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    INCOME TAXATION Basic Principles Learning Objectives: After studying this chapter, you should be able to: 1. Define taxation. 2. Describe the nature, basis and objectives of taxation, 3. Differentiate the three inherent powers of the State. 4. Explain the principles of a sound taxation system. S._ Identify and explain constitutional and inherent limitations, 6. Describe various sources of taxation laws, 7, Name and describe the situs of taxation and its application. 8 Define tax and describe its essential characteristics. 9. Identify and distinguish classification of taxes, 0, Have a fair knowledge of the sources of tax authority and the sources of tax laws 11. Describe the powers of the Commissioner of Internal Revenue. 12. Distinguish between income and capital. INTRODUCTION Most people receive their initial exposure to the Philippine income tax system when first faced with the responsibility of fling their own tax returns. AS a result, tax work is, sometimes viewed as a robotized process of filing out government forms~not a very challenging activity. Actually, the perception of tax work as a routine clerical process Is a grossly distorted view of the tax profession, Historically, most professional-level work has concerned ‘conceptual issues. In today’s society, that emphasis is greater than ever with computer systems handling an ever-increasing share of the mechanical chores of tax practice. This. allows tax professionals and business managers to devote an even greater share of their tme to substantive matters. basic poi In approaching the study of taxation, you should try to Keep three basic Points inp, G 1. Do not get ost in the detail of tax rules. ts that ability t0 APP the rues of to real-life situations that is important—not just having the talent to recite g,, ma by rote. in studying any area of tax law, you should be alert for possible Secisigg making implications. " 2 Keep in mind that tax ules area matter of faw. Hence, only egal authority (gg Statute, a regulation, a court case) can ever be a tax authority. If the we 8a application” of law to a given set of facts results ina solution at odds with accounting, economic, social, or moral theory, i s still the law that controle, Practical matter, most tax disputes arise over differences in opinion Concernin: what constitutes the “correct application” of tax aw to specific situations, " 3. Give lose attention to the use of language, particularly the wording of authorities, Verbal distinctions are often critical Terms having similar meaning everyday speech may have been defined differently in tax law. TAXATION Definition, Nature and Basis of Taxation Texation is the process or means by which the sovereign, through its lawmaking body, rans income to defray the necessary expenses ofthe government, Taxation, as a powe, of the State, is inherent in sovereignty. Taxes are the lifeblood of the government and their prompt and certain availabilty ae an imperious need (Commissioner vs. Pineda, 21 SCRA 105). A government. cannot, ‘continue to exist and operate without financial means. This inherent power gives the {government the right to tax citizens and properties within its jurisdiction. Taxation is indispensable and inevitable price for civilized society; without taxes, the Sovernment would be paralyzed (Commissioner vs. Algue, Feb. 17, 198, 158 SCRA). z os Indeed, the collection of taxes remains one of the primary undertakings of any Sovernment in order to provide sufficient funds with which a nation’s economy may be Sustained and developed, In this light, it has authority, be it one that serves a develope implement strategies and technologies that s of their collection systems, Internal Revenue (BIR). become the enduring goal of every tax 'd or a developing nation, to seek and hall support the continuing improvement |m the Philippines, the premier tax agency is the Bureau of Upon taxation depends the Government's ability to serve the people for whose benefit taxes are collected (Vera vs, Fernandez, 89 SCRA 199). The ultimate beneficiaries in the process are both the government and the citizens, The state collects taxes in the exercise of its sovereign rights for the support of the government, for the administration of the laws, and as a means for the continued operation of the various legitimate functions of the state. Objectives of Taxation Taxation is much more than just a means of raising revenue for the government. It is also one of the major means by which the national government attempts to achieve various economic and social objectives. These objectives include shitting wealth from the rich to the poor, maintaining price stability, stimulating economic growth, and encouraging full employment. In its efforts to achieve these objectives, Congress tends to use tax provisions in two different ways. First, some tax rules are enacted for the purpose of mitigating certain undesirable economic and social conditions already existing. For instance, low-income individuals often pay little or no national income taxes because of the elaborate system of exclusions, deductions, and credits of current law. Second, other tax rules provide Incentives for certain desirable activities. For instance, business can claim deductions for depreciation of productive assets much faster than the assets actually wear out, This provides incentive for businesses to invest in these assets, leading to increased ‘employment of low- and middle-income workers. All too often, the incentive and mitigating aspects of various tax provisions work at cross-purposes. Consider the two examples just mentioned. While the purpose of the rapid depreciation rules may be to increase investments in productive facilities that will lead to increased employment of low- and middle-income workers, rapid depreciation rates may also greatly reduce the tax liabilities of wealthy individual business-owners and thus actually increase, rather than reduce, the concentration of wealth in society. Perhaps it Is because of these conflicting objectives that Congress so often seems to exhibit ‘confused’ behavior when writing tax rules. When an incentive provision is enacted, numerous limitations and restrictions will usually prevent its application in many circumstances. There may also be exceptions to the exceptions. Often the congressional process of fine-tuning incentive tax provisions will create a maze of statutory law under which significant tax savings are possible, but only if transactions are carefully planned to fit within statutory requirements. State Powers 1. Taxation. The power of the state by which the sovereign raises revenue to defray the necessary expenses of the government. 2. Eminent Domain. The power of the state to take private property for public use upon payment of just compensation. . ~~ eto enact avs to promote Publi heaiy, 3. Police Power. The power of the stat welfare of the people. ‘morals, public safety and the general ‘ty Aspects of Taxation legislative intervey 1. Urft of the tas The nposton of tat. ss meen. ny Philipines, itis Congress that levies taxes; satura 2. Collection ofthe tax levied. This i essentially an administrat ; Basic Principles of a Sound Tax System 1. Fiscal adequacy. Sources of revenue ate sufficient to meet goye ‘expenditures; i 2. Equality or theoretical justice. The tax imposed must be proportionate to ‘pave, ability to pay; and r 3. Administrative feasibility. The law must be capable of convenient, just ang af administration, Limitations on the Power of Taxation ional and inherent tim ‘The power of taxation is, however, subject to constitutional mi Constitutional limitations are those provide for in the constitution or implied f, 7a Provisions while inherent limitations are restrictions tothe power to tax attaches tog ‘ature. The following are the inherent limitations: 1. Purpose. Taxes may be levied only for public purpose; Terrtoriaity. The State may tax persons and properties under its jurisdiction, {ternational comity. The property ofa foreign State may not be taxed by another, ‘4. Exemption. Governmental agencies performing governmental functions are exempt from taxation; 5. Non-delegation. The power to tax being legislative in nature may not be delegated Some Doctrines in Taxation Prospectivity of Tax Laws Taxes must be imposed prospectively. But ifthe legislative intent is for a tax statute to Operate retroactively, then such statute ‘must state so explicitly and clearly. in. the words Of the Supreme Court: “Taxes may be imposed retroactively by law but, unless so axpressed by such law, these taxes must only be imposed Prospectively.” (Hydra Resources vs. Court f Appeals, G.R. 80276, Dec. 21, 1990, 192 SCRA 604). Double Taxation Double taxation standing alone and not being forbidden by our fundamental law is not a valid defense against the legality of a tax measure, However, if double taxation amounts to a direct duplicate taxation, in that the same subject is taxed twice when it should be ‘taxed but once, in a fashion that both taxes are imposed for the same purpose by the same taxing authority, within the same jurisdiction or taxing district, for the same taxable period and for the same kind or character of a tax, then it becomes legally objectionable for being oppressive and inequitable. Indirect double taxation is one other than the direct double taxation, Though this type ‘may not prove unconstitutional, itis being avoided so as not to bring injustice to the taxpayer. An example of this occurs when business tax is imposed by the municipal government prior to the issuance of a business license to a taxpayer for engaging in an advertising business. His income from his advertising business shall later be imposed income tax by the national government. ‘When an item of income is taxed in the Philippines and the same income is taxed in another country, there is only a case of indirect duplicate taxation which is not legally prohibited because the taxes are imposed by different taxing authorities. ‘The usual methods of avoiding the occurrence of double taxation are: 1) allowing reciprocal exemptions either by law or by treaty; 2) allowance of tax credit for foreign taxes paid; 3) allowance of deduction for foreign taxes paid; and 4) reduction of the Philippine tax rate, Set-off of Taxes Taxes are not subject to set-off or legal compensation under Article 1279 of the Civil Code. This has been the Supreme Court ruling in Republic vs. Mambulao Lumber Co. (6 ‘SCRA 622). However, the high court reversed itself in the subsequent case of Domingo vs. Garlitos (8 SCRA 443), when it decided that legal compensation can take place when the taxes and the taxpayer's claim are fully liquidated, due, and demandable. Ina more recent case the Supreme Court echoed the Mambulao Lumber doctrine: "We have consistently ruled that there can be no offsetting of taxes against the claims that, the taxpayer may have against the government. A person cannot refuse to pay a tax on the ground that the government owes him an amount equal to or greater than the tax being collected. The collection of a tax cannot await the results of a lawsuit against the government” (Philex Mining Corporation vs. Commissioner of Internal Revenue, Court of Appeals and The Court of Tax Appeals, G.R. 125704, Aug. 28, 1998). Escape from Taxation ‘and tax evasion in order to esc, inimizes his tax tia ‘when the taxpayer mini ms arring opportunities. This s otherwise kng ies the process of Controlling itis common for taxpayers resort to tax avoidance from taxation. Tax avoidance happens taking advantage of legally avaiable tax as tax minimization; others call it tox planning: : e is a com) 8 Sctions so as to avold undesirable tax consequences. 12 avoidance is a completely jep,, it committin ae the penal al law can be avoided by not Ba cri activity. Just as the penalties of crimin: The ea taxes can be avoided by not engaging in those m violated in any way. Piper oe savings are achieved By arranging One's afars, ang thereby controlling the facts, so as to avoid the application of those rules of law tha. ‘would otherwise trigger a larger tax liability. rac evasion oocurs when the taxpayer resorts to unlawful avers t9 VESSEM OF to gy away with his tax liability. This is also known as tox dodging- Examples of tax evasion ane ay declaration of sales, overstatement of expenses and backdating an Importan, document. ‘ome hazy in practice, the basic notions of tay ly distinct. Both avoidance and evasion seg, su the means by which that goal is sought are not conducting taxable transactions. On the sf not complying with applicable provision, fasion connotes the integration of White the dividing line may sometimes bec: ‘avoidance and tax evasion are conceptual! the same objective, namely saving taxes. different. Avoidance is the legal process of other hand, tax evasion is the illegal process o of the law once the transactions already exist. Tax ev three factors: of less than the amount known by the 1. The end to be achieved (.e., payment he tax when it is shown that a tax ig taxpayer to be legally due, or nonpayment of tt due); 2. An accompanying state of mind that is deliberate and not accidental; and ‘A course of action or failure of action that is unlawful (Commissioner of Interna} Revenue vs. The Estate of Benigno P. Toda, Jr., G.R. 147188, Sept. 14, 2004). described as being in bad faith, wilful, or Situs of Taxation ‘The situs of taxation is the place of taxation. The rule is that the State may rightfully levy ‘and collect the tax where the subject being taxed has a situs under its jurisdiction. The situs of taxation is determined by a number of factors: 1. Subject matter or whatis being taxed. He may be a person or it may be a property, anact or activity; 2. Nature of tax or which tax to impose. It may be an income tax, an import duty or a real property tax; 3. Citizenship of the taxpayer; and 4. Residence of the taxpayer, The following situs of taxation apply: 1, Persons — Residence of the taxpayer. 2. Real property or tangible personal property ~ Location of the property. 3. Intangible personal property — As a rule, situs is the domicile of the owner unless he has acquired a situs elsewhere, 4, Income — Taxpayer's residence or citizenship, or place where the income was earned. 5. Business, occupation and transaction - Place where business. is being operated, occupation being practiced and transaction completed. 6. Gratuitous transfer of property ~ Taxpayer's residence or citizenship, or location of the property. TAXES Taxes are enforced proportional contributions from persons and property levied by the lawmaking body of the State by virtue of its sovereignty for the support of the government and all public needs. Tax, in a general sense, is any contribution imposed by the government upon individuals, for the use and service of the state, whether under the name of tol, tribute, tallage, gabel, impost, duty, custom, excise, subsidy, aid, supply, or other name. Tax, in its essential characteristics, is not a debt (Black’s Law Dictionary). Essential Characteristics of a Tax Itis an enforced contribution; Itis levied by the lawmaking body; itis proportionate in character; It is generally payable in money; Its imposed for the purpose of raising revenues; and Its to be used for public purpose. ‘Types of Tax Rate Structures Tax systems are often described as either regressive, Fern mores A Is said to be regressive if the average rate decreases 25 We Te ote of ceases, Broportional taxes (also called flat or uniform taxes the aver (386 Of tx tgp, Fy Constant for all levels of the tax base, whereas 9 progressive oF whieh ot average rate increases as the amount of the tax bases increases, . Notice that the definitions of regressive, proportional, and La ci Bee DASE on , direction of change in tax rates with respect to an increase Pane eae }held political view that the rich should pay 2 larger amount of tax tae Poor coulg c Upheld under any of the three rate structures—even a regressive one, . = Before a tax system can be classified as either regressive of eee Must Tense 35 9 percentage of some base amount In the previous Technical defn, Me the base used for this purpose is the base on which the taxis computed. ' Constitutional Provision on Progressive System of Taxation ‘The Supreme Court declared Republic Act (R.A.) 9337 or ‘the VAT Reform, Ah Constitutional. in the same decision, it clarified the constitutional provision At Progressive system of taxation. The increase in corporate income tax rate and ia ‘removal of certain exemptions are meant to distribute the burden of taxation, Althougy, Indirect taxes, e.g. VAT, are regressive by nature, the constitution does not prohipie the imposition of indirect taxes. When the Constitution mandated Congress to eyo), : Progressive system of taxation, it simply meant that direct taxes should be Dreerrey and that the regressive indirect taxes can be minimized with exemptions ang differentiated rates (G.R. 168056, G.R. 168207, G.R. 168461, G.R. 168463, and GR 168730, Sept. 1, 2005), : Classification of Taxes 1. Asto subject matter or object Personal, poll or capitation - Tax of a fixed amount imposed on individuats whether citizens oF not, residing within a specified territory without regarq y, their property or the occupation in which they may be engaged. Example community tax. b. Property ~ Tax imposed on property, whether real or personal, in proportion either to its value or in accordance with some other reasonable method gf apportionment. Example: real estate tax. ©. Excise - Tax imposed upon the performance of an act, the enjoyment of 3 Privilege or the engaging in an occupation. Examples: estate tax, donor's tax income tax, value-added tax. 2, As to who bears the burden Direct ~ Tax demanded from persons who are intended or bound by law to pay the tax. Examples: community tax, income tax, estate tax, donor's tax. 'b. Indirect - Tax which the taxpayer can shift to another. Examples: customs duties, value-added tax, some percentage taxes 3, As to determination of amount a. Specific - Tax imposed based on a physical unit of measurement, as by head or number, weight, or length or volume. Examples: tax on distilled spirits, fermented liquors, cigars, wines, fireworks, etc. 'b. Ad valorem ~ Tax of a fixed proportion of the value of property; needs an independent appraiser to determine its value. Examples: real estate tax, certain customs duties, excise taxes on cigarettes, gasoline and others. Excise taxes on certain specific goods imposed under the National Internal Revenue Code are either specific or ad valorem taxes. 4. Asto purpose General, fiscal or revenue - Tax with no particular purpose or object for which the revenue is raised, but is simply raised for whatever need may arise Examples: income tax, value-added tax. b. Special or regulatory ~ Tax imposed for a special purpose regardless of whether revenue is raised or not, and is intended to achieve some social or economic end. Example: protective tariffs or customs duties on certain imported goods to protect local industries against foreign competition. 5. As to authority imposing the tax or scope ‘a, National ~ Tax imposed by the national government. Examples: internal revenue taxes, tariff and customs duties. b. Municipal or local ~ Tax imposed by municipal governments for specific needs. Examples: real estate taxes, municipal licenses. 6. Asto graduation or rate a. Proportional ~ Tax based on a fixed percentage of the amount of property income or other basis to be taxed. Examples: percentage taxes, real estate taxes. 9 Progressive or graduated - Tax rate increases as the tax base , eres, Examples: income tax, estate tax, donor's tax. ‘s &Retressive~Taxrate decreases asthe tax base increases Example: vay tax : Tax Distinguished from Other Fees 1. From toll. Toit is a sum of money for the use of something, generally applied toy

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