up barops income tax reviewer

8/3/2019 Up Barops Income Tax Reviewer

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TABLE OF CONTENTS

I. Basic Concepts in Income Taxation 2

II. Persons Subject to Income Tax 2

INDIVIDUALSIII. Personal Exemptions 3IV. Taxation of Individuals 5V. Taxation of Fringe Benefits 11

CORPORATIONSVI. Taxation of Corporations 12VII. Exempt Corporations 17VIII. Improperly Accumulated Earnings Tax 19

PARTNERSHIPSIX. Taxation of Partnership 21

INCOMEX. Source of Income 23XI. Gross Income 25XII. Exclusions from Gross Income 28

DEDUCTIONSXIII. Business Expense 29XIV. Interest and Taxes 30XV. Losses and Bad Debts 31XVI. Depreciation and Depletion 34

XVII. Pension Trust and Charitable and Other Contributions 35XVIII. Research and Development and Premium Payments

on Health and Hospitalization Insurance 37XIX. Treatment of Foreign Income Tax 38XX. Non-deductible Expenses 40XXI. Losses from Wash Sales 41

CAPITAL GAINS AND LOSSESXXII. Ordinary Gains and Losses 41XXIII. Capital Gains and Losses 42XXIV. Installment Method 44

BASIC CONCEPTS IN INCOME TAXATION

What is income tax?An income tax is levied on the income from property or an occupation. It is imposed upon persons within the jurisdiction of the State to raise revenue for the support of the Government.

PurposeThe imposition of income tax is intended to:1. raise revenue to defray the expenses of the government;

2. mitigate the evils arising from the inequalities of wealth by a progressive scheme of taxation which places the burden on those best able to pay.


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What is income?Income means all wealth which flows to the taxpayer other than a mere return ofcapital. It includes gain derived from the sale or other disposition of capitalassets.

Income v. CapitalCapital is a fund, income is a flow. Capital is wealth, while income is the serv

ice (fruit) of the wealth. Capital is a tree, income is the fruit. Amounts received as a return of capital are not income.

Increase of Property ValueA mere increase in the value of property is not income, but merely unrealized increase in capital. The increase in the value of property is also known as appraisal surplus or revaluation increment.

Classification of Income according to Source1. Income from sources within the Philippines2. Income from sources without the Philippines3. Income from sources partly within and partly without the Philippines

PERSONS SUBJECT TO INCOME TAX

Who is a taxpayer?Under Sec 22(N), a taxpayer is any person subject to tax imposed by this Title.A person is defined in Sec 22(A) as an individual, a trust, estate or corporation.

Classification of Taxpayers

Primary ClassificationSub-classificationIndividualsResident Citizen (RC)Non-resident Citizen (NRC)Overseas Contract Worker (OCW)Resident Alien (RA)Non-resident Alien Engaged in Trade or Business ((NRAETB)Non-resident Alien NOT Engaged in Trade or Business ((NRANETB)CorporationsDomestic Corporation (DC)Resident Foreign Corporation (RFC)Non-resident Foreign Corporation (NRFC)Joint venture for construction projectsJoint venture for petroleum, coal, geothermal or energy operationsJoint stock companiesJoint accounts (cuentas en participacion)AssociationPartnershipsGeneral Professional Partnerships (GPP)Business Partnerships (BP)EstatesUnder judicial administrationNot under judicial administrationTrustsOrdinary trustRevocable trustIrrevocable trustEmployees trust

PERSONAL EXEMPTIONS

Legal Basis Sec 35

ConceptPersonal exemptions are arbitrary amounts allowed by law to be deducted from income to cover personal, living, or family expenses of the taxpayer. These deductions are allowed on the theory that the minimum requirements of subsistence of ataxpayer should be free from tax.

Kinds1. Basic Personal Exemptions (BPE) varies according to the status of taxpayer2. Additional Exemptions (AE) depends on the number of qualified dependent children

Amount of Basic Personal Exemptions

Kind of TaxpayerBasic Personal Exemption (BPE)Single individuals (includes widow/er)P20,000Married individual who are* judicially decreed as legally separated &* with no qualified dependentsP20,000Head of FamilyP25,000Each married individualP32,000* but note Sec 35(A) - In the case of married individuals where only one of thespouses is deriving gross income, only such spouse shall be allowed the personalexemption.

Who is a Head of the Family? [Sec 35(A), NIRC]1. An unmarried or legally separated man or woman with dependents who may be* one or both parents


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* one or more brothers or sisters, or* one or more legitimate, illegitimate or legally adopted children2. Such dependent must be living with and dependent upon him for chief support3. Such brothers or sisters or children are* not more than 21 years old* unmarried and* not gainfully employed OR

* regardless of age, are incapable of self-support because of mental or physicaldefect.

Additional Exemptions (AE) for Dependents

Who may claim?1. Married individual2. Head of family3. Legally separated spouses

In the case of married individuals, AE is claimed by only one spouse usually thehusband, except in the following instances, where the wife claims the AE:

1. express waiver by the husband as embodied in the withholding exemption certificate2. husband has no income3. husband works abroad

In the case of legally separated spouses, AE can be claimed by the spouse with custody of the child. [Sec 35(B), NIRC]

Amount of AEP8,000 per dependent child

Limit of AEShould not exceed 4 dependent children

Who is a dependent? [Sec 35(B), NIRC]1. A legitimate, illegitimate or legally adopted child2. chiefly dependent upon and living with the taxpayer3. not more than 21 years old4. unmarried and5. not gainfully employed or6. regardless of age, if incapable of self-support because of mental or physicaldefect

Note: Only children may be considered dependent for purposes of AE. Compare with dependent for purposes of BPE.

Certain Termschief support principal or main support given regularly such that withdrawal will result in destitute life for dependentliving with taxpayer living under one roof with taxpayer; includes situations where taxpayer is away from home on business, or dependent is away at school

Who are allowed BPE and AE?1. Resident Citizen (RC)2. Non-resident Citizen (NRC) inc. OFW3. Resident Alien (RA)4. Non-resident Alien engaged in trade or business (NRAETB) by virtue of reciprocity

Who are not allowed BPE and AE?1. Non-resident Alien engaged in trade or business (NRAETB) if no reciprocity


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2. Non-resident Alien not engaged in trade or business (NRANETB)

Amount of BPE and AE allowed to NRAETBAn amount equal to the exemptions allowed by NRAs country to Filipino citizens there but not to exceed the amount fixed by NIRC [Sec 35(D), NIRC]

Change of Status [Sec 35(C), NIRC]

1. If taxpayer marries during taxable year, taxpayer may claim corresponding BPEin full for such year.2. If taxpayer should have additional dependent(s) during taxable year, taxpayermay claim corresponding AE in full for such year.3. If taxpayer dies during taxable year, his estate may still claim BPE and AE for himself and his dependent(s) as if he died at the close of such year.4. If during the taxable yeara. spouse dies orb. any of the dependents dies or marries, turns 21 or becomes gainfully employedtaxpayer may still claim same exemptions as if the spouse or any of the dependents died, or married, turned 21 or became gainfully employed at the close of such

year.

TAXATION OF INDIVIDUALS

Individuals Subject to Tax1. Resident Citizen (RC)2. Non-resident Citizen (NRC)3. Resident Alien (RA)4. Non-resident Alien Engaged in Trade or Business (NRAETB)5. Non-resident Alien Not Engaged in Trade or Business (NRANETB)

Resident Citizen (RC) - a citizen of the Philippines who resides within the Phil

ippines [Sec 23(A)]

Non-resident Citizen (NRC)(1) A citizen of the Philippines who establishes the fact of his physical presence abroad with a definite intention to reside therein.(2) A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis.(3) A citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be physically present abroad most of thetime during the taxable year. (more than 182 days in a taxable year)(4) A citizen who has been previously considered as nonresident citizen and whoarrives in the Philippines at any time during the taxable year to reside permanently in the Philippines shall likewise be treated as a nonresident citizen for the taxable year in which he arrives in the Philippines with respect to his income derived from sources abroad [Sec 22(E)](5) Overseas Contract Worker (OCW)a) Filipino citizen who is working and deriving income from abroadb) seaman who is Filipino citizen and who receives compensation for services rendered abroad as member of the complement of a vessel engaged exclusively in international trade

Resident Alien (RA) an individual whose residence is within the Philippines andwho is not a citizen thereof [Sec 22(F)]

Non-resident Alien Engaged in Trade or Business (NRAETB)An individual whose residence is not within the Philippines and who is not a citizen thereof. [Sec 22(F)]


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A nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of more than 180 days during any calendar year shall be deemed a 'nonresident alien doing business in the Philippines.' [Sec 25(A)(1)]The term trade or business shall not include performance of services by the taxpayer as an employee. [Sec 22(CC)]

Non-resident Alien Not Engaged in Trade or Business (NRANETB)

A nonresident alien individual who shall come to the Philippines and stay therein for an aggregate period of less than 180 days during any calendar year

Tax Rates on Ordinary Income (Schedular Rates)

Income overBut less thanTaxPlusof Excess over10,0005%10,00030,00050010%10,00030,00070,0002,50015%30,00070,000140,0008,50020%70,000140,000250,00022,50025%140,000250,000500,00050,00030%250,000500,000125,00032%*500,000* 34% before 1 January 1999, 33% after 1 January 1999, 32% starting 1 January 2000

QUICK GLANCEIndividual TaxpayerSource of Taxable IncomeTax BaseTax RateResident Citizen (RC)Within and without the PhilsGross Income less BPE and AESchedular RatesNon-resident Citizen (NRC)Within the PhilippinesGross Income less BPE and AESchedular RatesResident Alien (RA)Within the PhilsGross Income less BPE and AESchedular RatesNon-resident Alien Engaged in Trade or Business (NRAETB)Within the PhilsGross Income less BPE and AESchedular RatesNon-resident Alien Not Engaged in Trade or Business (NRANETB)Within the PhilsGross Income25%Taxation of Passive Income of Individuals

1. Interest Incomea. interest income from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements- 20% final taxb. interest income received by individuals from a depository bank under the expanded foreign currency deposit system (EFCDS) - 7.5% final tax for residents, exempt if non-residentsc. Interest income from long-term deposit or investment certificates (LTDIC) e.g., savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments, which have maturity of 5 years or more exemptShould LTDIC holder pre-terminate LTDIC before the 5th year, a final tax shall b

e imposed on the entire income based on the remaining maturity:4 years to less than 5 years - 5%3 years to less than 4 years - 12%less than 3 years - 20%

2. Dividendsa. cash and/or property dividends actually or constructively received by an individual fromi. a domestic corporationii. a joint stock companyiii. insurance or mutual fund companiesiv. regional operating headquarters of multinational companiesb. share of an individual in the distributable net income after tax of a partnership (except a general professional partnership) of which he is a partnerc. share of an individual member or co-venturer in the net income after tax ofi. an associationii. a joint accountiii. a joint venture or consortium taxable as a corporation

Rate 10% for residents (RC, RA) and non-resident citizens (NRC),20% for non-resident aliens engaged in trade or business (NRAETB

)

3. Capital Gainsa. Sale of Shares of Stock not Traded in the Stock Exchange

A final tax rate is imposed on Net Capital Gains (NCG) from the sale, barter, exchange or other disposition of shares of stock in a domestic corporation in accordance with following schedule:


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

NCG = Selling Price Cost of Acquisition

If shares of domestic corporation are traded through the local stock exchange, the applicable tax rate is of 1% of the gross selling price (GSP) of the shares.

[Sec 127(A)] Therefore, the transaction is taxable whether the sale was at a profit or at a loss.

b. Sale of Real Property (Capital Gains Tax CGT)A final tax of 6% based on the gross selling price (GSP) or fair market value (FMV) whichever is higher, is imposed on the sale, exchange, or other dispositionof real property located in the Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales, by individuals,including estates and trusts

Capital Assets [Sec 39] - 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 which would properly be included in the inventory of the taxpayer or* property held by the taxpayer primarily for sale to customers in the ordinarycourse of his trade or business or* property used in the trade or business which is subject to the allowance for depreciation or* real property used in trade or business of the taxpayere.g., residential house, vacant lot

Special Case. - No capital gains tax (CGT) if the following requirementsare met:a. sale or disposition of their principal residence by natural persons

b. proceeds of sale is fully utilized in acquiring or constructing a new principal residence within 18 calendar months from the date of sale or dispositionc. historical cost or adjusted basis of the real property sold or disposed shallbe carried over to the new principal residence built or acquiredd. Commissioner shall have been 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 exemptione. tax exemption can only be availed of once every 10 years

If there is no full utilization of the proceeds of sale or disposition, the portion of the gain presumed to have been realized from the sale or disposition shall be subject to capital gains tax (CGT).

Formula: Unutilized amount x (higher of ) GSP or FMV = Taxable portion

GSP

GSP or FMV at the time of sale, whichever is higher, shall be multiplied by a fraction which the unutilized amount bears to the gross selling price in order todetermine the taxable portion

Table Summarizing Rates and Bases of Passive Income Taxation

RCNRCRANRAETBNRANETBwithinwithoutwithinwithinwithinwithinTaxable Income5-32% [24A]5-32% [24A]5-32% [24A]5-32% [24A]5-32% [24A]25% of gross income [25A]INTEREST from any currency bank deposit & yield or any other monetary benefit fr

om deposit substitutes and from trust funds and similar arrangements (PESO deposits)20% [24B]NA20% [24B]20% [24B]20% [25A]25% [25B]INTEREST income from Long Term deposit or investment certified by BSPexempt [24B]NAexempt [24B]exempt [24B]exempt [24B]25% [25B]INTEREST from DOLLAR deposits of individuals7.5% [24B]NAexempt [27D3]7.5% [24B]exempt [27D3]exempt [27D3]INTEREST income from PESO loans5-32% [24A]5-32% [24A]5-32% [24A]5-32% [24A]5-32% [24A]25% [25B]ROYALTIES in general20% [24B]5-32% [24A]20% [24B]20% [24B]20% [25A]25% [25B]ROYALTIES on books, literary works and musical compositions10% [24B]5-32% [24A]10% [24B]10% [24B]10% [25A]25% [25B]PRIZES in general (lottery)20% [24B]5-32% [24A]20% [24B]20% [24B]20% [25A]25% [25B]RCNRCRANRAETBNRANETBwithinwithoutwithinwithinwithinwithinPRIZES < P10,000 (lottery)5-32% [24B]5-32% [24A]5-32% [24B]5-32% [24B]5-32% [25A]25% [25B]Other WINNINGS (except PCSO)20% [24B]5-32% [24A]20% [24B]20% [24B]20% [25A]25% [25B]PCSO WINNINGSexempt [24B]NAexempt[24B]exempt[24B]exempt[25A]25% [25B]Cash/property DIVIDENDS received from domestic corp or from joint stock company,insurance or mutual fund cos and ROHQ of MNCs10% [24B]5-32% [24A] * received from foreign corp10% [24B]10% [24B]20% [25A]25% [25B]SHARE of partner in DISTRIBUTABLE NIAT of partnership (except GPP)10% [24B]NA10% [24B]10% [24B]20% [25A]25% [25B]SHARE of individual in NIAT of association, joint account, or JV or consortium t


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axable as corporation10% [24B]NA10% [24B]10% [24B]20% [25A]25% [25B]CAPITAL GAINS from Sale of SHARES of Stock not Traded5/10% of NCG [24C]5-32% [24A]5/10% of NCG [24C]5/10% of NCG [24C]5/10% of NCG [25A]5/10% of NCG [25B]CAPITAL GAINS from Sale of REAL PROPERTY6% of higher of GSP or FMV [24D]5-32% [24A]6% of higher of GSP or FMV [24D]6% of higher of GSP or FMV [24D]6% of higher of GSP or FMV [25A]6% of higher of GSP or FMV [25B]Legend:

NA Not ApplicableNIAT net income after taxGPP general professional partnershipsJV joint venture

ROHQ Regional operating headquartersMNCs Multinational corporationsNCG net capital gainsGSP gross selling priceFMV fair market value

Special Rates

Alien Individual Employed bya. Regional or Area Headquarters (RAHQ) and Regional Operating Headquarters (ROHQ) of Multinational Companies (MNCs)

b. Offshore Banking Unitsc. Petroleum Service Contractor and Subcontractor

Tax Rate and Base - 15% of gross income

* The same tax treatment shall apply to Filipinos employed and occupying the same position as those of aliens employed by these multinational companies [Sec 25(C), (D), (E)]

Married IndividualsThe husband and wife shall compute separately their individual income tax basedon their respective total taxable income: Provided, that if any income cannot bedefinitely attributed to or identified as income exclusively earned or realized

by either of the spouses, the same shall be divided equally between the spousesfor the purpose of determining their respective taxable income. [Sec 24(A)]

Married individuals, whether citizens, resident or nonresident aliens, who do not derive income purely from compensation, shall file a return for the taxable year to include the income of both spouses, but where it is impracticable for thespouses to file one return, each spouse may file a separate return of income butthe returns so filed shall be consolidated by the Bureau for purposes of verification for the taxable year. [Sec 51(D)]

TAXATION OF FRINGE BENEFITS

Legal Basis Sec 33, NIRC, Rev. Reg. No. 3-98

Fringe Benefit - any good, service or other benefit furnished or granted in cashor in kind by an employer to an individual employee except rank and file employees (The fringe benefit covered by Sec 33 refers to those enjoyed by managerialand supervisory employees.)

Managerial employee is one who is vested with the powers or prerogatives to laydown and execute management policies and/or to hire, transfer, suspend, lay-off,recall, discharge, assign or discipline employees.Supervisory employees are those who, in the interest of the employer, effectively recommend such managerial actions if the exercise of such authority is not mer

ely routinary or clerical in nature but requires the use of independent judgment.All employees not falling within any of the above definitions are considered ran


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k-and-file employees.

Examples of fringe benefits1. Housing2. Expense account3. Vehicle of any kind4. Household personnel, such as maid, driver and others

5. Interest on loan at less than market rate to the extent of the difference between the market rate and actual rate granted6. Membership fees, dues and other expenses borne by the employer for the employee in social and athletic clubs or other similar organizations7. Expenses for foreign travel8. Holiday and vacation expenses9. Educational assistance to the employee or his dependents

Tax Rate and Tax Base 32% on the grossed-up monetary value (GMV)

GMV represents the whole amount of income realized by the employee. GMV is determined by dividing the actual monetary value of the fringe benefit by 68% [100%

- tax rate of 32%]. For example, the actual monetary value of the fringe benefit is P1,000. The GMV is equal to P1,470.59 [P1,000 / 0.68].

Payor of Fringe Benefit Tax (FBT) the employer

Fringe Benefits which are not taxable1. Fringe benefits which are authorized and exempted from tax under special laws2. Contributions of the employer for the benefit of the employee to retirement,insurance and hospitalization benefit plans3. Benefits given to the rank and file employees, whether granted under a collective bargaining agreement or not4. If the grant of fringe benefits is for the convenience of the employer. (convenience of the employer rule)

5. De minimis benefits those which are of relatively small value are offered bythe employer as a means of promoting health, goodwill, and efficiency of employees. Examples are uniforms, rice subsidy, employee achievement awards, etc.

Special cases

For fringe benefits received by non-resident alien not engaged in trade of business (NRANETB), the tax rate is 25% of the grossed-up monetary value (GMV). The GMV is determined by dividing the actual monetary value of the fringe benefit by75% [100% - 25%].

For fringe benefits received by alien individuals and Filipino citizens employedby regional or area headquarters, regional operating headquarters, offshore banking units (OBUs), or foreign service contractor, the tax rate is 15% of the grossed-up monetary value (GMV). The GMV is determined by dividing the actual monetary value of the fringe benefit by 85% [100% - 15%].

INCOME TAX ON CORPORATIONS

Definition of a Corporation [Sec 22(B)]

The term corporation includes:1. partnerships, no matter how created or organized2. joint-stock companies

3. joint accounts (cuentas en participacion)4. association5. insurance companies


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It does not include:1. general professional partnerships (partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of whichis derived from engaging in any trade or business)2. joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating consortium agreement under a service contract with th

e Government.

Classification of Corporations1. Domestic Corporation (DC) - when applied to a corporation, means created or organized in the Philippines or under its laws [Sec 22(C)]2. Resident Foreign Corporation (RFC) - a foreign corporation engaged in trade or business within the Philippines [Sec 22(H)]3. Non-resident foreign coporation (NRFC) - a foreign corporation not engaged intrade or business within the Philippines [Sec 22(I)]

QUICK GLANCESources of Taxable IncomeTax BaseTax RatesDomestic Corp (DC)Within and without the Phils.Net income32%Resident Foreign Corp (RFC)Within the Phils.Net Income32%Non-resident Foreign Corp (NRFC)Within the Phils.Gross income32% final withholding tax (FWT)

TAXATION OF PASSIVE INCOME OF CORPORATIONS

DCRFCNRFCwithinwithoutwithinwithinTaxable Income32% [27A]32% [27A]32% [28A]32% of gross income [28B1]INTEREST from any currency bank deposit & yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements (PESO deposits)20% [27A]NA20% [28A7a]32% [28B1]INTEREST income from LT deposit or investment certified by BSP32% [27D]NA32% [28A7d]32% [28B1]INTEREST from DOLLAR deposits of individuals or NON-BANK corp7.5% [27D1]32% [27A]7.5% [28A7a]exempt [27D3]INTEREST income derived by EFCDS depositary BANK10% [27D3]32% [27A]10% [28A7b]exempt [27D3]DCRFCNRFCwithinwithoutwithinwithinINTEREST income from PESO loans32% [27A]NA32% [28A7a]NAINTEREST income of EFCDS depositary banks from DOLLAR loans granted to residents10% [27D3]10% [27D3]10% [28A7b]NAINTEREST income of EFCDS depositary banks from DOLLAR loans granted to non-residents32% [27A]32% [27A]32% [28A]NAROYALTIES in general20% [27D]32% [27A]20% [28A7a]32% [28B1]ROYALTIES on books, literary works and musical compositions20% [27D]32% [27A]20% [28A7a]32% [28B1]PRIZES in general (lottery)NA32% [27A]NANAPRIZES < P10,000 (lottery)NA32% [27A]NANAOther WINNINGS (except PCSO)NA32% [27A]NANACAPITAL GAINS from Sale of SHARES of Stock not Traded5/10% of NCG [27A]32% [27A]5/10% of NCG [28A7c]5/10% of NCG [28B5c]CAPITAL GAINS from Sale of REAL PROPERTY (land and buildings only)6% of higher of GSP or FMV [27A]32% [27A]32% [28A]32% [28B1]INTERCORPORATE DIVIDENDS from Domestic Corporationexempt [27D]32% [27A] * received from foreign corpexempt [28A7d]32%/15% [28B5b]MCIT - 2% of gross incomeYESYESYESNOLegend:NA Not ApplicableNIAT net income after taxJV joint ventureNCG net capital gainsGSP gross selling price

FMV fair market value

Capital Gains1. Sale of Domestic Sharesa. If the shares are not traded through the local stock exchange, a final tax isimposed on the net capital gains (NCG) in accordance with the following schedule:Not over P100,000..... 5%Amount in excess of P100,000.. 10%

Net Capital Gains (NCG) = Gross Selling Price (GSP) AcquisitionCost

b. If the shares are traded through the local stock exchange, a final tax of of1% is imposed based on the gross selling price (GSP). [Sec 127] Therefore, thetransaction is taxable whether the sale was at a profit or at a loss.

2. Sale of Land and Buildingsa. The sale, exchange or disposition of lands and/or buildings which are not actually used in the business of a domestic corporation and are treated as capitalassets is subject to a final tax of 6% based on the based on the gross selling price (GSP) or fair market value (FMV), whichever is higher.b. If the seller is a resident foreign corporation (RFC), the income or gain isincluded in the items of gross income and the net income of the resident foreigncorporation is subject to 32% tax rate.

c. If the seller is a non-resident foreign corporation (NRFC), the income or gain is subjected to a final tax rate of 32%.


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Inter-corporate Dividends

A dividend paid by a domestic corporation to another corporation.1. In the case of a domestic corporation (DC) or a resident foreign corporation(RFC), the dividends received are not subject to tax.2. In the case of a non-resident foreign corporation (NRFC), as a general rule,a final withholding tax at the rate of 32% is imposed on the dividends received

from a domestic corporation.However, if the country in which the NRFC is domiciled allows a tax credit for taxes deemed paid in the Philippines, a final withholding tax at the rate of 15% isimposed on the dividends received from domestic corporation with the remainderof 17% [32%- 15%] being deemed paid.

Interest Income of Domestic Banks under the Expanded Foreign Currency Deposit System (EFCDS)Transactions subject to 10% final tax:1. Income derived by a depository bank from foreign currency transactions with local commercial banks, including branches of foreign banks and other depositorybanks

2. Interest income from foreign currency loans granted by depository banks to residents

Corporations Subject to Special Tax Rates

1. Domestic CorporationsProprietary Educational Institutions and HospitalsTax Rate and Base 10% on net income within and without the Philippines.If gross income from unrelated trade or business or other activity exceeds 50% of total gross income derived from all sources, the tax rate of 32% shall be imposed on the entire taxable income.The term 'unrelated trade, business or other activity' means any trade, businessor other activity, the conduct of which is not substantially related to the exe

rcise or performance by such educational institution or hospital of its primarypurpose or function.A "Proprietary educational institution" is any private school maintained and administered by private individuals or groups with an issued permit to operate fromthe DECS, CHED or TESDA.

2. Resident Foreign Corporationsa. International Carriers doing business in the Philippines 2.5% on Gross Philippine Billings (GPB)

In the case of International Air Carriers, GPB refers to the amount of:* gross revenue derived from carriage of persons, excess baggage, cargo and mailoriginating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket orpassage document* gross revenue from tickets revalidated, exchanged and/or indorsed to another international airline if the passenger boards a plane in a port or point in the Philippines* for flights which originate from the Philippines, but transshipment of passenger takes place at any port outside the Philippines on another airline, the grossrevenue consisting of only the aliquot portion of the cost of the ticket corresponding to the leg flown from the Philippines to the point of transshipment

In the case of International Shipping, GPB means gross revenue whether for passenger, cargo or mail originating from the Philippines up to final destination, re

gardless of the place of sale or payments of the passage or freight documents.

b. Offshore Banking Units - final tax of 10%


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c. Regional or Area Headquarters and Regional Operating Headquarters of Multinational Companies* Regional or area headquarters (RAHQ) not subject to income taxRAHQ is a branch established in the Philippines by multinational companies and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates, s

ubsidiaries, or branches in the Asia-Pacific Region and other foreign markets.* Regional operating headquarters (ROHQ) final tax of 10%

d. Tax on Branch Profits Remittances* Taxable transaction any profit remitted by a branch to its head office* Tax Rate and Base 15% based on the total profits applied or earmarked for remittance without any deduction for the tax component* Non-taxable activities those activities which are registered with the Philippine Economic Zone Authority* Income not treated as branch profits unless effectively connected with the conduct of trade or business in the Philippines:i. Interests, dividends, rents, royalties, including remuneration for technical

servicesii. salaries, wages premiums, annuities, emolumentsiii. other fixed or determinable annual, periodic or casual gains, profits, incomeiv. capital gains

3. Non-resident Foreign Corporations (NRFC)a. Nonresident Cinematographic Film Owner, Lessor or Distributor 25% of gross income from all sources within the Philippinesb. Nonresident Owner or Lessor of Vessels Chartered by Philippine Nationals 4.5%of gross rentals, lease or charter fees from leases or charters to Filipino citizens or corporationsc. Nonresident Owner or Lessor of Aircraft, Machineries and Other Equipment 7.5%

of gross rentals or feesd. Interest Income from Foreign Loans 20% final taxe. Income from transactions with depository banks under the expanded foreign currency deposit system (EFCDS) exempt

Minimum Corporate Income Tax Rate (MCIT)

Who are subject to MCIT?Domestic Corporations (DC) and Resident Foreign Corporations (RFC)

Rate and Base 2% on gross incomeThe MCIT is imposed if the amount resulting from the imposition of the 2% tax rate is greater than the amount resulting from the imposition of the regular corporate tax rate of 32%.The term 'gross income' shall mean gross sales less sales returns, discounts andallowances and cost of goods sold. In the case of taxpayers engaged in the sale of service, 'gross income' means gross receipts less sales returns, allowances, discounts and cost of services.

When does the MCIT become applicable?beginning on the 4th taxable year from the time the corporation commenced its business operations

Carry-forward of excess minimum taxAny excess of the minimum corporate income tax (2%) over the normal income tax (

32%) shall be carried forward and credited against the normal income tax for the3 immediately succeeding taxable years.


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EXEMPT CORPORATIONS

Legal Basis [Sec 30]

The following organizations shall not be taxed in respect to income received bythem as such:

(A) Labor, agricultural or horticultural organization not organized principallyfor profit(B) Mutual savings bank not having a capital stock represented by shares, and cooperative bank without capital stock organized and operated for mutual purposesand without profit(C) A beneficiary society, order or association, operating fort he exclusive benefit of the members such as a fraternal organization operating under the lodge system, or mutual aid association or a nonstock corporation organized by employees providing for the payment of life, sickness, accident, or other benefits exclusively to the members of such society, order, or association, or nonstock corporation or their dependents(D) Cemetery company owned and operated exclusively for the benefit of its membe

rs(E) Nonstock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset shall belong to or inures to the benefit of any member, organizer, officer or any specific person(F) Business league chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any privatestock-holder, or individual(G) Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare(H) A nonstock and nonprofit educational institution(I) Government educational institution(J) Farmers' or other mutual typhoon or fire insurance company, mutual ditch or

irrigation company, mutual or cooperative telephone company, or like organization of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members for the sole purpose of meeting its expenses and(K) Farmers', fruit growers', or like association organized and operated as a sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses on the basis of the quantity of produce finished by them;

Notwithstanding the provisions in the preceding paragraphs, the 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. (YMCA v CIR)

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET)


Nature and Purpose of the TaxThe improperly accumulated earnings tax applies to every corporation formed or availed for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed.

The tax is intended to discourage corporations from permitting its profits not needed by business to accumulate instead of being distributed to stockholders inthe form of dividends.


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Rate and Base 10% of the improperly accumulated taxable income

Corporations Not Subject to IAET1. Publicly-held corporations2. Banks and other non-bank financial intermediaries

3. Insurance companies

Evidence of Purpose to Avoid Income Tax

1. Prima Facie EvidenceThe fact that any corporation is a mere holding company or investment company shall be prima facie evidence of a purpose to avoid the tax upon its shareholdersor members.2. Evidence Determinative of PurposeThe fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless the corporation, b

y the clear preponderance of evidence, shall prove to the contrary.

Improperly Accumulated Taxable Income

Formula: Taxable Income+ Income exempt from tax+ Income excluded from gross income+ Income subject to final tax + net operating loss carry-over- Dividends actually or constructively paid- Income tax paid for the taxable yearImproperly Accumulated Taxable Income

TAXATION OF PARTNERSHIP

Definition of PartnershipBy the contract of partnership two or more persons bind themselves to contributemoney, property, or industry to a common fund, with the intention of dividing the profits among themselves.Two or more persons may also form a partnership for the exercise of a profession. [Art. 1767, Civil Code]

Classification of Partnerships for Tax Purposes1. Partnerships subject to tax (Business Partnerships)2. Partnerships not subject to taxa. General Professional Partnerships (GPP) partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or businessb. joint venture or consortium formed for the purpose of undertaking construction projectsc. joint venture or consortium formed for the purpose of engaging in petroleum,coal, geothermal and other energy operations pursuant to an operating consortiumagreement under a service contract with the Government.

General Professional Partnerships (GPP)


Rules:


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1. A GPP as such shall not be subject to the income tax2. Persons engaging in business as partners in a GPP shall be liable for incometax only in their separate and individual capacities.3. For purposes of computing the distributive share of the partners, the net income of GPP shall be computed in the same manner as a corporation.4. Each partner shall report as gross income his distributive share, actually orconstructively received, in the net income of the partnership.

5. The income tax liability of a partner in a GPP is computed using the scheduler rates.

Business PartnershipsBusiness partnerships include all partnerships, no matter how created or organized, except those mentioned above. [Sec 22(B)]

The share of a partner in the distributable net income after tax of a business partnership is subject to 10% final tax. [Sec24(B)(2)]

Co-ownershipThere is co-ownership:

1. When two or more heirs inherit and undivided property from a decedent.2. When a donor makes a gift of an undivided property in favor of two or more donees.

When Co-ownership not subject to taxWhen the co-ownerships activities are limited merely to the preservation of the co-owned property. In such a case, the co-ownership, as such, is not subject to tax. The co-owners are liable for income tax in their separate and individual capacity.

When Co-ownership is subject to taxWhen the income of the co-ownership is invested by the co-owners in business, the co-owners have in effect constituted themselves into a partnership. In such a

case, the co-ownership shall be subject to tax as a corporation.

For tax purposes, the co-ownership of inherited properties is automatically converted into an unregistered partnership the moment the said common properties and/or the incomes derived therefrom are used as a common fund with intent to produce profits for the heirs in proportion to their respective shares in the inheritance as determined in a project partition either duly executed in an extrajudicial settlement or approved by the court in the corresponding testate or intestateproceeding. The reason for this is simple. From the moment of such partition, the heirs are entitled already to their respective definite shares of the estateand the incomes thereof, for each of them to manage and dispose of as exclusively his own without the intervention of the other heirs, and, accordingly he becomes liable individually for all taxes in connection therewith. If after such partition, he allows his share to be held in common with his co-heirs under a singlemanagement to be used with the intent of making profit thereby in proportion tohis share, there can be no doubt that, even if no document or instrument were executed for the purpose, for tax purposes, at least, an unregistered partnershipis formed. [Ona v CIR, G.R. No. L-19342, 25 May 1972]

SOURCE OF INCOME


Classification of Income according to Source

1. Income derived from sources within the Philippines2. Income derived from sources without the Philippines3. Income derived from sources partly within and partly without the Philippines


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Basic Principles1. Resident Citizens (RC) and Domestic Corporations (DC) are taxable on income derived from within and without the Philippines2. Non-resident Citizens (NRC), Non-resident Aliens (NRA), Resident Foreign Corporations (RFC) and Non-resident Foreign Corporations (NRFC) are taxable only onincome derived from within the Philippines.

A. Gross Income From Sources Within the PhilippinesThe following items of gross income shall be treated as gross income from sources within the Philippines:1. Interests derived from sources within the Philippines, and interests on bonds, notes or other interest-bearing obligation of residents2. Dividends received:a. from a domestic corporation; andb. from a foreign corporation, unless less than 50% of its gross income for theprevious 3-year period was derived from sources within the Philippines. The income which is considered as derived from within the Philippines is obtained by using the following formula:

Philippine Gross Income x Dividend = Income WithinWorldwide Gross Income

3. Compensation for labor or personal services performed in the Philippines4. Rentals and royalties from property located in the Philippines or from any interest in such property5. Gains, profits and income from the sale of real property located in the Philippines6. Gains, profits and income from the sale of personal property

Place of PurchasePlace of SaleTreatmentPhilippinesAbroadIncome from WithoutAbroadPhilippinesIncome from WithinThe gain from the sale of shares of stock in a domestic corporation shall be tre

ated as derived entirely from sources within the Philippines regardless of wherethe said shares are sold.

Allowable Deductions to Gross Income From Sources Within the Philippines1. General RuleFrom the items of gross income above, the following are allowed as deductions:a. expenses, losses and other deductions properly allocated to items of gross incomeb. ratable part of expenses, interests, losses and other deductions effectivelyconnected with the business or trade conducted exclusively within the Philippines which cannot definitely be allocated to some items of gross income

Philippine Gross Income x Unallocated Expenses = Expenses to beWorldwide Gross Income Allocated to Inco

mefrom With

in

2. ExceptionNo deductions for interest paid or incurred abroad shall be allowed from the item of gross income unless indebtedness was actually incurred to provide funds foruse in connection with the conduct or operation of trade or business in the Philippines.

B. Gross Income From Sources Without the Philippines

The following items of gross income shall be treated as income from sources without the Philippines:1. Interests other than those derived from sources within the Philippines


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2. Dividends other than those derived from sources within the Philippines3. Compensation for labor or personal services performed without the Philippines4. Rentals or royalties from property located without the Philippines or from any interest in such property5. Gains, profits and income from the sale of real property located without thePhilippines

Allowable Deductions to Gross Income From Sources Without the PhilippinesFrom the items of gross income specified above, the following are allowed as deductions:1. expenses, losses, and other deductions properly apportioned to items of grossincome2. ratable part of any expense, loss or other deduction which cannot definitelybe allocated to some items or classes of gross income

Gross Income from Without the Phils. x Unallocated Expenses = Expenses tobeWorldwide Gross Income Allocated to

Income from Without

SUMMARY

Item of IncomeTest of Source of IncomeInterestResidence of the DebtorIncome from ServicesPlace of PerformanceRentalLocation of the PropertyRoyaltyPlace of Use of the IntangibleGain on Sale of Personal PropertyLocation of the Property SoldGain on Sale of Domestic SharesAlways Income WithinDividendsa. From Domestic CorporationIncome Withinb. From Foreign CorporationIncome Within, if more than 50% of its gross income for the previous 3-year period was derived from sources within the Philippines. Income within computed usingthis formula:

Phil. Gross Income x Dividend = Income WithinWorldwide Gross

Income

Income without, if less than 50% of its gross income for the previous 3-year period was derived from sources within the Philippines.

GROSS INCOME

Definition of Gross IncomeGross Income means the total income of a taxpayer subject to tax. It means allincome derived from whatever source. It does not include income which is excluded or exempted by law.

Items of Gross Income1. Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items2. Gross income derived from the conduct of trade or business or the exercise ofa profession3. Gains derived from dealings in property4. Interests5. Rents6. Royalties7. Dividends8. Annuities9. Prizes and winnings10. Pensions

11. Partner's distributive share from the net income of the general professionalpartnership (GPP)


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Compensation IncomeCompensation income is that income arising from an employer-employee relationship. It includes:1. Salaries and wages2. Commissions3. Tips4. Allowances

5. Bonuses6. Fringe Benefits of rank and file employees

Fringe Benefits of Rank and File employeesBasic Rule: Convenience of the Employer RuleIf meals, living quarters, and other facilities and privileges are furnished toan employee for the convenience of the employer, and incidental to the requirement of the employees work or position, the value of that privilege need not be included as compensation.

Gains Derived From Dealings In PropertyDealings in property such as sales or leases may result in gain or loss. The ga

in from the transaction shall be taxable income. [Sec 32(A)]. The loss shall bedeductible if incurred in the conduct of trade or business. [Sec 34(D)].

Basic Formula for Computing Gain or Loss:Selling Price XXAcquisition Cost XX XGain (Loss) XX

If Selling Price is greater than Acquisition Cost, there is a Gain.If Selling Price is less than Acquisition Cost, there is a Loss.

Interest IncomeInterest income received by citizens, resident aliens, and non-resident aliens e

ngaged in trade or business from long-term deposit or investment certificates (LTDIC), e.g. savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments, shall be exempt from tax.

Interest income from Government securities such as Treasury Bills is subject totax.

Rental IncomeRental income of the lessor includes1. the actual rent itself2. prepaid or advance rent3. Security deposit, only if applied as rent

DividendsKinds of Dividends1. Cash Dividend2. Stock DividendAs a general rule, Stock Dividends are not subject to tax.However, if a corporation cancels or redeems stock issued as a dividend in sucha manner as to make the distribution and cancellation or redemption essentiallyequivalent to a distribution of a dividend, the amount distributed shall be considered taxable income. (Unscrupulous individuals may declare stock dividends, cancel or redeem them, and then distribute its cash equivalent, thus achieving twoobjectives finding shelter in the non-taxability of stock dividends and circumventing the tax on cash dividends. With the rule, the loophole is plugged.)

3. Property Dividend measured at the fair market value (FMV) of the property received


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4. Scrip Dividend measured at the fair market value (FMV) of the promissory notereceived5. Liquidating Dividend distribution of all the property of a corporation. It isstrictly not dividend income, but rather a sale of shares of stock resulting incapital gain or loss.

Partner's Distributive Share From Net Income Of General Professional Partnership

(GPP)1. A general professional partnership (GPP) as such shall not be subject to theincome tax.2. Persons engaging in business as partners in a general professional partnership (GPP) shall be liable for income tax only in their separate and individual capacities.3. For purposes of computing the distributive share of the partners, the net income of the partnership shall be computed in the same manner as a corporation.4. Each partner shall report as gross income his distributive share, actually orconstructively received, in the net income of the partnership. [Sec 26]

Other Sources of Income

1. Recovery of Damages representing compensation for loss of profits or income (exclude damages which compensate for injury to property or person)2. Recovery of Bad Debt Previously Written Off (Tax Benefit Rule)If the deduction of the bad debt in a prior year resulted in an income tax benefit in favor of the taxpayer, the bad debt recovered is taxable income in the year of recovery.There is an income tax benefit when the deduction of the bad debt in the prior year resulted in lesser income and hence tax savings for the company.

EXCLUSIONS FROM GROSS INCOME

Legal Basis [Sec 32(B)]

The following are excluded from gross income:1. Life InsuranceThe proceeds of life insurance policies paid to heirs or beneficiaries upon thedeath of the insured. (The reason is that insurance is a contract of indemnity and hence, the proceeds should be treated as indemnity and not as gain or income.)2. Amount Received by Insured as Return of PremiumThe amount received by the insured, as a return of premiums paid by him under life insurance. (The rationale is that this is a return of capital and not income.)3. Gifts, Bequests, and DevisesThe value of property acquired by gift, bequest, devise, or descent. (The reason is that these transactions are subject to transfer taxes estate or donors taxes.)However, income from such property, as well as gift, bequest, devise or descentof income from any property, in cases of transfers of divided interest, shall beincluded in gross income.4. Compensation for Injuries or SicknessThe amounts received as compensation for personal injuries or sickness, plus theamounts of any damages received, whether by suit or agreement, on account of such injuries or sickness.5. Income Exempt under TreatyIncome of any kind, to the extent required by any treaty obligation binding uponthe Government of the Philippines.

6. Retirement Benefits, Pensions, Gratuities, etc.-a. Retirement benefits received under RA 7641 and those received by employees ofprivate firms in accordance with a reasonable private benefit plan maintained b


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y the employer:Requisites:(1) The retiring employee has been in the service of the same employer for at least 10 years(2) The retiring employee is not less than 50 years of age at the time of his retirement(3) The benefits shall be availed of by an employee only once.

(4) That there be a reasonable private benefit plan as defined below.

A 'reasonable private benefit plan' means* a pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the benefit of some or all of his employees* wherein contributions are made by such employer for the employees* for the purpose of distributing to such employees the earnings and principal of the fund thus accumulated and* wherein it is provided in the plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees.

b. Any amount received by an employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of* death* sickness or* other physical disability or* for any cause beyond the control of the employee

c. The social security benefits, retirement gratuities, pensions and other similar benefits received from foreign government agencies and other institutions

d. Payments of benefits by the United States Veterans Administration

e. Benefits received from or enjoyed under the SSS

f. Benefits received from the GSIS

7. Miscellaneous Itemsa. Income Derived by Foreign GovernmentIncome derived from (1) investments in the Philippines in financial securities or (2) from interest on deposits in banks in the Philippines by(i) foreign governments(ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and(iii) international or regional financial institutions established by foreign governments.

b. Income Derived by the Government or its Political SubdivisionsIncome derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof.

c. Prizes and AwardsPrizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only if:(i) recipient was selected without any action on his part to enter the contest or proceeding and(ii) recipient is not required to render substantial future services as a condit

ion to receiving the prize or award

d. Prizes and Awards in Sports Competition


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All prizes and awards granted to athletes (1) in local and international sportscompetitions (2) sanctioned by their national sports associations.

e. 13th Month Pay and Other BenefitsGross benefits received by employees of public and private entities provided that the total exclusion shall not exceed P30,000 which shall cover:i. Benefits received by government employees under RA 6686

ii. Benefits received by employees pursuant to PD 851 (13th Month Pay Decree)iii. Benefits received by employees not covered by PD 851 andiv. Other benefits such as productivity incentives and Christmas bonus

f. GSIS, SSS, Medicare and Other ContributionsGSIS, SSS, Medicare and Pag-ibig contributions, and union dues of individuals

g. Gains from the Sale of Bonds, Debentures or other Certificate of IndebtednessGains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than 5 years.Note that what is exempt is the sale or exchange of the instruments. Note further that interest income from these instruments are likewise exempt if held by a

resident citizen (RC), non-resident citizen (NRC), resident alien (RA), or a non-resident alien engaged in trade or business (NRAETB). [Sec. 24(B)(1), 25(A)].If held by a non-resident alien not engaged in trade or business (NRANETB) or

a corporation, the interest income becomes taxable income.

h. Gains from Redemption of Shares in Mutual FundGains realized by the investor upon redemption of shares of stock in a mutual

fund company

DEDUCTIONS FROM GROSS INCOME

The term taxable income means the pertinent items of gross income specified in t

his Code [ref: Sec 32], less the deductions [ref: Sec 34] and/or personal and additional exemptions [ref: Sec 35], if any, authorized for such types of income by this Code or other special laws. [Sec 31]

Kinds of Deductions1. Itemized Deductions2. Optional Standard Deduction

Who can avail of deductions?All taxpayers except for those earning compensation income arising from personalservices rendered under an employer-employee relationship

Rules:1. Compensation income earners can avail themselves only of the deduction in Sec34(M), i.e., premium payments on health and/or hospitalization insurance.2. The following can claim itemized deductions:a. Corporations, whether domestic or foreignb. General Professional Partnershipsc. Individuals engaged in trade, profession or businessd. Estates and trusts engaged in trade or business3. Only citizens (RC, NRC) and resident aliens (RA) can elect between itemized deductions and optional standard deduction.

Itemized Deductions(A) Expenses

(B) Interest(C) Taxes(D) Losses


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(E) Bad debts(F) Depreciation(G) Depletion(H) Charitable and Other Contributions(I) Research and Development(J) Pension Trust(M) Premium Payments on Health and Hospitalization Insurance of an Individual Ta

xpayer

Optional Standard Deduction (OSD)* The Optional Standard Deduction is in lieu of the itemized deductions.* The OSD is in an amount not exceeding 10% of gross income.* The taxpayer shall signify in his return his intention to elect the OSD; otherwise he shall be considered as having availed himself of the itemized deductions.

Note: Gross Income = Gross Sales or Receipts Cost of Sales or Services

BUSINESS EXPENSE

Legal Basis Sec 34(A)

In a nutshell, what is allowed as a deduction are ordinary and necessary trade,business or professional expenses.

Requisites for Deductibility of Business Expense1. It must be ordinary and necessary2. It must be paid or incurred during the taxable year3. It must be connected with the conduct of the trade, business or exercise of aprofession4. The tax required to be withheld must have been paid to the BIR.

What are examples of ordinary and necessary expenses?1. salaries, wages, and other forms of compensation for personal services actually rendered, including the grossed-up monetary value (GMV) of fringe benefit furnished by the employer to the employee.2. travel expenses, here and abroad, while away from home (meaning tax home or the place of work) in the pursuit of trade, business or profession3. rentals and/or other payments which are required as a condition for the continued use or possession of property4. entertainment, amusement and recreation expenses

The term "Representation Expenses" shall refer to expenses incurred by a taxpayer in connection with the conduct of his trade, business or exercise of profession, in entertaining, providing amusement and recreation to, or meeting with, a guest or guests at a dining place, place of amusement, country club, theater, concert, play, sporting event, and similar events or places.

Requisites for deductibility of entertainment, amusement and recreation expenses:a. It must be paid or incurred during the taxable yearb. It must be directly related to the conduct of trade, business or exercise ofa professionc. It must not be contrary to law, morals, good customs, public policy or publicorderd. It must not have been paid, directly or indirectly, to a government official

or employee or to a private individual, or corporation, or general professionalpartnership (GPP), if it constitutes a bribe, kickback or other similar payment;e. It must be duly substantiated by adequate proof. The official receipts should


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be in the name of the taxpayer claiming the deduction andf. The appropriate amount of withholding tax should have been withheld and paidto the BIR.

Ceiling on entertainment, amusement and recreation expenseThe amount of actual entertainment, amusement and recreation expense paid or incurred within the taxable year by the taxpayer, but in no case shall such deducti

on exceed* 0.5% of net sales (i.e., gross sales less sales returns/allowances and sales discounts) for taxpayers engaged in sale of goods or properties or* 1.0% of net revenue (i.e., gross revenue less discounts) for taxpayers engagedin sale of services, including exercise of profession and use or lease of properties [Rev Reg. No. 10-2002]

Bribes, Kickbacks and Other Similar PaymentsNo deduction from gross income shall be allowed as business expense for any payment made, directly or indirectly, to a government official or employee or to a private corporation, general professional partnership, or a similar entity, if the payment constitutes a bribe or kickback.

Expenses Allowable to Private Educational InstitutionsIn addition to the expenses allowable as deductions, a private educational institution may at its option elect either:1. to deduct expenditures otherwise considered as capital outlays of depreciableassets incurred during the taxable year for the expansion of school facilitiesor2. to deduct allowance for depreciation

INTEREST AND TAXES

Legal Basis Sec 34(B) and 34(C)

InterestThe amount of interest paid or incurred within a taxable year on indebtedness inconnection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income.

Requisites for Deductibility1. There is an indebtedness.2. The indebtedness is that of the taxpayer.3. The indebtedness is connected with the taxpayers trade, profession, or business.4. The taxpayer is liable to pay interest on the indebtedness.5. The indebtedness must have been paid or accrued during the taxable year.

Reduction of Interest Expense as a Deductible ItemThe taxpayer's allowable deduction for interest expense shall be reduced by an amount equal to 38% of the interest income subjected to final tax:

Non-deductible Interest1. Interest paid in advance by the taxpayer who reports income on cash basis (because such interest shall be allowed as a deduction in the year the indebtednessis paid.)2. Interest paid by one person to a family member or a related taxpayer (subsidiary, affiliate) Sec 36(B)3. Interest on indebtedness incurred to finance petroleum exploration

Note: Interest for late payment of income tax is deductible, but fines and penalties for late payment are not deductible.


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Optional Treatment of Interest ExpenseAt the option of the taxpayer, interest incurred to acquire property used in trade business or exercise of a profession may be either (1) allowed as a deductionor (2) treated as a capital expenditure (asset).

Taxes

General Rule: Taxes paid or incurred within the taxable year in connection withthe taxpayer's profession, trade or business, shall be allowed as deduction.

Exceptions:1. income tax2. foreign income taxes, if claimed as tax credit3. estate and donor's taxes4. special assessment taxes assessed against local benefits of a kind tending toincrease the value of the property assessed5. value added tax6. fines and penalties due to late payment of tax

7. taxes which are final taxes

Requisites for Deductibility1. It must be paid or incurred within the taxable year.2. It must be paid or incurred in connection with the taxpayers trade, professionor business.3. It must be imposed directly on the taxpayer.

Examples of Deductible Taxes1. Import duties2. Business taxes3. Occupation taxes4. Privilege and license taxes

5. Excise taxes6. Documentary stamp taxes7. Automobile registration fees8. Real property taxes

Limitations on DeductionsIn the case of a nonresident alien individual engaged in trade or business (NRAETB) and a resident foreign corporation (RFC), the deductions for taxes shall beallowed only if and to the extent that they are connected with income from sources within the Philippines.

Phil net income x Taxes paid to a foreign country = Deductible foreign taxesWorldwide Net income

LOSSES AND BAD DEBTS

Legal Basis Sec 34(d) and 34(E)

LossesLosses actually sustained during the taxable year and not compensated for by insurance or other forms of indemnity shall be allowed as deductions.

Requisites for Deductibility

1. The loss must be actually sustained.2. It must be sustained in a closed and completed transaction.3. The property lost must be connected with the conduct of trade or business.


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4. The loss must be that of the taxpayer.5. The loss must not be compensated by insurance or other forms of indemnity.6. The loss must be reported to the BIR within 45 days from the date of loss. (Sworn Declaration of Loss)

Examples of causes of loss:Business loss those incurred in trade or business such as obsolescence, worthles

snessCasualty loss fires, storms, shipwreck, robbery, theft or embezzlement

No loss shall be allowed as a deduction if at the time of the filing of the return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return. (The purpose is to avoid the item from being deducted twice, tothe detriment of the Government.)

How (partial) loss is computed:

Formula: Book Value of property lost XX

Less: Salvage value of property lost XXInsurance recovery XXLoss (XX)

* If loss is total, the amount of book value is equivalent to the actual loss.

Obsolescence and WorthlessnessObsolescence of property is deductible as a loss when the property has to be discarded permanently because its usefulness is suddenly terminated.Worthlessness may be a ground for deductibility of the value of the property asa loss when it can be satisfactorily shown that the property had indeed become valueless. If securities become worthless during the taxable year and are capital assets, the loss resulting therefrom shall be considered as a loss from the sa

le or exchange, on the last day of such taxable year, of capital assets. (See discussion under heading Gains and Losses)Shrinkage in value of property is not a ground for deductibility as a loss. There has to be an actual loss sustained in order for it to be deductible.

Capital Losses(See discussion under heading Gains and Losses)

Wagering LossesLosses from wagering transactions shall be allowed only to the extent of the gains from such transactions. (Therefore, if there are no wagering gains, wageringloss cannot be deducted.)

Net Operating Loss Carry-Over (NOLCO)Net operating loss is the excess of allowable deductions over gross income.

The net operating loss of the business of the immediately preceding taxable yearshall be carried over as a deduction from gross income for the next 3 consecutive taxable years immediately following the year of such loss.

Requisites for application of NOLCO:1. any net loss incurred in a taxable year during which the taxpayer was exemptfrom income tax shall not be allowed as a deduction2. a net operating loss carry-over (NOLCO) shall be allowed only if there has been no substantial change in the ownership of the business.

There is no substantial change when1. not less than 75% in value of outstanding shares is held by or on behalf of t


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he same persons; or2. not less than 75% of the paid up capital is held by or on behalf of the samepersons.

Non-deductibility of certain lossesIn computing net income, no deductions shall be allowed in respect of losses from sales or exchanges of property directly or indirectly between members of a fam

ily or related taxpayers (subsidiaries, affiliates).

Bad Debts

Rule: Debts due to the taxpayer actually ascertained to be worthless and charged off within the taxable year are deductible from gross income.

Exceptions: The following are not deductible as bad debts:1. those debts not connected with profession, trade or business2. those sustained in a transaction entered into between family members or related taxpayers

Requisites for Deductibility:1. There must be a valid and subsisting debt.2. The debt must be connected with profession, trade or business.3. The debt must be actually ascertained to be worthless or uncollectible. (e.g., bankrupt debtor)4. The debt must be charged off within the taxable year.

Recovery of Bad Debts Previously DeductedThe recovery of bad debts previously allowed as deduction in the preceding yearsshall be included as part of the gross income in the year of recovery to the extent of the income tax benefit of said deduction. (Tax Benefit Rule)If the deduction of the bad debt in a prior year resulted in an income tax benefit in favor of the taxpayer, the bad debt recovered is taxable income in the yea

r of recovery.There is an income tax benefit when the deduction of the bad debt in the prior year resulted in lesser income and hence tax savings for the company.

DEPRECIATION AND DEPLETION

Legal Basis Sec 34(F) and 34(G)

DepreciationDepreciation is the gradual diminution of the useful value of tangible propertyresulting from wear and tear and normal obsolescence. There shall be allowed asa depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in the trade or business. The rationale for this is that property gradually approaches a point where its usefulness is exhausted.

Requisites for Deductibility1. The asset must be used in trade or business.2. The asset must have a limited useful life.3. The allowance must be reasonable.4. The allowance must be charged off during the year.5. The total allowances must not exceed the cost of the property.

Methods and Rates of Depreciation

1. Straight-line method (SL)Formula: Cost Salvage Value X

Estimated Useful Life of the Property


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2. Declining-balance method, using a rate not exceeding twice the rate for straight line methodUnder this method, the depreciation allowance per year varies. Depreciation islargest in the first year and continually decreases towards the end of the useful life of the property.

Example: Double Declining Balance Method (DDB)Cost: P100,000.00 / Salvage Value: P5,000.00Estimated Useful Life of the Property: 5 yearsStraight Line rate: 1/ estimated useful life or 1/5 or 20%Double Declining Rate: 20% x 2 = 40%

The depreciation for the first year is P40,000.00, computed as follows: [P100,000 x 40%]. Note that the salvage value is ignored in the declining balance method. The depreciation for the second year is P24,000.00, computed as follows: [(P100,000 P40,000) x 40%].

3. Sum-of-the-years-digit method (SYD)

Under this method, the annual depreciation is computed by applying a changing fraction to the cost of the property reduced by the salvage value. In the fraction, the numerator is the number of remaining years of the estimated useful life of the property and the denominator is the sum of the numbers representing the years of the life of the property.

Example: Cost of the Property: P105,000Salvage Value: P 5,000Estimated Useful Life: 5 years

Depreciation ScheduleYear 1 5 / 15 x (P105,000 P5,000)Year 2 4 / 15 x P100,000

Year 3 3 / 15 x P100,000Year 4 2 / 15 x P100,000Year 5 1 / 15 x P100,000

The denominator 15 is the sum of the years digits of the useful life of the property: 5 + 4 + 3 + 2 + 1.The numerator is the remaining years in the useful life of the property.

Depreciation of Properties Used in Petroleum OperationsAn allowance for depreciation in respect of all properties directly related to production of petroleum shall be allowed under the straight-line or declining-balance method of depreciation at the option of the service contractor. If the service contractor initially elects the declining-balance method, it may shift to the straight-line method. The useful life of such property shall not be more than 10 years. Properties not used directly in the production of petroleum shall be depreciated under the straight-line method on the basis of an estimated usefullife of 5 years.

Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business (NRAETB) or Resident Foreign Corporations (RFC)A reasonable allowance for the deterioration of property shall be permitted onlywhen such property is located in the Philippines.

Depletion of Oil and Gas Wells and MinesDepletion is the exhaustion of natural resources due to production. The rationa

le for depletion allowance is the recovery of the capital invested in the property.


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In the case of oil and gas wells or mines, a reasonable allowance for depletioncomputed using the cost-depletion method shall be granted provided that when theallowance for depletion shall not exceed the capital invested. The cost depletion method is based on the cost of a mine deposit to the taxpayer. The purposeof cost depletion is to return to the taxpayer, free of tax, that portion of thecost of mining resources which taxpayer spent in earning his taxable income.

Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien individual (NRA) or Foreign Corporation (RFC, NRFC)In the case of a nonresident alien individual engaged in trade or business in the Philippines or a resident foreign corporation, allowance for depletion of oiland gas wells or mines under paragraph (1) of this Subsection shall be authorized only in respect to oil and gas wells or mines located within the Philippines.

PENSION TRUST AND CHARITABLE AND OTHER CONTRIBUTIONS

Legal Basis Sec 34(H) and 34(J)

Pension TrustsAn employer may establish a pension trust to provide for the payment of reasonable pension to his employees.

Such employer who establishes a pension trust shall be allowed to deduct1. Contributions to such trust during the taxable year to cover the pension liability accruing during the year2. Payments into such trust during the taxable year in excess of such contributions

Payments mentioned in #2 above shall be allowed as a deduction only if such amount1. has not theretofore been allowed as a deduction AND

2. is apportioned equally over a period of 10 consecutive years beginning with the year in which the payment is made.

In summary, Contributions are deductible in full while Payments in excess of Contributions are deductible annually for 10 years and in equal parts.

Charitable and Other ContributionsContributions made within the taxable year are allowed as deductions from grossincome.

Requisites for Deductibility1. The contribution must be actually paid.2. It must be given to the entity specified by law.3. The net income of the entity must not inure to the benefit of any private stockholder or individual.4. The taxpayer making the contribution must be engaged in trade, business or profession.

Kinds of Contributions1. Those deductible in full2. Those subject to limit

Contributions Subject to Limit1. Contributions made to the Government or any of its agencies or political subdivisions exclusively for public purposes

2. Contributions made to accredited domestic corporation or associations organized exclusively for* religious


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* charitable* scientific* youth and sports development* cultural* educational or* rehabilitation of veterans3. Contributions to social welfare institutions

4. Contributions to non-government organizations

Limit of ContributionIndividual 10% of taxable income derived from trade or business, before deducting contributionsCorporation 5% of taxable income, before deducting contributions

Contributions Deductible in Full1. Donations to the Government, exclusively to finance priority activities in* education (e.g., UP, IBP)* health* youth and sports development

* human settlements* science and culture (e.g., CCP, National Museum) and* economic development2. Donations to Certain Foreign Institutions or International Organizations3. Donations to Accredited Non-government Organizations (NGO)

A "non-government organization" means a non profit domestic corporation:a. Organized and operated exclusively for scientific, research, educational, character-building and youth and sports development, health, social welfare, cultural or charitable purposes, no part of the net income of which inures to the benefit of any private individual.b. Which makes utilization directly for the active conduct of the activities constituting the purpose for which it is organized and operated.c. The level of annual administrative expense of which shall not exceed 30% of t

he total expenses.d. The assets of which, in the event of dissolution, would be distributed to another nonprofit domestic corporation organized for similar purpose, or to the State for public purpose.

* Note that when the requisites above are not met, the contribution becomes subject to limit.

Valuation of Charitable Contribution in KindThe amount of any charitable contribution of property other than money (i.e., contributions in kind) shall be based on the acquisition cost of said property.

Contributions Deductible by a General Professional Partnership (GPP)A GPP is not subject to income tax. In determining its net income, the GPP candeduct the contributions which are deductible in full. With respect to the contributions subject to limit, they may be claimed an deducted by the partners in proportion to their respective interest.

RESEARCH AND DEVELOPMENT AND PREMIUM PAYMENTS ON HEALTH AND HOSPITALIZATION INSURANCE

Legal Basis Sec 34(L) and 34(M)

Research and Development

Research and Development (R&D) may be treated either as:1. ordinary and necessary expenses or2. deferred asset which is periodically subject to depreciation or amortization.


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As an Ordinary and Necessary ExpenseRequisites for Deductibility1. The R&D expenses must have been paid or incurred during the taxable year.2. The R&D expenses must be connected with the conduct of the trade or businessof the taxpayer.

As a Deferred Asset subject to Depreciation or AmortizationAt the election of the taxpayer, the following R&D expenditures may be treated as deferred assets:1. Those paid or incurred by the taxpayer in connection with his trade, businessor profession2. Those not treated as expenses and3. Those chargeable to capital account but not chargeable to depreciable propertyThe deferred asset shall be allowed as deduction ratably distributed over a period of not less than 60 months. The taxpayer may elect this alternative not later than April 15 of each taxable year.

Limitations on DeductionThe following are not allowed as R&D expenses:1. Any expenditure for the acquisition or improvement of land or the improvementof depreciable property.2. Any expenditure incurred in ascertaining the existence, location, extent, orquality of any deposit of ore or other mineral, including oil or gas.

Premium Payments on Health and/or Hospitalization Insurance of an Individual TaxpayerThe amount of premiums not to exceed P2,400 per family or P200 a month paid during the taxable year for health and/or hospitalization insurance taken by the taxpayer for himself or his family, shall be allowed as a deduction from his grossincome provided the gross family income for the taxable year is not more than P2

50,000.

Requisites for Deductibility1. The taxpayer must be an individual, whether a compensation earner or engagedin trade or business.2. The premium payments is for health and/or hospitalization insurance of the taxpayer or his family.3. The taxpayers gross family income is not more than P250,000.

In the case of married taxpayers, only the spouse claiming the additional exemption for dependents shall be entitled to this deduction.

TREATMENT OF FOREIGN INCOME TAX

Legal Basis Sec 34(C)

A taxpayer has the option to claim foreign income tax either as:1. Tax Credit2. Deduction from Gross Income

Deduction from Gross IncomeIf the taxpayer elects to claim the foreign income tax as a deduction from grossincome, the foreign income tax is included among the itemized deductions. Suchdeduction is not subject to any limitation.

Tax CreditOnce the foreign income tax is claimed as a tax credit, it cannot anymore be cla


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imed as a deduction from gross income and vice versa.Tax Credit is amount of income tax paid or incurred to any foreign country allowed to be subtracted from the Philippine income tax due from the taxpayer. It isa remedy against international double taxation.

Who may claim Tax CreditOnly those persons whose income from within and without the Philippines may clai

m tax credit:-1. Resident Citizens (RC)2. Domestic Corporations (DC)3. Members of General Professional Partnership (GPP)4. Beneficiary of an estate or trust

Who may not claim Tax Credit1. Non-resident Citizens (NRC)2. Resident Alien (RA)3. Resident Foreign Corporation (RFC)4. Non-resident Foreign Corporation (NRFC)

Amount of Tax CreditThe amount of tax credit allowed is equivalent to the tax paid or incurred to aforeign country during the taxable year but not to exceed the following limits:1. The amount of tax credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sourceswithin such country bears to his entire taxable income for the same taxable year; and2. The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources without the Philippines taxable bears to his entire taxable income for the same taxable year.

In formula format, the limitations are as follows:

1. Taxable Income per Foreign Country x Philippine income tax = limitWorldwide Taxable Income

2. Taxable Income for all Foreign Countries x Philippine income tax = limitWorldwide Taxable Income

If there is only one foreign country involved, the first formula is used. If there are two or more foreign countries are involved, both formulae are computed,in which case the lower of the two limits is used as the amount of tax credit.

NON-DEDUCTIBLE EXPENSES

Legal Basis Sec 36

In GeneralIn computing net income, no deduction shall be allowed in respect to:-1. Personal, living or family expenses because not related to conduct of trade or business2. Capital Expenditures amount paid for buildings or improvements made to increase the value of property.3. Major Repairs amount spent in restoring property for which depreciation allowance has been made4. Premiums paid on any life insurance policy covering the life of any officer,

employee, or person financially interested in the trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary undersuch policy.


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Case 1Insured officer, employee, owner, stockholder, or other financially-interested personBeneficiary companyThe premium is a non-deductible expense. [Sec 36]

Case 2Insured officer, employee, owner, stockholder, or other financially-interested personBeneficiary officer, employee, owner, stockholder, or other financially-interested personThe premium is a deductible expense. The premium is likewise a fringe benefit on the part of the beneficiary.

COMPUTATION OF INDIVIDUAL INCOME TAX

1. For Pure Compensation Income Earners

Gross Compensation IncomeLess: Premium Payments for Health and Hospitalization InsuranceNet IncomeLess: Personal and Additional Exemptions XTaxable IncomeMultiplied by: Tax Rate (Schedular Rates)-Income Tax Payable

2. For Business or Professional Income Earners

Gross Compensation IncomeLess: Itemized Deductions or Optional Standard Deduction -

Net IncomeLess: Personal and Additional Exemptions-Taxable IncomeMultiplied by: Tax Rate (Schedular Rates)-

Income Tax Payable

LOSSES FROM WASH SALES

Legal Basis Sec 38

Wash sale is a sale of stocks or securities at a loss, whereby the seller acquired by purchase or exchange substantially identical stocks or securities within the 61-day period (within 30 days before or 30 days after) of such sale.

Requisites of a Wash Sale1. The sale of stocks or securities is at a loss.2. Within 30 days before or after such sale, the seller acquired by purchase orexchange substantially identical stocks or securities.3. The seller is not a dealer in stocks or securities.

The 61-day Period. The acquisition of stocks or securities within the 30 day-period before or after the date of sale is determinative of whether the sale is a

wash sale.

30 days before Date of Sale 30 days after


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--------------------------------------- x ----------------------------------------

Effects of Wash Sale Loss1. The loss from a wash sale is not deductible.2. If substantially identical shares are acquired within the 30-day period afterthe date of sale, the loss from wash sale is added to the cost of the shares ac

quired. Hence, the loss from wash sale has the effect of increasing the cost ofreacquired shares.

ORDINARY GAINS AND LOSSES

Legal Basis Sec 40

The sale of property may result in a gain or a loss. The law provides that thegain or loss be recognized.

Computation of Gain or Loss

1. The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis.2. The loss shall be the excess of the basis over the amount realized from suchsale or other disposition.3. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property (other thanmoney) received.

Amount Realized (Cash received + Fair Market Value [FMV] of property received)Less: Basis (usually the Cost of Acquisition of Property)Gain (or Loss, if basis is greater than amount realized)

Basis for Determining Gain or Loss from Sale or Disposition of Property

The basis of property shall be:-1. The cost, if such property was acquired by purchase2. The fair market value (FMV) as of the date of acquisition, if property was acquired by inheritance3. If the property was acquired by gift, the basis shall be the same as if it would be in the hands of the donor4. If the property was acquired for inadequate consideration, the basis is the amount paid by the transferee for the property

Exchange of PropertyGeneral Rule: Upon the exchange or property, the entire amount of the gain or loss shall be recognized.Except

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