Taxation-Mamalateo-1

1 REVIEWER ON TAXATION BY: ATTY. VICTORINO C. MAMALATEO

2 TABLE OF CONTENTS CHAPTER I: GENERAL PRINCIPLES & LIMITATIONS ON THE POWER OF TAXATION 3 CHAPTER II: INHERENT AND CONSTITUTIONAL LIMITATIONS .............................. 9 CHAPTER III: INCOME AND WITHHOLDING TAXES ...............................................15 CHAPTER IV: KINDS OF TAXPAYERS .....................................................................17 CHAPTER V: GROSS INCOME .................................................................................24 CHAPTER VI: EXCLUSIONS FROM GROSS INCOME.................................................45 CHAPTER VII: RETURN OF CAPITAL ......................................................................53 CHAPTER VIII: TAX BASES AND RATES .................................................................65 CHAPTER IX: ORDINARY ASSETS AND CAPITAL ASSETS .......................................67 CHAPTER X: TAX-FREE EXCHANGES.......................................................................70 CHAPTER XI: ACCOUNTING METHODS AND PERIODS ............................................72 CHAPTER XII: WITHHOLDING TAXES ....................................................................74 CHAPTER XIII: ESTATE TAX ..................................................................................75 CHAPTER XIV: DONOR’S TAX.................................................................................81 CHAPTER XV: INTRODUCTION TO VAT ..................................................................87 CHAPTER XVI: PERSONS LIABLE TO TAX ...............................................................88 CHAPTER XVII: OUTPUT TAX ON SALE OF GOODS OR PROPERTIES & SERVICES .. 89 CHAPTER XX: RATES OF VAT .................................................................................93 CHAPTER XXI: EXEMPT TRANSACTIONS ................................................................94 CHAPTER XXIV: INTRODUCTION – TAX REMEDIES................................................95 CHAPTER XXV: ADMINISTRATIVE REMEDIES OF GOVERNMENT ............................97 CHAPTER XXVI: JUDICIAL REMEDIES OF GOVERNMENT......................................101 CHAPTER XXVII: CIVIL PENALTIES .....................................................................102 CHAPTER XXVIII: REMEDIES OF TAXPAYERS ......................................................104 CHAPTER XXIX: ASSESMENT AND PROTEST ........................................................105 CHAPTER XXX: PRESCRIPTION............................................................................109 CHAPTER XXXI: TAX CREDIT OR REFUND ............................................................114 CHAPTER XXXII LOCAL BUSINESS TAXES............................................................121 CHAPTER XXXIII: REAL PROPERTY TAX ..............................................................127

3 CHAPTER I: GENERAL PRINCIPLES AND LIMITATIONS ON THE POWER OF TAXATION Q: Describe the power of taxation. May a legislative body enact laws to raise revenues in the absence of a constitutional provision granting said body the power to tax? Explain. A: The power of taxation is inherent in the State, being an attribute of sovereignty. As an incident of sovereignty, the power to tax has been described as unlimited in its range, acknowledging in its very nature no limits, so that security against its abuse is to be found only in the responsibility of the legislature which imposes the tax on the constituency who are to pay it (Mactan Cebu Int’l Airport Authority v. Marcos) Q: It is an attribute of sovereignty A: The power of taxation is an essential and inherent attribute of sovereignity, belonging as a matter of right to every independent government, without being expressly conferred by the people (Pepsi-Cola Bottling Co v Mun of Tanauan, Leyte) Q: Why is the power to tax considered inherent in a sovereign State? A: It is considered inherent in a sovereign State because it is a necessary attribute of sovereignty. Without this power, no sovereign State can exist nor endure. The power to tax proceeds upon the theory that the existence of a government is a necessity. The power to tax is an essential and inherent attribute of sovereignty, belonging as a matter of right to every independent State. No sovereign State can continue to exist without the means to pay its expenses, and for those means, it has the right to compel all citizens and property within its limits to contribute; hence, the emergence of power to tax. Q: May Congress under the 1987 Constitution, abolish the power to tax of local governments? A: No, Congress cannot abolish what is expressly granted by the fundamental law. The only authority conferred to Congress is to provide guidelines and limitations on the local government’s exercise of the power to tax (Sec. 5, Art. X, 1987 Constitution) Q: In our jurisdiction, which of the following statements may be erroneous? Justify your answer. Taxes are pecuniary in nature Taxes are enforced charges and contributions Taxes are imposed on persons and property within the territorial jurisdiction of a State Taxes are levied by the executive branch of government Taxes are assessed according to a reasonable rule of apportionment A: Taxes are levied by the executive branch of government. This statement is erroneous because “levy” refers to the act of imposition by the legislature which is done through the enactment of a tax law. Levy is an exercise of the power to tax, which is exclusively legislative in nature and character. Clearly, taxes are not levied by the executive branch of government. (NPC v Albay) Q: Enumerate the 3 stages or aspect of taxation. Explain each. A: The 3 stages or aspects of taxation are: Levy – this refers to the enactment of a law by Congress imposing a tax. Assessment and collection – this is the act of administration and implementation of the tax law by the executive department through the administrative agencies Payment – this is the act of compliance by the taxpayer including such options, schemes or remedies as may be legally available to him

4 Q: Discuss the meaning and the implications of the following statement: “Taxes are the lifeblood of government and their prompt and certain availability is an imperious need” A: The phrase “taxes are the lifeblood of government, etc.” expresses the underlying basis of taxation which is governmental necessity, for indeed, without taxation, a government can neither exist nor endure. Taxation is the indispensable and inevitable price for civilized society; without taxes, the government would be paralyzed. This phrase has been used to justify the validity of the laws providing for summary remedies in the collection of taxes. In Valley Trading Co. v CFI, when the Supreme Court ruled that the damages that may be caused to the taxpayer by being made to pay the taxes cannot be said to be a irreparable as it would be against the government’s inability to collect taxes. Q: Justice Holmes once said: “The power to tax is not the power to destroy while this Court (the Supreme Court) sits.” Describe the power to tax and its limitations A: The power to tax is an inherent power of the sovereign, which is exercised through the legislature, to impose burdens upon subjects and objects within its jurisdiction for the purpose of raising revenues to carry out the legitimate objects of government. The underlying basis for its exercise is governmental necessity for without it no government can exist nor endure. Accordingly, it has the broadest scope of all the powers of government because in the absence of limitations, it is considered as unlimited, plenary, comprehensive and supreme. The two limitations on the power of taxation are the inherent and constitutional limitations which are intended to prevent abuse on the exercise of the otherwise plenary and unlimited power. It is the Court’s role to see to it that the exercise of the power does not transgress these limitations. Q: For failure to comply with certain corporate requirements, the stockholders of ABC Corp. were notified by the SEC that the corporation would be subject to involuntary dissolution. The stockholders did not do anything to comply with the requirements, and the corporation was dissolved. Can the stockholders be held personally liable for the unpaid taxes of the dissolved corporation? Explain briefly. A: No. As a general rule, stockholders cannot be held personally liable for the unpaid taxes of a dissolved corporation. The rule prevailing under our jurisdiction is that a corporation is vested by law with a personality that is separate and distinct from those persons composing it (Sunio v NLRC). However, stockholders may be liable for the unpaid taxes of a dissolved corporation, if it appears that the corporate assets have passed into their hands (Tan TIong Bio v CIR). Likewise , when the stockholders have unpaid subscriptions to the capital of the corporation, they can be made liable for unpaid taxes of the corporation. Q: Among the taxes imposed by the BIR are income tax, estate tax and donor’s tax, value added tax, excise tax, other percentage taxes and documentary stamp tax. Classify these taxes into direct and indirect taxes, and differentiate direct from indirect taxes. A: Income tax, estate tax and donor’s tax are considered as direct taxes. On the other hand, VAT, excise tax, OPT and DST are indirect taxes. A direct tax is demanded from the very person who, as intended should pay the tax which he cannot shift to another, while an indirect tax is demanded in the first instance from one person with the expectation that he can shift the burden to someone else, not as a tax but as part of the purchase price (Maceda v. Macaraig). Q: The police power, the power to tax and the power of eminent domain are inherent powers of government. May a tax be validly imposed in the exercise of

5 the police power and not of the power to tax? If your answer is in the affirmative, give an example. A: The police power may be exercised for the purpose of requiring licenses for which licenses fees may have to be paid. The amount of the license fees for the regulation of useful occupations should only be sufficient to pay for the cost of the license and the necessary expense of police surveillance and regulations. For non-useful occupations, the license fee may be sufficiently high to discourage the particular activity sought to be regulated. It is clear from the foregoing that police power may not be exercised by itself alone for the purpose of raising taxes. However, police power may be exercised jointly with the power of taxation for the purpose of raising revenues (Lutz v. Araneta). Q: “X” is the owner of a residential lot situated at Quirino Avenue, Pasay City. The lot has an area of 300 square meters. On June 1, 1994, 100 sq meters of said lot owned by “X” was expropriated by the government to be used in the widening of Quirino Avenue for P300,000.00, representing the estimated assessed value of said portion. From 1991 to 1995, “X”, who is a businessman, has not been paying his income tax. X is now being assessed for the unpaid income taxes in the total amount of P150,000.00. X claims his income tax liability has already been compensated by the amount of P300,000.00 which the government owes him for the expropriation of his property. Decide. A: The income tax liability cannot be compensated with the amount owed by the government as compensation for his expropriated property. Taxes are distinct kind, essence and nature than ordinary obligations. Taxes and debts cannot be subject of compensation because the government and X are not mutually creditors and debtors of each other and a claim for taxes is not a debt, demand contract or judgment as it is allowable to be set off (Francis v. IAC). Q: A municipality, BB, has an ordinance which requires that all stores, restaurants and other establishments selling liquor should pay a fixed annual fee of P20,000.00. Subsequently, the municipal board proposed an ordinance imposing a sales tax equivalent to 5% of the amount paid for the purchase or consumption of liquor in stores, restaurants and other establishments. The municipal mayor, CC, refused to sign the ordinance on the ground that it would constitute double taxations. Is the refusal of the mayor justified? Reason briefly. A: No. The refusal of the mayor is not justified. The impositions are of different nature and character. The fixed annual fee is in the nature of a license fee imposed through the exercise of police power, while the 5% tax on purchase or consumption is a local tax imposed through the exercise of taxing powers. Both a license fee and a tax may be imposed on the same business or occupation, or for selling the same article and this is not in violation of the rule against double taxation (Compania General de Tobacos de Filipinas v. City of Manila). Q: (a) Is double taxation a valid defense against the legality of tax measure? (b) When an item of income is taxed in the Philippines and the same income is taxed in another country, is there a case of double taxation? (c) What are the unusual methods of avoiding the occurrence of double taxation? A: (a) No, double taxation standing alone and not being forbidden by our fundamental law is not a valid defense against legality of a tax measure (Pepsi-Cola Bottling Company of the Phil v. Mun of Tanauan, Leyte). However, if double taxation amounts to a direct duplicate taxation, in that the same subject is taxed twice when it should be taxed but once, in a fashion that both taxes are imposed for the same purpose by the same taxing authority, within the same jurisdiction or taxing district, for the same taxable period and for the same

6 kind or character of a tax, then it becomes legally objectionable for being oppressive and inequitable. (b) Yes, but it is only a case of indirect duplicate taxation which is not legally prohibited because the taxes are imposed by different taxing authorities. (c) The usual methods of avoiding the occurrence of double taxation are: 1. Allowing reciprocal exemption either by law or by treaty; 2. Allowance of tax credit for foreign taxes paid; 3. Allowance of deduction for foreign taxes paid; and 4. Reduction of the Philippine tax rate Q: X, a lessor of a property, pays real estate tax on the premises, a real estate dealer’s tax based on rental receipts and income tax on the rentals. He claims that this is double taxation. Decide A: There is no double taxation. “Double taxation” means taxing for the same tax period the same thing or activity twice, when it should be taxed but once, by the same taxing authority for the same purpose and with the same kind or character of tax. The real estate tax is a tax on property; the real estate dealer’s tax is a tax on the privilege to engage in business; while the income tax is a tax on the privilege to earn an income. These taxes are impose by different taxing authorities and are essentially of different kind and character. Q: Why are tax exemptions strictly construed against the taxpayer? A: Tax exemptions are strictly construed against the taxpayer because such provisions are highly disfavored and may almost be said to be odious to the law (Manila Electric Company v. Vera). The exception contained in the tax statutes must be strictly construed against the one claiming the exemption because the law does not look with favor on tax exemptions, they being contrary to the lifeblood theory which is underlying basis for taxes. The natural rule is that everyone in the state must contribute to the support of government. Exemptions are in derogation of sovereignty; hence, they must be strictly construed against the person claiming it (Commissioner v. Guerrero). Q: As an incentive for investors, a law was passed giving newly established companies in certain economic zone exemption from all taxes, duties, fees, imposts and other charges for a period of three years. ABC Corp. was organized and was granted such incentive. In the course of business, ABC Corp purchased mechanical equipment from XYZ, Inc. (a) Normally, the sale is subject to a sales tax. XYZ, Inc. claims, however, that since it sold the equipment to ABC Corp., which is tax exempt, XYZ should not be liable to pay sales tax. Is this claim tenable? (b) Assume arguendo that XYZ had to and did pay the sales tax. ABC Corp. later found, however, that XYZ merely shifted or passed on to ABC the amount of the sales tax by increasing the purchase price. ABC Corp. now claims for a refund from the BIR in an amount corresponding to the tax passed on to it, since it is tax exempt. Is the claim of ABC Corp meritorious? A: (a) No. Exemption from taxes is personal in nature and covers only taxes for which the taxpayer grantee is directly liable. The sales tax is a tax on the seller who is not exempt from taxes. Since XYX, Inc. is directly liable for the sales tax and no tax exemption privilege is ever given to it, therefore its claim that the sale is exempt is not tenable. A tax exemption is construed in strictissimi juris and it cannot be permitted to exist upon vague implications (Asiatic Petroleum Co Ltd v Llanes). (b) No. The claim of ABC Corp is not meritorious. Although the tax was shifted to ABC Corp. by the seller, what is paid by it is not a tax but part of the cost it has assumed. The taxpayer who can file a claim for refund is the person statutorily liable for the payment of the tax. Since ABC Corp. is not said taxpayer, it has no capacity to file a claim for refund.

7 Q: Due to an uncertainty w/n a new tax law is applicable to printing companies, DEF Printers submitted a legal query to the BIR on that issue. The BIR issued a ruling that printing companies are not covered by the new law. Relying on this ruling, DEF Printers did not pay said tax. Subsequently, however, the BIR reversed the ruling and issued a new one stating that the tax covers printing companies. Could the BIR now assess DEF for back taxes corresponding to the years before the new ruling? Reason briefly. A: No. The reversal of a ruling shall not be given a retroactive application, if said reversal will be prejudicial to the taxpayer. Therefore, BIR cannot assess DEF Printers for back taxes because it would be violative of the principle of non-retroactivity of ruling and doing so would result in grave injustice to the taxpayer who relied on the first ruling in good faith. Q: In view of the unfavorable balance of payment, condition and the increasing budget deficit, the President of the Philippines, upon recommendation of the NEDA, issues during a recess of Congress, an EO imposing an additional duty on all imports at the rate of 10% ad valorem. The EO also provides that the same shall take effect immediately. Ricardo San Miguel, an importer, questions the legality of the EO on the grounds that only Congress has the authority to fix the rates of import taxes and in any event, such an EO can take effect only 30 days after promulgation and the President has no authority to shorten said period. Are objections of Mr. San Miguel tenable? A: No, the objections are not tenable as the EO cannot take effect immediately. Being an external law and having the effect of law, the EO cannot become effective without publication, a requirement of due process (Tañada v Tuvera). Q: Mr. Pascual’s income tax from leasing his property reaches the maximum rate of tax under the law. He donated ½ of his said property to non-stock, non-profit educational institution whose income and assets are actually, directly and exclusively used for educational purposes, and therefore qualified for tax exemption under Article XIV, Section 4(3) of the Constitution and Section 3(h) of the Tax Code. Having thus transferred a portion of his said asset, Mr. Pascual succeeded in paying a lesser tax on the rental income derived from his property. Is there tax avoidance or tax evasion? Explain. A: There is tax avoidance. Mr. Pascual exploited a legally permissive alternative method to reduce his income tax for transferring part of his rental income to a tax exempt entity through a donation of one half of the income producing property. The donation is likewise exempt from the donor’s tax. The donation is the legal means employed to transfer the incidence of income tax on the rental income. Q: Distinguish tax evasion from tax avoidance. A: Tax evasion is a scheme used outside of those lawful means to escape tax liability and, when availed of, it usually subjects the taxpayer to further or additional civil or criminal liabilities. Tax avoidance, on the other hand, is a tax saving device within the means sanctioned by law; hence, lega. Q: When may a taxpayer suit be allowed? A: A taxpayer’s suit may only be allowed when an act complained of, which may include a legislative enactment, directly involves the illegal disbursement of public funds derived from taxation (Pascual v. Secretary of Public Works). No money shall be paid out of the Treasury, except in pursuance of an appropriation made by law. (Sec 29, Art VI, 1987 Constitution). Q: May taxes be the subject of set-off or compensation? Explain.

8 A: No. Taxes cannot be the subject of set-off or compensation for the following reasons: (1) taxes are of distinct kind, essence and nature, and these impositions cannot be classed in merely the same category as ordinary obligations; (2) the applicable laws and principles governing each are peculiar, not necessarily common, to each; and (3) public policy is better subserved if the integrity and independence of taxes are maintained (Republic v. Mambulao Lumber Company). Q: Can an assessment for a local tax be the subject of set-off or compensations against a final judgment for a sum of money obtained by the taxpayer against the local government that made the assessment? Explain. A: No. Taxes and debts are of different nature and character; hence, no set-off or compensation between these two different classes of obligations is allowed. The taxes assessed are the obligation of the taxpayer arising from law, while the money judgment against the government is an oblgation arising from contract, whether express or implied. Inasmuch as taxes are not debts, it follows that the two obligations are not susceptible to set-off or legal compensation. It is only when the local tax assessment and final judgment are both overdue, demandable, as well as fully liquidated may set-off or compensation be allowed.

9 CHAPTER II: INHERENT AND CONSTITUTIONAL LIMITATIONS Q: To provide means for rehabilitation and stabilization of the sugar industry so as to prepare it for the eventuality of the loss of the quota allocated to the Philippines resulting from the lifting of US sanctions against an African country, Congress passes a law increasing the existing tax on the manufacture of sugar on a graduated basis. All collections made under the law are to accrue to a special fund to be spent only for the purpose enumerated therein, among which are to place the sugar industry in a position to maintain itself and ultimately to insure its continued existence despite the loss of that quota, and to afford laborers employed in the industry a living wage and to improve their working conditions. X, a sugar planter, files a suit questioning the constitutionality of the law alleging that the tax is not for public purpose as the same is being levied exclusively for the aid and support of the sugar industry. Decide the case. A: The suit filed by the sugar planter questioning the constitutionality of the sugar industry stabilization measure is untenable. Taxation is no longer merely for raising revenue to support the existence of the government; the power may also be exercised to carry out legitimate objects of the government. It is a legitimate object of government to protect is local industry on which the national economy largely depends. Where the aim of the tax measure is to achieve such a governmental objective, the tax imposition can be said to be for a public purpose (Gaston v Republic Bank) Q: The Municipality of Malolos passed an ordinance imposing a tax on any sale or transfer of real property located within the municipality at arate of ¼ of 1% of the total consideration of such transaction. X sold a parcel of land in Malolos which he inherited from his deceased parents and refused to pay the aforesaid tax. He instead filed appropriate case asking that the ordinance be declared null and void since such a tax can only be collected by the national government, as in fact he has paid BIR the required CGT. The Municipality countered that under the Constitution, each local government is vested with the power to create its own sources of revenue and to levy taxes, and it imposed the subject tax in the exercise of said constitutional authority. Resolve the controversy. A: The ordinance passed by the Municipality of Malolos imposing a tax on the sale-ortransfer of real property is void. The Local Tax Code only allows provinces and cities to impose a tax on the transfer of ownership of real property (Secs 7 and 23, Local Tax Code). Municipalities are prohibited from imposing said tax that provinces are specifically authorized to levy (Sec 22, Local Tax Code). While it is true that the Constitution has given broad powers of taxation to LGU’s, this delegation, however, is subject to such limitations as may be provided by law (Sec 5, Art X, 1987 Constitution). Q: Ace Tobacco Corp bought a parcel of land situated in Pateros and donated it to the Municipal Gov’t of Pateros for the sole purpose of devoting the said land as a relocation site for the less fortunate constituents of said municipality. In accordance therewith, the Municipal Government of Pateros issued to the occupants/beneficiaries Certificates of Award giving them the respective areas where their houses are erected. Through Ordinance No. 2, Series of 1998, the said municipal government ordained that the lots awarded to the awardees/donees be finally transferred and donated to them. Determine the tax consequence of the foregoing dispositions with respect to the Municipal Government of Pateros. A: The Municipality of Pateros is not subjected to any donor’s tax on the value of land it subsequently donated, it being exempt from taxes as a political subdivisions of National Government.

10 Q: Mr. Cortez is a non-resident alien based in HK. During the calendar year 1999, he came to the Philippines several times and stayed in the country for an aggregate period of more than 180 days. How will Mr. Cortez be taxed on his income derived from sources within the Philippines? A: Mr. Cortez, being a non-resident alien individual who has stayed for an aggregate period of more than 180 days during the calendar year 1999, hsall for that taxable year be deemed to be a non-resident alien doing business in the Philippines. Considering the above, Mr. Cortez shall be subject to an income tax in the same manner as an individual citizen and a resident alien individual, on taxable income received from all sources within the Philippines (Sec. 25[A][1], NIRC). Thus, he is allowed to avail of the itemized deductions including the personal and additional exemptions but subject to the rule on reciprocity on the personal exemptions (Sec. 34[A] to [J] and [M] in relation to Sec. 25[A][1] and Sec. 35[D], NIRC). Q: X, a multinational corporation doing business in the Philippines, donated 100 shares of stock of said corporation to Mr. Y, its resident manager in the Philippines. What is the tax liability, if any, of X corporation? A: Foreign corporations effecting a donation are subject to donor’s tax only if the property donated is located in the Philippines. Accordingly, donation of a foreign corporation of its own shares of stocks in favor of resident employees is not subject to donor’s tax. However, if 85% of the business of the foreign corporation is located in the Philippines or the shares donated have acquired business situs in the Philippines, the donation may be taxed in the Philippines subject to the rule of reciprocity. Q: The President of the Philippines and the Prime Minister of Japan entered into an executive agreement in respect of a loan facility to the Philippines from Japan, whereby it was stipulated that interest on loans granted by private Japanese financial institutions to private financial institutions in the Philippines shall not be subject to Philippine income taxes. Is this tax exemption valid? Explain. A: Yes. The tax exemption is valid because an executive agreement has the force and effect of a treaty under the provision of Revenue Code. Taxation is subject to international comity. Q: An EO was issued pursuant to law, granting tax and duty incentives only to businesses and residents within the “secured area” of the Subic Economic Special Zone, and denying said incentives to those who live within the Zone but oustside such “secure area”. Is the constitutional right to equal protection of the law violated by the EO? Explain. A: No. Equal protection of the law clause is subject to reasonable classification. Classification, to be valid, must: (a) rest on substantial distinctions; (b) be germane to the purpose of the law; (c) not be limited to existing conditions only; and (d) apply equally to all member of the same class. There are substantial differences between big investors being in the “secured area” and the business operations outside the “secured area”. Q: Explain the requirement of uniformity as a limitation in the imposition and/or collection of taxes. A: The tax is uniform when it operates with the same force and effect in every place where the subject of it is found. It does not signify an intrinsic, but simply a geographical uniformity. Uniformity does not require the same treatment; it simply requires reasonable basis for classification. Q: The City of Makati, in order to solve the traffic problem in its business districts, decided to impose a tax, to be paid by the driver, on all private cars entering the

11 city during peak hours from 8am to 9am from Mondays to Fridays, but it exempts those cars carrying more than two occupants, excluding the driver. Is the ordinance valid? Explain. A: The ordinance is in violation of the rule of uniformity and equality, which requires that all subjects or objects of taxation, similarly situated must be treated alike and must not be classified in an arbitrary manner. In the case at bar, the ordinance exempts cars carrying more than two occupants from the said ordinance. Furthermore, the ordinance imposes the tax only on private cars and exempts public vehicles from the imposition of the tax, although both contribute to the traffic problem. There exists no substantial standard used in the classification used by the City of Makati. Another issue is the fact that the tax is imposed on the driver of the vehicle and not on the registered owner thereof. The ordinance does not only violate the requirement of uniformity; the same is also unjust because it places the burden on someone who had no control over the route of the vehicle. Hence, the ordinance is invalid for violating the rules of uniformity and equality as well as for being unjust. Q: X Corporation was the recipient in the 1990 of two tax exemptions both from Congress, one law exempting the company’s bond issues from taxes and the other exempting the company from taxes in the operation of its public utilities. The two laws extending the tax exemptions were revoked by Congress before their expiry dates. Were the revocations constitutional? A: Yes. The exempting statutes are both granted unilaterally by Congress in the exercise of taxing powers. Since taxations is the rule and tax exemption is the exception, any tax exemption unilaterally granted can be withdrawn at the pleasure of the taxing authority without violating the Constitution (Mactan Cebu Int’l Airport Authority v Marcos). Q: A law was passed granting tax exemption to certain industries and investments for a period of fiver years. But the three years later, the law was repealed. With the repeal, the exemptions were considered revoked by the BIR, which assessed the investing companies for unpaid taxes effective on the date of th repeal of the law. NPC and KTR companies questioned the assessments on the ground that, having made their investments in full reliance with the period of exemption granted by the law, its repeal violated their constitutional right against the impairment of the obligations and contracts. Is the contention of the companies tenable or not? Reason. A: The contention is not tenable. The exemption granted is in the nature of a unilateral tax exemption. Since the exemptions is spontaneous on the part of the legislature and no service or duty or other remunerative conditions have been imposed on the taxpayers receiving the exemption, it may be revoked at will by the legislature. What constitutes an impairment of the obligation of contracts is the revocation of an exemption which is founded on a valuable consideration because it takes the form and essence of a contract. Q: ART VI Section 28(3) of the 1987 Constitution provides that charitable institutions, churches and parsonages or convents appurtenant thereto, mosques, non-profit cemeteries and all lands, buildings, and improvements actually, directly and exclusively used for religious, charitable or educational purposes shall be exempt from taxation. (a) To what kind of tax does this exemption apply? (b) Is proof of actual use necessary for tax exemption purposes under the Constitution? A: (a) This tax exemption applies only to property taxes. What is exempted is not the institution itself but the lands, buildings and improvements actually, directly and exclusively used for religious, charitable and educational purposes.

12 (b) Yes, because tax exemptions are strictly construed against the taxpayer. There must be evidence to show that the taxpayer has complied with the requirements for exemption. Furthermore, RPT is based on use and not on ownership; hence, the same rule must also be applied for RPT exemptions. Q: The Roman Catholic Church owns a 2-hectare lot in a town in Tarlac province. The southern side and middle part are occupied by the Church and a convent, the eastern side, by a school run by the Church itself, the southern side, by some commercial establishments, while the rest of the property, in particular, the northwestern side, is idle or unoccupied. May the Church claim tax exemption on the entire land? Decide with reasons. A: No, The portions of land occupied and used by the Church, convent and school run by the church are exempt from real property taxes, while the portion of the land occupied by commercial establishments and the portion, which is idle, are subject to real property taxes. The usage of the property and not the ownership is the determining factor whether or not the property is taxable. Q: The Constitution exempts from taxation charitable institutions, churches, parsonages or convents appurtenant thereto, mosques and non-profit cemeteries and lands, buildings and improvements actually, directly and exclusively used for religious, charitable and educational purposes. Mercy Hospital is a 100-bed hospital organized for charity patients. May said hospital claim exemption from taxation under the above-quoted constitutional provision? Explain. A: Yes. Mercy Hospital can claim exemption from taxation under the provision of the Constitution, but only with respect to real property taxes provided that such real properties are used actually, directly and exclusively for charitable purposes. Q: In 1991, Imelda gave her parents a Christmas gift of P100,000.00 and a donation of P80,000.00 to her parish church. She also donated a parcel of land for the construction of a building to the PUP Alumni Association, a non-stock, nonprofit organization. Portions of the building shall be leased to generate income for the association. Is the donation to the parish church subject to tax? A: The donation of P80,000.00 to the parish church, even assuming that it is exclusively for religious purposes, is no tax-exempt because exemption granted under ART VI, Section 28(3) of the Constitution applies only to real estate taxes. Q: X sold a piece of land to the United Church of Christ of Quezon City, Inc. The land is to be devoted strictly for religious purposes by the Church. When the Church tried to register the title of the land, the Registry of Deeds refused claiming that the CGT was not paid. Is the transaction exempt from the CGT? Reason. A: No. Under section 21(e) in relation to Section 49(a)(4) of the NIRC, the seller is the one liable for the payment of the CGT from the sale of real property by an individual taxpayer. Meanwhile, the Church in this instant case is the buyer. Hence, Section 28(4) of the 1987 Constitution, which exempts church lands, buildings and improvements, does not apply because the obligation to pay the CGT herein is imposed on X, the seller, and not on the Church. Since payment of the CGT is a condition precedent for the registration of the transfer certificate of the title to real property, the non-payment herein by the seller is a valid reason for the Registry of Deeds to deny the transfer of title to the subject land. Q: Under Article XIV, Section 4(3) of the 1987 Constitution, all revenues and assets of non-stock, non-profit educational Institutions, used actually, directly and

13 exclusively for educational purposes, are exempt from taxes and duties. Are income derived from dormitories, canteens and bookstores as well as interest income on bank deposits and yields from deposit substitutes automatically exempt from taxation? Explain. A: no. The interest income on bank deposits and yields from deposit substitutes are not automatically exempt from taxation. There must be a showing that the income are included in the school's annual information return and duly audited financial statements, together with: (a) certifications from depository banks as to the amount of interest income earned from passive investments not subject to the 20% FWT; and (b) certification of actual, direct and exclusive utilization of said income for educational purposes; (c)!Board resolution on proposed project to be funded out of the money deposited in banks or placed in money market placements, which must be used actually, directly and exclusively for educational purposes. The income derived from dormitories, canteens and bookstores are not also automatically exempt from taxation. There is still the requirement for evidence to show actual, direct and exclusive use for educational purposes. It is to be noted that the 1987 Constitution does not distinguish with respect to the sources or origin of the income. Th distinction is with respect to the use which should be actual, direct and exclusive for educational purposes. Consequently, the provisions of Section 30 of the NIRC, that a non-stock and non-profit educational institution is exempt from taxation only in respect to income received By them as such could not affect the constitutional tax exemption. Where the Constitution does not distinguish with respect to sources or origin, the Tax Code should not make distinctions. Q: The HR introduced HB No. 7000, which was envisioned to levy a tax on various transactions. After the bill was approved by the House, the bill was sent to Senate as so required by the Constitution. In the upper house, instead of a deliberation on the House Bill, the Senate introduced Senate Bill no. 8000 which was its own version of the same tax. The Senate deliberated on this Senate Bill and approved the same. The House bill and Senate billNewer then consolidated in the Bicameral Committee. Eventually, the consolidated bill was approved and sent to the President who signed the same. The private sectors affected by the new law questioned the validity of the enactment on the ground that the constitutional provision requiring that all revenue bills should originate from the HR had been violated. Resolve the issue. A: There is no violation of the constitutional requirement that all revenue bills should originate from the HR. What is prohibited is for the Senate to enact revenue measures on its own without a bill originating from the House. But once the revenue bill was passed by the House and sent to the Senate, the latter's power to propose or concur with amendments. This follows from the co-equality of the two chambers of Congress. Q: XYZ Colleges is a non-stock, non-profit educational institution, run by the Archdiocese of BP City. It collected and received the following: Tuition fees; Dormitory fees; Rentals from canteen concessionaires; Interest from money market placements of the tuition fees; Donation of a lot and building by school alumni. 1. Which of these above-cited income and donation would not be exempt from taxation? Explain briefly. 2. Suppose that XYZ Colleges is a proprietary educational institution owned by the Archbishop's family, rather than the Archdiocese, which of those above-cited income and donation would be exempt from taxation? A: (1) All of the income derived by the non-stock, non-profit educational institution will be exempt from taxation, provided they are used actually, directly and exclusively for educational purposes are exempt from taxation. The donation is likewise exempt from

14 donor’s tax, if actually, directly and exclusively used for educational purposes, provided that not more than 30% of the donation is used by the done for administration purposes. The donee, being a non-stock, non-profit educational institution, is a qualified entity to receive an exempt donation, subject to conditions prescribed by law. Accordingly, none of the cited income and donation collected and received by the non-stock, non-profit educational institution would not be exempt from taxation. (2) If XYZ Colleges is a proprietary educational institution, all of its income from schoolrelated and non-school-related activities will be subject to the income tax, based on its aggregate net income derived from both activities. Accordingly, all of the income enumerated in the problem will be taxable. The donation of lot and building will likewise be subject to the donor’s tax because a donation to an educational institution is exempt only if the school is incorporated as a non-stock entity paying no dividends. Since the donee is proprietary educational institution, the donation is taxable. Q: Anne Lapada, a student activist, wants to impugn the validity of a tax on text messages. On what grounds may she do so? A: She may claim that the law adversely affects her since she sends messages by text and that the tax money is being extracted and spent in violation of the constitutionally guaranteed right to freedom of communication.

15 CHAPTER III: INCOME AND WITHHOLDING TAXES Q: Distinguish “scheduler treatment” from “global treatment” as used in income taxation. A: Under a schedular system, the various types/items of income (e.g. compensation; business/professional income) are classified accordingly and are accorded different tax treatments, in accordance with schedules characterized by graduated tax rates. Since these types of income are treated separately, the allowable deductions shall likewise vary for each type of income. Under the global system, all income received by the taxpayer are grouped together, without any distinction as to the type or nature of the income, and after deducting therefrom expenses and other allowable deductions, are subjected to tax at a graduated or fixed rate. Q: (a) Discuss the meaning of the global and schedular systems of taxation. (b) To which system would you say that the method of taxation under the NIRC belong? A: (a) A global system of taxation in one where the taxpayer is required to lump all items of income earned during a taxable period and pay tax under a single set of income tax rules on these different items of income. A schedular system of taxation provides for a different tax treatment of different types of income so that a separate tax return is required to be filed for each type of income and the tax is computed on a per return or per schedule basis. (b) The current method of taxation under the Tax Code belongs to a system which is partly schedular and partly global. Q: (1) What are the basic features of the present “income tax system?” A: Our present income tax system can be said to have the following basic features: (a) It has adopted a comprehensive tax situs by using the nationality, residence and source rules. This makes citizens and resident aliens taxable on their income derived from all sources while non-resident aliens are taxed only on their income derived from within the Philippines. Domestic corporations are also taxed on universal income while foreign corporations are taxed only on income from within. [NOTE: If the question is asked today, the answer should be: Resident citizens and domestic corporations are subject to tax on their worldwide income, while the other types of taxpayers (whether individual or corporation) are taxed only from sources within the Philippines beginning Jan 1, 1998 under RA 8424] (b) The individual income tax system is mainly progressive in nature in that it provides graduated rates of income tax. Corporations in general are taxed at a flat rate of 35% on net income [NOTE: tax rates 1998 = 34%; 1999 = 33%; 2000 = 32%; Nov 1 2005 = 35%; Jan 1 2009 = 30%] (c) It has retained more schedular than global features with respect to individual taxpayers but has maintained a more global treatment on corporations. Q: Distinguish a direct tax from an indirect tax. A: A direct tax is on in which the taxpayer who pays the tax is directly liable therefor; that is, the burden of paying the tax falls directly on the persons paying the tax. The impact and incidence of taxation remain with the person upon whom the tax was imposed. An indirect tax is one paid by a person who is not directly liable therefor, and who may therefore shift or pass on the tax to another person or entity, which ultimately assumes the tax burden. In this case, the impact of taxation is with the taxable seller of goods or service; while the incidence of taxation rests with the final consumer. Q: When is income taxable?

16 A: Income, gain or profit is subject to income tax, when the following requisites are present: (a) The money or property received is income, gain or profit (and not return of capital) (b) The income, gain or profit is receid (actually,or constructively), accrued, or realized during the taxable year; and (c) The income, gain or profit is not exempt from income tax under the Constitution, treaty or statute

17 CHAPTER IV: KINDS OF TAXPAYERS Q: Juan, a Filipino citizen, has emigrated to the US in 1997, where he is now a permanent resident. He owns certain income earning property in the Philippines from which he continues to derive substantial income. He also receives income form the employment in the United States on which the US income tax is paid. On which of the above income is the taxable. If at all in the Philippines, and how, in general terms, would such income or income be taxed? A: Juan will be taxed on both his income from the Philippines and on his income from the US because his being a citizen makes him taxable on all income wherever derived. For the income he derives from his projects in the Philippines, Juan shall be taxed on his net income under the Simplified Net Income Taxation Scheme whereby he shall be considered as a selfemployed individual. His income as employee in the US, on the other hand, shall be taxed in accordance with the schedular graduated rates of 1%, 2% and 3%, based on the adjusted gross income derived by non-resident citizens from all sources without the Philippines during each taxable year. [Note: New law beginning 1998 = income from sources within the Philippines of a non-resident citizen remains subject to Philippine income tax, but his income from sources outside the Philippines is exempt) Q: Federico, a Filipino citizen, migrated to the US some 6 years ago and got a permanent resident status or green card. Should he pay his Philippine income tax on the gains he derived from the sale in the NYSE in PLDT, a Philippine corporate whose shares are listed thereat? A: Yes. The gains from the sale of shares of stock in a domestic corporation shall be treated as derived entirely from sources within the Philippines, regardless of where the said shares are sold. By this provision of law, the gain if any from the sale of shares of stocks of a domestic corporation by any person shall be treated for income the Philippines. Q: From what sources of income are the following persons/corporations taxable by the Philippine government? 1. Citizen of the Philippines and Residing therein 2. Nonresident citizen 3. Citizen who is working and deriving income from abroad as an overseas contract worker 4. An alien individual, whether a resident or not of the Philippines; 5. A domestic corporation. A: 1. Taxable on all income within and without the Philippines 2. Taxable on income derived from sources within the Philippines 3. Taxable only on income from sources within the Philippines. 4. Taxable on income derived from sources within the Philippines 5. Taxable on all income derived from sources within and without. Q: Four Catholic parishes hired the services of Frank Binatra, a foreign nonresident entertainer, to perform for four nights at the Folk Arts Theatre, Binatra was paid P200,000.00 a night. The parishes earned P1,000,000.00which they can be used for the support of the orphans in the city. Who are liable to pay taxes? A: (a) The four Catholic parishes because the income received by them, not being income earned as such in the performance of their religious functions and duties, is taxable income under the last paragraph of Section 26; in relation to Section 26(e) of the Tax Code. In promoting and operating the Binatra Show, they engaged in an on activity conducted for profit.

18 (b) The income of Frank Binatra, a non-resident alien under our law, is taxable at the rate of 30% (now 25%) FWT based on the gross income from the show. Mr. Binatra is not engaged in any trade or business in the Philippines. Q: Mr. Sebastian is a Filipino seaman employed by a Norwegian company which is engaged exclusively in international shipping. He and his wife, who manages their business, filed a joint income tax return for 1997 on March 15, 1998. After an audit of the return, the BIR issued on April 20, 2001 a deficiency income tax assessment for the sum of P250,000.00, inclusive of interest and penalty. For failure of Mr. and Mrs. Sebastian to pay the tax within the period stated in the notice of assessment, the BIR issued on August 19, 2001 warrants of distraint and levy to enforce collection of the tax. (a)What is the rule of income taxation with respect to Mr. Sebastian’s income in 1997 as a seaman on board the Norwegian vessel engaged in international shipping? Explain your answer. (b)If you are the lawyer of Mr. and Mrs. Sebastian, what possible defense or defenses will you raise in behalf of your clients against the action of the BIR in enforcing collection of the tax by the summary remedies of warrants of distraint and lavy? Explain your answer. A: (a) The 1997 income of Mr. Sebastian as a seaman is considered as income of a nonresident citizen derived from without the Philippines. The total gross income, in US dollars (or if in other foreign currency, its dollar equivalent) from without the Philippines shall be declared by him for income tax purposes using a separate income tax return which will not include his income from business derived within the Philippines (to be covered by another return). He is entitle of $4,500 and foreign national income taxes paid to arrive at his adjusted income during the year. His adjusted income will be subject to the graduated tax rates of 1% to 3% (Note: The above provision was amended already by RA 8424 [Tax Code of 1997] effective January 1, 1998. Income from foreign sources of nonresident citizens is exempt from income tax) (b) I will raise the defense of prescription. The right of the BIR to assess prescribes after three years counted from the last day prescribed by law for the filing of income tax return, when the said return is filed on time. The last day for filing the 1997 income tax return is April 15, 1998. Since the assessment was issued only on April 20, 2001, the BIR’s right to assess has already prescribed Q: Alain Descartes, a French citizen permanently residing in the Philippines, received several items of income during the taxable year, such as consultancy fees received for designing a computer program and installing the same in the Shanghai facility of a Chinese firm; interests from his deposits in a local bank of foreign currency earned abroad converted to Philippine pesos; dividends received from an American corporation which derived 60% of its annual gross receipts from Philippine sources for the past 7 years; and gains derived from the sale of his condominium unit located in Taguig City to another resident alian. Which item of income is not subject to Phlippine income tax? A: The consultancy fees are not subject to Philippine income tax. Being an alien, it is subject to income tax only on income from sources within the Philippines. Since the consultancy fees are received by him for designing a computer program and installing the same in China, the same shall be treated as income from sources outside the Philippines. Q: Newtex International (Phils), Inc. is an American firm dully authorized to engage in business in the Philippines as a branch office. In its activity of acting as a buying agent for foreign, buyers of shirts and dresses abroad and performing liaison work between its home office and the Filipino garment manufacturers and

19 exporters, Newtex does not generate any income. To finance its office expenses here, its head office abroad regularly remits to it the needed amount. To oversee its operations and manage its office here, which had been in operation for two years, the head office assigned three foreign personnel. Are the three foreign personnel subject to Philippine income tax? A: The three foreign personnel are subject to tax on the income that they receive for services rendered in the Philippines. Non-resident aliens are subject to tax on income from sources within the Philippines. Income is deemed derived from sources within the country when it is earned for services rendered in the Philippines. Q: Mr. Cortez is a nonresident alien based in HK. During the calendar year 1999, he came to the Philippines several times and stayed in the country for an aggregated period of more than 180 days. How will Mr. Cortez be taxed on his income derived from sources within the Philippines and from abroad? A: Mr. Cortez being a nonresident alien individual who has stayed for an aggregate period of more than 180 days during the calendar year 1999, shall for that taxable year be deemed to be a nonresident alien doing business in the Philippines. Considering the above, Mr. Cortez shall be subject to an income tax in the same manner as a resident citizen on taxable income received from all sources within the Philippines. Thus, he is allowed to avail of the itemized deductions including the personal and additional exemptions, but subject to the rule on reciprocity on the personal exemptions. Q: Jonny transferred a valuable 10-door commercial apartment to a designated trustee, Miriam, naming in the trust instrument Santino, Johnny’s 10-year old son, as the sole beneficiary. The trustee is instructed to distribute the yearly rentals amounting to P720,000. The trustee consults you if she has to pay the annual income tax on the rentals received from the commercial apartment. (a) What advice will you give the trustee? (b) Will your advice be the same, if the trustee is directed to accumulate the rental income and distribute the same only when the beneficiary reaches the age of majority. Why or why not? A: (a) It depends. Where the trust document transferring the property is revocable, the rental income shall be included in computing the taxable income of the grantor. On the other hand, if the trust document is irrevocable and the donor’s tax on the value of the transferred property was duly paid by the grantor at the time of the creation of the trust, the rental income shall be reported by the trustee in the income tax return to be filed by her. Income tax shall apply to the income of the property held in trust, including income which is to be distributed currently by the fiduciary to the beneficiary. However, the taxable income of the trust shall be computed by allowing as deduction the amount of the income of the trust for the taxable year, which is to be distributed currently by the fiduciary to the beneficiary, but the amount so allowed as a deduction shall be included in computing the taxable income of the beneficiary, whether distributed to them or not. (b) No, my advice will be different if the trustee is directed to accumulate the rental income and distribute the same only when the beneficiary reaches the age of majority. Income tax shall also apply to income accumulated or held for future distribution under the terms of the trust document. However, the trustee is allowed as an additional deduction in computing he taxable year, which is property paid or credited during such year to any beneficiary, but the amount so allowed as deduction shall be included in computing the taxable income of the beneficiary. Q: Mr. Santos died intestate in 1989 leaving his spouse and five children as the only heirs. The estate consisted of a family home and a four-door apartment which was being rented to tenants. Within the year, an extrajudicial settlement of the estate was executed from the heirs, each of them receiving his/her due share. The surviving spouse assumed administration of the property. Each year, the net

20 income from the rental property was distributed to all, proportionately, on which they paid respectively, the corresponding income tax. In 1994, the income tax returns of the heirs were examined and deficiency income tax assessments were issued against each of them for the year 1989 to 19993, inclusive, as having entered into an unregistered partnership. Were the assessments justified? A: Yes, the assessments were justified because for income tax purposes, the co-ownership of inherited property is automatically converted into an unregistered partnership form the moment the said properties are used as a common fund with intent to produce profits for the heirs in proportion to their shares in the inheritance. From the moment of such partition, the heirs are entitled already to their respective definite shares of the estate and the income thereof, for each of them to manage and dispose of as exclusively their own, without the intervention of the other heirs, and accordingly, he becomes liable individually for all taxes in connection therewith. If after such partition, he allows his shares to be held in common with his co-heirs under a single management to be used with the intent of making profit thereby in proportion to his share, there can be no doubt that, even if no document or instrument were executed for the purpose, for tax purposes, at least, an unregistered partnership is formed. Q: Noel Langit and his brother, Jovy, bought a parcel of land which they registered in their names as pro indiviso owners (Parcel A). Subsequently, they formed a partnership, duly registered with SEC, which bought another parcel of land (Parcel B). Both parcels of land were sold, realizing a net profit of P1,000,000.00 for parcel A and P500,000.00 for parcel B. 1. The BIR claims that the sale of parcel A should be taxed as a sale by an unregistered partnership. Is the BIR correct? 2. The BIR also claims that the sale of parcel B should be taxed as a sale by a corporation. Is the BIR correct? A: (1) The BIR is not correct , since there is not showing that the acquisition of the property by Noel and Jovy Langit as pro indivisio owners, and prior to the formation of the partnership, was used, intended for use, or bears any relations whatsoever to the pursuit or conduct of the partnership business. The sale of parcel A shall therefore not be treated as a sale by an unregistered partnership, but an ordinary sale of a capital asset, and hence will be subject to the 5% (now 6%) CGT and documentary stamp tax on transfers of real property, said taxes to be borne equally by the co-owners. (2) The BIR is correct, since a “corporation” as deemed under the Tax Code includes partnerships, no matter how created or organized, except general professional partnerships. The business partnership, in the instant case, shall therefore be taxed in the same manner as a corporation on the sale of parcel B. The sale shall thus be subject to the creditable withholding tax on the sale of parcel B, and the partnership shall report the gain realized from the sale when it files its income tax return. Q: Roberto Ruiz and Conrado Cruz bought 3 parcels of land from Rodrigo Sabado on 4 May 1976. Then on 8 July 1977, they bought 2 parcel of land from Miguel Sanchez. In 1988, they sold the first three parcels of land to Central Realty, Inc. In 1989, they sold the two parcels to Jose Guerrero. Ruiz and Cruz realized a net profit of P100,000.00 for the sale in 1988 and P150,000.00 for the sale in 1989. The corresponding CGT were individually paid by Ruiz and Cruz. On 20 September 1990, however, Ruiz and Cruz received a letter from the Commissioner of Internal Revenue assessing them deficiency corporate income taxes for the years 1988 and 1989 because, according to the Commisioner, during said years they, as co-owners in the real estate transactions, formed an unregistered partnership or joint venture taxable as a corporation and that the unregistered partnership was subject to corporate income tax, as distinguished

21 from profits derived from the partnership by them, which is subject to individual income tax. Are Robert Ruiz and Conrado Cruz liable for deficiency corporate income tax? A: Roberto Ruiz and Conrado Cruz are not liable for corporate income tax. Evidently abandoning the Gatchalian ruling,, the Supreme Court in a recent ruling in Pascual v. Court of Tax Appeals (G.R. No. 78133, October 18, 1988) held that isolated transactions by two or more persons do not warrant their being considered as an unregistered partnership. They will instead be considered as mere co-owners, no corporate income tax is due on mere coownerships. It was, therefore, correct for Ruiz and Cruz to merely pay their individual tax income tax liabilities on the gain from sale of real estate transactions. Q: Five years ago, Marquez, Peneyra, Jayme, Posadas, and Manguit, all lawyers, formed a partnership which they named Marquez and Peneyra Law Offices. The Commissioner of Internal Revenue thereafter issued Revenue Regulations[s] No. 2-93 implementing R.A.7496, known as the Simplified Net Income Taxation Scheme (SNITS). Revenue Regualtion[s] No. 2-93 provides in part: “Sec. 6. General Professional Partnership. - The general professional partnership and the partners are covered by R.A. 7496. Thus, in determining profit of the partnership, only the direct costs mentioned in said law are to be deducted from partnership income. Also, the expenses paid or incurred by partners in their individual capacities in the practice of their profession which are not reimbursed or paid by the partnership but are not considered as direct costs are not deductible from his gross income.” (1)Marquez and Peneyra Law Offices Law Offices filed a taxpayer’s suit alleging that Revenue Regulations No. 2-93 violates the principle of uniformity in taxation because general professional partnerships are now subject to payment of income tax and that there is a difference in the tax treatment between individuals engaged in the practice of their respective professions and partners in general professional partnership. Is this contention correct? Explain. (2)Is Revenue Regulations No. 2-93 now considered as having adopted a gross income method instead of retaining the net income taxation scheme? Explain. A: (1) The contention is not correct. General professional partnerships remain to be a nontaxable entity. The partners comprising the same are taxable and they are obligated to report as income their share in the income of the general professional partnership during the taxable year, whether distributed or not. The Simplified Net Income Tax System (SNITS) treats professionals as one class of taxpayers so that they shall be treated alike, irrespective of whether they practice their profession alone or in association with other professionals under a general professional partnership. What are taxed differently are individuals and corporations. All individuals similarly situated are taxed alike under the regulations. Therefore, the principle of uniformity in taxation is not violated. On the contrary, all the requirements of a valid regulation have been complied with. (2) No. Revenue Regulation No. 2-93, implementing RA No. 7496, has indeed significantly reduced the items of deduction by limiting it to direct costs and expenses, or 40% of gross receipts maximum deduction in cases where the direct costs are difficult to determine. The allowance of the limited deductions, however, is still in consonance with the net income taxation scheme rather than the gross income method. While it is true that not all the expenses of earning the income might be allowed, this can well be justified by the fact that deductions are not matters of right but are matters of legislative grace. Q: Another Banking Corporation, which was organized in 2000 and existing under the laws of the Philippines and owned by the Sy Family of Makati City, set up in 2010 a branch office in Shanghai City, China, to take advantage of the presence of many Filipino workers in that area and its booming economy. During the year, the

22 bank management decided not to include the P20 million net income of the Shanghai Branch in the annual Philippine income tax return filed with the BIR, which showed a net taxable income of P30 million, because the Shanghai Branch is treated as a foreign corporation and is taxed only on income from sources within the Philippines, and since the loan and other business transactions were done in Shanghai, these incomes are not taxable in the Philippines (a)Is the bank correct in excluding the net income of its Shanghai Branch in the computation of its annual corporate income tax for 2010? Explain your answer (b)Should the Shanghai Branch of another Bank remit profit to its Head Office in the Philippines in 2011, is the branch liable to the 15% branch profit emittance tax imposed under Section 28A(A)(5) of the 1997 Tax Code? Explain your answer. A: (a) No. A domestic corporation is taxable on all income derived from sources within and without the Philippines (Sec. 23, NIRC). The income of the foreign branch and that of the Head Office will be summed up for income tax purposes, following the “single entity” concept and will all be included in the gross income of the domestic corporation in the annual Philippine income tax return. (b) No. The branch profit remittance tax is imposed only on remittance by branches of foreign corporation in the Philippines to their Head Office abroad. It is the outbound branch profits that is subject to the tax, not the inbound profits. Q: XYZ Law Offices, a law partnership in the Philippines and a VAT-registerd taxpayer, received a query by email from Gainsburg Corporation, a corporation organized under the laws of Delaware, USA, but the email came from California, where Gainsburg has an office. Gainsburg has no office in the Philippines and does no business in the Philippines. XYZ Law Offices rendered its opinion on the query and billed Gainsburg $1,000 from the opinion. Gainsburg remitted its payment through Citibank, which converted the remitted $1,000 to pesos. What are the implications of the payment to XYZ Law offices in terms of VAT and income taxes? A: The payment of XYZ Law Offices by Gainsburg Corporation is subject to income tax and VAT in the Philippines. For income tax purposes, the compensation for services is part of the gross income of the law partnership. From its total gross income within and without, it has to compute its nect income in the same manner as a corporation. The net income of the partnership, whether distributed or not, will be declare by the partners based on their agreement as part of their gross income who are to pay the income tax thereon in their individual capacity (Sec. 26, NIRC). For VAT purposes, the transaction is a zero-rated sale of services where the output tax is zero percent and XYZ is entitled to claim as refund or tax credit certificate the input taxes attributable to the zero rated sale, if the same is not utilized by the partnership. The services were rendered to a nonresident person, engaged in business outside the Philippines, which services are paid for in foreign currency inwardly remitted through the banking system, thereby making the sale of services subject to tax at zero-rated. Q: HK Co. is a Hong Kong company, which has a duly licensed Philippine branch engaged in trading activities in the Philippines. HK Co. also invested directly in 40% of the shares of stack of A Co., a Philippine corporation. These shares are booked in the Head Office of HK Co. and are not reflected as assets of the Philippine branch. In 1998, A Co. declared dividends to its stockholders. Before remitting the dividends to HK Co., A Co. seeks your advice as to whether it will subject the remittance to withholding tax. No need to discuss withholding tax rates, if applicable. Focus your discussion on what is the issue.

23 A: I will advise A Co. to withhold and remit the withholding tax on the dividends. While the general rule is that a foreign corporation is the same juridical entity as its branch office in the Philippines, when, however, the corporation transacts business in the Philippines directly and independently of its branch, the taxpayer would be the foreign corporation itself and subject to the dividend tax similarly imposed on nonresident foreign corporation. The dividends earned by a resident foreign corporation, which is exempt from tax. Q: Foster Corporation (FC) is a Singapore-based foreign corporation engaged in construction and installation projects. In 2010, Global Oil Corporation (GOC), a domestic corporation engaged in the refinery of petroleum products, awarded an anti-pollution project to Foster Corporation, whereby FC shall design, supply machinery, and equipment, and install an anti-pollution device for GOC’s refinery in the Philippines, provided that the installation part of the project may be subcontracted to a local construction company. Pursuant to the contract, the design and supply contracts were done in Singapore by FC, while the installation works were subcontracted by FC with Philippine Construction Corporation (PCC), a domestic corporation. The project with a total cost of P100M was completed in 2011 at the following cost components; (design – P20M, machinery and equipment – P50M and installation – P30M). Assume that the project was 40% complete in 2010 and 100% complete in 2011, based on the certificates issued by the architects and engineers working on the poject. GOC paid FC as follows: P60M in 2010 and P40M in 2011, and FC paid PCC in foreign currency through a Philippine bank as follows: P10M in 2010 and P20M in 2011. (a)Is FC liable to Philippine income tax, and if so, how much revenue shall be reported by it in 2010 and in 2011? Explain your answer. (b)Is PCC, which adopted the percentage of completion method of reporting income and expenses, liable to value added tax in 2010 and in 2011? Explain your answer. A: (a) No. FC is not liable to Philippine income tax. The revenues from the design and supply contracts, having been all done by FC (a foreign corporation), hence, not taxable to a foreign corporation in the Philippines. With respect to the installation works which was subcontracted by FC to PCC, a domestic corporation, it is PCC (not FC) that does the work in the Philippines and should report the income thereon. (b) Yes. PCC is liable to VAT as seller of services done in the Philippines for a fee. However, the sale of services to FC is subject to VAT at zero percent. Services rendered by a VATregistered local contractor to a nonresident foreign corporation who is outside the Philippines, paid for in foreign currency inwardly remitted through the Philippine banking system are zero-rated sales of services Q: Aplets Corporation is registered under the laws of the British Virgin Islands. It has extensive operations in Southeast Asia. In the Philippines, its products are imported and sold at a mark-up by its exclusive distributor, Kim’s Trading, Inc. The BIR compiled a record of all the imports of Kim from Aplets and imposed a tax on Aplets’ net income derived from its exports to Kim. Is the BIR correct? A: No. Aplets Corporation is a non-resident foreign corporation not engaged in trade or business in the Philippines and its sources of income from outside the Philippines. As a foreign corporation, it is subject to Philippine income tax only on income from sources within the Philippines. Gains, profits and income from the sale of personal property outside the Philippines shall be treated as income from sources outside the Philippines.

24 CHAPTER V: GROSS INCOME Q: 1. What is gross income for purposes of income tax? 2. How does income differ from capital? Explain. A: 1. Gross income means all income from whatever source derived, including (but not limited to) compensation for services, including fees, commissions, and similar items; gross income from business; gains derived from dealings in property; interest; royalties; dividends; annuities; prized and winnings; pensions; and partner’s distributive share of the gross income of general professional partnership 2. Income differs from capital in that income is any wealth which flows into the taxpayer other than a return of capital, while capital constitutes the investment which is the source of income. Therefore, capital is fund, while income is the flow. Capital is wealth, while income is the fruit. Income is liable to income tax, while capital ore return of capital is exempt from tax. Q: Mr. Francisco borrowed P10,000.00 from his friend, Mr. Gutierrez, payable in one year without interest. When the loan became due, Mr. Francisco told Mr. Gutierrez that he was unable to pay because of business reverses. Mr. Gutierrez took pitty on Mr. Francisco and condoned the loan. Mr. Francisco was solvent at the time he borrowed the P10,000.00 and at the time the loan was condoned. Did Mr. Francisco derived any income from the cancellation or condonation of his indebtedness? Explain. No. Mr Francisco did not derive any income from the cancellation or condonation of his indebtedness. Since it is obvious that the creditor merely desired to benefit the debtor in view of the absence of consideration for the cancellation, the amount of the debt is considered as a gift from the creditor to the debtor and need not be included in the latter’s gross income. The gift may, however, be subject to donor’s tax at 30%, since Mr. Francisco and Mr. Gutierrez are not members of the same family. Q: Bates advertising Company is a nonresident corporation duly organized and existing under the laws of Singapore. It is not doing business and has no office in the Philippines. Pilipinas Garment, Inc., a domestic corporation, retained the services of Bates to do all the advertising of its products abroad. For said services, Bates’ fees are paid through outward remittances. Are the fees received by Bates subject to any withholding tax? A: The fees paid to Bates Advertising Company, a non-resident foreign corporation, are not subject to withholding tax, since they are not subject to Philippine income tax. They are exempt because they do not constitute income from Philippine sources, the same being compensation for labor or personal services performed outside the Philippines. Q: A Co., is an off-line international carrier without any flight operation in the Philippines. It has, however, a liaison office in the Philippines which is duly licensed, with the SEC, established for the purpose of providing passenger and flight information, reservation and ticketing services. Are the revenues of A Co. from tickets reserved by its Philippine office subject to tax? A: The revenues in the Philippines of A Co. as an off-line airline from ticket reservation services are taxable income from whatever source under Section 28(a) of the Tax Code. This case in analogous to Commissioner v. BOAC, where the SC ruled that income received in the Philippines from the sale of tickets by an off-line airline is taxable as income from whatever source. Q: An international airline with no landing rights in the Philippines sold tickets in the Philippine s for air transportation. Is income derived from such sales of tickets

25 considered taxable income of the said international air carrier from Philippine sources under the Tax Code? Explain. A: No. While the tickets are sold here by the international airline, this is for carriage of persons, excess baggage, cargo and mail not originating from the Philippines, because the airline has no landing rights in the Philippines. The income from the sale of tickets is actually the gross revenue derived from the carriage of persons, excess baggage, cargo and mail and these revenues are considered as income from Philippine sources only if the flight originates from the Philippines in a continuous and uninterrupted flight, irrespective of the place of payment of the ticket or passage document. Accordingly, the income mentioned is not derived from Philippine sources. Q: Pacific, Inc. is engaged in overseas shipping. It time chartered one of its ships to a Japanese company on a five-year term. The charter was consummated through the efforts of Kamino Moto, a Tokyo based broker. The negotiation took place in Tokyo. The agreement calls the Pacific, Inc. to pay Kamino Moto $50,000.00. Your opinion is sought whether Pacific, Inc. should withhold the tax before sending the compensation of Kamino Moto. A: The compensation of Kamino Moto is not subject to withholding tax. Compensation for labor or personal services performed outside the Philippines are considered as income from sources without the Philippines. Kamino Moto’s effort in consummating the Charter is a form of labor or services. Considering further that Kamino Moto is a Tokyo-based broker, presumably a non-resident foreign corporation, it is taxable only on income within the Philippines. Q: ABC, a domestic corporation, entered into a software license agreement with XYZ, a non-resident foreign corporation based in the US. Under the agreement which the parties forged in the US, XYZ granted ABC the right to use a computer system program and to avail of technical know-how relative to such program. In consideration for such rights, ABC agreed to pay 5% of the revenues it receives from customers who will use and apply the program in the Philippines. Discuss the tax implications of the transactions. The royalty received by XYZ from ABC will be subject to Philippine income tax because the source of the royalty income is from the Philippines. Rentals and royalties from property located in the Philippines or from any interest in such property shall be treated as income from sources within the Philippines. Considering that XYZ is a nonresident foreign corporation, such royalty income is subject tot the 30% final withholding income tax under Section 29 (B) of the Tax Code, such tax to be withheld by ABC and paid in the same manner as provided in Section 58 of the Tax Code. XYZ does not have to file a Philippine income tax return on the royalty income. For VAT purposes, ABC must withhold and assume the payment of the 12% VAT on the royalty income, which input tax can be credited against ABC’s output tax for the taxable period. Q: A is a resident Filipino citizen. He purchased a parcel of land in Makati city in 1970 at a consideration of P1M. In 2011, the land, which remained undeveloped and idle, had a fair market value of P20M. Mr. B, another Filipino citizen, is very much interested in the property and he offered to buy the same for P20M. (a) Is A liable for income tax in 2011 based on the offer to buy by MR B? (b) Should A agree to sell the land in 2012 for P20M, subject to the condition as stated in the Deed of Sale that the buyer shall assume the capital gains tax thereon, how much is the income tax due on the transaction and when must the tax return be filed and tax be paid by the taxpayer? A: (a) A is not liable for income tax in 2011 because no income is realized by him during that year. Tax liability for income tax attaches only if there is a gain realized resulting from

26 a closed and complete transaction. (b) He shall be liable to pay the 6% capital gains tax based on the gross selling price of the property of P20M plus the capital gains tax assumed by the buyer (following the doctrine of constructive receipt of income). He should file the return within 30 days from the date of sale and pay the tax as he files the return. Q: What is meant by taxable income? A: Taxable income means the pertinent items of gross income specified in the Tax Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by the Tax Code or other special laws. Q: ABC Computer Corp. purchased some years ago Membership Certificate No. 7 from the Calabar Golf Club, Inc. for P300,000.00. In September 4, 1985, it transferred the same to Mr. John Johnson, its American computer consultant, to enable him to avail of the facilities of the Club during his stay here. The consultancy agreement expired two year later in the meantime, the value of the Club share appreciated and what was purchased by the corporation at P300,000.00, commanded a market value of P800,000.00 in 1987. Before he returned home a few days after his tenure ended, Mr. Johnson transferred the subject share to Mr. Robert James, the new consultant of the firm and the newly designated playing representative, under a Deed of Declaration of Trust and Assignment of Shares, wherein the former acknowledged the absolute ownership of ABC Computer Corp. over the share, that the assignment was without any consideration and that the share was placed in his name because the Club required it to be done. (a) Is the assignment/transfer of the shares from Johnson to James subject to income tax? (b) Is the said assignment a gift and, therefore, subject to gift tax? A: (a) The assignment or transfer of shares from Johnson to James is not subject to income tax. There had been no real change of ownership that took place. There having been no actual sale or exchange, no income tax incidence can be said to have occurred. In addition, there was really no income realized or received considering that in the Deed of declaration of Trust and Assignment of Shares, the absolute ownership of ABC Computer Corp was explicitly recognized. (b) The assignment can neither be held to be a gift. To be considered a gift within the context of the NIRC, there must be a transfer of ownership or a quantifiable interest. More importantly, the transfer of the membership certificate was merely a designation of the consultant to be the “playing representative” of ABC Computer Corporation in the Calabar Golf Club. Q: X, a multinational corporation doing business in the Philippines donated 100 shares of stock of said corporation to Mr. Y, its resident manager in the Philippines. (1)What is the tax liability, if any, of X corporation? (2)Assuming the shares of stocks were given to Mr. Yin consideration of his services to the corporation which are the tax implication? Explain. A: (1) Foreign corporations effecting a donation are subject to donor’s tax only if the property donated is located in the Philippines. Accordingly, donation of a foreign corporation of its own shares of stocks in favor of a resident employee is not subject to donor’s tax. However, if 85% of the business of the foreign corporation is located in the Philippines of the shares donated have acquired business situs in the Philippines the donation may be taxed in the Philippines subject to the rule of reciprocity. (2) If the shares of stocks were given to Mr. Y in consideration of his services to the corporation, the same shall constitute taxable compensation income to the recipient because it is a compensation for services rendered under an employee-employer relationship, hence, subject to income tax.

27 Q: X is employed as a driver of a corporate lawyer and he receives a monthly salary of P 5,000.00 with free board and lodging with an equivalent value of P 1,500.00. 1. What will be the basis of X’s income tax? Why? 2. Will your answer in question (1) be the same if X’s employer is an obstetrician? Why? A: 1. The basis of X’s income tax would depend on whether his employer is an employee or a practicing corporate lawyer. If his employer is an employee, the basis of X’s income tax is P 6,500.00 equivalent the total of the basic salary and the value of the board and lodging. This is so because the employer has no place of business where the free board and lodging may be given. On the other hand, if the corporate lawyer is a practicing lawyer (selfemployed), X should be taxed only on P 5,000.00, provided that the free board and lodging is given in the business premises of the lawyer and for his convenience, and that the free lodging was given to X as a condition for his employment. 2. If the employer is an obstetrician who is self-employed, the basis of his income will only be P 5,000.00, if it is proven that the free board and lodging is given within premises of said employer for his convenience and that the free lodging is required to be accepted by X as condition for employment. Otherwise, X would be taxed on P 6,500.00. Q: A Co., a Philippine corporation, has an executive (P) who is a Filipino citizen, A Co. has a subsidiary in Hong Kong (HK Co.] and will assign P for an indefinite period to work full time for HK Co. P will bring his family to reside in HK and will lease out his residence in the Philippines. The salary of P will be shouldered 50% by A Co. while the other 50% plus housing, cost of living and educational allowances of P’s dependents will be shouldered by HK Co. A Co. will credit the 50% of P’s salary to P’s Philippine bank account. P will sign the contract of employment in the Philippines. P will also be receiving rental income for the lease of his Philippine residence. Are these salaries, allowances and rentals subject to the Philippine income tax? A: The salaries and allowances received by P are not subject to Philippine income tax. P qualifies as a non-resident citizen because he leaves the Philippines for employment requiring him to be physically present abroad most of the time during the taxable year (Sec. 22[E], NIRC). A non-resident citizen is taxable only on income derived from Philippine sources (Sec. 23, NIRC). The salaries and allowances received from being employed abroad are incomes from without because these are compensation for services rendered outside of the Philippines (Sec. 42, NIRC). However, P is taxable on rental income for the lease of his Philippine residence because this is an income derived from within, the leased property being located in the Philippines (Sec. 42, NIRC). Q: Citing Section 10, Article VIII of the 1987 Constitution, which provides that salaries of judges shall be fixed by law and that during their continuance in office their salary shall not be decreased, a judge of MM Regional Trial Court questioned the deduction of withholding taxes from his salary since it results into a net

28 deduction of his pay. Is the contention of the judge correct? Reason briefly. A: No. The contention is incorrect. The salaries of judges are not tax-exempt and their taxability is not contrary to the provisions of Section 10, Article VIII of the Constitution on the non-diminution of the salaries of the judiciary during their continuance in office. The clear intent of the Constitutional Commission that framed the Constitution is to subject their salaries to tax as in the case of all taxpayers. Hence, the deduction of withholding taxes, being a manner of collecting the income tax on their salary, is not a diminution contemplated by the fundamental law (Nitafan, et al. v. Commissioner, 152 SCRA 284 [1987]). Q: A “Fringe benefit” is defined as being any good, service or other benefit furnished or granted in cash or in kind by an employer to an individual employee. Would it be the employer or the employee who is legally required to pay an income tax on it? Explain. A: It is the employer who is legally required to pay an income tax on the fringe benefit paid to supervisory or managerial employee. The fringe benefit paid to supervisory or managerial employee. The fringe benefit tax is imposed as a final withholding income tax on the fringe benefits of the employee, but the legal obligation to remit the tax is placed on the employer, such that if the tax is not paid, the legal recourse of the BIR is to go after the employer. Any amount or value received by the employee as a fringe benefit is considered tax-paid, or net of the income tax due thereon. The person who is legally required to pay is that person who, in case of non-payment, can be legally demanded to pay the tax. However, fringe benefit paid to a rank-and-file employee is taxable to said employee, which the employer is required to deduct the corresponding withholding tax, unless it is considered as de minimis benefit exempt from income tax. Q:1. Mr. Adrian is an executive of a big business corporation. Aside from his salary, his employer provides him with the following benefits: free use of a residential house to an exclusive subdivision, free use of a limousine and membership in a country club where he can entertain customers of the corporation. Which of these benefits, if any, must Mr. Adrian report as income? Explain. 2. Capt. Canuto is a member of the Armed Forces of the Philippines. Aside from his pay as captain, the government gives him free uniforms, free living quarters in whatever military camp he is assigned, and free meals inside the camp. Are these benefits income to Capt. Canuto? Explain. 3. Mr. Infante was hit by a wayward bus while on his way to work. He survived but had to pay P400,000.00 for his hospitalization. He was unable to work for six months which meant that he did not receive his usual salary of P10,000.00 a month or a total of P60,000.00. he sued the bus company and was able to obtain a final judgment awarding him P 400,000.00 as reimbursement for his hospitalization, P60,000.00 for the salaries he failed to receive while hospitalized, P200,000.00 as moral damages for his pain and suffering, and P100,000.00 as exemplary damages. He was able to collect in full from the judgment. How much income did he realize when he collected on the judgment? Explain. A: 1. Mr. Adrian must report the imputed rental value of the house and limousine as

29 income. If the rental value exceeds the personal needs of Mr. Adrian because he is expected to provide accommodation in said house for company guests or the car is used partly for business purpose, then Mr. Adrian is entitled only to a ratable rental value of the house and limousine as exclusion from gross income and only a reasonable amount should be reported as income. This is because the free housing and use of the limousine are given partly for the convenience and benefit of the employer (Henderson v. Collector, 1 SCRA 548). 2. No, the free uniforms, free living quarters and the free meals inside the camp area are not income to Capt. Canuto because these are facilities or privileges furnished by the employer for the employer’ convenience which are necessary incidents to proper performance of the military personnel’s duties. 3. None. The P200,000.00 moral and exemplary damages are compensation for injuries sustained by Mr. Infante. The P400,000.00 reimbursement for hospitalization expenses and the P60,000.00 for salaries he failed to receive are amounts of any damages received whether by suit or agreement on account of such injuries. Section 28(b)(5) of the Tax Code specifically excludes these amounts from the gross income of the injured individual (Sec. 28[b], NIRC and Sec. 63, Rev. Regs. No. 2). Q: The University of Bigaa, a non-stock, non-profit entity, operates a canteen for its students and a bookstore inside the campus. It also operates two dormitories for its students, one of which is in the campus. Is the University liable to pay income taxes for the operation of the: 1. Canteen? 2. Bookstore? 3. Two dormitories? A: 1. For the operation of the canteen inside the campus, the income thereon being incidental to the operations of the university as a school, is exempt (Art. XIV[4][3], Constitution; DECS Regulations No. 137-87, December 16. 2. For the same reasons, the University of Bigaa is not liable to pay income taxes for the operation of the bookstore, since this is an ancillary activity the conduct of which is carried out within the school premises. 3. The University of Bigaa shall not be liable to pay income taxes for the operation of the dormitory located in the campus, for same reasons as the foregoing. However, the latter shall be liable for income taxes on income from operations of the dormitory located outside the school premises. Q: Spouses Pablo Gonzales and Teresita Gonzales, both resident citizens, acquired during their marriage a residential house and lot located in Makati City, which is being leased to a tenant for a monthly rental of P100,000. Mr. Pablo Gonzales is the President of PG Corporation and he receives P50,000 salary per month. The spouses have only one minor child. In late June 2010, he was immediately brought to the hospital because of a heart attack and he was pronounced dead on June 30, 2010. With no liabilities, the estate of the late Pablo Gonzales was settled extra-judicially in early 2011.

30 1. Is Mr. Gonzales required to file income tax return for 2010? If so, how much income must he declare for the year? How much personal and additional exemption is he entitled to? 2. Is Mrs. Gonzales required to file income tax return for 2010? If so, how much income must be declare for the year and how much personal exemption is she entitled to? 3. Is the Estate of the late Pablo Gonzales required to file income tax return for 2010? If so, how much income must it declare for the year and how much personal exemption is it entitled to? A: 1. Yes, Mr. Pablo Gonzales is required to file income tax return and pay income tax on the following incomes for 2010: P300,000 – rental income (P100,000 / 2 x 6 months), and P300,000 (P50,000 x 6 months) – salary, from January to June 30. Only 50% of the rental is to be reported by him because the leased property is a property of the conjugal partnership of gains belonging to the spouses. He will be entitled to personal exemption of P50,000 and additional personal exemption of P25,000 for one minor child. If the taxpayer dies during the taxable year, his estate may still claim the personal and additional exemptions for himself and his dependent as if he died at the close of such year (Sec. 35, NIRC). 2. Yes, Mrs. Teresita Gonzales is required to file her income tax return and pay income tax on P600,000 (P50,000 x 12 months), rental income for the year (January to December 2010). If any income of the spouses cannot be definitely attributed to or identified as income exclusively earned or realized by either of the spouses, the same shall be divided equally between them for the purpose of determining their respective taxable income (Sec. 24 [A], NIRC). Since the deceased husband already claimed the additional personal exemption for the minor child, Mrs. Gonzales could no longer claim the additional personal exemption (Sec. 35[B], NIRC). 3. Yes, the Estate of the late Pablo Gonzales (through his Administrator or Executor) is also required to file its income tax return and pay tax, if applicable. Income tax imposed by Title II upon individuals shall apply to the income of estates, including income received by estates of deceased persons during the period of administration or settlement of the estate (Sec. 60, NIRC), and the estate of a decedent (which shall have its own TIN) shall be entitled to personal exemption of P20,000 (Sec. 61, NIRC). It is believed, however, that since the personal exemption of individuals has been increased to P50,000 under R.A. 9504 (social legislation) in 2008, the same amount of P50,000 shall also be extended to estates and trusts. The rental income to be reported by the estate shall be P300,000 (P100,000 / 2 x 6 months (from July 1 to December 31, 2010). Q: Mr. Domingo owns a vacant parcel of land. He leases the land to Mr. Enriques for ten years at a rental of P12,000.00 per year. The condition is that Mr. Enriquez will erect a building on the land which will become the property of Mr. Domingo at the end of the lease without compensation or reimbursement whatsoever for the value of the building. Mr. Enriquez erects the building. Upon completion, the building had a fair market value of P1 million. At the end of the lease, the building is worth only P900,000.00 due to depreciation. Will Mr. Domingo have income when the lease expires and becomes the owner of the building with a fair market value of P900,000.00? How much income must he report on the building? Explain.

31 A: When building is erected by a lessee in the leased premises in pursuance of an agreement with the lessor that the building becomes the property of the lessor at the end of the lease, the lessor has the option to report income as follows: a. The lessor may report as income the market value of the building at the time when such building is completed; or b. The lessor may spread over the life of the lease the estimated depreciated value of such building a the termination of the lease and report as income for each year of the lease an aliquot part thereof (Sec. 49, Rev. Regs. No. 2). Q: John McDonald, a U.S. citizen residing in Makati City, bought shares of stocks of a domestic corporation whose shares are listed and traded in the Philippine Stock Exchange, at the price of Php2 million. Yesterday, he sold the shares of stocks through his favorite Makati stockbroker at a gain of Php200,000. Is John McDonald directly sold the shares to his best friend, who is another U.S. citizen residing in Makati, at a gain of Php 200,000. Is he liable to Philippine income tax? If so, what is the tax base and rate? A: 1. No, John McDonald is exempt from Philippine income from his sale of shares of stocks of a domestic corporation that are listed and traded in the Philippine Stock Exchange by express provision of law (Sec. 24[c], NIRC, as amended by B.P. 221, May 25, 1982). He is, however subject to the stock transaction tax equivalent to one-half of one percent (1/2 of 1%) of the gross selling price or gross value in money of the shares of stock sold or exchanged (Sec. 127[A], NIRC). 2. Yes, John McDonald will be subject to Philippine income tax on the Php 200,000 gain arising from his direct sale of the listed shares of stocks of a domestic corporation to his friend residing in Makati. An alien individual, whether or not a resident of the Philippines, is taxable on income derived from sources within the Philippines (Sec. 23[D], NIRC). Gain from the sale of shares of stock in a domestic corporation shall be treated as derived entirely from sources within Philippines, regardless of where the said shares are sold (Sec. 42[E], NIRC). A final tax at the rates prescribed below is hereby imposed upon the net capital gains realized during the taxable year from the sale of shares of stock in a domestic corporation, except shares sold or disposed of through the stock exchange: Not over P100,000 5% On any amount in excess of P100,000 10% (Sec. 24[c], NIRC) Q: In 2000, Mr. Belen bought a residential house and lot for P1,000,000. He used the property as his and his family’s principal residence. It is now year 2013 and he is thinking of selling the property to buy a new one. He seeks your advice on how much income tax he would pay if he sells the property. The total zonal value of the property is P5,000,000 and the fair market value per tax declaration is P2,500,000. He intends to sell it for P6,000,000. What material considerations will you take into account in computing the income tax? Please explain the legal relevance of each of these considerations. A: Since the planned sale involves a real property classified as a capital asset, the material considerations to take into account to compute the income tax are:

32 1. The current fair market value of the property to be sold. The current fair market value is the higher between the zonal value and the fair market value per tax declaration; 2. The gross selling price of the property; 3. Determination of the tax base, which is the higher amount between the gross selling price and the current fair market value of the property. The income tax is computed at 6% of the tax base, which is in the nature of a final capital gains tax (Sec. 24[D][1], NIRC). However, since the property to be sold is a principal residence and the purpose is to buy a new one, I will advise Mr. Belen that the sale can be exempt from the 6% capital gains tax if he is willing to comply with the following conditions: a. He must utilize the entire proceeds of sale in acquiring a new principal residence within 18 months from date of disposition; b. He should notify the Commissioner of his intention to avail of the exemption within 30 days from date of sale; c. He should open an escrow account with a bank and deposit the 6% capital gains tax due on the sale. If he compliers with the utilization requirement, he will be entitled to get back his deposit of the tax payment; otherwise, the deposit will be applied against the capital gains tax due (Sec. 24[D][2], NIRC). Q: Melissa inherited from the father a 300-sq.m. lot. At the time of her father’s death on March 14, 1995, the property was valued at P720,000. On February 28, 1996, to defray the of the medical expenses of her sick son, she sold the lot for P600,000 on cash basis. The prevailing market value of the property at the time of sale was P3,000 per sq. m. 1. Is Melissa liable to pay capital gains tax on the transaction? If so, how much and why? If not, why not? 2. Is Melissa liable to pay VAT on the sale of the property? If so, how much and why? If not, why not? A: 1. Melissa is liable to pay the 6% capital gains tax based on the gross selling price (P600,000) or fair market value at the time of sale (P900,000 = P3,000 x 300 sq. m.), whichever is higher. The capital gains tax is P54,000 (P900,000 x 6%). Although Melissa actually incurred a loss in the sale of the real property, this loss is disregarded for income tax purposes because Section 24(D) of the Tax Code presumes that the seller realized a gain from the sale of such real property classified as a capital asset and it imposes the tax on the higher amount between the gross selling price and the fair market value, The real property is a capital asset, since it is not used in the trade or business of Melissa (Sec. 39[A], NIRC). 2. No. Melissa is exempt from VAT on the sale of the real property classified as a capital asset. To be subject to VAT, the real property must be classified as an ordinary asset, the seller must be engaged in the real estate business, and the amount of gross sales must have exceeded P1.5 million. In this case all the above requisites are not present. Q:Josel agreed to sell his condominium unit to Jess for P2.5 million. At the time of the sale, the property had a zonal value of P2.0 million. Upon the advice of a tax

33 consultant, the parties agreed to execute two deeds of sale, one indicating the zonal value P2.0 million as the selling price and the other, showing the true selling price of P2.5 million. The tax consultant filed the capital gains tax return, using the deed of sale showing the zonal value of P2.0 million as the selling price. Discuss the tax implications and consequences of the action taken by the parties. A: The capital gains tax due on the sale shall be based on the actual selling price of P2.5 million, which is higher than the zonal value of the property (Sec. 24[D][1], NIRC). The documentary stamp tax on the conveyance of real property shall likewise be based on the higher value (Sec. 196, NIRC). Accordingly, a deficiency capital gains tax and documentary stamp tax are due from Josel plus the 50% surcharge imposable on a fraudulent return. Both Josel and his tax consultant are criminally liable for tax evasion. Here, it is clear that the three (3) requisite factors to constitute tax evasion are present, viz.; (1) the end to be achieved, which is the payment of less than that known by them to be legally due; (2) an accompanying state of mind, which is evil, in bad faith, willful or deliberate and not merely accidental and (3) a course of action, which is unlawful (CIR v. Estate of Benigno P. Toda, Jr., 438 SCRA 290 [240]). Q: Juan Panalo won a damage suit for P500,000.00 against Juana Talo. Panalo got a writ of execution and made a levy on the lot of Talo. The lot was sold at public auction where Panalo was the highest bidder for P500,000.00 Panalo refused to pay any capital gains tax on his purchase of said lot. Your opinion. A: The capital gains tax from sales of real property is payable by the seller (Section 21[e] in relation to Section 49[a][4] of the NIRC). Hence, Panalo cannot refuse to pay the capital gains tax on his purchase of said lot, because he is treated as the statutory seller. Q: Pedro Manalo, a Filipino citizen residing in Makati City, owns a vacation house and lot in San Francisco, California, U.S.A., which he acquired in 2000 for P15,000,000. On January 10, 2006, he sold said real property to Juan Mayaman, another Filipino citizen residing in Quezon City, for P20,000,000. On February 9, 2006, Manalo filed the capital gains tax return and paid P1,200,000 representing 6% capital gains tax. Since Manalo did not derive any ordinary income, no income tax return was filed by him for 2006. After the tax audit conducted in 2007, the BIR officer assessed Manalo for deficiency income tax computed as follows: P5,000,000 (P2,000,000 less P15,000,000) x 35% = P1,750,000, without the capital gains tax paid being allowed as tax credit. Manalo consulted a real estate broker who said that the P1,200,000 capital gains tax should be credited from the P1,750,000 deficiency income tax. 1. Is the BIR officer’s tax assessment correct? Explain. 2. If you were hired by Manalo as his tax consultant, what advice would you give him to protect his interest? Explain. A: 1. A resident citizen like Pedro Manalo is taxable on all income derived from sources within and without the Philippines (Sec. 23[A], NIRC). Gains, profits and income from the sale of real property located without the Philippines are considered as incomes from sources without the Philippines (Sec. 42[C][5], NIRC). The vacation house and lot in California, USA is a capital asset, since it is not used in the taxpayer’s trade or business (Sec. 39[A][1], NIRC). However, it is not subject to the 6%

34 capital gains tax under Section 24(D)(1) of the Tax Code, since the real property is not located in the Philippines. Said preferential rate of income tax applies only when the seller is a resident citizen and the real property is classified as a capital asset located in the Philippines. Accordingly, the gain of P5 million (P20 million less P15 million) shall be included in the taxable income of Pedro Manalo for 2006 subject to the graduated income tax rates of 5% to 32% (Sec. 24[A][1], NIRC). It is, therefore, erroneous for the BIR to apply the corporate income tax rate of 35% on the taxable income of Pedro Manalo, a resident citizen. 2. The amount of P1,200,000 (6% times P15 million), representing capital gains tax erroneously paid by Pedro Manalo, may be credited against the ordinary income tax due on the taxable income for 2006, since capital gains tax is another form of income tax under Title II of the Tax Code. If the BIR official insists on not allowing such tax credit of capital gains tax erroneously paid against ordinary income tax due for the year, I would advise my client to file a written claim for tax credit or refund for the capital gains tax erroneously paid with the BIR within two (2) years from the date of payment (Secs. 204[c] and 229, NIRC). Q: Last July 12, 2000, Mr. & Mrs. Peter Camacho sold their principal residence situated in Tandang Sora, Quezon City for Ten million pesos (P10,000,000.00) with the intention of using the proceeds to acquire or construct a new principal residence in Aurora Hills, Baguio City. What conditions must be met in order that the capital gains presumed to have been realized from such sale may not be subject to capital gains tax? A: The conditions are: 1. The proceeds are fully utilized in acquiring or constructing a new principal residence within eighteen (18) calendar months from the sale or disposition of the principal residence; 2. The historical cost or adjusted basis of the real property sold or disposed shall be carried over to the new principal residence built or acquired; 3. The Commissioner of Internal Revenue must have been informed by Mr. & Mrs. Peter Camacho within thirty (30) days from the date of sale or disposition on July 12, 2000, through a prescribed statement / return of their intention to avail of the tax exemption; 4. That the said exemption can only be availed of once every ten (10) years; and 5. If there is no full utilization of the proceeds of sale or disposition, the unused portion of the gain presumed to have been realized from the sale or disposition shall be subject to capital gains tax (Sec. 24[D][2],NIRC). Q: Mr. Pedro Aguirre, a resident citizen, is working for a large real estate development company in the country and in 2010, he was promoted to VicePresident of the company. With more responsibilities comes higher pay. In 2011, he decided to buy a new car worth P2 million and he traded-in his old car with a market value of P800,000, and paid the difference of P1.2 million to the car company. The old car, which was bought three (3) years ago by the father of Mr. Pedro Aguirre at a price of P700,000, was donated by him and registered in the name of his son. The corresponding donor’s tax thereon was duly paid by the father.

35 1. How much is the cost basis of the old car to Mr. Aguirre? 2. What is the nature of the old car – capital asset or ordinary asset? 3. Is Mr. Aguirre liable to pay income tax on the gain from the sale of his old car? A: 1. P700,000. The basis of the property in the hands of the done-son is the carry-over basis, the same basis as if it would be in the hands of the donor-father (Sec. 40[B][3], NIRC). 2. The old car is a capital asset. It is a property held by the taxpayer (whether or not connected with his trade or business), but is not stock in trade or other property of a kind which would properly be included in the inventory of the taxpayer, if on hand at the close of the year, or property held primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business of a character subject to depreciation, or real property used in trade or business of the taxpayer (Sec. 39[A],NIRC). 3. Yes, he is liable to income tax on his capital gain of P100,000 (P800,000 less P700,000), but only 50% of the taxable gain shall be recognized and subject to income tax, considering that the holding period of the old car is more than one year (Sec. 39, NIRC). Q: In 2007, Mr. & Mrs. Renato Garcia, an overseas Filipino contract worker in Hong Kong, opened peso and dollar deposits at the Philippine branch of the Hong Kong Bank in Manila. During the year, the bank paid interest income of Php10,000 on the peso deposit and US$1,000 on the dollar deposit. The bank withheld final income tax equivalent to 20% of the entire interest income and remitted the same to BIR. 1. Are the interest incomes on the bank deposits of Mr. & Mrs. Renato Garcia subject to income tax? Explain. 2. Is the ban correct in withholding the 20% final tax on the entire interest income? Explain. A: 1. The interest income on the foreign currency deposit of Renato Garcia, a non-resident citizen, with the FCDU of HK Bank in Makati is exempt from Philippine income tax by express provision of law (Sec. 24[B] in relation to Sec. 28[A][7][b], NIRC). His interest income on peso deposit with HK Bank in Makati will be subject to the 20% final withholding tax (Sec. 24[B][1], NIRC in relation to Secs. 23[B] and 57[A], NIRC). The interest income on the foreign currency deposit of Mrs. Garcia, a resident citizen, with the FCDU of HK Bank in Makati is subject to the 7.5% final withholding tax (Sec. 24[B][1], NIRC), while her interest income on the peso deposit with the bank will be subject to the 20% final withholding tax. 2. No, as discussed above, the 20% final withholding tax applies only on the interest income on peso deposits. Since 20% FWT is higher that the 7.5% FWT on interest income on foreign currency deposit of Mrs. Garcia, she can file a written claim for refund or tax credit for the excess tax paid, and Renato Garcia can also file a written claim for refund or tax credit for the 20% FWT erroneously deducted and remitted to the BIR on his interest income on foreign currency deposit which is exempt from income tax. Q: On 3 January 1998, X, a Filipino citizen residing in the Philippines, purchased one hundred (100) shares in the capital stock of Y Corporation, a domestic company. On 3 January 2000, Y Corporation declared, out of the profits of the company earned after 1 January 1998, a hundred percent (100%) stock dividends on all stockholders of record as of 31 December 1999 as a result of which X

36 holding in Y Corporation became two hundred (200) shares. Are the stock dividends received by X subject to income tax? Explain. A: No. Stock dividends are not realized income. Accordingly, the different provisions of the Tax Code, imposing a tax on dividend income covers cash and property dividends only, making stock dividends in the equivalent of cash or property dividend, as when the distribution results to a change in ownership interest of the shareholders, the stock dividends will be subject to income tax (Sec. 24[B][2]; Sec. 2[A] and [B]; Sec. 28[B][5][b], NIRC). Q: In 2009, Caruso, a resident Filipino citizen, received dividend income from a U.S.-based corporation which owns a chain of Filipino restaurants in the West Coast, USA. The dividend remitted to Caruso is subject to U.S. withholding tax with respect to a non-resident alien like Caruso. 1. What will be your advice to Caruso in order to lessen the impact of possible double taxation on the same income? 2. Would you answer in 1 be the same, if Caruso became a U.S. immigrant in 2008 and had become a non-resident Filipino citizen? Explain the difference in treatment for Philippine income tax purposes. A:1. In order to lessen the impact of double taxation on the same income, I would advise Caruso to credit the U.S. income tax on the dividend paid to the U.S. Federal Government against the Philippine income tax to be paid to the Philippine Government. This privilege is, however, subject to limitation as to amount and proof of tax payment made to the U.S. government must be attached to the Philippine income tax return. 2. If Caruso became an immigrant in 2008 and thus became a non-resident Filipino citizen, such dividend income received from a U.S. corporation will be treated as a foreign-source income, exempt from the Philippine income tax. A non-resident Filipino citizen is taxed only on income from sources within the Philippines (Sec. 23[B],NIRC), and dividends received from a foreign corporation whose gross income for the three-year period was derived from sources outside the Philippines (Sec. 42[B], NIRC). Q: What do you think is the reason why cash dividends, when received by a resident citizen or alien from a domestic corporation, are taxed only at the final tax of 10% and not at the progressive tax rate schedule under Section 24(A) of the Tax Code? Explain your answer. A: The reason for imposing final withholding tax (rather than the progressive tax schedule) on cash dividends received by a resident citizen or alien from a domestic corporation is to ensure the collection of income tax on said income. If we subject the dividend to the progressive tax rate, which can only be done through the filing on income tax returns, there is no assurance that the taxpayer will declare the income, especially when there are other items of gross income earned during the year. It would be extremely difficult for the BIR to monitor compliance considering the huge number of stockholders. By shifting the responsibility to remit the tax to the corporation, it is very easy to check compliance because there are fewer withholding agents compared to the number of income recipients. Likewise, the imposition of a final withholding tax will make the tax available to the government at an earlier time. Finally, the final withholding tax will be a sure revenue to the government unlike when the dividend is treated as a returnable income where the recipient

37 thereof who is in a tax loss position is given the change too offset such loss against dividend income thereby depriving the government of the tax on said dividend income. Q: What are disguised dividends in income taxation? Give an example. A: Disguised dividends are those income payment made by a domestic corporation, which is a subsidiary of a non-resident foreign corporation, to the latter ostensibly for services rendered by the latter to the former, but which payments are disproportionately larger than the actual value of the services rendered. In such case, the amount over and above the true value of the service rendered shall be treated as a dividend, and shall be subjected to the corresponding tax of 35% on Philippine sourced gross income, or such other preferential rate as may be provided under a corresponding Tax Treaty. Example: Royalty payments under a corresponding licensing agreement. Q: The MKB-Phils is a BOI-registered domestic corporation licensed by the MKB of the United Kingdom to distribute, support and use in the Philippines its computer software systems, including basic and related materials for banks. The MKB-Phils provides consultancy and technical services, incidental thereto by entering into licensing agreements with banks. Under such agreements, the MKB-Phils will not acquire any proprietary rights in the licensed systems. The MKB-Phils pays royalty to the MKB-UK, net of 15% withholding tax prescribed by the RP-UK Tax Treaty. Is the income of the MKB-Phils under the licensing agreement with banks considered royalty subject to 20% final withholding tax? Why? If not, what kind of tax will its income be subject to? Explain. A: Yes. The income of MKB-Phils under the licensing agreement with banks shall be considered as royalty subject to 20% final withholding tax. The term royalty is broad enough to include technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme (Sec. 42[4][f], NIRC). Accordingly, the consultancy and technical services rendered by MKB-Phils which are incidental to the distribution, support and use of the computer systems of MKB-UK are taxable as royalty. Q: X is employed as security guard o Excel Supermarket, Inc. X lives in a room within the compound of Excel but he is not charged any rent. The rental value of the room is P300.00 a month. X wants your opinion on whether BIR can tax the value of the free use of his room. A: The rental value of the room is not taxable. Section 2.2 of the Revenue Audit Memorandum Order No. 1-87 provides that if the lodging is furnished in the business premises of the employer and the employee is required to accept such lodging as a condition of his employment, then the value of said lodging will be not taxable. It is merely for the convenience, comfort and pleasure of the employer. Q: Onyoc, an amateur boxer, won in a boxing competition sponsored by the Gold Cup Boxing Council, a sports association duly accredited by the Philippine Boxing Association. Onyoc received the amount of P500,000 as his prize which was donated by Ayala Land Corporation. The BIR tried to collect income tax on the amount received by Onyoc and donor’s tax from Ayala Land Corporation, which taxes, Onyoc and Ayala Land Corporation refuse to pay. Decide.

38 A: The prize will not constitute a taxable income to Onyoc; hence, the BIR is not correct in imposing the income tax R.A. No. 7549 explicitly provides that “All prized and awards granted to athletes in local and international sports tournaments and competitions held in the Philippines or abroad and sanctioned by their respective national sports associations shall be exempt from income tax.” Neither is the BIR correct in collecting the donor’s tax from Ayala Land Corporation. The law is clear when it categorically stated that the donor of said prizes and awards shall be exempt from the payment of the donor’s tax. Q: Evelyn is a graduate student of U.P. In January 1991, she won the Palanca Award for an outstanding short story she wrote. The award was P25,000.00 in cash. In February, 1991, she was also named Most Valuable Player of the Varsity volleyball team and she was given a trophy plus P10,000.00. Finally, in March 1991, she received a Fellowship Award from the University of California to pursue a master’s degree in American literature. The fellowship is for $10,000.00 plus free board and lodging for two (2) semesters. Should Evelyn include these awards and fellowship in her gross income? Reason. A: Gross income include prizes and winnings (Sec. 27, NIRC), except those stated in Section 28B(8), (E) of the NIRC, to wit: “(E) Prizes and awards made primarily in recognition of religious charitable, scientific, educational, artistic, literary, or civil achievement but only if: i. The recipient was selected without any action on his part to enter the contest or proceeding; and ii. The recipient is not required to render substantial future services as a condition to receiving the prize or award.” The first award granted to Evelyn was a Palanca award. This kind of award requires submission of literary works. Hence, this is included in the gross income because it fails to meet the legal requisites provided for in the afore-quoted provisions of law specifically item (i). The second award granted to Evelyn was the Most Valuable Player Award. In this kind of award, Evelyn did not file any application to enter into any contest. The award was given to her in recognition for her outstanding performance in the field of sports. However, the recognition in the field of sports is not among those stated in the afore-quoted provision of law. Thus, the award granted to her does not fall under the afore-quoted provision of law. The last award granted to her was the Fellowship Award. This requires also submission of application to quality for such award. Hence, it fails to meet the necessary requisites of the afore-quoted provision of law specifically item (1). Q: Is the prize of one million pesos awarded by the Reader’s Digest subject to withholding tax? Who is responsible for withholding the tax? What are the liabilities for failure to withhold such tax? A: It depends. If the prize is considered as winning derived from sources within the Philippines, it is subject to withholding of final tax (Sec. 24[B] in relation to Sec. 57[A], NIRC). If derived from sources without the Philippines, it is not subject to withholding of final tax because the Philippine tax law and regulations could not reach out to foreign

39 jurisdictions. The tax shall be withhold by the Reader’s Digest or local agent who has control over the payment of the prize. Any person required to withhold or who willfully fails to withhold, shall, in addition to the other penalties provided under the Code, be liable upon conviction to a penalty equal to the total amount of tax not withheld (Sec. 251, NIRC). In case of failure to withhold the tax or in case of under withholding, the deficiency tax shall be collected from the payer / withholding agent (1st par., Sec. 2.S7[A], Rev. Regs. No. 2-98). Any person required under the Tax Code or by rules and regulations to withhold taxes at the time or times required by law or rules and regulations shall, in addition to other penalties provided by law, upon conviction be punished by a fine of not less than Ten thousand pesos (Php10,000.00) and suffer imprisonment of not less than one (1) year but not more than ten (10) years (1st par., Sec. 255, NIRC). Q: Jose Miranda, a young artist and designer, received a prize of P100,000.00 for winning in the on-the-spot peace poster contest sponsored by a local Lions Club. Shall the reward be included in the gross income of the recipient for tax purpose? Explain. A: No. It is not includable in the gross income of the recipient because the same is subject to a final tax of 20%, the amount thereof being in excess of P10,000.00 (Sec. 24[B][1], NIRC). The prize constitute a taxable income because it was made primarily in recognition of artistic achievement which he won due to an action on his part to enter the contest (Sec. 32[B][7][c], NIRC). Since it is an on-the-spot contest, it is evident that he must have joined the contest in order to earn the prize or award. Q: Mr. Lajojo is a big-time swindler. In one year he was able to earn P1 million from his swindling activities. When the Commissioner of Internal Revenue discovered his income from swindling, the Commissioner assessed him a deficiency income tax for such income. The lawyer of Mr. Lajojo protested the assessment on the following grounds: 1) The income tax applies only to legal income, not to illegal income; 2) Mr. Lajojo’s receipts from his swindling did not constitute income because he was under obligation to return amount he had swindled, hence, his receipt from swindling was similar to a loan, which is not income, because for every peso borrowed he has a corresponding liability to pay one peso; and 3) If he has to pay the deficiency income tax assessment, there will be hardly anything left to return to the victims of the swindling. How will you rule on each of the three grounds for the protest? Explain. A:1. The contention that the income tax applies to legal income and not to illegal income is not correct. Section 28(a) of the Tax Code includes within the purview of gross income all income from whatever source derived. Hence, the illegality of the income will not preclude the imposition of the income tax thereon. 2. The contention that the receipts from his swindling did not constitute income because of his obligation to return the amount swindled is likewise not correct, When a taxpayer

40 acquires earnings, lawfully or unlawfully, without the consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition, he has received taxable income, even though it may still be claimed that he is not entitled to retain the money, and even thought he may still be adjudged to restore its equivalent (James v. U.S., 366 US 213, 1961). To treat the embezzled funds not as taxable income would perpetuate injustice by relieving embezzlers of the duty of paying income taxes on the money they enrich themselves with through embezzlement, while honest people pay their taxes on every conceivable type of income. 3. The deficiency income tax assessment is a direct tax imposed on the owner which is an excise on the privilege to earn an income. It will not necessarily be paid out of the same income that was subjected to the tax. Mr. Lajojo’s liability to pay the tax is based on his having realized a taxable income from his swindling activities and will not affect his obligation to make restitution. Payment of the tax is a civil obligation imposed by law while restitution is a civil liability arising from a crime. Q: Mr. Osorio, a bank executive, while playing golf with Mr. Perez, a manufacturing firm executive , mentioned to the latter that this (Osorio) bank had just opened a business relationship with a big foreign Importer of goods which Perez’ company manufactures. Perez requested Osorio to introduce him to this foreign Importer and put in a good word for him (Perez), which Osorio did. As a result, Perez was able to make a profitable business deal with the foreign importer. In gratitude, Perez, in behalf of his manufacturing firm, send Osorio an expensive car as a gift. Osorio called Perez and told him that there was really no obligation on the part of Perez or his company to give such an expensive gift. But Perez insisted that Osorio keep the car. The company of Perez deducted the cost of the car as a business expense. The Commissioner of Internal Revenue included the fair market value of the car as income of Osorio who protested that the car was a gift and therefore excluded from income. Who is correct, the Commissioner or Osorio? Explain. A: The Commissioner is correct. The car, having been given to Mr. Osorio in consideration of having introduced Mr. Perez to a foreign imported which resulted to a profitable business deal, is considered to be a compensation for services rendered. The transfer is not a gift because it is not made out of a detached or disinterested generosity but for a benefit accruing to Mr. Perez. The fact that the company of Mr. Perez takes a business deduction for the payment indicates that it was considered as a pay rather than a gift. Hence, the fair market value of the car is includible in the gross income pursuant to Section 28(a)(1) of the Tax Code (See 1974 Federal Tax Handbook, p. 145). A payment though voluntary, if it is in return for services rendered, or proceeds from the constraining force of any moral or legal duty a benefit characterized as a “gift” by the payor (Commissioner v. Duberstein, 363 U.S. 278). Q: An insolvent company had an outstanding obligation of P100,000.00 form a creditor. Since it could not pay the debt, the creditor agreed to accept payment through dacion en pago a property which had a market value P30,000.00. In the dacion en pago document, the balance of the debt was condoned. 1. What is the tax effect on the discharge of the unpaid balance of the obligation

41 on the debtor corporation? 2. Insofar as the creditor is concerned, how is he affected tax-wise as a consequence of the transaction? A:1. The condonation of the unpaid balance of the obligation has the effect of a donation made on the part of the creditor. It is obvious that the creditor merely desires to benefit the debtor and without any consideration therefore cancels the debt, the amount of the debt cancelled is a gift from the creditor to the debtor and need not be included in the latter’s gross income (Sec. 50, Rev. Regs. No. 2). 2. For the difference of P70,000.00, the creditor shall be subject to donor’s tax at the applicable rates provided for under the National Internal Revenue Code. Q: Mr. Francisco borrowed P10,000.00 from his friend, Mr. Gutierrez, payable in one year without interest. When the loan became due, Mr. Francisco told Mr. Gutierrez that he (Mr. Francisco) was unable to pay because of business reverses. Mr. Gutierrez took pity on Mr. Francisco and condoned the loan. Mr. Francisco was solvent at the time he borrowed the P10,000.00 and at the time the loan was condoned. Did Mr. Francisco derive any income from the cancellation or condonation of his indebtedness? Explain. A: No. Mr. Francisco did not derive any income from the cancellation or condonation of his indebtedness. Since it is obvious that the creditor merely desired to benefit the debtor in view of the absence of consideration for the cancellation, the amount of the debt is considered as a gift from the creditor to the debtor and need not be included in the latter’s gross income. Q: During the year, a domestic corporation derived the following items of revenue: (a) gross receipts from a trading business; (b) interests from money placements in the banks; (c) dividends from its stock investments in domestic corporations; (d) gains from stock transactions through the Philippine Stock Exchange; (e) proceeds under an insurance policy in the loss of goods. In preparing the corporate income tax return, what should be the tax treatment on each of the above items? A:The gross receipts from trading business is includible as an item of income in the corporate income tax return and subject to corporate income tax rate based on net income. The other items of revenue will not be included in the corporate income tax return. The interest from money market placements is subject to a final withholding tax of 20% dividends from domestic corporations are exempt from income tax; and gains from stock transactions with the Philippine Stock Exchange are subject to transaction tax which is in lieu of the income tax. The proceeds under an insurance policy on the loss of goods in of an item of income is but merely a return of capital; hence, not taxable. Q: XYZ Foundation is a non-stock, non-profit association duly organized for religious, charitable and social welfare purposes. Last January 3, 2000, it sold a portion of its lot used for religious purposes and utilized the entire proceeds for the construction of a building to house its free Day and Night Care Center for children of single parents. In order to subsidize the expenses of the Day and Night Care Center and to support its religious, charitable and social welfare projects, the

42 Foundation leased the 300 square meter area of the second and third floors of the building for use as a boarding house. The Foundation also operates a canteen and a gift shop within the premises, all the income from which is used actually, directly, and exclusively for the purposes for which the Foundation was organized. 1. Considering the constitutional provision granting tax exemption to non-stock corporations, such as those formed exclusively for religious, charitable or social welfare purposes, explain the meaning of the last paragraph of said Section 30 of the 1997 Tax Code, which states that "Income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities conducted for profit, regardless of the disposition made of such income shall be subject to tax imposed under this Code.” 2. Is the income derived by XYZ Foundation form the sale of a portion of its lot, rentals from its boarding house and the operation of its canteen and gift shop subject to tax? Explain. A: 1. The exemption contemplated in the Constitution covers real estate tax on real properties actually, directly and exclusively used for religious, charitable or social welfare purposes. It does not cover exemption from the imposition of income tax, which is within the context of Section 30 of the Tax Code. As a rule, non-stock, non-profit corporations organized for religious, charitable or social welfare purposes are exempt from income tax on their income received by them as such. However, if these religious charitable or social welfare corporations derive income from their properties or any of their activities conducted for profit, the income tax shall be imposed on said items of income, irrespective of their disposition (Sec. 30, NIRC; Commissioner v. YMCA, G.R. No. 124043, October 14, 1998; CIR v. St. Luke’s Medical Center, G.R. No. 195909, September 26, 2012). 2. Yes, The income derived from the sale of lot and rentals from its boarding house are considered as income from properties which are subject to tax. Likewise, the income from its activities conducted for profit, which are subject to tax. The income tax attaches irrespective of the disposition of these incomes. Q: Explain briefly whether the following items are taxable or non-taxable: (a) income from jueteng; (b) gain arising from expropriation of property; (c) taxes paid and subsequently refunded; (d) recovery of bad debts previously charged off; and (e) gain on the sale of a car used for personal purposes. A: a. It is taxable, The law imposes a tax on ‘income from any source whatever,’ which means that is includes income whether legal or illegal (Sec. 32[A], NIRC). b. Taxable. There is a material gain, not excluded by law, realized out of a closed and completed transaction. Gains from dealings in property are part of gross income (Sec. 32[A][3], NIRC). c. It depends. Taxes paid which are allowed as a deduction from gross income are taxable when subsequently refunded but only to the extent of the income tax benefit of said deduction (Sec. 34[C][1], NIRC). If follows that taxes paid which are not allowed as deduction from gross income, i.e., income tax, donor’s tax and estate tax, are not taxable when refunded. d. Recovery of bad debts previously charged off is taxable to the extent of income tax benefit of said deduction (Sec. 34[E][1], NIRC). e. Gain on the sale of a car used for personal purposes is taxable. This is a gain derived

43 from dealing in property which is part of the taxpayer’s gross income (Sec. 32[A][3], NIRC). There is a materials gain, not excluded by law, realized out of a closed and completed transaction. Q: State with reasons the tax treatment of the following in the preparation of annual income tax returns: 1. Proceeds of life insurance received by a child as irrevocable beneficiary; 2. 13th month pay and de minimis benefits; 3. Dividends received by a domestic corporation from (i) another domestic corporation; and (ii) a foreign corporations; 4. Interest on deposits with (i) BPI Family Bank; and (ii) a local offshore banking unit of a foreign bank; 5. Income realized from sale of (i) capital assets, and (ii) ordinary assets. A: 1. The proceeds of life insurance received by a child as irrevocable beneficiary are not to be reported in the annual income tax return, because they are excluded from gross income. This kind of receipt does not fall within the definition of income – “any wealth which flows into the taxpayer other than a mere return of capital.” Since insurance is compensatory in nature, the receipt is merely considered as a return of capital (Sec. 32 [B][1], NIRC); Fisher v. Trinidad, 43 Phil. 73 [1992]). 2. 13th month pay is excluded from gross income for income tax purposes to the extent of P30,000. Any excess will be included in the gross income as part of gross compensation income (Sec. 32[B][7][e], NIRC). 3.i. De minimis benefits are non-taxable fringe benefits. They are not to be reported in the income tax return because they are tax exempt. They are also exempt from the imposition of the fringe benefits tax (Sec. 33[C], NIRC). 3.ii. Dividends received by a domestic corporation from another domestic corporation are not subject to income tax; hence, should not be declared in the income tax return (Se. 27[D][4], NIRC). 4.i. Dividends received by a domestic corporation from a foreign corporation are subject to income tax and shall form part of the gross income. There is no law exempting this type of dividend from income tax (Sec. 32[7], NIRC). 4.ii. Interest on deposit with BPI Family Bank is a passive income subject to a final withholding tax rate of 20% the interest on deposit with a local offshore banking unit of a foreign bank is a passive income subject to a final withholding tax rate of 7.5% (Sec. 24[B][1],NIRC). Both interest incomes are not to be declared as part of gross income in the income tax return. 5.i. Generally, income realized from the sale of capital assets are not to be reported in the income tax return, as they are already subject to final taxes (capital gains tax on real property located in the Philippines and shares of stocks of a domestic corporation). What are to be reported in the annual income tax return are the capital gains derived from the disposition of capital assets other than real property located in the Philippines or shares of stocks in domestic corporations which are not subject to final taxes. 5.ii. Income realized from the sale of ordinary assets is taxable and the said income shall be declared in the annual income tax return. The income constitutes either income derived from the conduct of trade or business or a gain derived from dealings in property (Sec. 32[A][2] and [3], NIRC).

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45 CHAPTER VI: EXCLUSIONS FROM GROSS INCOME Q: On 30 June 2000, X took out a life insurance policy on his own life in the amount of P2,000,000.00 He designated his wife, Y, as irrevocable beneficiary to P1,000,000.00 and his son, Z, to the balance of P1,000,000.00, but in a latter designation, reserving his right to substitute him for another. On 1 September 2003, X died and his wife and son went to the insurer to collect the proceeds of X’s life insurance policy. Are the proceeds of the insurance subject to income tax on the part of Y and Z for their respective shares? Explain. A: No. The law explicitly provides that proceeds of life insurance policies paid to the heirs or beneficiaries upon the death of the insured are excluded from gross income and is exempt from taxation. The proceeds of life insurance received upon death of the insured constitutes a compensation for the loss of life; hence, a return of capital, which is beyond the scope of income taxation (Sec. 32[B][1], NIRC). [NOTE: The reservation as to his right to designate or substitute the beneficiary for another is not important for income tax purposes, although it is material for estate tax purposes.] Q: X, while driving home from his office, was seriously injured when his automobile was bumped from behind by a bus driven by a reckless driver. As a result, he had to pay P200,000.00 to his doctor and P100,000.00 to the hospital where he was confined for treatment. He filed a suit against the bus driver and the bus company and was awarded and paid actual damages of P300,000.00 (for his doctor and hospitalization bills), P100,000.00 by way of moral damages, and P50,000.00 for what he had to pay his attorney for bringing his case to court. Which, if any, of the following awards are taxable income to x and which are not? Explain. A: Nothing is taxable. Under the Tax Code, any amount received as compensation for personal injuries or sickness, plus the amounts for any damages received whether by suit or agreement, on account of such injuries or sickness shall be excluded from gross income. Since the entire amount of P450,000.00 received represents award of damages on account of the injuries sustained, all shall be excluded from his gross income. Obviously, these damages are considered by law as mere return of capital (Sec. 32[B][4], NIRC). Q: JR was a passenger on an airline that crashed. He survived the accident but sustained serious physical injuries which required hospitalization for 3 months. Following negotiations with the airline and its insurer, an agreement was reached under terms of which JR was paid the following amounts: P500,000.00 for his hospitalization; P250,000.00 as moral damages; P300,000.00 for loss of income during the period of his treatment and recuperation. In addition, JR received from his employer the amount of P200,000.00, presenting the cash equivalent of his earned vacation and sick leaves. Which, if any, of the amounts he received are subject to income tax? Explain. A: The amount of P200,000.00 that JR received from his employer is subject to income tax, except the money equivalent of ten (10) days unutilized vacation leave credits which is not taxable. Amounts of vacation allowances or sick leave credits which are paid to an employee constitutes compensation (Sec. 2.78[A][7], Rev. Regs. No. 2-98, as amended by Rev. Regs

46 No. 10-2000). The amounts that JR received from the airlines are excluded from gross income and not subject to income tax because they are compensation for personal injuries suffered from an accident as well as damages received as a result of an agreement on account of such injuries (Sec. 32[B][4], NIRC). Q: Company A decides to close its operations due to continuing losses and to terminate the services of its employees. Under the Labor Code, employees who are separated from service for such cause are entitled to minimum of one-half month pay for every year of service. Company A paid the equivalent of one month pay for every year of service and the cash equivalent of unused vacation and sick leaves as separation benefits. Are such benefits taxable and subject to withholding tax under the Tax Code? Decide with reasons. A: The separation benefits paid by Company A to its employees are excluded from gross income, being in the nature of benefits given to employees whose services were terminated due to causes beyond their control (Sec. 32[B][6][b], NIRC). The entire benefits, thus, are not taxable and not subject to withholding tax under the Tax Code. Q: A group of philanthropists organized a non-stock, non-profit hospital for charitable purposes to provide medical services to the poor. The hospital also accepted paying patients although none of its income accrued to any private individual; all income were plowed back for the hospital’s use and not more than 30% of its funds were used for administrative purposes. Is the hospital subject to tax on its income? If it is, at what rate? A: Yes, a non-stock, non-profit hospital organized for charitable purpose, although generally exempt from income tax, becomes taxable on income derived from activities conducted for profit. Services rendered to paying patients are considered activities conducted for profit which are subject to income tax, regardless of the disposition of the said income. The rate is 10% of net income, considering that the income earned appears to be derived solely from hospital-related activities (CIR v. St. Luke’s Medical Center, ibid). Private educational institution that engages in profitable undertaking is subject to tax. – A private educational institution which deviates from its purely educational purposes and activities shall be treated like any private domestic corporation engaged in business for profit with respect to income derived there from. The protective mantle of income tax benefit or exemption cannot be extended to a private educational institution which chooses to descend from its high pedestal of tax preference or immunity to the level of an ordinary private corporation engaged in profitable undertaking or business (Xavier School, Inc. v. Commissioner, CTA Case 1682, October 8, 1969). Q: 1. X, an employee of ABC Corporation died. ABC Corporation gave X’s widow an amount equivalent to X’s salary for one year. 2. Is the amount considered taxable income to the widow? Why? 3. Is said amount subject to tax? Explain. A: 1. No. the amount received by the widow from the decedent’s employer may either be a gift or a separation benefit on account of death. Both are exclusions from gross income pursuant to provisions of Section 28(b) of the Tax Code. 2. A, an employee of the Court of Appeals, retired upon reaching the compulsory age of 65

47 years. Upon compulsory retirement, A received the money value of his accumulated leave credits in the amount of P 500,000.00. 3. No. The commutation of leave credits, more commonly known as terminal leave pay, i.e., the cash equivalent of accumulated vacation and sick leave credits given to an officer or employee who retires, or separated from the service through no fault of his own, is exempt from income tax (BIR Ruling No. 238-91, November 8, 1991; Commissioner v. Castañeda, G.R. No. 96016, October 17, 1991). Q: Maribel Santos, a retired public school teacher, relies on her pension from the GSIS and the interest income from a time deposit of P 500,000.00 with ABC bank. Is Miss Santos liable to pay any tax on her income? A: Maribel Santos is exempt from tax on the pension from the GSIS (Sec. 28[b][7][F], NIRC). However, as regards her time deposit, the interest she receives thereon is subject to 20% final withholding tax (Sec. 21[a][c], NIRC). Q: X owns a half-hectare property in Bacoor, Cavite which in 1980 was expropriated by the national government, through the Department of Public Works and Highways. After 10 years, X was paid P 2,000,000.00 as just compensation plus 6% annual interest by the DPWH but minus the withholding tax. Is the action of DPWH proper? Reason. A: No, the action of DPWH is not proper. In the case of Province of Tayabas v. Perez (66 Phil. 467), just compensation was defined as “the just and complete equivalent of the loss which the owner of a thing expropriated has to suffer by reason of the expropriation.” Further, in BIR Ruling No. 61-91, “just compensation” was defined as that which is paid by the Government equivalent to the value of the property at the time of its taking. It is the fair and full equivalent for the indemnity. Based on the foregoing it is clear therefore that the amount received after 10 years as just compensation is not in any way a profit, gain or income on the part of X, in the same vein, the 6% annual interest paid by DPWH is not income. The same partakes of the nature of a penalty or indemnity due and accruing to X for having been deprived of the use and benefit by not being paid of the fair market value of the property since its taking 10 years ago. Hence, the DPWH should not have withheld taxes. Q: The employees of Travelers, Inc. staged a strike. X, a non-union member joined the strike and volunteered to picket the company premises from 8:00 A.M. to 12: P.M. Monday to Friday. Six months into the strike. X ran out of money and asked financial aid from the union since he has no other source of income and needed financial assistance in order to live. The union gave him P 1,000.00 a month to take care of his food requirements plus P 500.00 to take care of his monthly rent. When X filed his return, he excluded these benefits from his gross income. The exclusion was denied by the BIR. Decide. A: The P 1,500.00 is not compensation income because compensation income arises out of employer-employee relationship as payment for services without compensation. The P 1,500.00 is a gift from the labor union. According to Section 28(b)(3) of the NIRC, gifts are to be excluded from gross income. Thus, the BIR’s denial is not valid.

48 Q: Born of a poor family on 14 February 1944, Mario worked his way through college. After working for more than 2 years in X Manufacturing Corporation, Mario decided to retire and avail of the benefits under the very reasonable retirement plan maintained by his employer. He planned to invest whatever retirement benefits he would receive in a business that will provide his employer with the needed raw materials. On the day of his retirement on 30 April 1985, he received P 400,000.00 as retirement benefit. In addition, his endowment insurance policy, for which he was paying an annual premium of P 1,520.00 since 1965, also matured. He was then paid the face value of his insurance policy in the amount of P 50,000.00. 1. Is Mario’s P 400,000.00 retirement benefit subject to income tax? 2. Is his P 50,000.00 insurance proceeds exempt from income taxation? A: 1. Mario’s P 400,000.00 retirement benefit is subject to income tax. To be exempt, the retirement pay must have been extended to an employee who is at least 50 years of age and who would have worked for at least ten (10) years with the employer. The amount cannot be considered as a separation pay that would have exempted benefits from income tax since it was Mario who had decided to retire instead of being required to do so (Sec. 28, NIRC). 2. The P 50,000.00 insurance proceeds is not totally exempt from income tax. The excluded amount is only that portion which corresponds to the premiums that he had paid since 1965. At the rate of P 1,520.00 per year multiplied by twenty (20) years which was the period of the policy, he must have paid a total of P 30,400.00. Accordingly, he will be subject to report as taxable income the amount of P 19,6000.00 (Sec. 28, NIRC). Q: Delstar Emmanuel Perez, a government employee, retires from the service upon reaching the compulsory retirement age of 65. Would the amount he is entitled to receive by way of commutation of his accumulated leave credits, of his terminal leave pay, be subject to income tax? A: The amount that Emmanuel Perez is to receive should not be subjected to income tax, and such was the ruling by the Supreme Court in the Re: Zialcita Administrative Case (Adm. Matter No. 90-6015-SC, October 18, 1990). The ruling apparently repudiated, or at least is inconsistent with, its earlier decision in Commissioner v. Victoriano, G.R. No. 83176, August 10, 1989. Q: Pedro Reyes, an official of Corporation X, asked for an “earlier retirement” because he was emigrating to Australia. He was paid P 2,000,000.00 as separation pay in recognition of is valuable services to the corporation. Juan Cruz, another official of the same company, was separated for occupying a redundant position. He was given P 1,000,000.00 as separation pay. Jose Bautista was separated due to his falling eyesight. He was given P 5,000.00 as separation pay. All the three (3) were not qualified to retire under the BIRapproved pension plan of the corporation. 1. Is the separation pay given to Reyes subject to income tax? 2. How about the separation pay received by Cruz? 3. How about the separation pay received by Bautista? A: 1. The separation pay given to Reyes is subject to income tax as compensation income because it arises from a service rendered pursuant to an employer-employee relationship. It

49 is not considered an exclusion from gross income because the rule in taxation is tax construed in strictissimi juris or the rule on strict interpretation of tax exemptions. 2. The separation pay received by Cruz is not subject to income tax because his separation from the company was involuntary (Sec. 28[b][7], NIRC). 3. The separation pay received by Bautista is likewise not subject to his separation is due to disability, hence involuntary. Under the law, separation pay received through involuntary causes is exempt from taxation. Q: A Co., a Philippine corporation, has two divisions – manufacturing and construction. Due to the economic situation, it had to close its construction division and lay-off the employees in that division. A Co. has a retirement plan approved by the BIR, which requires a minimum of 50 years of age and 10 years of service in the same employer at the time of retirement. There are 2 groups of employees to be laid off: (a)Employees who are at least 50 years of age and has at least 10 years of service at the time of termination of employment; and (b)Employees who do not meet either the age or length of service. A Co. plans to give the following: For category (A) employees – the benefits under the BIR approved plan plus an ex gratia payment of one month of every year of service. For category (B) employees – one month for every year of service. For both categories, the cash equivalent of unused vacation and sick leave credits. A Co. seeks your advice as to whether or not it will subject any of these payments to withholding tax. Explain your advice. A: For category ‘A’ employees, all the benefits received on account of their separation are not subject to income tax; hence, no withholding tax shall be imposed. The benefits received under the BIR-approved plan upon meeting the service requirement and age requirement are explicitly excluded from gross income. The ex gratia payment also qualifies as an exclusion from gross income, being in the nature of benefit received on account of separation due to causes beyond he employees’ control (Sec 32[B], NIRC). The cash equivalent of unused vacation and sick leave credits qualifies as part of separation benefits excluded from gross income (CIR v. Court of Appeals, G.R. No. 96016, October 17, 1991). For category ‘B’ employees, all the benefits received by them will also be exempt from income tax; hence, not subject to withholding tax. These are benefits received on account of separation due to causes beyond the employees’ control, which are specifically excluded from gross income (Sec. 32[B], NIRC). Q: Mr. Jacobo worked for a manufacturing firm. Due to business reverse the firm offered voluntary redundancy program in order to reduce overhead expenses. Under the program an employee who offered to resign would be given separation pay equivalent to his three month’s basic salary for every year of service. Mr. Jacobo accepted the offer and received P 400,000.00 as separation pay under the program.

50 After all the employees who accepted the offer were paid, the firm found its overhead still excessive. Hence it adopted another redundancy program. Various unprofitable departments were closed. As a result, Mr. Kintanar was separated from the service. He also received P 400,000.00 as separation pay. Did Mr. Jacobo derive income when he received his separation pay? Explain. A: Yes, Mr. Jacobo derived a taxable income when he received his separation pay because his separation from employment was voluntary on his part in view of his offer to resign. What is excluded from gross income is any amount received by an official or employees as a consequence of separation of such official or employee from the service of the employer for any cause beyond the control of the said official or employee (Sec. 28, NIRC). Q: Mr. Quiroz worked as chief accountant of a hospital for forty-five years. When he retired at 65 he received retirement pay equivalent to two months’ salary for every year of service as provided in the hospital BIR approved retirement plan. The Board of Directors of the hospital felt that the hospital should give Quiroz more than what was provided for in the hospital’s retirement plan. In view of his loyalty and Invaluable services for forty-five years; hence, it resolved to pay him a gratuity of P1 Million over and above his retirement pay. The Commissioner of Internal Revenue taxed the P1 Million as part of the gross compensation income of Quiroz who protested that it was excluded from income because (a) it was a retirement pay, and (b) it was a gift. 1. Is Mr. Quiroz correct in claiming that the additional P1 Million was retirement pay and therefore excluded from income? Explain. 2. Is Mr. Quiroz correct in claiming that the additional P1 Million was gift and therefore excluded from income? Explain. A:1. No. The additional P1 Million is not a retirement pay but a part of the gross compensation income of Mr. Quiroz. This is not a retirement benefit received in accordance with a reasonable private benefit plan maintained by the employer as it was not paid out of the retirement plan. Accordingly, the amount received in excess of the retirement benefits that he is entitled to receive under the BIR-approved retirement plan would not quality as an exclusion from gross income. 2. No. The amount received was in consideration of his loyalty and invaluable services to the company which is clearly a compensation income received on account of employment. Under the employer’s motivation test, ‘emphasis should be placed on the value of Mr. Quiroz services to the company as the compelling reason for giving him the gravity; hence it should constitute a taxable income. The payment would only qualify as a gift if there is nothing but good will, esteem and kindness’ which motivated the employer to give the gratuity (Stanton v. U.S., 186 F. Supp. 393). Such is not the case in the herein problem. Q: XYZ Foundation is a non-stock, non-profit association duly organized for religious, charitable and social welfare purposes. Last January 3, 2000, it sold a portion of its lot used for religious purposes and utilized the entire proceeds for the construction of a building to house its free Day and Night Care Center for children of single parents. In order to subsidize the expenses of the Day and Night Care Center and to support its religious, charitable and social welfare projects, the Foundation leased the 300 square meter area of the second and third floors of the building for use as a boarding house. The Foundation also operates a canteen and