TAXATION

FUNDAMENTAL PRINCIPLES OF TAXATION

Taxation
1. As a power – refers to the inherent power of the state to demand enforced contribution for public purpose to
support the government.
2. As a process – the legislative act of laying a tax to raise income for the government to defray its necessary
expenses

Purpose of Taxation
1. Primary – to raise revenue
2. Secondary
a. Regulatory
- To regulate the conduct of businesses or professions
- To achieve economic and social stability
- To protect local industries
b. Compensatory
- Key instrument of social control - Check inflations
- Reduces inequities in wealth distributions - Tools on international bargains
- Strengthens anemic enterprises - Promotes science and inventions
- Provides incentives
- Uses as implement in the exercise of police power to promote general welfare

The Life Blood Doctrine

Taxes are indispensable to the existence of the state. Without taxation the state cannot raise revenue to support is
operations

Nature or Characteristics of the Power of Taxation

1. for public purpose 5. exaction payable in money
2. inherently legislative in nature 6. territorial
3. subject to international comity or treaty
4. not absolute being subject to constitutional and inherent limitations

How exercised:
- Legislation of laws by Congress and tax ordinances by the Local Sangguanian
- Tax collection by the administrative branch of the government

Scope of the Power of Taxation

Taxation is supreme, comprehensive, unlimited and plenary. It includes the power to destroy

Discretion of the Taxing Power- this extends to:

1. amount or rate of the tax 5. situs of taxation
2. kinds of tax to be collected 6. method of collection
3. apportionment of the tax 7. purposes for its levy, provided for public purpose
4. the person, property and excises to be taxed, provided within it jurisdiction

Underlying principles behind the power of taxation

1. Principles of Necessity – the existence of the government is a necessity and it cannot continue without means
to support itself – this is the Theory of Taxation
2. Benefit Received Theory – the government and the people have the reciprocal and mutual duties of support
and protection – this is the Basis of Taxation

Legal Basis of the Power of Taxation

1. Benefit-received theory
2. the sovereign power of the state over is people and property
3. the presumption of receipts or enjoyment of benefits and protection by the people
4. to protect new conditions by imposing special duties
5. to uplift social conditions by imposing regulatory taxes or licenses

In everything, LOVE & SERVE the LORD!

Objects of Taxation
1. businesses 5. acts
2. interests 6. persons
3. transactions 7. properties
4. rights 8. privileges

Phases of Stages of Taxation

a. Levy or Imposition Impact of taxation Aspects of
b. Assessment of tax Taxation
c. Payment of the tax Incidence of Taxation
- these all comprise the taxation system

Elements of the tax system

a. Tax structure b. Tax administration c. Public tax consciousness

Principles of a sound tax system

a. Fiscal Adequacy – sources of revenue should be sufficient to meet the demand for public expenditure
b. Administrative Feasibility- tax laws must be capable of convenient, just and effective administration
c. Theoretical Justice- tax must be imposed with equity and certainty and must consider the taxpayers ability to
pay and benefits received
- Non-observance of the principles does not necessarily render a tax levy unconstitutional.

Principal Approaches in the distribution of tax burden

a. Benefit Approach – tax payment should be based on benefits received
b. Ability to Pay Approach – tax payments should be based relative to the ability of taxpayers to pay

Taxation and Economic Efficiency

1. Income Effect – makes people economically efficient (ex: transformation)
2. Substitution Effect – makes people economically inefficient (ex: indirect taxes)

The Inherent Powers of the Government

1. Power of Taxation – the power to take property for the support of the government and for public purpose
2. Police Power – the power to enact laws to promote the general welfare of the people. It is wider in application
because it is the general power to make laws.
3. Power of Eminent Domain – the power to take private property for public use upon payment of just
compensation

Point of Differences of the Inherent Powers of the State

Point of Difference Taxation Police Power Eminent Domain
Exercising Authority Government Government Government or private
entities
Necessity of Delegation is not There must be There must be due
Delegation necessary since it is delegation before local delegation before local
inherent governments could government or private
exercised it party may exercise it
Purpose Revenue and support Property is taken for Property is taken for public
of the government public use use
Persons affected Community or class of Community or class of Operates on the owner of
individuals individuals the property

Effect of transfer of
property rights
Amount of Imposition
Money paid as taxes There is no transfer of There is transfer of right to
becomes part of the title, at most there is property whether it be of
public fund restraint on the ownership or lesser right
injurious use of
property
Unlimited Sufficient to cover the No imposition, the owner
costs of regulation is paid the fair market value
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 of his property
Importance Most important of the Most superior
three
Relationship with the Inferior to the “Non- Superior to the “Non- Superior and may override
Constitution Impairment Clause” of Impairment Clause” of the “Non-Impairment
the Constitution the Constitution Clause” because the welfare
of the state is superior to
private contracts
Limitation Constitutionally and Public interest and the Public purpose and just
inherently restricted requirement of due compensation
process

Similarities of the Three Powers

1. All three powers are necessary attributes of sovereignty, resting upon necessity
2. all are inherent powers of the State
3. All are legislative in nature
4. They are ways in which the State interferes with private rights and property
5. They exist independently with the Constitution although the condition for their exercise may be prescribed or
limited by the Constitution
6. They all presuppose an equivalent compensation received by the persons affected by the exercise of the power,
whether directly, indirectly or remote.
7. The exercise of these powers by the local government units may be limited by national legislature
*Police power can be used to raise revenue for the government (ex: license fee)

LIMITATIONS OF TAXATION POWER

A. Constitutional Limitation
1. observance of due process of law
2. equal protection of the law
3. uniformity in taxation
4. progressive scheme of taxation
5. non-imprisonment for non-payment debt or poll tax
6. non-impairment of obligation and contract
7. free worship rule
8. non-appropriation of public funds or property for the benefit of any church, sect or system of religion
9. exemption of religious, charitable or educational entities, non-profit cemeteries, churches and mosque from
property taxes.
10. exemption from taxes of the revenues and assets of non-profit, non-stock educational institutions including
grants, endowments, donations or contributions for educational purposes
11. concurrence of a majority of all members of Congress for the passage of a law granting tax exemption
12. non-diversification of tax collections
13. non-delegation of the power of taxation
Exception:
a. power to tax was delegated to the President under the Flexibility Clause of the Tariff and Customs Code
b. power to tax was delegated to the local government units under the Local Government Code
c. matters involving the expedient and effective administration and implementations of assessment and
collection of taxes or certain aspects of taxing process that are not legislative in character
14. non-impairment of the jurisdiction of the Supreme Court to review tax cases
15. appropriations, revenue or tariff bills shall originate exclusively in the House of Representatives but the
Senate may propose or concur with amendments
16. each local government unit shall exercise the power to create its own sources of revenue and shall have a
just share in the national taxes

B. Inherent Limitation
1. territoriality of taxation
2. subject to international comity or treaty
3. tax exemption of the government
4. tax is for public purpose
5. non-delegation of the power of taxation
*The last 2 limitations are also Constitutional limitations

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SITUS OF TAXATION
The place of taxation

Factors that determine the situs of taxation

1. nature, kind or classification of the tax 5. sources of income
2. subject matter of the tax 6. place of exercise, business or occupation being taxed
3. citizenship of the taxpayer 7. place where income-producing activity was held or done
4. residence of the taxpayer

Applications
1. persons – residence of the taxpayer
2. community development tax – residence or domicile of the taxpayer
3. business taxes – where the business was conducted or place where the transaction took place
4. privilege or occupation tax – where the privilege is exercised
5. real property tax – where the property is located
6. personal property taxes –
a. tangible – where they are physically located
b. intangible – domicile of the owner unless the property has acquired a situs elsewhere
7. Income – place where the income is earned or residence or citizenship of the taxpayer
8. Transfer Taxes – residence or citizenship of the taxpayer or location of the property
9. Franchise Taxes – State that grants the franchise
10. Corporate Taxes – depend on the law of incorporation

DOUBLE TAXATION
Taxing the object or subject within the territorial jurisdiction twice, for the same period, involving the same kind of
tax by the same taxing authority

Kinds:
1. Direct Double Taxation – this objectionable and prohibited because it violates the constitutional provision on
uniformity and equality
2. Indirect Double Taxation – no constitutional violation. Ex: taxing the same property by two different taxing
authority

International Double Taxation –a double taxation caused by two different taxing authorities, one domestic and
one foreign

Remedies to Double Taxation

1. provision for tax exemption
2. allowance for tax credit
3. allowance for principle of reciprocity
4. enter into treaties with and agreement with foreign government

Forms of Escape from Taxation

A. Those that will not result in loss of revenue to the government
1. Shifting –the process of transferring the tax burden from the statutory taxpayer to another without
violating the law.
2. Capitalization – the seller is willing to lower the price of the commodity provided the taxes will be
shouldered by the buyers
3. Transformation – the manufacturer absorbs the additional taxes imposed by the government without
passing it to the buyers for fear of lost of his market. Instead, it increases quantity of production, thereby
turning their units of production at a lower cost resulting to the transformation of the tax into a gain
through the medium of productions.

B. Those that will result to loss of revenue to the government

1. Tax Evasion – tax dodging – resorting to acts and devices that illegally reduces or totally escape the payment
of taxes that are due to the taxpayer. They are prohibited and are therefore are not subject to penalties.
2. Tax Avoidance –tax minimization scheme – the reduction or totally escaping payment of taxes through
legally permissible means, that are not prohibited and therefore are not subject to penalties.
3. Tax Exemption- an immunity, privilege or freedom from payment of a charge or burden to which others
are obliged to pay.

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Kinds of Exemptions:
1. Express- granted by the constitution, statute, treaties, ordinance, contracts or franchise
a. constitutional
b. statutory
c. contractual
2. Implied – exempted by accidental or intentional omission
3. Total-exemption from all taxes (OFWs)
4. Partial –exemption from certain taxes, partially or totally

Grounds for Exemption

1. It may be based on a contract
2. It may be based on grounds of public policy - ex: granting of exemptions to rural banks, and sweepstakes or
lotto winnings
3. It may be based on some grounds to foster charitable and other benevolent institutions
4. It may be created under a treaty on grounds of reciprocity
5. It may be created to lessen the rigors of international double or multiple taxation

Distinction between tax evasion and tax avoidance

Tax Evasion Tax Avoidance
It is a scheme used outside of those lawful means It is a tax saving device within the means sanctioned
and when availed of, it usually subjects the by law
taxpayer to penalties
It is accomplished by breaking the law Accomplished by legal procedures and do not violate
the law
It connotes fraud, deceit and malice No fraud is involved

Tax Exemptions:
 is not automatic
 is non-transferable
 is revocable by the government (except when granted under a valid contract or by the Constitution)
 rule shall be uniform
 does not contravene the LifeBlood Doctrine
 is always disfavored
 is allowed only under a clear and unequivocal provision of the law
 on real property tax will be based on the Doctrine of Usage and not Doctrine of Ownership, except for real properties
owned by the government which is absolutely exempt form taxation
 on real property tax cannot be granted by local governments but can condone real property tax liabilities in
special cases
 on local taxes can be granted by local governments but they cannot condone existing liabilities on local taxes

Fundamental Doctrine in Taxation

1. No court may enjoin the collection of taxes
2. Claim for exemptions shall be interpreted strictly against the taxpayer
3. A law that permit deduction from the tax base is strictly construed against the taxpayer
4. Tax assessment are presumed to be correct and done in good faith
5. Tax laws are generally prospective in application
6. Tax are not subject to compensation or set-off
7. Refund of taxes do not earn interest because interest do not run against the government

Distinction between Tax Amnesty and Tax Condonation

Tax Amnesty – a general pardon or intentional overlooking by the state of its authority to impose penalties on
persons otherwise guilty of tax evasion or violation of tax laws. The purpose is to give the erring taxpayer a chance
to reform and become part of the society with a clean slate.

Tax Condonation – means to remit or to desist or refrain form exacting or imposing a tax. It cannot extend to
refund of taxes already paid when obtaining condonation.

Tax Exemption Tax Amnesty

There is no tax liability at all Connotes condonation from payment of existing tax
liability
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 The grantee need not pay anything The grantee pays a portion
Can be availed of by any qualified taxpayer Not always available

TAXATION
TAXES, TAX LAWS AND TAX ADMINISTRATION

Tax
An enforced proportionate contribution imposed upon persons, properties, businesses, rights, interests, privileges,
transactions and acts within the territorial jurisdiction of the taxing authority exercise by the legislature for a public
purpose and generally payable in money.

Elements of a Valid Tax:

1. must not violate the constitutional, inherent and or contractual limitation of the power of taxation
2. must be uniform and equitable, not unjust, excessive, oppressive, confiscatory or discriminatory
3. must be for a public purpose
4. must be levied by the taxing power (legislature) having jurisdiction over the object of taxation
5. must be proportionate in character
6. generally payable in money, at regular interval (not regular in payment)

Classification of Taxes
A. As to purpose
1. Fiscal – general, fiscal or revenue- tax imposed for the general purpose of the government or to raise
revenue for government needs ex: income tax
2. Regulatory – special or sumptuary – tax imposed for a special purpose or to achieve some social or
economic ends ex: tariff or custom duties

B. As to subject matter
1. Personal, poll or capitation – tax of a fixed amount imposed on individuals residing within a specified
territory without regard to their property or the occupation in which they be engaged in. ex: community tax
certificate
2. Property tax – tax imposed on property, whether real or personal, in proportion, either to its value or in
accordance with some other reasonable method of apportionment. Ex: real estate tax
3. Excise tax or privilege tax – tax imposed upon the performance of an act, the enjoyment of a privilege or
the engaging in an occupation. Ex: income tax, value-added tax, privilege tax on business or occupation.

C. As to incidence
1. Direct – the tax is demanded from one person in who is intended to pay it. Example: income tax and
personal tax
2. Indirect – the tax is demanded from one person in the expectation and intention that he shall indemnify
himself at the expense of another by shifting the tax to another taxpayer. Example: Value-Added Tax,
customs duties and some percentage taxes

D. As to amount
1. Specific tax – a tax of a fixed amount imposed by the head or number. Example: tax on distilled spirits,
cigars and wines (PX/piece)
2. Ad valorem – tax is imposed for a fixed proportion of the amount or value of the property to which the tax
is assessed. Examples: excise taxes on cigarettes and gasoline, real property taxes and certain customs duties
(X% of selling price)

E. As to rate
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 1. Proportional or flat rate – the tax is based on a fixed percentage of the amount of the property, income or
other basis to be taxed. Ex: real estate tax, VAT and percentage taxes
2. Progressive or graduated tax – the tax rate increases as the tax base increases. Progressive rate is preferred
in achieving vertical equity. Ex: income tax, estate tax and donor’s tax
3. Regressive tax – the tax the rate of which decreases as the tax base increases. The Philippines has no
regressive tax, but some indirect taxes manifest a regressive effect.
4. Mixed tax

F. As to imposing authority
1. National tax – imposed by the National Government.
Examples:
a. income taxes c. value-added tax e. other percentage taxes
b. estate and donors tax d. excise tax f. documentary stamp tax
2. Local tax – tax imposed municipal or local governments.
Examples:
a. real property tax d. community tax; and
b. professional tax e. tax on banks and other financial institutions
c. business taxes, fees and charges

DISTINCTION OF TAX WITH SIMILAR ITEMS

TAX VS. REVENUE

Tax Revenue
Refers to the amount imposed Refers to the amount collected
Only one of the sources of government The product of taxation. It refers to tall the
revenues funds derived by the government whether
from tax or from other sources

TAX VS. LICENSE*

Point of distinction Tax License
Purpose For revenue For regulation
Amount No limit Limited
Subject of Imposition Person, properties, business Required for the
rights, interests, privilege, acts commencement of a business
and transactions profession
Effect of non-compliance Does not necessarily make the Makes the business illegal
act, business or profession
illegal
Revocability Has a nature of permanence Always revocable
Scope The power to tax includes the Power to license does not
power to license include the power to tax
When imposed Post-activity Pre-activity
Basis of imposition Current data Preceding year or quarter
date. If new business, based
on capitalization
Sources of Power Taxing power of the Police power of the
government government

TAX VS. TOLL*

Tax
Demand of sovereignty
One’s support for the government
Imposed only by the government
Based on government needs
Toll
Demand of ownership
Compensation for the use of somebody else’s
property
May be imposed by the government or by private
individuals
Determined by the cost of the property or
improvements thereon

TAX VS. DEBT*

Tax Debt
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Basis Law Contract
Effect of non-compliance May involved imprisonment, except No imprisonment
for poll tax
Assignable? No Yes
Mode of settlement Generally money Cash or In kind
Set-off? Generally not subject to set-off Subject to set-off
Interest Does not earn interest except when Draws interest when stipulated or
delinquent when in default

TAX VS. SPECIAL ASSESSMENT*

Tax
Subject of the imposition business, interests, transactions,
rights, persons, properties or
privileges
Effect on the person May be made a personal liability of
owning the subject the person assessed
because it is the land that answers
Basis of Imposition Necessity with no hope of direct or
immediate benefit to the taxpayer
Coverage of application General application
Special Assessment
Land
Cannot be made the personal
liability of the person assessed,
for the liability
Entirely on benefits received
Exceptional in application

TAX VS. TARIFF

Tariff refers to a book of rates containing names of merchandises with corresponding duties to be paid for the
same. Tariff refers to the duties payable on goods imported or exported. It is a system or principle of imposing
duties on the importation or exportation of goods. *Customs duties and tariffs are used interchangeably

TAX VS. PENALTY

Tax Penalty
to regulate conduct through
Purpose to raise revenue punishment and suppression
of injurious act
Exercising authority the government the government or by private
individuals
Source Law Law or contract
Mode of settlement in money in money or in kind

Note:
 Payment of tax is compulsory to those who are covered by imposition
 Taxes are important because they are the lifeblood of the government.
 Taxes are personal. The burden of taxation cannot be transferred from one person to the other by private
agreement as this is determined by law
 While the power of taxation includes the power to destroy, it is not absolute. It is subject to limitation or
restrictions.

TAX LAW
Any law that provides for the assessment and collection of taxes for the support of the government and other
public purposes

Sources of Tax Laws:

1. Constitution 5. Administrative Issuances or BIR Rulings
2. Statutes and Presidential Decrees 6. Judicial Decisions
3. Executive Orders and Batas Pambansa 7. Local Ordinances
4. Tax Treaties and conventions with foreign countries 8. Revenue Regulation of by the DoF

Revenue Regulation
Formal pronouncement intended to clarify or explain the tax law and carry into effect its general provisions by
providing details of administration and procedure. They have the force and effect of law.
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Administrative issuances or BIR Rulings – these are the less general interpretations of the tax laws at the
administrative levels, being issued from time to time by the CIR, to clarify certain provisions of the tax law. They
are merely advisory or sort of an information service to the taxpayer such that, none of them are binding except to
the addressee and may be reversed by the BIR at anytime.

NATURE OF PHILIPPINES TAX LAWS

Philippine Tax Laws are civil and nature and character. They remain effective even in times of war. They are not
penal in nature although penalties are provided for their violation because they do not define crimes and provide for
their punishment.

FUNDAMENTAL DOCTRINES IN TAXATION

A. Marshall Dictum – “The power to tax includes the power to destroy”
- Constitutional if taxation power is used validly as an implement of police power in discouraging certain acts
and enterprises inimical to public welfare.
- Unconstitutional if in raising revenue, taxation is allowed to confiscate or destroy properties
B. Holmes Doctrine – “Taxation power is the power to build”
The power to tax should not be the power to destroy. The power to destroy is merely a consequence of
taxation.
C. Doctrine of Judicial Non-interference
The courts cannot inquire into the wisdom of a taxing act or the advisability or expediency of at ax. The
impracticability and absurd consequences of a tax law should be addressed to the legislature and administrative
authorities and not the courts
D. Prospectivity of Tax Laws – tax laws are prospective in character and application
Exceptions:
1. the retroactive application is necessarily implied from the provisions of the law
2. it involves income tax
3. the retroactive application is clearly the intent of the Congress
E. Imprescriptibility in Taxation – Taxes are imprescriptible unless the law itself provides for such prescription.
F. Principle of “Strictissimi Juris” – “Taxation is the rule and exemption is the exception”
Tax exemption must be strictly construed against the taxpayer and liberally in favor of the government.

G. Doctrine of Equitable Recoupment

- Where the refund of taxes are barred by prescription which can no longer be claimed by a taxpayer but there
is a present tax being assessed against the said taxpayer, such present tax may be recouped or set-off against
the tax, the refund of which has been barred.
- Basis: The government cannot enrich itself at the expense of the taxpayer.
*This doctrine is not applicable in the Philippines as it conflicts with prescription laws.
H. Non-compensation or Set-off Rule
The government and the taxpayer are not creditor and debtor to each other. Taxes are not in the nature of
contracts between the parties but grew out of a duty arising from law; hence, they cannot be set-off.
I. Doctrine of Estoppel
The State cannot be estopped by the neglect, errors, or mistakes of its agents or officers. Thus, the erroneous
application and enforcement of law by public officials do not block the subsequent correct application of the
statutes. The doctrine of estoppel operates only against the taxpayer.

TAX ADMINISTRATION

The Bureau of Internal Revenue

The Bureau of Internal Revenue is tasked with tax administration function of the government. Together with the
Bureau of Customs, they are under the supervision and control of the Department of Finance.

Chief Officials of the Bureau

1. 1 chief officer: The Commissioner of Internal Revenue
2. 4 assistant chief: Deputy Commissioners

Powers of the Bureau

1. Assessment and collection of taxes
2. Enforcement of all forfeitures, penalties, and fines and judgments in all cases decided in its favor by the courts

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3. Giving effects to and administering the supervisory and police powers conferred to it by the NIRC and or other
laws
4. Assignment of internal revenue officers and other employees to other duties
5. Provisions and distribution to proper officials of forms, receipts, certificates, stamps; etc
6. Issuances of receipts and clearances
7. Submit annual report, pertinent information to Congress and reports to the Congressional Oversight
Committee in matters of taxation

Powers of the Commissioner of Internal Revenue*

1. To interpret the provisions of the NIRC (subject to review by the Secretary of Finance)
2. To decide tax cases (subject to the exclusive appellate jurisdiction of the Court of Tax Appeals)
3. To obtain information and to summon, examine and take testimony of persons to effect tax collection
4. To make assessment and prescribe additional requirement for tax administration and enforcement
5. To make or amend a return for and in behalf of a taxpayer; or to disregard one filed by the taxpayer
6. To change a tax period
7. To compromise a tax liabilities of taxpayers
8. To conduct inventory surveillance
9. To prescribe presumptive gross sales or receipts
10. To prescribe real estate values
The CIR is authorized to divide the Philippines into zones or areas and determine the fair market value of the
real properties located in each zones or area.
11. To accredit tax agents
Individuals or general professional partnerships who have been denied their accreditation may appeal to the
Secretary of Finance who shall act on the appeal within 60 days from the receipt of such appeal. Failure by him
to rule on the appeal within the prescribed period shall be deemed approval of the application for accreditation.
12. To inquire into bank deposits under certain cases
13. To prescribe additional procedures or documentary requirements
14. To delegate his powers to any subordinate officer with rank equivalent to a division chief of an office
15. To refund or credit internal revenue taxes
16. To abate or cancel tax liabilities in certain cases
17. To examine tax returns and determine tax due thereon;
18. To cause revenue officers and employees to make a canvass from time to time of any revenue district or region
concerning taxpayers.

Powers of the CIR that cannot be delegated*

1. The power to recommend the promulgation of rules and regulations to the Secretary of Finance.
2. The power to issue rulings of first impression or to reverse, revoke or modify any existing rulings of the Bureau.
3. The power to compromise or abate any tax liability (Note: to be discussed in tax remedies)
Exception: Compromise by Regional Evaluation Boards under the following requisites:
a. assessments are issued by the regional offices involving basic deficiency tax of P500,000.00, and
b. involves minor criminal violations as may be determined by rules and regulations to be promulgated by the
Secretary of Finance, upon recommendation of the CIR, discovered by regional and district officials
4. The power to assign and reassign internal revenue officers to establishment where articles subject to excise tax are
produced or kept. Revenue officers assigned to any such establishments shall in no case stay in his assignment
for more than 2 years.

Rules in assignments to other duties

Revenue officers assigned to perform assessment and collection function shall not remain in the same assignment
for more than 3 years. Assignment of internal revenue officers and employees of the Bureau to special duties shall not
exceed 1 year.

Agents and Deputies for Collection of National Internal Revenue Taxes

1. The Commissioner of Customs and his subordinates with respect to collection of national internal revenue taxes
on imported goods.
2. The head of appropriate government offices and his subordinates with respect to the collection of energy tax.
3. Banks duly accredited by the Commissioner with respect to receipts of payments of internal revenue taxes
authorized to the made thru banks.

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TAXATION
FUNDAMENTALS OF INCOME TAXATION

INCOME
All wealth which flows into the taxpayer other than a mere return of capital and includes gains

Why is income taxed?

Income is the best measure of a taxpayer’s ability to pay.

Basic Definitions:
Gross Income – refers to what is income for taxation purposes
Taxable Income – as the pertinent items of gross income that are subject to tax after allowable deductions
Tax Base – the value of a certain goods, or property for taxation purposes

Characteristics of Gross Income:

1. Return on capital and resulted increased networth at the moment of its generation
2. Realized benefit by the taxpayer (realization means actual or constructive receipt of in cash)
Example of constructive receipts of income:
1. credit to an account own by the taxpayer
2. declaration of a share of the profits of a general professional partnership
3. offsetting debt with right to received dividends
4. cancellation of debt in payment of service

Which do not constitute gross income?

1. Receipts representing returns of capital
Examples:
a. Proceeds of life insurance policy (upon death of the insured)
b. Proceeds received by the insured (still living) representing return of premium
2. Unrealized income
Examples:
a. Appreciation of value of properties
b. Unrealized gains on investments
3. Those exempted by the Constitution, statues or treaty or contract with taxpayers
Examples:
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 a. Receipt of non-profit institutions from their main activities
b. Contributions to GSIS, SSS, PhilHealth, Pag-Ibig and
c. Retirement and separation benefits under certain circumstances
d. Tax holiday for entities registered pursuant to the Omnibus Investment Code
e. Income of foreign government or corporations owned or controlled by them

Taxation of Gross Income under the NIRC:

A. Passive Income Tax
1. Capital gains tax – few final tax is imposed on certain gains on dealings on properties
Examples include final tax on:
a. Final tax on net gain on sale of domestic stocks directly to buyer (withheld at source)
b. Final tax on gains on sale of real property located in the Philippines classified as capital asset
2. Other withheld final tax – these are groups of passive income that are subject to withholding by the income
payor.
Examples include final tax on:
a. Interest on deposits with banks d. Winnings
b. Prizes e. Royalties
c. Dividends received from domestic corporation
B. Regular (Active) Income Tax – applies to all items of gross income that are generated by the taxpayer in the
ordinary course of business or to those items of passive income that are not covered by final taxes.
Regular income tax is either:
1. Progressive tax (0-32% schedular rates) – applicable to individual and taxable trusts and estates
2. Final tax (35%) – applicable to corporations

Examples active income:

1. Compensation income
2. Professional income
3. Business income
4. Those items of income that are excluded from capital gains tax
a. Gain on sale of properties located abroad
b. Gain on sale of properties located in the Philippines by non-residents
c. Gain on sale of other non-domestic stocks and non-real property capital assets
5. Those items of income that are excluded from other final taxes
a. Interest income on notes receivable (not deposit)
b. Prizes where the taxpayer has no intention or active effort to compete (Nobel Prize, cash awards to
“Most Outstanding Citizens of Baguio”)
c. Dividends from foreign corporations
6. Others
a. Certain tax benefits (example: items of deductions claimed in the past that are subsequently
recovered)
b. Obligations waived by the creditors in consideration of service

SITUS OF INCOME
A. Interest – debtor’s residence
B. Dividends
1. By a domestic corporation – within the Philippines
2. By a foreign corporation – apply the income dominance test
Basis:
World gross income for the three-year period ending the current taxable year preceding the declaration of
such dividends
a. If Philippine gross income is less than 50% of the basis, the whole dividend is considered earned outside
the Philippines
b. If Philippine gross income is at least 50% of this, the ratio of Philippine gross income over the basis
multiplied by the dividend received is considered earned within the Philippines.
C. Service – place of performance of the service
D. Rent – location of the property
E. Royalties – place where the intangible is used
F. Gain on sale
a. Real property – location of the property
b. Domestic shares of stock – always within the Philippines
c. Personal property – place of sale
In everything, LOVE & SERVE the LORD!
G. Mining – location of mine
H. Farming - location of farm
I. Merchandising – place of sale
Place of Puchase Place of Sale Income is earned
a. Within within within
b. within abroad abroad
c. abroad within within
d. abroad abroad abroad
J. Manufacturing – place of production and place of sale (Sec. 42(E), NIRC):
Whether full or partial processing, for example:
Place of Production Place of Sale Income is earned
a. Within within within
b. within abroad within and abroad
c. abroad within within and abroad
d. abroad abroad abroad

Allocation methods:
1. With factory or production price – the value as transfer price of the factory to the selling segment is deemed
the selling price of the commodity transferred.*
2. Without factory or production price – the portion deemed earned within the Philippines is:
(Property value, Philippines/ Property value, world) * 50% of income P xxx
(Gross sales, Philippines/ Gross sales, world) * 50% of income xxx
Manufacturing income earned from the Philippines P xxx

TAX ACCOUNTING PERIODS

Gross income accumulates over a period of time. Income taxation would require adoption of an accounting period
wherein to measure the income. The NIRC provides that “taxable income shall be computed upon the basis of the
taxpayer’s annual accounting period in accordance with the methods of accounting regularly employed in keeping
the books of such taxpayer.”

There are two types of tax accounting periods:

1. Calendar year – the 12-month period ending December 31 and is applicable to:
a. Individuals
b. taxpayers who do not keep books d. taxpayers with accounting periods other than the fiscal year
c. taxpayers with no annual accounting period
2. Fiscal period – any 12 months period ending the last day of any month other than December 31st. This is Not
available to non-corporate taxpayers.

Normally, accounting period are uniformly 12 months, however, short accounting period may arise in the following
cases:
1. death of a taxpayer 3. dissolution of a business
2. newly organized business 4. changes in accounting period

TAX PAYMENTS
Tax shall be paid on the 15th day of the fourth month following the close of the taxpayer’s taxable year.

TAX ACCOUNTING METHODS

So as the reporting of items of gross income would be consistent, tax accounting methods should be applied such
as the following:
A. Principal Methods
1. Cash Basis Method – income is recorded in the year it is actually or constructively received; expenses are
generally reported in the year it is paid
2. Accrual Method – income is reported in the year it is earned and expenses are deducted in the year incurred
3. Hybrid method – combination of both cash basis and accrual basis method
B. Deferred Payment Sales
1. Installment method – applicable in the following three cases only:
a. Sale of personal property by a dealer
b. Casual sale of personal property where:
a. selling price is over P1,000.00
b. initial payment do not exceed 25% of the selling price
In everything, LOVE & SERVE the LORD!
 c. property is of a kind which would be included in the taxpayer’s inventory if on hand at the close of
the taxable year
c. Sale of real property where the initial payment do not exceed 25% of the selling price
Initial Payment – refers to payments which the seller receives upon the execution of the instruments of
sale and those scheduled to be received in the year of sale or disposition. It simply means “total first year
payments” but do not include receipts of evidence of indebtedness of the buyer such as notes.
2. Deferred payment basis – applicable when the buyer has issued evidence of obligation (notes). The notes shall
be valued at its market value at the date of receipt. The difference between the fair value and the face value
is reported as interest income in future taxable period. This is an alternative to delaying tax payments when
the installment method is not available.
C. Long-term Construction Contracts
1. Percentage of completion – this is applicable only to long-term construction contracts covering a period in excess
of one year (Architect or engineer’s certification is required)
2. Completed contract basis – gross income is recognized upon completion of construction contract
D. Farming income
Crop year basis – applicable only to farmers engaged in the production of crops which takes more than a year
from the time of planting to the process of gathering and disposal. Expenses paid or incurred are deductible in
the year the gross income from the sale of the crops is realized.
E. Leasehold improvement
1. Outright method – the value of the leasehold improvement attributable to the lessor is reported in taxable
income at the time of completion of the leasehold
2. Spread-out method – the value of the leasehold improvement attributable to the lessor is recognized in taxable
income over the lease term

Reminders on Tax Accounting Methods:

a. Absence of accounting method or use of one that do not clearly reflects the income
If the taxpayer has no accounting method or if the method employed does not clearly reflect the income,
the computation shall be made in accordance with such method as in the opinion of the Commissioner
clearly reflects the income.
b. Consolidation of gross income from two or more methods
If a taxpayer adopted the cash basis and accrual basis in accounting for income earned on separate trade or
business, he may opt to combine the two income determined from the respective methods as a consolidated
income for tax purposes.
c. Change of Tax Method
- Prior BIR approval is required
- If the taxpayer changes its accounting methods from accrual to installment method, he should include in
future periods the collection of receivables in future gross income.*
d. Expenditures benefiting future periods
Expenditures benefiting more than one taxable period is deferred and allocated to those periods expected to
be benefited by the expenditure.
e. Advanced receipt of items of gross income
Receipt of income in advance is taxable in the year of receipt.

GENERAL RULE IN INCOME TAXATION

Income Taxable in the Philippines
Type of Taxpayers Earned Philippines Earned Abroad
I. Individuals
A. Citizens
1. Resident  
2. Non-resident 
B. Aliens
1. Resident 
2. Non-resident
a. In business 
b. Not in business 
C. Estate and Trusts same rule with individuals

II. Corporations
A. Domestic  
B. Foreign 
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 1. Resident 
2. Non-resident 

TAX COMPLIANCE
The Philippines follows the “self-assessment method” wherein taxpayers determine their gross income, prepare
their income tax returns and pay the tax accordingly. The return filed is presumed correct unless proven otherwise
by the government. However, in cases of failure to file a return, the Commissioner of Internal Revenue shall file a
return from best available information and such return thus filed is presumed correct. The taxpayer has the burden
of proof in this case. The same rule applies when tax authorities has reasons to believed that the tax return of the
taxpayer is grossly misstated.

Income tax return is required for items of gross income that are subject to:
1. Regular Income Tax (quarterly and annual consolidated return)
2. Capital Gains Tax (per transaction and an annual consolidated return)

Who shall file income tax returns?

1. Every resident Filipino citizen
2. Every non-resident Filipino citizen on his income from sources within the Philippines
3. Every resident alien on income from sources within the Philippines; and
4. Every non-resident alien engaged in trade or business or in the exercise of profession in the Philippines, on
income from sources within the Philippines

Who are not required to file individual returns for income tax?
1. An individual whose gross income does not exceed his total personal and additional exemptions, except
those engaged in business or profession
2. An individual with respect to pure compensation income, derived from sources in the Philippines, the
income tax on which has been correctly withheld, except those with concurrent employment
3. An individual whose income has been subjected to final income tax
4. An individuals who is exempt from filing income tax returns in pursuant to other provisions of the Tax
Code and other laws.

Where to file income tax returns?

1. Authorized agent bank
2. Revenue District Officer
3. Collection Agent
4. Duly authorized Treasurer of the city or municipality in which the taxpayer has his legal residence or
principal place of business in the Philippines or
5. Office of the Commissioner if the taxpayer has no legal residence or place of business in the Philippines

Payment of Income Tax

1. Outright
2. Installments (for individual taxpayers)

The Networth Method

The Networth Method serves as a test of the existence of income when not specifically disclosed.

Possible Gross Income = Personal Expenditures + Change in Networth*

*The change in Networth is computed as:

Asset, end - Liabilities, end = Net Worth, end

Less: Assets, beginning - Liabilities, beginning = Networth, beginning
Change in networth
The possible gross income is generally taxable, except when it:
1. is excluded by law, contract, treaty, public policy from taxation
2. result from additional investment
3. is not income for income tax purposes (i.e. does not meet the three characteristics of gross income)

In everything, LOVE & SERVE the LORD!

In everything, LOVE & SERVE the LORD!