Dear students,

CAVEAT : What I am sharing to you is merely the guide I use when I

conduct my lectures; hence, this is the material in its SKELETAL FORM.
This is just but a STUDY GUIDE and not even a supplementary study
notes. You still have to read, digest, comprehend, and understand the
LAW.

By the way, I did not include here those other topics we have already
discussed in class.

Just please inform me when shall be our FINAL EXAM, which shall
be 80% Income Taxation and 20% General Principles.

Regards,

-cca-

GROSS INCOME

The NIRC adopts the all inclusive approach in defining Gross Income.
Section 32 clearly provides: all income derived from whatever source.
Apparently, therefore, even if the income is derived from an unlawful source, the
same shall be made part of Gross Income.

Section 32(A) specifically enumerates certain items of income, which are

generally subject to income tax under, or given a special treatment in, the NIRC or
other tax treaties.

We have:

1) Compensation for services, in whatever form paid, including but

not limited to fees, salaries, wages, commissions and similar items;
2) Gross income derived from the conduct of trade or business or from
the exercise of a profession;
3) Gains derived from dealings in property;
4) Interests;
5) Rents;
6) Royalties;
7) Dividends;
8) Annuities;
9) Prizes and winnings;
10) Pensions;
11) Partners distributive share from the net income of a GPP.

What you have to take note here is that, the enumeration is NOT
EXCLUSIVE. Those which are not specifically enumerated are still subject to tax,
UNLESS they are among those which are EXCLUDED from Gross Income under
Section 32(B) or exempted from tax under special laws.

I. Compensation Income: This covers all remuneration for services

performed by an employee for his employer under an employer-
employee relationship, unless specifically excluded by the NIRC; such
 as in the case of a purely statutory minimum wage earner, whose
wages are not taxable.

II. Business Income: This covers the gross income derived from the
conduct of trade or business. This particular income arises from self-
employment or practice of profession. This shall not include income
from performance of service by the taxpayer as an employee.

Unlike purely compensation income, business allowable deductions may be

had from the business income as may be provided under Section 34.

Gross Business Income Php XXX

Less: Allowable Deductions Php XXX
Net Income Php XXX
Less: Basic Personal Exemption Php XXX
: Additional Exemption, if any Php XXX
Net Taxable Income Php XXX

This category of income is taxed at the graduated rates from 5%-32%, and
which graduated income tax schedule is used for individual income taxpayers
earning compensation income, business/professional income, or both.

Just few areas to take note of:

Interests earned by banks and other lending institutions

For income tax purposes, the interests earned by banks and other lending
institutions from their lending activities are considered as gross income derived
from the conduct of trade or business under Section 32(A)(2) and NOT as
interests under subparagraph (A)(4).

The distinction is important because subparagraph (A)(2) recognizes

deductions, while subparagraph (A)(4) does not recognize deductions since the latter
pertains to INTERESTS considered to be passive income, which shall then be
subject to 20%FWT.

So, if the interest income is earned by a taxpayer who is not engaged in

lending activities in their ordinary course of trade or business, said interest income
shall be deemed a mere passive income; thus, subject to 20%FWT and shall no
longer be a reportable income.

However, if the interest income is earned by a taxpayer who is in the

business of lending, such as the banks, said interest income shall form part of the
Gross Income and certain allowable deductions may be had therefrom, which shall
ultimately be subject to the 5%-32% graduated income tax schedule in cases of
individual taxpayers and 30% NCIT in case of corporate income taxpayers.

III. Gains derived from dealings in properties: gains or income

derived from dealings in properties (whether personal or real) are
generally subject to income tax.

The tax depends on whether the subject properties are classified as capital
assets or ordinary assets.
 ORDINARY ASSETS are those referring to: (a) stock in trade of the taxpayer
or other property of a kind which would properly be included in the inventory of the
taxpayer; (b) property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business; (c) property used in the trade or business,
of a character which is subject to the allowance for depreciation; or (d) real property
used in trade or business of the taxpayer. If the asset is not among those we have
mentioned, the same shall be classified as a CAPITAL ASSET.

Taxpayers engaged in real estate business.

Real properties held by taxpayers engaged in the real estate business

(specifically: real estate dealers, real estate developers, and real estate lessors) are
considered as ordinary assets. So gains derived or losses incurred from the
disposition thereof shall be considered ordinary gains or ordinary losses,
respectively.

Gains or losses from the sale of capital assets are called capital gains or
losses; while gains or losses from the sale of ordinary assets are called ordinary
gains or losses.

The NIRC provides a special tax treatment for capital gains or losses. Capital
gains may either be subject to a regular income tax or a capital gains tax.

Gains from the sale of ordinary assets are called ordinary gains, which are
subject to the regular income tax. On the other hand, gains from the sale of capital
assets are called capital gains, which are subject to 6% CGT, which is a FWT, if the
sale involves REAL PROPERTIES and LOCATED IN THE PHILIPPINES.

In all other cases, capital gains are subject to a REGULAR INCOME TAX,
specifically:

1) Capital gains from the transfer of REAL properties located OUTSIDE of

the Philippines;
2) Capital gains from the transfer of PERSONAL properties whether located
OUTSIDE or WITHIN the Philippines.

SUMMARY:

PARTICULARS INCOME TAX TREATMENT

Ordinary Asset
Gain from sale of real property classified The gain is classified as an ordinary
as ordinary asset by a taxpayer engaged gain, which shall form part of the
in real estate business taxpayers GROSS INCOME.

The sale shall be subject to:

1% CWT if the GSP or FMV does not

exceed Php500,000.00;

3% CWT if the GSP or FMV exceeds

 Php500,000.00 but does not exceed
Php2,000,000.00; and,

5% if GSP or FMV exceeds

Php2,000,000.00
Gain from sale of real property classified The gain is classified as an ordinary
as ordinary asset by a taxpayer not gain, which shall form part of the
engaged in real estate business taxpayers GROSS INCOME.

The sale shall be subject to 6% CWT.

Loss from sale of real property classified The loss is classified as an ordinary loss
as ordinary asset (i.e. a loss incurred in trade, business or
profession), which shall be deductible
from the taxpayers gross income.
Capital Asset
Gain from the sale of real property The gain is classified as a capital gain,
classified as capital asset and located which shall be subject to 6% CGT, which
within the Philippines tax is a FWT.
Gain from the sale of personal property The gain is classified as a capital gain,
classified as capital asset and located which shall form part of the taxpayers
within the Philippines GROSS INCOME.

With regard to an individual taxpayer,

100% of the capital gain will be
recognized if the asset has been held for
not more than one (1) year and only 50%
if the asset has been held for more than
one (1) year (HOLDING PERIOD).

NOTE: the rule on the HOLDING

PERIOD does not apply to a
CORPORATE TAXPAYER. Its gain or
loss shall be recognized in full regardless
of the holding period, subject to the
capital loss limitation.

What is this capital loss limitation?

This provides that the taxpayer may

only claim his capital losses as
deductions up to the extent of his capital
gains during the taxable year. The
excess of capital losses over capital gains
cannot be deducted from the taxpayers
ordinary income.

NOTE: this net capital loss may be

carried-over in the following taxable
year only if the taxpayer is an individual
taxpayer and subject to certain
limitations, to wit:

a) The amount of the net capital loss

carry-over must not exceed the net
 taxable income in the year the net
capital loss is sustained;
b) The net capital loss may only be
carried over in the following year
(and not in the succeeding years);
Gain from the sale of real or personal With regard to a resident citizen or a
property classified as capital asset and domestic corporation, the gain is
located outside the Philippines classified as a capital gain (subject to the
rule on the holding period), which shall
form part of the taxpayers GROSS
INCOME.
Loss from the sale of real property
classified as capital asset

EXEMPTIONS and ALLOWABLE DEDUCTIONS

Allowable Deductions are items or amounts, which the law allows to be

deducted from gross income in order to arrive at the taxable income.

1) From COMPENSATION INCOME:

i) Basic personal exemption;
ii) Additional exemption, if applicable.

2) From BUSINESS INCOME:

i) Basic personal exemption;
ii) Additional exemption, if applicable;
iii) Itemized deductions under the Tax Code (Section 34-
items A-J);
iv) In lieu of (iii), Optional Standard Deduction not to exceed
forty (40%) percent of the taxpayers gross sales or gross
receipts, as the case may be. NOTE: before, OSD is only
ten (10%) percent, but by the advent of RA 9504
amending the Tax Code, OSD is raised to 40%.

3) From PASSIVE INCOME:

i) No deductions are allowed considering that by the very
nature of the tax being imposed on passive income, it is a
FINAL TAXthat is, the income is taxed at source.

Personal Exemption

Personal exemptions are arbitrary amounts allowed as deductions from

gross income of the individual taxpayer from compensation, business, or even
practice of profession.

Personal exemptions in a sense represent the personal, living and family

expenses of the taxpayer.

It is ARBITRARY because the amount of the deduction allowed by law is

fixedthat is, regardless of the actual personal, living and family expenses of the
individual taxpayer, the personal exemption shall only be in the amount of fifty
thousand (Php 50,000.00) pesos regardless of status.
 Individual taxpayers allowed personal exemptions:

i) Citizens, residents and non-residents;

ii) Resident Aliens;
iii) Non-resident aliens, but only those engaged in trade or business;
NRA-NETB are not allowed personal exemptionsthey are not
even allowed any deductions, basic personal and additional
exemptions, considering that their income within the
Philippines are subject to 25% Final Tax.

TAKE NOTE: NRA-ETB may be allowed basic personal exemptions BUT

NOT additional exemptions. In fact the basic personal exemptions granted to
NRA-ETB are subject to certain conditionsthat is, FIRST, subject to the
reciprocity rule, if the country of the alien does not grant the same
privilege to Filipinos therein, the same shall not likewise be granted to them;
SECOND, his basic personal exemptions shall be the lesser amount between
that granted by his country to the Filipinos therein and that provided by our
own tax laws.

iv) ESTATES and TRUSTS, which are, for purposes of basic

personal exemptions, treated as a single individual taxpayer.

Additional Exemption

Additional exemption granted to an individual taxpayer who has

dependent child or children in the amount of twenty five thousand (Php
25,000.00) pesos for each dependent child not exceeding four (4) children.

QUESTION: What if the individual taxpayer is single, not married, may the
said taxpayer avail of the additional exemption?

ANSWER: YES. An individual taxpayer, whether single or married, shall be

allowed an additional exemption for each dependent child. For as long as the
taxpayer has a dependent child, even if the taxpayer is not married, he/she may
avail of said exemption. But, take note, the law requires that the taxpayer so
claiming must have the custody of the dependent child for which the taxpayer is
claiming an additional exemption for.

TAKE NOTE of the parameters for dependent childhe/she is a:

i) legitimate, illegitimate or legally adopted child;

ii) chiefly dependent upon and living with the taxpayer;
iii) not more than 21 years old;
iv) unmarried and not gainfully employed;
v) or if such dependent, regardless of age, is incapable of
self-support because of mental or physical defect.

ILLUSTRATION:

X, the taxpayer, single, with 5 qualified dependent children. The following

data are available:
 Gross Compensation Income (Phil) P 300,000.00

If X is a resident citizen:

Gross Compensation Income P 300,000.00

Less: Basic personal exemption 50,000.00
: Additional exemption 100,000.00 150,000.00
Taxable Income P 150,000.00

If X is a resident alien: the same

What if X is a non-resident alien employed by a regional operating

headquarter of a multinational company?

Gross Compensation Income P 300,000.00

Multiply by applicable tax rate 15%
Tax due xxx

What if the Gross Compensation Income is a Business Income and that X is a

citizen?

Gross Business Income P 300,000.00

Less: Itemized deductions (or OSD) xxx
: Personal exemption 50,000.00
: Additional exemption 100,000.00 xxx
Taxable income P xxx

What if X is a NRA-ETB?

Gross Business Income P 300,000.00

Less: Itemized deductions (or OSD) xxx
: Personal exemption 50,000.00
: Additional exemption (N/A) xxx
Taxable income P xxx

TN: the personal exemption is subject to reciprocity.

What if X is NRA-NETB?

Gross Business Income P 300,000.00

Multiply by FT rate 25%

ALLOWABLE DEDUCTIONS

Under Section 31 of the NIRC, the income tax is generally imposed on TAXABLE
INCOME, which is the difference between the items of Gross Income and Allowable
Deductions. While the definition given for Gross Income is all inclusive, the
definition for deductions is different.

The rule on recognizing Allowable Deductions is stringent as compared to

recognizing items of Gross Income.
 We have certain requirements that must be met before an item be considered
as Allowable Deduction. We have:

1) It is ordinary and necessary to the taxpayers trade, business or

profession;
2) It must be paid or incurred during the taxable year;
3) It is linked to the taxpayers trade, business or profession;
4) Its amount must be reasonable;
5) It must be properly substantiated with evidence;
6) If the payment is subject to withholding, the corresponding tax must have
been withheld; and,
7) Its payment must be LEGITIMATE and LAWFUL.

Ordinary and necessary expenses

The first requirement is that the expense must be ordinary and necessary.
This prevents the taxpayer from turning non-deductible personal expenses into
deductible business expenses by commingling his business and personal
transactions.

However, without limiting the coverage of ordinary and necessary expenses,

this term normally covers:

1) The cost of goods sold or cost of services rendered;

2) Management expenses;
3) Commissions;
4) Salaries and wages;
5) Supplies;
6) Incidental repairs;
7) Transportation expenses;
8) Depreciation of equipment used in the trade or business;
9) Travelling expenses while away from home solely in the pursuit of a trade
or business;
10) Advertising and other selling expenses;
11) Insurance premiums against fire, storm, theft, accident or other similar
losses in the case of a business; and,
12) Rental for the use of business property.

(see RR No. 2-40, Section 65)

Link between the expense and business

A taxpayer must establish a logical link between the expense and its
business. The principle of allocating expenses is grounded on the premise that the
taxable income of a taxpayer is derived from carrying on its business.

Expenses that are inherently personal or capital in nature may not be

claimed as deductions. They must have a direct relationship with the taxpayers
taxable activity.

I would just like to discuss very briefly the concept of matching principle of
accounting. What you have to remember is that expenses which are directly related
to income subject to FWT or exempt from tax may not be claimed as items of
deductions from the income which are subject to the regular income tax. Otherwise,
there will be a distortion of the taxpayers income.

In Hospital de San Juan De Dios versus CIR, an old case, GR No. L-

31305, May 10, 1990, the Supreme Court held that the expenses incurred in the
administration or management of petitioners passive investments may not be
claimed as tax deductions. The SC explained that the petitioners activities never
went beyond that of a passive investor, which did not come within the purview of
carrying on any trade, business or profession. The principle of allocating expenses
was grounded on the premise that the taxable income was derived from carrying on
a trade or business or profession, as distinguished from mere receipt of interests
and dividends from ones passive investments.

Another issue would be this: the taxpayer obtains a loan and uses its
proceeds in acquiring government bonds (a passive investment). Is the interest
expense on the loan acquired deductible as an allowable deduction from the Gross
Income of the taxpayer?

Applying the matching principle of accounting, the interest expense

pertaining to the loan should not be claimed as a tax deduction from income subject
to the regular tax.

Test of reasonableness of an expense

The amount claimed as deduction must represent a reasonable payment for

the goods or services which the taxpayer acquired in the conduct of his trade,
business or profession.

Say for example in case of advertising expenses, there are no clear-cut

criteria or fixed tests in determining the reasonableness of an advertising expense.
The right to a deduction depends on a number of factors, such as: (a) the type and
size of the business in which the taxpayer is engaged; (b) the volume and amount of
its net earnings; (c) the nature of the expenditure itself; and, (d) the intention of the
taxpayer and the general economic conditions.

In CIR versus General Foods, Inc., G.R. No. 143672, April 24, 2003, the
Supreme Court disallowed the questioned expense on the ground that it failed to
meet the following conditions:

i) Reasonableness of the amount incurred; and,

ii) The amount incurred must not be a capital outlay to create goodwill
for the product or the taxpayers business.

The Supreme Court noted that the expense was inordinately large. The
expense was designed to stimulate the future sale of merchandise. Furthermore, the
venture was to protect the brand franchise. It was tantamount to efforts to
establish a reputation and is akin to the acquisition of capital assets which
normally should be spread out over a reasonable period of time. (taxpayer should
merely recognize a PREPAID advertising expense, which must be spread out over a
reasonable period of time)

Another example would be in the case of depreciation of motor vehicles. The

claimed depreciation should represent a reasonable allowance for the exhaustion,
wear and tear of the property being used in the business.
 With regard to the depreciation expense that may be claimed on account of
motor vehicles, the regulations (RR No. 12-2012 and RMC No. 2-2013) provide
the following notable limitations:

1) Only one (1) vehicle for land transport is allowed for the use of an official
or employee;
2) The value of such vehicle should not exceed Php2.4M;
3) No depreciation is generally allowed for yachts, helicopters, airplanes,
and/or aircrafts, UNLESS the taxpayers main line of business is
transport operations or lease of transportation equipment and the vehicles
purchased are used in said operations.

Substantiation requirement

The taxpayer must substantiate with sufficient evidence: (i) the amount of the
expense claimed; and, (ii) the link between the expense and its business. Such
evidence must be preserved UNTIL the last day prescribed by law within which the
BIR may issue an assessment. That is Section 235 of NIRC.

With respect to most deductions, however, a taxpayer may rely on the

COHAN RULE. This rule provides that while a taxpayer is not relieved from the
burden of substantiating its claimed deduction, the BIR should permit a reasonable
amount of deductions taking into account the nature of the business of the taxpayer.

The absence of sufficient or available supporting document is not sufficient to

disallow the claimed deduction.

There was this old case of Zamora versus CIR, the BIR disallowed 50% of his
claimed promotion expenses since they were not supported by official receipts. In
sustaining the BIR, the Supreme Court explained that since promotion expenses
constituted one of the deductions in conducting a business, the same must satisfy
the requirement of the NIRC. Claims for the deduction of promotion expenses or
entertainment expenses must also be substantiated or supported by records
showing in detail the amount and nature of the expense incurred.

Considering that the application of Zamora showed that she went abroad on a
combined medical and business trip, not all of her expenses came under the
category of ordinary and necessary expenses. Part thereof constituted her personal
expenses. There having been no means by which to ascertain which expense was
incurred by her in connection with the business and which was incurred for her
personal benefit, it was proper for the BIR to consider 50% of the said amount as
business expense and the other 50%, as her personal expense, which is not
deductible from Gross Income.

Withholding tax requirement

An expense shall be allowed as a deduction only if it is shown that the

prescribed withholding tax has been paid to the BIR. That is provided under Section
34(k) of the NIRC.

Nonetheless, the taxpayer may still claim the expense as an income tax
deduction when the payee reported the income and pays the corresponding tax, or
the withholding agent (referring to the taxpayer) pays the tax including the interest
and surcharge, if applicable, at the time of the investigation.

Legitimacy of expenses

The expense claimed by the taxpayer must be legitimate. The expense: (a) in
particular, must not be in the nature of a bribe, kickback and other similar
payments; and, (b) in general, must not be contrary to law, morals, good customs,
public order or public policy.

Let us go to the individual items as allowable deductions. We will be

discussing only some, which I think have some gray areasothers, being already
self-explanatory.

Compensation for personal services

Salaries, wages and other forms of compensation for personal services (such
as allowances, bonuses and benefits, including the GMV of fringe benefits) are
generally regarded as ordinary and necessary in carrying on any trade or business.
Their aggregate amount must be more or less commensurate to the value of the
services actually rendered by the taxpayers employees. Any amount beyond the
reasonable value of such services may not be claimed as a deduction for income tax
purposes.

Few points to take note:

Donations made to employees that do not have in them the element of

compensation, or are in excess of reasonable compensation for services rendered are
not deductible from gross income.

Another would be those extraordinarily unusual amounts paid by the

corporate taxpayer to its officer in the guise and form of compensation for their
supposed services, without any relation to the measure of their actual services,
cannot be regarded as ordinary and necessary expensesrather, it may even be
regarded as DIVIDENDS, which shall more appropriately be subject to dividends
tax of 10%FWT.

Rentals

There are two (2) basic types of leases recognized in the NIRC: (i) operating
lease; and (ii) finance lease. Section 34, referring to allowable deductions,
contemplates an OPERATING LEASE.

Discuss difference of operating lease from finance lease. The latter refers to
one where the financial lessee is obligated to make periodic payments denominated
as lease rentals, which enable the financial lessor to recover the purchase price of
the property which had been paid to its supplier.

So, it is an operating lease, the rentals from which, is what is being

contemplated under Section 34 of the NIRC. How about the cost borne by a lessee in
erecting buildings or making permanent improvements on the land of which he is a
lessee? The same may be capitalized and amortized over the life of the buildings or
improvements, or the term of the lease, whichever is shorter.
Cost of Materials

As a rule, a taxpayer may only claim as an income tax deduction the cost of
materials and supplies, which are actually consumed and used in operation during
the taxable year. The cost of such materials and supplies must not have been
deducted in determining the net income for any previous taxable years.

Repairs

Take note of the conditions in order for costs of repairs may be claimed as
income tax deductions.

Take note, further, that repairs which are in the nature of replacement, to
the extent that they arrest deterioration and appreciably prolong the life of the
property, should be capitalized and charged against the depreciation reserves if
such accounts are kept. They may not be claimed as income tax deduction.

Expenses in the exercise of profession

The amounts spent for books, furniture, and professional instruments and
equipment of a permanent character may not be claimed as income tax deductions.
However, such amounts may be subject to depreciation.

Entertainment, amusement, and recreation expenses

Representation expenses refer to those incurred by a taxpayer in

entertaining, providing amusement and recreation to (or meeting with) a guest or
guests at a dining place, place of amusement, country club, theatre, concert, play,
sporting event, and similar events or places.

In the case of a country, golf, sports club, or any other similar club where the
employee or officer of the taxpayer is the registered member and the incurred
related expenses are paid for by the taxpayer, such expenses are presumed to be
fringe benefits (at any rate, the Grossed-up Monetary Value of which is allowable
deduction as compensation), subject to fringe benefits tax.

Take note: the BIR has provided a ceiling of the entertainment, amusement
and recreation expenses that may be claimed as deductions (see Revenue Regulation
No. 10-02).

Interests

Take note of the following:

i) Requisites for its deductibility;

ii) Business related indebtedness the interest must arise from an

obligation incurred by the taxpayer in the ordinary course of trade or
business. Thus, the interest from a personal loan may not be claimed
as a deduction;

iii) Indebtedness between related parties this exception will discourage

transactions between related parties whose sole purpose is to create
interest deductions without any change in their economic interests;
 iv) Indebtedness incurred to finance petroleum exploration the non-
deductible expense referred to pertains to interest or other
consideration paid or incurred by a service contractor engaged in the
discovery and production of indigenous petroleum in the Philippines in
respect of the financing of its petroleum operations, pursuant to
Section 23 of PD 8, as amended by PD 87;

v) Optional treatment of interest expense on capital expenditure at the

option of the taxpayer, interest incurred to acquire property used in
trade, business or exercise of a profession may be allowed as a
deduction or treated as a capital expenditure. The NIRC does not
prohibit the deduction of interest on a loan incurred for acquiring
machinery and equipment. Neither does it compel the capitalization of
interest payments on such a loan. It is simply silent on a taxpayers
right to elect one or the other tax treatment of such interest payments;

vi) Rule on tax arbitrage this limitation applies, regardless whether a

tax arbitrage scheme was employed or when the interest bearing loan
and/or investment was made. It is sufficient, during the taxable year,
there is an interest expense incurred on one side and an interest
income earned on the other side, which interest income had been
subjected to final withholding tax;

Taxes

As a rule, a taxpayer may claim as an income tax deduction any tax whatever
its name or nature paid directly to the Government or to any of its political
subdivisions.

However, the NIRC only contemplates the tax proper. Fines and penalties
which are incident to delinquency may not be claimed as taxes.

Take note of those types of taxes, which by their very nature are not so
deductible.

Also take note of the rule with respect to the deductibility of foreign taxes
(tax deduction versus tax credit).

Losses

In order for the taxpayer to claim losses as income tax deductions, they must
be: (i) actually sustained during the taxable year; and, (ii) not compensated for by
insurance or other forms of indemnity.

Take note of the following:

i) Casualty losses;
ii) Capital losses;
iii) Losses from wash sales of stocks or securities;
iv) Wagering losses;
v) Abandonment losses;
 vi) Carry-over of losses the NIRC authorizes a taxpayer to carry-over to
(and claim as income tax deductions in) the subsequent year/s the
following losses, subject to certain limitations:

a) Net operating losses (i.e., the excess of allowable deductions

over gross income) of the taxpayer, which had not been
previously offset as deductions from the gross income;
b) Net capital losses (i.e., the excess of the losses from sales or
exchanges of capital assets over the gains from such sales or
exchanges). Take note, further, of the rule on the HOLDING
PERIOD.
vii) Bad debts further take note of the tax benefit rule with respect to
bad debts;
viii) Depreciation;
ix) Depletion;
x) Amortization;
xi) Charitable and other contributions
- Contributions to the government;
- Contributions to certain foreign institutions or international
organizations;
- Contributions to BIR-accredited NGOs
xii) Research and development;
xiii) Pension trusts
xiv) Premium payments on health and/or hospitalization insurance of an
individual taxpayer;
xv) OPTIONAL STANDARD DEDUCTION

INCOME TAXATION OF CORPORATION

Topics to concentrate:

a) Normal corporate income tax (NCIT);

b) Minimum corporate income tax (MCIT);
c) Improperly accumulated earnings tax (IAET);
d) Gross Income Tax (GIT).

Normal Tax Liability

The normal corporate income tax (NCIT) (interchangeably termed as

REGULAR corporate income tax) shall mean the income tax rates as prescribed
under Sections 27(A), 28(A)(1) and 29 (B)(1) of the NIRC:

The NCIT under the NIRC shall be 35% effective January 1, 1997; 34%
effective January 1, 1998; 33% effective January 1, 1999; and 32% effective January
1, 2000 onwards.

HOWEVER, on May 24, 2005, the then President signed into law RA 9337 or
the Expanded Value-Added Tax Act of 2005. Under said law, beginning November
1, 2005, the NCIT rate shall be 35%. And such NCIT rate shall be reduced to 30%
effective January 1, 2009. So, the prevailing NCIT rate now is 30%.

Classification of Corporate Income Taxpayers

 1) Domestic Corporations These are the corporations, which are created
or organized under and by virtue of Philippine laws. Under domestic
corporations we have:

i) Domestic corporations, in general;

ii) GOCCs;
iii) Taxable business partnerships;
iv) Proprietary educational institutions;
v) Non-profit hospitals.

2) Foreign Corporations These are the corporations, which are

organized in accordance with laws of their respective countries. Under
this classification, we have:

i) Resident Foreign Corporations Those engaged in

trade or business in the Philippines;
ii) Non-resident Foreign Corporations Those not
engaged in trade or business in the Philippines.

3) General Professional Partnerships those formed by persons for the

sole purpose of exercising their common profession, no part of the income
of which is derived from engaging in any trade or business.

- A GPP shall not be subject to the income tax but the individual
partners composing it are.

4) Estates and Trusts but take note, it shall be the rules in taxation of
individuals generally apply to estates and trusts. The taxable income of an
estates and trusts shall be computed in the same manner and on the same
basis as in the case of an individual. Estates and Trusts are even allowed
personal exemption of P50,000.00. The income tax rates for individual
taxpayers likewise apply.

QUESTION: How about JOINT VENTURES or consortiums?

ANSWER: Joint ventures or consortiums formed for the purpose of undertaking
construction project pursuant to an operating or consortium agreement are not
subject to the regular corporate income tax. The co-venturers shall be individually
liable for the payment of corporate income tax on their respective earnings derived
from the joint venture project.

Sources of Income

Aside from knowing the classification of the corporate taxpayer, the source of
income is the next important thing to determinewhether it is from within the
Philippines or without. The following rules shall apply:

1) Domestic corporations are taxable on income from sources within and

without the Philippines;
2) Foreign corporations, whether resident or non-resident, are taxable on
income derived from within the Philippines.

Categories of Income and Tax Rates

 1) Business Income Generally, business income earned by a corporation
is taxed at rates provided under Sections 27(A) for domestic corporations,
28(A)(1) for resident foreign corporations, and 28(B)(1) for non-resident
foreign corporations.
2) Passive Income Passive income, same as that with individual
taxpayers, shall be subject to a separate and final tax; and as such, these
shall not be included in gross income computation.

Let us go over the different classifications of corporate taxpayers:

1) Domestic Corporations, in general.

- Generally, the pro-forma computation of the normal income tax of

domestic corporations follows:

Gross Income P xxx

Less: Allowable Deductions P xxx
Net Taxable Income P xxx
Multiply by NCIT rate 30%
Tax Due P xxx

- Domestic corporations are allowed to opt to be taxed at fifteen

(15%) percent of GROSS INCOME (GIT) on certain conditions.
What are those conditions, we will discuss those separately.

- Further, domestic corporations are subject to minimum corporate

income tax (MCIT), which shall likewise be discussed separately.

- Partnerships, other than GPPs, are taxed the same way as the
domestic corporations.

2) Proprietary Educational Institutions and Non-profit hospitals See

Section 27(B).

- TAKE NOTE: the hospital must be for non-profit; otherwise, the

hospital shall not be covered under this provision. With respect to
educational institutions, the same must be proprietary, in other
words, for profit; otherwise, if it is non-profit, the same shall be
tax exempt.

- These type of corporate taxpayers shall be subject to ten (10%)

percent on their taxable income and not thirty (30%) percent.

- However, if the gross income from unrelated trade, business or

other activity exceeds fifty (50%) percent of the total gross income
derived from all sources, the tax prescribed under Section 27(A)
that is, 30%, shall be imposed on the entire taxable income.

- Unrelated trade, business or other activity means any trade,

business or other activity, the conduct of which is not substantially
 related to the exercise or performance by such educational
institution or non-profit hospital of its primary purpose or function.

- STMS, a proprietary educational institution, has a gross income for

the taxable year of P15million. Of the total gross income, P5million
was derived from unrelated trade or business. Total deductions
amount to P3million.

Gross Income P 15million

Less: Allowable deductions P 3million
Net taxable income P 12million
X 10%
Tax due P 1.2million

The 10% tax rate applies because the gross income from
unrelated trade or business did not exceed the 50% limit of
the total gross income.

3) GOCCs see Section 27(C)

- GOCCs are generally taxable the same way domestic corporations

are, except:

i) Government Service Insurance System (GSIS);

ii) Social Security System (SSS);
iii) Philippine Health Insurance Corporation (PHIC);
iv) Philippine Charity Sweepstakes Office (PCSO).

- How about the Philippine Amusement and Gaming Corporation

(PAGCOR)? It used to be exempted under Section 27(C); but by
virtue of R.A. 9337, the same was deleted from the list.

- Take note, further, that by virtue of R.A. 10026, which was signed
into law in 2010, Local Water Districts (LWD) was granted tax
exemption. The law mandates that the amount saved due to the
exemption shall be used by the LWDs for capital equipment
expenditure that will result to an expanded water services coverage
and improved water quality in the provinces, cities and
municipalities.

4) Resident Foreign Corporations, in general taxed the same way as

domestic corporations. Just take note that RFCs are taxable only on income derived
from sources within the Philippines.

But, there are particular resident foreign corporations, which are

differently taxed, such as:

i) International Shipping subject to 2.5% tax on gross

Philippine billings.

- Gross Philippine billings shall mean gross revenue whether for

passenger, cargo or mail originating from the Philippines up to
 final destination regardless of the place of sale or payments of the
passage or freight documents.

ii) Offshore Banking Units subject to 10% FINAL income tax

on interest income derived from foreign currency loans granted
to residents.

- What are those OBUs? Take note that these are those branches,
subsidiaries or affiliates of a foreign banking corporation which is
duly authorized by the BSP to transact offshore banking business
in the Philippines.

iii) Regional Operating Headquarters subject to 10% of their

taxable income.

- What are those Regional Operating Headquarters? They are those

branches established in the Philippines by multinational
companies. And these multinational companies are operating; thus,
earning or deriving income in the Philippines through their
regional operating headquarters established in the Philippines.

iv) Regional or Area Headquarters these are not subject to

income tax in the Philippines.

- So, how is it different from a Regional Operating Headquarter?

These are those branches established in the Philippines by
multinational companies, which are engaged in any of the following
services: general administration and planning; business planning
and coordination; sourcing and procurement of raw materials and
components; sales promotion; training and personnel management;
logistics services; R & D; technical support and maintenance; data
processing and communication, and business development;

- These REGIONAL or AREA Headquarters do not earn or derive

income from the Philippines and which as simply as supervisory,
communications and coordinating center for their affiliates,
subsidiaries, or branches in the Asia Pacific Region and other
foreign markets.

5) Non-resident Foreign Corporation, in general The basis of tax for this

type of corporate taxpayer is GROSS INCOME from sources within the
Philippines, such as interests, dividends, rents, royalties, salaries, premiums
(except reinsurance premiums), annuities, emoluments or other fixed or
determinable annual, periodic gains or income, and capital gains.

Non-resident Foreign Corporation, in particular:

i) Non-resident Cinematographic Film Owner, Lessor or

Distributor taxed at 25% of GROSS income (royalties);

ii) Non-resident Owner or Lessor of Vessels chartered by

Philippine Nationals taxed at 4.5% of GROSS income (rentals);
 iii) None-resident Owner or Lessor of Aircraft, Machinery and
other Equipment taxed at 7.5% of GROSS income (rentals);

QUESTION: A Chinese Company performs maintenance services in China

for one of its clients, a Philippine Company, and transmits the same, say its
diagnosis for the maintenance, electronically through recorded media. Is the
income earned by the said Chinese Company from its Philippine client
subject to Philippine income tax?

TAKE NOTE: Non-resident foreign corporations are liable to income tax in

the Philippines ONLY on income from services performed in the Philippines.

ALLOWABLE DEDUCTIONS for Corporations

Allowable deductions are items or amounts which the law allows to be

deducted from gross income in order to arrive at the taxable income.

A domestic or resident foreign corporation may deduct from its business

income, the itemized deductions under the NIRC. Or, these corporations may elect
for the Optional Standard Deductions in an amount not exceeding forty (40%)
percent (R.A. 9504). However, you have to TAKE NOTE, that non-resident foreign
corporations are NOT allowed deductions from gross income.

So, lets discuss briefly the different items in computing for the income tax.

First, GROSS INCOME, this is the entire income from business without any
deductions yet either for itemized deductions or optional standard deduction.

Second, ITEMIZED DEDUCTIONS or the OSD, as the case may be.

Third, TAXABLE INCOME, that is the pertinent items of gross income less
the deductions authorized for such types of income. Taxable income is the amount
or tax base upon which the appropriate tax rate is applied to arrive at the fourth
item, which is the TAX DUE.

Then, we will be discussing MINIMUM CORPORATE INCOME TAX

(MCIT), IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) and
GROSS INCOME TAX (GIT)

MINIMUM CORPORATE INCOME TAX (MCIT) MCIT was conceived to

address the problem on the non-declaration and under-declaration of corporate
income and revenues. TAKE NOTE, that if the circumstances warrant, even if the
operations of a corporation result in a net loss, it will still be subject to the MCIT.

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) In addition to the

NCIT or MCIT, as the case may be, corporations are required to pay IAET. This
applies to earnings which the corporation tries to accumulate instead of being
distributed (through what we call as dividends) to avoid payment of income taxes by
shareholders. Recall that dividends received by a RC, NRC, RA from a domestic
corporation shall be subject to a 10% final income tax; NRA-ETB, 20% final
income tax; and NRA-NETB, 25% final income tax;
GROSS INCOME TAX (GIT) Corporations, at their option, may be allowed by
the President to be taxed at 15% of gross income. Quite obviously, this is not
applicable to non-resident foreign corporations considering that they are
automatically taxed on GROSS income. I just want you to take note of two (2)
matters with respect to GIT: (1) the option to be taxed based on gross income shall
be available only to corporations whose ratio of the cost of sales to gross sales from
all sources does not exceed fifty (50%) percent; and, (2) the election of the GIT
option by the corporation shall be irrevocable for three (3) consecutive taxable
years during which the corporation is qualified under the scheme.

Lets discuss further MCIT. The rule on MCIT applies not only to domestic
corporations but also to resident foreign corporations.

However, in case of resident foreign corporations, take note, that said rule
shall apply only to those which are subject to normal income tax and not to those
special types of resident foreign corporations, such as international shipping (2.5%
on gross Philippine billings), OBUs (10%), regional operating and regional or area
headquarters.

MCIT of two (2%) percent on the GROSS INCOME as of the end of the
taxable year is imposed upon any domestic corporation BEGINNING the FOURTH
(4TH) TAXABLE YEAR immediately following the taxable year in which such
corporation commenced its business operations

(NOTE: ideally, the year of registration is the year of the commencement of business
operations; but, take note, it does not always necessarily follow. So, to be safe, if
confronted with it, choose commencement of the business operations).

Under the said situation, the MCIT shall be imposed whenever: (1) such
corporation has zero or negative taxable income; OR (2) the amount of the MCIT is
higher than the computed NCIT.

QUESTION: In view of the rule on MCIT, it is apparent that domestic

corporations, regardless of its level of income, has to pay a certain amount of tax
whether NCIT or MCIT. But, in what instance when the corporation can escape the
payment of the tax, even the MCIT?

ANSWER: The Secretary of Finance, upon recommendation of the

Commissioner, may suspend the imposition of the MCIT upon submission of proof
by the applicant-corporation, duly verified by the Commissioners authorized
representative, that the corporation sustained substantial losses on account of a
prolonged labor dispute or because of force majeure or because of legitimate
business reverses.

Treatment of Excess MCIT paid The excess MCIT paid shall be carried
forward and may be credited against the NCIT due for a period not exceeding
three (3) years immediately succeeding the taxable year in which the same has
been paid.

Any amount of the excess MCIT paid which has not or cannot be so credited
against the NCIT due for the 3-year reglementary period shall lose its creditability.

ESTATES AND TRUSTS

 The rules in taxation of individuals generally apply to estates and trusts. The
taxable income of an estate or trust shall be computed in the same manner and on
the same basis as in the case of individuals. Estates and trusts are allowed a
personal exemption of Php50,000.00 (see R.A. 9504, sec. 8).

The income tax rates for individual taxpayers likewise apply to estates and
trusts. The taxable year of estates and trusts shall be the calendar year just like
individuals.

Take note further:

Consolidation of income of two or more trusts When two or more

trusts are created by the same grantor and the beneficiary in both trusts is the
same, the taxable income of all the trusts shall be consolidated and the tax
computed on such consolidated income.

GENERAL PARTNERSHIPS

Under your Civil Law, how do you define General Partnerships? It is a

contract whereby the parties agree to contribute money, property or industry to a
common fund with the intention of dividing the profits among themselves.

We have two (2) classifications of general partnerships:

1) General Professional Partnerships formed for the sole purpose of

exercising their common profession;
2) General co-partnership (compania collectiva)

GPP we all know shall not be subject to the income tax but, take note, that
the GPP is still required to file annual income tax return or more appropriately
termed as ANNUAL INFORMATION RETURN for the purposes of furnishing
information as the items of gross income, deductions, and the names, TINs, and
most importantly the SHARE of each of the partners. This is so important for the
BIR considering that the partners in a GPP shall be the ones liable for income tax
in their separate and individual capacities.

Special attention to Section 26 of the NIRC: for purposes of computing the

distributive share of the partners, the net income of the GPP shall be
computed in the same manner as that of the corporations. As such, therefore,
a GPP may claim either the allowed itemized deductions or the OSD allowed to
corporations. The net income determined thereby is the distributable net income
from which the share of each partner is to be determined and to be taxed.

GPPs, unlike corporations and general co-partnerships, DO NOT pay income

taxes. Rather, the GPP serves as a conduit or pass-through entity where its income
is ultimately taxed to the partners comprising it.

In computing taxable income, all expenses which are ordinary and necessary,
incurred or paid for the practice of profession, are allowed as deductions. Since the
taxable income is in the hands of the partner, as a rule, apart from the expenses
claimed by the GPP in determining its net income, the individual partner can still
claim deductions incurred or paid, not by the GPP, but by himself that contributed
to the earning of the income taxable to him.
 Itemized or OSD for GPP See Revenue Regulation 2-2010 amending
Revenue Regulation 16-2008.