Taxation Law Bar 1999 ACo., a Philippine corporation, has two divisions — manufacturing and construction. Due to the economic situation, it had to close its construction division and lay-off the employees in that division. A Co. has a retirement plan approved by the BIR, which requires a minimum of 50 years of age and 10 years of service in the same employer at the time of retirement. There are 2 groups of employees to be laid off: ‘A. Employees who are at least 50 years of age and has at 10 years of service at the time of termination of employment. B. Employees who do not meet either the age or length of service A Co. plans to give the following: For category (A) employees - the benefits under the BIR approved plan plus an ex gratia payment of one month of every year of service. For category (B) employees - one month for every year of service. For both categories, the cash equivalent of unused vacation and sick leave credits. ACo. seeks your advice as to whether or not it will subject any of these payments to WT. Explain your advice. (5%) SUGGESTED ANSWER: For category A employees, all the benefits received on account of their separation are not subject to income tax, hence no withholding tax shall be imposed. The benefits received under the BIR- approved plan upon meeting the service requirement and age requirement are explicitly excluded from gross income. The ex gratia payment also qualifies as an exclusion from gross income being in the nature of benefit received on account of separation due to causes beyond the employees’ control. (Section 32(B),NIRC). The cash equivalent of unused vacation and sick leave credits qualifies as part of separation benefits excluded from gross income (CIR v. Court of Appeals, GR No.96016, October 17, 1991). For category B employees, all the benefits received by them will also be exempt from income tax, hence not subject fo withholding tax. These are benefits received on account of separation due to causes beyond the employees’ control, which are specifically excluded from gross income. (Section 32(B), NIRC). ALTERNATIVE ANSWER: Alllof the payments are not subject to income tax and should not also be subject to WT. ‘The employees were laid off, hence separated for a cause beyond their control. Consequently, the amounts to be paid by reason of such involuntary separation are excluded from gross income, irrespective of whether the employee at the time of separation has rendered less than ten years of service and/or is below fifty years of age. (Section 32(B), NIRC). (BAR 1999) ‘A Co, a Philippine corporation. Issued preferred shares of stock with the following features: 4. Non-voting;2. Preferred and cumulative dividends at the rate of 10% per annum, whether or not in any period the amount is covered by earnings or projects; 3. In the event of dissolution of the issuer, holders of preferred stock shall be paid in full or ratably as the assets of the issuer may permit before any distribution shall be made to common stockholders; and 4. The issuer has the option to redeem the preferred stock. A Co. declared dividends on the proferred stock and claimed the dividends as interests” deductible from its gross income for income tax purposes. The BIR disallowed the deduction. A Co. maintains that the preferred shares with their features are really debt and therefore the dividends are really interests. Decide.(10%) SUGGESTED ANSWER: The dividends are not deductible from gross income. Preferred shares shall be considered capital regardless of the conditions under which such shares is issued and, therefore, dividends paid thereon are not considered interests which are allowed to be deducted from the gross income of the corporation. (Revenue Memorandum Circular No. 17-71, July 12, 1971). (BAR 1999) Explain if the following items are deductible from gross income for income tax purposes. Disregard who is the person claiming the expense. (5%) Interest on loans used to acquire capital equipment or machinery. SUGGESTED ANSWER: This is a deductible item from gross income. The law gives the taxpayer the option to claim as a deduction: or treat as capital expenditure interest incurred to acquire property used in trade, business or exercise of a profession. (Section 34(B) (3), NIRC). (BAR 1999) Explain if the following items are deductible from gross income for income tax purposes. Disregard who is the person claiming the deduction. (5%) - Worthless securities SUGGESTED ANSWER: Worthless securities, which are ordinary assets, are not allowed as deduction from gross income because the loss is not realized. However, if these worthless securities are capital assets, the ‘owner is considered to have incurred a capital loss as of the last day of the taxable year and, therefore, deductible to the extent of capital gains. (Section 34(D)(4), NIRC). This deduction, however, is not allowed to a bank or trust company. (Section 34(B)(2), NIRC). (BAR 1999) Explain if the following items are deductible from gross income for income tax purposes. Disregard who is the person claiming the deduction. (5%) - Reserves for bad debts. SUGGESTED ANSWER: Reserve for bad debts are not allowed as deduction from gross income. Bad debts must be charged off during the taxable year to be allowed as deduction from gross income. The mere setting up of reserves will not give rise to any deduction. (Section 34(B), NIRC). (BAR 1999)Explain if the following items are deductible from gross income for income tax purposes. Disregard who is the person claiming the expense. (5%) - Depreciation of goodwill, SUGGESTED ANSWER: Depreciation for goodwill is not allowed as deduction from gross income. While intangibles maybe allowed to be depreciated or amortized, itis only allowed to those intangibles whose use in the business or trade is definitely limited in duration. (Basilan Estates, Inc. v. CIR, 21 SCRA 17). Such is not the case with goodwill. ALTERNATIVE ANSWE! Depreciation of goodwill is allowed as a deduction from gross income if the goodwill is acquired through capital outlay and is known from experience to be of value to the business for only a limited period. (Section 107, Revenue Regulations No. 2). In such case, the goodwill is allowed to be amortized over its useful life to allow the deduction of the current portion of the expense from gross income, thereby paving the way for a proper matching of costs against revenues which is an essential feature of the income tax system. (BAR 1999) ACo., a Philippine corporation, has an executive (P) who is a Filipino citizen. A Co. has a subsidiary in Hong Kong (HK Co.) and will assign P for an indefinite period to work full time for HK Co. P will bring his family to reside in HK and will lease out his residence in the Philippines. The salary of P will be shouldered 50% by A Co. while the other 60% plus housing, cost of living and educational allowances of P’s dependents will be shouldered by HK Co. ACo.- will credit the 50% of P’s salary to P’s Philippine bank account. P will sign the contract of employment in the Philippines. P will also be receiving rental income for the lease of his Philippine residence. Are these salaries, allowances and rentals subject to the Philippine income tax?(5%) SUGGESTED ANSWER: The salaties and allowances received by P are not subject to Philippine income tax. P qualifies as a non-resident citizen because he leaves the Philippines for employment requiring him to be physically present abroad most of the time during the taxable year. (Section 22(E), NIRC). A non- resident citizen is taxable only on income derived from Philippine sources. (Section 23, NIRC). The salaries and allowances received from being employed abroad are incomes from without because these are compensation for services rendered outside of the Philippines. (Section 42, NIRC) However, P is taxable on rental income for the lease of his Philippine residence because this is an income derived from within, the leased property being located in the Philippines. (Section 42, NIRC). (BAR 1999) HK Co. is a Hong Kong corporation not doing business in the Philippines. It holds 40% of the shares of A Co., a Philippine company, while the 60% is owned by P Co., a Filipino- ‘owned Philippine corporation. HK ‘Co. also owns 100% of the shares of B Co., an Indonesian company which has a duly licensed Philippine branch. Due to worldwide restructuring of the HK Co. group, HK Co. decided to sell all its shares in A and B Cos. The negotiations for the buy-out and the signing of the Agreement of Sale were all done in the