Basic: Tax Benefit Rule (2003)

(a) What is meant by the "tax benefit rule"?

SUGGESTED ANSWER:

(a) TAX BENEFIT RULE states that the taxpayer is

obliged to declare as taxable income subsequent recovery of
bad debts in the year they were collected to the extent of
the tax benefit enjoyed by the taxpayer when the bad debts
were written-off and claimed as a deduction from income.
It also applies to taxes previously deducted from gross
income but which were subsequently refunded or credited.
The taxpayer is also required to report as taxable income
the subsequent tax refund or tax credit granted to the
extent of the tax benefit the taxpayer enjoyed when such
taxes were previously claimed as deduction from income.

(b) Give an illustration of the application of the tax

benefit rule.
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SUGGESTED ANSWER:
(b) X Company has a business connected receivable
amounting to P100,000.00 from Y who was declared
bankrupt by a competent court. Despite earnest efforts to
collect the same, Y was not able to pay, prompting X
Company to write-off the entire liability. During the year of
write-off, the entire amount was claimed as a deduction for
income tax purposes reducing the taxable net income of X
Company to only P1,000,000.00. Three years later, Y

Answers to the BAR: Taxation 1994-2006 (Arranged by Topics)

voluntarily paid his obligation previously written-off to X
Company. In the year of recovery, the entire amount
constitutes part of gross income of X Company because it
was able to get full tax benefit three years earlier.
Basic; Basis of Income Tax (1996)
X is employed as a driver of a corporate lawyer and receives
a monthly salary of P5,000.00 with free board and lodging
with an equivalent value of P1,500.00.
1 What will be the basis of X's income tax? Why
2 Will your answer in question (a) be the same if X's
employer is an obstetrician? Why?
SUGGESTED ANSWERS:
1) The basis of Xs income tax would depend on whether
his employer is an employee or a practicing corporate
lawyer.
If his employer is an employee, the basis of X's income
tax is P6,500.00 equivalent to the total of the basic salary and the
value of the board and lodging. This is so because the
employer/corporate lawyer has no place of business where the free
board and lodging may be given.
On the other hand, if the corporate lawyer is a "practicing
lawyer (self-employed), X should be taxed only on P5,000.00
provided that the free board and lodging is given in the business
premises of the lawyer and for his convenience and that the free
lodging was given to X as a condition for employment.
2) If the employer is an obstetrician who is self-employed,
the basis of X's income will only be P5,000.00 if it is proven
that the free board and lodging is given within the business
premises of said employer for his convenience and that the
free lodging is required to be accepted by X as condition for
employment. Otherwise, X would be taxed on P6,500.00.
Basic; Gross Income: Define (1995)
What is "gross Income" for purposes of the Income tax?
SUGGESTED ANSWER:
GROSS INCOME means all income from whatever source
derived, including (but not limited to) compensation for
services, including fees, commissions, and similar items;
gross income from business; gains derived from dealings in
property; interest; rents; royalties; dividends; annuities; prizes
and winnings; pensions; and partner's distributive share of
the gross income of general professional partnership (Sec. 28,
NIRC).
ALTERNATIVE ANSWER:
a) Gross income means all wealth which flows into the
taxpayer other than as a mere return of capital. It includes
the forms of income specifically described as gains and
profits including gains derived from the sale or other
disposition of capital.
b) Gross income means income (in the broad sense) less
income which is, by statutory provision or otherwise,
exempt from the tax imposed by law (Sec. 36, Rev. Reg.
No. 2). Gross income from business means total sales, less
cost of goods sold, plus any income from investments
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and from incidental or outside operations or
sources (Sec. 43, Rev. Reg. No. 2).
Basic; Income vs. Capital (1995)
How does "Income" differ from "capital"? Explain.
SUGGESTED ANSWER:
Income differs from capital in that INCOME is any wealth
which flows into the taxpayer other than a return of capital
while capital constitutes the investment which is the source
of income. Therefore, capital is fund while income is the
flow. Capital is wealth, while income is the service of
wealth. Capital is the tree while income is the fruit (Vicente
Madrigal et al v. James Rqfferty, 38 Phil. 414).
Basic; Schedular Treatment vs. Global Treatment
(1994)
Distinguish "schedular treatment" from "global treatment" as
used in income taxation.
SUGGESTED ANSWER:
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Under a SCHEDULER SYSTEM, the various types/items of
income (compensation; business/professional income) are classified
accordingly and are accorded different tax treatments, in
accordance with schedules characterized by graduated tax
rates. Since these types of income are treated separately, the
allowable deductions shall likewise vary for each type of
income.
Under the GLOBAL SYSTEM, all income received by the
taxpayer are grouped together, without any distinction as to
the type or nature of the income, and after deducting
therefrom expenses and other allowable deductions, are
subjected to tax at a fixed rate.
Compensation; Income Tax: Due to Profitable Business
Deal (1995)
Mr. Osorio, a bank executive, while playing golf with Mr.
Perez, a manufacturing firm executive, mentioned to the
latter that his (Osorio) bank had just opened a business
relationship with a big foreign importer of goods which
Perez' company manufactures. Perez requested Osorio to
introduce him to this foreign importer and put in a good
word for him (Perez), which Osorio did. As a result, Perez
was able to make a profitable business deal with the foreign
Importer.
In gratitude, Perez, in behalf of his manufacturing firm,
sent Osorio an expensive car as a gift. Osorio called Perez
and told him that there was really no obligation on the part
of Perez or his company to give such an expensive gift. But
Perez insisted that Osorio keep the car. The company of
Perez deducted the cost of the car as a business expense.
The Commissioner of Internal Revenue included the fair
market value of the car as Income of Osorio who protested
that the car was a gift and therefore excluded from income.
Who is correct, the Commissioner or Osorio? Explain.
SUGGESTED ANSWER:
The Commissioner is correct. The car having been given to
Mr. Osorio in consideration of having introduced Mr.
Perez to a foreign Importer which resulted to a profitable
business deal is considered to be a compensation for
Answers to the BAR: Taxation 1994-2006 (Arranged by Topics)
services rendered. The transfer is not a gift because it is not made
out of a detached or disinterested generosity but for a benefit
accruing to Mr. Perez. The fact that the company of Mr. Perez
takes a business deduction for the payment indicates that it was
considered as a pay rather than a gift. Hence, the fair market value
of the car is includable in the gross income pursuant to Section
28(a)(l) of the Tax Code (See 1974 Federal Tax Handbook, p. 145). A
payment though voluntary, if it is in return for services rendered,
or proceeds from the constraining force of any moral or legal duty
or a benefit to the payer is anticipated, is a taxable income to the
payee even if characterized as a 'gift' by the payor (Commissioner
vs. Duberstein, 363 U.S. 278).