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1999 Taxation Law Bar Q & A

Dividends; Income Tax; Deductible Gross Philippine bank account. P will sign the
Income (1999) A Co., a Philippine corporation, contract of employment in the Philippines. P
issued preferred shares of stock with the will also be receiving rental income for the lease
following features: of his Philippine residence. Are these salaries,
1) Non-voting; allowances and rentals subject to the Philippine
2) Preferred and cumulative dividends at the income tax? (5%)
rate of 10% per annum, whether or not in
any period the amount is covered by SUGGESTED ANSWER:
earnings or projects;
3) In the event of dissolution of the issuer, The salaries and allowances received by P are
holders of preferred stock shall be paid in not subject to Philippine income tax. P qualifies
full or ratably as the assets of the issuer as a nonresident citizen because he leaves the
may permit before any distribution shall be Philippines for employment requiring him to be
made to common stockholders; and physically present abroad most of the time
4) The issuer has the option to redeem the during the taxable year. (Section 22(E), NIRC). A
preferred stock. non- resident citizen is taxable only on income
derived from Philippine sources. (Section 23,
A Co. declared dividends on the preferred stock NIRC). The salaries and
and claimed the dividends as interests allowances received from being employed
deductible from its gross Income for income tax abroad are incomes from without because these
purposes. The BIR disallowed the deduction. A are compensation for services rendered outside
Co. maintains that the preferred shares with of the Philippines. (Section 42, NIRC).
their features are really debt and therefore the
dividends are realty interests. Decide. (10%) However, P is taxable on rental income for the
lease of his Philippine residence because this is
SUGGESTED ANSWER: an income derived from within, the leased
The dividends are not deductible from gross property being located in the Philippines.
income. Preferred shares shall be considered (Section 42, NIRC).
capital regardless of the conditions under which
such shares are issued and, therefore, dividends Deductions: Deductible Items from Gross
paid thereon are not considered 'interest' which Income (1999) Explain if the following items are
are allowed to be deducted from the gross deductible from gross income for income tax
income of the corporation. (Revenue purposes. Disregard who is the person claiming
Memorandum Circular No. 17-71, July 12, the expense. (5%)
1971). 1) Interest on loans used to acquire capital
equipment or machinery.
Personal; Income Tax: Non-Resident Citizen 2) Depreciation of goodwill.
A Co., a Philippine corporation, has an SUGGESTED ANSWER:
executive (P) who is a Filipino citizen. A Co. has
a subsidiary in Hong Kong (HK Co.) and will 1) Interest on loans used to acquire capital
assign P for an indefinite period to work full equip- ment or machinery is a deductible item
time for HK Co. P will bring his family to reside from gross income. The law gives the taxpayer
in HK and will lease out his residence in the the option to claim as a deduction or treat as
Philippines. The salary of P will be shouldered capital expenditure interest in- curred to acquire
50% by A Co. while the other 50% plus housing, property used in trade, business or exercise of a
cost of living and educational allowances of P's profession. (Section 34(B) (3), NIRC).
dependents will be shouldered by HK Co. A Co.
will credit the 50% of P's salary to P's 2) Depreciation for goodwill is not
allowed as de- duction from gross income. bank or trust company. (Section 34(E)(2),
While intangibles maybe allowed to be NIRC).
depreciated or amortized, it is only allowed to
those intangibles whose use in the business or Exemptions: Retirement Benefits: Work
trade is definitely limited in duration. (Basilan Separation (1999) A Co., a Philippine
Estates, Inc. v, CIR, 21 SCRA 17). Such is not corporation, has two divisions —
the case with goodwill. manufacturing and construction. Due to the
economic situation, it had to close its
ALTERNATIVE ANSWER: construction division and lay- off the employees
Depreciation of goodwill is allowed as a in that division. A Co. has a retirement plan
deduction from gross income if the goodwill is approved by the BIR, which requires a
acquired through capital outlay and is known minimum of 50 years of age and 10 years of
from experience to be of value to the business service in the same employer at the time of
for only a limited period. (Section 107, Revenue retirement. There are 2 groups of employees to
Regulations No. 2). In such case, the goodwill is be laid off:
allowed to be amortized over its useful life to 1) Employees who are at least 50 years of age
allow the deduction of the current portion of the and has at 10 years of service at the time of
expense from gross income, thereby paving the termination of employment.
way for a proper matching of costs against Employees who do no meet either the age
revenues which is an essential feature of the or length of service A Co. plans to give the
income tax system. following:
a. For category (A) employees - the benefits
Deductions: Non-Deductible Items; Gross under the BIR plan plus an ex gratia
Income (1999) payment of one year of every year of
Explain if the following items are deductible service.
from gross income for income tax purposes.
Disregard who is the person claiming the
deduction. (5%) b. For category (B) employees - one month
1. Reserves for bad debts. for every year of service.
2. Worthless securities For both categories, the cash equivalent of
unused vacation and sick leave credits.
A Co. seeks your advice as to whether or not it
1. RESERVE FOR BAD DEBTS are not will subject any of these payments to WT.
allowed as deduction from gross income. Explain your advice. (5%)
Bad debts must be charged off during the
taxable year to be allowed as deduction SUGGESTED ANSWER:
from gross income. The mere setting up of
reserves will not give rise to any deduction. For category A employees, all the benefits
(Section 34(E). NTRC). received on account of their separation are not
subject to income tax, hence no withholding tax
2. WORTHLESS SECURITIES, which are shall be imposed. The benefits received under
ordinary assets, are not allowed as the BIR-approved plan upon meeting the
deduction from gross income because the service requirement and age requirement are
loss is not realized. However, if these explicitly excluded from gross income. The ex
worthless securities are capital assets, the gratia payment also qualifies as an exclusion
owner is considered to have incurred a from gross income being in the nature of benefit
capital loss as of the last day of the taxable received on account of separation due to causes
year and, therefore, deductible to the extent beyond the employees' control. (Section 32(B),
of capital gains. (Section 34(D)(4), NIRC). NIRC). The cash equivalent of unused vacation
This deduction, however, is not allowed to a and sick leave credits qualifies as part of
separation benefits excluded from gross income
(CIR v. Court of Appeals, GR No. 96O16, P Co. should not subject the payments of the
October 17, 1991). purchase price to withholding tax. While the
seller is a non-resident foreign corporation
For category B employees, all the benefits which is not normally required to file returns in
received by them will also be exempt from the Philippines, therefore, ordinarily all its
income tax, hence not subject to withholding income earned from Philippine sources is taxed
tax. These are benefits received on account of via the withholding tax system, this is not the
separation due to causes beyond the employees' procedure availing with respect to sales of
control, which are specifically excluded from shares of stock. The capital gains tax on the sale
gross income. (Section 32(B), NIRC). of shares of stock of a domestic corporation is
always required to be paid through a capital
gains tax return filed. The sale of the shares of
ALTERNATIVE ANSWER; stock of the Indonesian Corporation is not
subject to income tax under our jurisdiction
All of the payments are not subject to income because the income derived there from is
tax and should not also be subject to considered as a foreign-sourced income.
withholding tax. The employees were laid off,
hence separated for a cause beyond their ALTERNATIVE ANSWER:
control. Consequently, the amounts to be paid
by reason of such involuntary separation are Yes, but only on the shares of stocks of A Co.
excluded from gross income, irrespective of and only on the portion of the purchase price,
whether the employee at the time of separation which constitutes capital gains. Under the Tax
has rendered less than ten years of service Code of 1997, the capital gains tax imposed
and/or is below fifty years of age. (Section under Section 28(B)(5)(c) is collectible via the
32(B), NIRC). withholding of tax at source pursuant to Section
57 of the same Code.
Sales of Share of Stocks: Capital Gains Tax (Note: The bar candidate might have relied on
Return (1999) the provision of the Tax Code of 1997 which
HK Co. is a Hong Kong corporation not doing provides that the capital gains tax is imposed as
business in the Philippines. It holds 40% of the withholding taxes (Section 57, NIRC). This
shares of A Co., a Philippine company, while procedure is impractical and, therefore, not
the 60% is owned by P Co., a Filipino-owned followed in practice because the buyer/
Philippine corporation. HK Co. also owns 100% withholding agent will not be in a position to
of the shares of B Co., an Indonesian company determine how much income is realized by the
which has a duly licensed Philippine branch. seller from the sale. For this reason, any
Due to worldwide restructuring of the HK Co. of the foregoing suggested answers should be
group, HK Co. decided to sell all its shares in A given full credit).
and B Cos. The negotiations for the buy-out and
the signing of the Agreement of Sale were all Dividends: Withholding Tax (1999)
done in the Philippines. The Agreement HK Co., is a Hong Kong company, which has a
provides that the purchase price will be paid to duly licensed Philippine branch, engaged in
HK Co's bank account in the U. S. and that little trading activities in the Philippines. HK Co. also
to A and B Cos. Shares will pass from HK Co. invested directly in 40% of the shares of stock
to P Co. in HK where the stock certificates will of A Co., a Philippine corporation. These shares
be delivered. P Co. seeks your advice as to are booked in the Head Office of HK Co. and
whether or not it will subject the payments of are not reflected as assets of the Philippine
purchase price to Withholding Tax. Explain branch. In 1998, A Co. declared dividends to its
your advice. (10%) stockholders. Before remitting the dividends to
HK Co., A Co. seeks your advice as to whether
SUGGESTED ANSWER: it will subject the remittance to WT. No need to
discuss WT rates, if applicable. Focus your However, if the lot sold is an ordinary asset, the
discussion on what is the issue. (10%) excess of the fair market value over the
consideration received shall be considered as a
SUGGESTED ANSWER: gift subject to the donor's tax.

I will advise A Co. to withhold and remit the The sale of shares of stock below the fair
withholding tax on the dividends. While the market value thereof is subject to the donor's
general rule is that a foreign corporation is the tax pursuant to the provisions of Section 100 of
same juridical entity as its branch office in the the Tax Code. The excess of the fair market
Philippines, when, however, the corporation value over the selling price is a deemed gift.
transacts business in the Philippines directly
and independently of its branch, the taxpayer ALTERNATIVE ANSWER:
would be the foreign corporation itself and
subject to the dividend tax similarly imposed on The sale of shares of stock below the fair
non-resident foreign corporation. The dividends market value will not give rise to the imposition
attributable to the Home Office would not of the donor's tax. In determining the gain from
qualify as dividends earned by a resident the transfer, the selling price of the shares of
foreign corporation, which is exempt from tax. stocks shall be the fair market value of the
(Marubeni Corporation v. Commissioner, GR shares of stocks transferred. (Section 6, RR No.
No. 76573, September 14, 1989). 2-82). In which case, the reason for the
imposition of the donor's tax on sales for
Donor’s Tax; Sale of shares of Stock & Sale inadequate consideration does not exist.
of Real Property (1999)
A, an individual, sold to B, his brother-in-law, BIR: Collection of Tax Deficiency (1999)
his lot with a market value of P1,000,000 for A died, survived by his wife and three children.
P600.000. A's cost in the lot is P100.000. B is The estate tax was properly paid and the estate
financially capable of buying the lot. settled and divided and distributed among the
four heirs. Later, the BIR found out that the
A also owns X Co., which has a fast growing estate failed to report the income received by
business. A sold some of his shares of stock in the estate during administration. The BIR
X Co. to his key executives in X Co. These issued a deficiency income tax assessment plus
executives are not related to A. The selling price interest, surcharges and penalties. Since the 3
is P3,000,000, which is the book value of the children are residing abroad, the BIR sought to
shares sold but with a market value of collect the full tax deficiency only against the
P5,000,000. A's cost in the shares sold is widow. Is the BIR correct? (10%)
P1,000,000. The purpose of A in selling the
shares is to enable his key executives to acquire SUGGESTED ANSWER:
a propriety interest in the business and have a Yes, the BIR is correct. In a case where the
personal stake in its business. Explain if the estate has been distributed to the heirs, the
above transactions are subject to donor's tax. collection remedies available to the BIR in
(5%) collecting tax liabilities of an estate may either
(1) sue all the heirs and collect from each of
SUGGESTED ANSWER: them the amount of tax proportionate to the
inheritance received or (2) by virtue of the lien
The first transaction where a lot was sold by A created under Section 219, sue only one heir
to his brother-in-law for a price below its fair and subject the property he received from the
market value will not be subject to donor's tax if estate to the payment of the estate tax. The BIR,
the lot qualifies as a capital asset. The transfer for therefore, is correct in pursuing the second
less than adequate and full consideration, which gives remedy although this will give rise to the right
rise to a deemed gift, does not apply to a sale of property of the heir who pays to seek reimbursement
subject to capital gains tax. (Section 100, NIRC). from the other heirs. (CIR v. Pineda, 21 SCRA
105). In no case, however, can the BIR enforce A Co., X Bank and the suppliers have not been
the tax liability in excess of the share of the issued by the BIR letter of authority to examine.
widow in the inheritance. A Co. and X Bank believe that the BIR is on a
"fishing expedition" and come to you for
BIR: Prescriptive Period; Assessment & counsel. What is your advice? (10%)
Collection (1999) A Co., a Philippine
Corporation, filed its 1995 Income Tax Return SUGGESTED ANSWER:
(ITR) on April 15, 1996 showing a net loss. On
November 10, 1996, it amended its 1995 ITR to I will advise A Co. and B Co. that the BIR is
show more losses. After a tax investigation, the justified only in getting information from the
BIR disallowed certain deductions claimed by former but not from the latter. The BIR is
A Co., putting A Co. in a net income position. authorized to obtain information from other
As a result, on August 5, 1999, the BIR issued persons other than those whose internal revenue
a deficiency income assessment against A Co. A tax liability is subject to audit or investigation.
Co. protested the assessment on the ground that However, this power shall not be construed as
it has prescribed: Decide. (5%) granting the Commissioner the authority to
inquire into bank deposits. (Section 5. NIRC).
Taxpayer: City Board of Assessment
The right of the BIR to assess the tax has not Decision; Where to appeal (1999)
prescribed. The rule is that internal revenue taxes shall A Co., a Philippine corporation, is the owner of
be assessed within three years after the last day machinery, equipment and fixtures located at its
prescribed by law for the filing of the return. (Section plant in Muntinlupa City. The City Assessor
203, NIRC), However, if the return originally characterized all these properties as real
filed is amended substantially, the counting of properties subject to the real property tax. A Co.
the three-year period starts from the date the appealed the matter to the Muntinlupa Board of
amended return was filed. (CIR v. Phoenix Assessment Appeals. The Board ruled in favor
Assurance Co., Ltd., 14 SCRA 52). There is a of the City. In accordance with RA 1125 (An
substantial amendment in this case because a Act creating the Court of Tax Appeals). A Co.
new return was filed declaring more losses, brought a petition for review before the CTA to
which can only be done either (1) in reducing appeal the decision of the City Board of
gross income or (2) in increasing the items of Assessment Appeals. Is the Petition for Review
deductions, claimed. proper? Explain. (5%)

Taxpayer: BIR Audit or Investigation (1999)
A Co., a Philippine corporation, is a big No. The CTA’s devoid of jurisdiction to
manufacturer of consumer goods and has entertain appeals from the decision of the City
several suppliers of raw materi- als. The BIR Board of Assessment Appeals. Said decision is
suspects that some of the suppliers are not instead appealable to the Central Board of
properly reporting their income on their sales to Assessment Appeals, which under the Local
A Co. The CIR therefore: Government Code, has appellate jurisdiction
1) Issued an access letter to A Co. to furnish over deci- sions of Local Board of Assessment
the BIR information on sales and payments Appeals. (Caltex Phils, foe. v. Central Board
to its suppliers. of Assessment Appeals, L- 50466, May 31,
2) Issued an access letter to a bank (CX Bank) 1982).
to furnish the BIR on deposits of some
suppliers of A Co. on the alleged ground
that the suppliers are committing tax Taxpayer: Overwitholding Claim for
evasion. Refund (1999)
A Co. is the wholly owned subsidiary of B Co.,
a non- resident German company. A Co. has a Commissioner's decision on disputed
trademark licensing agreement with B Co. On assessment. When the Commissioner decided to
Feb. 10, 1995, A Co. remitted to B Co. royalties collect the tax assessed without first deciding
of P 10,000,000, which A Co. subjected to a on the taxpayer's protest, the effect of the
withholding tax of 25% or P2,500,000. Upon Commissioner’s action of filing a judicial
advice of counsel, A Co. realized that the proper action for collection is a decision of denial of
withholding tax rate is 10%. On March 20, the protest, in which event the taxpayer may file
1996, A Co. filed a claim for refund of an appeal with the CTA. (Republic v. Lim Tian
P2.500.000 with the BIR. The BIR denied the Teng & Sons, Inc., 16 SCRA 584; Dayrit v.
claim on Nov. 15, 1996. On Nov. 28, 1996, A Cruz, L-39910, Sept. 26, 1988).
Co. filed a petition for review with the CTA. The
BIR attacked the capacity of A Co., as agent, to 3. Has the RTC jurisdiction over the
bring the refund case. Decide the issue. (5%) collection case filed by the BIR? Explain.


A Co., the withholding agent of the non- The RTC has no jurisdiction over the collection
resident foreign corporation is entitled to claim case filed by the BIR. The filing of an appeal
the refund of excess withholding tax paid on the with the CTA has the effect of divesting the
income of said corporation in the Philippines. RTC of jurisdiction over the collection case. At
Being a withholding agent, it is the one held the moment the taxpayer appeals the case to the
liable for any violation of the withholding tax Court of Tax Appeals in view of the
law should such a violation occur. In the same Commissioner's filing of the collection case with
vein, it should be allowed to claim a refund in the RTC which was considered as a decision of
case of overwitholding. (CIR v. Wander Phils. denial, it gives a justifiable basis for the
Inc., GR No. 68378, April 15, 1988, 160 SCRA taxpayer to move for dismissal in the RTC of
573; CIR v. Procter & Gamble PMC, 2O4 the Government's action to collect the tax
SCRA 377). liability under dispute. (Yabes v. Flojo, 15
SCRA 278; San Juan v. Vasquez, 3 SCRA 92).
There is no final, executory and demandable
Taxpayer: Protest against Assessment (1999) assessment which can be enforced by the BIR,
A Co., a Philippine corporation, received an once a timely appeal is filed.
income tax deficiency assessment from the BIR
on May 5, 1995. On May 31, 1995, A Co. filed Taxpayer: Protest against Assessment (1999)
its protest with the BIR. On July 30, 1995, A A Co., a Philippine corporation, received an
Co. submitted to the BIR all relevant supporting income tax deficiency assessment from the BIR
documents. The CIR did not formally rule on on November 25, 1996. On December 10, 1996,
the protest but on January 25, 1996, A Co. was A Co. filed its protest with the BIR On May 20,
served a summons and a copy of the complaint 1997, the BIR issued a warrant of distraint to
for collection of the tax deficiency filed by the enforce the assessment. This warrant was
BIR with the Regional Trial Court (RTC). On served on A Co. on May 25, 1997. In a letter
February 20, 1996, A Co. brought a Petition for dated June 4, 1997 and received by A Co. 5 days
Review before the CTA. The BIR contended later, the CIR formally denied A Co.'s protest
that the Petition is premature since there was no stating that it constitutes his final decision on
formal denial of the protest of A Co. and should the matter. On July 6, 1997, A Co. filed a
therefore be dismissed. Petition for Review with the CTA. The BIR
1. Has the CTA jurisdiction over the case? moved to dismiss the Petition on the ground
2. that the CTA has no jurisdiction over the case.
Yes, the CTA has jurisdiction over the case
because this qualifies as an appeal from the SUGGESTED ANSWER:
The CTA has jurisdiction over the case. The
appealable decision is the one which
categorically stated that the Commissioner's
action on the disputed assessment is final and,
therefore, the reckoning of the 30-day period to
appeal was on June 9, 1999. The filing of the
petition for review with the CTA was timely
made. The Supreme Court has ruled that the
CIR must categorically state that his action on a
disputed assessment is final; otherwise, the
period to appeal will not commence to run. That
final action cannot be implied from the mere
issuance of a warrant "of distraint and levy.
(CIR v. Union Shipping Corporation, 185
SCRA 547).