NATIONAL TAXATION (National Internal Revenue Code of 1997, as amended by RA

10963 or the Tax Reform for Acceleration and Inclusion Law)

Taxing authority
Jurisdiction, power, and functions of the Commissioner of Internal Revenue
Interpreting tax laws and deciding tax cases
SEC. 4. Power of the Commissioner to Interpret Tax Laws and to Decide Tax Cases. -
The power to interpret the provisions of this Code and other tax laws shall be under the
exclusive and original jurisdiction of the Commissioner, subject to review by the
Secretary of Finance.
The power to decide disputed assessments, refunds of internal revenue taxes, fees or
other charges, penalties imposed in relation thereto, or other matters arising under this
Code or other laws or portions thereof administered by the Bureau of Internal Revenue
is vested in the Commissioner, subject to the exclusive appellate jurisdiction of the
Court of Tax Appeals.

Can the Commissioner of Internal Revenue inquire into the bank deposits of a
taxpayer? If so, does this power of the Commissioner conflict with RA 1405 (Secrecy of
Bank Deposits Law)
The Commissioner of Internal Revenue is authorized to inquire into the bank
deposits of:
1. any taxpayer upon his written consent;
2. a decedent to determine his gross estate;
3. any taxpayer who has filed an application for
compromise of his tax liability by means of financial
incapacity to pay his tax liability;
4. A specific taxpayer or taxpayers subject of a request for the supply of tax information
from a foreign tax authority pursuant to an international convention or agreement on tax
matters to which the Philippines is a signatory.
The limited power of the Commissioner does not conflict with R.A. No. 1405
because the provisions of the Tax Code granting this power is an exception to the
Secrecy of Bank Deposits Law as embodied in a later legislation. Furthermore, in case
a taxpayer applies for an application to compromise the payment of his tax liabilities on
his claim that his financial position demonstrates a clear inability to pay the tax
assessed, his application shall not be considered unless and until he waive in writing his
privilege under R.A. No. 1405, and such waiver shall constitute the authority of the
Commissioner to inquire into the bank deposits of the taxpayer.

Non-retroactivity of rulings
SEC. 246. Non- Retroactivity of Rulings. - Any revocation, modification or reversal of
any of the rules and regulations promulgated in accordance with the preceding Sections
or any of the rulings or circulars promulgated by the Commissioner shall not be given
retroactive application if the revocation, modification or reversal will be prejudicial to the
taxpayers, except in the following cases:
(a) Where the taxpayer deliberately misstates or omits material facts from his return or
any document required of him by the Bureau of Internal Revenue;
(b) Where the facts subsequently gathered by the Bureau of Internal Revenue are
materially different from the facts on which the ruling is based; or
(c) Where the taxpayer acted in bad faith.

Rule-making authority of the Secretary of Finance

SEC. 244. Authority of Secretary of Finance to Promulgate Rules and Regulations. -
The Secretary of Finance, upon recommendation of the Commissioner, shall
promulgate all needful rules and regulations for the effective enforcement of the
provisions of this Code.

Income tax
Definition, nature, and general principles
Criteria in imposing Philippine income tax
SEC. 23. General Principles of Income Taxation in the Philippines. - Except when
otherwise provided in this Code:
(A) A citizen of the Philippines residing therein is taxable on all income derived from
sources within and without the Philippines;
(B) A nonresident citizen is taxable only on income derived from sources within the
Philippines;
(C) An individual citizen of the Philippines who is working and deriving income from
abroad as an overseas contract worker is taxable only on income derived from sources
within the Philippines: Provided, That a seaman who is a citizen of the Philippines and
who receives compensation for services rendered abroad as a member of the
complement of a vessel engaged exclusively in international trade shall be treated as an
overseas contract worker;
(D) An alien individual, whether a resident or not of the Philippines, is taxable only on
income derived from sources within the Philippines;
(E) A domestic corporation is taxable on all income derived from sources within and
without the Philippines; and
(F) A foreign corporation, whether engaged or not in trade or business in the
Philippines, is taxable only on income derived from sources within the Philippines.

Types of Philippine income taxes

1. personal income tax on individuals
2. regular corporate income tax corporation
3. minimum corporate income tax on corporation
4. capital gain tax (such as: [a] sale of sharesof stocks of a domestic corporation by a
person who is not a dealer in securities and ; [b] on sale of real property classified as a
capital asset by a person who is not a real estate dealer or developer)
5. tax on passive investment income (such as: interest, dividend, royalty)
6. fringe benefit tax
7. branch profit remittance tax on Phil.branches of foreign corp
8. tax on improperly accumulated earning tax of corp
9. final withholding tax on certain income.

Taxable period
CALENDAR METHOD
ITR, whether for an individual or for corp, assoc, or partnership, are required to be filed
on Dec. 31st of every year

FISCAL PERIOD
corporation, assoc, or partnership may with the approval of the Commissioner of IR, file
their returns and compute their income on the basis of a fiscal year
- an accounting period of 12 months ending on the last day of the month other than Dec.
DOES NOT APPLY TO - individual taxpayer

SHORT PERIOD
an accounting period of a taxpayer for less than 12 mos, as when the annual accounting
period of a subsidiary is changed to conform with the annual accounting period adopted
by its foreign parent company
for easy consolidation of their audited worldwide financial statements.
THIS IS AS AN EXEPTION TO THE RULE
- that the accounting period or taxable year consist of 12 months.

Kinds of taxpayers
Definition and nature
Income is an amount of money coming to a person or corporation within a specified
time, whether for payment of services, interest or profit from investment. Unless
otherwise specified, income means cash or its equivalent.
When income is taxable
Existence of income
Realization and recognition of income

For income to be taxable, the requites are: GRE

1. There must be gain or profit;
2. The gain must be received or realized; and
3. The gain must not be excluded or exempt by law or treaty from taxation.

Gain must be realized or received

This implies that not all economic gains constitute taxable income. Thus, a mere
increase in the value of property is not income but merely an unrealized increase in
capital.

When is income considered received?

1. actual receipt
2. constructive receipt

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

Examples of constructive receipt

1. Interest coupons which have matured and are payable, but have not been
cashed.
2. Defaulted coupons are income for the year in which paid.
3. Partner’s distributive share in the profits of a general professional partnership is
regarded as received by the partner, although not yet distributed.

Tests in determining whether income is earned for tax purposes

1. Severance test
As capital or investment is not income subject to tax, the gain or profit derived from the
exchange or transaction of said capital by the taxpayer for his separate use, benefit and
disposal is income subject to tax.
2. Realization Test there is no taxable income until there is a separation from capital of
something of exchangeable value, thereby supplying the realization or transmutation
which would result in the receipt of income.
3. Economic Benefits Test or Doctrine of Proprietary Interest means any economic
benefit to the employee that increases his net worth, whatever may have been the
mode by which it is effected, is taxable.

Tax-free exchanges
Tax-free exchanges refer to those instances enumerated in Section 40(C)(2) of the
National Internal Revenue Code (NIRC) of 1997 that are not subject to Income Tax,
Capital Gains Tax, Documentary Stamp Tax and/or Value-added Tax, as the case may
be.
In general, there are two kinds of tax-free exchange: (1) transfer to a controlled
corporation; and, (2) merger or consolidation.
In the first instance, no gain or loss shall be recognized if property is transferred to a
corporation by a person in exchange for stock or unit of participation in such corporation
of which as a result of such exchange said person, alone or together with others, not
exceeding four persons, gains control of said corporation.
In the second instance, no gain or loss shall be recognized if in pursuance of a plan of
merger or consolidation (a) a corporation, which is a party to a merger or consolidation,
exchanges property solely for stock in a corporation, which is a party to the merger or
consolidation; or, (b) a shareholder exchanges stock in a corporation, which is a party to
the merger or consolidation, solely for the stock of another corporation also a party to
the merger or consolidation; or, (c) a security holder of a corporation, which is a party to
the merger or consolidation, exchanges his securities in such corporation, solely for
stock or securities in another corporation, a party to the merger or consolidation.

Gross Income
Definition and nature
Mr. Gipit borrowed from Mr. Maunawain 100,000, payable in five equal monthly
installments. Before the first installment became due, Mr. Gipit rendered general
cleaning services in the entire office building of Mr. Maunawain, and as compensation
therefor, Mr. Maunawain cancelled the indebtedness of Mr. Gipit up to the amount of
75,000. Mr. Gipit claims that the cancellation of his indebtedness cannot be considered
as gain on his part which must be subject to income tax, because according to him, he
did not actually receive payment from Mr. Maunawain or the general cleaning services.
Is Mr. Gipit correct? Explain.
No. The law provides that if a debtor performs services for a creditor who cancels
the debt in consideration for such services, the debtor realizes income to that amount as
compensation for his services. In the given problem, the cancellation of Mr. Gipit’s
indebtedness up to the amount of 75,000 gave rise to compensation income subject to
income tax, since Mr. Maunawain condoned such amount as consideration for the
general cleaning services rendered by Mr. Gipit.

In 2010, Mr. Platon sent his sister Helen $1,000 via a telegraphic transfer through the
Bank of PI. The bank's remittance clerk made a mistake and credited Helen with
$1,000,000 which she promptly withdrew. The bank demanded the return of the
mistakenly credited excess, but Helen refused. The BIR entered the picture and
investigated Helen. Would the BIR be correct if it determines that Helen earned taxable
income under these facts?
(A) No, she had no income because she had no right to the mistakenly credited funds.
(B) Yes, income is income regardless of the source.
(C) No, it was not her fault that the funds in excess of $1,000 were credited to her.
(D) No, the funds in excess of$1,000 were in effect donated to her.
(B) Yes, income is income regardless of the source. The law defines gross
income as all income derived from whatever source. Consequently, the flow of wealth,
without any distinction as to the lawfulness of its source, is subject to income tax. In
other words, the phrase “income from whatever source” discloses a legislative policy to
include all income not expressly exempted within the class of taxable income under the
law.

What is the “all event test”? Explain Briefly.

The “all events test” is a test applied in the realization of income and expense by
an accrual-basic taxpayer. The test requires (1) the fixing to the right to the income or
liability to pay; and (2) the availability of reasonably accurate determination of such
income or liability, to warrant the inclusion of the income or expense the gross income
or deductions during the taxable year.

Mr. Jose Castillo is a resident Filipino Citizen. He purchased a parcel of land in Makati
City in 1970 at a consideration of 1Million. In 2011, the land, which remained
undeveloped and idle, had a fair market value of 20 Million. Mr. Antonio Ayala, another
Filipino citizen, is very much interested in the property and he offered to buy the same
for 20 Million. The Assessor of Makati City re-assessed in 2011 the property at 10
Million. Is Mr. Castillo liable for income tax in 2011 based on the offer to buy by Mr.
Ayala? Explain your answer.
 No. Mr. Castillo is not liable for income tax in 2011 because no income is realized
by him during that year. Tax liability for income tax attaches only if there is a gain
realized resulting from a closed and complete transaction.

Definition
Concept of income from whatever source derived
Gross income vs. net income vs. taxable income
Classification of income subject to tax
Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items.

Fringe benefits
A “fringe benefit’ is defined as being any good, service or other benefit furnished or
granted in cash or in kind by an employer to an individual employee. Would it be the
employer or the employee who is legally required to pay an income tax on it? Explain.
It is the employer who is legally required to pay an income tax on the fringe
benefit. The fringe benefit tax is imposed as a final withholding tax placing the legal
obligation to remit the tax on the employer, such that, if the tax is not paid the legal
recourse of the BIR is to go after the employer. Any amount or value received by the
employee as a fringe benefit is considered tax paid hence, net of the income tax due
thereon. The person who is legally required to pay (same as statutory incidence as
distinguished from economic incidence) is that person who, in case of non-payment,
can be legally demanded to pay the tax.

In 2011, Solar Computer Corporation (Solar) purchased a proprietary membership

share covered by Membership certificate No. 8 from the Mabuhay Golf Club, Inc. for
500,000. On December 27, 2012, it transferred the same to David, its American
consultant, to enable him to avail of the facilities of the Club. David executed a Deed of
Declaration of Trust and Assignment of Shares wherein he acknowledged the absolute
ownership of Solar over the share; that the assignment was without any consideration;
and that the share was placed in his name because the Club required it to be done. In
2013, the value of the share increased to 800,000. Is the said assignment a “gift” and,
therefore, subject to gift tax? Explain.
No. It is a fringe benefit taxable to the employer. The value of the right to avail of
the privileges attendant to Mabuhay Golf Club, Inc. Membership Certificate is due to
David’s merits or services as a computer consultant. Hence, the assignments not being
gratuitous, and there being no intent to transfer ownership, it is not subject to gift tax.

Professional income
Income from business
Income from dealings in property
Distinguish a “capital asset" from an “ordinary asset".
The term “capital asset” regards all properties not specifically excluded in the
statutory definition of capital assets, the profits or loss on the sale or the exchange of
which are treated as capital gains or capital losses. Conversely, all those properties
specifically excluded are considered as ordinary assets and the profits or losses
realized must have to be treated as ordinary gains or ordinary losses. Accordingly,
“capital assets” includes property held by the taxpayer whether or not connected with
his trade or business, but the term does not include any of the following, which are
consequently considered “ordinary assets:”
1. stock in trade of the taxpayer or other property of a kind which would properly be
included in the inventory of the taxpayer if on hand at the close of the taxable year;
2. property held by the taxpayer primarily for sale to customers in the ordinary course of
trade or business;
3. property used in the trade or business of a character which is subject to the
allowance for depreciation provided in the Tax Code; or
4. real property used in trade or business of the taxpayer. The statutory definition of
“capital assets” practically excludes from its scope, it will be noted, all property held by
the taxpayer if used in connection with his trade or business.

What is the rationale for the rule prohibiting the deduction of capital losses from ordinary
gains? Explain.
It is to insure that only costs or expenses incurred in earning the income shall be
deductible for income tax purposes consonant with the requirement of the law that only
necessary expenses are allowed as deductions from gross income. The term
“necessary expenses” presupposes that in order to be allowed as deduction, the
expense must be business connected, which is not the case insofar as capital losses
are concerned. This is also the reason why all nonbusiness connected expenses like
personal, living and family expenses, are not allowed as deduction from gross income.

In 1990, Mr. Naval bought a lot for 1,000,000 in a subdivision with the intention of
building his residence on it. In 1994, he abandoned his plan to build his residence on it
because the surrounding area became a depressed area and land values in the
subdivision went down; instead, he sold it for 800,000. At the time of the sale, the zonal
value was 500,000. Is the land a capital asset or an ordinary asset? Explain.
The land is a capital asset because it is neither for sale in the ordinary course of
business nor a property used in the trade or business of the taxpayer.

Is there any income tax due on the sale? Explain.

Yes. Mr. Naval is liable to the 6% capital gains tax imposed under the Tax Code
based on the gross selling price of 800,000 which is an amount higher than the zonal
value.

In January 1970, Juan Gonzales bought one hectare of agricultural land in Laguna for
100,000. This property has a current fair market value of 10 million in view of the
construction of a concrete road traversing the property. Juan Gonzales agreed to
exchange his agricultural lot in Laguna for a one-half hectare residential property
located in Batangas, with a fair market value of 10 million, owned by Alpha Corporation,
a domestic corporation engaged in the purchase and sale of real property. Alpha
Corporation acquired the property in 2007 for 9 million. What is the nature of the real
properties exchanged for tax purposes - capital asset or ordinary asset? Explain.
 The one hectare agricultural land owned by Juan Gonzales is a capital asset
because it is not a real property used in trade or business. The one-half hectare
residential property owned by Alpha Corporation is an ordinary asset because the
owner is engaged in the purchase and sale of real property.

Is Juan Gonzales subject to income tax on the exchange of property? If so, what is the
tax base and rate? Explain.
Yes. The tax base in a taxable disposition of a real property classified as a
capital asset is the higher between two values: the fair market value of the property
received in exchange and the fair market value of the property exchanged. Since the
fair market value of two properties are the same, the said fair market value should be
taken as the tax base which is 10 million. The income tax rate is 6%.

Is Alpha Corporation subject to income tax on the exchange of property? If so, what is
the tax base and rate? Explain.
Yes. The gain from the exchange constitutes an item of gross income, and being
a business income, it must be reported in the annual income tax return of Alpha
Corporation. From the pertinent items of gross income, deductions allowed by law from
gross income can be claimed to arrive at the net income which is the tax base for the
corporate income tax rate of 30%.

Mr. H decided to sell the house and lot wherein he and his family have lived for the past
10 years, hoping to buy and move to a new house and lot closer to his children’s school.
Concerned about the capital gains tax that will be due on the sale of their house, Mr. H
approaches you as a friend for advice if it is possible for the sale of their house to be
exempted from capital gains tax and the conditions they must comply with to avail
themselves of said exemption.
I would advise Mr. H that it is possible for the sale of their house to be exempted
from capital gains tax provided the following conditions under the Tax Code are
complied with:
1. The proceeds of the sale is fully utilized in acquiring or construction new principal
residence within 18 calendar months from the date of the sale or disposition;
2. The historical cost or adjusted basis of the real property sold or disposed will be
carried over to the new principal residence built or acquired;
3. The Commissioner has been duly notified, through a prescribed return, within 30
days from the date of sale or disposition of the person’s intention to avail of the tax
exemption; and
4. The exemption was availed only once every 10 years.

Cebu Development Inc. (CDI) has an authorized capital stock of 5,000,000 divided into
50,000 shares with a par value of One Hundred Pesos per share. Of the authorized
capital stock, twenty-five thousand shares have been subscribed. Mr. Juan Legaspi is a
stockholder of CDI where he has subscription amounting to 13,000 shares. To fully pay
his unpaid subscription in the amount of 950,000, Mr. Legaspi transferred to the
corporation a parcel of land that he owns by virtue of a Deed of Assignment. Upon
investigation, the BIR discovered that Mr. Legaspi acquired said property for only
500,000. Is Mr. Legaspi liable for any taxable gain?
No. The transfer by Mr. Legaspi to the corporation of the parcel of land in
payment of his unpaid subscription did not increase his stockholdings in the corporation.
It cannot be said that he acquired control of the corporation by virtue of the transfer of
the land. His percentage of stockholdings in the capital stock of the corporation remains
the same after the transfer as before.

Passive investment income

BBB, Inc., a domestic corporation, enjoyed a particularly profitable year in 2014. In June
2015, its Board of Directors approved the distribution of cash dividend to its
stockholders. BBB, Inc. has individual and corporate stockholders. What is the tax
treatment of the cash dividends received from BBB, Inc. by the following stockholders: A
resident citizen
A final withholding tax for 10% shall be imposed upon the cash dividends actually
or constructively received by a resident citizen from BBB, Inc (Section 24B2).

Non-resident alien engaged in trade or business

A final withholding tax of 20% shall be imposed upon the cash dividends actually
or constructively received by a non-resident alien engaged in trade or business from
BBB, Inc (Section 25A2).

Non-resident alien not engaged in trade or business

A final withholding tax equal to 25% percent of the entire income received from
all sources within the Philippines, including the cash dividends received from BBB, Inc
(Section 25B2).

Domestic corporation
Dividends received by a domestic corporation from another domestic corporation,
such as BBB, Inc., shall not be subject to tax (Section 27D4).

Non-resident foreign corporation

A final withholding tax of 15% is imposed on the amount of cash dividends
received from a domestic corporation like BBB, Inc. subject to the condition that the
country in which the non-resident foreign corporation is domiciled, shall allow a credit
against the tax due from it taxes deemed paid in the Philippines equivalent to of 15%
representing the difference between the regular income tax rate and the preferential
rate. Otherwise, it is subject to an income tax of 30% to be withheld at source(Section
28B5b).

Mr. Javier is a non-resident senior citizen. He receives a monthly pension from the
GSIS which he deposits with the PNB-Makati Branch. Is he exempt from income tax
and therefore not required to file an income tax return?
Mr. Javier is exempt from income tax on his monthly GSIS pension (S32B6c) but
not on the interest income that might accrue on the pensions deposited with PNB which
are subject to final withholding tax (S25). Consequently, since Mr. Javier’s sole taxable
income would have been subjected to a final withholding tax, he is not required
anymore to file an income tax return.

What are disguised dividends in income taxation? Give an example.

Disguised dividends are those income payments made by a domestic
corporation, which is a subsidiary of a non- resident foreign corporation, to the latter
ostensibly for services rendered by the latter to the former, but which payments are
disproportionately larger than the actual value of the services rendered. In such case,
the amount over and above the true value of the service rendered shall be treated as a
dividend, and shall be subjected to the corresponding tax of 30% on Philippine sourced
gross income, or such other preferential rate as may be provided under a corresponding
Tax Treaty. Example: Royalty payments under a corresponding licensing agreement.

Annuities, proceeds from life insurance or other types of insurance

Noel Santos is a very bright computer science graduate. He was hired by Hewlett
Packard. To entice him to accept the offer of employment, he was offered the
arrangement that part of his compensation would be an insurance policy with a face
value of 20 Million. The parents of Noel are made the beneficiaries of the insurance
policy. Will the proceeds of the insurance form part of the income of the parents of Noel
and be subject to income tax? Reason briefly.
No. Under the Tax Code, the proceeds of life insurance policy of Noel paid to his
parents upon his death shall not be included in gross income and shall be exempt from
taxation(Section 32B1).

Born of a poor family on 14 February 1944. Mario worked his way through college. After
working for more than 2 years in X Manufacturing Corporation, Mario decided to retire
and avail of the benefits under the very reasonable retirement plan maintained by his
employer. He planned to invest whatever retirement benefits he would receive in a
business that will provide his employer with the needed raw materials. On the day of his
retirement on 30 April 1985, he received 400,000 as retirement benefit. In addition, his
endowment insurance policy, for which he was paying an annual premium of 1,520
since 1965 also matured. He was then paid the face value of his insurance policy in the
amount of 50,000. Is his 50,000 insurance proceeds exempt from income taxation?
No. The 50,000 insurance proceeds is not totally exempt from income tax. Under
the Tax Code, the excluded amount is only that portion which corresponds to the
premiums that he had paid since 1965. He must have paid a total of 30,400 [1520
(annual premium) x 20 years (1965 -1985)]. Accordingly, he will be subject to report as
taxable income the amount of P 19,600 (Section 32B2).

Prizes and awards

Mr. A, a citizen and resident of the Philippines is a professional boxer. In a professional
boxing match held in 2013, he won prize money in United States (US) dollars equivalent
to 300,000. Is the prize money paid to and received by Mr. A in the US taxable in the
Philippines? Why?
 Yes. Under the Tax Code, the income within and without of a resident citizen is
taxable. Since Mr. A is a resident Filipino citizen, his income worldwide is taxable in the
Philippines.

May Mr. A’s prize money qualify as an exclusion from his gross income? Why?
No. The exclusion finds application only to amateur athletes where the prize was
given in an event sanctioned by the appropriate national sports association affiliated
with the Philippine Olympic Committee and not to professional athletes like Mr. A.
Therefore, the prize money would not qualify as an exclusion from Mr. A’s gross income
(Section 32B7d).

The US already imposed and withheld income taxes from Mr. A’s prize money. How
may Mr. A use or apply the income taxes he paid on his prize money to the US when he
computes his income tax liability in the Philippines for 2013?
The Tax Code gives Mr. A the option to either deduct the income taxes withheld
and paid to the US government from his gross income or credit it against his Philippine
income tax liability for taxable year 2013 (Section 34C).

Pensions, retirement benefit or separation pay

Z is a Filipino immigrant living in the United States for more than 10 years. He is retired
and he came back to the Philippines as a balikbayan. Every time he comes to the
Philippines, he stays here for about a month. He regularly receives a pension from his
former employer in the United States, amounting to $1000 a month. While in the
Philippines, with his pension pay from his former employer, he purchased three
condominium units in Makati which he is renting out for 15,000 a month each. Does the
$1000 pension become taxable because he is now residing in the Philippines? Reason
briefly.
No. Under the Tax Code, the provisions of any existing law to the contrary
notwithstanding, the $1000 pension received by Z from his former employer in the
United States shall not be included in his gross income and shall be exempt from
taxation (Section 32B6c).

X, an employee of ABC Corporation died. ABC Corporation gave X’s widow an amount
equivalent to X’s salary for one year. Is the amount considered taxable income to the
widow? Why?
No. The amount received by the widow from the decedent’s employer may either
be a gift or a separation benefit on account of death. Both are exclusions from gross
income pursuant to provisions of the Tax Code (Section 32B).

A, an employee of the Court of Appeals, retired upon reaching the compulsory age of 65
years. Upon compulsory retirement, A received the money value of his accumulated
leave credits in the amount of 500,000. Is said amount subject to tax? Explain.
No. The commutation of leave credits, more commonly known as terminal leave
pay, i.e., the cash equivalent of accumulated vacation and sick leave credits given to an
officer or employee who retires, or separated from the service through no fault of his
own, is exempt from income tax (Section 32B6a).
Under what conditions are retirement benefits received by officials and employees of
private firms excluded from gross income and exempt from taxation?
Retirement benefits received under R.A. No. 7641 and those received by officials
and employees of private firms, whether, individual or corporate, in accordance with the
employer’s reasonable private benefit plan approved by the BIR, are excluded from
gross income and exempt from income taxation if the retiring official or employee
was:TFON
1. In service of same employer for at least 10 years;
2. Not less than fifty years of age at time of retirement;
3. Availed of the benefit of exclusion only once.
4. The retiring official or employee should not have previously availed of the privilege
under the retirement plan of the same or another employer (Section 32B6a).

Income from any source

Explain briefly whether income from any source is taxable or non- taxable:
It is taxable. The law imposes a tax on income from any source whatever which
means that it includes income whether legal or illegal.

Exclusions and exemptions

Rationale
Taxpayers who may avail
Distinguished from deductions and tax credits
Deductions from gross income
State with reasons the tax treatment of proceeds of life insurance received by a child as
irrevocable beneficiary the preparation of annual income tax returns.
Under the Tax Code, the proceeds of life insurance received by a child as
irrevocable beneficiary are not to be reported in the annual income tax returns, because
they are excluded from gross income and not subject to income taxation (Section
32B1).

Mr. Rodrigo, an 80-year old retired businessman, fell in love with 20-year old Tetchie
Sonora, a night club hospitality girl. Although she refused to marry him she agreed to be
his “live-in" partner. In gratitude Mr. Rodrigo transferred to her a condominium unit,
where they both live, under a deed of sale for 10 Million. Mr. Rodrigo paid the capital
gains tax of 6% of 10 Million. The Commissioner of Internal Revenue found that the
property was transferred to Tetchie Sonora by Mr. Rodrigo because of the
companionship she was providing him. Accordingly, the Commissioner made a
determination that Sonora had compensation income of 10Million in the year the
condominium unit was transferred to her and issued a deficiency income tax
assessment. Tetchie Sonora protests the assessment and claims that the transfer of the
condominium unit was a gift and therefore excluded from income. How will you rule on
the protest of Tetchie Sonora? Explain.
I will grant the protest and cancel the assessment. The transfer of the property by
Mr. Rodrigo to Ms. Sonora was gratuitous. The deed of sale indicating a 10 million
consideration was simulated because Mr. Rodrigo did not receive anything from the
sale. The problem categorically states that the transfer was made in gratitude to Ms.
Sonora’s companionship. The transfer being gratuitous is subject to donor’s tax. Mr.
Rodrigo should be assessed deficiency donor’s tax and a 50% surcharge imposed for
fraudulently simulating a contract of sale to evade donor’s tax.

Mr. Infante was hit by a wayward bus while on his way to work. He survived but had to
pay 400,000 for his hospitalization. He was unable to work for six months which meant
that he did not receive his usual salary of 10,000 a month or a total of 60,000. He sued
the bus company and was able to obtain a final judgment awarding him 400,000 as
reimbursement for his hospitalization, 60,000 for the salaries he failed to receive while
hospitalized, 200,000 as moral damages for his pain and suffering, and 100,000 as
exemplary damages. He was able to collect in full from the judgment. How much
income did he realize when he collected on the judgment? Explain.
None. The 200,000 moral and exemplary damages are compensation for injuries
sustained by Mr. Infante. The 400,000 reimbursement for hospitalization expenses and
the 60,000 for salaries he failed to receive are amounts of any damages received
whether by suit or agreement on account of such injuries. The Tax Code specifically
exclude these amounts from the gross income of the individual injured (Section 32B4).

JR was a passenger of an airline that crashed. He survived the accident but sustained
serious physical injuries which required hospitalization for 3 months. Following
negotiations with the airline and its insurer, an agreement was reached under the terms
of which JR was paid the following amounts: 500,000 for his hospitalization; 250,000 as
moral damages; 300,000 for loss of income during the period of his treatment and
recuperation. In addition, JR received from his employer the amount of 200,000
representing the cash equivalent of his earned vacation and sick leaves. Which, if any,
of the amounts he received are subject to income tax? Explain.
The amount of 200,000 that JR received from his employer is subject to income
tax except the money equivalent of ten days unutilized vacation leave credits which is
not taxable. Amounts of vacation allowances or sick leave credits which are paid to an
employee constitutes compensation. The amounts that JR received from the airline are
excluded from gross income and not subject to income tax because they are
compensation for personal injuries suffered from an accident as well as damages
received as a result of an agreement (negotiation) on account of such injuries (Section
32B4).

A Co., a Philippine corporation, has two divisions manufacturing and construction. Due
to the economic situation, it had to close its construction division and lay-off the
employees in that division. A Co. has a retirement plan approved by the BIR, which
requires a minimum of 50 years of age and 10 years of service in the same employer at
the time of retirement. There are 2 groups of employees to be laid off:
a. Employees who are at least 50 years of age and has at 10 years of service at the
time of termination of employment.
b. Employees who do not meet either the age or length of service.
A Co. plans to give the following:
For category (A) employees – the benefits under the BIR approved plan plus an ex
gratia payment of one month of every year of service.
For category (B) employees – one month for every year of service. For both categories,
the cash equivalent of unused vacation and sick leave credits. A Co. seeks your advice
as to whether or not it will subject any of these payments to withholding tax. Explain
your advice.
The payments to for Category A employees are not subject to withholding tax.
The benefits received under the BIR-approved plan upon meeting the service
requirement and age requirement are excluded from gross income (Section 32B6a).
The ex gratia payment also qualifies as an exclusion from gross income being in the
nature of benefit received on account of separation due to causes beyond the
employees' control (Section 32B6b). The cash equivalent of unused vacation and sick
leave credits qualifies as part of separation benefits excluded from gross income.
All the benefits received by category B employees will also not be subject to
withholding tax. These are benefits received on account of separation due to causes
beyond the employees' control, which are specifically excluded from gross income
(Section 32B6b).

Onyoc, an amateur boxer, won in a boxing competition sponsored by the Gold Cup
Boxing Council, a sports association duly accredited by the Philippine Boxing
Association. Onyoc received the amount of 500,000 as his prize which was donated by
Ayala Land Corporation. The BIR tried to collect income tax on the amount received by
Onyoc and donor’s tax from Ayala Land Corporation, which taxes, Onyoc and Ayala
Land Corporation refuse to pay. Decide.
The prize will not constitute a taxable income to Onyoc, said prizes and awards
be subject to donor’s tax, hence the BIR is not correct in imposing the taxes. Under the
law, all prizes and awards granted to athletes in local and international sports
tournaments and competitions held in the Philippines or abroad and sanctioned by their
respective national sports associations shall be exempt from taxation (Section 327d).

Deductions from gross income

Peter is the Vice-President for Sales of Golden Dragon Realty Conglomerate, Inc.
(Golden Dragon). A group of five foreign investors visited the country for possible
investment in the condominium units and subdivision lots of Golden Dragon. After a tour
of the properties for sale, the investors were wined and dined by Peter at the posh
Conrad's Hotel at the cost of 150,000. Afterward, the investors were brought to a party
in a videoke club which cost the company 200,000 for food and drinks, and the amount
of 80,000 as tips for business promotion officers. Expenses at Conrad's Hotel and the
videoke club were receipted and submitted to support the deduction for representation
and entertainment expenses. Decide if all the representation and entertainment
expenses claimed by Golden Dragon are deductible. Explain.
Not all of the representation and entertainment expenses claimed by Golden
Dragon are deductible. I would allow only a deduction in such amounts as are
reasonable under the circumstances but in no case shall all deductions for
representation and entertainment expenses, including those above enumerated, exceed
0.50% of net sales.
Masarap Food Corporation (MFC) incurred substantial advertising expenses in order to
protect its brand franchise for one of its line products. In its income tax return, MFC
included the advertising expense as deduction from gross income, claiming it as an
ordinary business expense. Is MFC correct? Explain.
No. The protection of taxpayer’s brand franchise is analogous to the
maintenance of goodwill or title to one’s property which is in the nature of a capital
expenditure. An advertising expense, of such nature does not qualify as an ordinary
business expense, because the benefit to be enjoyed by the taxpayer goes beyond one
taxable year.

Give the requisites for deductibility of a loss. OACCE

1. They must be ordinary losses that are incurred by a taxable entity as a result of its
day to day operations conducted for profit or otherwise, or casualty losses.
2. They must have been losses that are actually sustained during the taxable year.
3. Must not have been compensated for by insurance or other forms of indemnity.
4. If they are casualty losses, they are of property connected with trade, business, or
profession and the lose arises from fires, storms, shipwreck, or other casualties, or from
robbery, theft or embezzlement.
5. Must not have been claimed as a deduction for estate tax purposes in the estate tax
return.

A is a travelling salesman working full time for Nu Skin Products. He receives a monthly
salary plus 3% commission on his sales in a Southern province where he is based. He
regularly uses his own car to maximize his visits even to far flung areas. One fine day a
group of militants seized his car. He was notified the following day by the police that the
marines and the militants had a bloody encounter and his car was completely destroyed
after a grenade hit it. A wants to file a claim for casualty loss. Explain the legal basis of
your tax advice.
A is not entitled to claim a casualty loss because all of his income partake the
nature of compensation income. Under the Tax Code, taxpayers earning compensation
income arising from personal services under an employer-employee relationship are not
allowed to claim deduction.

Rakham operates the lending company that made a loan to Alfonso in the amount of
120,000 subject of a promissory note which is due within one year from the note’s
issuance. Three years after the loan became due and upon information that Alfonso is
nowhere to be found, Rakham asks you for advice on how to treat the obligation as “bad
debt.” Discuss the requisites for deductibility of a “bad debt.”
I shall advise Rakham to treat the obligation as “bad debt” by deducting the same
from his income tax return, and proving compliance with the following requisites
required by the Tax Code: ECSAADR
a. There must be an existing indebtedness due to the taxpayer which must be valid and
legally demandable.
b. The same must be connected with the taxpayer’s trade, business or practice of
profession.
c. The same must not be sustained in a transaction entered into between related
parties.
d. The same must be actually charged off the books of accounts of the taxpayer as of
the end of the taxable year.
e. The debt must be actually ascertained to be worthless and uncollectible during the
taxable year.
f. The debts are uncollectible despite diligent effort exerted by the taxpayer.
g. Must have been reported as receivables in the income tax return of the current or
prior years.

Explain if depreciation of goodwill is deductible from gross income for income tax
purposes. Disregard who is the person claiming the expense.
Depreciation for goodwill is not allowed as deduction from gross income. Under
the Tax Code, while intangibles maybe allowed to be depreciated or amortized, it is only
allowed to those intangibles whose use in the business or trade is definitely limited in
duration. Such is not the case with goodwill.

The Filipinas Hospital for Crippled Children is a charitable organization. X visited the
hospital, on his birthday, as was his custom. He gave 100,000 to the hospital and 5,000
to a crippled girl whom he particularly pitied. A crippled son of X is in the hospital as one
of its patients. X wants to exclude both the 100,000 and the 5,000 from his gross
income. Discuss.
Only the 100,000 contribution of X to Filipinas Hospital for Crippled Children may
be qualified. To be deductible, however, the same must be:
a. actually paid or made to Filipinas Hospital for Crippled Children, which must be
organized and operated exclusively for religious, charitable, scientific, youth and sports
development, cultural or educational purposes or for rehabilitation of veterans or to
social welfare institutions no part of which inures to the benefit of any private individual;
b. made within the taxable year;
c. not more than 10% of the X’s taxable income to be computed without including the
contribution.
The 5,000 contribution to the crippled girl cannot be claimed as a deduction as
the Tax Code accorded no privilege to similar contributions extended to private
individuals.

Concept as return of capital

Itemized deductions vs. Optional Standard Deduction
In 2012, Dr. K decided to return to his hometown to start his own practice. At the end of
2012, Dr. K found that he earned gross professional income in the amount of 1,000,000.
While he incurred expenses amounting to 560,000 constituting mostly of his office
space rent, utilities, and miscellaneous expenses related to his medical practice.
However, to Dr. K’s dismay, only 320,000 of his expenses were duly covered by
receipts. What are the options available for Dr. K so he could maximize the deductions
from his gross income?
In order to maximize his deductions, Dr. K may avail of the optional standard
deduction (OSD) which is an amount not exceeding forty percent of his gross sales or
gross receipts. The OSD can be claimed without being required to present proof or
evidence of expenses paid or incurred by him.

Items not deductible

OXY is the president and chief executive officer of ADD Computers Inc. When OXY was
asked to join the government service as director of a bureau under the Department of
Trade and Industry, he took a leave of absence from ADD. Believing that its business
outlook, goodwill and opportunities improved with OXY in the government, ADD
proposed to obtain a policy of insurance on his life. On ethical grounds, OXY objected to
the insurance purchase but ADD purchased the policy anyway. Its annual premium
amounted to P100,000. Is said premium deductible by ADD Computers, Inc.? Reason.
No. The premium is not deductible because it is not an ordinary business
expense. The term "ordinary’ is used in the income tax law in its common significance
and it has the connotation of being normal, usual or customary. Paying premiums for
the insurance of a person not connected to the company is not normal, usual or
customary. Another reason for its non-deductibility is the fact that it can be considered
as an illegal compensation made to a government employee. This is so because if the
insured, his estate or heirs were made as the beneficiary (because of the requirement of
insurable interest), the payment of premium will constitute bribes which are not allowed
as deduction from gross income.
On the other hand, if the company was made the beneficiary, whether directly or
indirectly, the premium is not allowed as a deduction from gross income.

Noel Santos is a very bright computer science graduate. He was hired by Hewlett
Packard. To entice him to accept the offer of employment, he was offered the
arrangement that part of his compensation would be an insurance policy with a face
value of 20 Million. The parents of Noel are made the beneficiaries of the insurance
policy. Can the company deduct from its gross income the amount of the premium?
Reason briefly.
Yes. The premiums paid are ordinary and necessary business expenses of the
company. They are allowed as a deduction from gross income so long as the employer
is not a direct or indirect beneficiary under the policy of insurance. Since the parents of
the employee were made the beneficiaries, the prohibition for their deduction does not
exist.

Freezy Corporation, a domestic corporation engaged in the manufacture and sale of ice
cream, made payments to an officer of Frosty Corporation, a competitor in the ice
cream business, in exchange for said officer’s revelation of Frosty Corporation’s trade
secrets.
May Freezy Corporation claim the payment to the officer as deduction from its gross
income? Explain.
No. The payments made in exchange for the revelation of a competitor’s trade
secrets is considered as an expense which is against law, morals, good customs or
public policy, which is not deductible. Also, the law will not allow the deduction of bribes,
kickbacks and other similar payments. Applying the principle of ejusdem generis,
payment made by Freezy Corporation would fall under “other similar payments” which
are not allowed as deduction from gross income.