Taxation-Mamalateo-1

51 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; CIR v. CA and YMCA, 298 SCRA 83). 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. (Sec. 30, NIRC; CA and CIR v. YMCA, ibid.). 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 Register of Deeds refused, claiming that the capital gains tax was not paid. Is the transaction exempt from the capital gains tax? Reason. A: 1. No. Under Section 21(e) in relation to Section 49(a)(4) of the National Internal Revenue Code, the seller is the one liable for the payment of the capital gains tax 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 capital gains tax herein is imposed on X, the seller, and not on the Church. Since payment of the capital gains tax is a condition precedent for the registration of the transfer certificate of 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. 2. No. The tax exemption granted to churches in the Constitution refers to property tax and not to capital gains tax which is an income tax. Besides, the capital gains tax is the liability of the seller X and not the purchaser. Q: Under Article XIV, Section 4(3) of the 1987 Philippine Constitution, all revenue s and assets of non-stock, non-profit education institutions, used actually, directly and exclusively for educational purposes, are exempt from taxes and duties. Are

52 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 incomes are included in the school’s annual information return and duly audited financial statements together with: 1. Certifications from depository banks as to the amount of interest income earned from passive investments not subject to the 20% final withholding tax; 2. Certification of actual, direct and exclusive utilization of said income for education purposes; 3. Board resolution on proposed project to be funded out of the money deposited in banks or placed in money market placements (Finance Department Order No. 149-95, November 24, 1995), 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 Philippine Constitution does not distinguish with respect to the source or origin of the income. The 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 of 1997, that a non-stock and nonprofit 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 source or origin, the Tax Code should not make distinctions.

53 CHAPTER VII: RETURN OF CAPITAL Q: In 1990, X started constructing a commercial building with spaces for lease to the public. X required Y, a prospective lessee to sign a pre-lease agreement, which principally provided: (a) that the lessee shall extend to the lessor a non-interest bearing loan of P100,000.00 payable within twelve (12) months; and (b) that in consideration of the loan, the lessee shall be given preference in the lease and his rentals shall not be increased while the loan remains unpaid. Upon completion of the building, Y extended the loan of P100,000.00 to X and he was given a space in its ground floor. May the BIR consider the P100,000.00 as taxable income of X? Reason. A: Section 28 of the NIRC defines “gross income” as all income from whatever sources derived including but not limited to the following items: a) Compensation for services, including fees, commissions, and similar items; b) Gross income derived from business; c) Gains derived from dealings in property; d) Interest; e) Rents; f) Royalties; g) Dividends; h) Annuities; i) Prizes and winnings; j) Pensions; and k) Partner’s distributive share of the gross income of general professional partnership. Further, under Section 36 of Revenue Regulations No. 2, “taxable income” in a broad sense means all wealth which flows into the taxpayer other than as a mere return of capital. It includes the forms of the income specifically described as gains and profits, including gains derived from the sale or other disposition of assets. Gross income, means income (in the broad sense) less income which is by statutory provision or otherwise exempt from the tax imposed by law. Applying the above provision of law to the case at bar, the amount P100,000.00, being a loan or an indebtedness, is an outlay, not a taxable income or gain. Q: Distinguish “Exclusion from Gross Income” from “Deductions From Gross Income.” Give an example of each. A: Exclusive from gross income refer to a flow of wealth to the taxpayer which are not treated as part of gross income, for purposes of computing the taxpayer’s taxable income, due to the following reasons: (1) It is exempted by the fundamental law; (2) It is exempted by statute; (3) it does not come within the definition of income (Sec. 61, Rev. Regs. No. 2). Deductions from gross income, on the other hand, are the amounts, which the law allows to be deducted from gross income in order to arrive at net income. Exclusions pertain to the computation of gross income, while deduction pertain to the computation of net income.

54 Exclusions are something received or earned by the taxpayer, which do not form part of gross income while deductions are something spent or paid in earning gross income. Example of an exclusion from gross income is proceeds of life insurance received by the beneficiary upon the death of the insured which is not an income or 13th month pay of an employee not exceeding P30,000.00, which is an income not recognized for tax purposes. Example of a deduction is business rental. Q: Atty. Gambino is a partner in a general professional partnership. The partnership computes its gross revenues, claims deductions allowed under the Tax Code, and distributes the net income to the partners, including Atty. Gambino, in accordance with its articles of partnership. In filing his own income tax return, Atty. Gambino claimed deductions that the partnership did not claim, such as purchase of law books, entertainment expenses, car insurance and car depreciation. The BIR disallowed the deductions. Was the BIR correct? A: No, the BIR is wrong in disallowing the deduction claimed by Atty. Gambino. It appears that the general professional partnership claimed itemized deductions from its gross revenues in arriving at its distributable net income. The share of a partner in the net income of the partnership must be reported by him as part of his gross income from practice of profession and he is allowed to claim further deductions which are reasonable, ordinary and necessary in the practice of profession and were not claimed by the partnership in computing its net income (Sec. 26, NIRC; Rev. Regs. No. 16-2008, February, 2010). [NOTE: The examinee may want to qualify his answer further by citing the rules on (a) purchases of law books, which can be a capital expenditure; (b) entertainment of law books, which can be a capital ceiling for sellers of services; (c) car insurance and depreciation, which are deductible only to the extent that it was used for business or practice of law]. Q: Masarap Food Corporation (MFC) incurred substantial advertising expenses in order to protect its brand franchise for one of its line products. In its income tax return, MFC included he advertising expense as deduction from gross income, claiming it as an ordinary business expense. Is MFC correct? A: In 1995, respondent paid P9.4 million for advertising a product. This was disallowed by the BIR as ordinary and necessary expense and considered the same as capital expenditure, since the amount was staggering, which was incurred to create or maintain some form of goodwill for the taxpayer’s trade or business or for the industry or profession of which the taxpayer is a member. The court held that “goodwill” generally denotes the benefit arising from connection and reputation, and efforts to establish reputation are akin to acquisition of capital assets. Therefore, expenses related thereto are not (ordinary and necessary) business expenses but are capital expenditures (that are not deductible pursuant to the provisions of Section 36 of the Tax Code) (Commissioner v. General Foods Phils., G.R. No. 143672, April 24, 2003). Q: In December 1993, the Sangguniang Bayan authored a Christmas bonus of P3,000.00, a cash gift of P5,000.00, and transportation and representation allowance of P6,000.00 for each of the municipal employees. 1) Is the Christmas bonus subject to any tax? 2) How about the cash gift?

55 3) How about the transportation and representation allowances? A: 1.The Christmas bonus given by the Sangguniang Bayan to the municipal employees is taxable as additional compensation (Sec. 21 [a], NIRC). 2. The cash gift per employee of P5,000.00 being substantial may be considered taxable also. It is n the nature of additional compensation income as it is highly doubtful if municipal governments are authorized to make gifts in substantial sums such as this. It is not furthermore gift of “small value” which employers might give to their employees on special occasions like Christmas – items which could be exempt under BIR Revenue Audit Memorandum Order No. 1-87. [NOTE: It is considered as de minimis benefits under Rev. Regs. No. 3-98, as amended; hence exempt from income tax and fringe benefits tax.] 3. The transportation and representation allowances are actually reimbursements for expenses incurred by the employee for the employer. Said allowances spent by the employee for the employer are designed to enhance the quality of the service that the employer is supposed to perform for its clientele like the people of the municipality. Q: Gold and Silver Corporation gave extra 14th month bonus to all its officials and employees in the total amount of P75 million. When it filed its corporate income tax return the following year, the corporation declared a net operating loss. When the income tax return of the corporation was reviewed by the BIR the following year, it disallowed as item of deduction the P75 million bonus the corporation gave its officials and employees on the ground of unreasonableness. The corporation claimed that the bonus is an ordinary and necessary expense that should be allowed. A: I will rule against the deductibility of the bonus. The extra bonus is both not normal to the business and unreasonable. Admittedly, there is no fixed test for determining the reasonableness of a bonus as an additional compensation. This depends upon many factors, such as the payment must be made in good faith; the character of the taxpayer’s business; the volume and amount of its net earnings; the locality; the type and extent of the services rendered; the salary policy of the corporation; the size of the particular business; the employees’ qualification and contributions to the business venture; and general economic conditions (C.M. Hoskins & Co., Inc. v. CIR, 30 SCRA 434 [1969]). Giving an extra bonus at a time that the company suffers operating loss is not a payment in good faith and is not normal to the business; hence unreasonable and not qualify as ordinary and necessary expense. Q: X just hurdled the bar examinations and immediately engaged in the practice of law. In preparing his income tax return he listed the following as deductible items: (a) fees paid to the Supreme Court to be able to take the bar examinations; (b) fees paid to a law school to enroll in its pre-bar review classes; (c) malpractice insurance; and (d) amount spent to entertain a judge who decided his first case. Which deductions are allowable? Reason. A: Section 29 of the National Internal Revenue Code on deductions, among other things, provide: “(a) Expenses

56 1) Business Expenses (a) In General – All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. Including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses while away from home in the pursuit of a trade, profession or business: rentals or other payments required to be made as a condition to the continued use or possession, for the purpose of the trade, profession or business of property to which the taxpayer has not taken nor is not taking title or in which he has no equity.” Further, Section 69 of Revenue Regulations No. 2, as amended, otherwise known as “Income Tax Regulations,” reads: “Sec. 69. Professional Expenses - A professional may claim as deductions the cost of supplies used by him or in the practice of his profession, expenses paid in the operation and repair of transportation equipment used in making professional calls, dues not professional societies and subscriptions to professional journals; the rent paid for office rooms, the expenses of the fuel, light, water, telephone, etc. used on such offices, and me hire of office assistants. Amounts currently expended for books, furniture and professional instruments and equipment, the useful life of which is short, may be deducted. But amounts expended for books, furniture and professional instruments and equipment of a permanent character are not allowable deductions.” From the foregoing provisions of law that ordinary and necessary expenses incurred during a taxable year pertaining directly to the practice of a profession may be allowed as deductions, it may be inferred from a keen reading of Section 69 of Revenue Regulations No. 2 that aside from personal exemptions, only direct costs or overhead expenses incurred in the actual practice of a profession may be claimed; i.e., supplies, fuel, light, electricity, salaries, etc. Applying the above considerations in the case at bar, it appears that among the expenses, the same being an ordinary and necessary expense in the pursuit of a profession as defined by Section 29 of the NIRC and further qualified by Revenue Regulations No. 2. The tuition fees for the pre-bar classes and the bar examination fees paid to the Supreme Court by X do not qualify as deductible expenses under Revenue Regulations No. 2. As for the amount spent by X to entertain the Judge who decided his first case, the same may not be claimed as an expense. A business expenses to be deductible must be sustained by adequate proof and that the same must not be against the law or public policy (Consolidated Mines v. Court of Tax Appeals and Commissioner, 58 SCRA 618). Q: X is the Advertising Manager of Mang Douglas Ham, Inc. X had dinner with Y, owner of a chain of burger restaurants, to convince the latter to carry Mang Douglas’ hamburger. After Y agreed, both X and Y went their separate ways. X celebrated by going to as single’s bar. He picked up a partner and consumed a bottle of beer. He drove home at 3:00 a.m. On his way, he sideswiped a pedestrian who died as a result of the accident. X settled the case extra-judicially by paying the heirs of the pedestrian P50,000.00. The money, however, came from Mang Douglas Hamburger, Inc. Discuss whether the P50,000.00 can be claimed by Mang Douglas Hamburger, Inc. as an ordinary and necessary expense. A: No. As the expenditure had not been incurred in carrying on his trade or business, the

57 same cannot be considered an ordinary and necessary expense for which deduction may be claimed. Such expense is a personal expense which is not deductible form the gross income pursuant to Section 36 of the 1997 Tax Code. Q: MC Garcia, a contractor who won the bid for the construction of a public highway, claims as expenses, facilitation fees which according to him are standard operating procedure in transactions with the government. Are these expenses allowable as deduction from gross income? A: No. The alleged facilitation fees which he claims as standard operating procedure in transactions with the government comes in the form of bribes or “kickback” which are not allowed as deductions from gross income (Sec. 34 [A][l][c], NIRC). Q: In order to facilitate the processing of its application for a license from a government office, Corporation A found it necessary to pay the amount of Php100,000 deductible from the gross income of Corporation A? On the other hand, is the Php100,000 taxable income of the approving official? Explain your answers. A: Since the amount of Php100,000 constitutes a bribe, it is not allowed as a deduction from gross income of Corporation “A” (Sec. 34[A][1][c], NIRC). However, to the recipient government official, the same constitutes a taxable income. All income from legal or illegal sources is taxable absent any clear provision of law exempting the same. This is the reason why gross income had been defined to include income derived from whatever source (Sec. 32[A], NIRC). Illegally acquired income constitutes realized income under the claim of right doctrine (Rutkin v. U.S., 343 U.S. 130). Q: (1993) Q: X is the proprietor of Vanguard, which is a security and detective agency. X was able to get the contract to provide the security services of a government agency calling for the deployment of 100 security guards on a 24-hour basis. The director, X gives him at the end of the month P100,000.00 per guard hired. May X deduct from his income the money he paid to the director? Reasons. A: The money to please the director is not deductible. This is a form of bribery. Deductions shall not be allowed if the expense is contrary to law, public policy or for immoral purposes (Zamora v. Commissioner, 8 SCRA 163; Roxas v. CTA and Commissioner, 23 SCRA 276). Q: Are contributions to a candidate in an election subject to donor’s tax? On the part of the contributor, is it allowable as a deduction from gross income? A: 1. No, provided the recipient candidate had complied with the requirement for filing of returns of contributions with the Commission on Elections as required under the Omnibus Election Code. 2. The contributor is not allowed to deduct the contributions because the said expenses is not directly attributable to, the development, management, operation and/or conduct of a trade, business or profession (Sec. 34[A][l][a], NIRC). Furthermore, if the candidate is an incumbent government official or employee, it may even be considered as a bribe or a kickback (Sec. 34[A][l][c], NIRC). Q: Sometime in December 1980, a taxpayer donated to his son 3,000 shares of stock of San Miguel Corporation. For failure to file a donor’s return on the donation

58 within the statutory period, the taxpayer was assessed the sum of P102,000.00, as donor’s tax plus 25% surcharge or P25,500.00 and 20% interest or P20,400,00 which he paid on June 24, 1985. On April 10, 1986, he filed his income tax return for 1985 claiming among others, a deduction for interest amounting to P9,500.00 and reported a taxable income of P96,000.00. On November 10, 1986, the taxpayer filed an amended income tax return for the same calendar year 1985, claiming therein an additional deduction in the amount of P20,400.00 representing interest paid on the donor’s gift tax. A claim for refund of alleged overpaid income tax for 1985 was filed with the Commissioner which was subsequently denied. Upon appeal with the Court of Tax Appeals, the Commissioner took issue with the Court of Tax Appeals’ determination that the amount paid by the taxpayer for interest on his delinquent taxes is deductible from the gross income for the same year pursuant to Section 29 (b)(1) of the National Internal Revenue Code. The Commissioner of Internal Revenue pointed out that a tax is not indebtedness. He argued that there is a fundamental distinction between a “tax” and a “debt”. According to the Commissioner, the deductibility of interest on indebtedness from a person’s income tax cannot extend to interest on taxes. What is your opinion on the argument of the Commissioner that a tax is not indebtedness so that deducibility on the interest on taxes should not be allowed? A: The Commissioner’s argument is misplaced because the interest on the donor’s tax is not one that can be considered as having been incurred in connection with the taxpayer’s trade, business or exercise of profession. Tax obligations constitute indebtedness for purposes of deduction from gross income of the amount of interest paid on indebtedness (CIR v. Palanca, 18 SCRA 496). Although interest payment for delinquent taxes is not deductible as tax, the taxpayer is not precluded from claiming said interest as deduction as such (Collector v. Magalona, L-15802, September 30, 1960). Q: Explain if the following items are deductible from gross income for income tax purposes. Disregard who is the person claiming the expense. 1) Interest on loans used to acquire capital equipment or machinery; 2) Depreciation of good will. A:1. This is a deductible item from gross income. The law gives the taxpayer the option to claim as a deduction or treat as capital expenditure interest incurred to acquire property used in trade, business or exercise of a profession (Sec. 34[B][3], NIRC). 2. Depreciation for goodwill is not allowed as deduction from gross income. While intangibles may be allowed to be depreciated or amortized, it is only allowed to those intangibles whose use in the business or trade is definitely limited in duration (Basilan Estates v. CIR, 21 SCRA 17). Such is not the case with goodwill. Q: A Co., a Philippine corporation, issued preferred shares of stock with the following features: 1. Non-giving;

59 2. Preferred and cumulative dividends at the rate of 10% per annum, whether or not in any period the amount is covered by earnings or projects; 3. In the event of dissolution of the issuer, holders of preferred stock shall be paid in full ratably as the assets of the issuer may permit before any distribution shall be made to common stockholders; and 4. The issuer has the option to redeem the preferred stock. A Co. declared dividends on the preferred stock and claimed the dividends as interest deductible from its gross income for income tax purposes. The BIR disallowed the deduction. A Co. maintains that the preferred shares with their features are really debt and therefore the dividends are really interest. Decide. A: The dividends are not deductible from gross income. Preferred shares shall be considered capital, regardless of the conditions under which such shares are issued and, therefore, dividends paid thereon are not considered “interest” which are allowed to be deducted from the gross income of the corporation (RMC No. 17071, July 12, 1971). Q: “A” is a travelling salesman working full time for Nu Skin Products. He received a monthly salary plus 3% commission on his sales in a Southern province where he is based. He regularly uses his own car to maximize his visits even to far-flung areas. One fine day, a group of militants seized his car. He was notified the following day by the police that the marines and the militants had a bloody encounter and his car was completely destroyed after a grenade hit it. “A” wants to file a claim for casually loss. Explain the legal basis of your tax advice. A: I would advise “A” not to file a claim for casualty loss deduction from gross income, because he derives purely compensation income, which includes the 3% commission on his sales, from his employer. An individual who receives compensation income under an employer- employee relationship is not entitle to any kind of deduction (whether itemized or the standard deduction) from gross income (Sec. 34, NIRC). Indeed, he is allowed to deduct from his gross compensation income only the personal and additional exemptions authorized in Section 35 of the Tax Code. Besides, to be deductible from gross income, casualty loss must relate to a property connected with the trade, business or profession of the taxpayer (Sec. 34[D][2], NIRC). Q: Give the requisites for deductibility of a loss. A: The requisites for deductibility of a loss are: (a) loss belongs to the taxpayer; (b) actually sustained and charged off during the taxable year; (c) evidenced by a closed and completed transaction; (d) not compensated by insurance or other forms of indemnity; (e) not claimed as a deduction for estate tax purposes in case of individuals taxpayers; and (f) if it is a casualty loss it is evidenced by a declaration of loss filed within 45 days with the BIR. Q: X is a traveling salesman in Jolo, Sulu. In the course of this travel, a band of MNLF seized his car by force and used it to kidnap a foreign missionary. The next day, X learned that the military and the MNLF band had a chance encounter. Using heavy weapons, the military fired at the MNLF band that tried to escape with the use of X’s car. All the members of the band died and X’s car was a total wreck. Can X deduct the value of his car from his income as casualty loss? Reason.

60 A: Section 29(1)(c) of the National Internal Revenue Code provides that in cases of individual taxpayers, losses to be deductible must: a) Actually be sustained and charged off within the taxable year; b) Have been incurred in trade, profession or business or in any transaction entered into for profit, though not connected with trade, profession, or business; c) Be evidenced by a closed and completed transaction. Moreover, Section 1 of Revenue Regulations No. 12-77 defined “casualty loss” as a complete or partial destruction of property resulting from an identifiable event of sudden, unexpected, or unusual nature. It denotes accidents, some sudden invasion by hostile agency, and excludes progressive deterioration. Based on the above-mentioned laws the circumstances of the case at bar, the value of the wrecked car is deducible as casualty loss provided the regulations governing substantiation requirements for losses are complied with. Q: Explain if the following items are deductible from gross income for income tax purposes. Disregard who is the person claiming the deduction. 1) Reserves for bad debts; 2) Worthless securities. A: 1. Reserves for bad debts are not allowed as deduction from gross income. Bad debts must be charged off during the taxable year to be allowed as deduction from gross income. The mere setting up of reserves will not give rise to any deduction (Sec. 34[E],NIRC). 2. Worthless securities, which are ordinary assets, are not allowed as deduction from gross income because the loss is not realized. However, if these worthless securities are capital assets, the owner is considered to have incurred a capital assets, the owner is considered to have incurred a capital loss as of the last day of the taxable year and, therefore, deductible to the extent of capital gains (Sec. 34[D][4], NIRC). This deduction, however, is not allowed to a bank or trust company (Sec. 34[E][2], NIRC). Q: PQR Corporation claimed as a deduction in its tax return the amount of P1,000,000.00 as bad debts. The corporation was assessed by the Commissioner of Internal Revenue for deficiency taxes on the ground that the debts cannot be considered as “worthless,” hence, they do not quality as bad debts. The company asks for your advice on “What factors will hold in determining whether or not the debts are bad debts?” Answer and explain briefly. A: In order that debts shall be considered as bad debts because they have become worthless, the taxpayer should establish that during the year for which it became evident in the exercise of sound, objective business judgment that there remained no practical, but only vaguely theoretical , prospect that the debt would ever be paid (Collector of Internal Revenue v. Goodrich International Rubber Co., 21 SCRA 1336 [1967]). “Worthless” is not determined by an inflexible formula or slide rule calculation, but upon the exercise of sound business judgment. The factors to be considered include, but are not limited to, the following: (a) the debtor has no property nor visible income; (b) the debtor has been adjudged bankrupt or insolvent; (c) collateral with small amounts of debts and further action on the accounts would entail expenses exceeding the amounts sought to be collected.

61 Q: 1. What is meant by the “tax benefit rule”? 2. Give an illustration of the application of the tax benefit rule. A: 1. Tax benefit rule states that the taxpayer is obliged to declare as taxable income subsequent recovery of bad debts in the year they were collected to the extent of the tax benefit enjoyed by the taxpayer when the bad debts were written-off and claimed as deduction from gross income. It also applies to taxes previously deducted from gross income but which were subsequently refunded or credited. The taxpayer is also required to report as taxable income the subsequent tax refund or tax credit granted to the extent of the tax benefit of the taxpayer enjoyed when such taxes were previously claimed as deduction from income. 2. X Company has a business connected receivable amounting to P100,000.00 from Y who was declared bankrupt by a competent court. Despite earnest efforts to collect the same, Y was not able to pay, prompting X Company to write-off the entire liability. During the year of write-off, the entire amount was claimed as a deduction for income tax purposes reducing the taxable net income of X Company to only P1,000,000.00. Three 93) years later, Y voluntarily paid his obligation previously written-off to X Company. In the year of recovery, the entire amount constitutes part of gross income of X Company because it was able to get full tax benefit three (3) years earlier. Q: 1. What is the proper allowance for depreciation of any property used in trade or business? 2. What is the annual depreciation of a depreciable fixed asset with a cost of P100,000.00 and an estimated useful life of 20 years and salvage value of P10,000.00 after its useful life? A: 1. The proper allowance of depreciation of any property used in trade or business refers to the reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) said property. The reasonable allowance shall include, but not limited to, an allowance computed under any of the following methods: (a) straight-line method; (b) declining-balance method; (c) sum-of-years-digit method; and (d)any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner of Internal Revenue (Sec. 34[F], NIRC). 2. The annual depreciation of the depreciable fixed asset may be computed on the straightline method which will allow the taxpayer to deduct an annual depreciation of P4,500, arrived at by dividing the depreciable value of P100,000 by the estimated useful life (20 years). Q: The Filipinas Hospital for Crippled Children is a charitable organization. X visited the hospital, on his birthday, as was his custom. He gave P1,000,000.00 to the hospital and P5,000.00 to a crippled girl whom he particularly pitied. A crippled son of X is in the hospital as one of its patients. X wants to exclude both the P100,000.00 and the P5,000.00 from his gross income. Discuss. A: Under Section 29 (h)(1) of the National Internal Revenue Code charitable contributions to be deductible must be: a. Actually paid or made to domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes or for rehabilitation of veterans or

62 to social welfare institutions no part of which inures to the benefits of any private individuals; b. Made within the taxable year; c. Not more than 6% (for individuals) or 3% (for corporations) of the taxpayer’s taxable income to be computed without including the contribution. Applying the above-provisions of law to the case at bar, it is clear therefore that only the P100,000.00 contribution of X to Filipinas Hospital for Crippled Children qualified as a deductible contribution. Section 29(h)(1) of the NIRC expressly provides that the same must be actually paid to a charitable organization to be deductible. Note that the law accorded no privilege to similar contributions extended to private individuals. Hence, the P5,000.00 contribution to the crippled girl cannot be claimed as a deduction. Q: X’s favorite charity organization is the Philippine National Red Cross (PNRC). To raise money, PNRC sponsored a concert featuring the Austria Boys Choir. X advanced P100,000.00 to the PNRC for which he was issued a promissory note. Before its maturity, X cancelled and returned the note to PNRC. An advertising man, X also undertook the promotions of the Austria Boys Choir. Part of the promotions campaign was to ask prominent personalities to publicly donate blood to the PNRC a day before the concert. X himself donated 100cc. of blood. X intends to claim as deductions the value of the note, the cash value of the promotions campaign and the cash value of the blood he donated. Give your legal advice. A: The value of the note can be claimed as deduction as charitable contribution. While the amount was originally a loan, it can be considered to have become a gift or contribution when X cancelled and returned the note to PNRC, a charitable organization. On the other, the cash value of the promotions campaign cannot be claimed as a d deduction. Advertising expenses can only be deducted from the revenues where the expense were incurred. In the case at hand, PNRC is the revenue-producing entity not X. X did not derive any revenue. Thus, the cash value of his promotions campaign cannot be claimed as deduction. Finally, the cash value of the blood donated by X cannot be claimed as deduction. Blood has no monetary value in this case as it is not disbursed in the form of expense. Q: Taxpayers, whose only income consist of salaries and wages from their employers, have long been complaining that they are not allowed to deduct any item from their gross income for purposes of computing their net taxable income. With the passage of the Comprehensive Tax Reform Act of 1997, is this complaint still valid? Explain your answer. A: No more. Gross compensation income earners are now allowed at least an item of deduction in the form of premium payments on health and / or hospitalization insurance in an amount not exceeding P2,400.00 per annum (Sec. 34[M], NIRC). This deduction is allowed if the aggregate family income do not exceed P 250,000.00 and by the spouse, in case of married individual, who claims additional personal exemption for dependents. Q: Ernesto, a Filipino citizen and a practicing lawyer, filed his income tax return for 2007, claiming optional standard deductions. Realizing that he has enough

63 documents to substantiate his profession-connected expenses, he now plans to file an amended income tax return for 2007, in order to claim itemized deductions, since no audit has been commenced by the BIR on the return he previously filed. Will Ernesto to allowed to amend his return? Why or why not? A: Ernesto will not be allowed to file an amended return for 2007, not because of Section 6(A) of the 1997 Tax Code which allows the filing of amended tax return provided that no audit notice has been served upon him by the BIR in the meantime, but because of Section 34 (L) of the Tax Code, which provides that “Such election (of the itemized or standard deduction) when made in the return shall be irrevocable for the taxable year for which the return is made.” Q: Distinguish allowable deductions from personal exemptions. Give an example of an allowable deduction and another example for personal exemption. A: The distinction between allowable deductions and personal exemptions are as follows: 1. As to amount – Allowable deductions generally refer to actual expenses incurred in the pursuit of trade, business or practice of profession while personal exemptions are arbitrary amounts allowed by law. 2. As to nature – Allowable deductions constitute business expenses while personal exemptions pertain to personal expenses. 3. As to purpose – Deductions are allowed to enable the taxpayer to recoup his cost of doing business while personal exemptions are allowed to cover personal, family and living expenses. 4. As to claimants – Allowable deductions can be claimed by all taxpayers, corporate or otherwise, while personal exemptions can be claimed only by individual taxpayers. Q: Mar and Joy got married in 1990. A week before their marriage, Joy received, by way of donation, a condominium unit worth P750,000.00 from her parents. After marriage, some renovations were made at a cost of P150,000.00. The spouses were both employed in 1991 by the same company. On 30 December 1992, their first child was born, and a second child was born on 07 November 1993. In 1994, they sold the condominium unit and bought a new unit. Under the foregoing facts, what were the events in the life of the spouses that had income tax incidence? A: The events in the life of Spouses Mar and Joy, which have income tax incidences, are the following: a. Their marriage in 1990 qualifies them to claim personal exemption for married individuals; b. Their employment in 1991 by the same company will make them liable to the income imposed on gross compensation income; c. Birth of the first child in December 1992 would give rise to an additional exemption of P5,000.00 (now P25,000.00) for the taxable year 1992; d. Birth of their second child in November 1993 would likewise entitle them to claim additional exemption of P5,000.00 (now P25,000.00) raising their additional personal exemptions to P10,000.00 for taxable year 1993;

64 e. Sale of their condominium unit in 1994 shall make the spouses liable to the 5% (now 6%) capital gains tax on the gain presumed to have been realized from the sale. Q: RAM got married to LISA last January 2003. On November 30, 2003, LISA gave birth to twins. Unfortunately, however, LISA died in the course of her delivery. Due to complications, one of the twins also died on December 15, 2003. In preparing his income tax return for the year 2003, what should RAM indicate in the return as his civil status; (a) single; (b) married; (c) head of the family; (d) widower, (e) none of the above? Why Reason. A: RAM should indicate “(b) married” as his civil status in preparing his income tax return for the year 2003. The death of his wife during the year will not change his status because should the spouse die during the taxable year, the taxpayer may still claim the same exemptions (that of being married) as if the spouse died at the close of such year (Sec. 35[c], NIRC). Q: OXY is the president and chief executive officer of ADD Computers, Inc. When OXY was asked to join the government service as director of a bureau under the Department of Trade and Industry, he took a leave of absence from ADD. Believing that its business outlook, goodwill and opportunities improved with OXY in the government, ADD proposed to obtain a policy of insurance on this life. On ethical grounds, OXY objected to the insurance purchase but ADD purchased the policy anyway. Its annual premium amounted to P100,000.00. Is said premium deductible by ADD Computers? Reason. A: No. The premium is not deductible because it is not an ordinary business expense. The term “ordinary” is used in the income tax law in its common significance and it has the connotation of being normal, usual or customary (Deputy v. Du Pont, 308 US 488 [1940]). Paying premium for the insurance of a person not connected to the company is not normal, usual or customary. Another reason for its non-deductibility is the fact that it can be considered as an illegal compensation made to a government employee. This is so because if the insured, his estate or heirs were made as the beneficiary (because of the requirement of insurable interest), the payment of premium will constitute bribes which are not allowed as deduction from gross income (Sec. 34[A][1][c], NIRC). On the other hand, if the company was made the beneficiary, whether directly or indirectly, the premium is not allowed as a deduction from gross income (Sec. 36[A][4], NIRC).

65 CHAPTER VIII: TAX BASES AND RATES Q: ABC, a domestic corporation, sold in 1989 two (2) condominium units of Legaspi Towers in Roxas Boulevard for P8,158,142.00. The corporation declared in its income tax return for taxable year 1989 its gains derived from the sale of two (2) condominium units as follows: UNIT A UNIT B (316.5 sq.ft.) (322 sq.ft.) Proceeds from sale P3,933,679 P4,224,463 Less: (a)Acquisition costs (Deed of Sale 9/9/83) 1,501,295 1,529,755 (b)Payments of Realty Tax 49,248 55,413 Total of (a)(b) 1,550,543 1,585,168 Gains 2,383,136 2,639,295 Without going into computations, answer the following question: Since ABC derived gains from the sale of the condominium units, should it pay the 5% capital gains tax, 35% corporate income tax or none of the above because the corporation is not a real estate dealer? Discuss. A: ABC Corporation must pay the 35% corporate income tax. The National Internal Revenue Code does not provide for the payment by corporations of 5% (now 6%) capital gains tax on the sale of real property, whether considered capital assets or not. Such income is included in the computation of net income (gross taxable income less deductions) and is subject to the tax rate of 35%. [NOTE: Existing law imposes the final tax of 6% on the gain presumed to have been realized on the sale of lands and/or buildings of corporations treated as capital assets. The applicable corporate income tax rate beginning January 1, 2000 under R.A. 8424 is 32% and starting November 1, 2005 under R.A. 9337 is 35%, but starting January 1, 2009, the rate is 30%]. Q: What is the “immediacy test”? Explain briefly.

66 A: To determine the reasonable needs of the business in order to justify an accumulation of earnings (and not impose the 10% tax on improperly accumulated earnings of corporations), the “immediacy test” under American jurisprudence has been adopted in the Philippines. Thus, the term “reasonable needs of the business” is construed to mean the immediate needs of the business to accumulate earnings and profits (instead of declaring dividends to shareholders), including reasonably anticipated needs.

67 CHAPTER IX: ORDINARY ASSETS AND CAPITAL ASSETS Q: Oriental, Inc. holds a proprietary share of Capital Gold Club, Inc. It assigned without any consideration this share to X, one of its foreign consultants, to enable him to use its facilities for the duration of his stay in the Philippines. X signed a Declaration of Trust where he acknowledged that the share is owned by Oriental, Inc. and where he promised to transfer the same to whoever will succeed him as consultant. When X’s contract with Oriental, Inc. expired, he left the Philippines and assigned for free the share to Y, his successor in office. What tax, if any, can be imposed by the BIR on the transaction? A: The BIR cannot impose any tax because there was no real transfer of the ownership of the subject Capitol Golf Club, Inc. (“Capitol”) proprietary share from X to Y. Oriental, Inc. is the true owner of the Capitol proprietary share. It remained the true owner from the time of the Capitol share’s use by X, to the transfer of the Capitol share’s use to Y. Oriental remained the legal owner thereof all throughout, while X and Y are only the beneficial owners. Q: X-land Condominium Corporation was organized by the owners of units in Xland Building Corporation in accordance with the Master Deed with Declaration of Restrictions. The X-land Building Corporation, the developer of the building, conveyed the common areas in favor of the X-land Condominium Corporation. Is the conveyance subject to tax? A: The conveyance is not subject to any tax. The same is without consideration, and not in connection with a sale made to X-land Condominium Corporation, and the purpose of the conveyance to the latter is for the management of the common areas for the common benefit of the unit owners. The same is not subject to income tax since no income was realized as a result of the conveyance, which was made pursuant to the Condominium Act (R.A. 4264), and the purpose of which was merely to vest title to the common areas in favor of the X-land Condominium Corporation. There being no monetary consideration, neither is the conveyance subject to the creditable withholding tax imposed under Resume Regulation No. 1-90, as amended. The second conveyance was actually no conveyance at all because when the units were sold to the various buyers, the common areas were already part and parcel of the sale of said units pursuant to the Condominium Act. However, the Deed of Conveyance is subject to documentary stamp tax. Q: In 1990, Mr. Naval bought a lot for P1,000,000.00 in a subdivision with the intention of building his residence on it. In 1994, he abandoned his plan to build his residence on it because the surrounding area became a depressed area and land values in the subdivision went down; instead, he sold it for P800,000.00. At the time of the sale, the zonal value was P500,000.00. Is the land a capital asset or an ordinary asset? Explain. Is there any income tax due on sale? Explain. A: (1) The land is a capital asset because it is neither for sale in the ordinary course of business nor a property used in the trade or business of the taxpayer (Se. 33, NIRC). Yes, Mr. Naval is liable to the 5 % (now 6%) capital gains tax imposed under Section 21(e) of the Tax Code based on the gross selling price of P800,000.00, which is an amount higher than the zonal value. Q: In January, 1970, Juan Gonzales bought one hectare of agricultural land in Laguna for P100,000. This property has a current fair market value of P10 million in view of the construction of a concrete road traversing the property. Juan Gonzales agrees to exchange his agricultural lot in Laguna for a one-half hectare

68 residential property located in Batangas, with a fair market value of P10 million, owned by Alpha Corporation, a domestic corporation engaged in the buy and sale of real property. Alpha Corporation acquired the property in 2007 for P9 million. What is the nature of the real properties exchanged for tax purposes--capital asset or ordinary asset? Explain. Is Juan Gonzales subject to income tax on the exchange of property? If so, what is the tax base and rate? Explain. Is Alpha Corporation subject to income tax on the exchange of property? If so, what is the tax base and rate? Explain. A: a. The term “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer 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 taxable year, or property held by the taxpayer 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 which is subject to the allowance for depreciation, or real property used in trade or business, of a character which is subject to the allowance for depreciation, or real property used in trade or business of the taxpayer (Sec. 39[A][1], NIRC). Based on the foregoing definition, the agricultural land of Juan Gonzales is a capital asset, while the residential property of Alpha Corporation is an ordinary asset. Yes, Juan Gonzales is subject to the capital gains tax equal to 6% of the gross selling price or fair market value at the time of the exchange, whichever is higher, on the agricultural land in Laguna he exchanged to Alpha Corporation. In this case, the law presumes that Juan Gonzales makes a profit from sale or transfer of property (Sec. 24[D][1], NIRC). Yes, Alpha Corporation is liable to pay corporate income tax on the net taxable income (gross sales less cost of sales and deductions) realized by it from the sale or exchange of its Batangas property for the agricultural land in Laguna owned by Juan Gonzales. The net profit of P1 million (P10 million selling price less P9 million cost) will be added to the other ordinary incomes and from such gross income, business expenses and other allowable deductions will be deducted to arrive at net taxable income for the year to which we will apply the regular corporate income tax rate of 35%. Q:1. What is the difference between capital gains and ordinary gains? What does the term “ordinary income” include? A: 1. Capital gains are gains realized from the sale or exchange of capital assets, while ordinary gains refer to gains realized from the sale or disposition of ordinary assets. The term ordinary income includes any gain from the sale or exchange of property which is not a capital asset. These are the gains derived from the sale or exchange of property such as stock in trade of the taxpayer 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 taxable year, or property held by the taxpayer primarily for sale to customers in the course of his trade or business, or property used in trade or business of a character which is subject to the allowance for depreciation, or real property used in trade or business of the taxpayer (Sec. 22[Z] in relation to Sec. 39[A][1], NIRC). Q: An individual, who owns a ten (10)-door apartment with a monthly rental of P10,000.00 each residential unit, sold this property to another individual taxpayer. Is the seller liable to pay the capital gains tax? A: No. The seller is not liable to pay the capital gains tax because the property sold is an ordinary asset, i.e., real property used in trade or business. It is apparent that the taxpayer is engaged in the real estate business, regularly renting out the 10-door apartment. Q: A corporation, engaged in real estate development, executed deeds of sale on various subdivided lots. One buyer, after going around the subdivision, bought a

69 corner lot with a good view of the surrounding terrain. He paid P1.2 million, and the title to the property was issued. A year later, the value of the lot appreciated to a market value of P1.6 million, and the buyer decided to build his house thereon. Upon inspection, however, he discovered that a huge tower antenna had been erected on the lot frontage totally blocking his view. When he complained, the realty company exchanged his lot with another corner lot with an equal area but affording a better view. Is the buyer liable for capital gains tax on the exchange of the lots? A: Yes, the buyer is subject to capital gains tax on the exchange of lots on the basis of prevailing fair market value of the property transferred at the time of the exchange of the fair market value of the property received, whichever is higher (Sec. 21[e], NIRC). Real property transaction subject to capital gains tax are not limited to sales but also exchanges of property unless exempted by a specific provision of law. Q: A, a doctor by profession, sold in the year 2000 a parcel of land which he bought as a form of investment in 1990 for Php1 million. The land was sold to B, his colleague, at a time when the real estate prices had gone down and so the land was sold only for Php800,000 which was then the fair market value of the land. He used the proceeds to finance his trip to the United States. He claims that he should not be made to pay the 6% final tax because he did not have any actual gain on the sale. Is his contention correct? Why? A: No. The 6% capital gains tax on sale of real property held as capital asset is imposed on the income presumed to have been realized from the sale which is the fair market value or selling price thereof, whichever is higher (Sec. 24[D], NIRC). Actual gain is not required for the imposition of the tax, but it is the gain by fiction of law which is taxable Q: What is the rationale for the rule prohibiting the deduction of capital losses from ordinary gains? Explain. A: Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges (Sec. 39[c], NIRC). Thus, capital losses are not deductible from ordinary gains. The rationale for this rule is that a capital asset refers to property held which is not considered as an ordinary asset. Generally, capital assets are properties of the taxpayer that are not used in his trade or business, as distinguished from ordinary assets which are used in the trade or business of the taxpayer. To allow the deduction of non-business (capital) losses from business (ordinary) income or gain could mean the reduction or even elimination of taxable income of the taxpayer through personal, non-business related expenses, resulting in substantial losses of revenue to the government.

70 CHAPTER X: TAX-FREE EXCHANGES Q: HK Co. is a Hong Kong corporation not doing business in the Philippines. It holds 40% of the shares of A Co., a Philippine company, while the 60% is owned by P Co., a Filipino-owned Philippine corporation. HK Co. also owns 100% of the shares of B Co., an Indonesian company which has a duly licensed Philippine branch. Due to worldwide restructuring of the HK Co. group, HK Co. decided to sell all its shares in A and B Companies. The negotiations for the buy-out and the signing of the Agreement of Sale were all done in the Philippines. The agreement provides that the purchase price shall be subject to withholding tax. Explain your advice. A: P Co. should not subject the payments of the purchase price to withholding tax. While the seller is a non-resident foreign corporation which is not normally required to file returns in the Philippines and therefore, ordinarily all its income earned from Philippine sources is taxed via the withholding tax system, this is not the procedure availing with respect to sales of shares of stock. The capital gains tax on the sale of shares of stock of a domestic corporation is always required to be paid through capital gains tax return filed. The sale of the shares of stock of the Indonesian Corporation is not subject to income tax under our jurisdiction because the income derived therefrom is considered as a foreign-source income. Q: Cebu Development Inc. (CDI) has an authorized capital stock of P5,000,000.00 divided into 50,000 shares with a par value of One Hundred Pesos (P100.00) per share. Of the authorized capital stock, Legaspi is a stockholder of CDI where he has subscription amounting to 13,000 shares. To fully pay his unpaid subscription in the amount of P950,000.00, Mr. Legaspi transferred to the corporation a parcel of land that he owns by virtue of a Deed of Assignment. Upon investigation, the BIR discovered that Mr. Legaspi acquired said property for only P500,000.00. 1) Is Mr. Legaspi liable for any taxable gain? 2) Is the CDI liable for any taxable gain? A: 1) The transfer by Mr. Legaspi to the corporation of the parcel of land in payment of his unpaid subscription did not increase his stockholdings in the corporation. It cannot be said that he acquired control of the corporation by virtue of the transfer of the land. His percentage of the stockholding in the capital stock of the corporation remains the same after the transfer as before. Therefore, Mr. Legaspi derived taxable gain for his economic gain which was realized by virtue of the exchange of the land for the liability for the subscription. CDI itself is not liable for any taxable gain since subscription payments are not considered as taxable income being merely investments in the corporation. However, a taxable incidence may occur as and when the corporation sells the parcel of land for a price over and above the value of the shares of stock or in this case over and above P950,000.00. Until such time, however, there is no realizable income on the part of the corporation. Q: 1) In a qualified tax-free exchange of property for shares under Section 34(c)(2) of the Tax Code, what is the tax basis for computing the capital gains on: (a) the sale of the assets received by the corporation; and (b) the sale of the shares received by the stockholders in exchange of the assets? In a qualified merger under Section 34(c)(2) of the Tax Code, what is the tax basis for computing the capital gains on: (a) thesale of the assets received by the surviving corporation from the absorbed corporation; and (b) the sale of the shares of stock received by the stockholders from the surviving corporation? A: 1) In a qualified tax-free exchange of property for shares of stock under Section 34(c)(2) of the Tax Code, the tax basis for computing the gain on the:

71 sale of the assets received by the corporation shall be the original/historical cost (i.e., purchase price plus expenses of acquisition) of the property/assets given in exchange of the shares of stock. sale of the shares of stock received by the stockholders in exchange of the assets shall be the original/historical cost of the property given in exchange of the shares of stock. In a qualified merger under Section 34(c)(2) of the Tax Code, the tax basis for computing the capital gains on: the sale of the assets received by the surviving corporation from the absorbed corporation shall be the original/historical cost of the assets when still in the hands of the absorbed corporation. the sale of the shares of stock received by the stockholders from the surviving corporation shall be the acquisition/historical cost of assets transferred to the surviving corporation. Q: Three brothers inherited in 1992 a parcel of land valued for real estate tax purposes at P3.0 million which they held in co-ownership. In 1995, they transferred the property to a newly organized corporation as their equity which was placed at the zonal value of P6.0 million. In exchange for the property, the three brothers thus each received shares of stock of the corporation with a total par value of P2.0 million or, altogether, a total of P6.0 million. No business was done by the Corporation, and the property remained idle. In the early part of 1997, one of the brothers, who was in dire need of the funds, sold his shares to the two brothers for P2.0. Is the transaction subject to any internal revenue tax (other than the documentary stamp tax)? A: Yes. The exchange in 1995 is a tax-free exchange so that the subsequent sale of one of the brothers of his shares to the other two (2) brothers in 1997 will be subject to income tax. This is so because the tax-free exchange merely deferred the recognition of income on the exchange transaction. The gain subject to income tax in the sale is measured by the difference between the selling price of the shares transferor at the time of exchange which is the fair market value of his share in the real property at the time of inheritance (Sec. 34[b][2], NIRC). The net gain from the sale of shares of stock is subject to the schedular capital gains tax of 10% for the first P100,000.00 and 20% for the excess thereof (Sec. 21[d], NIRC). [NOTE: The current capital gains tax rates are 5% on the first P100,000.00 net capital gain and 10% on the amount over P100,000.00]. Q: Last July 12, 2000, Mr. and 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: When the real property sold or disposed by a natural person (e.g., citizen or resident alien) is a capital asset and his principal residence, the capital gains presumed to have been realized from the sale or disposition thereof shall be exempt from the 6% capital gains tax, provided that: The proceeds of sale is fully utilized in acquiring or constructing a new principal residence within 18 calendar months from the date of sale or disposition; The Commissioner is duly notified by the taxpayer within 30 days from the date of sale or disposition through a prescribed return of his intention to avail of the tax exemption; and The tax exemption is availed only once every 10 years. 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.

72 CHAPTER XI: ACCOUNTING METHODS AND PERIODS Q: What is the "all events test"? Explain briefly. A: Accrual of income and expense is permitted when the "all events test" has been met. This test requires (1) fixing a right to the income or the liability to pay, and (2) availability of reasonably accurate determination of such income or liability. It does not, however, demand that the amount of income or liability be known absolutely; it only requires that a taxpayer has at its disposal the information necessary to compute the amount with reasonable accuracy, which implies something less than an exact or completely accurate amount. Q: Mr. Javier is a non-resident senior citizen. He receives a monthly pension from the GSIS, which he deposits with the PNB-Makati Branch. Is he exempt from income tax and therefore not required to file an income tax return? A: Mr. Javier is exempt from income tax on his monthly GSIS pension (Sec. 32[B][6][f], NIRC), but not on the interest income that might accrue on the pensions deposited with PNB which are subject to final withholding tax. Consequently, since Mr. Javier's sole taxable income would have been subjected to a final withholding tax, he is not required anymore to file an income tax return (Sec. 51[A][2][c], NIRC). Q: In the year 2000, X worked part time as a waitress in a restaurant in Mega Mall for 8am to 4pm and then as a cashier in a 24-hour convenience store in her neighborhood. The total income of X for the year from the two employees does not exceed her total personal and additional exemption for the year 2000. Was she required to file an income tax return last April? Explain your answer. A: Yes. An individual deriving compensation concurrently from two or more employers at any time during the taxable year shall file an income tax return (Sec. 51[A][2][b], NIRC). Q: Robert Patterson is an American who first arrived in the Philippines in 1944 as a member of the US Armed Forces that liberated the Philippines. After the war he returned to the United States but came back to the Philippines in 1958 and stayed here up to the present. He is presently employed in the United States Naval Base, Olongapo City. For the year 1985, he earned US$10,856.00. Sometime in 1986, the District Revenue Office of the Bureau of Internal Revenue served him a notice, informing him that he did not file his income tax return for the year 1985 and directing him to file said return in 10 days. He refused to file any return claiming that he is not a resident alien and is therefore not required to file any income tax return. Is Patterson's claim correct? A: Patterson's claim is not correct. While Patterson is exempt from income tax, an exemption from income tax does not, however, necessarily mean an exemption likewise from the filing of an income tax return (Garrison v Court of Appeals, 187 SCRA 525). Q: a) How often does a domestic corporation file income tax return for income earned during a single taxable year? Explain the process. b) What is the reason for such procedure? A: a) A domestic corporation is required to file income tax returns four (4) times for income earned during a single taxable year. Quarterly returns are required to be filed for the first three quarters where the corporation shall declare its quarterly summary of gross income and deductions on a cumulative basis (Sec. 75, NIRC). Then, a final adjustment return is required to be filed covering the total taxable income for the entire year, calendar or fiscal (Sec. 76, NIRC).

73 b) The reason for this procedure is to ensure the timeliness of collection tomeet the budgetary needs of the government. Likewise, it is designed to ease the burden on the taxpayer by providing it with an installment payment scheme, rather than requiring the payment of the tax on a lump-sum basis after the end of the year.

74 CHAPTER XII: WITHHOLDING TAXES Q: What is meant by income subject to "final tax"? Give at least two examples of income of resident individuals that is subject to the final tax. A: Income subject to the final tax refers to an income wherein the tax due is fully collected through the withholding tax system. Under this procedure, the payor of the income withholds the tax and remits it to the government as a final settlement of the income tax due on said income. The recepient is no longer required to include the item of income subjected to "final tax" as part of his gross income in his income tax returns. Examples of income subject to final tax are divided income, interest from bank deposits, royalties, etc. Q: Is a non-resident alien who is not engaged in trade or business or in the exercise of profession in the Philippines but who derived rental income from the Philippines required to file an income tax return on April of the year following his receipt of said income? If not, why not? A: No. The income tax on all income derived from Philippine sources by a non-resident alien who is not engaged in trade or business in the Philippines is withheld by the lessee as a Final Withholding Tax (Sec. 57[A], NIRC). The government cannot require persons outside of its territorial jurisdiction to file a return; for this reason, the income tax on income derived from within must be collected through the withholding tax system and thus relieve the recipient of the income the duty to file income tax returns (Sec. 51, NIRC). Q: To start a business of his own, Mr. Mario de Guzman oped for an early retirement from a private company after ten (10) years of service. Pursuant to the company's qualified and approved private retirement plan, he was paid his retirement benefit which was subjected to the withholding tax. Is the employer correct in withholding the tax? Explain. Under what conditions are retirement benefits received by officials and employees of private firms excluded from gross income and exempt from taxation? A: (a) It depends. An employee retiring under a company's qualified and private retirement plan can only be exempt from income tax on his retirement benefits if the following requisites are met: (1) that the retiring employee must have been in service of the same employer for at least 10 years; (2) that he is not less than 50 years of age at the time of retirement; and (3) the benefit is availed of only once. In the instant case, there is no mention whether the employee has likewise complied with requisites number (2) and (3). The conditions to be met in order that retirement benefits received by officials and employees of private firms are excluded from gross income and exempt from taxation are as follows: Under R.A. 4917 (those received under a reasonable private benefit plan): the retiring official or employee must have been in service of the same employer for at least 10 years; that he is not less than 50 years of age at the time of retirement; and that the benefit is availed of only once. Under R.A. 7641 (those received from employers without any retirement plan): Those received under existing collective bargaining agreement and other agreements are exempt; and In the absence of retirement plan or agreement providing for retirement benefits, the benfits are excluded from gross income and exempt from income tax if: (i) retiring employee must have served at least five (5) years; and (ii) that he is not less than 60 years of age but not more than 65.

75 CHAPTER XIII: ESTATE TAX Q: (1) What is the principle of mobilia sequuntur personam? (2) Are donations inter vivos and donations mortis causa subject to estate taxes? A: (1) Principle of mobilia sequuntur personam refers to the principle that taxation of intangible personal property generally follows the residence or domicile of the owner thereof. Donations inter vivos are subject to donor's gift tax (Sec. 91[a], Tax Code) while donations mortis causa are subject to estate tax (Sec. 77, Tax Code). However, donations inter vivos constituted lifetime like transfers in contemplation of death or revocable transfers (Sec. 78[b] and [c], Tax Code) may be taxed for estate tax purposes, the theory being that the transferor's control thereon extends up to the time of his death. Q: John Cerna, Filipino citizen, married to Maria Cerna, died in a vehicular accident in NLEX on July 10, 2007. The spouses owned, among others a 100-hectare agricultural land in Sta. Rosa, Laguna with current fair market value of P20 million, which was subject matter of a Joint Venture Agreement about to be implemented with Star Land Corporation (SLC), a well-known real estate development company. He bought the said real property for P2 million fifty [50] years ago. On January 5, 2208, the administrator of the estate and SLC jointly announced their big plans to start conversion and development of the agricultural lands in Sta. Rosa, Laguna into first-class residential and commercial centers. As a result, the prices of real properties in the locality have doubled. The administrator of the Estate of Jose Cernan filed the estate tax return on January 9, 2008, by including in the gross estate the real property at P2 million. After 9 months, the BIR issued deficiency estate tax assessment, by valuing the real property at P40 million. (a) Is the BIR correct in valuing the real property at P40 million? (b) If you disagree, what is the correct value to be used for estate tax purposes? A: a. No, BIR is wrong in valuing the real property at P40 million. The P40 million represents the value of the real property in 2008, after the announcement by the joint venture partners that development plans would be pursued in the area. The value of the gross estate of the decedent shall be determined by including the value at the time of death in 2007 of all property, real or personal, tangible or intangible, wherever situated (Sec. 85, NIRC). Since the fair market value of the real property at the time of death of Mr. Jose Cerna in 2007 was P20 million, this market value should be the one used for purposes of determining the gross estate. Whatever is the value of the property after his death--whether it increases or decreases-- is of no moment for estate tax purposes. Q: Ralph Donald, an American Citizen, was a top executive of a U.S. company in the Philippines until he retired in 1999. He came to like the Philippines so much that following his retirement, he decided to spend the rest of his life in the country. He applied for and was granted a permanent resident status the following year. In the spring of 2004, while vacationing in Orlando, Florida, USA, he suffered a heart attack and died. At the time of his death, he left the following properties: (a) bank deposits with Citibank Makati and Citibank Orlando, Florida; (b) a rest house in Orlando, Florida; (c) a condominium unit in Makati; (d) shares of stock in the Philippine subsidiary of the U.S. company where he worked; (e) shares of stock in San Miguel Corp. and PLDT; (f) shares of stock in Disney World in Florida; (g) U.S. treasury bonds; and (h) proceeds from a life insurance policy issued by a U.S. corporation. Which of the following assets shall be included in the taxable gross estate in the Philippines? Explain.

76 A: Being a resident of the Philippines at the time of his death, the gross estate of Ralph Donald shall include all his property, real or personal, tangible or intangible, wherever situated at the time of his death (Sec. 85, NIRC). Thus, the following shall be included in his taxable gross estate in the Philippines: a. bank deposits with Citibank Makati and Citibank Orlando, Florida b. a rest house in Orlando, Florida c. a condominium unit in Makati d. shares of stock in the Philippine subsidiary of the U.S. company e. shares in San Miguel Corp. and PLDT f. shares of stock in Disney World in Florida g. U.S. treasury bonds The proceeds from a life insurance policy issued by a U.S. corporation is included as part of the gross estate of Ralph Donald, if the designation of the beneficiary is revocable or irrespective of the nature of the designation, if the designated beneficiary is either the estate of the deceased, his executor or administrator. If the designated beneficiary is other than the estate, executor or administrator and the designation is irrevocable, the proceeds shall not form part of his gross estate (Sec. 85[E], NIRC). Q: Jose Ortiz owns 100 hectares of agricultural land planted to coconut trees. He died on May 30, 1994. Prior to his death, the government, by operation of law, acquired under the Comprehensive Agrarian Reform Law all his agricultural lands except five (5) hectares. Upon the death of Ortiz, his widow asked you how she will consider the 100 hectares of agricultural land in the preparation of the estate tax return. What advice will you give her? A: The 100 hectares of land, which Jose Ortiz owned but which prior to his death on May 30, 1994 were by the government under CARP, are no longer part of his taxable gross estate, with the exception of the remaining five (5) hectares which under Section 78(a) of the Tax Code still forms part of "decedent's interest." Q: Cliff Robertson, an american citizen, was a permanent resident of the Philippines. He died in Miami, Florida. He left 10,000 shares of Meralco, a condominium unit at the Twin Towers Building at Pasig, Metro Manila and a house and lot in Los Angeles, California. What assets shall be included in the Estate Tax Return to be filed with the BIR? A: All of Mr. Robertson's assets, consisting of 10,000 shares in the Meralco, a condominium unit in Pasig, and his house and lot in Los Angeles, California, are taxable. The properties of a resident alien decedent like Mr. Robertson are taxable wherever situated (Secs. 77, 78 and 98, NIRC). Q: Mr. Agustin, 75 years old and suffering from an incurable disease, decided to sell for valuable and sufficient consideration, a house and lot to his son. He died one year later. In the settlement of Mr. Agustin's estate, the BIR argued that the house and lot were transferred in contemplation of death and should therefore form part of the gross estate for estate tax purposes. Is the BIR correct? A: No. The house and lot were not transferred in contemplation of death; therefore, these properties should not form part of the decedent's gross estate. To qualify as a transfer in contemplation of death, the transfer must be either without consideration or for insufficient consideration. Since the house and lot were sold for valuable and sufficient consideration, there is no transfer in contemplation of death for estate tax purposes (Sec. 85[B], NIRC). Q: A, aged 90 years and suffering from incurable cancer, on August 1, 2001 wrote a will and, on the same day, made several inter vivos gifts to his children. Ten days later, he died. In your opinion, are the inter vivos gifts considered transfers in contemplation of death for purposes of determining properties to be included in his gross estate? Explain your answer.

77 A: Yes. When the donor makes his will within a short time of, or simultaneously with, the making of gifts, the gifts are considered as having made in contemplation of death (Roces v. Posadas, 58 Phils. 108). Obviously, the intention of the donor in making the inter vivos gifts is to avoid the imposition of the estate tax and since the donees are likewise his forced heirs who are called upon to inherit, it will create a presumption juris tantum that said donations were made mortis causa; hence, the properties donated shall be included as part of A's estate. Q: In 1999, Xavier purchased from his friend, Yuri, a painting for P500,000. The fair market value of the painting at the time of purchase was P1 million. yuri paid all the corresponding taxes on the transaction. In 2001, Xavier died. In his last will and testament, Xavier bequeathed the painting, already worth P1.5 million, to his only son, Zandro. The will also granted Zandro the power to appoint his wife, Wilma, as successor to the painting in the event of Zandro's death. Sandro died in 2007, and Wilma succeeded to the property. (a) Should the painting be included in the gross estate of Xavier in 2001 and thus, be subject to estate tax? (b) Should the painting be included in the gross estate of Zandro in 2007 and thus, be subject to estate tax? (c) May a vanishing deduction be allowed in either or both of the estates? A: a. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated (Sec. 85, NIRC). Accordingly, the fair market value of the painting in 2001, which was owned by Xavier at the time of his death, should be included in the gross estate of Xavier and be subject to estate tax. The value of the painting in 2007, which was bequeathed by Xavier to Zandro by will in 2001 with power to appoint his wife, Wilma, as successor to the painting, should not be included in the gross estate of Zandro. Only property passing under a general power of appointment is included in the gross estate of the decedent. In this case, the painting has to be transferred by Zandro to his wife, Wilma, based on the will of his father, Xavier, and since the power of appointment granted by Xavier to Zandro is specific (i.e. only to his wife), such property should not be included in his gross estate in 2007. No, vanishing deduction is not available to both Estates of Xavier and Zandro because in the case of Xavier, he acquired the painting by purchase, and in the case of Zandro, the painting shall not be included in his gross estate; hence, there would be no double taxation of the same property, for estate tax purposes. Moreover, the two (2) deaths must occur within a period of five (5) years. In this case, the death of Zandro occurred in 2007, and more than five (5) years have, therefore, elapsed from the date of death of Xavier in 2001. Q: In June 2000, X took out a life insurance policy of his own life in the amount of P2,000,000.00. He designated his son, Z, as his beneficiary with respect to P1,000,000.00, reserving his right to substitute him for another. X died in September 2003. are the proceeds of life insurance to form part of the gross estate of X? Explain. A: Only the proceed of P1,000,000,00 given to the son, Z, shall form part of the gross estate of X. Under the Tax Code, proceeds of life insurance shall form part of the gross estate of the decedent to the extent of the amount receivable by the beneficiary designated in the policy of insurance except when it is expressly stipulated that the designation of the beneficiary is irrevocable. As stated in the problem, only the designation of Y is irrevocable, and the decedent reserved the right to substitute Z as beneficiary for snother person. Accordingly, the proceeds received by Y shall be excluded, while the proceeds received by Z shall be included in the gross estate of X (Sec. 85[E],NIRC). Q: A died, survived by his wife and three children. The estate tax was properly paid and the estate settled and divided and distributed among the four heirs.

78 Later the BIR found out that the estate failed to report the income received by the estate during administration. The BIR issued a deficiency income tax assessment plus interest, surcharges and penalties. Since the 3 children are residing abroad, the BIR sought to collect the full tax deficiency only against the widow. Is the BIR correct? A:Yes. The BIR is correct. In a case where the estate has been distributed to the heirs, the collection remedies available to the BIR in collecting tax liabilities of an estate may either (1) sue all the heirs and collect from each of them the amount of tax proportionate to the, inheritance received or (2) by virtue of the lien created under Section 219, sue only one heir and subject the property he received from the estate to the payment of the estate tax. The BIR, therefore, is correct in pursuing the second remedy although this will give rise to the right of the heir who pays to seek reimbursement from the other heirs (Collector v. Pineda, 21 SCRA 105). In no case, however, can the BIR enforce the tax liability in excess of the share of the widow in the inheritance. Q: While driving his car to Baguio City last month, Pedro Asuncion, together with his wife, Assunta, and only son, Jaime, met an accident that caused the instantaneous death of Jaime. The following day, Assunta also died in a hospital. The spouses and their son had the following assets and liabilities at the time of death: Assunta Exclusive Conjugal Jaime Cash P10,000,000 P1,200,000 Cars 2,000,000 500,000 Land 5,000,000 2,000,000 Residential house 4,000,000 Mortgage payable 2,500,000 Funeral expenses 300,000 a. Is the Estate of Jaime Asuncion liable to estate tax? Explain. b. Is vanishing deduction applicable to the Estate of Assunta Asuncion? Explain. A: a. The Estate of Jaime Asuncion is not liable to estate tax. At the time of death, his gross estate amounted to P1,200,000. Since his estate is entitled to standard deduction of P1 million and funeral expenses equivalent to 5% of his gross estate not exceeding P200,000, plus the fact that the first P200,000 of his net estate is exempt from estate tax, there would be no estate tax due on his net estate. No, there would be no vanishing deduction allowed to the Estate of Assunta Asuncion, since she did not inherit or receive any property from her deceased son, Jaime, that was previously subjected to estate tax or donor's tax. While her estate could be entitled to receive one-half of P1.2 million (or P600,000) cash deposit from her deceased son, this is exempt from estate tax, as explained above. To be entitled to the vanishing deduction, it is important that the property (cash of P600,000 in the instant case) must have been taxed in the estate of a prior decedent.

79 Q: What is vanishing deductions in estate taxation? A: Vanishing deductions or property previously taxed in estate taxation refers to the diminishing deductibility/exemption, at the rate of 20% over a period of five (5) years until it is lost after the fifth year, of any property (situated in the Philippines) forming part of the gross estate, acquired by the decedent from a prior decedent who died within a period of five (5) years from the decedent's death. Q: Vanishing deduction is availed of by taxpayers to: a. correct his accounting records to reflect the actual deductions made; b. reduce his gross income; c. reduce his output value-added tax liability; d. reduce his gross estate. Choose the correct answer. Explain. A: I choose (d), reduce his gross estate. Vanishing deduction or property previously taxed is one of the items of deductions allowed in computing the net estate of a decedent (Sec. 86[A][2] and 86[B][2], NIRC). Q: Mr. Castro inherited from his father, who died in June 10, 1994, several pieces of real property in Metro Manila. The estate tax return was filed and the estate tax due in the amount of P250,000.00 was paid on December 6, 1994. The Tax Fraud Division of the BIR investigated the case on the basis of confidential information given by Mr. Santos on January 6, 1998 that the return filed by Mr. Castro was fraudulent and that he failed to declare all properties left by his father with intent to evade payment of the correct tax. As a result, a deficiency estate tax assessment for P1,250,000.00, inclusive of 50% surcharge for fraud, interest and penalty, was issued against him on January 10, 2001. Mr. Castro protested the assessment, on the ground of prescription. A. Decide Mr. Castro's protest. B. What legal requirement must Mr. Santos comply with so that he can claim his reward? Explain. A: A. The protest should be resolved against Mr. Castro. What was filed is a fraudulent return making the prescriptive period for assessment 10 years from discovery of the fraud (Sec. 222, NIRC). Accordingly, the assessment was issued within the prescriptive period to make an assessment based on a fraudulent return. B. The legal requirements that must be satisfied by Mr. Santos to entitle him to reward are as follows: He should voluntarily file confidential information under oath with the Law Division of the Bureau of Internal Revenue alleging therein the specific violations constituting fraud; The information must not yet be in the possession of the Bureau of Internal Revenue, or refer to a case already pending or previously investigated by the Bureau of internal Revenue; Mr. Santos should not be a government employee or a relative of a government employee within the sixth degree of consanguinity; and The information must result to collections of revenues and/or fines and penalties (Sec. 282, NIRC). Q: a) Discuss the rule on situs of taxation with respect to the imposition of the estate tax on property left behind by a non-resident decedent. Mr. Felix de la Cruz, a bachelor resident citizen, suffered from a heart attack while on a business trip to the USA. He died intestate on June 15, 2000 in New York City, leaving behind real properties situated in New York; his family home in Valle Verde, Pasig City; an office condominium in Makati City; shares of stocks in san Miguel Corporation; cash in bank; and personal belongings. The decedent is

80 heavily insured with Insular Life. He had no known debts at the time of his death. As the sole heir and appointed Administrator, how would you determine the gross estate of the decedent? What deductions may be claimed by the estate and when and where shall the return be filed and estate tax paid? A: a) The value of the gross estate of a non-resident decedent who is a Filipino citizen at the time of his death shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated to the extent of the interest therein of the decedent at the time of his death (Sec. 85[A], NIRC). These properties shall have a situs of taxation in the Philippines; hence, subject to Philippine estate taxes. On the other hand, in the case of a non-resident decedent who at the time of his death was not a citizen of the Philippines, only that part of the entire gross estate which is situated in the Philippines to the extent of the interest therein of the decedent at the time of his death shall be included in his taxable estate, provided that with respect to intangible personal property, we apply the rule of reciprocity. The gross estate shall be determined by including the value at the time of his death all of the properties mentioned, to the extent of interest he had at the time of his death because he is a Filipino citizen (Sec. 85[A], NIRC). With respect to the life insurance proceeds, the amount includible in the gross estate for Philippine tax purposes would be to the extent of the amount receivable by the estate of the deceased, his executor, or administrator, under policies taken out by decedent upon his own life, irrespective of whether or not the insured retained the power of revocation or to the extent of the amount receivable by any beneficiary designated in the policy of insurance, except when it is expressly stipulated that the designation of the beneficiary is irrevocable (Sec. 85[E], NIRC). The deductions that may be claimed by the estate are: The actual funeral expenses or in an amount of equal to five percent (5%) of the gross estate, whichever is lower , but in no case to exceed two hundred thousand pesos (P200,000.00) (Sec. 86[A][1][a],NIRC); The judicial expenses in the testate or intestate proceedings (Sec. 86[A][1], NIRC); The value of the decedent's family home located in Valle Verde, Pasig City in an amount not exceeding one million pesos (P1,000,000.00) and upon presentation of a certification of the barangay captain of the locality that the same has been the decedent's family home (Sec. 86[A][4], NIRC); The standard deduction of P1,000,000.00 (Sec. 86[A][5], NIRC); Medical expenses incurred within one year from death in an amount not exceeding P500,000.00 (Sec. 86[A][6], NIRC). The estate tax return shall be filed within six (6) months from the decedent's death (Sec. 90[B], NIRC), provided that the Commissioner of Internal Revenue shall have authority to grant in meritorious cases, a reasonable extension not exceeding thirty (30) days for filing the return (Sec. 90[C], NIRC). Except in cases where the Commissioner of Internal Revenue otherwise permits, the estate tax return shall be filed with an authorized agent bank, or Revenue District Officer, Collection Officer, or duly authorized Treasurer of Pasig City, the City in which the decedent, Mr. de la Cruz, was domiciled at the time of his death (Sec. 90[D], NIRC).

81 CHAPTER XIV: DONOR’S TAX Q: Celia donated P110,000 to her friend Victoria, who was getting married. Celia gave no other gift during the calendar year. What is the donor's tax implication on Celia's donation? A: Celia shall pay a 30% donor's tax on the P100,000 cash donation, since Victoria, the donee, is a stranger to her. A "stranger" is a person who is not a brother, sister (whether by whole or half-blood), spouse, ancestor and lineal descendant; or a relative by consanguinity in the collateral line within the fourth civil degree of relationship (Sec. 99[B], NIRC). Celia is not entitled to deduct the amount of P10,000 as dowry or gift on account of marriage because that privilege is given only to parents of the donee who is getting married (Sec. 101[A], 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? Assuming the shares of stocks were given to Mr. Y in consideration of his services to the corporation, what are the tax implications? 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 resident employees is not subject to donor’s tax (BIR Ruling No. 018-87, January 26, 1987). 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. 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 an employer-employee relationship; hence, subject to income tax. The par value or stated value of the shares issues also constitutes deductible expense to the corporation, provided it is subjected to withholding tax on wages. Q: Mr. Bill Morgan, a Canadian citizen and a resident of Scarborough, Ontario sends a gift check of $20,000.00 to his future Filipino daughter-in-law who is to be married to his only son in the Philippines. Is the donation by Mr. Morgan subject to tax? Explain. What is the tax consequence, if any, to the donee (Filipino daughter-in-law of Mr. Morgan)? Can you name one kind of gift that is exempt from donor’s tax which is extendible to both residents and non-residents or non-citizens of the Philippines? Include qualifications, if any. A: 1) Yes. While the gift has been made on account of marriage, to qualify for exemption to the extent of the first P10,000.00 of the value thereof, such gift should have been given to a legitimate, recognized natural or adopted child of the donor. The gift, with respect to the donee, is excluded from the gross income and is exempt from income taxation. There is no donee’s gift tax. Gifts made to or for the use of the National Government or any entity created by any of its agencies which is not conducted for profit, or to any political subdivision of the said Government, are exempt from gift tax with respect to both residents and non-residents. Q: In the settlement of the estate of Mr. Barbera who died Intestate, his wife renounced her inheritance and her share of the conjugal property in favor of their

82 children. The BIR determined that there was a taxable gift and thus assessed Mrs. Barbera as a dono. Was the BIR correct? A: The BIR is correct that there was a taxable gift but only insofar as the renunciation of the share of the wife in the conjugal property is concerned. This is a transfer of property without consideration, which takes effect during the lifetime of the transfer/wife, and it thus qualifies as a taxable gift (Rev. Regs. No. 2-2003). Q: Spouses Jose San Pedro and Clara San Pedro, both Filipino citizens, are the owners of a residential house and lot in Quezon City. After the recent wedding of their son, Mario, to Maria, the spouses donated said real property to them. At the time of the donation, the real property has a fair market value of P2 million. Are Mario and Maria subject to income tax for the value of the real property donated to them? Explain. Are Jose and Clara subject to donor’s tax? If so, how much is the taxable gift of each spouse and what rate shall be applied to the gift? Explain. A: a) Mario and Maria, donees, are exempt from income tax on the value of the real property received by them through donation of their parents. The value of the property acquired by gift, bequest, devise, or descent, shall not be included in the gross income of the donees. However, income from such property shall be included in their gross incomes during the year (Sec. 23[B][3], NIRC). Spouses Jose and Clara are subject to donor’s tax on the fair market value (P2 million) of real property donated to their son, Mario, and on the donation made to Mario’s wife, Maria. There are four (4) taxable donations of P500,000 made by the spouses. Donor Jose made P500,000 donation to his son, Mario, and another donation of P500,000 to his daughter-inlaw, Maria. Donor Clara also made P500,000 donation to her son, Mario, and another donation of P500,000 to her daughter-in-law, Maria. Since the donations to their son, Mario, were made by the Spouses Jose and Clara on account of his marriage, Jose and Clara can each deduct P10,000 from his or her gross gift. Their net gifts of P490,000 (P500,000 less P10,000) will be subject to the graduated donor’s tax rates ranging from 2% to 15% (Sec. 99[A], NIRC). With respect to their donations to their daughter-in-law, Maria, their gross gifts of P500,000 shall be subject to the 30% donor’s tax rate, considering that the donee is a stranger in relation to the donors. A “stranger” is a person who is not a: (i) brother, sister (whether by whole or half-blood), spouse, ancestor and lineal ascendant; or (ii) relative by consanguinity to the collateral line within the fourth degree of relationship (Sec. 99[B], NIRC). Q: Ace Tobacco Corporation bought a parcel of land situated at Pateros and donated it to the Municipal Government of Pateros for the sole purpose of devoting the said land as a relocation site for the less fortunate constituents of aid municipality. In accordance therewith, the Municipal Government of Pateros issued to the occupants/beneficiaries Certificates of Award giving to 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 be finally transferred and donated to them. Determine the tax consequence of the foregoing dispositions with respect to Ace Tobacco Corporation, the Municipal Government of Pateros, and the occupants/beneficiaries. A: The donation by Ace Tobacco Corporation is exempt from the donor’s tax because it qualifies as a gift to or for the use of any political subdivision of the National Government (Sec. 101[2], NIRC). The conveyance is likewise exempt from documentary stamp tax because it is a transfer without consideration. Since the donation is to be used as a relocation site for the less fortunate constituents of the municipality, it may be considered as an undertaking for human settlements; hence, the value of the land may be deductible in

83 full from the gross income of Ace Tobacco Corporation if it is in accordance with National Priority Plan determined by the National Economic Development Authority (Sec. 34[H][2][a], NIRC). If the utilization is not in accordance with a National Priority Plan determined by the National Economic Development Authority, then Ace Tobacco Corporation may deduct the value of the land donated only to the extent of five percent (5%) of its taxable income derived from trade or business as computed without the benefit of the donation (Sec. 34[H][2][a] in relation to Sec.34[H][1], NIRC). The Municipality of Pateros is not subject to any donor’s tax on the value of land it subsequently donated, it being exempt from taxes as a political subdivision of the National Government. The occupants/beneficiaries are subject to real property taxes because they now own the land. Q: A, an individual, sold to B, his brother-in-law, his lot with a market value of P1,000,000.00 for P600,000.00. A’s cost in the lot is P100,000.00. b is financially capable of buying the lot. A also owns X Co., which has a fast growing business. A sold some of shares of stock in X Co. to his key executives in X Co. These executives are not related to A. The selling price is P3,000,000.00 which is the book value of the shares sold but with a market value of P5,000,000.00. A’s cost in the shares sold is P1,000,000.00. The purpose of A in selling the shares is to enable his key executives to acquire proprietary interest in the business and have a personal stake in the business. Explain if the above transactions are subject to donor’s tax. A: The first transaction where a lot was sold by A to his brother-in-law for a price below its fair market value will not be subject to donor’s tax if the lot qualifies as a capital asset. The transfer for less than adequate and full consideration which gives rise to a deemed gift, does not apply to a sale of property subject to capital gains tax (Sec. 100, NIRC). However, if the lot sold is an ordinary asset, the excess of the fair market value over the consideration received shall be considered as a gift subject to the donor’s tax. The sale of shares of stock below the fair market value thereof is subject to the donor’s tax pursuant to the provisions of Section 100 of the Tax Code. The excess of the fair market value over the selling price is a deemed gift. Q: Levox corporation wanted to donate P5 million as prize money for the world professional billiard championship to be held in the Philippines. Since the Billiard Sports Federation of the Philippines does not recognize the event, it was held under the auspices of the International Professional Billiards Association, Inc. Is Levox subject to donor’s tax on its donation? A: Yes, since the national sports association for billiards does not sanction the event, and the donation is not included among the exempt donations under the law. Q: On December 6, 2001, LVN Corporation donated a piece of vacant lot situated in Mandaluyong City to an accredited and duly registered non-stock, non-profit educational institution to be used by the latter in building a sports complex for students. May the donor claim in full as deduction from its gross income for the taxable year in 2001 the amount of the donated lot equivalent to its fair market value/zonal value at the time of the donation? Explain your answer. In order that donations to non-stock, non-profit educational institution may be exempt from the donor’s gift tax, what conditions must be met by the donee? A: a. No. Donations and/or contributions made to qualified donee institutions consisting of property other than money shall be based on the acquisition cost of the property. The donor

84 is not entitled to claim as full deduction the fair market value/zonal value of the lot donated (Sec.34[H], NIRC). In order that donations to non-stock, non-profit educational institution may be exempt from the donor’s gift tax, it is required that not more than 30% of the said gifts shall be used by the donee-institution for administration purposes (Sec. 101[A][3], NIRC). Q: In 1991, imeda 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. (1) Is the Christmas gift of P100,000.00 to Imelda’s parents subject to tax? (2) How about the donation to the parish church? (3) How about the donation to the PUP Alumni Association? A: (1) The Christmas gift of P100,000.00 (now P200,000.00) given by Imelda to her parents is taxable up to P50,000.00 (now P100,000.00) because under the law (Sec. 92[a] now Sec. 99[A], NIRC), net gifts not exceeding P50,000 are exempt. The donation of P80,000.00 to the parish church even assuming that it is exclusively for religious purposes is not tax-exempt because the exemption granted under Article VI, Section 28(3) of the Constitution applies only to real estate taxes (Lladoc v. Commissioner, 14 SCRA 292). The donation to the PUP Alumni Association does not also qualify for exemption both under the Constitution and the afore-cited law because it is not an educational or research organization, corporation, institution, foundation or trust. Q: Are contributions to a candidate in an election subject to donor’s ta? On the part of the contributor, is it allowable as a deduction from gross income? A: No, provided the recipient candidate had complied with the requirement for filing of returns of contributions with the Commission on Elections as required under the Omnibus Election Code. The contributor is not allowed to deduct the contributions because the said expense is not directly attributable to, the development, management, operation and/or conduct of a trade, business or profession (Sec. 3[A][1][a], NIRC). Furthermore, if the candidate is an incumbent government official or employee, it may even be considered as bribe or a kickback (Sec. 34[A][1][c], NIRC). Q: Miguel, a citizen and resident of Mexico, donated US$1,000 worth of stocks in Barack Motors Corporation, a Mexican company, to his legitimate son, Miguelito, who is residing in the Philippines and about to be married to a Filipino girlfriend. Mexico does not impose any transfer tax of whatever nature on all gratuitous transfers of property. (a) Is Miguel entitled to claim a dowry exclusion? Why or why not? (b) Is Miguel entitled to the rule of reciprocity in order to be exempt from the Philippine donor’s tax? Why or why not? A: a. Dowries or gifts made on account of marriage and before its celebration or within one year thereafter by parents to each of their legitimate, recognized natural or adopted children to the extent of the first Ten thousand pesos (P10,000) is exempt from donor’s tax (Sec. 101[A], NIRC). To be entitled to the dowry exemption under the donor’s tax law, the donor must be a resident of the Philippines. SInce Miguel is a non-resident alien, he does not qualify to claim such exemption. Miguel is not entitled to the rule of reciprocity in order to be exempt from the Philippine donor’s tax. In the first place, the donation by Miguel, a non-resident Mexican citizen, of the shares of stock of Barack Motors Corporation, a Mexican company, which has not acquired business situs in the Philippines, to his son, Miguelito, is exempt from donor’s tax

85 under Section 104 of the 1997 TAx Code, which provides that “...where the donor was a non-resident alien at the time of his donation, his real and personal property so transferred but which are situated outside the Philippines shall not be included as part of his ‘gross gift.’” In other words, there is nothing to be subject to donor’s tax, and there is no reciprocity rule necessary to claim exemption. Q: Kenneth Yusoph owns a commercial lot which he bought many years ago for P1 million. It is now worth P20 million although the zonal value is only P15 million. He donates one-half pro indiviso interest in the land to his son Dino on 31 December 1994, and the other one-half pro indiviso interest to the same son on 2 January 1995. How much is the value of the gifts in 1994 and 1995 for purposes of computing the gift tax? Explain. The Revenue District Officer questions the splitting of the donations into 1994 and 1995. He says that since there were only two (2) days separating the two (2) donations they should be treated as one, having been made within one year. Is he correct? Explain. Dino subsequently sold the land to a buyer for P20 million. How much did Dino gain on the sale? Explain. Suppose, instead of receiving the lot by way of donation, Dino received it by inheritance. What would be his gain on the sale of the lot for P20 million? Explain. A: (1) The value of the gifts for purposes of computing the gift tax shall be P7.5 million in 1994 and P7.5 million in 1995. In valuing a real property for gift tax purposes the property should be appraised at the higher of two values as of the time of donation which are (a) the fair market value as determined by the Commissioner (which is the zonal value fixed pursuant to Sec.16[e] of the Tax Code), or (b) the fair market value as shown in the schedule of values fixed by the Provincial and City Assessors. The fact that the property is worth P20 million as of the time of donation is immaterial, unless it can be shown that this value is one of the two values mentioned as provided under Section 81 of the Tax Code. The Revenue District Officer is not correct because the computation of the gift tax is cumulative but only insofar as gifts made within the same calendar year. Therefore, there is no legal justification for treating two (2) gifts effected in two (2) separate calendar years as one gift. Dino gained an income of P19 million from the sale. Dino acquires a carry-over basis which is the basis of the property in the hands of the donor or P1 million. The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis for determining gain (Sec. 34[a], NIRC). Since the property was acquired by gift, the basis for determining gain shall be the same as if it would be in the hands of the donor or the last preceding owner by whom the property was not acquired by gift. Hence, the gain is computed by deducting the basis of P1 million from the amount realized which is P20 million. If the commercial lot was received by inheritance the gain from the sale for P20 million is P5 million because the basis is the fair market value as of the date of acquisition. The steppedup basis of P1.5 million which is the value for estate tax purposes is the basis for determining the gain (Sec. 34[b][2], NIRC). Q: Your bachelor client, a Filipino residing in Quezon City, wants give his sister a gift of P200,000. He seeks your advice, for purposes of reducing if not eliminating the donor’s tax on the gift, on whether it is better for him to give all of the P200,000 on Christmas 2001 or to give P100,000 on Christmas 2001 and the other P100,000 on January 1, 2002. Please explain your advice. A: I would advice him to split the donation. Giving the P200,000 as a one-time donation would mean that it will be subject to a higher tax bracket under the graduated tax

86 structure, thereby necessitating the payment of donor’s tax. On the other hand, splitting the donation into two equal amounts of P100,000 given on two (2) different years will totally relieve the donor from the donor’s tax because the first P100,000 donation in the graduated brackets is exempt (Sec. 99, NIRC). While the donor’s tax is computed on the cumulative donations, the aggregation of all donations made by a donor is allowed only over one calendar year. Q: a) When the donee or beneficiary is a stranger, the tax payable by the donor shall be 30% of the net gifts. For purposes of this tax, who is a stranger? What conditions must concur in order that all grants, donations and contributions to non-stock, non-profit private educational institutions may be exempt from the donor’s tax under Section 101(a) of the Tax Code? A: a) A “stranger” is a person who is not a: Brother or sister (whether by whole or half-blood), spouse, ancestor and lineal descendant; or Relative by consanguinity in the collateral line within the fourth degree of relationship (Sec. 98[B], NIRC) The following are the conditions: Not more than 30% of said gifts shall be used by such donee for administration purposes; The educational institution is incorporated as a non-stock, non-profit, paying no dividends, governed by trustees who receive no compensation, and devoting all its income. whether students’ fees or gifts, donations, subsidies or other forms of philanthropy, to the accomplishment and promotion of the purposes enumerated in its Articles of Incorporation (Sec. 101[A][3], NIRC).

87 CHAPTER XV: INTRODUCTION TO VAT Q: Characteristics of Value Added Tax A: 1. It is a tax on the value added by the taxpayer. It is collected through the “tax credit method” or “invoice method.” It is a transparent form of sales tax. It is a broad-based tax on consumption of goods, properties or services in the Philippines as it applies to all stages of manufacture, production, and distribution of goods and services. It is an indirect tax. The Philippines adopted the “separate indication of tax method.” There is no cascading in the value added tax system.

88 CHAPTER XVI: PERSONS LIABLE TO TAX Q: Greenhills Condominium Corporation is an existing non-stock, non-profit association of unit owners in Greenhills Tower, San juan City since 2001. To be able to reduce the association dues being collected from the unit owners, the Board of directors of the corporation agreed to lease part of the ground floor of the condominium building to DEF Savings Bank for P120,000 a month starting January, 2007. Is the non-stock, non-profit association liable to value added tax in 2007? If your answer is in the negative, is it liable to another kind of business tax? Will the association be liable to value added tax in 2008, if it increases the rental to P150,000 a month beginning January, 2008? Explain. A: a. No, Greenhills Condominium Corporation will not be subject to value added tax, since its gross rental income for the year 2007 will be P1,440,000 (P120,000 times 12). The sale or lease of goods or properties or the performance of properties other than the transactions mentioned in the preceding paragraphs, where the gross annual sales and/or receipts do not exceed the amount of One million five hundred thousand pesos (P1,500,000), shall be exempt from value added tax (Sec. 109[V], NIRC). However, it would be subject to the 3% percentage tax on its gross rental income under Section 116 of the Tax Code. Yes. If Greenhills Condominium Corporation increases the monthly rental income to P150,000, it will be subject to the 12% value added tax beginning November 1, 2008, unless it registers as a VAT person effective January 1, 2008. The reason for this is that the gross annual rental income of the association for 2008 would be P1,800,00 (P150,000 times 12) (Sec. 109[V], NIRC). Moreover, the association will be deemed to be engaged in the leasing, despite its being a non-stock, non-profit organization. The phrase “in the course of trade or business” means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person, regardless of whether or not the person engaged therein is a non-stock,non-profit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity (Sec. 105, NIRC). Q: Newtex International (Phils.), Inc. is an American firm duly authorized to engage in business in the Philippines as a branch office. In its activity 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 exporters, Newtex does not generate any income. To finance its office its office expenses here, its head office abroad regularly remits to it the needed amount. To see its operation and manage its office here, which had been in operation for two years, the head office assigned three foreign personnel. Is Newtex subject to VAT? A: Newtex is not subject to VAT. The VAT is imposed on sellers and not on buyers. The branch office did not derive any income or compensation so as to possibly permit the imposition of a value added tax on compensation for services rendered. In addition, since the transactions are direct export sales, the VAT does not apply. Export sales are among those that are either zero-rated or exempt from value added tax (Secs. 99-100,NIRC

89 CHAPTER XVII: OUTPUT TAX ON SALE OF GOODS OR PROPERTIES AND SERVICES Q: Deemed sale A: The following transactions are considered as deemed sales: Transfer, use or consumption not in the course of business of goods or properties originally intended for sale or for use in the course of business; Distribution or transfer to shareholders or investors as share in the profits of the VATregistered persons or to creditors in payment of debt; Consignment of goods, if actual sale is not made within sixty days following the date such goods were consigned; and Retirement from or cessation of business, with respect to inventories of taxable goods existing as of such retirement or cessation. Q: An alien employee of the Asian Development Bank (ADB) who is retiring soon has offered to sell his car to you, which he imported tax-free for his personal use. The privilege of exemption from tax is granted to qualified personal use under the ADB Charter, which is recognized by the tax authorities. If you decide to purchase the car, is the sale subject to tax? Explain. A: Yes. The sale is subject to tax. Section 107(B) of the Tax Code provides that “[I]n the case of tax-free importation of goods into the Philippines by persons, entities or agencies exempt from tax, where such goods are subsequently sold, transferred or exchanged in the Philippines to non-exempt persons or entities, the purchasers, transferees, or recipients shall be considered the importer thereof, who shall be liable for any internal revenue tax on such importation.” Q:State whether the following transactions are (a) VAT exempt; (b) subject to VAT at 10% (now 12%); or (c) subject to VAT at 0%: Sale of fresh vegetables by Aling Ining at the Pamilihang Bayan ng Trece Martirez; Services rendered by Jake’s Construction Company, a contractor to the World Health Organization in the renovation of its offices in Manila; Sale of tractors and other agricultural implements by Bungkal Incorporated to local farmers; Sale of RTW by Cely’s Boutique, a Filipino dress designer, in her dress shop and other outlets; Fees for lodging paid by students to Bahay-Bahayan dormitory (monthly fee P1,500). A: 1. VAT exempt. Sale of agricultural products such as fresh vegetables in their original state, of a kind generally used as, or producing foods for human consumption, is exempt from VAT (Sec. 109[c], NIRC). VAT at 10%. Since Jake’s Construction Company has rendered services to the World Health Organization, which is an entity exempted from taxation under international agreements to which the Philippines is a signatory, the supply of services is subject to zero percent (0%) rate (Sec. 108[B][3], NIRC). VAT at 10%. Tractors and other agricultural implements fall under the definition of goods which include all tangible objects which are capable of pecuniary estimation (Sec. 106[A][1], NIRC), the sales of which are subject to VAT at 10%. This is subject to VAT at 10%. This transaction also falls under the definition of goods, the sales of which are subject to VAT at 10%. VAT exempt. The monthly fee paid by each student falls under the lease of residential units with a monthly rental per unit not exceeding P8,000 (now P10,000), which is exempt from VAT, regardless of the amount of aggregate rentals received by the lessor during the year (Sec. 109[x], NIRC). The term “unit” shall mean per person in the case of dormitories, boarding houses, and bed spaces (Sec. 4.103-1, Rev. Regs. No. 7-95).

90 Q: Your client, United Market Cooperative, is requesting the Commissioner of Internal Revenue to exempt it from the payment of VAT on its purchases of prime commodities from food suppliers/manufacturers on the ground that it is exempt from all taxes, including VAT, under R.A. No. 6938, the Cooperative Code of the Philippines. Do you think our client can obtain the necessary exemption from the BIR? If your answer is in the affirmative, explain the basis for the grant. If your answer is in the negative, state the basis for the rejection of the request. A: 1. An exemption is not necessary. The value added tax is not imposed on the purchaser but on the seller, except in importation of goods. No. The exemption to which the taxpayers are entitled to refers to those that are levied on the exempt taxpayer or directly imposed on the exempted goods. The value added tax is imposed on the sellers of goods and services, not on the purchasers. Q:Royal Mining is a VAT-registered domestic mining entity. One of its products is silver being gold to the Bangko Sentral ng Pilipinas. It filed a claim with the BIR for tax refund on the ground that under Section 106 of the Tax Code, sales of precious metals to the Bangko Sentral are considered export sales subject to zerorated VAT. Is Royal Mining’s claim meritorious? Explain. A:No, Royal Mining’s claim is not meritorious because it is the sale of gold (and not silver) to the BSP that is considered as export sale subject to zero-rated VAT. Q:Emiliano Paupahan is engaged in the business of leasing out several residential apartment units he owns. The monthly rental for each unit ranges from P8,000 to P10,000. His gross rental income for one year is P1,650,000. He consults you on whether it is necessary for him to register as a VAT taxpayer. What legal advice will you give him, and why? A:Since the rental income per unit per month of his apartment units (which ranges from P8,000 to P10,000) does not exceed the threshold provided for in the VAT law in the amount of P10,000, his rental income is exempt from VAT under Section 109(Q) of the 1997 Tax Code. In view, thereof, it does not matter whether or not he has exceeded the general threshold for the preceding twelve months of P1,500,00 prescribed in Section 109(V) of the Tax Code. Thus, my advice is for him not to register as a VAT person. He will be exempt from VAT under Section 109(Q) and for the 3% percentage tax under Section 116 of the Tax Code. Q:Mr. Abraham Eugenio, a pawnshop operator, after having been requested by the Revenue District Officer to pay value added tax pursuant to a Revenue Memorandum Order (RMO) of the Commissioner of Internal Revenue, filed with the Regional Trial Court an action questioning the validity of the RMO. If you were the judge, will you dismiss the case? A:Yes. An RMO is in reality a ruling or an opinion issued by the Commissioner in implementing the provisions of the Tax Code dealing with the taxability of pawnshops. The power to review rulings issued by the Commissioner is lodged with the CTA and not with the RTC. A ruling falls within the purview of “other matters arising under the Tax Code,” appealable only to the CTA (CIR v. Leal, 392 SCRA 9 [2002]). Q: In 2010, pursuant to a Letter of Authority (LA) issued by the Regional Director, Mr. Abcede was assessed deficiency income taxes by the BIR for the year 2009. He paid the deficiency. In 2011, Mr. Abcede received another LA for the same year 2009, this time from the National Investigation Division, on the ground that Mr. Abcede;s 2009 return was fraudulent. Mr. Abcede contested the LA on the ground that he can only be investigated once in a taxable year. Decide.

91 A: The contention of Mr. Abcede is not tenable. While the general rule is to the effect that for income tax purposes, a taxpayer must be subject to examination and inspection by the internal revenue officers only once in a taxable year, this will not apply if there is a fraud, irregularity, or mistakes as determined by the Commissioner. In the instant case, what triggered the second examination is the findings by the BIR that Mr. Abcede’s 2009 return was fraudulent. Accordingly, Mr. Abcede the examination is legally justified. (Sec. 235, NIRC) Q: “A” Co., a Philippine corporation, is a big manufacturer of consumer good and has several suppliers of raw materials. The BIR suspects that some of the suppliers are not properly reporting their income on the sales to “A” Co. The CIR therefore: (a) Issued an access letter to “A” Co. to furnish the BIR information on sales and payment to its suppliers. (b) Issued an access letter to a bank (“X” Bank) to furnish the BIR on deposits of some suppliers of “A” Co. on the alleged ground that the suppliers are committing tax evasion. “A” Co., “X” Bank and the suppliers have not been issued by the BIR letter of authority to examine. “A” Co. and “X” Bank believe that the BIR is on a “fishing expedition” and come to you for counsel. What is your advice? A: I will advice “A” Co. and “X” Bank that the BIR is justified only in getting information from the former but not from the latter. The BIR is authorized to obtain information from the other persons than those whose internal revenue tax liability is subject to audit or investigation. However, this power shall not be constructed as granting the Commissioner the authority to inquire into bank deposits (Sec. 5, NIRC) Q: Can the Commissioner of Internal Revenue inquire into the bank deposits of a taxpayer? If so does this power of the Commissioner conflict with R.A. 1405, Secrecy of Bank Deposits Law? A: The Commissioner of Internal Revenue is authorized to inquire into the bank deposit of: (1) A decedent to determine his gross estate. (2) Any taxpayer who has filed an application for compromise of his tax liability by means of financial incapacity to pay his tax liability (Sec. 6[F], NIRC). The limited power of the Commissioner does not conflict with R.A. No. 1405 because of the provisions of the Tax Code granting this power is an exception to Secrecy of Bank Deposits Law as embodied in a later legislation. Furthermore, in case a taxpayer applies for an application to compromise the payment of his tax liabilities on his claim that his financial position demonstrates a clear inability to pay the tax assessed, his application shall not be considered unless and until he waives in writings his privilege under R.A. 1405, and such waiver shall constitute the authority of the Commissioner to inquire into the bank deposits of the taxpayer. Q:X dies in year 2000 leaving a bank deposit of P 2,000,000.00 under joint account with his associates in a law firm. Learning of X’s death from the newspapers, the Commissioner wrote to every bank in the country asking them to disclose to him the amount of deposits that might be outstanding in his name or jointly with others at the date of his death. May the bank holding the deposit refuse to comply on the ground of the Secrecy of Bank Deposit Law? Explain. A: No. The commissioner has the authority to inquire into bank deposit accounts of a decedent to determine his gross estate notwithstanding the provisions of the Bank Secrecy Law. Hence, the banks holding the deposits in question may not refuse to disclose the amount of deposits on the ground of secretary of bank deposits (Sec. 6 [F], NRC). The fact that the deposit is a joint account will not preclude the Commissioner from inquiring thereon because the law mandates that if a bank has knowledge of the death of a person, who maintained a bank deposit account alone or jointly with another, it shall not allow any

92 withdrawal from the said deposit account, unless the Commissioner has certified that the taxes imposed thereon have been paid (Sec. 97, NIRC0. Hence, to be able to gibe the required certification, the inclusion of the deposit is imperative. Q: A taxpayer is suspected not to have declared his correct gross income in his return filed for 1997. The examiner requested the Commissioner to authorize him to inquire into the bank deposits of the taxpayer so that he could proceed with the net worth method of investigation to establish fraud. May the examiner be allowed to look into the taxpayer’s bank deposits? In what cases may the Commissioner or his duly authorized representative be allowed to inquire or look into the bank deposits of a taxpayer? A: No, as this would be violative of R.A. 1405, the Bank Deposits Secrecy Law. The Commissioner or his duty authorized representative may be allowed to inquire or look into the bank deposits of a taxpayer in the following cases: For the purpose of determining the gross estate of a decedent; Where the taxpayer has filed an application for compromise of his tax liability by reason of financial incapacity to pay such tax liability (Sec. 6[F], NIRC); Where the taxpayer has signed a waiver authorizing the Commissioner or his duly authorized representatives to inquire into the bank deposits.

93 CHAPTER XX: RATES OF VAT Q:Royal Mining is a VAT-registered domestic mining entity. One of its products is silver being gold to the Bangko Sentral ng Pilipinas. It filed a claim with the BIR for tax refund on the ground that under Section 106 of the Tax Code, sales of precious metals to the Bangko Sentral are considered export sales subject to zerorated VAT. Is Royal Mining’s claim meritorious? Explain. A:No, Royal Mining’s claim is not meritorious because it is the sale of gold (and not silver) to the BSP that is considered as export sale subject to zero-rated VAT.

94 CHAPTER XXI: EXEMPT TRANSACTIONS Q:Emiliano Paupahan is engaged in the business of leasing out several residential apartment units he owns. The monthly rental for each unit ranges from P8,000 to P10,000. His gross rental income for one year is P1,650,000. He consults you on whether it is necessary for him to register as a VAT taxpayer. What legal advice will you give him, and why? A:Since the rental income per unit per month of his apartment units (which ranges from P8,000 to P10,000) does not exceed the threshold provided for in the VAT law in the amount of P10,000, his rental income is exempt from VAT under Section 109(Q) of the 1997 Tax Code. In view, thereof, it does not matter whether or not he has exceeded the general threshold for the preceding twelve months of P1,500,00 prescribed in Section 109(V) of the Tax Code. Thus, my advice is for him not to register as a VAT person. He will be exempt from VAT under Section 109(Q) and for the 3% percentage tax under Section 116 of the Tax Code. Q:Mr. Abraham Eugenio, a pawnshop operator, after having been requested by the Revenue District Officer to pay value added tax pursuant to a Revenue Memorandum Order (RMO) of the Commissioner of Internal Revenue, filed with the Regional Trial Court an action questioning the validity of the RMO. If you were the judge, will you dismiss the case? A:Yes. An RMO is in reality a ruling or an opinion issued by the Commissioner in implementing the provisions of the Tax Code dealing with the taxability of pawnshops. The power to review rulings issued by the Commissioner is lodged with the CTA and not with the RTC. A ruling falls within the purview of “other matters arising under the Tax Code,” appealable only to the CTA (CIR v. Leal, 392 SCRA 9 [2002]).

95 CHAPTER XXIV: INTRODUCTION – TAX REMEDIES Q: In 2010, pursuant to a Letter of Authority (LA) issued by the Regional Director, Mr. Abcede was assessed deficiency income taxes by the BIR for the year 2009. He paid the deficiency. In 2011, Mr. Abcede received another LA for the same year 2009, this time from the National Investigation Division, on the ground that Mr. Abcede;s 2009 return was fraudulent. Mr. Abcede contested the LA on the ground that he can only be investigated once in a taxable year. Decide. A: The contention of Mr. Abcede is not tenable. While the general rule is to the effect that for income tax purposes, a taxpayer must be subject to examination and inspection by the internal revenue officers only once in a taxable year, this will not apply if there is a fraud, irregularity, or mistakes as determined by the Commissioner. In the instant case, what triggered the second examination is the findings by the BIR that Mr. Abcede’s 2009 return was fraudulent. Accordingly, Mr. Abcede the examination is legally justified. (Sec. 235, NIRC) Q: “A” Co., a Philippine corporation, is a big manufacturer of consumer good and has several suppliers of raw materials. The BIR suspects that some of the suppliers are not properly reporting their income on the sales to “A” Co. The CIR therefore: (a) Issued an access letter to “A” Co. to furnish the BIR information on sales and payment to its suppliers. (b) Issued an access letter to a bank (“X” Bank) to furnish the BIR on deposits of some suppliers of “A” Co. on the alleged ground that the suppliers are committing tax evasion. “A” Co., “X” Bank and the suppliers have not been issued by the BIR letter of authority to examine. “A” Co. and “X” Bank believe that the BIR is on a “fishing expedition” and come to you for counsel. What is your advice? A: I will advice “A” Co. and “X” Bank that the BIR is justified only in getting information from the former but not from the latter. The BIR is authorized to obtain information from the other persons than those whose internal revenue tax liability is subject to audit or investigation. However, this power shall not be constructed as granting the Commissioner the authority to inquire into bank deposits (Sec. 5, NIRC) Q: Can the Commissioner of Internal Revenue inquire into the bank deposits of a taxpayer? If so does this power of the Commissioner conflict with R.A. 1405, Secrecy of Bank Deposits Law? A: The Commissioner of Internal Revenue is authorized to inquire into the bank deposit of: (1) A decedent to determine his gross estate. (2) Any taxpayer who has filed an application for compromise of his tax liability by means of financial incapacity to pay his tax liability (Sec. 6[F], NIRC). The limited power of the Commissioner does not conflict with R.A. No. 1405 because of the provisions of the Tax Code granting this power is an exception to Secrecy of Bank Deposits Law as embodied in a later legislation. Furthermore, in case a taxpayer applies for an application to compromise the payment of his tax liabilities on his claim that his financial position demonstrates a clear inability to pay the tax assessed, his application shall not be considered unless and until he waives in

96 writings his privilege under R.A. 1405, and such waiver shall constitute the authority of the Commissioner to inquire into the bank deposits of the taxpayer. Q:X dies in year 2000 leaving a bank deposit of P 2,000,000.00 under joint account with his associates in a law firm. Learning of X’s death from the newspapers, the Commissioner wrote to every bank in the country asking them to disclose to him the amount of deposits that might be outstanding in his name or jointly with others at the date of his death. May the bank holding the deposit refuse to comply on the ground of the Secrecy of Bank Deposit Law? Explain. A:No. The commissioner has the authority to inquire into bank deposit accounts of a decedent to determine his gross estate notwithstanding the provisions of the Bank Secrecy Law. Hence, the banks holding the deposits in question may not refuse to disclose the amount of deposits on the ground of secretary of bank deposits (Sec. 6 [F], NRC). The fact that the deposit is a joint account will not preclude the Commissioner from inquiring thereon because the law mandates that if a bank has knowledge of the death of a person, who maintained a bank deposit account alone or jointly with another, it shall not allow any withdrawal from the said deposit account, unless the Commissioner has certified that the taxes imposed thereon have been paid (Sec. 97, NIRC0. Hence, to be able to gibe the required certification, the inclusion of the deposit is imperative. Q:A taxpayer is suspected not to have declared his correct gross income in his return filed for 1997. The examiner requested the Commissioner to authorize him to inquire into the bank deposits of the taxpayer so that he could proceed with the net worth method of investigation to establish fraud. May the examiner be allowed to look into the taxpayer’s bank deposits? In what cases may the Commissioner or his duly authorized representative be allowed to inquire or look into the bank deposits of a taxpayer? A:No, as this would be violative of R.A. 1405, the Bank Deposits Secrecy Law. The Commissioner or his duty authorized representative may be allowed to inquire or look into the bank deposits of a taxpayer in the following cases: a) For the purpose of determining the gross estate of a decedent; b) Where the taxpayer has filed an application for compromise of his tax liability by reason of financial incapacity to pay such tax liability (Sec. 6[F], NIRC); c) Where the taxpayer has signed a waiver authorizing the Commissioner or his duly authorized representatives to inquire into the bank deposits.

97 CHAPTER XXV: ADMINISTRATIVE REMEDIES OF GOVERNMENT Q: For failure of Oceanic Company, Inc.(OCEANIC) to pay deficiency taxes of Php20 Million, the Commissioner of Internal Revenue issued warrants of distraint on OCEANIC's personal properties and levy on its real properties. Meanwhile, the Department of Labor through the Labor Arbiter rendered a decision ordering OCEANIC to pay unpaid wages and other benefits to its employees. Four barges belonging to OCEANIC were levied upon by the sheriff and later sold at public auction. The Commissioner of Internal Revenue filed a motion with the Labor Arbiter to annul the sale and enjoin the sheriff from disposing the proceeds thereof. The employees of OCEANIC opposed the motion contending that Article 110 of the Labor Code gives first preference to claims for unpaid wages. Resolve the motion. Explain. A: The motion filed by the Commissioner should be granted because the claim of the government for unpaid taxes is generally preferred over the claims of laborers for unpaid wages. The provision of Article 110 of the Labor Code, which gives laborers' claims for preference, applies only in case of bankruptcy or liquidation of the employer's business. In the instant case, OCEANIC is not under bankruptcy or liquidation at the time the warrants of distraint and levy were issued; hence, the lien of the employees is unwarranted (CIR v.NLRC,G.R. No.74965,November 9,1994). Q: Is the BIR authorized to collect estate tax deficiencies by the summary remedy of levy upon and sale of real properties of the decedent without first securing the authority of the court sitting in probate court over the supposed will of the decedent? A: Yes. The BIR is authorized to collect estate tax deficiency through the summary remedy of levying upon and sale of real properties of a decedent, without the cognition and authority of the court sitting in probate over the supposed will of the deceased, because the collection of estate tax is executive in character. As such, the estate tax is exempted from the application of the statute of non-claims, and this is justified by the necessity of government funding, immortalized in the maxim that taxes are the lifeblood of the government (Marcos II v.CA and CIR,273 SCRA 47). Q: Is the BIR authorized to issue a warrant of garnishment against the bank account of a taxpayer despite the pendency of his protest against the assessment with the BIR or appeal with the Court of Tax Appeals? A: The BIR is authorized is issue a warrant of garnishment against the bank account of a taxpayer despite the pendency of protest (Yabes v.Flojo,15 SCRA 278).Nowhere in the Code is the Commissioner required to rule first on the protest before he can institute collection proceedings on the tax assessed. The legislative policy is to give the Commissioner much latitude in the speedy and prompt collection of taxes because it is in taxation that the Government depends to obtain the means to carry on its operations (Republic v.Lim Tian Teng Sons,16 SCRA 584). Q: State and discuss briefly whether the following cases may be compromised or may not be compromised: a. Delinquent accounts; b. Cases under administrative protest, after issuance of the final assessment notice to the taxpayer, which are still pending; c. Criminal tax fraud cases; d. Criminal violations already filed court;

98 e. Cases where final reports of reinvestigation or reconsideration have been issued resulting in the reduction of the original assessment agreed to by the taxpayer when he signed the required agreement form. A: a. Delinquent accounts may be compromised, if either of the two conditions is present:(1) the assessment is of doubtful validity, or (2) the financial position of the taxpayer demonstrates a clear inability to pay the tax (Sec.204[A],NIRC;Sec.2,Rev.Regs.No.30-2002); b. These may not be compromised, provided that it is premised upon doubtful validity of the assessment or financial incapacity to pay; c. These may not be compromised, so that the taxpayer may not profit from his fraud, thereby discouraging its commission; d. These may not be compromised in order that the taxpayer will not profit from his criminal acts; e. Cases where final reports of reinvestigation or reconsideration have been issued resulting in the reduction of the original assessment agreed to by the taxpayer when he signed the required agreement form, cannot be compromised. By giving his conformity to the revised assessment, the taxpayer admits the validity of the assessment and his capacity to pay the same (Sec.2,Rev.Regs.No.30-2002). Q: After the tax assessment had become final and unappealable, the Commissioner of Internal Revenue initiated the filing of a civil action to collect the tax due from NX. After several years, a decision was tendered by the court ordering NX to pay the tax due plus penalties and surcharges. The judgment became final and executory, but attempts to execute the judgment award were futile. Subsequently, NX offered the Commissioner a compromise settlement of 50% of the judgment award, representing that this amount is all he could really afford. Does the Commissioner have the power to accept the compromise offer? Is it legal and ethical? Explain briefly. A: Yes. The Commissioner has the power to accept the offer of compromise, if the financial position of the taxpayer clearly demonstrates a clear inability to pay the tax (Sec.204, NIRC). As represented by NX in his offer, only 50% of the judgment award is all he could really afford. This is an offer for compromise based on financial incapacity which the Commissioner shall not accept, unless accompanied by a waiver of the secrecy of bank deposits (Sec.6[F],NIRC).The waiver will enable the Commissioner to ascertain the financial position of the taxpayer, although the inquiry need not be limited only to the bank deposits of the taxpayer but also as to his financial position as reflected in his financial statements or other records upon which his property holdings can be ascertained. If indeed the financial position of NX as determined by the Commissioner demonstrates a clear inability to pay the tax, the acceptance of the offer is legal and ethical because the ground upon which the compromise was anchored is within the context of the law and the rate of compromise is well within and far exceeds the minimum prescribed by law, which is only 10% of the basic tax assessed. A: Yes. The commissioner has the power to accept the offer of compromise, if the financial position of the taxpayer clearly demonstrates a clear inability to pay the tax (Sec. 204, NIRC). As represented by NX in his offer, only 50% of the judgment award is all he could really afford. This is an offer for compromise based on financial incapacity which the Commissioner shall not accept, unless accompanied by a waiver of the secrecy of bank

99 deposits (Sec. 6[F], NIRC). The waiver will enable the Commissioner to ascertain the financial position of the taxpayer, although the inquiry need not be limited only to bank deposits of the taxpayer but also as to his financial position as reflected in his financial statements or other records upon which his property holdings can be ascertained. If indeed he financial position of NX as determined by the Commissioner demonstrates a clear inability to pay the tax, the acceptance of the offer is legal and ethical because the ground upon which the compromise was anchored is within the context of the law and the rate of compromise is well within and far exceeds the minimum prescribed by law, which is only 10% of the basic tax assessed. Q: Under what conditions may the Commissioner of Internal Revenue be authorized to: a. Compromise the payment of any internal revenue tax? A:The Commissioner of Internal Revenue maybe authorized to compromise the payment of any internal revenue tax where: 1) A reasonable doubt as to the validity of the claim against the taxpayer exists;or 2) The financial position of the taxpayer demonstrates a clear inability to pay the assessed tax. 3) Abate or cancel a tax liability? A: The Commissioner of Internal Revenue may abate or cancel a tax liability when: 1) The tax or any portion thereof appears to be unjustly or excessively assessed;or 2) The administration and collection costs involved do not justify the collection of the amount due (Sec.204[B], NIRC). Q: An Information was filed in court for willful non-payment of income tax, the assessment of which has become final. The accused, through counsel, presented a motion that be allowed to compromise his tax liability subject of the information. The prosecutor indicated his conformity to the motion. Is this procedure correct? A: No. Criminal violations, if already filed in court, may not be compromised (Sec.204[B], NIRC). Furthermore, the payment of the tax due after apprehension shall not constitute a valid defense in any prosecution for violation of any provisions of the Tax Code (Sec.247[a], NIRC). Finally, there is no showing that the prosecutor in the problem is a legal officer of the Bureau of Internal Revenue to whom the conduct of criminal actions is lodged by the Tax Code. Q: May the Commissioner of the Internal Revenue compromise the payment of withholding tax (tax deducted and withheld at source) where the financial position of the taxpayer demonstrates a clear inability to pay the assessed tax? A: No. A taxpayer who is constituted as withholding agent who has deducted and withheld at source the tax on the income payment made by him holds the taxes as trust funds for the government (Sec.58[D],NIRC) and is obligated to remit them to the BIR. The subsequent inability of the withholding agent to pay/remit the tax withheld is not a ground for compromise; because the withholding tax is not a tax upon the withholding agent but it is only a procedure for the collection of a tax. Q: Minolta Philippines, Inc. (Minolta) is an EPZA-registered enterprise enjoying preferential tax treatment under a special law. After investigation of its withholding tax returns for the taxable year 1997,the BIR issued a deficiency withholding tax assessment in the amount of Php150,000.00.On May 15,1999,because of financial difficulty, the deficiency tax remained unpaid, as a

100 result of which the assessment became final and executory. The BIR also found that, in violation of the provisions of the NIRC, Minolta did not file its final corporate income tax return for the taxable year 1998, because it allegedly incurred net loss from its operations. On May 17, 2002 the BIR filed with the RTC an action for collection of the deficiency withholding tax for 1997. A. Will the BIR's action for collection prosper? As counsel of Minolta, what action will you take? Explain. B. May criminal violations of the Tax Code be compromised? If Minolta makes voluntary offer to compromise the criminal violations for non-filing and non-payment of taxes for the year 1998, may the Commissioner accept the offer? Explain. A: A. Yes. BIR’s action for collection will prosper because the assessment is already final and executor. It can already be enforced through judicial action. As counsel of Minolta, I will introduce evidence that the income payment was reported by the payee and the income tax was paid thereon in 1997 so that my client may be allowed to pay only the civil penalties for non-withholding pursuant to Revenue memorandum Order No. 38-83. B. All criminal violations of the Tax code may be compromised except those already filed in court or those involving fraud (Sec. 204, NIRC). Accordingly, if Minolta makes a voluntary offer to compromise the criminal violations for non-filing and non-payment of taxes for the year 1998, the Commissioner may accept the offer which is allowed by law. However, if it can be established that a tax has not been paid as a consequence of non-filing of the return, the civil liability for taxes may be dealt with independently of the criminal violations. The compromise settlement of the criminal violations will not relieve the taxpayer from its civil liability. But the civil liability for taxes may also be compromised if the financial position of the taxpayer demonstrates a clear inability to pay the tax. Q: A domestic corporation failed to withhold and remit the tax on income received from Philippine sources by a non-resident foreign corporation. In addition to the civil penalties provided for under the Tax Code, a compromise penalty was imposed for violation of the withholding tax provisions. May the Commissioner of Internal Revenue legally enforce the collection of compromise penalty? A: No. There is no showing that the compromise penalty was imposed by the Commissioner of Internal Revenue with the agreement and conformity of the taxpayer (Wonder Mechanical Engineering Corporation v.Court of Tax Appeals, et al.,64 SCRA 555).