GNotes Income Tax 100814 Part1

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TAX 1 SYLLABUS ASSOCIATE DEAN LILY K. GRUBA S/Y 2014-2015 1

GUIDE NOTES ON INCOME TAX (Part 1)

TITLE II TAX ON INCOME

Q: What is income? How is it different from capital?

* In Madrigal v. Rafferty , Madrigal and Paterno were legally

married and their marriage was contracted under theprovisions of law concerning conjugal partnerships. In 1915,Madrigal filed his income tax return for the previous year.

Later, however, Madrigal contended that his declared incomewas in fact the income of the conjugal partnership existing

between himself and his wife. Thus, his declared income wassupposed to be divided into 2 equal parts, i.e., ! to be

considered the income of Madrigal and!

of Paterno. The CIRargued that a distinction must be drawn between the ordinaryform of commercial partnership and the conjugal partnership ofspouses resulting from the relation of marriage. The Supreme

Court agreed with the CIR. Paterno had an inchoate right inthe property of her husband during the life of the conjugalpartnership. She had an interest in the ultimate property rightsand in the ultimate ownership of property acquired as income

after such income had become capital. However, Paterno’sright to ! of the income of the conjugal partnership was notabsolute. The High Court found that Paterno had no estate

and income of her own which could properly be considered forpurposes of income taxation.The Supreme Court had occasion to differentiate between

income and capital in this manner: “Income as contrasted withcapital or property is to be the test. The essential differencebetween capital and income is that capital is a fund; income is

a flow. A fund of property existing at an instant of time is calledcapital. A flow of services rendered by that capital by thepayment of money from it or any other benefit rendered by a

fund of capital in relation to such fund through a period of timeis called an income. Capital is wealth, while income is theservice of wealth.”

[Madrigal v. Rafferty, GR No. L-12287, 7 August 1918.]

** In Conwi v. Court of Tax Appeals, petitioners were Filipinocitizens and employees of Procter & Gamble, Philippine

Manufacturing Corporation. In the years 1970 and 1971,petitioners were assigned to other subsidiaries of Procter &Gamble outside of the Philippines, during which time

petitioners were paid USD as compensation for services intheir foreign assignments. Were petitioners liable to pay

income tax on their dollar earnings? The Supreme Court heldin the affirmative. The governing law then was Section 21 of

the old Tax Code, amended up to 4 August 1969, whichimposed a tax upon the taxable net income received duringeach taxable year from all sources by a citizen of thePhilippines, whether residing here or abroad. [NOTE: Today,

the 1997 Tax Code treats resident citizens and non-residentcitizens differently.] Petitioners’ dollar earnings were classifiedas income and hence, subject to income tax. The next issuewas the exchange rate to be used to determine the peso

equivalent of the dollar earnings of petitioners for income taxpurposes. The Supreme Court held that the par value of thepeso, not the prevailing free market rate of exchange, should

be the guiding rate used for purposes of computing incometax.In this case, income was defined in this sense: it is “an amount

of money coming to a person or corporation within a specifiedtime, whether as payment for services, interest or profit frominvestment. Unless otherwise specified, it means cash or its

equivalent. Income can also be thought of as a flow of thefruits of one’s labor.”


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[Conwi v. Court of Tax Appeals, GR Nos. 48532 and 48533,31 August 1992.]

*** At issue in CIR v. Court of Appeals was the taxability of theshares of stock in ANSCOR owned by the estate of Don Andres Soriano as well as Don Andres Soriano’s widow, DoñaCarmen Soriano. On various dates, (1) the estate and Doña

Carmen exchanged a portion of their common shares forpreferred shares, and (2) ANSCOR redeemed a portion of thecommon shares owned by the estate and Doña Carmen.

ANSCOR’s business purpose for the redemption of stocks wasto partially retire said stocks as treasury shares in order to

reduce the company’s foreign exchange remittances in casecash dividends were declared. Subsequently, ANSCOR was

issued an assessment for deficiency withholding tax at sourcebased on the transactions of exchange and redemption ofstocks. Regarding the exchange of stocks, the Supreme Courtfound that there was no change in the proportional interest of

the estate and Doña Carmen before and after the exchange.The exchange transaction did not result into a flow of wealthand hence, there was no income tax liability. As regards the redemption of stocks, the issue was,

particularly, whether ANSCOR’s redemption of stocks from itsstockholder as well as the exchange of common with preferredshares could be considered as essentially equivalent to the

distribution of taxable dividends, making the proceeds thereoftaxable income. The Supreme Court started by saying that thestock dividends, strictly speaking, represent capital and do not

constitute income to its recipient. The mere issuance of stockdividends is not yet subject to income tax. As capital, the stockdividends postpone the realization of profits. However, a

redemption of the stocks converts into money the stockdividends which become a realized profit or gain andconsequently, the stockholder’s separate property. As realized

income, the proceeds of the redeemed stock dividends can bereached by income taxation regardless of the existence of anybusiness purpose for the redemption. Here, the proceeds of

the redemption of the stock dividends were deemed taxabledividends, i.e., income subject to income tax which wasrequired to be withheld at source.“The determining factor for the imposition of income tax is

whether any gain or profit was derived from a transaction.”Furthermore, there are 3 elements in the imposition of incometax, namely: (1) there must be gain or profit; (2) the gain or

profit is realized or received, actually or constructively; and (3)the gain or profit is not exempted by law or treaty from income

tax. “Any business purpose as to why or how the income wasearned by the taxpayer is not a requirement. Income tax is

assessed on income received from any property, activity orservice that produces the income because the Tax Codestands as an indifferent neutral party on the matter whereincome comes from.”

[CIR v. Court of Appeals, GR No. 108576, 20 January 1999.]

**** In Chamber of Real Estate and Builders’ Associations, Inc.

v. Romulo, petitioner was an association of real estate

developers and builders in the country. It assailed the validityof the imposition of minimum corporate income tax (MCIT) oncorporations and creditable withholding tax (CWT) on sales of

real properties classified as ordinary assets. On the topic ofMCIT, petitioner argued that MCIT violated the due processclause because it levied income tax even if there was no

realized gain. In effect, MCIT was a tax on capital. Accordingto petitioner, income tax could only be imposed on income, notcapital. The Supreme Court took the opportunity to explain the

concept and rationale of MCIT as follows: MCIT on domesticcorporations came about as a result of the perceivedinadequacy of the self-assessment system in capturing the


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1995, respondent received a certain sum representing hersales commission income from which JUBANITEX withheldthe corresponding 10% withholding tax and remitting such

amount to the BIR. Respondent filed a claim for tax refund onthe contention that her sales commission income was nottaxable in the Philippines because the same was acompensation for her services rendered in Germany and

therefore considered as income from sources outside thePhilippines. Was respondent’s sales commission incometaxable in the Philippines? The Supreme Court held

affirmatively. Pursuant to Sections 23(D) and 25 of the 1997Tax Code, non-resident aliens, whether or not engaged in

trade or business, are subject to Philippine income taxation ontheir income received from all sources within the Philippines.

What is thus meant by “source” of income? Source of incomerelates to the property, activity or service that produced theincome. “The important factor therefore which determines thesource of income of personal services is not the residence of

the payor, or the place where the contract for service isentered into, or the place of payment, but the place where theservices were actually rendered.” Here, the Supreme Courtfound that respondent failed to show substantial evidence, or

“that relevant evidence that a reasonable mind might acceptas adequate to support the conclusion that it was in Germanywhere she performed the income producing service which

gave rise to the reported monthly sales in the months of Marchand May to September of 1995. She thus failed to dischargethe burden of proving that her income was from sources

outside the Philippines and exempt from the application of ourincome tax law. Hence, the claim for tax refund should bedenied.”

[CIR v. Baier-Nickel, GR No. 153793, 29 August 2006.]

Q: Define income tax.

* Black’s Law Dictionary defines “income tax” as a tax “on theannual profits arising from property, business pursuits,

professions, trades, or offices.” It is a tax “on a person’sincome, wages, salary, commissions, emoluments, profits, andthe like, or the excess thereof over a certain amount.”

** Income tax is a tax on all yearly profits arising from property,professions, trades or offices, or a tax on a person’s income,emoluments, profits and the like. It is tax on income, whether

net or gross, realized in one taxable year. [27 Am Jur. 308.]

*** At issue in CIR v. Court of Appeals was the taxability of theshares of stock in ANSCOR owned by the estate of Don

Andres Soriano as well as Don Andres Soriano’s widow, DoñaCarmen Soriano. On various dates, (1) the estate and DoñaCarmen exchanged a portion of their common shares forpreferred shares, and (2) ANSCOR redeemed a portion of the

common shares owned by the estate and Doña Carmen. ANSCOR’s business purpose for the redemption of stocks wasto partially retire said stocks as treasury shares in order toreduce the company’s foreign exchange remittances in case

cash dividends were declared. Subsequently, ANSCOR wasissued an assessment for deficiency withholding tax at sourcebased on the transactions of exchange and redemption of

stocks. Regarding the exchange of stocks, the Supreme Courtfound that there was no change in the proportional interest ofthe estate and Doña Carmen before and after the exchange.

The exchange transaction did not result into a flow of wealthand hence, there was no income tax liability. As regards the redemption of stocks, the issue was,

particularly, whether ANSCOR’s redemption of stocks from itsstockholder as well as the exchange of common with preferredshares could be considered as essentially equivalent to the


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distribution of taxable dividends, making the proceeds thereoftaxable income. The Supreme Court started by saying that thestock dividends, strictly speaking, represent capital and do not

constitute income to its recipient. The mere issuance of stockdividends is not yet subject to income tax. As capital, the stockdividends postpone the realization of profits. However, aredemption of the stocks converts into money the stock

dividends which become a realized profit or gain andconsequently, the stockholder’s separate property. As realizedincome, the proceeds of the redeemed stock dividends can be

reached by income taxation regardless of the existence of anybusiness purpose for the redemption. Here, the proceeds of

the redemption of the stock dividends were deemed taxabledividends, i.e., income subject to income tax which was

required to be withheld at source.“The determining factor for the imposition of income tax iswhether any gain or profit was derived from a transaction.”Furthermore, there are 3 elements in the imposition of income

tax, namely: (1) there must be gain or profit; (2) the gain orprofit is realized or received, actually or constructively; and (3)the gain or profit is not exempted by law or treaty from incometax. “Any business purpose as to why or how the income was

earned by the taxpayer is not a requirement. Income tax isassessed on income received from any property, activity orservice that produces the income because the Tax Code

stands as an indifferent neutral party on the matter whereincome comes from.”[CIR v. Court of Appeals, GR No. 108576, 20 January 1999.]

Q: Does income tax form part of operating expenses?

* Should income tax be included in the computation ofoperating expenses of a public utility? This was one of thequestions answered in Republic of the Philippines v. Manila

Electric Company . In this case, in 1993, Meralco filed with theERB an application for the revision of its rate schedules, i.e.,increase in its distribution charge. Income taxes paid by

Meralco were included as part of its operating expenses forpurposes of rate determination. The ERB argued againstincluding income taxes paid by Meralco as part of the publicutility’s operating expenses as this should be “borne by the

stockholders who are recipients of the income or profitsrealized from the operation of their business,” and henceshould not be passed on to the consumers. The Supreme

Court acknowledged that “the public utility is allowed a returnon capital over and above operating expenses. However, only

such expenses and in such amounts should be allowed fordetermination of the rates to be charged by a public utility.”

Does income tax form part of Meralco’s operating expensesfor purposes of computing a fair return on capital? TheSupreme Court answered negatively. “Income tax paid by apublic utility is inconsistent with the nature of operating

expenses. In general, operating expenses are those which arereasonably incurred in connection with business operations toyield revenue or income. They are items of expenses whichcontribute or are attributable to the production of income or

revenue.”On the other hand, income tax is “imposed on an individual orentity as a form of excise tax or a tax on the privilege of

earning income. In exchange for the protection extended bythe State to the taxpayer, the government collects taxes as asource of revenue to finance its activities. Clearly, by its

nature, income tax payments of a public utility are notexpenses which contribute to or are incurred in connectionwith the production of profit of a public utility. Income tax

should be borne by the taxpayer alone as they are paymentsmade in exchange for benefits received by the taxpayer fromthe State.”


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[Republic of the Philippines v. Manila Electric Company, GRNos. 141314 and 141369, 15 November 2002.]

Q: Distinguish between income tax and percentage tax.

* Does the 20% final withholding tax on a bank’s passiveinterest income form part of its taxable gross receipts in

computing the gross receipts tax? This was the issue resolvedin CIR v. Solidbank Corporation. In this case, Solidbanksought the refund of allegedly overpaid gross receipts tax for

the year 1995. The CIR opposed on the ground that althoughthe 20% final withholding tax on Solidbank’s interest income

was not actually received because it was remitted directly tothe government, the fact that the amount redounded to

Solidbank’s benefit made it part of the taxable gross receipts incomputing the 5% gross receipts tax. The Supreme Courtadhered to the CIR’s view and ruled that the amount of interestincome withheld in payment of the 20% final withholding tax

formed part of gross receipts in computing for the grossreceipts tax on banks. The High Court said that as a bank,Solidbank was covered by both gross receipts tax and finalwithholding tax. However, the Supreme Court took the

opportunity to differentiate gross receipts tax, which is apercentage tax, from final withholding tax, which is an incometax.

“A percentage tax is a national tax measured by a certainpercentage of the gross selling price or gross value in moneyof goods sold, bartered or imported; or of the gross receipts or

earnings derived by ay person engaged in the sale of services.It is not subject to withholding.” [NOTE: The subject matter ofgross receipts tax is the privilege of engaging in the business

of banking.]On the other hand, “[a]n income tax , on the other hand, is anational tax imposed on the net or the gross income realized in

a taxable year. It is subject to withholding.” [NOTE: Thesubject matter of final withholding tax is the passive incomegenerated in the form of interest on deposits and yield on

deposit substitutes.][CIR v. Solidbank Corporation, GR No. 148191, 25 November2003.]

Q: What are the kinds of income tax systems?

* The case of Tan v. del Rosario dealt with the constitutionality

of RA No. 7496, also commonly known as the Simplified NetIncome Taxation Scheme (SNIT), amending certain provisions

of the old Tax Code. One argument raised by petitioners wasthat the law now taxed single proprietorships and

professionals differently from the manner it imposed tax oncorporations and partnerships. Another argument was thatgeneral professional partnerships should not be treateddifferently from ordinary business partnerships. The Supreme

Court held that the classification made between singleproprietorships and professionals on the one hand, andcorporations and partnerships on the other, was valid.Furthermore, “[w]hat may instead be perceived to be apparent

from the amendatory law is the legislative intent to increasinglyshift the income tax system towards the schedular approach inthe income taxation of individual taxpayers and to maintain, by

and large, the present global treatment on taxablecorporations.” [NOTE: See footnotes 2 and 3 of the decision.Schedular approach is defined as a system employed where

the income tax treatment varies and made to depend on thekind or category of taxable income of the taxpayer. Globalapproach, on the other hand, refers to a system where the tax

treatment view indifferently the tax base and generally treats incommon all categories of taxable income of the taxpayer.]


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On the topic of partnerships, the Supreme Court confirmedthat general professional partnerships and ordinary businesspartnerships are treated differently for purposes of income

taxation. In general professional partnerships, “the partnersthemselves, not the partnership (although it is still obligated tofile an income tax return [mainly for administration and data],are liable for the payment of income tax in their individual

capacity computed on their respective and distributive sharesof profits. In the determination of the tax liability, a partnerdoes so as an individual , and there is no choice on the matter.

In fine, under the Tax Code on income taxation, the generalprofessional partnership is deemed to be no more than a mere

mechanism or a flow-through entity in the generation ofincome by, and the ultimate distribution of such income to,

respectively, each of the individual partners.”[Tan v. del Rosario, GR Nos. 109289 and 109446, 3 October1994.]

Q: What are the basic features of our present income taxsystem?

* Our present income tax system is global, schedular, and

progressive.

Q: What are the kinds of tax rates?

* Tax rates are either (1) flat or proportional, or (2) graduated.The latter may further be classified into (a) progressive, or (b)

regressive.

Q: What are the kinds of income according to tax rates?

* Income may either be subject to (1) schedular tax, (2) finaltax, or (3) reduced rate, e.g., minimum corporate income tax.

** Income subject to schedular tax includes: (a) compensationincome earned by an individual; (b) income from trade or

exercise of profession of an individual; and (c) income earnedby an estate or trust.

*** Income subject to final tax includes: (a) interest, royalties,

prizes, and winnings; (b) cash or property dividends; (c) capitalgains from sale of shares of stock not traded in the stockexchange; and (d) capital gains from sale of real property.

Q: What law governs Philippine income taxation?

* The basic Philippine income tax law can be found in the 1997

Tax Code, i.e., RA No. 8424, as amended. The latestamendment to our Philippine income tax law is found in RANo. 9504 (2008).

** US tax cases have persuasive effect in our jurisdictionbecause Philippine income taxation is patterned after its UScounterpart.

CHAPTER I - DEFINITIONSSec. 22, Definitions - When used in this Title:(A) The term 'person' means an individual, a trust, estate

or corporation.(B) The term 'corporation' shall include partnerships, nomatter how created or organized, joint-stock companies,

joint accounts (cuentas en participacion), association, orinsurance companies, but does not include general professional partnerships and a joint venture or

consortium formed for the purpose of undertakingconstruction projects or engaging in petroleum, coal,geothermal and other energy operations pursuant to an


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operating consortium agreement under a service contractwith the Government. 'General professional partnerships'are partnerships formed by persons for the sole purpose

of exercising their common profession, no part of theincome of which is derived from engaging in any trade orbusiness.(C) The term 'domestic,' when applied to a corporation,

means created or organized in the Philippines or under itslaws.(D) The term 'foreign,' when applied to a corporation,

means a corporation which is not domestic.(E) The term 'nonresident citizen' means:

(1) A citizen of the Philippines who establishes to thesatisfaction of the Commissioner the fact of his physical

presence abroad with a definite intention to residetherein.(2) A citizen of the Philippines who leaves the Philippinesduring the taxable year to reside abroad, either as an

immigrant or for employment on a permanent basis.(3) A citizen of the Philippines who works and derivesincome from abroad and whose employment thereat

requires him to be physically present abroad most of thetime during the taxable year.(4) A citizen who has been previously considered asnonresident citizen and who arrives in the Philippines at

any time during the taxable year to reside permanently inthe Philippines shall likewise be treated as a nonresidentcitizen for the taxable year in which he arrives in the

Philippines with respect to his income derived fromsources abroad until the date of his arrival in thePhilippines.

(5) The taxpayer shall submit proof to the Commissionerto show his intention of leaving the Philippines to reside permanently abroad or to return to and reside in the

Philippines as the case may be for purpose of thisSection.(F) The term 'resident alien' means an individual whose

residence is within the Philippines and who is not acitizen thereof.(G) The term 'nonresident alien' means an individualwhose residence is not within the Philippines and who is

not a citizen thereof.(H) The term 'resident foreign corporation' applies to aforeign corporation engaged in trade or business within

the Philippines.(I) The term 'nonresident foreign corporation' applies to a

foreign corporation not engaged in trade or businesswithin the Philippines.

(J) The term 'fiduciary' means a guardian, trustee,executor, administrator, receiver, conservator or any person acting in any fiduciary capacity for any person.(K) The term 'withholding agent' means any person

required to deduct and withhold any tax under the provisions of Section 57.(L) The term 'shares of stock' shall include shares of

stock of a corporation, warrants and/or options to purchase shares of stock, as well as units of participationin a partnership (except general professional partnerships), joint stock companies, joint accounts, joint

ventures taxable as corporations, associations andrecreation or amusement clubs (such as golf, polo orsimilar clubs), and mutual fund certificates.

(M) The term 'shareholder' shall include holders of ashare/s of stock, warrant/s and/or option/s to purchaseshares of stock of a corporation, as well as a holder of a

unit of participation in a partnership (except general professional partnerships) in a joint stock company, a joint account, a taxable joint venture, a member of an


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association, recreation or amusement club (such as golf, polo or similar clubs) and a holder of a mutual fundcertificate, a member in an association, joint-stock

company, or insurance company.(N) The term 'taxpayer' means any person subject to taximposed by this Title.(O) The terms 'including' and 'includes', when used in a

definition contained in this Title, shall not be deemed toexclude other things otherwise within the meaning of theterm defined.

(P) The term 'taxable year' means the calendar year, or thefiscal year ending during such calendar year, upon the

basis of which the net income is computed under thisTitle. 'Taxable year' includes, in the case of a return made

for a fractional part of a year under the provisions of thisTitle or under rules and regulations prescribed by theSecretary of Finance, upon recommendation of thecommissioner, the period for which such return is made.

(Q) The term 'fiscal year' means an accounting period oftwelve (12) months ending on the last day of any monthother than December.

(R) The terms 'paid or incurred' and 'paid or accrued' shallbe construed according to the method of accountingupon the basis of which the net income is computedunder this Title.

(S) The term 'trade or business' includes the performanceof the functions of a public office.(T) The term 'securities' means shares of stock in a

corporation and rights to subscribe for or to receive suchshares. The term includes bonds, debentures, notes orcertificates, or other evidence or indebtedness, issued by

any corporation, including those issued by a governmentor political subdivision thereof, with interest coupons orin registered form.

(U) The term 'dealer in securities' means a merchant ofstocks or securities, whether an individual, partnership orcorporation, with an established place of business,

regularly engaged in the purchase of securities and theresale thereof to customers; that is, one who, as amerchant, buys securities and re-sells them to customerswith a view to the gains and profits that may be derived

therefrom.(V) The term 'bank' means every banking institution, asdefined in Section 2 of Republic Act No. 337, as amended,

otherwise known as the General banking Act. A bank mayeither be a commercial bank, a thrift bank, a development

bank, a rural bank or specialized government bank.(W) The term 'non-bank financial intermediary' means a

financial intermediary, as defined in Section 2(D)(C) ofRepublic Act No. 337, as amended, otherwise known asthe General Banking Act, authorized by the BangkoSentral ng Pilipinas (BSP) to perform quasi-banking

activities.(X) The term 'quasi-banking activities' means borrowingfunds from twenty (20) or more personal or corporate

lenders at any one time, through the issuance,endorsement, or acceptance of debt instruments of anykind other than deposits for the borrower's own account,or through the issuance of certificates of assignment or

similar instruments, with recourse, or of repurchaseagreements for purposes of relending or purchasingreceivables and other similar obligations: Provided,

however, That commercial, industrial and other non- financial companies, which borrow funds through any ofthese means for the limited purpose of financing their

own needs or the needs of their agents or dealers, shallnot be considered as performing quasi-banking functions.(Y) The term 'deposit substitutes' shall mean an


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alternative from of obtaining funds from the public (theterm 'public' means borrowing from twenty (20) or moreindividual or corporate lenders at any one time) other

than deposits, through the issuance, endorsement, oracceptance of debt instruments for the borrowers ownaccount, for the purpose of relending or purchasing ofreceivables and other obligations, or financing their own

needs or the needs of their agent or dealer. Theseinstruments may include, but need not be limited tobankers' acceptances, promissory notes, repurchase

agreements, including reverse repurchase agreementsentered into by and between the Bangko Sentral ng

Pilipinas (BSP) and any authorized agent bank,certificates of assignment or participation and similarinstruments with recourse: Provided, however, That debt

instruments issued for interbank call loans with maturityof not more than five (5) days to cover deficiency inreserves against deposit liabilities, including those

between or among banks and quasi-banks, shall not beconsidered as deposit substitute debt instruments.(Z) The term 'ordinary income' includes any gain from the

sale or exchange of property which is not a capital assetor property described in Section 39(A)(1). Any gain fromthe sale or exchange of property which is treated orconsidered, under other provisions of this Title, as

'ordinary income' shall be treated as gain from the sale orexchange of property which is not a capital asset asdefined in Section 39(A)(1). The term 'ordinary loss'

includes any loss from the sale or exchange of propertywhich is not a capital asset. Any loss from the sale orexchange of property which is treated or considered,

under other provisions of this Title, as 'ordinary loss'shall be treated as loss from the sale or exchange of property which is not a capital asset.

(AA) The term 'rank and file employees' shall mean allemployees who are holding neither managerial norsupervisory position as defined under existing provisions

of the Labor Code of the Philippines, as amended.(BB) The term 'mutual fund company' shall mean an open- end and close-end investment company as defined underthe Investment Company Act.

(CC) The term 'trade, business or profession' shall notinclude performance of services by the taxpayer as anemployee.

(DD) The term 'regional or area headquarters' shall meana branch established in the Philippines by multinational

companies and which headquarters do not earn or deriveincome from the Philippines and which act assupervisory, communications and coordinating center for

their affiliates, subsidiaries, or branches in the Asia- Pacific Region and other foreign markets.(EE) The term 'regional operating headquarters' shall

mean a branch established in the Philippines bymultinational companies which are engaged in any of thefollowing services: general administration and planning;

business planning and coordination; sourcing and procurement of raw materials and components; corporatefinance advisory services; marketing control and sales promotion; training and personnel management; logistic

services; research and development services and productdevelopment; technical support and maintenance; data processing and communications; and business

development.(FF) The term 'long-term deposit or investmentcertificates' shall refer to certificate of time deposit or

investment in the form of savings, common or individualtrust funds, deposit substitutes, investment managementaccounts and other investments with a maturity period of


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not less than five (5) years, the form of which shall be prescribed by the Bangko Sentral ng Pilipinas (BSP) andissued by banks only (not by nonbank financial

intermediaries and finance companies) to individuals indenominations of Ten thousand pesos (P10,000) andother denominations as may be prescribed by the BSP.(GG) The term ‘statutory minimum wage’ earner shall

refer to rate fixed by the Regional Tripartite Wage andProductivity Board, as defined by the Bureau of Laborand Employment Statistics (BLES) of the Department of

Labor and Employment (DOLE). (As amended by RA No.9504.)

(HH) The term ‘minimum wage earner’ shall refer to aworker in the private sector paid the statutory minimumwage; or to an employee in the public sector with

compensation income of not more than the statutoryminimum wage in the non-agricultural sector wherehe/she is assigned. (As amended by RA No. 9504.)

CHAPTER II - GENERAL PRINCIPLESSec. 23, General Principles of Income Taxation in the

Philippines. - Except when otherwise provided in thisCode:23(A) A citizen of the Philippines residing therein istaxable on all income derived from sources within and

without the Philippines;

Q: How is a resident citizen taxed?

* In Conwi v. Court of Tax Appeals, petitioners were Filipinocitizens and employees of Procter & Gamble, Philippine

Manufacturing Corporation. In the years 1970 and 1971,petitioners were assigned to other subsidiaries of Procter &Gamble outside of the Philippines, during which time

petitioners were paid USD as compensation for services intheir foreign assignments. Were petitioners liable to payincome tax on their dollar earnings? The Supreme Court held

in the affirmative. The governing law then was Section 21 ofthe old Tax Code, amended up to 4 August 1969, whichimposed a tax upon the taxable net income received duringeach taxable year from all sources by a citizen of the

Philippines, whether residing here or abroad. [NOTE: Today,the 1997 Tax Code treats resident citizens and non-residentcitizens differently.] Petitioners’ dollar earnings were classified

as income and hence, subject to income tax. The next issuewas the exchange rate to be used to determine the peso

equivalent of the dollar earnings of petitioners for income taxpurposes. The Supreme Court held that the par value of thepeso, not the prevailing free market rate of exchange, should

be the guiding rate used for purposes of computing incometax.In this case, income was defined in this sense: it is “an amount

of money coming to a person or corporation within a specifiedtime, whether as payment for services, interest or profit frominvestment. Unless otherwise specified, it means cash or itsequivalent. Income can also be thought of as a flow of the

fruits of one’s labor.”[Conwi v. Court of Tax Appeals, GR Nos. 48532 and 48533,31 August 1992.]

23(B) A nonresident citizen is taxable only on incomederived from sources within the Philippines;

23(C) An individual citizen of the Philippines who isworking and deriving income from abroad as an overseas

contract worker is taxable only on income derived fromsources within the Philippines: Provided, That a seamanwho is a citizen of the Philippines and who receives


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compensation for services rendered abroad as a memberof the complement of a vessel engaged exclusively ininternational trade shall be treated as an overseas

contract worker;

23(D) An alien individual, whether a resident or not of thePhilippines, is taxable only on income derived from

sources within the Philippines;

Q: How is a nonresident alien taxed?

* In CIR v. Baier-Nickel, respondent was a non-resident

German citizen who was employed as a commission agent ofJUBANITEX, which was a domestic corporation. It was agreedthat respondent would receive 10% sales commission on all

sales actually concluded and collected through her efforts. In1995, respondent received a certain sum representing hersales commission income from which JUBANITEX withheld

the corresponding 10% withholding tax and remitting suchamount to the BIR. Respondent filed a claim for tax refund onthe contention that her sales commission income was nottaxable in the Philippines because the same was a

compensation for her services rendered in Germany andtherefore considered as income from sources outside thePhilippines. Was respondent’s sales commission income

taxable in the Philippines? The Supreme Court heldaffirmatively. Pursuant to Sections 23(D) and 25 of the 1997Tax Code, non-resident aliens, whether or not engaged in

trade or business, are subject to Philippine income taxation ontheir income received from all sources within the Philippines.What is thus meant by “source” of income? Source of income

relates to the property, activity or service that produced theincome. “The important factor therefore which determines thesource of income of personal services is not the residence of

the payor, or the place where the contract for service isentered into, or the place of payment, but the place where theservices were actually rendered.” Here, the Supreme Court

found that respondent failed to show substantial evidence, or“that relevant evidence that a reasonable mind might acceptas adequate to support the conclusion that it was in Germanywhere she performed the income producing service which

gave rise to the reported monthly sales in the months of Marchand May to September of 1995. She thus failed to dischargethe burden of proving that her income was from sources

outside the Philippines and exempt from the application of ourincome tax law. Hence, the claim for tax refund should be

denied.”[CIR v. Baier-Nickel, GR No. 153793, 29 August 2006.]

23(E) A domestic corporation is taxable on all incomederived from sources within and without the Philippines;and

Q: What are considered corporations for income taxpurposes?

* Section 22(B) of the 1997 Tax Code defines “corporation” inthis wise:

(B) The term 'corporation' shall include partnerships, nomatter how created or organized, joint-stock companies, joint accounts (cuentas en participacion), association, or

insurance companies, but does not include general professional partnerships and a joint venture orconsortium formed for the purpose of undertaking

construction projects or engaging in petroleum, coal,geothermal and other energy operations pursuant to anoperating consortium agreement under a service contract


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with the Government. 'General professional partnerships'are partnerships formed by persons for the sole purposeof exercising their common profession, no part of the

income of which is derived from engaging in any trade orbusiness.

** In the case of Obillos v. CIR , Jose Obillos, Sr. bequeathed

two lots located in Greenhills, San Juan to his four children(here, the petitioners) to enable them to build their residences. After more than a year, petitioners resold the lots to Walled

City Securities Corporation and Canda. Petitioners derivedfrom the sale a total profit of Php 134,341.88, or Php 33,584

for each of them. Petitioners treated each of their profits as acapital gain and paid an income tax on ! thereof. Later, theCIR issued an assessment against petitioners for deficiency

income tax on the ground that petitioners formed anunregistered partnership or joint venture. Hence, the CIRrequired petitioners to pay corporate income tax on the total

profit, in addition to individual income tax on each of theirshares. The CIR considered the share of the profits of each ofpetitioners as a distributive dividend taxable in full (not a merecapital gain of which ! is taxable). The Supreme Court

disagreed. The Court held that it was error to considerpetitioners as having formed a partnership. Petitioners weremerely co-owners. “To consider them as partners would

obliterate the distinction between a co-ownership and apartnership. The petitioners were not engaged in any jointventure by reason of that isolated transaction. Their original

purpose was to divide the lots for residential purposes. If lateron they found it not feasible to build their residences on thelots because of the high cost of construction, then they had no

choice but to resell the same to dissolve the co-ownership.The division of the profit was merely incidental to thedissolution of the co-ownership which was in the nature of

things a temporary state. It had to be terminated sooner orlater.”[Obillos v. CIR, GR No. L-68118, 29 October 1985.]

*** In Pascual v. CIR , Pascual and Dragon together boughtfive parcels of land. In 1968, petitioners sold two parcels ofland to Marenir Development Corporation, while the remaining

three parcels of land were sold to Reyes and Samson in 1970.Petitioners realized a net profit in the 1968 sale in the amountof Php 165,224.70, while they realized a net profit of Php

60,000 in the 1970 sale. The corresponding capital gains taxeswere paid by petitioners in 1973 and 1974 by availing of the

tax amnesties granted in said years. Later, an assessment fordeficiency corporate income taxes for the years 1968 and1970 was issued against petitioners. The CIR contended that

during said years, petitioners as co-owners in the real estatetransactions formed an unregistered partnership or jointventure taxable as a corporation. The Supreme Court held that

a mere co-ownership existed between petitioners. There wasno adequate basis to support the proposition that petitionersformed an unregistered partnership. “The sharing of returnsdoes not in itself establish a partnership whether or not the

persons sharing therein have a joint or common right orinterest in the property. There must be a clear intent to form apartnership, the existence of a juridical personality different

from the individual partners, and the freedom of each party totransfer or assign the whole property.” Hence, petitionerscould not have been liable for corporate income taxes.

[Pascual v. CIR, GR No. L-78133, 18 October 1988.]

**** In Afisco Insurance Corporation v. Court of Appeals,

petitioners were 41 non-life insurance corporations in thePhilippines. Upon issuance by them of machinery insurancepolicies, petitioners entered into a Quota Share Reinsurance


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Treaty and a Surplus Reinsurance Treaty with MunchenerRuchversicherungs-Gesselschaft, a nonresident foreigninsurance corporation. The reinsurance treaties required

petitioners to form a pool. Accordingly, a pool composed ofpetitioners was formed. The CIR issued an assessmentagainst petitioners for deficiency corporate income taxes onthe ground that the pool of machinery insurers was a

partnership taxable as a corporation. Petitioners protested theassessment and belied the existence of a partnership. TheSupreme Court agreed with the CIR. It held that the following

unmistakably indicated a partnership or an association amongpetitioners that was taxable as a corporation:

(1) The pool had a common fund consisting of money andother valuables that were deposited in the name andcredit of the pool. This common fund paid for the

administration and operation expenses of the pool.(2) The pool functioned through an executive board, which

resembled the board of directors of a corporation,

composed of one representative for each of petitioners.(3) Petitioners shared in the profits derived from the

business ceded to the pool. A partnership is formed when persons contract to devote to a

common purpose either money, property or labor with theintention of dividing the profits among themselves. On theother hand, an association implies associates who enter into a

joint enterprise for the transaction of business.[Afisco Insurance Corporation v. Court of Appeals, GR No.112675, 25 January 1999.]

23(F) A foreign corporation, whether engaged or not intrade or business in the Philippines, is taxable only on

income derived from sources within the Philippines.

Q: Give an example of a resident foreign corporation.

* In CIR v. Tokyo Shipping Co., Ltd., respondent was a foreigncorporation represented in the Philippines by a domestic

corporation. It owned and operated tramper vessel M/VGardenia. In December 1980, NASUTRA chartered M/VGardenia to load 16,500 metric tons of raw sugar in thePhilippines. In the same month, the domestic corporation paid

the required income and common carrier’s taxes based on theexpected gross receipts of the vessel. Upon arriving at theGuimaras Port of Iloilo, however, the vessel found no sugar for

loading. Claiming the prepayment of income and commoncarrier’s taxes as erroneous since no receipt was realized from

the charter agreement, respondent instituted a claim for taxrefund or credit. Was respondent entitled to its claim? TheSupreme Court stated that a resident foreign corporation

engaged in the transport of cargo was liable for taxesdepending on the amount of income it derived from sourceswithin the Philippines. Before such a tax liability could be

enforced, the taxpayer must be shown to have earned incomesourced from the Philippines. The Supreme Court found thatrespondent adduced sufficient evidence to prove that it derivedno receipt from its charter agreement with NASUTRA. The

tramper vessel M/V Gardenia arrived in Iloilo on 10 January1981 but found no raw sugar to load and returned to Japanwithout any cargo laden on board. Thus, respondent was

entitled to its claim for tax refund or credit of prepaid incomeand common carrier’s taxes.[CIR v. Tokyo Shipping Co., Ltd., GR No. 68252, 26 May

1995.]

Q: Give examples of nonresident foreign corporations.

* In CIR v. British Overseas Airways Corporation, BOAC was aBritish Government-owned corporation engaged in the


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international airline business. As such, it operated airtransportation service and sold transportation tickets over theroutes of the other airline members. For the years 1959 to

1971, BOAC had no landing rights for traffic purposes in thePhilippines. It did not carry passengers and/or cargo to andfrom the Philippines, although from 1959 to 1971, BOACmaintained a general sales agent in the country which was

responsible for selling BOAC tickets covering passengers andcargoes. The CIR issued an assessment against BOAC fordeficiency income taxes for the years 1959 to 1971 for the sale

of tickets in the Philippines for air transportation. Was BOAC aresident foreign corporation doing business in the Philippines?

The Supreme Court held affirmatively. BOAC, during theperiods covered by the subject assessments, maintained ageneral sales agent in the Philippines which performed

activities in the exercise of the functions normally incident to,and in progressive pursuit of, the purpose and object of itsorganization as an international air carrier. BOAC was held to

be engaged in business in the Philippines through its localagent during the period covered by the assessments.“There is no specific criterion as to what constitutes ‘doing’ or‘engaging in’ or ‘transacting’ business. Each case must be

adjudged in the light of its peculiar environmentalcircumstances. The term implies a continuity of commercialdealings and arrangements, and contemplates, to that extent,

the performance of acts or works or the exercise of some ofthe functions normally incident to, and in progressiveprosecution of commercial gain or for the purpose and object

of the business organization. In order that a foreigncorporation may be regarded as doing business in within aState, there must be a continuity of conduct and intention to

establish a continuous business, such as the appointment of alocal agent, and not one of a temporary character.”

[CIR v. British Overseas Airways Corporation, GR Nos. L-65773-74, 30 April 1987.]

** The issue in N.V. Reederij “Amsterdam” v. CIR was theincome tax liability of a foreign shipping corporation whichcalled on Philippine ports to load cargoes for foreigndestination on two occasions (in 1963 and 1964), and which

collected freight fees on these transactions. The SupremeCourt classified N.V. Reederij “Amsterdam” as a foreigncorporation not engaged in trade or business in the

Philippines. It did not have a branch office in the Philippinesand it made only two calls in Philippine ports in different years.

“In order that a foreign corporation may be consideredengaged in trade or business, its business transactions mustbe continuous. A casual business activity in the Philippines by

a foreign corporation, as in the present case, does not amountto engaging in trade or business in the Philippines for incometax purposes.”

[N.V. Reederij “Amsterdam” v. CIR, GR No. L-46029, 23 June1988.]

*** In Marubeni Corporation v. CIR , Marubeni Corporation (the

“Head Office”) was a Japanese corporation which establisheda branch office (the “Branch Office”) in the Philippines. TheHead Office made equity investments in Atlantic Gulf and

Pacific Co. of Manila. In 1981, AG&P declared and paid cashdividends to the Head Office. AG&P directly remitted the cashdividends to the Head Office, net not only of the 10% final

dividend tax, but also of the withheld 15% profit remittance tax(based on the remittable amount after deducting the 10% finaldividend tax). Later, the Head Office filed a claim for tax refund

or credit of alleged erroneously paid branch profit remittancetax on the dividends remitted by AG&P to the Head Office. Theissue in this case revolved around the Head Office’s tax


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liability on its dividend income from Philippine sources. TheSupreme Court deemed it wise to first determine theclassification of the Head Office for income taxation purposes.

The Head Office contended that following the principal-agentrelationship theory, because the Branch Office was a residentforeign corporation, the Head Office was likewise a residentforeign corporation. Hence, the Head Office was subject only

to the 10% final dividend tax. Upon the other hand, the CIRargued that the Head Office was a nonresident foreigncorporation which was neither subject to the 10% final

dividend tax nor the withheld 15% branch profit remittance tax.Instead, the Head Office was subject to the 35% final

withholding tax on its gross income earned from Philippinesources. The Supreme Court declared that in this particulartransaction, the Head Office was considered a nonresident

foreign corporation. The general rule is that a foreigncorporation is the same juridical entity as its branch office inthe Philippines. However, “when the foreign corporation

transacts business in the Philippines independently of itsbranch, the principal-agent relationship is set aside. Thetransaction becomes one of the foreign corporation, not of thebranch. Consequently, the taxpayer is the foreign corporation,

not the branch or the resident foreign corporation.” Being anonresident foreign corporation with respect to the transactionin question, generally, the Head Office must be taxed 35% of

its gross income from all sources within the Philippines.However, based on now Section 28(B)(5)(b) of the 1997 TaxCode and the relevant provision of the RP-Japan Tax Treaty

(i.e., the tax sparing rule), a discounted rate of 15% was givento the Head Office on dividends received from AG&P.[Marubeni Corporation v. CIR, GR No. 76573, 14 September

1989.]

**** Philippine income taxation recognizes two kinds of foreigncorporations: (1) resident foreign corporation, and (2)nonresident foreign corporation. What makes a foreign

corporation a resident of the Philippines? In State InvestmentHouse, Inc. v. Citibank, N.A., respondents were foreign bankswith principal offices situated outside of the Philippines. Saidbanks were licensed to do business in the country and did so

for many years, through branch offices or agencies. Werethese Philippine branches or units considered residents of thePhilippines pursuant to then prevailing Insolvency Law, or

were they residents of the state under the laws of which theywere respectively incorporated? The Supreme Court

acknowledged that the Insolvency Law itself did not contain adefinition of the term “resident.” The Court resorted to areading of other statutes, albeit of subsequent enactment and

effectivity, from which enlightening notions of the term couldbe derived, e.g., then prevailing Tax Code, Offshore BankingLaw, and General Banking Act. “Courts have held that ‘a

domestic corporation is regarded as having a residence withinthe state at any place where it is engaged in the particulars ofthe corporate enterprise, and not only at its chief place orhome office;’ that ‘a corporation may be domiciled in one state

and resident in another; its legal domicile in the state of itscreation presents no impediment to its residence in a real andpractical sense in the state of its business activities.” Here, the

Supreme Court found that the foreign banks were residents ofthe Philippines. It was not the grant of license to do businessin the country which made them residents of the Philippines.

The license merely gave them legitimacy to their business inthe Philippines. The “necessary element in its signification islocality of existence.”

[NOTE: Residence is the place where a corporation operatesand transacts business, whereas domicile is the state of thatcorporation’s formation or organization.]


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[State Investment House, Inc. v. Citibank, N.A., GR Nos.79926-27, 17 October 1991.]

CHAPTER III - TAX ON INDIVIDUALS

[NOTE: At present, the graduated individual income tax ratesshall be between 5-32%. [RA No. 9504 (2008).] On the other

hand, the regular corporate income tax rate is 30%. [RA No.9337 (2005).]

Sec. 24, Income Tax Rates. -24(A) Rates of Income Tax on Individual Citizen and

Individual Resident Alien of the Philippines. -24(A)(1) An income tax is hereby imposed:(a) On the taxable income defined in Section 31 of this

Code, other than income subject to tax underSubsections (B), (C) and (D) of this Section, derived foreach taxable year from all sources within and without the

Philippines be every individual citizen of the Philippinesresiding therein;(b) On the taxable income defined in Section 31 of this

Code, other than income subject to tax underSubsections (B), (C) and (D) of this Section, derived foreach taxable year from all sources within the Philippinesby an individual citizen of the Philippines who is residing

outside of the Philippines including overseas contractworkers referred to in Subsection(C) of Section 23 hereof;and

(c) On the taxable income defined in Section 31 of thisCode, other than income subject to tax underSubsections (B), (C) and (D) of this Section, derived for

each taxable year from all sources within the Philippinesby an individual alien who is a resident of the Philippines.24(A)(2) Rates of Tax on Taxable Income of Individuals.

The tax shall be computed in accordance with and at therates established in the following schedule:Not over P10,000…………………………………. 5%

Over P10,000 but not over P30,000…………… P500+10%of the excess over P10,000Over P30,000 but not over P70,000……………P2,500+15%of the excess over P30,000

Over P70,000 but not over P140,000……..……P8,500+20%of the excess over P70,000Over P140,000 but not over

P250,000…………P22,500+25% of the excess overP140,000

Over P250,000 but not overP500,000…………P50,000+30% of the excess overP250,000

Over P500,000 …………………………………..P125,000+32%of the excess over P500,000For married individuals, the husband and wife, subject to

the provision of Section 51(D) hereof, shall computeseparately their individual income tax based on theirrespective total taxable income: Provided, that if any

income cannot be definitely attributed to or identified asincome exclusively earned or realized by either of thespouses for the purpose of determining their respectivetaxable income.

Provided, That minimum wage earners as defined inSection 22(HH) of this Code shall be exempt from the payment of income tax on their taxable income: Provided,

further, That the holiday pay, overtime pay, night shiftdifferential pay and hazard pay received by suchminimum wage earners shall likewise be exempt from

income tax. (As amended by RA No. 9504.)


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Q: What is the difference in treatment between a co-owner anda partner?

* In the case of Obillos v. CIR , Jose Obillos, Sr. bequeathedtwo lots located in Greenhills, San Juan to his four children(here, the petitioners) to enable them to build their residences. After more than a year, petitioners resold the lots to Walled

City Securities Corporation and Canda. Petitioners derivedfrom the sale a total profit of Php 134,341.88, or Php 33,584for each of them. Petitioners treated each of their profits as a

capital gain and paid an income tax on ! thereof. Later, theCIR issued an assessment against petitioners for deficiency

income tax on the ground that petitioners formed anunregistered partnership or joint venture. Hence, the CIRrequired petitioners to pay corporate income tax on the total

profit, in addition to individual income tax on each of theirshares. The CIR considered the share of the profits of each ofpetitioners as a distributive dividend taxable in full (not a mere

capital gain of which ! is taxable). The Supreme Courtdisagreed. The Court held that it was error to considerpetitioners as having formed a partnership. Petitioners weremerely co-owners. “To consider them as partners would

obliterate the distinction between a co-ownership and apartnership. The petitioners were not engaged in any jointventure by reason of that isolated transaction. Their original

purpose was to divide the lots for residential purposes. If lateron they found it not feasible to build their residences on thelots because of the high cost of construction, then they had no

choice but to resell the same to dissolve the co-ownership.The division of the profit was merely incidental to thedissolution of the co-ownership which was in the nature of

things a temporary state. It had to be terminated sooner orlater.”[Obillos v. CIR, GR No. L-68118, 29 October 1985.]

24(B) Rate of Tax on Certain Passive Income. -24(B)(1) Interests, Royalties, Prizes, and Other Winnings. -

A final tax at the rate of twenty percent (20%) is herebyimposed upon the amount of interest from any currencybank deposit and yield or any other monetary benefit fromdeposit substitutes and from trust funds and similar

arrangements; royalties, except on books, as well asother literary works and musical compositions, whichshall be imposed a final tax of ten percent (10%); prizes

(except prizes amounting to Ten thousand pesos(P10,000) or less which shall be subject to tax under

Subsection (A) of Section 24; and other winnings (exceptPhilippine Charity Sweepstakes and Lotto winnings),derived from sources within the Philippines: Provided,

however, That interest income received by an individualtaxpayer (except a nonresident individual) from adepository bank under the expanded foreign currency

deposit system shall be subject to a final income tax atthe rate of seven and one-half percent (7 1/2%) of suchinterest income: Provided, further, That interest income

from long-term deposit or investment in the form ofsavings, common or individual trust funds, depositsubstitutes, investment management accounts and otherinvestments evidenced by certificates in such form

prescribed by the Bangko Sentral ng Pilipinas (BSP) shallbe exempt from the tax imposed under this Subsection:Provided, finally, That should the holder of the certificate

pre-terminate the deposit or investment before the fifth(5

th ) year, a final tax shall be imposed on the entire

income and shall be deducted and withheld by the

depository bank from the proceeds of the long-termdeposit or investment certificate based on the remainingmaturity thereof:


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Four (4) years to less than five (5) years - 5%;Three (3) years to less than (4) years - 12%; andLess than three (3) years - 20%

Q: Explain the concept of final withholding tax.

* In China Banking Corporation v. CIR, Chinabank paid a

certain sum as gross receipts tax on its income from interestson loan, investments, commissions, services, collectioncharges, foreign exchange profits and other operating

earnings during the second quarter of 1994. Does the 20%final withholding tax on a bank’s passive interest income form

part of its taxable gross receipts in computing the grossreceipts tax? The CIR contended that the term “gross receipts”meant the entire income or receipt, without any deduction. The

Supreme Court held that the amount of interest incomewithheld in payment of the 20% final withholding tax formedpart of Chinabank’s gross receipts in computing the gross

receipts tax on banks. “As commonly understood, the term‘gross receipts’ means the entire receipts without anydeduction. Deducting any amount from the gross receiptschanges the result, and the meaning, to net receipts. Any

deduction from gross receipts is inconsistent with a law thatmandates a tax on gross receipts, unless the law itself makesan exception.”

Furthermore: “Unless otherwise provided by law, ownership isessential in determining whether interest income forms part oftaxable gross receipts. Ownership is the circumstance that

makes interest income part of the taxable gross receipts of thetaxpayer. When the taxpayer acquires ownership of moneyrepresenting interest, the money constitutes income or receipt

of the taxpayer.” Here, the amount constituting the 20% finalwithholding tax, being originally owned by Chinabank as part

of its interest income, should form part of its taxable grossreceipts subject to gross receipts tax.[China Banking Corporation v. CIR, GR Nos. 146749, 10 June

2003.]

** Does the 20% final withholding tax on a bank’s passiveinterest income form part of its taxable gross receipts in

computing the gross receipts tax? This was the issue resolvedin CIR v. Solidbank Corporation. In this case, Solidbanksought the refund of allegedly overpaid gross receipts tax for

the year 1995. The CIR opposed on the ground that althoughthe 20% final withholding tax on Solidbank’s interest income

was not actually received because it was remitted directly tothe government, the fact that the amount redounded toSolidbank’s benefit made it part of the taxable gross receipts in

computing the 5% gross receipts tax. The Supreme Courtadhered to the CIR’s view and ruled that the amount of interestincome withheld in payment of the 20% final withholding tax

formed part of gross receipts in computing for the grossreceipts tax on banks. The High Court said that as a bank,Solidbank was covered by both gross receipts tax and finalwithholding tax. However, the Supreme Court took the

opportunity to differentiate gross receipts tax, which is apercentage tax, from final withholding tax, which is an incometax.

“A percentage tax is a national tax measured by a certainpercentage of the gross selling price or gross value in moneyof goods sold, bartered or imported; or of the gross receipts or

earnings derived by ay person engaged in the sale of services.It is not subject to withholding.” [NOTE: The subject matter ofgross receipts tax is the privilege of engaging in the business

of banking.]On the other han, “[a]n income tax , on the other hand, is anational tax imposed on the net or the gross income realized in


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partner, or on the share of an individual in the net incomeafter tax of an association, a joint account, or a jointventure or consortium taxable as a corporation of which

he is a member or co-venturer:Six percent (6%) beginning January 1, 1998;Eight percent (8%) beginning January 1, 1999;Ten percent (10% beginning January 1, 2000.

Provided, however, That the tax on dividends shall applyonly on income earned on or after January 1, 1998.Income forming part of retained earnings as of December

31, 1997 shall not, even if declared or distributed on orafter January 1, 1998, be subject to this tax.

24(C) Capital Gains from Sale of Shares of Stock notTraded in the Stock Exchange. - The provisions of Section

39(B) notwithstanding, a final tax at the rates prescribedbelow is hereby imposed upon the net capital gainsrealized during the taxable year from the sale, barter,

exchange or other disposition of shares of stock in adomestic corporation, except shares sold, or disposed ofthrough the stock exchange.

Not over P100,000…………………………….. 5%On any amount in excess of P100,000………… 10%

24(D) Capital Gains from Sale of Real Property. -

24(D)(1) In General. - The provisions of Section 39(B)notwithstanding, a final tax of six percent (6%) based onthe gross selling price or current fair market value as

determined in accordance with Section 6(E) of this Code,whichever is higher, is hereby imposed upon capitalgains presumed to have been realized from the sale,

exchange, or other disposition of real property located inthe Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales,

by individuals, including estates and trusts: Provided,That the tax liability, if any, on gains from sales or otherdispositions of real property to the government or any of

its political subdivisions or agencies or to government- owned or controlled corporations shall be determinedeither under Section 24 (A) or under this Subsection, atthe option of the taxpayer. (2) Exception. - The provisions

of paragraph (1) of this Subsection to the contrarynotwithstanding, capital gains presumed to have beenrealized from the sale or disposition of their principal

residence by natural persons, the proceeds of which isfully utilized in acquiring or constructing a new principal

residence within eighteen (18) calendar months from thedate of sale or disposition, shall be exempt from thecapital gains tax imposed under this Subsection:

Provided, That the historical cost or adjusted basis of thereal property sold or disposed shall be carried over to thenew principal residence built or acquired: Provided,

further, That the Commissioner shall have been dulynotified by the taxpayer within thirty (30) days from thedate of sale or disposition through a prescribed return of

his intention to avail of the tax exemption hereinmentioned: Provided, still further, That the said taxexemption can only be availed of once every ten (10)years: Provided, finally, that if there is no full utilization of

the proceeds of sale or disposition, the portion of the gain presumed to have been realized from the sale ordisposition shall be subject to capital gains tax. For this

purpose, the gross selling price or fair market value at thetime of sale, whichever is higher, shall be multiplied by afraction which the unutilized amount bears to the gross

selling price in order to determine the taxable portion andthe tax prescribed under paragraph (1) of this Subsectionshall be imposed thereon.


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Q: Explain the relevance of payment of capital gains tax in thesale of real property.

* In the case of Chua v. Court of Appeals, the Supreme Courtclassified the agreement between Valdes-Choy as the sellerand Chua as the buyer as a contract to sell (not a contract of

sale) over a property situated in San Lorenzo Village, MakatiCity. Ownership over the subject property was retained byValdes-Choy and was not to pass to Chua until full payment of

the purchase price. On the topic of payment of capital gainstax, the High Court had this to say: “The buyer has more

interest in having the capital gains tax paid immediately sincethis is a pre-requisite to the issuance of a new Torrens title inhis name. Nevertheless, as far as the government is

concerned, the capital gains tax remains a liability of the sellersince it is a tax on the seller’s gain from the sale of the realestate. Payment of the capital gains tax, however, is not a pre-

requisite to the transfer of ownership to the buyer . The transferof ownership takes effect upon the signing and notarization ofthe deed of absolute sale.”[Chua v. Court of Appeals, GR No. 119255, 9 April 2003.]

** In Torcuator v. Bernabe, the Supreme Court likewisecharacterized as a contract to sell the agreement between the

Bernabe Spouses (seller) and the Torcuator Spouses (buyer)over a vacant lot in Ayala Alabang Village. The Court cited thefollowing reasons: (1) the agreement imposed upon the

Torcuator Spouses the obligation to fully pay the agreedpurchase price for the property; (2) the parties clearly intendedthe construction of a residential house on the property as

another suspensive condition which had to be fulfilled; and (3)there was neither actual nor constructive delivery of theproperty to the Torcuator Spouses. The Supreme Court further

ruled that “the issue of whether the agreement violated the lawas it deprived the government of capital gains tax is whollyirrelevant. Capital gains taxes, after all, are only imposed on

gains presumed to have been realized from sales, exchangesor dispositions of property. Having declared that the contract tosell in this case was aborted by [the Torcuator Spouses’]failure to comply with the twin suspensive conditions of full

payment and construction of a residence, the obligation to paytaxes never arose.”[Torcuator v. Bernabe, GR No. 134219, 8 June 2005.]

Sec. 25, Tax on Nonresident Alien Individual. -

25(A) Nonresident Alien Engaged in trade or BusinessWithin the Philippines. -25(A)(1) In General. - A nonresident alien individual

engaged in trade or business in the Philippines shall besubject to an income tax in the same manner as anindividual citizen and a resident alien individual, on

taxable income received from all sources within thePhilippines. A nonresident alien individual who shallcome to the Philippines and stay therein for an aggregate

period of more than one hundred eighty (180) days duringany calendar year shall be deemed a 'nonresident aliendoing business in the Philippines'. Section 22 (G) of thisCode notwithstanding.

25(A)(2) Cash and/or Property Dividends from a DomesticCorporation or Joint Stock Company, or Insurance orMutual Fund Company or Regional Operating

Headquarter or Multinational Company, or Share in theDistributable Net Income of a Partnership (Except aGeneral Professional Partnership), Joint Account, Joint

Venture Taxable as a Corporation or Association.,Interests, Royalties, Prizes, and Other Winnings. - Cashand/or property dividends from a domestic corporation,


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or from a joint stock company, or from an insurance ormutual fund company or from a regional operatingheadquarter of multinational company, or the share of a

nonresident alien individual in the distributable netincome after tax of a partnership (except a general professional partnership) of which he is a partner, or theshare of a nonresident alien individual in the net income

after tax of an association, a joint account, or a jointventure taxable as a corporation of which he is a memberor a co-venturer; interests; royalties (in any form); and

prizes (except prizes amounting to Ten thousand pesos(P10,000) or less which shall be subject to tax under

Subsection (B)(1) of Section 24) and other winnings(except Philippine Charity Sweepstakes and Lottowinnings); shall be subject to an income tax of twenty

percent (20%) on the total amount thereof: Provided,however, that royalties on books as well as other literaryworks, and royalties on musical compositions shall be

subject to a final tax of ten percent (10%) on the totalamount thereof: Provided, further, That cinematographicfilms and similar works shall be subject to the tax

provided under Section 28 of this Code: Provided,furthermore, That interest income from long-term depositor investment in the form of savings, common orindividual trust funds, deposit substitutes, investment

management accounts and other investments evidencedby certificates in such form prescribed by the BangkoSentral ng Pilipinas (BSP) shall be exempt from the tax

imposed under this Subsection: Provided, finally, thatshould the holder of the certificate pre-terminate thedeposit or investment before the fifth (5 th ) year, a final tax

shall be imposed on the entire income and shall bededucted and withheld by the depository bank from the proceeds of the long-term deposit or investment

certificate based on the remaining maturity thereof:Four (4) years to less than five (5) years - 5%;Three (3) years to less than four (4) years - 12%; and

Less than three (3) years - 20%.25(A)(3) Capital Gains. - Capital gains realized from sale,barter or exchange of shares of stock in domesticcorporations not traded through the local stock

exchange, and real properties shall be subject to the tax prescribed under Subsections (C) and (D) of Section 24.25(B) Nonresident Alien Individual Not Engaged in Trade

or Business Within the Philippines. - There shall belevied, collected and paid for each taxable year upon the

entire income received from all sources within thePhilippines by every nonresident alien individual notengaged in trade or business within the Philippines as

interest, cash and/or property dividends, rents, salaries,wages, premiums, annuities, compensation,remuneration, emoluments, or other fixed or determinable

annual or periodic or casual gains, profits, and income,and capital gains, a tax equal to twenty-five percent (25%)of such income. Capital gains realized by a nonresident

alien individual not engaged in trade or business in thePhilippines from the sale of shares of stock in anydomestic corporation and real property shall be subject tothe income tax prescribed under Subsections (C) and (D)

of Section 24.25(C) Alien Individual Employed by Regional or AreaHeadquarters and Regional Operating Headquarters of

Multinational Companies. - There shall be levied,collected and paid for each taxable year upon the grossincome received by every alien individual employed by

regional or area headquarters and regional operatingheadquarters established in the Philippines bymultinational companies as salaries, wages, annuities,


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compensation, remuneration and other emoluments, suchas honoraria and allowances, from such regional or areaheadquarters and regional operating headquarters, a tax

equal to fifteen percent (15%) of such gross income:Provided, however, That the same tax treatment shallapply to Filipinos employed and occupying the same position as those of aliens employed by these

multinational companies. For purposes of this Chapter,the term 'multinational company' means a foreign firm orentity engaged in international trade with affiliates or

subsidiaries or branch offices in the Asia-Pacific Regionand other foreign markets.

25(D) Alien Individual Employed by Offshore BankingUnits. - There shall be levied, collected and paid for eachtaxable year upon the gross income received by every

alien individual employed by offshore banking unitsestablished in the Philippines as salaries, wages,annuities, compensation, remuneration and other

emoluments, such as honoraria and allowances, fromsuch off-shore banking units, a tax equal to fifteen percent (15%) of such gross income: Provided, however,

That the same tax treatment shall apply to Filipinosemployed and occupying the same positions as those ofaliens employed by these offshore banking units.25(E) Alien Individual Employed by Petroleum Service

Contractor and Subcontractor. - An Alien individual whois a permanent resident of a foreign country but who isemployed and assigned in the Philippines by a foreign

service contractor or by a foreign service subcontractorengaged in petroleum operations in the Philippines shallbe liable to a tax of fifteen percent (15%) of the salaries,

wages, annuities, compensation, remuneration and otheremoluments, such as honoraria and allowances, receivedfrom such contractor or subcontractor: Provided,

however, That the same tax treatment shall apply to aFilipino employed and occupying the same position as analien employed by petroleum service contractor and

subcontractor. Any income earned from all other sources within thePhilippines by the alien employees referred to underSubsections (C), (D) and (E) hereof shall be subject to the

pertinent income tax, as the case may be, imposed underthis Code.

Sec. 26, Tax Liability of Members of General ProfessionalPartnerships. - A general professional partnership as

such shall not be subject to the income tax imposedunder this Chapter. Persons engaging in business as partners in a general professional partnership shall be

liable for income tax only in their separate and individualcapacities.For purposes of computing the distributive share of the

partners, the net income of the partnership shall becomputed in the same manner as a corporation.Each partner shall report as gross income his distributive

share, actually or constructively received, in the netincome of the partnership.

Q: How are partners of a general professional partnership

taxed?

* The case of Tan v. del Rosario dealt with the constitutionality

of RA No. 7496, also commonly known as the Simplified NetIncome Taxation Scheme (SNIT), amending certain provisionsof the old Tax Code. One argument raised by petitioners was

that the law now taxed single proprietorships andprofessionals differently from the manner it imposed tax oncorporations and partnerships. Another argument was that


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trade or business or the exercise of a profession, dealings inproperty, interests, rents, royalties, dividends, annuities, prizesand winnings, pensions, and a partner’s distributive share in

the net income of a general professional partnership. The

Supreme Court held that: “The definition of gross income isbroad enough to include all passive incomes subject tospecific rates or final taxes. However, since these passive

incomes are already subject to different rates and taxed finallyat source, they are no longer included in the computation ofgross income, which determines taxable income.

[CIR v. Philippine Airlines, Inc., GR No. 160528, 9 October2006.]

[NOTE: At present, the graduated individual income tax ratesshall be between 5-32%. [RA No. 9504 (2008).] On the other

hand, the regular corporate income tax rate is 30%. [RA No.9337 (2005).]

Sec. 27, Rates of Income tax on Domestic Corporations. -27(A) In General. - Except as otherwise provided in thisCode, an income tax of thirty-five percent (35%) is hereby

imposed upon the taxable income derived during eachtaxable year from all sources within and without thePhilippines by every corporation, as defined in Section22(B) of this Code and taxable under this Title as a

corporation, organized in, or existing under the laws of

the Philippines: Provided, That effective January 1, 2009,the rate of income tax shall be thirty percent (30%).

In the case of corporations adopting the fiscal-yearaccounting period, the taxable income shall be computedwithout regard to the specific date when specific sales,

purchases and other transactions occur. Their incomeand expenses for the fiscal year shall be deemed to havebeen earned and spent equally for each month of the

period.The corporate income tax rate shall be applied on theamount computed by multiplying the number of months

covered by the new rate within the fiscal year by the

taxable income of the corporation for the period, dividedby twelve.Provided, further, That the President, upon the

recommendation of the Secretary of Finance, mayeffective January 1, 2000, allow corporations the option tobe taxed at fifteen percent (15%) of gross income as

defined herein, after the following conditions have beensatisfied:

(1) A tax effort ratio of twenty percent (20%) of GrossNational Product (GNP);(2) A ratio of forty percent (40%) of income tax collection

to total tax revenues;(3) A VAT tax effort of four percent (4%) of GNP; and(4) A 0.9 percent (0.9%) ratio of the Consolidated Public

Sector Financial Position (CPSFP) to GNP.The option to be taxed based on gross income shall beavailable only to firms whose ratio of cost of sales to

gross sales or receipts from all sources does not exceedfifty-five percent (55%).The election of the gross income tax option by thecorporation shall be irrevocable for three (3) consecutive

taxable years during which the corporation is qualified

under the scheme.For purposes of this Section, the term 'gross income'

derived from business shall be equivalent to gross salesless sales returns, discounts and allowances and cost ofgoods sold. "Cost of goods sold' shall include all

business expenses directly incurred to produce themerchandise to bring them to their present location anduse.


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For a trading or merchandising concern, 'cost of goods'sold shall include the invoice cost of the goods sold, plusimport duties, freight in transporting the goods to the

place where the goods are actually sold, including

insurance while the goods are in transit.For a manufacturing concern, 'cost of goodsmanufactured and sold' shall include all costs of

production of finished goods, such as raw materials used,direct labor and manufacturing overhead, freight cost,insurance premiums and other costs incurred to bring the

raw materials to the factory or warehouse.In the case of taxpayers engaged in the sale of service,

'gross income' means gross receipts less sales returns,allowances and discounts. (As amended by RA No. 9337.)

27(B) Proprietary Educational Institutions and Hospitals. -Proprietary educational institutions and hospitals whichare nonprofit shall pay a tax of ten percent (10%) on their

taxable income except those covered by Subsection (D)hereof: Provided, that if the gross income from unrelatedtrade, business or other activity exceeds fifty percent

(50%) of the total gross income derived by sucheducational institutions or hospitals from all sources, thetax prescribed in Subsection (A) hereof shall be imposedon the entire taxable income. For purposes of this

Subsection, the term 'unrelated trade, business or other

activity' means any trade, business or other activity, theconduct of which is not substantially related to the

exercise or performance by such educational institutionor hospital of its primary purpose or function. A'Proprietary educational institution' is any private school

maintained and administered by private individuals orgroups with an issued permit to operate from theDepartment of Education, Culture and Sports (DECS), or

the Commission on Higher Education (CHED), or theTechnical Education and Skills Development Authority(TESDA), as the case may be, in accordance with existing

laws and regulations.

27(C) Government-owned or Controlled-Corporations, Agencies or Instrumentalities. - The provisions of existing

special or general laws to the contrary notwithstanding,all corporations, agencies, or instrumentalities owned orcontrolled by the Government, except the Government

Service Insurance System (GSIS), the Social SecuritySystem (SSS), the Philippine Health Insurance

Corporation (PHIC), the local water districts (LWD) andthe Philippine Charity Sweepstakes Office (PCSO), shall pay such rate of tax upon their taxable income as are

imposed by this Section upon corporations orassociations engaged in s similar business, industry, oractivity. (As amended by RA No. 10026.)

Q: What are government owned or controlled corporations(GOCCs)? What are government instrumentalities?

GNotes Income Tax 100814 Part1

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Transcript of GNotes Income Tax 100814 Part1