CBA 2 (TAX)

CBA2 (week 1)
Taxation may be defined as a State power, a legislative process, and a mode of
government cost distribution
1. As a state power
Taxation is an inherent power of the State to enforce a proportional
contribution from its subjects for public purpose
2. As a process
Taxation is a process of levying taxes by the legislature of the State to
enforce proportional contributions from its subjects for public purpose
3. As a mode of cost distribution
Taxation is a mode by which the State allocates its costs or burden to its
subjects who are benefited by its spending

The Theory of Taxation

Every government provides a vast array of public services including defense,
public order and safety, health, education, social protection among others.
A system of government is indispensable to every society. Without it, the people
will not relish the benefits of a civilized and orderly society. However, government
cannot exist without a system of funding. The government’s necessity for funding
is the theory of taxation.

The Basis of Taxation

The government provides benefits to people in the form of public services, and the
people provide the funds that finance the government. This mutuality of support
between the people and the government is referred to as the basis of taxation.

Receipt of benefits is conclusively presumed

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Every citizen and resident of the State directly or indirectly benefits from the
public services rendered by the government. While most public services are
received indirectly, their realization by every citizen and resident is undeniable. In
taxation, the receipt of these benefits by the people is conclusively presumed.
Thus, taxpayers cannot avoid payment of tax under the defense of absence of
benefit received. The direct receipt or actual availment of government services is
not a precondition to taxation.

Theories of cost allocation

The government regards the following general considerations in the exercise of its
taxation power:
1. Benefit received theory
2. Ability to pay theory

Benefit Received Theory

This presupposes that the more benefit one receives from the government,
the more taxes he should pay.

Ability to pay theory

This presupposes that taxation should also consider the taxpayer’s ability to
pay. Taxpayers should be required to contribute based on their relative capacity to
sacrifice for the support of the government.
In short, those who have more should be taxed more even if they benefit less from
the government. Those who have less should be taxed less even if they receive
more of the benefits from the government.
Aspects of Ability to Pay Theory
1. Vertical Equity
Vertical Equity proposes that the extent of one’s ability to pay is directly
proportional to the level of his tax base

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2. Horizontal equity
Horizontal equity requires consideration of the particular circumstance of the
taxpayer

Vertical equity is a gross concept while horizontal equity is a net concept.

The Lifeblood Doctrine

Taxes are the lifeblood of the government, and their prompt and certain availability
are an imperious need. Upon taxation depends the government’s ability to serve the
people for whose benefit taxes are collected.
Implications of the lifeblood doctrine in taxation:
1. Tax is imposed even in the absence of a Constitutional grant
2. Claims for tax exemption are construed against taxpayer
3. The government reserves the right to choose the objects of taxation
4. The courts are not allowed to interfere with the collection of taxes
5. In income taxation:
a. Income received in advance is taxable upon receipt
b. Deduction for capital expenditure and prepayments is not allowed as it
effectively defers the collection of income tax
c. A lower amount of deduction is preferred when a claimable expense is subject to
limit
d. A higher tax base is preferred when the tax object has multiple tax bases

Inherent powers of the state

A government has its basic needs and rights which co-exist with its creation. It has
rights to sustenance, protection, and properties. The government sustains itself by
the power of taxation, secures itself and the well-being of its people by police

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power, and secures its own properties to carry out its public services by power of
eminent domain.
These rights are dubbed as “powers” are natural, inseparable, and inherent to every
government. Therefore, the exercise of these powers by the government is
presumably understood and acknowledged by the people from the very moment
they establish their government. These powers are naturally exercisable by the
government even in the absence of an express grant of power in the Constitution.

The Inherent Powers of the State

1. Taxation power is the power of the State to enforce proportional contribution
from its subjects to sustain itself
2. Police power is the general power of the State to enact laws to protect the well-
being of the people
3. Eminent domain is the power of the State to take private property for public use
after paying just compensation
Comparison of three powers of the State
Point of Taxation Police Power Eminent Domain
Difference
Exercising Government Government Government and
Authority private utilities
Purpose For the support To protect the For public use
of the general welfare
government of the people
Persons affected Community or Community or Owner of the property
class of class of
individuals individuals
Amount of Unlimited Limited No amount imposed
Imposition (Tax based on (Imposition is (The government
government limited to cover pays just
needs) cost of compensation)
regulation)
Importance Most important Most superior Important
Relationship with Inferior to “non- Superior to the Superior to the “Non-
the constitution impairment “non-impairment impairment clause” of
clause” of the clause” of the the Constitution
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 Constitution Constitution
Limitation Constitutional Public interest Public purpose and
and Inherent and due process just compensation
limitations

Similarities of the three powers of the State:

1. They are all necessary attributes of sovereignty
2. They are all inherent to the State
3. They are all legislative in nature
4. They are all ways in which the State interferes with private rights and properties
5. They all exist independently of the Constitution and are exercisable by the
government even without Constitutional grant. However, the Constitution may
impose conditions or limits for their exercise.
6. They all presuppose an equivalent form of compensation received by the persons
affected by the exercise of the power
7. The exercise of these powers by the local government units may be limited by
the national legislature.
Scope of the Taxation Power
The scope of taxation is widely regarded as comprehensive, plenary, unlimited,
and supreme.
However, despite the seemingly unlimited nature of taxation, it is not absolutely
unlimited. Taxation has its own inherent limitations and limitations imposed by the
Constitution.
The limitations of Taxation Power
A. Inherent limitation
1. Territoriality of taxation
2. International comity
3. Public purpose
4. Exemption of the government
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 5. Non-delegation of taxing power
B. Constitutional limitations
1. Due process of law
2. Equal protection of law
3. Uniformity rule in taxation
4. Progressive system of taxation
5. Non-imprisonment for non-payment of debt or poll tax
6. Non-impairment of obligation and contract
7. Free worship rule
8. Exemption of religious or charitable entities, non-profit cemeteries,
churches and mosque from property taxes
9. Non-appropriation of public funds or property for the benefit of church,
sect, or system of religion
10. Exemption from taxes of the revenues and assets of non-profit, non-stock
educational institutions
11. Concurrence of majority of all members of Congress for the passage of
law granting tax exemption
12. Non-diversification of tax collections
13. Non-delegation of power of taxation
14. Non-impairment of the jurisdiction of the Supreme Court to review tax
cases
15. The requirement that appropriations, revenue, or tariff bills shall
originate exclusively in the House of Representatives
16. The delegation of taxing power to local government units

INHERIT LIMITATION OF TAXATION

Territoriality of taxation

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 Public services are normally provided within the boundaries of the State.
Thus, government can only demand tax obligations upon its subjects or residents
within its territorial jurisdiction.

Two-fold obligations of taxpayers:

1. Filing of returns and payment of taxes
2. Withholding of taxes on expenses and its remittance to the government

These obligations can only be demanded and enforced by the Philippine

government upon its citizens and residents. It cannot enforce these upon subjects
outside its territorial jurisdiction as this would result in encroachment of foreign
sovereignty.

Exception to territoriality principle

1. In income taxation, resident citizens and domestic corporations are taxable on
income derived within and outside the Philippines
2. In transfer taxation, residents or citizens such as resident citizens, non-resident
citizens and resident aliens are taxable on transfers of properties located within or
outside the Philippines.
International comity
No country is more powerful than the other. It is by this principle that each country
observes international comity or mutual courtesy or reciprocity between them.
Hence,
1. Governments do not tax the income and properties of other governments
2. Governments give primacy to their treaty obligations over their own domestic
tax laws
Embassies or consular offices of foreign governments in the Philippines including
international organizations and their non-Filipino staff are not subject to income
taxes or property taxes. Under the National Internal Revenue Code (NIRC), the

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income of foreign government and foreign government-owned and controlled
corporations are not subject to income tax.
When a state enters into treaties with other states, it is bound to honor of the
agreements as a matter of mutual courtesy with the treaty partners even if the same
conflicts with its local tax laws.

Public purpose
Tax is intended for the common good. Taxation must be exercised absolutely for
public purpose. It cannot be exercised to further any private interest.

Exemption of the government

Under the NIRC, government properties and income from essential public
functions are not subject to taxation. However, income of the government from its
properties and activities conducted for profit including income from government-
owned and controlled corporation is subject to tax.
Non-delegation of taxing power
The legislative taxing power is vested exclusively in Congress and is non-
delegable pursuant to the doctrine of separation of the branches of the government
to ensure a system of checks and balances.
Exceptions to the rule of non-delegation
1. Under the Constitutional, local government units are allowed to exercise the
power of tax to enable them to exercise their fiscal autonomy
2. Under the Tariff and Customs Code, the President is empowered to fix the
amount of tariffs to be flexible to trade conditions.
3. Other cases that require expedient and effective administration and
implementation of assessment and collection of taxes.

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CONSTITUTIONAL LIMITATION OF TAXATION
Observance of due process of law
No one should be deprived of his life, liberty, or property without due process of
law. Tax laws should neither be harsh nor oppressive.
Aspects of Due process
1. Substantive due process
Tax must be imposed only for public purpose, collected only under authority of a
valid law and only by the taxing power having jurisdiction. An assessment without
legal basis violates the requirement of due process
2. Procedural due process
There should be no arbitrariness in assessment and collection of taxes, and the
government shall observe the taxpayer’s right to notice and hearing. The law
established procedures which must be adhered to in making assessments and in
enforcing collections.
Under NIRC, assessments shall be made within three years from the due date of
filing of the return or from the date of actual filing, whichever is later. Collection
shall be made within five years from the date of assessment. The failure of the
government to observe these rules violates the requirement of due process
Equal Protection of the law
No person shall be denied the equal protection of law. This rule applies where the
taxpayers are under the same circumstances and conditions.
Uniformity rule in taxation
The rule of taxation shall be uniform and equitable. Taxpayers under dissimilar
circumstances should not be taxed the same. Each class is taxed differently, but
taxpayers falling under the same class are taxed the same. Hence, uniformity is
relative equality.
Progressive system of Taxation
Congress shall evolve a progressive system of taxation. Under progressive system
of taxation, tax rate increases as the tax base increases The Constitution favors
progressive tax as it is consistent with the taxpayer’s ability to pay.

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Non-imprisonment for non-payment of poll tax
As a policy, no one shall be imprisoned because of his poverty, and no one shall be
imprisoned for mere inability to pay debt.
However, the Constitutional guarantee applies only when the debt is acquired by
the debtor in good faith. Debt acquired in bad faith constitutes estafa, a criminal
offense punishable by imprisonment.

Is non-payment of tax equivalent to non-payment of debt?

Tax arises from law and is a demand of sovereignty. It is distinguished from debt
which arises from private contracts. Non-payment of tax compromises public
interest while the non-payment of debt compromises private interest. The non-
payment of tax is similar to a crime. The Constitutional guarantee on non-
imprisonment for non-payment of debt does not extend to non-payment of tax
except poll tax.

POLL, PERSONAL, COMMUNITY OR RESIDENCY TAX:

Poll tax has two components:
A. Basic community tax
B. Additional community tax
The Constitutional guarantee on non-imprisonment for non-payment of poll tax
applies only to the basic community tax.

Non-impairment of obligation and contracts

The State should set an example of good faith among its constituents. It should not
set aside its obligations from contracts by the exercise of its taxation power.
Free worship rule
The Philippine government adopts free exercise of religion and does not subject its
exercise to taxation. Consequently, the properties and revenues of religious
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institutions such as tithes or offerings are not subject to tax. However, this does not
extend to income from properties or activities of religious institutions that are
proprietary or commercial in nature.
Exemption of religious, charitable or educational entities, non-profit cemeteries,
churches and mosques, lands, buildings, and improvement from property tax
The Constitutional exemption from property tax applies for properties actually,
directly, and exclusively used for charitable, religious, and educational purposes.

Non-appropriation of public funds

This constitutional limitation is intended to highlight the separation of religion and
the state.
Exemption from taxes of the revenues and assets of non-profit, non-stock
educational institutions including grants, endowments, donations, or contributions
for educational purposes
This exemption applies only on revenues and assets that are actually, directly, and
exclusively devoted for educational purposes.
Consistent with this constitutional recognition of education as a necessity, the
NIRC also exempts government educational institutions from income tax and
subjects private educational institutions to a minimal 10% income tax
Concurrence of a majority of all members of Congress for the passage of a law
granting tax exemption
The Constitution requires the vote of the majority of all members of Congress in
the grant of tax exemption.
In the approval of an exemption law, an absolute majority or the majority of all
members of Congress, not a relative majority or quorum majority, is required.
However, in the withdrawal of tax exemption, only a relative majority is required.

Non-diversification of tax collections

Tax collections should be used only for public purpose.
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Non-delegation of the power of taxation
The principle of checks and balances in a republican state requires that taxation
power as part of lawmaking be vested exclusively in Congress.
However, delegation may be made on matters involving the expedient and
effective administration and implementation of assessment and collection of taxes.
Also, some aspects of the taxing process that are non-legislative in character are
delegated.
Non-impairment of jurisdiction of the Supreme Court to review tax cases
Notwithstanding the existence of Court of Tax Appeals, which is a special court,
all cases involving taxes can be raised to and finally decided by the Supreme Court
of the Philippines.
Appropriations, revenue, or tariff bills shall originate exclusively in the House of
Representatives, but the Senate may propose, or concur with amendments
Laws that add income to the National Treasury and those that allows spending
therein must originate from the House of Representatives while Senate may concur
with amendments.
Each local government unit shall exercise the power to create its own sources of
revenue and shall have a just share in the national taxes
This is a constitutional recognition of the local autonomy of local governments and
an express delegation of the taxing power.
Stages of the exercise of Taxation Power
1. Levy or imposition
2. Assessment and collection
Levy or imposition
This involves enactment of a tax law by Congress and is called impact of taxation.
It is also referred to as the legislative act in taxation.
Congress is composed of two bodies:
1. The House of Representatives, and
2. The Senate

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As mandated by the Constitution, tax bills must originate from the House of
Representatives. Each may, however, have their own versions of a proposed law
which is approved by both bodies, but tax bills cannot originate exclusively from
the Senate.
Matters of legislative discretion in the exercise of taxation
1. Determine the object of taxation
2. Setting the tax rate or amount to be collected
3. Determine the purpose for the levy which must be public use
4. Kind of tax imposed
5. Apportionment of the between the national and local government
6. Situs of taxation
7. Method of collected
Assessment and Collection
The tax law is implemented by the administrative branch of the government.
Implementation involves assessment or the determination of the tax liabilities of
taxpayers and collection. This stage is referred to as incidence of taxation or the
administrative act of taxation.

SITUS OF TAXATION
Situs is the place of taxation. It is the tax jurisdiction that has the power to levy
taxes upon the tax object. Situs rules serve as frames of reference in gauging
whether the tax object is within or outside the tax jurisdiction of the taxing
authotity.
Examples of Situs Rules:
1. Business tax situs: Businesses are the subject to the tax in the place when the
business is conducted
2. Income tax situs on service: Service fees are subjected to tax where they are
rendered.
3. Income tax situs on sale of goods: The gain on sale is subjected to tax in the
place of sale.
4. Property tax situs: Properties are taxable in their location.

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 5. Personal tax situs: Persons are taxable in their place of residence
OTHER FUNDAMENTAL DOCTRINES IN TAXATION
1. Marshall Doctrine – “The power to tax involves the power to destroy”.
Taxation power can be used as an instrument of police power. It can be used
to discourage or prohibit undesirable activities or occupation. As such,
taxation power carries with it the power to destroy.

However, the taxation power does not include the power to destroy if it used
solely for the purpose of raising revenue.

2. Holmes’ Doctrine - “Taxation power is not power to destroy while the

court sits”. Taxation power may be used to build or encourage beneficial
activities or industries by the grant tax incentives

While the Marshall Doctrine and the Holme`s Doctrine appear to contradict
each other, both are actually employed in practice in practice. A good
manifestation of the Marshall Doctrine is the imposition of excessive tax on
cigarettes

3. Prospective of tax laws – Tax laws are generally prospective in operation.

An ex post facto or a law that retroacts is prohibited by the Constitution.

Exceptional, income tax laws may operate retrospectively. If so intended by

Congress under certain justifiable conditions. For example, Congress can
levy tax on income earned during periods of foreign occupation even after
the war.

4. Non-Compensation or set-off - Taxes are not subject to automatic set-off

compensation. The taxpayer cannot delay payment of tax to wait for the
resolution of a lawsuit involving his pending claim against the government.
Tax is not a debt; hence, it is not subject to set-off. This rule is important to
allow the government sufficient period to evaluate the validity of the claim.

Exceptions:

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 a) Where the taxpayer`s claim has an already become due and
demandable such as when the government already recognize the same
and an appropriation for refund was made
b) Cases of obvious overpayment of taxes
c) Local taxes

5. Non-assignment of taxes – Tax obligation cannot be assigned or transferred

to another entity by contract. Contracts executed by taxpayers to such effect
shall not prejudice the right of the government to collect.

6. Imprescriptibillity in taxation – Prescription is the lapsing of a right due to

the passage of time. When one sleep on his right over an unreasonable of
time, he is presumed to be waiving his right. The government`s right to
collect taxes does not prescribe unless the law itself provides for such
prescription.

Under the NIRC, tax prescribes if not collected within 5 years from the date
of its assessment. In the absence of an assessment, tax prescribes if not
collected by judicial action within 3 years from the sate the return is required
to be filed. However, taxes due from taxpayers who did not file return or
those who filed fraudulent returns do not prescribe.

7. Doctrine of estoppel – Under the doctrine of estoppel, any

misrepresentation made by one part toward another who relied therein in
good faith will be held true and binding against that person who made the
misrepresentation.

The government is not subject to estoppel. The error of any government

employee does not bind the government. It is held that the neglect or
omission of government officials entrusted with the collection of taxes
should not be allowed to bring harm or detriment to the interest of the
people. Also subsequent correct application of the same.

8. Judicial Non-interference – Generally, courts are not allowed to issue

injunction against the government pursuit to collect tax as this would
unnecessarily defer tax collection. This rule is anchored on the Lifeblood
Doctrine.

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9. Strict Construction of Taxes Laws – When the law provides for taxation,
taxation is the general rule unless there is a clear exemption. Hence the
maxim, “Taxation is the rule, exemption the exception.’’

When the language of the law is clear and categorical, there is no room from
interpretation. There is only room for application. However, when taxation
laws are vague, the doctrine of strict legal construction is observed.

Vague tax laws

Vague tax laws are constructed against the government and in favour of the
taxpayers. A vague tax law means no tax law. Obligation arising from law
not presumed. The Constitutional requirement of the due process requires
laws to be sufficiently clear and expressed in their provisions.

Vague exemption laws

Vague tax exemption laws are construed against the taxpayer in the favour
of the government. A vague tax exemption law means no exemption law.
The claim for exemption is construed strictly against the taxpayer in
accordance with the lifeblood doctrine.

The right of taxation is inherit to the State. It is a prerogative essential the

perpetuity of the government. He who claims exemption from the common
burden must justify his claims by the clearest grant of organic or the statue
law.

When exemption is claimed, it must be shown indubitably to exist. At the

outset, every presumption is against it. A well-founded doubt is a fatal to the
claim; it is only when the terms of the concession are too explicit to admit
fairly of any other construction that the proposition can be supported.

Tax exemption cannot arise from vague inference. Tax exemption must be
clear and unequivocal. A taxpayer claiming a tax exemption must point to a
specific provision of law conferring on the taxpayer, in clear and plain
terms, exemption from common burden. Any doubt whether a tax exemption
exists is resolved against the taxpayer.

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DOUBLE TAXATION
Double taxation occurs when the same taxpayer is twice by the same tax
jurisdiction for the same thing.

Element of double taxation

1. Primary Element: Same object
2. Secondary Elements:
a. Same type of tax
b. same purpose of tax
c. Same jurisdiction
d. Same tax period
Types of Double Taxation
1. Direct double taxation - This occurs when all element of double taxation
exists for both impositions.
Example:
a. An income tax 10% on monthly sales and a 2% income tax on the
annual sales (total of monthly sales)
b. A 5% tax on bank reserve deficiency and another 1% penalty per
day as a consequence of such reserve deficiency

2. Indirect double taxation – This occurs when at least one of the

secondary elements of double taxation is not common for both
impositions.
Examples:
a. The national government levels business tax on the sales gross
receipts of business while the government levels business tax upon
the same sales or receipt.
b. The national government collects income tax from a taxpayer on
his income while the local government collects community tax
upon the same income.
c. The Philippine government taxes foreign incomes of domestic
corporations and resident citizens while a foreign government also
taxes the same income (international double taxation).
Nothing in our law expressly prohibits double taxation. In fact, indirect double
taxation is prevalent in practice. However, direct double taxation is discouraged
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because it is oppressive and burdensome to taxpayers. It is also believed to counter
the rule of equal protection and uniformity in the Constitution.

How can double taxation minimized?

The impact of double taxation can be minimized by any one or combination of the
following:
a. Provision of tax exemption – only one tax law is allowed to apply to a tax
object while the other law exempts the same tax object
b. Allowing foreign tax credit - both tax laws of the domestic made country
and a foreign country tax object but the tax payments made in the foreign
tax law is deductible against the tax due the domestic tax law
c. Allowing reciprocal tax treatment – provisions in tax laws imposing a
reduced tax rate or even exemption if the country of the foreign taxpayer
also give the same treatment to Filipino non-residential therein.
d. Entering into treaties or bilateral agreements – countries may stipulate
for a lower tax rates for their resident if they engage in transaction that
are taxable by both of them.
ESCAPES FROM TAXATION
Escapes from taxation are the means available to the taxpayer to the limit or even
avoid the impact of taxation
Categories of Escapes from Taxation
A. Those that result to loss of government revenue
1. Tax evasion, also known as tax dodging, refers to any act or trick that
trend to illegally reduce or avoid the payment of tax
Example:
a. This can be achieved by gross understatement of income, non-declaration
of income, overstatement of expense or tax credit.
b. Misrepresenting the nature or amount of transaction to take advantage of
lower taxes.

2. Tax avoidance, also known as tax minimization, refers to any act or trick
that reduces or totally escapes taxes by any legally permissible means.
Example:
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 a. Selection and execution of transaction that would expose taxpayers to
lower taxes.
b. Maximizing tax options, tax carry-overs or tax credits
c. Careful tax planning

3. Tax exemption, also known as tax holiday, refers to the immunity,

privilege or freedom from being subject to a tax which other are subject
to. Tax exemptions may be granted by the Constitution, law, or contract.

All forms of tax exemptions can be revoked by Congress except those

granted by Constitution and those granted under contracts.
Those that do not result to loss of government revenue
1. Shifting – this is process of transferring tax burden to other taxpayers.
Forms of Shifting
a. Forward shifting – this is the shifting of tax which follows the noemal
flow of distribution (i.e. from manufacturer to wholesalers, retailers to
consumers). Forward shifting is common with essential commodities and
service such as food and fuel.
b. Backward shifting – This is the reverse of forward shifting. Backward
shifting is common with non-essential commodities where buyer have
considerable market power and commodities with numerous substitute
products.
c. Onward shifting – this refers to any tax shifting in the distribution
channel that exhibits forward shifting or backward shifting.
Shifting is common with business taxes where taxes imposed on business
revenue can be shifted or passed-on to customer.
2. Capitalization – This pertains to the adjustment of the value of an asset
caused by changes in tax rates.

For instance, the value of a mining property will correspondingly decrease

when mining output is subjected to higher taxes. This is form of backward
shifting tax.

3. Transformation – This pertains to the elimination of wastes or losses by the

taxpayers to form savings to compensate for the tax imposition or increase in

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 taxes.

Tax Amnesty
Amnesty is general pardon granted by the government for erring taxpayers to give
them a chance to reform and enable them to have fresh start to be a part of a
society with a clean state. It is an absolute forgiveness or waiver by the
government on its right to collect and is retrospective in application
Tax Condonation
Tax condonation is forgiveness of the tax obligation of a certain taxpayer under
certain justifiable grounds. This is also referred to as tax remission.
Because they deprive the government of revenues, tax exemption, tax refund, tax
amnesty and tax condonation are construed against the taxpayers and in favour of
the government.
Tax Amnesty vs. Tax Condonation
Amnesty covers both civil and criminal liabilities, but condonation covers only
civil liabilities of taxpayers.
Amnesty operators retrospectively by forgiving past violations. Condonation
applies prospectively to any unpaid balance of the tax, hence, the portion already
paid by the taxpayer will not be refunded.
Amnesty is also conditional upon the taxpayer paying the government a portion of
the tax whereas condition requires no payment.

CBA 2 (week 2 & 3)

Taxation Law
Taxation law refers to any law that arises from the exercise of taxation power of
the State.
Types of Taxation Law

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1. Tax Laws – These are laws that provide for the assessment and collection of
taxes
Example:
A. The National Internal Revenue Code
B. The Tariff and Customs Code
C. The Local Tax Code
D. The Real Property Tax Code

2. Tax exemption laws – These are laws that grant certain immunity from taxation
Examples:
A. The minimum wage law
B. The Omnibus Investment Code
C. Barangay Micro-Business Enterprise (BMBE)
D. Cooperative Development Act

Sources of Taxation Laws

1. Constitution
2. Statutes and Presidential Decrees
3. Judicial decisions and case laws
4. Executive Orders and Batas Pambansa
5. Administrative Issuances
6. Local Ordinances
7. Tax treaties and conventions with foreign countries
8. Revenue Regulations

Types of Administrative Issuances

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1. Revenue regulations
2. Revenue Memorandum Orders
3. Revenue Memorandum Rulings
4. Revenue Memorandum Circulars
5. Revenue Bulletins
6. BIR Rulings

Revenue Regulations – are issuances signed by the Secretary of Finance upon

recommendation of Commissioner of Internal Revenue (CIR) that specify,
prescribe, or define rules and regulations for the effective enforcement of the
provisions of the National Internal Revenue Code (NIRC) and related statutes.
Revenue Memorandum Orders are issuances that provide directives or instructions;
prescribe guidelines, and outline processes, operations, activities, workflows,
methods, and procedures necessary in the implementation of stated policies, goals,
objectives, plans, and programs of the Bureau in all areas of operations except
auditing.
Revenue Memorandum Rulings – are rulings, opinions, and interpretations of the
CIR with respect to the provisions of the Tax code and other tax laws as applied to
a specific set of facts, with or without established precedents, and which the CIR
may issue from time to time for the purpose of providing taxpayers guidance on
the tax consequences in specific situations.
Revenue Memorandum Circulars – are issuances that publish pertinent and
applicable portions as well as amplifications of laws, rules, regulations, and
precedents issued by the BIR and other agencies/offices.
Revenue Bulletins refer to periodic issuances, notices, and official announcements
of the CIR that consolidate the BIR’s position on certain specific issues of law or
administration in relation to the provisions of the Tax Code, relevant tax laws, and
other issuances for the guidance of the public.
BIR Rulings are official positions of the BIR to queries raised by taxpayers and
other stakeholders relative to clarification and interpretation of tax laws.
Types of Rulings:
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1. Value Added Tax (VAT) Rulings
2. Internal Tax Affairs Division (ITAD) rulings
3. BIR Rulings
4. Delegated Authority (DA) Rulings

Generally Accepted Accounting Principles (GAAP) vs. Tax Laws

Taxpayers normally follow GAAP in recording transactions in their books.
However, in the preparations and filing of tax returns, taxpayers are mandated to
follow the tax law in case of conflict with GAAP
Nature of Philippine Tax Laws
Philippine tax laws are civil and not political in nature.
Our internal revenue laws are not penal in nature because they do not define crime.
Their penalty provisions are merely intended to secure taxpayers’ compliance.
Elements of valid tax
1. Tax must be levied by the taxing power having jurisdiction over the object of
taxation
2. Tax must not violate constitutional and inherent limitations
3. Tax must be uniform and equitable
4. Tax must be for public purpose
5. Tax must be proportional in character
6. Tax is generally payable in money

Classification of taxes
A. As to purpose
1. Fiscal or revenue tax - tax imposed for general purpose
2. Regulatory – tax imposed to regulate businesses, conduct, acts, or transactions
3. Sumptuary – tax levied to achieve some social or economic objectives
P a g e 23 | 104
B. As to subject matter
1. Personal, poll or capitation – tax on persons who are residents of a particular
territory
2. Property tax – a tax on properties, real or personal
3. Excise or privilege tax – tax imposed upon the performance of an act, enjoyment
of a privilege or engagement in an occupation

C. As to incidence
1. Direct tax – When both the impact and incidence of taxation rest upon the same
taxpayer, the tax is said to be direct.
2. Indirect tax – When the tax is paid by any person other than the one who is
intended to pay the same, the tax is said to be indirect.
The statutory taxpayer is the person named by the law to pay the tax. An economic
taxpayer is the one who actually pays the tax.
D. As to amount
1. Specific Tax – tax of a fixed amount imposed on a per unit basis such as per
kilo, liter or meter, etc.
2. Ad valorem – a tax of a fixed proportion imposed upon the value of the tax
object
E. As to rate
1. Proportional Tax – This is flat or fixed rate
2. Progressive or graduated tax – this is a tax which imposes increasing tax rates as
the tax base increases.
3. Regressive Tax – This tax imposes decreasing tax rates as the tax base increase
4. Mixed tax – This tax manifest tax rates which is a combination of any of the
above types of tax
F. As to imposing authority
1. National Tax – tax imposed by the national government

P a g e 24 | 104
Examples:
A. Income tax
B. Estate tax
C. Donor’s tax
D. Value Added Tax
E. Other percentage tax
F. Excise tax
G. Documentary stamp tax
2. Local tax - tax imposed by the municipal or local government
Examples:
A. Real Property Tax
B. Professional Tax
C. Business taxes, fess, and charges
D. Community tax
E. Tax on banks and other financial institutions
Distinction of taxes with similar items
Tax vs. Revenue
Tax refers to the amount imposed by the government for public purpose. Revenue
refers to all income collections of the government.
Tax vs. License Fee
Tax emanates from taxation power and is imposed upon any object such as
persons, properties, or privileges to raise revenue.
License fee emanates from police power and is imposed to regulate the exercise of
a privilege such as the commencement of a business or a profession.
Tax vs. Toll
Tax is a levy of government; hence, it is a demand of sovereignty. Toll is a charge
for the use of other’s property; hence, it is a demand of ownership.
P a g e 25 | 104
Tax vs. Debt
Tax arises from law while debt arises from private contracts.
Tax vs. Special Assessment
Tax is an amount imposed upon persons, properties, or privileges. Special
assessment is levied by the government on lands adjacent to a public improvement.
Tax vs. Tariff
Tax is an amount imposed upon persons, privilege, transactions, or properties.
Tariff is the amount imposed on imported or exported commodities.
Tax vs. Penalty
Tax is an amount imposed for the support of the government. Penalty is an amount
imposed to discourage an act.
Tax system
Tax system refers to the methods or schemes of imposing, assessing, and collecting
taxes.

Types of tax systems according to imposition

1. Progressive – employed in the taxation of income of individuals, and transfers of
properties by individuals
2. Proportional – employed in taxation of corporate income and businesses
3. Regressive – not employed in the Philippines
Types of tax system according to impact
1. Progressive system
A progressive tax system is one that emphasizes direct taxes. A direct tax cannot
be shifted. Hence, it encourages economic efficiency as it leaves no other resort to
taxpayers than to be efficient.
2. Regressive system

P a g e 26 | 104
A regressive system is one that emphasizes indirect taxes. Indirect taxes are shifted
by businesses to consumers; hence, the impact of taxation rests upon the bottom
end of the society. In effect, a regressive tax system is anti-poor.
Tax Collection Systems
A. Withholding system on income tax – under this collection system, the payor of
the income withholds or deducts the tax on the income before releasing the same to
the payee and remits the same to the government.
1. Creditable withholding tax – an estimated tax required by the government to be
withheld by employers against the compensation income to their employees
A. Withholding tax on compensation – an estimated tax required to be withheld by
the government to be deducted on certain income payments made by taxpayers
engaged in business
B. Expanded withholding tax
2. Final Withholding Tax – a system of tax collection wherein payors are required
to deduct the full tax on certain income payments
Differences between FWT and CWT
Final Withholding Tax Creditable
Withholding Tax
Income tax withheld Full Portion
Coverage of Certain passive income Certain passive income
withholding and active income
Who remits the actual Income payor Income payor for the
tax CWT and the taxpayer
for the balance
Necessity for income Not required Required
tax return for taxpayer

B. Withholding system on business tax – when the national government agencies

and instrumentalities including government-owned and controlled corporations
(GOCCs) purchase goods or services from private suppliers, the law requires
withholding of the relevant business tax

P a g e 27 | 104
C. Voluntary compliance system – the taxpayer himself determines his income,
reports the same through income tax returns and pays the tax to the government.
This is also referred to as “Self-assessment method”.
The tax due determined under this system will be reduced by:
a. Withholding tax on compensation withheld by employers
b. Expanded withholding taxes withheld by suppliers of goods or services
D. Assessment or enforcement system – the government identifies non-compliant
taxpayers, assesses their tax dues including penalties, demands for taxpayer’s
voluntary compliance or enforces collections by coercive means.
Principles of a sound tax system
1. Fiscal Adequacy – requires that sources of government funds must be sufficient
to cover government costs.
2. Theoretical justice – suggest that taxation should consider the taxpayer’s ability
to pay
3. Administrative feasibility – suggest that tax laws should be capable of efficient
and effective administration to encourage compliance.
The following are applications of the principle of administrative feasibility:
1. E-filing and e-payment of taxes
2. Substituted filing for employees
3. Final withholding tax on non-resident aliens or corporations
4. Accreditation of authorized agent banks in the filing and payment of taxes
Tax administration refers to the management of the tax system.
Chief Officials of the Bureau of Internal Revenue
1. 1 commissioner
2. 4 Deputy commissioners
a. Operations group
b. Legal enforcement group
c. Information systems group
P a g e 28 | 104
 d. Resource management group
Powers of the Bureau of Internal Revenue
1. Assessment and collection of taxes
2. Enforcement of all forfeitures, penalties and fines, and judgments in all cases
decided in its favor by the courts
3. Giving effect to, and administering the supervisory and police powers conferred
to it by the NIRC and other laws
4. Assignment of internal revenue officers and other employees to other duties
5. Provision and distribution of forms, receipts, certificates, stamps, etc. to proper
officials
6. Issuance of receipts and clearances
7. Submission of annual report, pertinent information to Congress and reports to
the Congress Oversight Committee in manners of taxation
POWERS OF THE COMMISSIONERS OF INTERNAL REVENUE
1. To interpret provision of the NIRC, subject to review by the Secretary of
Finance

2. To decide tax cases to subject to the exclusive appellate jurisdiction of the

Court of tax Appeals, such as:
a. Disrupted assessments
b. Refunds of internal revenue taxes, fees, or, other charges
c. Penalties imposed
d. Other NIRC and special law matters administered by the BIR

3. To obtain information and to summon, examine =, and take testimony of

persons to affect tax collection
Purpose: For the CIR to ascertain:
a. The correctness of any tax return or in making a return when none has
been made by taxpayers
b. The tax liability of any persons for any internal revenue tax or in
correcting any such liability
c. Tax compliance of the taxpayers

P a g e 29 | 104
 Authorized acts:
a. To examine any book, paper, record or other data relevant to such
inquiry
b. To obtain on a regular basis any information from any person other
than the person whose internal revenue tax liability is subject to audit
c. To summon the person liable for tax or required to file a return, his
employees, or any person having possession and custody of his books
of accounts and accounting records to produce such books, papers,
records or other data to give testimony
d. To take testimony of the person concerned, under oath, as may be
relevant or material to inquiry
e. To cause revenue officers and employees to make canvass any
revenue district

4. To make assessment and prescribe additional requirement for tax

administration and enforcement

5. To examine tax returns and determine tax due thereon

The CIR or his duly authorized representatives may authorize the
examination of the taxpayers and the assessment of the correct amount of
tax. Failure to file a return shall not prevent the CIR from authorizing the
examination.
Tax or deficiency assessment are due upon notice and demand by CIR
and his representatives.
Returns, statement or declaration shall not be withdrawn but may be
modified, changed and amended by the taxpayers within 3 years from the
due of filling, except when a notice from audit or investigation has been
actually served upon the taxpayers
When a return shall not be forthcoming within the prescribed deadline
and when there is a reason to believe that the return is false, incomplete on
erroneous, the CIR shall asses the basis of the evidence available.
In case a person fails to file a required return or the other documents
at the time prescribed by law or wilfully files a false or fraudulent return or
other documents, CIR shall make or amend the return from his own
knowledge and from such information obtained from testimony. The return

P a g e 30 | 104
 shall be presumed prima facie correct and sufficient for all legal purpose.

6. To conduct inventory or surveillance

7. To prescribe presumptive gross sales and receipts for taxpayers when:

a. The tax payer failed to issue receipts; or
b. The CIR believes that the books or other records of the taxpayers do
not correctly reflect the declaration in the return.
The presumptive gross sales or receipt shall be derived from the
performance of similar business under similar circumstances adjusted for
other relevant information.
8. To terminate tax period when the taxpayer is:
a. Retiring from business
b. Intending to leave the Philippines
c. Intending to remove, hid, or conceal his property
d. Intending to perform any act tending to obstruct the proceedings for
the collection of the tax render the same ineffective
The termination of the taxable period shall be communicated through a
notice to the taxpayers together with a request for immediate payment.
Taxes shall be due and payable immediately.
9. To prescribe real property values
The CIR is authorized to divide the Philippines into zones and
prescribe real property values after consultation with competent appraiser.
The values prescribed are referred to as a zonal value.
For purpose of internal revenue taxes, fair values of real property shall
mean whichever is higher of:
a. Zonal value prescribed by the Commissioner
b. Fair market values as shown in the schedule of market values of the
Provincial And City Assessor’s Office.
The NIRC previously used the assesses values which is merely a fraction of
the fair market value. Assessed value is the basis of the real tax in local
taxation. The value to use now is the full fair value of the property.
10.To compromise tax liabilities of taxpayers
11.To inquire into bank deposits, only under the following instances:

P a g e 31 | 104
 a. Determine of the gross estate of decedent
b. To substantiate the taxpayers claim of financial incapacity to pay tax
in an application for tax compromise
In cases of financial incapacity, inquiry can proceed only if the taxpayer
waives his privilege under the Bank Deposit Secrecy Act.
12.To accredit and register tax agents
The denial by the CIR of application of accreditation is appealable to the
Department of Finance. The failure of the Secretary of Finance to act on the
appeal within 60 days is deemed and approval.
13.To refund credit internal revenue taxes

14.To abate or cancel tax liabilities in certain cases

15.To prescribe additional procedures or documentary requirements

16.To delegate his powers to any subordinate officer with a rank equivalent to a
division of office

Non- delegate power of the CIR

The following powers of the Commissioner shall not be delegated
1. The power to recommend the promulgation of rules and regulation to the
Secretary of Finance.

2. The power to issue rulings of first impression or to reverse, revoke or

modify any exiting rulings of the Bureau.

3. The power to compromise or abate any tax liability

Exceptionally, the Regional Evaluation Boards may compromise tax
liabilities under the following:
a. Assessments are issued by the regional offices involving basic deficiency
tax of P500,00 or less and
b. Minor criminal violations discovered by regional and district officials
Composition of the Regional Evaluation Board
a. Regional Director as chairman
P a g e 32 | 104
 b. Assistant Regional Director
c. Heads of the Legal, Assessment and Collection Division
d. Revenue District Officer having jurisdiction over taxpayer

4. The power to assign and reassign internal revenue officers to establishments

where articles subject to excise tax are produced or kept.
Rules is assignments of revenue officers to other duties
1. Revenue officers assigned to an establishment where excisable articles and
kept shall in no case stay there for more than 2 years.
2. Revenue officers assigned to perform assessment and collection function
should not remain in the same assignment for more than 3 years.
3. Assignment of internal revenue officers anf employees of the Bureau is
special duties shall not exceed 1 year.

Agents and Deputies for Collection Internal Revenue Taxes

The following are constituted agents for collection of internal revenue taxes
1. The Commissioner of Customs and his subordinated with respect to
collection of national internal revenue taxes on imported goods

2. The head of appropriate government offices and his subordinates with

respect to the collection of energy tax.

3. Banks duty accredited by the Commissioner with the respect to receipts of

payments of internal revenue taxes authorized to be made thru banks. There
are referred to as authorized government depositary banks (AGBD).

THEIR AGENCIES TASKED WITH TAX COLLECTIONS OR TAX

INCENTIVES RELATED FUNCTIONS
1. Bureau of Customs
2. Board of Investments
3. Philippine Economic Zone Authority
4. Local Government Tax Collection Unit

P a g e 33 | 104
Bureau of Customs (BOC)
Aside from its regulatory functions, the bureau of Customs is tasked to administer
collection of tariffs on imported articles and collection of the Value Added Tax on
importation. Together with BIR, the BOC is under the supervision of the
Department of Finance.
The Bureau of Custom is headed by the Customs Commissioner and assisted by
five Deputy Commissioners and 14 District Collectors.

Board of Investments (BOI)

The BOI is tasked to lead the promotion of investments in the Philippines b
assisting Filipinos and foreign investors to venture and prosper in desirable areas
of economic activities. It supervises the grant of tax incentives under the Omnibus
Investment Code. The BOI is an attached agency of the Department of Trade and
Industry (DTI).
The BOI is composed of five full-time governors, excluding the DTI secretary as
its chairman. The President of the Philippines shall appoint a vice chairman of the
board who shall act as the BOI’s managing head.

Philippine Economic Zone Authority (PEZA)

The PEZA is created to promote investments in export-oriented manufacturing
industries in the Philippines and, among other myriads of functions, supervise the
grant of both fiscal and non-fiscal incentive.
PEZA registered enterprise enjoy tax holidays for certain years, exemption from
import and export taxes including local taxes. The PEZA is also an attached
agency of the DTI.
The PEZA is headed by the director general and is assisted by the three deputy
directors.

Local Government Tax Collecting Units

Provinces, municipalities, cities and barangays also imposed and collect various
taxes to rationalize their fiscal autonomy.

P a g e 34 | 104
The special tax treatments of BOI-registered or PEZA-registered enterprises
including the local taxes imposed by the local governments will be discussed under
Local & Preferential Taxation by the same author.

TAXPAYER CALSSIFIVATION FOR PURPOSES OF TAX

ADMINISTRATION
For purposes of effective and efficient tax administration, taxpayers are classified
into:
1. Large taxpayers – under the supervision of the Large Taxpayers Service (LTS)
of the BIR National Office.
2. Non-large taxpayers – under the supervision of the respective Revenue District
Office (RDOs) where the business, trade or profession of the taxpayer is situated.
Criteria for Large Taxpayer:
A. As to payment
1. Value Added Tax – At least P200, 000 per quarter for the preceding year.
2. Excise Tax – At least P1, 000, 000 tax paid for the preceding year.
3. Income Tax – At least P1, 000, 000 annual income tax for the preceding
year.
4. Withholding Tax - At least P1, 000, 000 annual withholding tax payments
or remittances from all types of withholding taxes.
5. Percentage Tax – At least P200, 000 percentage tax paid or payable per
quarter for the preceding year.
6. Documentary stamp tax – At least P1, 000, 000 aggregate amount per
year.

B. As to financial conditions and results of operations

1. Gross receipts or sales – P1, 000, 000, 000 total annual gross sales or
receipts.
2. Net worth – P300, 000, 000 total net worth at the close of each calendar or
fiscal year.
P a g e 35 | 104
 3. Gross purchases – P800, 000, 000 total annual purchases for the
preceding year.
4. Top corporate taxpayer listed and published by the Securities and
Exchange Commission

Automatic classification of taxpayers as large taxpayers

The following taxpayers shall be automatically classified as large taxpayers upon
notice in writing by the CIR:
1. All branches of taxpayers under the Large Taxpayer’s Service
2. Subsidiaries affiliates, and entities of conglomerates or group of companies of
the large taxpayer
3. Surviving company in case of merger or consolidation of a large taxpayer
4. A corporation that absorbs the operation or business in case of spin-off of a and
large taxpayer
5. Corporation with an authorized capitalization of at least P300, 000, 000
registered with the SEC
6. Multinational enterprises with an authorized capitalization or assigned capital of
at least P300, 000, 000
7. Publicly listed corporations
8. Universal, commercial, and foreign banks (the regular business unit and foreign
currency deposit unit shall be considered one taxpayer for purposes of classifying
them as large taxpayer)
9. Corporate taxpayer with at least P100, 000, 000 authorized capital in banking,
insurance, telecommunication, utilities, and petroleum, tobacco, and alcohol
industries.
10. Corporate taxpayers engaged in the production of metallic minerals

CBA 2 (week 4)

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Chapter 3 - Introduction to Income Tax

CHAPTER 3

INTRODUCTION TO INCOME TAXATION

Chapter Overview and Objectives

This chapter discusses the concept of tax income, the situs of

income, and the types of taxpayers.

After this chapter, readers are expected to comprehend and

demonstrate knowledge on the following:

1. The concept of gross income

2. The types of income taxpayers
3. The general rules in income taxation
4. The income tax situs rules

THE CONCEPT OF INCOME

Why Is Income subject to tax?

Income is regarded as the best measure of taxpayers' ability to pay

tax. It is an excellent object of taxation in the allocation of
government costs.

What Is Income for taxation purposes?

The tax concept of income is simply referred to as "gross Income"

under the NIRC. A taxable item of income is referred to as an "item
of gross income" or Inclusion in gross income".

P a g e 37 | 104
Gross income simply means taxable income in layman's term.
Under the NIRC, however, the term 'taxable income' refers to certain
items of gross income less deductions and personal exemptions
allowable by law. Technically, gross income is broader too pertain to
any income that can be subjected to income tax.

Gross income is broadly defined as any inflow of wealth to the

taxpayer from whatever source, legal or illegal, that Increases net
worth. It includes income from employment, trade, business or
exercise of profession, income from properties, and other sources
such as dealings in properties and other regular or casual
transactions.

ELEMENTS OF GROSS INCOME

1. It is a return on capital that increases net worth.

2. It is a realized benefit
3. It is not exempted by law, contract, or treaty.

RETURN ON CAPITAL

Capital means any wealth or property. Gross income is return on

wealth or property that increase the taxpayers`s net worth.

Illustration

ABC purchased goods for P300 and sold them for P500. P500
consideration can be analyzed as follows:

Selling price (total consideration received) P 500 Total

return

P a g e 38 | 104
Cost (value of inventory forgone) 300 Return of
capital
Mark-up (gross income) P 200 Return on
capital

The return on capital that increase net worth is income subject to

income tax. Return of capital merely maintains net worth; hence,
it is not taxable. An improvement in net worth indicates an ability
to pay tax.

Capital items deemed with infinite value

There are capital items that infinite value are incapable of pecuniary
Valuation. Anything received as compensation for their loss is
deemed a return of capital.

Examples:

1. Life
2. Health
3. Human reputation

Life

The value of life is immeasurable by money. Under sec. 32 of NIRC,

the proceeds of life insurance policies paid to the heirs or
beneficiaries upon death is the insured, whether in a single sum or
otherwise, are exempt from income tax.

P a g e 39 | 104
The proceeds of a life insurance contract collected by an employer
as a beneficiary from the life insurance of an officer or any person
directly interested with his trade are likewise exempt. These
proceeds are viewed as advanced recovery future loss.

However, the following are taxable return on capital from insurance

policies:

a. Any excess amount received over premiums paid by the

insured upon surrender or maturity of the policy (i.e. the
insured outlives the policy.)
b. Gain realized by the insured from the assignment or sale his
insurance policy
c. Interest income from the unpaid balance of the proceeds of
the policy
d. Any excess of the proceeds received over the acquisition
costs and premium payments by an assignee of a life
insurance policy

Health

Any compensation received In consideration for the loss of health

such as compensation for personal injuries or tortuous acts is
deemed a return of capital. Human Reputation

The value of one's reputation cannot be measured financially. Any

indemnity received as compensation for its impairment is deemed a
return of capital exempt from income tax.

Examples include moral damages received from:

P a g e 40 | 104
 a. Oral defamation or slander

b. Alienation of affection

c. Breach of promise to marry

Recovery of lost capital vs. Recovery of lost profits

The loss of capital results in decrease in net worth while the, loss of
profits does not decrease net worth. The recovery of lost capital
merely maintains net worth while the recovery of lost profits
increases net worth. Therefore, the recovery of lost profits is a
return on capital.

Taxable recovery of lost profits

The recovery of lost profits through insurance, indemnity contracts,

or legal suits constitutes a taxable return on capital.

The following are taxable recoveries of lost profits:

a. Proceeds of crop or livestock insurance

b. Guarantee payments
c. Indemnity received from patent infringement suit

Illustration 1

Mang Tomas insured his strawberry crop In a P200,000 crop

insurance coverage against calamities. The crop was eventually
destroyed by an unusual frost Mang Tomas was paid the P200,000
insurance proceeds.

The P200,000 proceeds which is a reimbursement for the lost value

of the future harvest 4 an item of gross income. The value of the lost
P a g e 41 | 104
crops is, In effect, realized not through actual harvest but through the
insurance contract.

Illustration 2

Mr Santiago purchased a franchise. The franchisor guaranteed an

annual franchise income of P100,000 to Mr Santiago. In the first
year of operation, Mr Santiago's outlet only earned P60,000. The
franchisor paid the P40,000 difference to Mr Santiago.

The P40,000 guarantee payment is not a gratuity but a recovery of

lost profit for Mr Santiago; hence, subject to Mr Santiago shall report
P100,000 as franchise income,

Illustration 3

Mindoro Inc. experienced an unusual decline in its income after a

competitor copied its patented invention. Mindoro sued the
competitor patent infringement and was awared an indemnity
P3,000,000.

The P3,000,000 indemnity is a compensation for the income not

realized by Mindoro Inc. to the patent infringement. The same is an
item of gross income.

The recovery of lost income or profits is not intended to compensate

for the loss of capital. It is as good as realization of income; hence, it
is an item of gross income.

REALIZED BENEFIT

What is meant by realized benefit?

P a g e 42 | 104
The “benefit” concept

The term “benefit” means any form of advantage derives by the

taxpayer. There benefit when there is an increase in the net worth
of the taxpayer. An increase net worth occurs when one receives
income, donation or inheritance.

The following are not benefits, hence, not taxable:

a. Receipt of a loan – properties increase but obligations also

increase resoluting in an offsetting effect in networth.

b. Discovery of lost properties – under the law, the finder has an

obligation return the same to the owner.

c. Receipt of money or property to be held in trust for, or to be

remitted to another person.

If the taxpayer is entitled to keep for his account portion of a

receipt, only to portion is a benefit.

Illustration

1. An employee was granted P20,000 transportation advance. He

liquidated P18,000 transportation expenses and was allowed by his
employer to keep the P2,000. Only the P2,000 retained by the
employee is considered income since this was the extent he was
benefiter. (RR2-98)

2. A security agency receives P120,000 from clients, P100,000 of

which is for the salaries of security guards. Under RMC 39-2007,
only the P20,000 attributable the agency is considered income of

P a g e 43 | 104
the agency since it is the extent is its beneficial. The P100,000
pertaining to salaries of security guards is recognized byt the agent
as liability upon receipt.

The 'realized" concept

The term realized means earned. It requires that there is a degree of

undertaking or sacrifice from the taxpayer to be entitled of the
benefit.

Requisites of a realized benefit

1. There must be an exchange transaction.

2. The transaction involves another entity.
3. It increases the net worth of the recipient

Types of Transfers

1. Bilateral transfers or exchanges, stich as:

a. Sale
b. Barter

These are referred to as "onerous transaction”.

2. Unilateral transfers, such as:

a. Succession - transfer of property upon death

b. Donation

These are also referred to as “gratuitous transactions".

Under current usage, unilateral transfers are simply referred to as

"transfers" while bilateral transfers are called "exchanges." Benefits

P a g e 44 | 104
derived from onerous transactions are "earned or realized'; hence,
they are subject to income tax. Benefits derived from gratuitous
transactions are not realized because of the absence of an earning
process. Benefits derived from gratuitous transactions are subject
to transfer tax, not income tax.

3. Complex transactions

Complex transactions are partly gratuitous and partly onerous.

These are commonly referred to as "transfers for less than full and
adequate consideration". The gratuitous portion of the transaction is
subject to transfer tax while the benefit from the onerous portion is
subject to income tax.

Illustration

A taxpayer sold his car which was previously purchased for

PI00,000 and With a current fair value of P180,000 for only
P130,000.

The transaction will be analyzed as follows:

Fair value P 180,000

P50,000 – Subject to transfer
Selling Price 130,000
P30,000 – Subject to transfer
Cost 100,000

The excess of fair value over selling price is gratuity or gift whereas
the excess of the selling price over the cost is an item of gross
income.
P a g e 45 | 104
What is meant by another entity?

Every person, natural or juridical, is an entity. Natural persons are

living person while juridical persons are those created by law such
as partnerships and corporations. An entity may be taxable entity
or an exempt entity. A taxable item of gross income arises from
transactions which involve another natural as juridical entity.

Gains or income derived between relatives, corporations, and

between a partner and the partnership are taxable since it is made
between a holding a parent company and its subsidiaries and
between sister companies are taxable because each corporation is a
separated entity. This applies regardless of the underlying economic
relationship.

However, the sales of a home office to its branch office are not
taxable because they pertain to one and the same taxable entity.
Furthermore, the income between businesses of a proprietor should
not be taxed since proprietorship businesses taxable upon the same
owner. note that a proprietorship business is not juridical entity.

Benefits in the absence of tranfers

The increase in wealth of the taxpayer in the form of appreciation or

increase the value of his properties or decrease in the value of his
obligations in the absence of a sale or barter transaction is not
taxable.

These are referred to as unrealized gains or holding gains because

they haven’t yet materialized in an exchange transaction.

P a g e 46 | 104
Examples of unrealized or holding gains:

a. Increase in value of investments in equity or debt security.

b. Increase in value of real properties held (revaluation increment)

c. Increase in value of foreign currencies held or receivable

d. Decrease in value of foreign currencies denominated debt by the

virtue of favourable fluctuation in exchange rates

e. Birth of animals offspring, accruals of fruits in an orchard or

growth of the vegetables

f. Increase in value of land due to the discovery of mineral reserves

Rendering of services

The rendering of services for a consideration is an exchange but

does not cause loss of capital. Hence, the entire consideration
income or service fees is an item of gross income.

Illustration

Mr Saladin lists the following possible items of gross income:

Compensation income P 200,000

Winnings from gambling 100,000

Increase in value of investments 50.000

Appreciation in the value of land owned 300,000

Debtor Saladin cancelled by creditors in

consideration for services he rendered to them 150,000

P a g e 47 | 104
Debt of Saladin cancelled by his creditor out of affection 250,000

Loan received from a bank 400,000

The items of gross income are:

Compensation income P 200,000

Winnings from gambling 100,000

Debt of Saladin forgiven in consideration

for service rendered to his creditors 150,000

Notes:

1. Gains from gambling and the forgiveness of debt in

consideration of services or properties received are realized
gains from exchanges.
2. The forgiveness of debt out of affection or mere generosity of
the creditor is a gratuitous transfer subject to transfer tax.
3. The loan received from a bank constitutes a transfer but is not
a benefit

Basis of Exemption of Unrealized Income

Normally, taxpayers will have the ability to pay tax when their
income materializes in an exchange transaction since tax is
generally payable in money.

This does not mean, however, that only income realized in cash is
subject to tax. Income realized in non-cash properties are, in effect,

P a g e 48 | 104
received in cash but the taxpayer used the same to acquire the non-
cash property. Income received in non-cash considerations is
taxable at the fair value of the property received. Moreover,
exempting income realized in non-cash considerations would open a
wide avenue for tax evasion since taxpayers can easily divert their
income in the form of non-rash consideration.

Taxable of Receipt/Realization Benefits

Taxable items of income may be realized by the taxpayer in two

ways:

1. Actual receipt

Actual receipt involves actual physical taking of the income in the

form of cash or property.

2. Constructive receipt

Constructive receipt involves no actual physical taking of the

income but the taxpayer is effectively benefited.

Examples:

a. Offset of debt of the taxpayer in consideration for the sale of good

service
b. Deposit of the income to the taxpayer’s checking account
c. Matured detachable interest coupons on coupon bonds not yet
enchased by the taxpayer
d. Increase in the capital of a partner from the profit of the
partnership

P a g e 49 | 104
Inflow of wealth without increase in net worth

The inflow of wealth to a person that does not increase his net
worth is income due to the total absence of benefit.

Examples:

a. Receipt of property in trust

b. Borrowing of money under an obligation to return

In law, the proceeds of embezzlement or swindling where money is

taken with an original intention to return are considered as income
because of the increase net worth of the swindler.

NOT EXEMPTED BY LAW, CONTRACT, OR TREATY

An item of gross income is not exempted by the Constitution, law,

contract or treaty from taxation.

The following items of income are exempted by law from taxation;

hence, they are not considered items of gross income:

1. Income of qualifie employee trust fund

2. Revenues of non-profit non-stock edicational institutions
3. SSS, GSIS, Pag-Ibig, or PhilHealth benefits
4. Salaries and wages of minimum wage earners and qualified
senior citizen
5. Regular income of Barangay Micro-business Enterprises (BMBEs)
P a g e 50 | 104
6. Income of foreign governments and foreign government-owned by
controlled corporation
7. Income international missions and organizations with income tax
immunity

Items of gross income that are exempted from taxation are

discussed extensions under Exclusions in Gross Income in Chapter
8.

TYPES OF INCOME TAXPAYERS

A. Individuals

1. Citizen

a. Resident citizen
b. Non-resident citizen

2. Alien

a. Resident alien
b. Non-resident alien
a. engaged in trade or business
b. not engaged in trade or business Taxable estates and
trusts

B. Corporations

1. Domestic corporation
2. Foreign corporation
a. Resident foreign corporation

P a g e 51 | 104
 b. Non-resident foreign corporation

INDIVIDUAL INCOME TAXPAYERS

Citizens

Under the Constitution, citizens are:

a. Those who are citizens of the Philippines at the time. of

adoption of the Constitution on February 2, 1987
b. Those whose fathers or mothers are citizens of the Philippines
c. Those born before January 17, 1973 of Filipino mothers who
elected Filipino citizenship upon reaching the age of majority
d. Those who are naturalized in accordance with the law.

ClassIflcation of citizens:

A. Resident citizen - A Filipino citizen residing in the Philippines

B. Non-resident citizen includes:
1. A citizen of the Philippines who establishes to the
satisfaction of the Commissioner; the fact of his: physical
presence abroad with a definite intention to reside
therein;
2. A citizen of the Philippines who leaves the Philippines
during the taxable year to reside abroad, either as an
immigrant or for an employment on permanent basis;
3. A citizen of the Philippines who works and derives
income from abroad and whose employment thereat
requires him to be physically present abroad most of the
time during the taxable year;

P a g e 52 | 104
 4. A citizen who has been previously considered as non-
resident citizen and who arrives in the Philippines at any
time during the taxable year to reside citizen in the
Philippines shall likewise be treated as a non-resident
citizen for the taxable year in which he arrives in the
Philippines with respect to his income derived from
sources abroad until the date of his arrival in the
Philippines.

Filipinos working in Philippine embassies or Philippine consulate

offices are not considered non-resident citizens.

Alien

A. Resident Alien – an individual who is residing in the Philippines

but is not citizen thereof, such as:

1. An alien who lives in the Philippines without definite intention

as to be stay; or
2. One who comes to the Philippines for a definite purposes
which in a nature would require an extended stay and to that
end makes his home temporarily in the Philippines, although
it may be his intention all times to return to his domicile
abroad;

An alien who has acquired residence in the Philippines retains his

status such until he abandons the same or actually depart from the
Philippines.
P a g e 53 | 104
B. Non-resident alien – an individual who is not residing in the
Philippines are who is not a citizen thereof

1. 1. Non-resident aliens engaged in business (NRA-ETB) – aliens

who stay in the Philippines for an aggregate period of more
than 180 days during the year.
2. Non-resident aliens not engaged in business (NRA-NETB) –
include:
a. Aliens who come to the Philippines for a definite purpose
which is in nature may be promptly accomplished;
b. Aliens who shall come to the Philippines and stay therein
for the aggregate period of now more than 180 days
during the year.

THE GENERAL CLASSIFICATION RULE FOR INDIVIDUALS

1. Intention

The intention of the taxpayer regarding the nature of his stay

whithin outside the Philippines shall determine his appropriate
residence classification. The taxpayer shall submit to the CIR of
theBIR documentaries proofs suck as visas, work contracts and
other documents indicating such intention.

Documents purporting short term stay such as tourist visa is shall

not result the reclassification of the taxpayer normal residency.
Documents purposes a long term stay such as immigration visa or

P a g e 54 | 104
working visa for an extension period would result in the automatic
reclassification of the taxpayer residency.

Examples:

a. An alien is normally non-resident An alien who come to the

Philippines with a tourist visa would still be classified as
non-resident alien.
b. A citizen is normally resident A citizen who would go abroad
under a tourist visa would still be considered a resident
citizen.
c. An alien who come to the Philippines with an immigration
visa would be reclassified as a resident alien upon his
arrival.
d. A citizen who would go abroad with a two-year working visa
would be reclassified as a non-resident citizen upon his
departure.

2. Length of stay

In default of such documentary proof, the length of stay of the

taxpayer is considered:

a. Citizens staying abroad for a period of at least 183 days are

considered non-resident
b. Aliens who stayed in the Philippines for more than 1 year as
of the end of the taxable year are considered resident

P a g e 55 | 104
 c. Aliens who are staying in the Philippines for not more than
1 year but more than 180 days are deemed non-resident
aliens engaged in business.
d. Aliens who stayed in the Philippines for not more than 180
days are considered non-resident aliens not engaged in
trade or business.

Illustration 1

Luiz Mario Aresmendi, a Mexican actor, was contracted by a

Philippine television company to do a project in the Philippines. He
arrived in the country on February 29, 2019 and returned to Mexico
three weeks later upon completion of the project.

Luiz Mario Arismendi shall be classified as on NRA-NETB in 2019.

His stay is for a definite purpose which in its nature will be
accomplished immediately

Illustration 2

Mamoud Jibril, a Libyan national, arrived in the country on

November 4, 2019. Mr Jibril stayed in the Philippines since then
without any working visa or work permit.

For the year 2019, Mr Jibril would be considered on NRA-NETS

because he stayed in the Philippines for less than 180 days as of
December 31, 2019. If he is still within the Philippines until December
3.1, 2020, he will qualify as a resident alien for 2020.

Illustration 3

P a g e 56 | 104
Without any definite intention as to the nature of his stay, Juan
Masipag, a Filipino citizen, left the Philippines and stayed abroad
abroad from March 15, 2019 to April 1, 2020 before returning
Philippines.

For year 2019, Juan is a non-resident citizen because he is absent

for more than 183 days but he will be classified as resident citizen
for the year 2020 because he is absent for less than 183 days in
2020.

Taxable Estates and Trusts

1. Estate
Estate refers to the properties, rights, and obligations of a
deceased person not extinguished by his death.

Estates under judicial settlement are treated as individual

taxpayers. The estate is taxable on the income of the
properties left by the decedent. Estate under extrajudicial
settlement are exempt entities. The income of the properties of
the estate under extrajudicial settlement is taxable to the hot
2. Trust
A trust is an arrangement whereby one person (grantor or
trustor) transfer (i.e. donates) property to another person
(beneficiary), which will be held under the management of a
third party (trustee or fiduciary).

P a g e 57 | 104
 A trust that is irrevocably designated by the grantor is treated
in taxation as it is an individual taxpayer. The income of the
property held in trust is taxation to the trust. Trusts that are
designated as revocable by the grantor are not taxable entities
and are not considered as individual taxpayers. The income
properties held under revocable trusts is taxable to the grantor
not to the trust.

When the trust agreement is silent as to revocability of the

trust, the trust presumed to be revocable.

CORPORATE INCOME TAXPAYERS

The term 'corporation' shall include partnerships, no matter how

created organized, joint-stock companies, joint accounts,
association, or insurance, companies, except general professional
partnerships and a joint venture consortium formed for the purpose
of undertaking construction projects engaging in petroleum, coal,
geothermal, and other energy operations persuant an operating
consortium agreement under a service contract government.

Hence, the term corporation includes profit-oriented and non-profit

institutions such as charitable institutions,' cooperatives,

P a g e 58 | 104
government agencies, instrumentalities, associations, leagues, civic
or religious and other organization.

Domestic Corporation

A domestic corporation is acorporation that is organized in

accordance in Phillippine laws

Foreign Corporation

A foreign corporation is one organized under a foreign law.

Types of foreign corporations:

1. Resident foreign corporation (RFC) - a foreign corporation which

operates and conducts business in the Philippines through a
permanent establishment (i.e. a branch)
2. Non-resident foreign corporation (NRFC) -a foreign corporation
which does not operate or conduct business in the Philippines

Note

1. A corporation that incorporates in the Philippines is a

domestic corporation under the Incorporation Test even if the
same is controlled by foreigners.
2. A foreign corporation that transacts business with residents
through a resident branch is taxable on such transactions as
a resident foreign corporation through its branch. However, if
it transacts directly to residents outside its branch, its taxable
as a non-resident foreign corporation on the direct
transactions.

P a g e 59 | 104
Special Corporations

Special corporations are domestic or foreign corporations which

are subject to special tax rules or preferential tax rates.

OTHER CORPORATE TAXPAYERS

1. Partnership

A partnership is a business organization owned by two or more

persons who contribute their industry or resources to a common
fund for the purpose of dividing the profits from the venture.

Types of partnership

a. General professional partnership (GPP)

A GPP is a partnership formed for the exercise of a common

profession. All partners, must belong to the same profession.

A GPP is not treated as ta corporation taxable entity. It is

exempt from income tax, but the partners are taxable in their
individual capacity with respect their share in the income of
the partnership.

b. Business partnership

A business partnership is one formed for profit. It is taxable as

a corporation.

Example:

a. A partnership between Andrix, a lawyer, and Mark an

accountant, to practice in taxation advisory services would be

P a g e 60 | 104
 a business partnership since the two partners are not either
same profession.
b. A partnership between accountants Zeus and Darrell to
venture into a beauty parlor would be a business partnership
since the venture is not in practice of a common profession.
c. A partnership between accountants Dominic and Jasmine May
to venture into audit services would be a general professional
partnership.

2. Joint venture

A joint venture is a business undertaking for a particular purpose.

It may be organized as a partnership or a corporation.

Types of joint ventures

a. Exempt joint ventures

Exempt joint ventures are those formed for the purpose of

undertaking construction projects or engaging in petroleum, coal,
geothermal and other energy operations pursuant to an operating
consortium agreement under a service contract with the
Government.

Similar to a GPP, this type of joint venture is not treated as

corporation and is tax-exempt on its regular income, but their
ventures are taxable to their share in the net income of the joint
venture.

b. Taxable joint ventures

P a g e 61 | 104
All other joint ventures are taxable as corporations.

c. Co-ownership

A co-ownership is joint ownership of a property formed for the

purpose of preserving the same and/or dividing its income.

A co-ownership that is limited to property preservation or income

collection is not taxable entity and is exempt but the co-owners are
taxable on the share on the income of the co-owned property.

However, a co-ownership that reinvest the income of the co-owned

property to other income-producing properties or ventures will be
considered or unregistered partnership taxable as a corporation.

THE GENERAL RULES IN INCOME TAXATION

Taxable on income earned

Individual taxpayer Within Without

Resident citizen ✔ ✔
Non-resident citizen ✔
Resident alien ✔
Non-resident alien ✔

Corporate taxpayers
Domestic corporation ✔ ✔
Resident foreign corporation ✔
Non-resident foreign corporation ✔

P a g e 62 | 104
Note:

1. Consistent with the territoriality rule, all taxpayers, except

resident citizens and domestic corporations, are taxable only
on income earned within the Philippines.
2. The NIRC uses the term 'without the Philippines' to mean
outside the Philippines.

The Residency and Citizenship Rule

Taxpayers who are residents and citizens of the Philippines such as

resident citizen and domestic corporations are taxable on all income
from sources within and without the Philippines. A corporation is a
citizen of the country of incorporation. Thus, a domestic corporation
is a citizen of the Philippines.

Basis of the extraterritorial taxation

Resident citizens and domestic corporations derive most of the

benefits from the Philippine government compared to all other
classes of taxpayers by virtue of their proximity to the Philippine
government.

Under our laws, resident citizens and domestic corporations enjoy

preferential privileges over aliens. Also, between resident and non-
resident citizens, resident citizens have full access of the public
services of our government because they are in the country. The
taxation of foreign income of resident citizens and domestic
corporations properly reflects this difference in benefits consistent
with the Benefit Received Theory.

P a g e 63 | 104
The extra-territorial tax treatment of resident citizens and domestic
corporations is also intended as a safety net to the potential loss of
tax revenues brought by situs relocation or the practice of executing
or structuring transactions such that hxome will be realized abroad
to avoid Philippine income taxes.

The Issue of International double taxation

The rule on extraterritorial taxation on resident citizens and

domestic corporations exposes these taxpayers to double taxation.
However, the NIRC allows a tax credit for taxes paid in foreign
countries. In fact, resident citizens and domestic corporations pay
minimal taxes in the Philippines on their foreign income because of
the tax credit

SITES OF INCOME

The situs of income is the place of taxation of income. It is the

jurisdiction that has the authority to impose tax upon the income.

Situs of income vs. source of income

Situs of income should be differentiated from the source of income.

The latter pertains to the activity or property that produces the
income.

Situs is important in determining whether or not an income is

taxable in Philippines. Situs is particularly important to taxpayers
taxable only on income within. However, it is also important to
taxpayers taxable on global income purposes of the computation of
the foreign tax credit.
P a g e 64 | 104
INCOME SITUS RULES

Types of income Place of Taxations (situs)

1. Interest income Debtor’s residence

2. Royalties Where the intangible is employed

3. Rent income Location of the property

4. Service income Place where the service is rendered

Illusration

A taxpayer had the following income:

Interest income from deposits in a foreign bank P
300,000
Interest from domestic bonds 50,000
Royalties from books published in the Philippines 100,000
Rent income from porperties abroad (th lease contracts were
executed in the Philippines) 150,000
Professional fees for services rendered in the
Philippines to non-resident clients (paid in US Dollars)
400,000

Applying the situs rules, the following are the situs of the
aforementioned income:

World
Within Without
Total
Interest on foreign deposits P P P

P a g e 65 | 104
 - 300,000 300,000
Interest from domestic
50,000 50,000
bonds
Royalties from books in the
100,00 100,00
Philippines
Rent income on foreign
150,000 150,000
properties
Professional fees 400,00 400,00
Total P P P
550,00 450,00 1,000,000

Resident citizen or domestic corporation taxpayers would be tax on

the world income while other taxpayers would be taxable only on
the income from within the Philippines.

OTHER INCOME MTUS RULES

A. Gain on sale of properties

1. Personal property
a. Domestic securities - presumed earned within the
Philippines
b. Other personal properties - earned in the place where the
property is sold
2. Real property - earned where the property is located

Illustration

A taxpayer had the following income:

P a g e 66 | 104
Gain on sale of domestic stocks P 200,000
Gain on sale of foreign bonds 100,000
Gain on sale of a commercial lot in Baguio City
500,000
Gain on sale of car in Ontario, Canada 200,000
Gain on sale of machineries in Mexico, Pampanga 250,000
Interest income on foreign bonds 50,000
Dividends on domestic stocks 150,000

The following table summarizes the situs of the foregoing income:

Within Without
Gain on sale of domestic stocks P 200,000
Gain on sale of foreign bonds P 100,000
Gain on sale of commercial lot 500,000
Gain on sale of car in Canada 200,000
Gain on the sale of machineries 250,000
Interest on foreign bonds 50,000
Dividends on domestic stocks 150 000

Total P 1,100,000 P 350,000

B. Dividend income from:

1. Domestic Corporation - presumed earned within

2. Foreign Corporation
P a g e 67 | 104
 a) Resident foreign corporation - depends on the pre-dominance
test

The pre-dominance test

If the ratio of the Philippine gross income over the world gross
income of the resident foreign corporation in the three-year
period preceding the year of dividend declaration is:

 At least 50%, the portion of the dividend corresponding to

the Philippine gross income ratio is earned within,
 Less than 50%, the entire dividends received is earned
abroad

b) Non-resident foreign corporation - earned abroad

Illustration

In 2019, Sarah received a P400,000 dividend income from ABC

corporation. ABC Corporation had the following gross income in
2016 through 2018:

2016 2017 2018 Total

Philippines P 100,000 P 200,000 P 300,000 P 600,000
Abroad 200, 000 100,000 100,000 400,000
Total P 300, 000 P 300,000 P 400,000 P
1,000,000

If ABC Corporation is a:

1. Domestic Corporation – the entire P400,000 is earned within

2. Non-resident foreign corporation – the entire P400,000 is
earned abroad.
P a g e 68 | 104
3. Resident foreign corporation – the P400,000 dividend shall be
split

Gross Income Ratio = P600,000/P1,000,000 = 60%

Earned within the Philippines (60% x P400,000) P
240,000
Earned without the Phillippines (40% x P400,000)
160,000
Total dividends P
400,000

Supposing that the ratio is 49% the entire P400,000 will be

deemed earned outside the Philippines.

C. Merchandising Income – earned where the property is sold

Illustration

Source of gross income Amount

Goods purchased and sold within P
200,000
Goods purchased within and sold abroad
100,000
Goods purchased abroad and sold within
150,000
Goods purchased and sold abroad
350,000

The income earned within and without shall be:

P a g e 69 | 104
 Within Without
Purchased and sold within P 200,000
Purchased within and sold abroad P
100,000
Purchased abroad and sold within 150,000
Purchased abroad and sold abroad
350,000
Total P 350,000 P 450,000

D. Manufacturing income – earned where the goods are

manufactured and sold

Operations Remarks
Productio Distribution
n
Total income from production and
Within Within distribution is earned within the
Philippines
Total income from production and
Without Without distribution is earned without the
Philippines
Product income is earned within,
Within Without Distribution income is earned
without
Distribution income is earned
Without Within within, Production income is
earned without
Illustration 1

P a g e 70 | 104
Butuan Inc. manufactures goods and sells them through its
branch. Butuan bills its branch established market prices. Butuan
reported the following gross income:

Home office Branch Total

Sales P 4,000,000 P 2,000,000

P 6,000,000
Cost of goods sold 2,400,000 1,200,000
3,600,000
Gross income P 1,600,000 P 800,000 P
2,400,000

The following shows the status of the gross income of Butuan under
each of the following scenario:

Scenario Home Office Branch Within

Without
No.1 Philippines Philippines P
2,400,000 P 0
No.2 Abroad Abroad 0
2,400,000
No.3 Philippines Abroad 1,600,000
800,000
No.4 Abroad Philippines 800,000
1,600,000

Note:

P a g e 71 | 104
 1. Both production and distribution are conducted by the same
taxable entity, Butuan Inc.
2. The branch is not a separate taxable entity but is an integral
part of Butuan Inc; hence, its income is taxable to Butuan Inc.

Illustration 2

Assuming production is conducted by a parent corporation and the

distribution is conducted by its subsidiary corporation

Parent Subsidiary Total

Sales P 4,000,000 P 2,000,000 P
6,000,000
Cost of goods sold 2,400,000 1,200,000 3,600,000
Gross income P 1,600,000 P 800,000 P
2,400,000

The gross income recognized by each corporation is taxable to each

corporation because each corporation is a separate taxpayer. The
situs of taxation shall be the place of sale without regard to the
seller or the supplier.

The following are the situs of income for the parent corporation:

Scenari Subsidiar
Parent Within Without
o y
No. 1 Philippine Philippines P
P
s 1,600,000
No. 2 Abroad Abroad - 1,600,000
No. 3 Philippine Abroad 1,600,000 -
P a g e 72 | 104
 s
No. 4 Abroad Philippines - 1,600,000

The following are the situs of income for the subsidiary corporation:

Scenari Subsidiar
Parent Within Without
o y
No. 1 Philippine Philippines P
P 800,000
s -
No. 2 Abroad Abroad - 800,000
No. 3 Philippine Abroad
- 800,000
s
No. 4 Abroad Philippines 800,000 -

Note to readers:
Readers are advised to master the situs rules as this have a
significant effect on your comprehension of advanced tax rules to
be introduces in succeeding chapters.

CBA 2(week 5)

CHAPTER 4
INCOME TAX SCHEMES, ACCOUNTING PERIODs, ACCOUNTING
METHODS, AND REPORTING
Chapter Overview and Objectives
This chapter provides an overview of the income tax schemes under the NIRC.
After this chapter, readers are expected to gain familiarization and demonstrate
mastery of the following:
P a g e 73 | 104
 a. Types of taxation schemes and their scope
b. Concept of accounting period and its types
c. Concept of accounting methods and their accounting procedures
d. Types of tax returns, their deadline and place of filing

INCOME TAXATION SCHEMES

There are three income taxation schemes under the NIRC:
a. Final income taxation
b. Capital gains taxation
c. Regular income taxation
An item of gross income is taxable in any of these tax schemes.
Item of gross income

Taxable to any one of

Final Income Taxation Capital Gains Taxation Regular Income

Taxation

Mutually exclusive coverage

The tax schemes are mutually exclusive. An item of gross income that is subject to
tax in one scheme will not be taxed by the other schemes. Similarly, items of
income that are exempted in one scheme are not taxable by the other schemes.

CLASSIFICATION OF ITEMS OF GROSS INCOME

Because of the different tax schemes, items of gross income can be classified as
follows:
I. Gross income subject to final tax
P a g e 74 | 104
2. Gross income subject to capital gains tax
3. Gross income subject to regular tax
Readers are advised to master the coverage of both final income tar and capital
gains tax. A thorough understanding of these exceptional tax treatments is very
essential to your mastery of Income Taxation.
FINAL INCOME TAXATION
Final income taxation is characterized by final taxes wherein full taxes are
withheld by the income payor at source. The recipient income taxpayer receives
the income net of taxes. The payor is the one required by law to remit the tax to the
government. Consequently, the recipient income taxpayer does not need to file
income tax returns because the withheld tax constitutes the full tax due and are
therefore deemed final payments. This system of taxation is referred to as the final
withholding tax system.
Final taxation is applicable only on certain passive income listed by the law. Not
all items passive income is subject to final tax.
Passive income vs. active income
Passive incomes are earned with very minimal or even without active involvement
Of the taxpayer in the earning process.
Examples of passive income:
1. Interest income from banks
2. Dividends from domestic corporations
3. Royalties
Active or regular income arises from transactions requiring a considerable degree
of effort or undertaking from the taxpayer. It is the direct opposite of passive
income.
Examples of active income:
1. Compensation income
2. Business income
3. Professional income
P a g e 75 | 104
Final income taxation will be discussed in detail in Chapter 5.
CAPITAL GAINS TAXATION
Capital gains tax is imposed on the gain realized on the sale, exchange and
dispositions of certain capital assets.
Capital assets are assets not used in business, trade or profession. Capital assets are
the opposites of ordinary assets. Ordinary assets are assets used in business trade or
profession such as inventory, supplies or property, plant and equipment
Also, not all capital gains are subject to capital gains tax. Most of them are subject
to regular income tax.
The NIRC identifies capital gains tax as a final tax but they are hybrid forms of
final taxes since it also employs self-assessment method. The taxpayer still files
capital gains tax returns to report the gain and pay the tax to the government.
Capital gains taxation applies only to two types of capital assets: domestic stock
and real property.
Capital gains taxation will be discussed in detail in Chapter 6.
REGULAR INCOME TAXATION
The regular income tax is the general rule in income taxation and covers all other
income such as:
1. Active income
2. Other income
a. Gains from dealings in properties, not subject to capital gains tax
b. Other passive income not subject to final tax
Items of gross income from these sources are valued or measured using an
accounting method, accumulated over an accounting period, and reported to the
government through an income tax return. Regular income taxation makes use of
the self-assessment method.
ACCOUNTING PERIOD
Accounting period is the length of time over which income is measured and
reported.
Types of Accounting Periods
P a g e 76 | 104
1. Regular accounting period- 12 months in length
a. Calendar
b. Fiscal
2. Short accounting period - less than 12 months
Calendar year
The calendar accounting period starts from January I and ends December 31. This
accounting period is available to both corporate taxpayers and individual
taxpayers.
Under the NIRC, the calendar year shall be used when the:
1. Taxpayer's annual accounting period is other than a fiscal year (i.e. longer than
12 months in length)
2. Taxpayer has no annual accounting period (i.e. less than 12 months in length)
3. Taxpayer does not keep books
4. Taxpayer is an individual
Fiscal year
A fiscal accounting period is any 12-month period that ends on any day other than
December 31. The fiscal accounting period is available only to corporate income
taxpayers and is not allowed to individual income taxpayers.
Deadline of Filing the Income Tax Return
Under the NIRC, the return is due for filing on the fifteenth day of the fourth
month following the close of the taxable year of the taxpayer. The regular tax due
is payable upon filing of the income tax return.
Illustration: Due date of the annual income return
1. Taxpayers under the calendar year must file their annual income tax return for
the current period not later than April 15 of the following year.
2. A corporate taxpayer with fiscal year ending June 30, 2019 must file its annual
income tax return not later than October 15, 2019.
INSTANCES OF SHORT ACCOUNTING PERIOD

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1. Newly commenced business - The accounting period covers the date of the start
of the business until the designated year-end of the business.
Illustration
Palawan Inc. started business operation on June 30, 2019 and opted to use the
calendar year accounting period.
Palawan should file its first income tax return covering June 30 to December 31,
2019 for the year 2019. The return must be filed on or before April 15, 2020.
2. Dissolution of business —The accounting period covers the stare of the current
year to the date of dissolution of the business.
Illustration
Tawi-tawi Inc. is on the fiscal year accounting period ending every March 31. It
ceased business operation on August 15, 2019.
Tawi-tawi should file its last income tax return covering April 1 to August 15,
2019. Under the Old NIRC, dissolving corporations shall file their return within 30
days from the cessation of activities or 30 days from the approval of merger by the
Securities and Exchange Commission in the case of merger. BPI vs. CIR.
GR144653, August 28, 2011). Hence, the return shall be filed on or before
September 15, 2019.
For individuals, the return shall be due on or before April 15, 2020. There is no
requirement for early filing under the NIRC.
3. Change of accounting period by corporate taxpayers — the accounting
period covers the start of the previous accounting period up to the designated year-
end of the new accounting period. Note that BIR approval is required in changing
an accounting period. It is not automatic
Illustration 1
Effective February, 2019, Sulu Corporation changed its calendar accounting period
to a fiscal year ending every June 30.
Sulu Corporation shall file an adjustment return covering the income from
January 1 to June 30, 2019 on or before October 15, 2019.
Illustration 2

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Effective August 2019, Zamboanga Company changed its fiscal year accounting
period ending every June 30 to the calendar year.
Zamboanga Company should file an adjustment return covering July I to
December 31, 2019 on or before April 15, 2020.
4. Death of the taxpayer — the accounting period covers the start of the calendar
year until the death of the taxpayer.
Illustration
Mr Jacob died on November 2, 2019.
The heirs of Mr Jacob or his estate administrators or executors shall file his last
income tax return covering his income from January 1 to November 2, 2019. There
is no requirement for early filing in case of death of taxpayers. Hence, the income
tax return shall be filed on or before the usual deadline, April 15, 2020.
It must be noted that cut-off of income must be made at date point of death because
properties such as income accruing before death are part of the estate of the
decedent in Estate Taxation while those income accruing after death are not part
thereof. Hence, it is mandatory for the accounting period of the taxpayer to be
terminated exactly at the date of death.
Note that the requirement of the old law to presume that the taxpayer died at year-
end apply only for purposes of claiming then personal exemption. It is not a
mandate to extend the accounting period of the deceased taxpayer until year-end.
5. Termination of the accounting period of the taxpayer by the Commissioner
of Internal Revenue — The accounting period covers the start of the current year
until the date of the termination of the accounting period.
Illustration
The accounting period of a taxpayer under the calendar year basis was terminated
by the CIR on August 2, 2019.
The taxpayer must file an income tax return covering January 1 to August 2, 2019.
The income tax return and the tax shall be due and payable immediately.
ACCOUNTING METHODS
Accounting methods are accounting techniques used to measure income.

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Types of Accounting Methods
1. The general methods
a. Accrual basis
b. Cash basis
2. Installment and deferred payment method
3. Percentage of completion method
4. Outright and spread-out method
5. Crop year basis
General Methods for income from sale of goods or service
1. Accrual basis
Under the accrual basis of accounting, income is recognized when earned
regardless of when received. Expense is recognized when incurred regardless of
when paid.
Income is said to have accrued when the right to receive is established or when an
enforceable right to secure payment is created against the counterparty.
2. Cash basis
Under the cash basis of accounting, income is recognized when received and
expense is recognized when paid.
Tax and accounting concepts of accrual basis and cash basis distinguished.
The financial accounting concept of accrual basis and cash basis are similar to their
tax counterparts, except only for the following tax rules:

1. Advance income is taxable upon receipt.

Income received in advance is taxable upon receipt in pursuant to the Lifeblood
Doctrine and the Ability to Pay Theory. The subsequent taxation of advanced
income in the period earned will expose the government to non-collection. This
rule is applicable on the sale of service not on goods.
2. Prepaid expense is non-deductible

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Prepaid expenses are advanced payment for expenses of future taxable periods.
These are not deductible against gross income in the year paid. They are deducted
against income in the future period they expire or are used in the business, trade or
profession of the taxpayer.
Normally the expensing of prepayments does not properly reflect the income of the
taxpayer. It also contradicts the Lifeblood Doctrine as it effectively defers the
recognition of income.
3. Special accounting requirement must be followed.
There are cases where the tax law itself provides for a specific accounting
treatment of an income or expense. The specified method must be observed even if
it departs from the basis regularly employed by the taxpayer is keeping his books.
The tax accrual basis income is determined as follows:
Cash income P xxx,xxx
Accrued (uncollected) income xxx,xxx
Advanced income xxx,xxx
Gross income P xxx,xxx

The tax accrual basis expense is determined as follows:

Cash expenses P xxx,xxx
Accrued (unpaid) expense xxx,xxx
Amortization of prepayments and xxx,xxx
depreciation of capital expenditures
Deductions P xxx,xxx

The cash basis income is determined as follows:

Cash income P xxx,xxx
Advanced income xxx,xxx

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Gross income P xxx,xxx

The cash basis income is determined as follows:

Cash expenses P xxx,xxx
Amortization of prepayments and xxx,xxx
depreciation of capital expenditures
Deductions P xxx,xxx
Illustration
A taxpayer providing services reported the following in 2019 and 2020:
2019 2020
Collections from services rendered P 500,000 P 800,000
Accrued income from services rendered 500,000 400,000
Collection from accrued income of 2019 - 470,000
Collection for services not yet rendered 300,000 200,000
Payment of expenses of current period 400,000 600,000
Accrued expenses 100,000 150,000
Payment of accrued expenses of 2019 - 100,000
Payment for expenses of the following year 200,000 300,000
Tax Accrual Basis
2019 2020
Cash income P 500,000 P 800,000
Accrued income 500,000 400,000
Collection for future services — advances 300,000 200,000
Total gross income P 1,300,000 P 1,400,000
Less: Deduction
Cash expenses P 400,000 P 600,000
Accrued expenses 100,000 150,000
P a g e 82 | 104
Amortization of 2019 prepaid expense - 200,000
Total deductions P 500,000 P 950,000
Net income P 800,000 P 450,000
Points to consider in converting GAAP Accrual Basis to Tax Accrual Basis
1. In accounting accrual basis, income is recognized when earned even if not yet
received. Advanced income is inherently not included in net income. For purpose
of taxation, advanced income is taxable. Hence, it must be added to accrual basis
gross income.
2. In accounting, expenses is recognized when accrued even if not yet paid,
Prepaid expenses are inherently not deducted. Hence, no adjustment for
prepayments is necessary under accrual basis.
Tax Cash Basis
2019 2020
Collection from services rendered P 500,000 P *1,270,000
Collection for future services - advances 300,000 200,000
Total gross income P 800,000 P 1,470,000

Less: Deduction
Payments of expenses P 400,000 P **700,000
Amortization of 2019 prepayments - 200,000
Total deductions P 400,000 P 900,000
Net income P 400,000 P 570,000
Note: P800,000 + P470,000 = P1,270,000: P600,000 + P100,000 = P700,000
Points to consider In converting GAAP cash basis to Tax cash basis

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I. Under the accounting cash basis, income is recognized when received not when
it is earned. Advanced income is inherently recognized as income. Hence, no
adjustment is necessary as
2. Under accounting cash basis, expense is deducted when paid including prepaid.
Hence, the deducted prepaid expenses must be reversed for purposes of taxation.
Sellers of goods
The gross income of taxpayers selling goods is determined as follows:
Sales P xxx,xxx
Less: Cost of goods sold xxx,xxx
Gross income P xxx,xxx
The cost of sales is computed using the inventory method:
Beginning inventory P xxx,xxx
Add: Purchases xxx,xxx
Total goods available for sale P xxx,xxx
Less: Ending inventory xxx,xxx
Cost of goods sold P xxx,xxx

The expensing of the purchase cost of goods does not properly and fairly reflect
the income of the taxpayer particularly when there are significant fluctuations in
inventory levels between accounting periods. This could expose the taxpayer to
risk of BIR assessment. The use of the accrual method is suggested but of course
subject to practical and cost considerations.

Hybrid basis
The hybrid basis is any combination of accrual basis, cash basis and or other
methods of accounting. It is used when the taxpayer has several businesses which
employ different accounting methods.
Illustration

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Mr Roxas has two proprietorship businesses: a service business which uses cash
basis and a trading business which uses accrual basis.
The gross income as determined by cash basis in the service business and the
gross income as determined by the accrual basis in the trading business are simply
combined. There is no requirement to measure the income of different businesses
under a single accounting method.
Sale of goods with extended payment terms
The sale of goods with extended payment terms may be reported using the accrual
basis, installment method, or deferred payment method.
Installment method
Under the installment method, gross income is recognized and reported in
proportion to the collection from the installment sales.
Installment method is available to the following taxpayers:
1. Dealers of personal property on the sale of properties they regularly sell
2. Dealers of real properties, only if their initial payment does not exceed 25% of
the selling price
3. Casual sale of non-dealers in property, real or personal, when their selling price
exceeds P 1,000 and their initial payment does not exceed 25% of the selling price
Initial payment
Initial payment means total payments by the buyer, in cash or property, in the
taxable year the sale was made. The term "initial payment" is broader than down
payment. It also includes the installment payments in the year of sale.
Selling price
Selling price means the entire amount for which the buyer is obligated to the seller.
It is computed as follows:
Cash received and/or receivable P xxx,xxx
Fair market value of property received or xxx,xxx
receivable

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 Mortgage or any indebtedness assumed by the xxx,xxx
buyer
Selling price P xxx,xxx
Contract price
The contract price is the amount receivable in cash or property from the buyer. It is
usually the selling price in the absence of an agreement whereby the debtor
assumes indebtedness on the property.
Comprehensive Illustration
Canlubang Company, a car dealer, sold a machine with a tax basis of on
installment on January 3, 2020. Canlubang received a P200, 000 cash down
payment and a promissory note for the balance payable in six installments of P300,
000 every July 3 and January 3 thereafter.
The selling price and gross profit on the sale is computed as follows:
Cash downpayments P 200,000
Notes receivable 1,800,000
Selling Price P 200,000
Less: Tax basis of machine sold ( 1,200,000)
Selling price P 800,000
Accrual basis
Under the accrual basis, the entire P800,000 gross profit shall be reported as gross
income in 2016, the year of sale.
Installment basis
Canlubang cannot readily use the installment method because it is a dealer of cars
rather than a dealer of machineries. The sale of properties of which the seller is not
a dealer is referred to as a "casual sale." Hence, the ratio of initial payment shall be
tested first.
The initial payment of Canlubang can be computed as follows:
Cash downpayment (January 3, 2020) P 200,000
First installment (July 3, 2020) 300,000
P a g e 86 | 104
 Initial payment P 500,000
Ratio of initial payment 25%
Canlubang can use the installment method. The contract price or the amount due
shall be determined next. Since there is no mortgage assumed by the buyer, the
selling price is the contract price.
The gross profit will be reported in gross income throughout the installment period
by the formula: (Collection/Contract price) x Gross profit
Canlubang shall recognize the following gross income:
At the date of sale: (P200K/P2M x P800,000) P 80,000
Upon every installment: (P300K/P2M x P800,000) P 120,000
If Canlubang is a dealer in machinery, it can avail of the installment method even
if the ratio of its initial payment over selling price exceeds 25% so long as the
selling price on the installment sale exceeds P1,000.
With indebtedness assumed by the buyer
The application of the installment method will slightly vary when the buyer
assumes indebtedness on the property sold.
In this case, the selling price is no longer the contract price. The contract price is
the residual amount after deducting the mortgage from the selling price. Thus,
Selling price P xxx,xxx
Less: Mortgage assumed by buyer xxx,xxx
Contract price P xxx,xxx
Illustration
On January 3, 2020, Tagaytay, Inc. a real property dealer, sold a lot costing P
1,400,000 for P 2, 000,000. The lot was encumbered by a P 1,000,000 mortgage
which was assumed by the buyer. The buyer paid P 200,000 downpayment. The
balance is due over four installment of P 200,000 every July 3 and January 3
theather.
The gross profit can be computed as follows:
Selling price P 2,000,000

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Less: Tax basis of lot sold 1,400,000
Gross profit P 600,000
Note that dealers of real properties are subject to limitation on the use of
installment method. The ratio of initial payment shall be determined first.
January 3, 2020 cash downpayment P 200,000
June 3.2020 installment 200,000
Initial payment P 400,000
Ratio of initial payment (P 400,000/P 2,000,000) 20%
Tagaytay is qualified to use the installment method. The contract price should be
determined next.
Selling price P 2,000,000
Less: Mortgage assumed by buyer 1,000,000
Contract price P 1,000,000
Alternatively, the contract price can be computed directly as follows:
Cash downpayment P 200,000
Collectible balance (P 200,000 x 4 installment) 800,000
Contract price P 1,000,000
Tagaytay shall recognize the following gross income:
At the date of sale: (P200K/PIM x P600,000) P 120,000
Upon every installment: (P200K/PIM x P600,000) P 120,000

Indebtedness assumed tax basis of property sold

When the indebtedness assumed by the buyer exceeds the tax basis of the property
sold, the excess is an indirect receipt realized by the seller. This is an indirect
downpayment which must be added as part of the contract price and the initial
payment. Note also that under this condition, all collection from the contract
including the excess mortgage is a collection of income.
The contract price shall be computed as follows:
P a g e 88 | 104
Selling price P xxx,xxx
Less: Mortgage assumed by buyer xxx,xxx
Cash collectible P xxx,xxx
Add: Excess indebtedness — constructive receipt xxx,xxx
Contract price P xxx,xxx
The initial payment shall be computed as follows:
Downpayment P xxx,xxx
Installment in the year of sale xxx,xxx
Excess of mortgage over tax basis xxx,xxx
Initial payment P xxx,xxx

Illustration
On July 1, 2020, a taxpayer made a casual sale of property with a tax basis of P
1,300,000 for P 2,000,000. The property was subject to a mortgage which was
agreed to be assumed by the buyer. The buyer paid a P 100,000 down payment
with the balance due in two installments of P 200,000 on December 31, 2020 and
July 1, 2021.
The gross profit on the sale is determined as follows:
Selling price P 2,000,000
Less: Tax basis of property sold 1,300,000
Gross profit P 700,000
The initial payment shall be determined first:
Downpayment P 100,000
December 31, 2020 installment 200,000
Excess mortgage ( P 1,500,000 – P 1,300,000 ) 200,000
Initial payment P 500,000

P a g e 89 | 104
Ratio of initial payment ( P 500K/P 2,000,000 ) 25%
The contract price shall be computed as:
Selling price P 2,000,000
Less: Mortgage assumed by buyer 1,500,000
Cash collectible P 500,000
Excess mortgage ( P 1,500,000 – P 1,300,000 ) 200,000
Contract price P 700,000
Note that the gross profit on the sale is the same as the contract price. Hence, any
collection from the contract including the excess mortgage shall be recognized as
gross Income upon collection.
Canlubang shall recognize the following gross income
At the date of sale (P200K down + PI00K excess) P 300,000
Upon receipt of first installment — 12/31/2020 200,000
Upon receipt of second installment — 7/1/2021 200,000
Total gross profit on the contract P 700,000

Deferred payment method

The deferred payment method is a variant of the accrual basis and is used in
reporting income when a non-interest bearing note is received as consideration in a
Site. Under the deferred payment method, the gross income is computed based on
the present value (discounted value) of a note receivable from the contract. The
discount interest on the note is amortized (i.e., spread) as interest income over the
installment term.
Illustration
On December 31, 2019, a taxpayer sold an office building costing P 1,400,00 for P
2,000,000. The buyer made downpayment and the balance, evidenced by a note, is
due in 2 annual installments of P 500,000 every December 31 starting December
31, 2020.

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Note that the installment method cannot be allowed since the ratio of initial
payment is already 50% (P 1,000,000/ P 2,000,000).
Assume the note is non-interest bearing but can be discounted at a local bank for P
900.000. Under the deferred payment method, the reportable gross income for each
year shall be:
2019 2020 2021
Cash downpayments P 1,000,000
Present value of the note 900,000
Selling price P 1,900,000
Less: Tax basis of the 1,400,000
property
Gross income P 500,000
Interest income
( P 1,000,000 – P 900,000 ) P 50,000 P 50,000
Note:
1. The difference between the face value and the present value of the note, known
as discount, will not be recognized in gross income at the date of sale but will be
deferred and recognized as interest income.
2. The discount is amortized as interest income upon every collection on the
balance of the note as follows: P 500,000 total note balance x P 100,000 discount.
In the case of interest-bearing notes, the use of the deferred payment method will
bear the same result as the accrual basis of accounting.

The Percentage of Method for Construction Contract

Under the percentage of completion method, the estimated gross income from
construction is reported based on the percentage of completion of the construction
project.
There are several method of estimating projects completion in practice, but the
output method based on engineering survey is prescribed by the NIRC.

P a g e 91 | 104
Illustration in 2019, Cagayan construction Company accepted a P 5,000,000 fixed
price constructions contract. The following shows the details its construction
activities:
2019 2020
Construction expenses P 3,000,000 P 1,200,000
Engineer`s estimate of completion 70% 100%
The reportable gross income on construction will simply be computed as follows:
2019 2020
Contract Price P 5,000,000 P 5,000,000
Multiply by:% of completion 70% 100%
Construction Revenue P 3,500,000 P 5,000,000
Less: Construction revenue in prior year - 3,500,000
Construction revenue this year P 3,500,000 P 1,500,000
Less: Expense during the year 3,000,000 1,200,000
Construction gross income P 500,000 P 300,000
Income from Leasehold improvement
Leasehold improvements are tangible improvements made by the lessee to the
property of the lessor. Improvements will benefit the lessor when their useful life
extends beyond the lease term. This benefit is referred to as income from leasehold
improvement.
Under Revenue Regulations No. 2, the income from leasehold improvement can be
reported using either of the following method at the option of the taxpayer:
1. Outright method
The lessor may report as income the fair market value of such buildings or
improvements subject to the lease at the time when such buildings or
improvements are completed.
2. Spread-out method

P a g e 92 | 104
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.
The depreciated value of the leasehold improvement is computed as:
Cost of improvement x Excess useful life over lease term
Useful life of the improvement
Illustration
On January 1, 2020, Anderson leased a vacant lot to Greg under a 20-year lease
contract. Greg immediately constructed a building on the lot at a total cost of. The
building has useful life of 30 years.
Outright method
Under the plain wordings of Section 49 of Revenue Regulations No. 2, Anderson
shall recognize the entire fair value of the improvement as gross income upon
completion of the improvement in 2020. This is not income in its totality, but this
is the amount referred to by the regulation.
Spread-out method
The depreciated value of the property at the termination of the lease is the value of
the years of usage of the lessor. This can be computed by splitting the value of the
improvement as follows:
Years of
User usage Allocation Cost
Lessee 20 20/30 x P 4,500,000 P 3,000,000
Lessor 10 10/30 x P 4,500,000 1,500,000
Total 30 P 4,500,000
The P l,500,OOO depreciated value of the improvement at the termination of the
lease is an income from leasehold improvement by the lessor.
Under the spread-out method, Anderson shall spread the income over 20 periods or
recognize an annual income of P 75,000 from the leasehold improvement from
Year 2020 through Year 2039.
Note to Readers
P a g e 93 | 104
It should be pointed out that this rule exists only in the regulation and is absent in
the NIRC. Some taxpayers are questioning its validity pointing out lack of legal
basis. However, it is fairly proper to consider the depreciated value of the
improvement that remains to the lessor upon termination of the lease as income
because it is an actual benefit to the lessor. These are, in effect, additional rental
consideration in kind.
However, the treatment specified by the outright method is perceived as unjust and
abusive, and is an improper introduction of legislation.
The depreciated value of the improvement at the termination of the lease should be
the proper value to be recognized as gross income under the outright method.
This view is supported by the fact that the spread-out method could not have been
an option if the outright method intended to tax the entire fair value of the
improvement considering the huge disproportion in the reportable gross income in
the two options.
The outright method as mandated by the regulation will best apply in cases where
lessees pay the lessor rentals in the form of leasehold improvements or when
leasehold improvements made by lessees are treated as reductions to cash rentals.
In such cases, the fair value of the leasehold improvements upon completion is
unquestionably income to the lessor for taxation purposes.
Agricultural or Farming Income
Farming income is commonly measured using the cash basis or accrual basis such
as in the following:
a. Animal husbandry
b. Short-term crops
Illustration
Northern Barn had the following details of its agricultural activity during the year:
Total sales of fattened pigs, on credit P 12,000,000
Increase in fair value of pig herd compared last year 2,700,000
Total costs of farm feeds and supplies bought 7,000,000
Total costs of farm feeds and supplies used 6,800,000

P a g e 94 | 104
Administrative and selling expenses 1,200,000
Northern Barn shall compute its net income using either method as follows:
Accrual method Cash basis
Sales P 12,000,000 P 11,000,000
Direct farm costs 6,800,000 6,800,000
Gross profit from operations P 5,200,000 P 5,200,000

Less: administrative and selling 1,200,000 1,200,000

expenses
Net income P 5,000,000 P 4,000,000
The accounting for long-term crops depends on the harvesting frequency:
a. Perennial crops- those that yield harvests through years
b. One-time crops- those that are harvested once after several years
The initial farm development costs of perennial crops like mangoes, mangosteen
coconut and banana are capitalized and amortized over the expected years of
harvest. The harvests are accounted for using cash basis or accrual basis. One-time
crops are accounted for using the crop year basis.
Crop year basis
Under the crop year basis, farming income is recognized as the difference between
the proceeds of harvest and expenses of the particular crop harvested. The
expenses of each crop are accumulated and deducted upon the harvest of the crop.
Illustration
Juan dela Cruz, a farmer, plants a certain crop that takes more than a year to
harvest. Juan had the following data on his farming operations:
2019 2020 2021
Proceeds of harvest P - P 750,000 P 1,000,000
1st cropping expenses 400,000 200,000 -
2nd cropping expenses - 500,000 300,000

P a g e 95 | 104
The reportable farming income using crop year method would be:
2019 2020 2021
Proceeds of harvest - P 750,000 P 1,000,000
Less: Cropping expenses
Incurred last year 400,000 500,000
Incurred this year 200,000 300,000
Farming gross income P 150,000 P 200,000
Change in Accounting Methods and Accounting Periods
Under the NIRC, the change in accounting methods by any taxpayer and the
change in accounting period by corporate taxpayers require prior BIR notice.
TAX REPORTING
Types of Returns to the Government
1. Income tax returns provides details of the taxpayer's income, expense, tax due
and tax due, tax credit and tax still due the government
2. Withholding tax returns — provides reports of income payments subjected to
withholding tax by the taxpayer-withholding agent
3. Information returns
Information Returns
Certain taxpayers are also required to file information returns. Information return
do not involve any payment or withholding of tax but are essential to the
government in its tax mapping efforts and in its evaluation of tax compliance.
The non-filing of income tax returns, withholding tax returns, or information
returns is subject to penalties, fines, and or imprisonment.
MODE OF FILING INCOME TAX RETURNS
1. Manual Filing System
The traditional manual system of filing income tax return is by paper documents
where taxpayers fill up BIR forms to report income, expenses, or any declaration
required to be filed with the BIR.

P a g e 96 | 104
Under the NIRC, the income tax return shall be filed to the following in
descending order of priority, within the revenue district office where the taxpayer
is registered or required to register:
1. An authorized agent bank (AAB)
2. Revenue Collection Officer
3. Duly authorized city or municipal treasurer, if there is no BIR office in the
locality
2. E-BIR Forms
The BIR introduced the e-BIR Forms with an offline or online version. Taxpayers
fill up their income tax returns in electronic spreadsheets without the need of
writing on papers returns. The system ensures completeness of data on the return
and is capable of online submission. If there are no penalties that require BIR
assessments, taxpayers would have to print a hard copy of the filled tax returns and
proceed directly to the bank for payment.

3. Electronic Filing and Payment System (EFPS)

The EFPS is a paperless tax filing System developed and maintained by the BIR.
Taxpayers file tax returns including attachments in electronic format and pay the
tax through the Internet.
Taxpayers mandated to use the eFPS
1. Large taxpayers duly notified by the BIR
2. Top 20.000 private corporations duly notified by the BIR
3. Top 5,000 individual taxpayers duly notified by the BIR
4. Taxpayers who wish to enter into contracts with government offices
5. Corporations with paid-up capital of
6. PEZA-registered entities and those located within Special Economic Zones
7. Government offices, in so far as remittance of withheld VAT and business tax
are concerned
8. Taxpayers included in the Taxpayer Account Management Program (TAMP)

P a g e 97 | 104
9. Accredited importers, including prospective importers required to secure the
Importers Clearance Certificate (ICC) and Custom brokers Clearance Certificate
(BCC)

In case of unavailability of the eFPS during maintenance or instances of technical

errors, eFPS enrolled taxpayers may file manually.
Grouping of Taxpayers under EFPS
1. Group A
c. Banking institutions
d. Insurance and pension funding
e. Non-bank financial intermediation
f. Activities auxiliary to financial intermediation
g. Construction
h. Water transport
i. Hotels and restaurants
j. Land transport

2. Group B
a. Manufacture and repair of furniture
b. Manufacture of basic metals
c. Manufacture of chemicals, and chemical products
d. Manufacture of coke, refined petroleum, and fuel products
e. Manufacture of electrical machinery, and apparatus NEC
f. Manufacture of fabricated metal products
g. Manufacture of foods, products, and beverages
h. Manufacture of machineries, and equipment NEC
i. Manufacture of medical, precision, and optical instruments
j. Manufacture of motor vehicles, trailers and semi-trailers
k. Manufacture of office, accounting and computing machineries
l. Manufacture of other non-metallic mineral products
m. Manufacture of other transport equipment
n. Manufacture of other wearing apparel
o. Manufacture of papers, and paper products
p. Manufacture of radio, TV, and communication equipment, and apparatus
q. Manufacture of rubber and plastic products
r. Manufacture of textiles
P a g e 98 | 104
 s. Manufacture of tobacco products
t. Manufacture of wood and wood products
u. Manufacturing N.E.C
v. Metallic ore mining
w. Non-metallic mining and quarrying

3. Group C
a. Retail sale
b. Wholesale trade and commission trade
c. Sale, maintenance, repair of motor vehicle, and sale of automotive fuel
d. Collection, purification, and distribution of water
e. Computer and related activities
f. Real estate activities

4. Group D
a. Air transport
b. Electricity, gas, steam, and hot water supply
c. Postal and telecommunications
d. Publishing, printing, and reproduction of recorded media
e. Recreational, cultural, and sporting activities
f. Recycling
g. Renting out of goods and equipment
h. Supporting and auxiliary transport activities

5. Group E
a. Activities of membership organizations Inc.
b. Health and social work
c. Private educational services
d. Public administration and defense compulsory social security
e. Public educational services
f. Research and development
g. Agriculture, hunting, and forestry
h. Farming of animals
i. Fishing
j. Other service activities
k. Miscellaneous business activities
l. Unclassified activities
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PAYMENT OF INCOME TAXES
The general rule is "pay as you file". The capital gains tax and regular income tax
are paid as the taxpayer files his return. Installment payment of income tax is
allowed on certain conditions
Taxpayers under the EFPS system shall e-pay their tax online through internet
banking service. The account of the taxpayer will be auto-debited for the amount
of taxes to be paid.
BASIC COMPARISON OF FILING AND PAYMENT SYSTEMS
Manual e-BIR Forms eFPS
Data entry Manual Electronic Electronic
Filing/Submission Manual Electronic Electronic
Tax payment Manual Manual Electronic

PENALTIES FOR LATE FILING OR PAYMENT OF TAX

The late filing and payment of taxes is subject to the following additional charges:
1. Surcharge-
a. 25% of the basic tax for failure to file or pay deficiency taxon time
b. 50% for willful neglect to file and pay taxes

The non-filing is considered 'willful neglect' if the BIR discovered the non-filing
first. This is the case when the taxpayer received a notice from the BIR to file
return prior to his actual filing. If the taxpayer filed a return before the receipt of
such notice, the same is considered simple neglect subject to the 25% surcharge.
2. Interest - Double of the legal interest rate for loans or forbearance of any money
in the absence of any express stipulation
Since the legal interest is currently set at 6%, the interest penalty is therefore 12%
per annum effective January 1, 2018. Note that NIRC imposed an interest penalty
of 20% per annum until December 31, 2017.

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Under the new rules established by RR21-2018, the interest period shall be
computed based on actual days divided 365 days. The additional day in February
during a leap year will be counted. The yearly-monthly-daily counting method
established in prior regulations is already abandoned.
A month normally have 30 days except the following:
31-day months January, March, May, July, August, October, December

28 or 29-day month February

The best way to put this in mind is that 31-day and 30-day months are alternating
from January to July, but the sequence is reset in August. Also put in mind that
February is a 28-day month, except on a leap year.
How to identify a leap year?
A year divisible by 4 with a whole number quotient without a decimal is a leap
year. Years 2016, 2020, 2024, 2028 and so on are leap years. Leap years have 29
days in February hence the actual number of days in a leap year is 366 not the
usual 365. This is due to the fact that our planet revolves around the sun in 365 ¼
days. Hence, there is an extra one complete day in every four calendar years.
Under the illustrative guidelines in RR21-2018, the new day counting system for
the interest penalty will be implemented for tax assessments effective January 1,
2018. This means it will be applied even if the tax assessment pertains to 2017 and
prior years.
Illustration 1: Basic procedure
The tax return of the taxpayer vas due on April 15, 2019 but was filed on August 3,
2019. The tax due per return of the taxpayer amounts to Pl00, 000.
The number of days would be counted as follows:
Period Days
April (30 - 15) 15
May 31
June 30
July 31
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August 3
Total days 110
The interest penalty shall be computed as P 100, 000 x 12% xl 00/365 = P3,
287.67.
Illustration 2: Interest In a leap year
A taxpayer-withholding agent failed to file his withholding tax return and failed to
remit the P50, 000 withholding tax thereon on April 30, 2019. The taxpayer filed
the return on July 16, 2020.

The number of days would be counted as follows:

Period Days
April 30, 2019 to April 30, 2020 366
May 2020 31
June 2020 30
August 2020 16
Total days 443
The interest penalty shall be computed as P 50,000 x 12% x 443/365 = P7, 282.19.
Note that the interest period passes through February of leap year 2020.
Illustration 3: Interest in transition years
An individual taxpayer has a tax due of P40, 000 for taxable year 2016 due on
April 15, 2017. The taxpayer settled his tax on February 10, 2018.
The interest in 2017 shall be computed using the old 20% interest penalty rate
while the interest in 2018 shall be computed using the 12% interest penalty rate.
April 16 2017 to December 31, 207 is 260 days. January 1; 2018 to February 10,
2018 is 41 days. Hence, the interest shall be computed as follows:
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2017 interest (P40,OOO x x 260/365) P 5,698.63
2018 interest (P40,OOO x 12% x 41/365) 539.18
Interest penalty P 6, 237.1
3. Compromise penalty -
Compromise penalty is an amount paid in lieu of criminal prosecution over a tax
violation.
The schedules of compromise penalty related to income taxes are included in
Appendix 4 for your reference.
INTEGRATIVE ILLUSTRATION
An individual taxpayer filed his 2018 income tax return with a computed tax due
of P100, OOO on July 15, 2019. A total of P20, 000 creditable withholding taxes
was deducted by various income payors from his gross income.

The total amount to be paid by the taxpayer including penalties shall be:
Tax due P 100, 000
Less: Tax credits (creditable withholding taxes) 20,000
Net tax due P 80, 000
Plus: Penalties
Surcharge (P80, OOO x 25%) 20, 000
Interest (P80, OOO x 12% x 91/365) 2,393
Compromise penalty* 15, 000
Total tax due P 117, 393

Note:
1. The deadline of the 2018 income tax return is April 15, 2019. April 15, 2019 to
July 15, 2019 is a 91-day period.
2. Interest is computed from the net amount of tax due before the 25% surcharge.
Imposition of interest upon the surcharge is illegal.
3. The compromise penalty is taken from the table of compromise penalties for
failure to file and or pay internal revenue tax at the time or times required by law,
as follows;
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 If the amount of tax unpaid
Exceeds But not exceed Compromise is
..... ..... .....
P 20.000 P 50.000 P 10.000
50,000 1000,000 15,000
100,000 500,000 20,000

You may check the schedule of compromise penalty for late payment of income
tax in Appendix 4 for your reference.
PENALTIES FOR NON-FILING OR LA TE FILING OF INFORMA TION
RETURN
For each failure to file a separate information return, statement or list, or keep any
record, or supply any information required by the Code or by the Commissioner on
the date prescribe therefor, unless it is shown that such failure is due to reasonable
cause not to wilful neglect, shall be subject to a penalty off P 1, 000 for each such
failure. Provided that the amount imposed for all such failure during a calendar
year shall not exceed P25, 000.00

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