property in kind to a legatee or distributee, no income is realized. Where, however, prior to the
settlement of the estate, the executor or administrator sells property of a decedent's estate for more than the
appraised value placed upon it at the death of the decedent, the excess is income, taxable to the estate. Where
property is sold after the settlement of the estate by the devisee, legatee or heir at a price greater than the
appraised value placed upon it at the time he inherited the property from the decedent, he is taxable
individually on any profit derived. An allowance paid a widow or heir out of the corpus of the estate is not
deductible from gross income.
SECTION 212. Liability for tax on estate or trusts. — Liability for payment of the tax attaches to the person of
an executor or administrator up to and after his discharge, where prior to distribution and discharge he had
notice of his tax obligations or failed to exercise due diligence in determining whether or not such obligations
existed. Liability for the tax also follows the estate itself, and when the estate has been distributed, the heirs,
devisees, legatees, and distributors may be required to discharge the amount of the tax due and unpaid, to the
extent of and in proportion to any share received. The same consideration apply to other trusts. Where the tax
has been paid on the net income of an estate or trust by the fiduciary, the net income on which the tax is paid
is free from tax when distributed to the beneficiaries.
SECTION 213. Exemption allowed to estate or trusts. — An estate or a trust is allowed a personal exemption
of P1,800. Each beneficiary is entitled to but one personal exemption, no matter from how many trusts he may
receive income.
(Section 61 of the Code)
SECTION 214. Fiduciary returns. — Fiduciaries are required to make returns of income on B.I.R. Form No.
17.01, in duplicate, when the gross income of the person, trust, or estate for whom or which they act amounts
to P1,800 or more and will be subject to all the provisions of law which apply to individuals. A fiduciary making
return shall make oath that he has sufficient knowledge of the affairs of the person trust, or estate for whom or
which he acts to enable him to make such return, and that the same is, to the best of his knowledge and belief,
true and correct. A return by one of two or more joint fiduciaries in the form prescribed filed in the
municipality or city in which such fiduciary resides shall be sufficient compliance with the requirement for
fiduciary returns.
A fiduciary acting as the guardian of a minor or other incapacitated person must make a return for such minor
or incapacitated person and pay the tax, unless such minor or incapacitated person himself makes a return or
cause it to be made. The parent is held to be the natural guardian of a minor child.
SECTION 215. Returns in case of two or more trusts. — Where, in the case of more than one trust, the
creator of the trust in each instance is the same person and the trustee in each instance is the same but the
beneficiaries are different, the trustee should make a separate return for each of the trusts in his hands. When
a trustee holds trust created by different persons for the benefit of the same beneficiary, he should also make a
return for each trust separately. But where a person creates two or more trusts in favor of the same beneficiary
[Section 56(b) (2)] appointing two or more trustees, the latter should each make a separate return for each
trust but in such case the Commissioner of Internal Revenue will consolidate the net incomes of the different
trusts and compute the tax on such consolidated income, allowing only one absolute exemption of 1,800.
SECTION 216. Return by receiver. — A receiver who stands in the place of an individual or corporation must
render a return of income and pay the tax for his trust, but a receiver of only part of the property of an
individual or corporation need not. If the receiver acts for an individual the return shall be on B.I.R. Form No.
17.01. When acting for a corporation a receiver is not treated as a fiduciary, and in such case the return shall be
Revenue Regulations 02-40
made, as if by the corporation itself, on B.I.R. Form No. 17.02.
(Section 62 of the Code)
SECTION 217. Fiduciaries indemnified against claims for taxes paid. — Fiduciaries are indemnified against the
claims or demands of every beneficiary for all payments of taxes which they shall be required to make and they
shall have credit for such payments in any accounting which they make as such fiduciaries.
(Section 63 of the Code)
SECTION 218. Tax on personal holding companies. — Section 63 imposes for such taxable year beginning
after December 31, 1938 (in addition to the tax imposed by Section 24 of the Code), a tax upon corporations
classified as personal holding companies. Corporations so classified are exempt from the additional tax on
corporation improperly accumulating surplus imposed by Section 25, but are not exempt from the other taxes
imposed by Title II of the Code. Unlike the tax imposed by Section 25, the tax imposed by Section 63 applies to
all personal holding companies defined as such in Section 64, regardless of whether or not they were formed
or availed of to accumulate earnings or profits for the purpose of avoiding the tax upon shareholders. The tax
imposed by Section 63 is 45 per cent of the amount of the undistributed net income.
A foreign corporation, whether resident or non-resident, which is classified as a personal holding company
under Section 64 (not including a foreign personal holding company as defined in Section 67) is subject to the
tax imposed by Section 63 with respect to its income from sources within the Philippines. The term "personal
holding company" as used in Chapter VIII of Title II of the Code does not include a foreign corporation if (1) its
gross income from sources within the Philippines for the period specified in Section 37(a) (2) (B) is less than 50
per cent of its total gross income from all sources and (2) all of its stock outstanding during the last half of the
taxable year is owned by nonresident alien individuals, whether directly or indirectly through other foreign
corporations. (Section 64 of the Code)
SECTION 219. Definition of personal holding company. — A personal holding company is any corporation
(other than a corporation specified in section 64(b) which for the taxable year meets (a) the gross income
requirement specified in Section 220 of these regulations, and (b) the stock ownership requirement specified
in Section 221 of these regulations. Both requirements must be satisfied and both must be met with respect to
each taxable year.
SECTION 220. Gross income requirement. — To meet the gross income requirement, it is necessary that
either of the following percentages of gross income of the corporation for the taxable year be personal holding
company income as defined in Section 65:
(a) Eighty per cent or more; or
(b) Seventy per cent or more if the corporation has been classified as a personal holding company for any
taxable year beginning after December 31, 1938, unless —
(1) A taxable year has intervened since the last taxable year for which it was so classified, during no
part of the last half of which the stock ownership requirement specified in Section 64(a) (2) exists;
or
(2) Three consecutive years have intervened since the last taxable year for which it was so classified,
during each of which its personal holding company income was less than 70 per cent of its gross
income.
In determining whether the personal holding company income is equal to the required percentage of the total
gross income, the determination must not be made upon the basis of gross receipts, since gross income is not
synonymous with gross receipts. For a further discussion of what constitutes "gross income", see Section 29 of
the Code and the regulations prescribed under that section.
SECTION 221. Stock ownership requirements. — To meet the stock ownership requirement, it is necessary
that at some time during the last half of the taxable year more than 50 per cent it value of the outstanding
stock of the corporation be owned, directly or indirectly, by or for not more than five individuals: For such
purpose, the ownership of the stock must be determined as provided in Section 66.
In the event of any change in the stock outstanding during the last half of the taxable year, whether in the
Page 32 of 39
number of shares or classes of stock, or whether in the ownership thereof, the conditions existing immediately
prior .and subsequent to each change must be taken into consideration.
In determining whether the statutory conditions with respect to stock ownership are present at any time
during the last half of the taxable year, the phrase "in value" shall, in the light of all the circumstances, be
deemed the value of the corporate stock outstanding at such time (not including treasury stock). This value
may be determined upon the basis of the company's net worth, earning and dividend paying capacity,
appreciation of assets, together with such other factors as have a bearing upon the value of the stock. If the
value of the stock is greatly at variance with that reflected by the corporate books the evidence of such value
should be filed with the return. In any case where there are two or more classes of stock outstanding, the total
value of the stock should be allocated among the different classes according to the relative value of each class
therein.
The rules stated in the last two preceding paragraphs are equally applicable in determining the stock
ownership requirement specified in Section 65(e); relating to personal service contracts and Section 65(f),
relating to the use of corporation property by a shareholder. The stock ownership requirement specified in
these sections relates, however, to the stock outstanding at anytime during the entire taxable year and not
merely during the last half thereof.
(Section 65 of the Code)
SECTION 222. Personal holding company income. — The term "personal holding company income" means
the portion of the gross income which consists of the following:
(1) DIVIDENDS. — The term "dividends" includes dividends as defined in Section 83 (a), and amounts
required to be included in gross income under Section 69 (b) of this Code. It does not include stock dividends
(to the extent that they do not constitute income to the shareholders with the meaning of Section 83(b) of the
Code) and liquidating dividends.
(2) INTEREST (other than interest constituting rent). — The term "interest" means any amount, includible in
gross income, received for the use of money loaned except that it does not include interest constituting rent
[see subparagraph (1)].
(3) ROYALTIES (other than mineral, oil, or gas royalties). — The term "royalties" include amounts received for
the privilege of using patents, copyrights, secret processes and formulas, good will, trade marks, trade brands,
franchises, and other like property. It does not include rents, or overriding royalties received by an operating
company. As used in this paragraph the term "overriding royalties" means amounts received from the sublease
by the operating company which originally leased and developed the natural resources property in respect of
which such overriding royalties are paid.
(4) ANNUITIES. — The term "annuities" includes annuities only to the extent includible in the computation of
gross income. [See Section 29(b) (2)].
(5) GAINS FROM THE SALE OR EXCHANGE OF STOCK OR SECURITIES. — The term "gains from the sale or
exchange of stock or securities" as used in Section 65(b) applies to all gains (including gains from liquidation
dividends and other distributions from capital) from the sale or exchange of stock or securities includible in
gross income. The term "stock or securities" as used in Section 65(b) includes shares or certificates of stock, or
interest in any corporation (including any joint stock company, insurance, company association, or other
organization classified as a corporation under Title II) certificates of interest or participation in mineral royalty,
or leave, collateral trust certificates, voting trust certificates, stock rights or warrants, bonds, debentures,
certificates of indebtedness, notes, car trusts certificates, bills of exchange, obligations issued by or on behalf
of a Government, State, Territory, or political subdivision thereof. In the case of "regular dealers in stock or
securities" the term does not include gains derived from the sale or exchange of stock or securities made in the
normal course of business. The term "regular dealer in stock or securities" means corporations with an
established place of business regularly engaged in the purchases of stock or securities and their resale to
customers, but such corporations are not dealers with respect to stock or securities held for speculation or
investment.
(6) GAINS FROM FUTURES TRANSACTIONS IN COMMODITIES. — Gains from futures transactions in
commodities include gains from futures transactions in any commodity on or subject to the rules of a board of
trade or commodity exchange, but do not include gains from cash transactions or gains by a producer,
processor, merchant, or handler of the commodity, which arise out of bonafide hedging transactions
reasonably necessary to the conduct of its business in the manner in which such business is customarily and
Revenue Regulations 02-40 Page 33 of 39

usually conducted by others. In general, personal holding company income includes gains on futures contracts rendered by the shareholders of the corporation) equals 15 per cent or more of the gross income of the
which are speculative. Futures contracts representing true hedges against price fluctuations in spot goods are corporation for the taxable year.
not speculative transactions, though not concurrent with spot transactions. Futures contracts which are not The term "mineral, oil, or gas royalties" means all royalties, except "overriding royalties", received from any
hedges against spot transactions are speculative unless they are hedges against concurrent futures or forward interest in mineral, oil, or gas royalties. As used in this paragraph the term "overriding royalties" means
sales or purchases. amounts received from the sublease by the operating company which originally leased and developed the
(7) INCOME FROM ESTATES AND TRUSTS. — The income from estates and trusts which is to be included in natural resources property in respect of which such overriding royalties are bid.
personal holding company income consists of the income from estates and trusts which is required to be (Section 66 of the Code)
included in the gross income of the corporation under Section 29 in relation to Section 56 of the Code,
together with the gains derived by the corporation from the sale or other disposition of any interest in an SECTION 223. Stock ownership. — For the purpose of determining whether —
estate or trust. (a) A corporation is a personal holding company in so far as such determination is based on the stock
(8) AMOUNTS RECEIVED UNDER PERSONAL SERVICE CONTRACTS. — Amounts includible in personal holding ownership requirement specified in Section 64(a) (2), or
company income as amount received under personal service contracts consist of amounts received pursuant to (b) Amounts received under a personal service contract or from the sale of such a contract constitute
a contract under which the corporation is to furnish personal services, and amounts received from a sale or personal holding company income in so far as such determination is based on the stock ownership
other disposition of such a contract, if — requirement specified in Section 65 (e), or
(a) Some person other than the corporation has the right to designate (by name or by description) the (c) Compensation for the use of property constitutes personal holding company income in so far as such
individual who is to perform the services or if the individual who is to perform the services is designated (by determination is based on the stock owner-ship requirement specified in Section 65(f), stock owned by an
name or by description) in the contract; and individual includes stock constructively owned by him as provided in Section 66. All forms and classes of stock,
(b) At some time during the taxable year 25 per cent or more in value of the outstanding stock of the however denominated, which represent the interests of shareholders, members, or beneficiaries in the
corporation is owned, directly or indirectly, by or for the individual who has performed, is to perform, or may corporation shall be taken into consideration.
be designated (by name or by description), as the one to perform such services. For this purpose the stock
ownership must be determined as provided in Section 66 of the Code. SECTION 224. Stock not owned by individual. — In determining the ownership of stock for any of the
The application of Section 65(e) may be illustrated by the following examples: purposes set forth in the preceding section, stock owned, directly or indirectly, by or for a corporation,
Example (1): A, whose profession is that of an actor, owns all of the outstanding capital stock of the M partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, partners,
Corporation. The Corporation entered into a contract with A under which A was to perform personal services or beneficiaries. For example, if A and B, two individuals, are the exclusive and equal beneficiaries of a trust or
for the person or persons whom the M Corporation might designate, in consideration of which A was to receive estate, and if such trust or estate owns the entire capital stock of the M Corporation, and if the M Corporation
P10,000 a year from the M Corporation. The M Corporation entered into a contract with the O Corporation in in turn owns the entire capital stock of the N Corporation, then the stock of both the M Corporation and the N
which A was designated to perform personal services for the O Corporation in consideration of which the O Corporation shall be considered as being owned equally by A and B as the individuals owning the beneficial
Corporation was to pay the M Corporation P500,000 a year. The P500,000 received by the M Corporation from interest therein.
the O Corporation constitutes a personal holding company income.
Example (2): The N Corporation, the entire outstanding capital stock of which is owned by four individuals, is SECTION 225. Family and partnership ownership. — In determining the ownership of stock for any of the
engaged in engineering. The N Corporation entered into a contract with the O Corporation to perform purposes set forth in Section 223 of these regulations, an individual shall be considered as owning the stock
engineering services for the O Corporation, in consideration of which the O Corporation was to pay the N owned, directly or indirectly, by or for his family or by or for his partner. For the purposes of such
Corporation P50,000. The individual who was to perform the services was not designated (by name or by determination the family of an individual includes only his brothers and sisters (whether by the whole or half
description) in the contract and no one but the N Corporation had the right to designate (by name or by blood), spouse, ancestors, and lineal descendants.
description) such individual. The P50,000 received by the N Corporation from the O Corporation does not
constitute personal holding company income. HTaIAC The application of the family and partnership rule in determining the ownership of stock for the purpose set
(9) COMPENSATION FOR USE OF PROPERTY. — The compensation for the use of, or the right to use, the forth in (a) of Section 223 of these regulations is illustrated by the following example:
property of the corporation which is to be included in personal holding company income consists of amounts
received as compensation (however designated and from whomsoever received) for the use of, or the right to Example: The M Corporation at some time during the last half of the taxable year had 1,800 shares of
use, property of the corporation in any case in which, at any time during the taxable year 25 per cent or more outstanding stock, 450 of which were held by various individuals having no relationship to one another and
in value of the outstanding stock of the corporation is owned, directly or indirectly, by or for an individual none of whom were partners, and the remaining 1,350 were held by 51 shareholders as follows:
entitled to the use of the property, whether such right is obtained directly from the corporation or by means of Relationship Shares Shares Shares Shares Shares
a sublease or other arrangement. The property may consist of a yacht, a city residence, a country house, or any An individual A 100 B 20 C 20 D 20 E 20
other kind of property. His father AF 10 BF 10 CF 10 DF 10 EF 10
(10) RENTS (including interest constituting rent). — The rents which are to be included in personal holding His wife AW 10 BW 40 CW 40 DW 40 EW 40
company income consist of compensation, however, designated including charter fees, etc., for the use of, or His brother AB 10 BB 10 CB 10 DB 10 EB 10
the right to use, real property, or any other kind of property and the interest on debts bowed to the His son AS 10 BS 40 CS 40 DS 40 ES 40
corporation, to the extent such debts represent the price for which real property held primarily for sale to His daughter by
customers in the ordinary course of its trade or business was sold or exchanged by the corporation, but do not former marriage
include amounts constituting personal holding company income under Section 65(f) and paragraph (9) of this (son's half sister) ASHS 10 BSHS 40 CSHS 40 DSHS 40 ESHS
section. However, rents do not constitute personal holding company income if constituting 50 per cent or more 40
of the gross income of the corporation. His brother's wife ABW 10 BBW 10 CBW 10 DBW 160 EBW
(II) MINERAL, OIL, OR GAS ROYALTIES. — The income from mineral, oil, or gas royalties is to be included as 10
personal holding company income, unless (A) the aggregate amount of such royalties constitutes 50 percent or His wife's father AWF 10 BWF 10 CWF110 DWF 10 EWF 10
more of the gross income of the corporation for the taxable year and (B) the aggregate amount of deductions His wife's brother AWB 10 BWB 10 CWB 10 DWB 10 EWB
allowable for expenses under Section 30 (a) of the Code (other than compensation for personal services 10
Revenue Regulations 02-40 Page 34 of 39

His wife's brother's In determining whether the foreign personal holding company income is equal to the required percentage of
wife AWBW 10 BWBW 10 CWBW 10 DWBW 10 EWBW the total gauss income, the determination must not be made on the basis of gross receipts since gross income
110 is not synonymous with gross receipts. For a further discussion on what constitutes "gross income," see Section
Individual's partner AP 10 - - - - - - - - 29(n) and the regulations prescribed under that section.

By applying the statutory rule provided in Section 66(a) five individuals own more than 50 per cent of the
outstanding stock as follows:
A (including AF, AW, AB, AS, ASHS, AP) 160
B (including BF, BW, BB, BS, BSHS) 160
CW (including C, CS, CWF, CWB) 220
DB (including D, DF, DBW) 200
EWB (including EW, EWF, EWBW) 170
——
Total, or more than 30 per cent 910
Individual A represents the obvious case where the head of the family owns the bulk of the family stock and
naturally is the head of the group. A's partner owns to shares of the stock. Individual B represents the case
where he is still head of the group because of the ownership of stock by his immediate family. Individuals C and
D represent cases where the individuals fall in groups headed in C's case by his wife and in D's case by his
brother because of the preponderance of holdings on the part of relatives by marriage. Individual E represents
the case where the preponderant holding of others eliminate that individual from the group.
The method of applying the family and partnership rule as illustrated in the foregoing example also applies in
determining the ownership of stock for the purposes stated in (b) and (c) of Section 223 of these regulations.
SECTION 226. Options. — In determining the ownership of stock for any of the purposes set forth in Section
223 of these regulations if any person has an option to acquire stock, such stock may be considered as owned
by person. The term "option" as used in this section includes an option to acquire such an option and each one
of a series of such options, so that the person who has an option on an option to acquire stock may be
considered as the owner of the stock.
(Section 67 of the Code)
SECTION 227. Definition of foreign personal holding company. — A foreign personal holding company is any
foreign corporation (other than a corporation exempt from taxation under Section 27 of the Code) which for
the taxable year meets (a) the gross income requirements specified in Section 67 (a) (1), and (b) the stock
ownership requirement specified in Section 67(a) (2). Both requirements must be satisfied and both must be
met with respect to each taxable year.
A foreign corporation which comes within the classification of a foreign personal holding company for any
taxable year beginning after December 31, 1938, is not subject to taxation for such taxable year under Section
25 of the Code but may be subject to taxation under that section for other taxable years. The fact that a foreign
corporation is a foreign personal holding company does not relieve the corporation from liability for the tax
imposed generally under Section 24 upon foreign corporations, since such tax applies regardless of the
classification of the foreign corporation as a-foreign personal holding company.
SECTION 228. Gross income requirement. — To meet the gross income requirement, it is necessary that
either of the following percentages of gross income of the corporation for the taxable year be foreign personal
holding company income in accordance with Section 68 in relation to Section 65 of the Code:
(a) Sixty per cent of more; or
(b) Fifty per cent or more if the foreign corporation has been classified as a foreign personal holding
company for the taxable year ending after December 31, 1938, unless —
(1) A taxable year has intervened since the last taxable year for which it was so classified, during no
part of which the stock ownership requirement specified in Section 67 (a) (z) exist; or
(2) Three consecutive years have intervened since the last taxable year for which it was so classified,
during each of which its foreign personal holding company income was less than 50 per cent of its gross
income.
SECTION 229. Stock ownership requirement. — To meet the stock ownership requirement it is necessary
that at some time in the taxable year more than 50 per cent in value of the outstanding stock of the foreign
corporation be owned, directly or indirectly, by or for not more than five individuals who are citizens or
residents of the Philippines.
In the event of any change in the stock outstanding during the taxable year, whether in the number of shares
or classes of stock, or whether in the ownership thereof, the conditions existing immediately prior and
subsequent to each change must be taken into consideration, since a corporation comes within the
classification if the statutory conditions with respect to stock ownership are present at any time during the
taxable year.
In determining whether the statutory conditions with respect to stock ownership are present at any time
during the taxable year, the phrase "in value" shall, in the light of all the circumstances, be deemed the value of
the corporate stock outstanding at such time (not including treasury stock). This value may be determined
upon the basis of the company's net worth, earning and dividend paying capacity, appreciation of assets,
together with such other factors as have a bearing upon the value of the stock. If the value of the stock which is
used is greatly at variance with that reflected by the corporate books, the evidence of such value should be
filed with the return. In any case where there are two or more classes of stock outstanding, the total value of
all the stock should be allocated among the different classes according to the relative value of each lass
therein. DIcSHE
(Section 68 of the Code)
SECTION 230. Gross income and stock ownership requirements of foreign personal holding companies. —
For the purpose of determining whether a foreign corporation satisfies the gross income requirement
prescribed under Section 67(a)(1), the same items of income classified under Section 65 as personal holding
company income shall, if received by a foreign corporation, be considered as foreign personal holding company
income. In determining whether a foreign corporation satisfies the stock ownership requirement prescribed
under Section 67(a) (2) the rules established in Section 66 shall apply.
(Section 69 of the Code)
SECTION 231. Income of foreign personal holding companies taxed to Philippine shareholders. — (a) General
rule. — Section 69 does not impose a tax on. foreign personal holding companies. The undistributed net
income (from all sources), of such companies, however, must be included in the manner and to the extent set
forth in this section, in the gross income of their "Philippine shareholders", that is, the shareholders who are
individual citizens or residents of the Philippines.
(b) AMOUNT INCLUDIBLE IN GROSS INCOME. — Each Philippine shareholder, who was a shareholder on the
day in the taxable year of the, foreign personal holding company which was the last day on which the
stockholders satisfying the stock ownership requirement of Section 67(a)(2), hereinafter referred to as the
"Philippines group", existed with respect to the company, shall include in his gross income a dividend, for the
taxable year in which or with which the taxable year of the company ends, the amount he would have received
as a dividend if on such last day there has been distributed by the company and received by the shareholders
an amount which bears the same ratio to the net income of the company for the taxable year as the portion of
such taxable year up to and including such last day bears to the entire taxable year.
The undistributed net income of the foreign personal holding company is includible only in the gross income of
the Philippine shareholders who were shareholders in the company on the last day of its taxable year on which
the Philippine groups existed with respect to the company. Such Philippine shareholders, accordingly, are
determined by the stock holdings as of such specified time. This applies to every Philippine shareholder who
was a shareholder in the company at the specified time regardless of whether the Philippine shareholder is
included with the Philippine group.
Revenue Regulations 02-40
The Philippine shareholders must include in their gross income their distributive shares of that proportion of
the undistributed net income for the taxable-year of the company which is equal in ratio to that which the
portion of the taxable year up to and including the last day on which the Philippine group with respect to the
company existed bears to the entire taxable year. Thus if the last day in the taxable year on which the required
Philippine group existed was also the end of the taxable year, the portion of the taxable year up to and
including such last day would be equal to 100 per cent and in such case, the Philippine shareholders would be
required to return their distributive shares in the entire undistributed net income. But if the last day on which
the required Philippine group existed was September 30, and the taxable year was a calendar year, the portion
of the taxable year up to and including such last day would be equal to nine-twelfths of the undistributed net
income.
The amount which each Philippine shareholder must return is that amount which he would have received as a
dividend if the above specified portion of the undistributed net income had in fact been distributed by the
foreign personal holding company as a dividend on the last day of its taxable year on which the required
Philippine group existed. Such amount is determined, therefore, by the interest of the Philippine shareholder in
the foreign personal holding company, that is, by the number of shares of stock owned by the Philippine
shareholder and the relative rights of his class of stock, if there are several classes of stock outstanding. Thus, if
a foreign personal holding company has both common and preferred stock outstanding and the preferred
shareholders are entitled to a specific dividend before any distribution may be made to the common
shareholders, then the assumed distribution of the stated portion of the undistributed net income must first be
treated as a payment of the specified dividend on the preferred stock before any part may be allocated as a
dividend on the common stock.
The assumed distribution of the required portion of the undistributed net income must be returned as
dividend income by the Philippine shareholders for their respective taxable years in which or with which the
taxable year of the foreign personal holding company ends. In applying this rule, the date as of which the
Philippine group last existed with respect to the company is immaterial. CTDHSE
(Section 70 of the Code)
SECTION 232. Information returns by officers and directors of certain foreign corporations. — (a)
REQUIREMENT FOR FILING RETURNS. — (1) General. — Under Section 70 (a), on the 15th day of each month
which begins after July 1, 1939, each individual who on such 15th day is an officer or, a director of a foreign
corporation which, with respect to its taxable year preceding the taxable year in which such month occurs, was
a foreign personal holding company, is required to file with the Commissioner of Internal Revenue a monthly
information return as provided in Section 70(a). The Commissioner of Internal Revenue may authorize the filing
of returns covering periods longer than a month.
(2) RETURNS JOINTLY MADE. — If two or more officers or directors of a foreign corporation are required to
file information returns for any period under Section 70(a), any two or more of such officers or directors may,
in lieu of filing separate returns for such period, jointly execute and file one return.
(b) FORM OF RETURN. — The return under Section 70(x). of the Code and this section shall be made on the
form prescribed by the Commissioner of Internal Revenue. Each officer or director should carefully prepare his
return so as to set forth fully and clearly the information called for therein and by the applicable regulations.
Returns which have not been so prepared will not be considered as meeting the requirements of the law.
(c) CONTENTS OF RETURN. — The return shall, in accordance with provisions of this section and the
instructions on the form, set forth with respect to the preceding period the following information:
(1) Name and address of corporation;
(2) Kind of business in which the corporation is engaged;
(3) Date of incorporation;
(4) The country under the laws of which the corporation is incorporated;
(5) Number of shares and par value of common stock of the corporation outstanding as of the beginning and
end of the period;
(6) Number of shares and par value of preferred stock of the corporation outstanding as of the beginning and
end of the period, the rate of dividend on such stock and whether such dividend is cumulative or
noncumulative;
(7) A description of the convertible securities issued by the corporation, including a statement of the face
value of, and rate of interest on, such securities:
Page 35 of 39
(8) The name and address of each shareholder, the class and number of shares held by each, together with
any changes in stock holdings during such period;
(9) The name and address of each holder of securities convertible into stock of the corporation, the class,
number and face value of the securities held by each, together with any changes in the holding of such
securities during the period;
(10) A certified copy of any resolution or plan, and any amendments thereof or supplements thereto, for or in
respect of the dissolution of the corporation of the liquidation of the whole or any part of its capital stock; and
(11) Such other information as may be required by the return form.
If a person is required to file a return under Section 70(a) of the Code and this section with respect to
more than one foreign corporation, a separate return must be filed with respect to each foreign corporation.
(d) VERIFICATION OF RETURNS. — All returns required by Section 70(a) and this section shall be verified
under oath or affirmation of the parties rendering the same.
SECTION 233. Annual information returns by officers and directors of certain foreign corporations. — (a)
Requirement for filing returns.
(1) GENERAL. — Under Section 70(b), on the sixtieth day after the close of the taxable year of a foreign
personal holding company each individual who on such sixtieth day is an officer or director of the corporation
shall file with the Commissioner of Internal Revenue an annual information return as provided in that section
of the Code and this section.
(2) RETURNS JOINTLY MADE. — If two or more officers or directors of a foreign corporation are required to
file annual information returns under Section 70(b) for any taxable year of the corporation any two or more of
such officers or directors may in lieu of filing separate annual returns for such taxable year, jointly execute and
file one annual return.
(b) FORM OF RETURN. — The return under Section 70(b) and this section shall be made on the form
prescribed by the Commissioner of Internal Revenue. Each officer or director should carefully prepare his
returns so as to set forth fully and clearly the information called for therein and by the applicable regulations.
Returns which have not been so prepared will not he considered as meeting the requirements of the law.
(c) CONTENTS OF RETURN. — The return shall, in accordance with the provisions of this section and the
instructions on the form, set forth with respect to the taxable year of the foreign personal holding company the
following information:
(1) The gross income, deductions and credits, net income, and undistributed net income of the foreign
personal holding company for such taxable year, in complete detail;
(2) The same information with respect to such taxable year which is required by Section 70(a) and paragraph
(c) of the preceding section, except that if all the required returns with respect to such year have been filed
under Section 70(a) and the preceding section, no information under Section 70(b) (2) and this paragraph need
be set forth in such annual return; and
(3) Such other information as may be required by the return form.
(d) VERIFICATION OF RETURNS. — All returns required by Section 70(b) and this section shall be verified
under oath or affirmation of the parties rendering the same.
(Section 71 of the Code)
SECTION 234. Information returns by shareholders of certain foreign corporations. —
(a) REQUIREMENT FOR FILING RETURNS.
(1) General. — On the 15th day of each month which begins after July 1, 1939 each Philippine shareholder,
by or for whom 50 per cent or more in value of the outstanding stock of a foreign corporation is owned,
directly or indirectly [including, in the case of an individual, stock owned by members of his family as
defined in Section 66(b)], if such foreign corporation with respect to its taxable year preceding the taxable
year in which such month occurs was a foreign personal holding company, shall file with the
Commissioner of Internal Revenue an information, return as provided in Section 71(a). The Commissioner
of Internal Revenue may authorize the filing of returns covering period longer than a month.
(2) Duplicate returns. — If a shareholder in a foreign corporation files, as an officer or director in such
corporation, the returns required by Section 70(b), such returns shall be considered as returns filed under
Section 71(a).
(b) FORM OF RETURN. — The return under Section 71(a) shall be made on the form prescribed by the
Commissioner of Internal Revenue. Each shareholder should carefully prepare his return so as to set forth fully
and clearly the information called for therein and by the applicable regulations. Returns which have not been
Revenue Regulations 02-40
so prepared will not be considered as meeting the requirements of the law.
(c) CONTENTS OF RETURN. — The return shall, in accordance with the provisions of this section and the
instructions on the form, set forth with respect to the preceding period the same information as required, to
be shown on that form by Section 70(a) and paragraph (c) of Section 232 of these regulations.
If a person is required to file a return under Section 71(a) of the Code and this section with respect to more
than one foreign corporation, a separate return must he filed with respect to each foreign corporation.
(d) VERIFICATION OF RETURNS. — All returns required by Section 71(a) of the Code and this section shall be
verified under oath or affirmation of the parties rendering the same.
SECTION 235. Annual information returns by shareholders of certain foreign corporations. —
(a) REQUIREMENT FOR FILING RETURNS.
(1) General. — Under Section 71(b) of the Code, on the sixtieth day after the close of the taxable year of a
foreign personal holding company, each Philippine shareholder, by or for whom on such sixtieth day 50 per
cent or more in value of the outstanding stock of the company is owned, directly or indirectly [including the
case of an individual stock owned by members of his family as defined in Section 66(b)], shall file with the
Commissioner of Internal Revenue an information returns as provided in that section and this section.
(2) Duplicate returns. — If a shareholder in a foreign corporation files as an officer or director in such
corporation, the return required by Section 70(b), such returns shall be considered as returns filed under
Section 71(b).
(b) FORM OF RETURN. — The return under Section 71(b) shall be made on the form prescribed by the
Commissioner of Internal Revenue. Each shareholder should carefully prepare his return so as to set forth fully
and clearly the information called for therein and by the applicable regulations. Returns which have not been
so prepared will not be considered as meeting the requirements of the law.
(c) CONTENTS OF RETURN. — The return shall, in accordance with the provisions of this section and the
instructions on the form, set forth with respect to the taxable year of the foreign personal holding company the
same information which is required under Section 71(a), paragraph (c) of Section 232 of these regulations and
paragraph (c) of the preceding section, except that if all the required returns with respect to such year have
been filed under Section 71(a), no return under Section 71(b) is required.
If a person is required to file an annual return under Section 71(b) with respect to more than one foreign
personal holding company, a separate return must be filed with respect to each foreign personal holding
company.
(d) VERIFICATION OF RETURNS. — All returns required by Section 71(b) and this section shall be verified
under oath or affirmation of the parties rendering the same.
(Section 72 of the Code)
SECTION 236. Ad valorem penalty for failure to file return. — In case of a failure to make and file a return or
list within the time prescribed by law, not due to willful neglect, where such return or list is voluntarily filed by
the taxpayer without notice from the Commissioner of Internal Revenue or other officer and it is shown that
the failure to file it in due time was due to a reasonable cause, no surcharge will be added to the amount of tax
due on the return. In such cases, in order to avoid the imposition of the surcharge, the taxpayer must make a
statement showing all the facts alleged as a reasonable cause for failure to file the return on time in the form
of an affidavit which should be attached to the return. If the Commissioner of Internal Revenue is satisfied that
the delinquency was due to a reasonable cause, no surcharge will be added to the tax due on the return.
Whether or not reasonable cause exists will depend upon the circumstances of each case. As a general rule, if
the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return
within the prescribed time, the delay will be considered as being due to a reasonable cause.
In case of a failure to make and file a return or list within the time prescribed by law, not due to willful neglect,
where the taxpayer voluntarily files the return without notice from the Commissioner of Internal Revenue or
other officer and attaches to such return the affidavit mentioned in the preceding paragraph but where the
Commissioner of Internal Revenue is not satisfied as to the reasonableness of the cause of the delinquency, a
surcharge of 25 per cent will be added to the amount of tax due on the return.
In case the failure to make and file a return or list within the time prescribed by law is due to willful neglect a
surcharge of 50 per cent will be added to the amount of tax due on the return. There is willful neglect in the
case of a taxpayer who, being liable to file a return, knowingly delays the filing of such return. Where the filing
Page 36 of 39
of the return has been delayed for a considerable length of time, the delinquency will be presumed to be due
to willful neglect.
The amount of surcharge so added to the tax due on the return shall be collected at the same time and in the
same manner and as part of the tax unless the tax has been paid before the discovery of the cause giving rise
to the imposition of the surcharge, in which case the amount so added shall be collected in the same manner
as the tax.
SECTION 237. Ad valorem penalty for false or fraudulent return. — In case a false or fraudulent return or list
is made, the Commissioner of Internal Revenue shall add to the tax ascertained to be due on the true net
income of the taxpayer a surcharged of 50 per cent of the amount of such tax. If payment has been made on
the basis of such false or fraudulent return before the discovery of the falsity or fraud, the basis of the
surcharge of 50 per cent will be the amount of the tax due on the true net income less the amount so paid.
(Section 73 of the Code)
SECTION 238. Penalty for failure to file return or to pay tax. — Any person liable to pay the tax, to make a
return or to supply information required under Title II of the Code, who refuses or neglects to pay such tax, to
make such return or to supply such information at the time or times specified in each case shall be punished by
a fine of not more than P2,000 or by imprisonment for not more than six months, or both. In case of a
corporation failing to file its, return or pay the tax, the penalty prescribed under the first paragraph of Section
73 will be imposed upon the president, vice-resident, or other responsible officer required to file the return of
the corporation or pay the tax due from the same, in accordance with the provisions of Section 46(a) and 51(b)
of the Code. In the case of a duly registered general copartnership, failing to file the return required under
Section 49 of the Code, the penalty prescribed under the first paragraph of Section 73 will be imposed upon
the managing partner or other responsible officer of such partnership.
SECTION 239. Penalty imposed upon person causing a false or fraudulent corporate return to be filed. — If a
false or fraudulent return is filed for a corporation or duly registered general copartnership, the individual or
any officer thereof causing such return to be filed shall be punished by a fine not exceeding P4,000 or by
imprisonment for not more than one year, or both.
(Section 74 of the Code)
SECTION 240. Penalty on corporation refusing or neglecting to make return. — A corporation or duly
registered general copartnership, refusing or neglecting to make a return required under Title II of the Code, or,
rendering a false or fraudulent return, will be liable to a fine of not exceeding P20,000. The fine imposed under
Section 74 will be paid by the corporation or duly registered general copartnership as an entity, and is in
addition to the penalty which may be imposed under Section 73 of the Code upon the president, vice-
president, or other responsible officer of a corporation or duly registered general copartnership.
(Section 75 of the Code)
SECTION 241. Return of information as to payments of dividends. — Every domestic resident foreign
corporation is hereby required to render a return, in duplicate, on the form prescribed for corporations (B.I.R.
Form No. 17.02) of its payments of profits or dividends to stock holders for the taxable year or period covered
by the return, stating the name and address of each stockholder, the number and class of shares owned by
him, the date and amount of such dividend paid him, and when the surplus out of which it was paid was
accumulated. Such return should be verified by the oath or affirmation of the person rendering the same.
(Section 76 of the Code)
SECTION 242. Application for and issuance of license for collecting foreign items. — Every individual or
organization undertaking, for profit or otherwise, the collection of dividends or interest on foreign securities
(not payable in the Philippines) by means of coupons, checks, or bills of exchange shall, upon application,
obtain a license therefor from the Commissioner of Internal Revenue. The application shall show the name,
address, occupation, and status (as to citizenship or nationality and residence) of the applicant.
(Section 77 of the Code)
SECTION 243. Return of information as to payments of P1,800 or more. — All persons, corporations,
Revenue Regulations 02-40
partnerships, and associations, making payment to another person of fixed or determinable income of P1,800
or more in a taxable year must render a return thereof to the Commissioner of Internal Revenue within the
time fixed for the filing of the annual returns of said person, corporations, partnerships, and associations. The
name and address of the recipient of the income should be stated, if possible. Although to make necessary a
return of information the income must be fixed or determinable, it need not be annual or periodical.
The names of all employees to whom payments of P1,800 or over a year are made, whether such total sum is
made up of wages, salaries, commissions, or compensation in any other form, must be reported.
Compensations in kind, such as living quarters, meals, and lodging, are taxable income to the recipient and, as
such, should be reported if the sum total of the same and the other compensation in cash received shall
amount to P1,500 or more during the year.
In the case of payments of annual or periodical income to nonresident alien individual or to foreign
corporations or firm not engaging in trade or business within the Philippines and not having any office or place
of business therein, the return by withholding agents shall constitute and be treated as return of information.
SECTION 243. Return of information as to payments of P1,800 or more. — All persons, corporations,
partnerships and associations making payments to another of fixed or determinable income of P1,800 or more
in a taxable .year must render a return thereof in duplicate on the form prescribed therefor (BIR Form No.
17.01-B). These forms should be attached to and filed together with the annual income tax returns of said
persons, corporations, partnerships and associations as payers, within the time fixed by law for the filing of
income tax returns. The payments referred to herein do not include the following:
(1) Dividend payments mentioned under Section 75 of the National Internal Revenue Code.
(2) Salaries, wages, bonuses, and other compensations in kind, such as living quarters, meals, and lodging
which are subject to withholding tax and reported in W-2 forms as provided for under Republic Act 590.
(3) Payments subject to withholding tax at source enumerated under Section 53 of the National Internal
Revenue Code.
Examples of income covered by these regulations and to be declared in BIR Form 17.01-B are interests, rents,
commissions, royalties, advertisements, professional fees, and the like, arising generally from payments
between payers and recipients who have no employer-employee relationship.
(Revenue Regulations No. 9-65 amending and superseding section 243 appearing on page 723. As of October
20, 1965, these Regulations, dated June 30, 1965, have not yet been published in the Official Gazette).
(Section 78 of the Code)
SECTION 244. Return of corporation contemplating dissolution or retiring from business. — All corporations,
partnership, joint accounts and associations, contemplating dissolution or retiring from business without
formal dissolution shall, within 30 days after the approval of such resolution authorizing their dissolution, and
within the same period after their retirement from business, file their income tax returns covering the profit
earned or business done by them from the beginning of the year up to the date of such dissolution or
retirement and pay the corresponding income tax due thereon upon demand by the Commissioner of Internal
Revenue to addition to the income tax return required to be filed they shall also submit within the same period
the following:
(a) Copy of the resolution authorizing such dissolution;
(b) Balance sheet at the date of dissolution or retirement and a profit and loss statement covering the period
from the beginning of the taxable year to the date of dissolution or retirement;
(c) In the case of a corporation, the names end addresses of the shareholders and the number and par value
of the shares held by each; and in the case of a partnership, joint-account or association, the name of the
partners or members and the capital contributed by each;
(d) The value and a description of, the assets received in liquidation by each shareholder;
(e) The name and address of each individual or corporation, other than shareholders, if any, receiving assets
at the time of dissolution together with a description and the value of the assets received by such
individuals or corporations; and the consideration, if any, paid by each of them for the assets received.
(Section 79 of the Code)
Page 37 of 39
SECTION 245. Return of information by brokers. — When required by the Commissioner of Internal Revenue,
each person doing business as a broker shall render a return or statement showing the names and addresses of
customers to whom or for whom payments were made or from whom business was transacted during the
calendar year or other specified period, and giving all other particulars which may be needed by the
Commissioner of Internal Revenue.
(Section 80 of the Code)
SECTION 246. Information returns as to formation, etc., of foreign corporation. — (a) IN GENERAL. — Any
attorney, accountant, fiduciary, bank, trust company, financial institution, or other person, who, after July 5,
1939, aids, assists, counsels, or advises in, or with respect to, the formation, organization, or reorganization of
any foreign corporation (including a foreign association or partnership) shall file with the Commissioner of
Internal Revenue, within thirty days after giving such aid, assistance, counsel or advise, an information return;
as provided in Section 80 and this section. The return must be filed in every such case (1) regardless of the
nature of the counsel or advice given, whether for or against the formation, organization, or reorganization of
the foreign corporation, or the nature of the aid or assistance rendered and (2) regardless of the action taken
upon the advice or counsel, that is, whether the foreign corporation is actually formed, organized, or
reorganized.
If, in a particular case, the aid, assistance, counsel or advice given by any person extends over a period of more
than one day and not for more than thirty days, such persons, to avoid the multiple filing of returns, may file a
single return for the entire period. In such case, the return shall be filed within thirty days from the first day of
such period: If, in a particular case, the aid, assistance, counsel, or advice given by any person extends over a
period of more than thirty days, such person may file a return at the end of each thirty days included within
such period and at the end of the fractional part of a thirty day period, if any, extending beyond the last full
thirty days. In each such case, the return must disclose all the required information which was not reported on
a prior return.
(b) SPECIAL PROVISIONS. — (1) Employers. — In the case of aid, assistance, counsel, or advice in, or with
respect to, the formation, organization, or reorganization of a foreign corporation given by a person in whole or
in part through the medium of subordinates or employees (including in the case of a corporation the officers
thereof), the return of the employer must set forth to the full extent all information prescribed by these
regulations, including that which, as an incident to such employment, is within the possession or knowledge or
under the control of such subordinates or employees.
(2) EMPLOYEES. — The obligation of a subordinate or employee (including in the case of a corporation the
officers thereof) to file a return with respect to any aid, assistance, counsel, or advice in, or with respect to, the
formation, organization, or reorganization of a foreign corporation, given as an incident to his employment, will
be satisfied if a complete and adequate return as prescribed by these regulations is duly filed by the employer
setting forth all of the information within the possession or knowledge or under the control of such
subordinate or employee.
Clerks, stenographers, and other subordinates or employees, rendering aid or assistance solely of a clerical or
mechanical character in, or with respect to, the formation, organization or reorganization of a foreign
corporation are not required to file returns by reason of such services.
(3) RETURNS JOINTLY MADE. — If two or more persons aid, assist, counsel, or advise in, or with respect to,
the formation, organization, or reorganization of a particular foreign corporation, any two or more of such
persons may, in lieu of filing several returns jointly execute and file one return.
(c) PENALTIES. — For criminal penalties for failure to file the return required by Section 80, see Section 73 of
the Code.
(d) CONTENTS OF RETURNS. — The return shall set forth the following information to the full extent such
information is within the knowledge or possession or under the control of the person required to file the
return.
(1) The name and address of the person (or persons) to whom and the person (or persons) for whom or on
Revenue Regulations 02-40
whose behalf the aid, assistance, counsel, or advice was given;
(2) A complete statement of the aid, assistance, counsel, or advice given;
(3) Name and address of the foreign corporation and the country under the laws of which it was formed,
organized, or reorganized;
(4) The months and year when the foreign corporation was formed, organized, or reorganized;
(5) A statement of how the formation, organization, or reorganization of the foreign corporation was
effected;
(6) A complete statement of the reasons for, and the purposes sought to be accomplished, by, the formation,
organization, or reorganization of the foreign corporation;
(7) A statement showing the classes and kinds of assets transferred to the foreign corporation in connection
with formation, organization, or reorganization, including a detailed list of any stock or securities included in
such assets, and a statement showing the names and addresses of the persons who were the owners of such
assets immediately prior to the transfer;
(8) The names and addresses of the shareholders of the foreign corporation at the time of the completion of
its formation, organization, or reorganization, showing the classes of stock and number of shares held by each;
(9) The name and address of the person (or persons) having custody of the books of account and records of
the foreign corporation;
(10) Such other information as may be required by the return form; and
(11) Where any of the information required to be furnished is withheld because its character is claimed to be
privileged as a communication between attorney and client within the meaning of Section 80, the return must
so state and must contain a complete statement of the nature and the circumstances of the communication on
which a decision as to the propriety of the claim of privilege may be reached.
If a person aids, assists, counsels, or advises in or with respect to, the formation, organization, or
reorganization of more than one foreign corporation, a separate return must be filed with respect to each
foreign corporation.
(e) VERIFICATION OF RETURN. — All returns required by Section 80 and this section shall be verified under
oath or affirmation.
(Section 81 of the Code)
SECTION 247. Disposition of income tax returns. — All income tax returns filed with the Commissioner of
Internal Revenue constitute public records which shall be open to inspection under rules and regulations
prescribed by the Secretary of Finance with the approval of the President of the Philippines. The circumstances
under which income tax returns may be inspected by interested parties are dealt with under separate
regulations.
SECTION 248. Publication of list of persons filing returns and paying taxes. — The second paragraph of
Section 81 expressly authorizes the Commissioner of Internal Revenue, with the approval of the Secretary of
Finance, to cause to be prepared and published in any newspaper or made available to public inspection
through other means, lists containing the names and addresses of persons who have filed income tax returns,
or lists of those who paid income taxes, or both such kinds of lists.
(Section 82 of the Code)
SECTION 249. Recovery of tax. — A suit or proceeding may be maintained for the recovery of any internal-
revenue tax alleged to have been erroneously or illegally assessed and collected, in accordance with Section
306 of the Code. However, where the Commissioner of Internal Revenue believes that a return is false or
fraudulent or contains any understatement or undervaluation and proceeds to assess and collect the tax due,
no portion of the tax so collected shall be recovered by any suit unless it is proved that the return was not in
fact false or fraudulent and did not contain any understatement or undervaluation, except with respect to
return is made in good faith regarding annual depreciation of oil or gas wells and mines.
(Section 83 of the Code)
SECTION 250. Dividends. — Dividends, for the purpose of the law, comprise any distribution whether in cash
or other property, in the ordinary course of business, even though extraordinary in amount, made by a
domestic or resident foreign corporation, joint-stock company, partnership, joint account (cuentas en
Page 38 of 39
participacion), association, or insurance company to the shareholders or members out of its earnings or profits
accumulated since March 1, 1913.
Although interest on certain Government bonds and other similar obligations is not taxable when received by a
corporation, upon amalgamation with the other funds of the corporation, such income loses its identity and
when distributed to shareholders, is taxable to the same extent as other dividend.
A taxable distribution made by a corporation to individual stockholders or members shall be included is the
gross income of the distributees when the cash of other property is unqualifiedly made subject to their
demand. Dividends, in cash or other property received by an individual, are subject to tax in his hands in the
same manner another income.
Dividends, whether in cash or other property, received by a domestic or resident foreign corporation from a
domestic corporation are taxable only to the extent of 25 per cent thereof in accordance with Section 24 of the
Code. Dividends received by a domestic corporation from a foreign corporation, whether resident or
nonresident, are taxable to the extent that they constitute income from sources within the Philippines, as
provided in Section 37 (a) (2) (b) of the Code. Dividends paid by the domestic corporation to a nonresident
foreign corporation are taxable in full. (For definition of the different classes of corporations, see Section 84 of
the Code).
SECTION 251. Dividends paid in property. — Dividends paid in securities or other property (other than its
own stock), in which the earnings of a corporation have been invested, are income to the recipients to the
amount of the full market value of such property when receivable by individual stockholders. When receivable
by corporations, the amount of such dividends includible for purposes of the tax on corporations are specified
in Section 24 of the Code. (See also Section 250 of these regulations). A dividend paid in stock of another
corporation is not a stock dividend, even though the stock distributed was acquired through the transfer by the
corporation declaring the dividends of property to the corporation the stock of which is distributed as a
dividend. Where a corporation declares a dividend payable in a stock of another corporation, setting aside the
stock to be so distributed and notifying the stockholders of its action, the income arising to the recipients of
such stock is its market value at the time the dividend becomes payable. Scrip dividends are subject to tax in
the year in which the warrants are issued.
SECTION 252. Stock dividends. — A stock dividend which represents the transfer of surplus to capital
account is not subject to income tax. However a dividend in stock may constitute taxable income to the
recipients thereof notwithstanding the fact that the officers or directors of the corporation (as defined in
Section 84) choose to call such distribution as a stock dividend. The distinction between a stock dividend which
does not, and one which does, constitute income taxable to the shareholder is the distinction between a stock
dividend which works no change in the corporate entity, the same interest in the same corporation being
represented after the distribution by more shares of precisely the same character, and a stock dividend where
there either has been a change of corporate identity or a change in the nature of the shares issued as dividends
whereby the proportional interest of the shareholders after the distribution is essentially different from his
former interests. A stock dividend constitutes income if it gives the shareholder an interest different from that
which his former stock holdings represented. A stock dividend does not constitute income if the new shares
confer no different rights or interests than did the old — the new certificates plus the old representing the
same proportionate interest in the net assets of the corporation as did the old.
SECTION 253. Sale of stock received as dividends. — Stock issued by a corporation, as a dividend, does not
constitute taxable income to a stockholder in such corporation, but gain may be derived or loss sustained by
the stockholder, whether individual or corporate, from the sale of such stock, which gain or loss will be treated
as arising from the sale or exchange of a capital asset. (See Section 34 of the Code.) The amount of gain derived
or loss sustained from the sale of such stock, or from the sale of the stack with respect to which it is issued,
shall be determined in accordance with the following rules:
(a) Where the stock issued as dividend is all or substantially the same character or preference as the stock
upon which the stock dividend is paid, the cost of each share (or when acquired prior to March 1, 1913,
the fair market value as of such date) will be the quotient of the cost (or such fair market value) of the old
Revenue Regulations 02-40 Page 39 of 39

shares of stock divided by the total number of the old and new shares.
(b) Where the stock issued as a dividend is in whole or in part of a character or preference materially (Promulgated February 11, 1941, XXXIX Off. Gaz., No. 18, page 325)
different from the stock upon which the stock dividend is paid, the cost (and when acquired prior to
March 1, 1913, the fair market value as of such date) of the old shares of stock shall be divided between
such old stock and the new stock, in proportion, as nearly as may be, to the respective value of each class Recommended by:
of stock, old and new, at the time the new shares of stock are issued, and the cost (or when acquired
prior to March 1, 1913, the fair market value as of such date) of each share of stock will be the quotient BIBIANO L. MEER
of the cost (or such fair market value as of March 1, 1913) of the class to which such share belongs Collector of Internal Revenue
divided by the number of shares in that class.
(c) Where the stock with respect to which a stock dividend is issued was purchased at different times and at MANUEL ROXAS
different prices and the identity of the lots can. not be determined, any sale of the original stock, will be Secretary of Finance
charged to the earliest purchases of such stock, and any sale of dividend stock issued with respect to such
stock will be presumed to have been made from the stock issued with respect to the earliest purchased
stock, to the amount of the dividend chargeable to such stock.
(d) Where the stock with respect to which a stock dividend is declared was purchased at different times and
at different prices, and the dividend stock issued with respect to such stock can not be identified as
having been issued with respect to any particular lot of such stock, then any sale of such dividend stock
will be presumed to have been made from the stock issued with respect to the earliest purchased stock,
to the amount of the stock dividend chargeable to such stock.

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

SECTION 255. Sources of distribution. — For the purpose of income taxation every distribution made by a
corporation is made out of earnings or profits to the extent thereof and from the most recently accumulated
earnings or profits. In determining the source of a distribution, consideration should be given first, to the
earnings or profits of the taxable year; second, to the earnings or profits accumulated since February 28, 1913,
only in the case where, and to the extent that, the distribution made during the taxable year are not regarded
as out of the earnings or profits of the taxable year and all the earnings or profits accumulated since February
28, 1913, have been distributed; and, fourth, to sources other than earnings or profits only after the earnings
or profits have been distributed.

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

SECTION 257. Income and deductions of American citizens residing in the Philippines. — Under subsection
(u) of Section 84, a citizen of the United States residing in the Philippines, is taxable on income from sources
both within and without the Philippines, except income from sources within the United States. Accordingly,
items of deductions allocable to income of such taxpayer from sources within the United States are not
deductible from his income subject to Philippine income tax. (Deemed repealed since our independence).

SECTION 258. Effective date. — These regulations shall take effect upon their promulgation in the Official
Gazette.