CHAPTER 1_INCOME TAXATION by RB

INCOME TAXATION

Chapter 1 Introductory Concepts

Taxation – defined as a state of power, a legislative process, and a mode of government

cost distribution.

As a state power. Taxation is an inherent power of the State to enforce a
proportional contribution from its subjects for public purposes.
As a legislative process. Taxation is a process of levying (collecting) taxes by
the legislature of the State to enforce a proportional contributions from its subjects
for public purpose.
As a mode of cost distribution. Taxation is a mode by which the State allocates
its costs or burden to its subjects who are benefited by its spending.
The Governments necessity for funding – The theory of Taxation.
Government provides a vast array of public services such as defense, public order
and safety, health, education, and social protection among other. It cannot exist
without a system of funding. (That is why there is taxes, it serves as a funding
system for government.)
The mutual support between people and the government – The basis of Taxation.
The people provide funds that finance the government and the Government
provides benefits to the people.

Public services

Government People

Taxes

Receipt of benefits is conclusively presumed – This entails that taxpayers cannot
avoid payment of taxes under the defense of absence of benefit received. The
direct receipt or actual availment of government services is not a precondition to
taxation.

Theories of Cost Allocation –The following are the general consideration of the
government in the exercise of its taxation power:
Benefit Received Theory. The theory presupposes that the more benefit one
receives from the government, the more taxes he should pay.
Ability to Pay Theory. The theory presupposes that taxation should also consider
the taxpayer’s ability to pay. (Those who have more should be taxed more even
if they benefit less. Those who have less shall contribute less even if they
receive more benefits.)

Aspects of the Ability to Pay Theory
Vertical Equity. It proposes that the extent of one’s ability to pay is directly
proportional to the level of his tax base. It is a gross concept.
Horizontal Equity. It requires consideration of the particular circumstance of
taxpayer. It is a net concept.

Vertical Equity Horizontal Equity

Anna – P 200,000 income Both Anna and Brenda have
Brenda – P 400,000 income P 300,000 income

Anna – P 50,000 incurred expenses
Brenda should be taxed more than Brenda –P200,000 incurred expenses

Anna because Brenda has greater

income. Hence, Brenda has greater Anna should be taxed more than

capacity to contribute. Brenda because Anna has lesser

expenses. Hence, Anna has greater

capacity to contribute.

The Lifeblood Doctrine – Taxes are the lifeblood of the government. Taxes are essential
and indispensable to the continued subsistence of the
government

Implications of the lifeblood doctrine in taxation:
1. Tax is imposed even in the absence of a Constitutional Grant.
2. Claims for tax exemption are construed (taken) against taxpayers.
3. The government reserves the right to choose the objects of taxation.
4. The courts are not allowed to interfere with the collection of taxes.
5. In income taxation:

a. Income received in advance is taxable upon receipt.
b. Deduction for capital expenditures and prepayments is not allowed as it

effectively defers the collection of income tax.
c. A lower amount of deduction is preferred when a claimable expense is

subject to limit.
d. A higher tax bases is preferred when the tax object has multiple tax bases.
Inherent Powers of the State:
Taxation Power. The power of the State to enforce proportional contribution from
its subjects to sustain itself.
Police Power. The general power of the State to enact laws to protect the well-
being of its people.
Eminent Domain. The power of the State to take private property for public use
after paying just compensation.
Similarities of the three powers of the State:
1. Necessary attributes of sovereignty
2. Inherent to the state
3. Legislative in nature
4. All ways in which the State interferes with private rights and properties
5. Exist independently of the Constitution and are exercisable by the government
even in the absence of Constitutional Grant. Constitution may impose
conditions or limits for their exercise.
6. Presuppose an equivalent form of compensation received by the persons
affected by the exercise of the power.

7. Exercise of these powers by the local government units may be limited by the
national legislature.

Comparison of the three powers of the State:

Point of Difference Taxation Police Power Eminent Domain

Exercising Authority Government Government Government and
Purpose Private Entities
For the support of To protect the For public use
Persons affected the Government general welfare of
Amount of Owner of Property
Imposition Community or class the people
of individuals No amount imposed
Unlimited Community or class (The government
of individuals pay just
(Tax is based on Limited compensation.)
government needs.) (Imposition is

limited to cover cost
of regulation)

Importance Most Important Superior Important

Relationship with Inferior to the Superior to the Superior to the
Constitution “Non-impairment “Non-impairment “Non-impairment

Clause” of the Clause” of the Clause” of the

Constitution Constitution Constitution

Limitation Constitutional and Public interest and Public purpose and

inherent limitations due process just compensation

Scope of the Taxation Power – widely regarded as comprehensive, plenary, unlimited
and supreme. Despite its seemingly unlimited nature,
it is not absolutely unlimited because of inherent and
constitutional limitations

Limitations of the Taxation Power
A. Inherent limitations
1. Territoriality of taxation. The government can only demand tax obligations
upon its subjects or residents within its territorial jurisdiction.
Two-fold obligations of taxpayers:
a. Filing of returns and payment of taxes
b. Withholding of taxes on expenses and its remittance to the government
Exception to the Territoriality principle
a. In income taxation, resident citizens and domestic corporations are
taxable on income derived within and outside the Philippines.
b. In transfer taxation, resident citizens, non-resident citizens and
resident aliens are taxable on transfers of properties located within and
outside the Philippines.

2. International comity. No country is powerful than the other country.
a. Governments do not tax the income and properties of the other
government.
b. Governments give primacy to their treaty obligations over their own
domestic tax laws.
Embassies or consular offices of foreign government including
their non-Filipino staff are not subject to income taxes or property
taxes, under the National Internal Revenue Code (NIRC).

3. Public purpose. Tax is intended for the common good. Taxation must be
exercised absolutely for the public purpose and cannot be exercised to further
any private interest.

4. Exemption of the government. The government can exercise the power upon
anything including itself. However, it normally does not tax itself as this will not
raise additional funds but will impute only additional cost.
Under NIRC, government properties and income from essential public
functions are not subject to taxation. However, government properties &
activities conducted for profit and income of Government Owned and
Controlled Corporations (GOCCs) are subject to tax

5. Non-delegation of the taxing power. The legislative taxing power is vested
exclusively in the Congress and is non-delegable pursuant to the doctrine of
separation of the branches of the government to ensure a system of checks
and balances.
Exceptions to the Rule of Non-delegation
1. Under the Constitutions, the LGU are allowed to exercise the power to
tax to enable them to exercise their fiscal autonomy.
2. Under the Tariff and Customs Code, the President is empowered to fix
the amount of tariffs to be flexible to trade conditions.
3. Other cases that require expedient and effective administration and
implementation of assessment and collection of taxes.

B. Constitutional limitations
1. Due process of law. No one should be deprived of his life, liberty, or property
without due process of law
Aspects of Due Process
1. Substantive due process (legal basis). Tax must be imposed only for
public purpose, collected only under authority of a valid law and only by the
taxing power having jurisdiction. An assessment without a legal basis
violates the requirement of due process.
2. Procedural due process (taxpayer’s right to notice and hearing).
There should be no arbitrariness in assessment and collection of taxes.
Under NIRC, assessment shall be made within 3 years from the due
date of filing of the return or from the date of actual filing, whichever

is later. Collection shall be made within 5 year from the date of
assessment.
2. Equal protection of the law. Taxpayers should be treated equally both in
terms of rights conferred & obligations imposed.
3. Uniformity rule in taxation. Each class of taxpayers is taxed differently, but
taxpayers under the same class are taxed the same. Hence, uniformity is
relative equal.
4. Progressive system of taxation. Tax rates increase as the tax base increases
consistent with the taxpayers’ ability to pay. This aids an equitable distribution
of wealth to the society as taxes the rich more than the poor.
5. Non-imprisonment for non-payment of debt or poll tax. No one shall be
imprisoned for mere inability to pay debt acquired in good faith. However, the
constitutional guarantee applies only when the debt is acquired in good faith.
Debt acquired in bad faith constitutes estafa, a criminal offense punishable by
imprisonment.
The constitutional guarantee on non-imprisonment for non-payment of debt
does not extend to non-payment of tax, except poll tax.
Poll tax components:
a. Basic Community Tax. A constitutional guarantee of non-

imprisonment for non-payment of poll tax applies only to basic
community tax.
b. Additional Community Tax. Non-payment of additional community tax
is an act of tax evasion punishable by imprisonment.
6. Non-impairment of obligation and contract. Tax exemptions granted under
contract should be honored and should not be cancelled by a unilateral
government action.
7. Free worship rule. Philippines adopts free exercise of religion and does not
subject its exercise to taxation. Tithes or offering are not subject to tax.
However, the exemption does not extend to income from properties or
activities of religious institutions that are commercial in nature.
8. Exemption of religious or charitable entities, non-profit cemeteries,
churches and mosques, lands, buildings and improvements from
property taxes. The Constitutional exemption applies to properties actually,
directly and exclusively used for charitable, religious and educational purposes.
Following the Doctrine of Use, properties actually devoted for religious,
charitable, or education activities are exempt from real property taxes.
9. Non-appropriation of public funds or property for the benefit of any
church, sect or system of religion. This is intended to highlight the
separation of religion and the State. Compensation of religious people
working in government institutions are not considered religious
appropriation.
10. Exemption from taxes of the revenues and assets of non-profit, non-stock
educational institutions (including grants, endowments, donations or

contributions for education purposes). The Constitution recognizes the
necessity of education by granting tax exemption on revenues and assets
of non-profit educational institutions. Government Educational Institutions
are exempt from income tax while Private Educational Institutions are subject
to minimal 10% income tax.
11. Concurrence of a majority of all members of Congress for the passage of
law granting tax exemption. Tax exemption law counters the lifeblood
doctrine as it deprives the government of revenues. Granting tax exemption
requires the vote of the absolute majority of all the members of the Congress.
12. Non-diversification of tax collections. Tax collections should be used only
for public purpose. It should never be diversified or used for private purpose.
13. Non-delegation of the power taxation. The legislative taxing power is vested
exclusively in the Congress and is non-delegable pursuant to the doctrine of
separation of the branches of the government to ensure a system of checks
and balances.
14. Non-impairment of the jurisdiction of the Supreme Court to review tax
cases. Notwithstanding the existence of the Court of Tax Appeals, which is a
special court, all cases involving taxes can be raised to and be finally decided
by the Supreme Court of the Philippines.
15. The requirement that appropriations, revenue, or tariff bills shall originate
exclusively in the House of Representative.(But the Senate may propose or
concur with amendments). Laws that add income to the national treasury and
those that allows spending therein must originate from the House of
Representatives while Senate may concur with amendments.
16. The delegation of taxing power to local government units. Each LGU shall
exercise the power to create its own sources of revenue and shall have a just
share in the national taxes.
Stages of the Exercise of Taxation Power:
1. Levy or Imposition - Involves the enactment of a tax law by Congress and is
called the impact of taxation. It is also referred a Legislative Act in Taxation.

Two bodies of Congress that approves tax bills:
a. The House of the Representative – this is where the tax bills must

originates.
b. The Senate – they may have their own version of the tax bill however,

tax bills cannot exclusively originates from them.
Matters of Legislative discretion in the exercise of taxation:

1. Determining the object of taxation
2. Setting the tax rate or amount to be collected
3. Determining the purpose of levy which must the public use
4. Kind of tax to be imposed
5. Appointment of the tax between the national and local government
6. Situs of taxation
7. Method of collection

2. Assessment and Collection - The tax law is implemented by the administrative
branch of the government. This is the incidence of taxation or the administrative
act of taxation.

Situs of Taxation – the place of taxation.
Situs rules:
1. Businesses are subject to tax in the place where the business is conducted
2. Service fees are subject to tax where they are rendered
3. The gain on sale of goods is subject to tax in the place of sale
4. Properties are taxable in their location
5. Personal or poll tax should be paid in the place of the person’s residence

Other Fundamental Doctrines of Taxation
1. Marshall Doctrine - The power to tax involves the power to destroy. Taxation
power is used to discourage or prohibit undesirable activities or occupation.
Taxation power does not include the power to destroy if it is used solely for the
purpose of raising revenue
Example: Excessive tax imposed on production and sale of cigarettes
2. Holme’s Doctrine – Taxation power is not the power to destroy while the court
sits. Taxation power may be used to build or encourage beneficial activities or
industries by the grant of tax incentive.
Example: Creation of ecozones with tax holidays and provisions of
incentive, such as Ominibus Investment Codee and the Barangay Micro-
Business Enterprise (BMBE) Law.
3. Prospectivity of tax laws – Tax laws are generally prospective in application.
An ex post facto law or a law that retroacts is prohibited by the Constitution.
4. Non-compensation or set-off – Taxes are not subject to automatic set-off or
compensation. Taxpayer cannot delay payment of tax to wait for the resolution
of a lawsuit involving his pending claim against the government. Tax is not a
debt; hence, it is not subject to set-off.
Exceptions:
a. When the taxpayer’s claim is already due & demandable
b. Cases of obvious overpayment of taxes
c. Local taxes
5. Non-assignment of taxes – Tax obligations cannot be assigned or transferred
to another entity by contract.
6. Imprescriptibility in taxation – Taxes due from taxpayers who did not file a
return or those who filed fraudulent returns do not prescribe. Prescription is
the lapsing of a right due to the passage of time.
Under NIRC, tax prescribe if not collected within 5 years from the date of its
assessment. In the absence of assessment, tax prescribe if not collected
by judicial action within 3 years from the date the return is requires to be
filed.
7. Doctrine of Estoppel - Any misrepresentation made by one party toward
another who relied in good faith will be held true and binding against that person

who made the representation. The government is not subject to estoppel.
Erroneous applications of the tax law by public officers do not block the
subsequent correct application of the same.
8. Judicial Non-interference - Courts are not allowed to issue injunction against
the government’s pursuit to collect tax as this would unnecessarily defer (delay)
tax collection.
9. Strict Construction of Tax Law – Taxation is the rule, exemption is the
exception.

When the language of the law is clear and categorical, there is no room for
interpretation, hence, there is only room for application.
When taxation laws are vague, the doctrine of strict legal construction
is observed.

Vague tax laws. Vague tax laws are construed against the
government as if there is no such law. In favour of the taxpayers.
Vague exemption laws. Vague exemption laws are construed
against the taxpayer as if there is not such exemption law. In favour
of the government.

Double Taxation – Double taxation occurs when the same taxpayer is taxed twice by the

same tax jurisdiction for the same thing.

Elements of Double Taxation

1. Primary element: same object
2. Secondary elements:

a. Same type of tax
b. Same purpose of tax
c. Same taxing jurisdiction
d. Same tax period

Types of Double Taxation

1. Direct Double Taxation. This occurs when all the element of double taxation exist
for both imposition.

2. Indirect Double Taxation. This occurs when at least one of the secondary
elements of double taxation is not common for both imposition.

Nothing in our law expressly prohibits double taxation but it is
discouraged because it is oppressive and burdensome to taxpayers.

Minimization of Double Taxation

1. Provision of tax exemption
2. Allowing foreign tax credits
3. Allowing reciprocal tax treatment
4. Entering into treaties or bilateral agreements

Escapes from Taxation. These are the means available to the taxpayer to limit or

even avoid the impact of taxation.

Categories of Escapes from taxation

a. Those that result to loss of government revenue
1. Tax evasion. Also known as tax dodging, refers to any act or trick that tends
to illegally reduce or avoid the payment of tax.
2. Tax avoidance. Also known as tax minimization, refers to any act or trick that
reduces or totally escapes taxes by any legally permissible means.
3. Tax exemption. Also known as tax holiday, refers to the immunity, privilege
or freedom from being subject to a tax which others are subject to.

b. Those that do not result to loss of government revenue
1. Shifting. The process of transferring tax burden to other taxpayers.
Forms of Shifting
a. Forward Shifting – this follows the normal flow of distribution,
commonly to the essential commodities and services.
b. Backward Shifting – the reverse of forward shifting. Common with
non-essential commodities where buyers have considerable market
power and commodities with numerous substitute products.
c. Onward Shifting – this refers to any tax shifting in the distribution
channel that exhibits forward shifting or backward shifting.
2. Capitalization. This pertains to the adjustment of the value of an asset
caused by changes in tax rates. The reduction in the price of the tax object
equal to the capitalized value of future taxes which the purchaser will be
paying.
3. Transformation. This pertains to the elimination of wastes or losses by the
taxpayer for form savings to compensate for the tax imposition or increase in
taxes

Tax Amnesty - General pardon granted by the government for erring taxpayers to give

them chance to reform. It is an absolute forgiveness or waiver by the government
on its right to collect tax. It is retrospective in application.

Tax Condonation - Also referred to as tax remission. It is the forgiveness of the tax

obligation of a certain taxpayer under justifiable grounds. It is prospective in
application.

Tax Amnesty vs. Tax Condonation

Tax Amnesty Tax Condonation
Covers both civil and criminal liabilities Covers only civil liabilities
Retrospective Application Prospective Application
Requires payment Requires no payment