Taxation I - PreFinals - Corporation Income Taxation

TAXATION I CORPORATE INCOME TAX A. Introduction and Definition of Terms Corporation – includes partnership no matter how created or organized, joint account companies, insurance companies and other associations except: 1. General professional partnership 2. Joint Venture for the purpose of undertaking construction projects 3. Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government -

What is a corporation? Does it include partnership? What does it include? o

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Yes, except general professional partnerships.

A corporation is defined based on Section 22, includes partnership no matter how created or organized, joint account companies, insurance companies and other associations except: 

1. General professional partnership

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2. Joint Venture for the purpose of undertaking construction projects

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3. Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government

Sec 22. (B) The term "corporation" shall include partnerships, no matter how created or organized, joint-stock companies, joint accounts (cuentas en participacion), association, or insurance companies, but does not include general professional partnerships and a joint venture 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 the Government. "General professional partnerships" are 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 business. -

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Why does it exclude general professional partnership? For tax purposes, that a corporation includes all partnership except general professional partnership? Are there any type of partnership that you know? o

Partnerships may be taxable business partnerships or the non-taxable partnerships which is the general professional partnership. In some books or in some discussions, you will see general co-partnership, but they are actually partnerships which are still taxable.

o

Generally, let’s just classify them into 2 kinds. The taxable partnerships, these are the business partnerships, the unregistered partnerships/

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And the non-taxable partnerships, which are the general professional partnerships.

What is a partnership? So if this room forms a partnership, it will be taxable to 30%? o

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Binigyan answers: Yes.

Does corporation include associations? Is an association a corporation? Note: Don’t confuse yourself with corporations being taxable all the time. My question is simple, is an association a corporation? Does it fall under corporate tax payers? o

Note that NOT ALL corporations are taxable.

***In broken line borders are outline notes.

In straight line borders are codal provisions.

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Yes,

What is a joint venture? Example. o

If you have a 10 hectare parcel of land and you put it in a corporation. So, corporation is a real estate corporation because the business is into land holdings. What will you do if you want to develop the land but you don’t have the funds to do it?

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40 Million 60 Million 100 Million total income

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To Your Income To the income of the Construction Company

Is this really exempt from income tax? NO! Someone else is liable and not the joint venture. (Someone else is taxed separately)

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Corporations enter into joint ventures with other corporations for purposes of developing construction projects. if you are a land owner and you don’t have funds to develop that land that you own. You task a construction company who will develop the parcel of land and make condominium units, subdivision units out of it. Sharing would be 40-60 fusion or 30-70. You don’t spend. You are the owner of the land, you don’t spend for anything in the construction. After all is finished, 40% of the units given to you and 70 percent of the units will be owned by the construction company. o

In that case, if you are the land owner and you get to have 40% of the subdivision units transferred in your name, is this subject to Capital Gains Tax? Is it a sale? 

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Now, if the joint venture between your corporation and the construction company earns income, is it subject to income tax? Is your joint venture subject to the corporate tax rate of 30%? o

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CGT is imposed not only in sale and exchange but any other modes of disposition. But in this case it is NOT subject of CGT for the reason that the transfer is not really for a disposition of property but to simply effect what has been agreed in the joint venture agreement.

General corporation or partnerships, they are not subject to the corporate tax. They are exempt from income tax actually. The income of joint ventures between 2 corporations under the sole management of either one company or particular group of persons will also be not covered under the corporate tax of 30%.

But is the income really taxable? Can the government not collect any form of tax covered by the joint venture? Parcel of land with houses, everything was sold, 40% of the income, 40 million was given to you, 60 million was retained by the construction company. Since the total of 100million income is not taxable in a joint venture. So is this really free from tax? Can the government not really collect any form of tax on the income derived from the activity covered by the joint venture agreement? Who will be liable for the 100million income, is it the joint venture or someone else? o

Someone else. Who is this someone else?

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Joint venture for purposes of undertaking construction projects are not subject to corporate tax of 30%. Nonetheless, any income distributed to the parties who enter into a joint venture agreement will be separately taxable to income tax.



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So, meaning to say, that the 4 million will be added to your other income of your corporation and the 60 million to the income of the construction company. It will still be subject to 30% tax still as part of the income for the entire taxable year.

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It does not mean that joint venture is really free from the corporate tax of 30%. It is free from the corporate tax of 30% but the liability will be shouldered separately by the parties of the joint venture agreement. Now that’s joint venture.

Corporations are defined to include partnerships, associations or joint ventures, joint stock companies, joint accounts except for 3: o

1. General Professional Partnerships

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2. Joint Venture for the purpose of undertaking construction projects

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3. Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government 

You have to be specific, all joint ventures as a rule, are subject to the corporate tax of 30% except if it for undertaking construction projects or a joint consortium for the petroleum, geothermal and other energy operations but it has to be with the government.

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If it’s a joint consortium NOT in contract with the government, it is taxable still. So you have to be careful on the requisites for these 3 entities which are not covered by the definition of a corporation.

General Professional Partnership (GPP) – partnerships formed by person for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business. Persons engaged in business as partners in a GPP, shall be liable for income tax only in their separate and individual capacities. 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. Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership. Income of a GPP is deemed constructively received by the partners. -

General Profession partnership. We now know, that the income of a joint venture is not taxable to the joint venture but taxable separately. How about general professional partnerships? Would the income of general professional partnerships be absolutely be free from tax or is it taxable on someone else? o

You remembered when we said that any share of the partners in GPPs, the undistributed shares will still be considered as constructive income already taxable on the part of the individual partners. Now, even if the GPP is not subject to 30% corporate tax rate on the net income, the net income is considered as earned by the partners composing the GPP. And taxable separately on the part of these partners to 5%- 32%.

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But is the GPP free from the obligation of filing an income tax return? 

General professional partnerships even if they are exempt from income tax are required to file an Income Tax Return for the simple reason that it is the only tool that the government will use to determine whether the partners composing the GPP are correctly declaring their income. It’s the basis, if there are 3 partners, the only thing that the government will do is divide it into 3, 1/3 must have been reported as part of the income tax return of the individual partners.

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In fact, the individual partners, when they submit their income tax return, strictly, they have to include and submit the income tax return of the GPP.



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So you will see class that taxation may not be imposed in this type of person, whether natural or juridical but somehow since there is an income, the tax will be imposed upon some other tax payer.

Joint Venture – created when 2 corporations, while registered and operating separately, are placed under one sole management which operated the business affairs of said companies as though they constituted a single entity thereby obtaining substantial economy and profits in the operation. Joint Account – created when 2 persons form or create a common fund and such persons engages in a business for profit. This may result in a taxable unregistered association or partnership Joint Stock Companies – the midway between a corporation and a partnership, a hybrid personality”, somewhat a corporation because this is managed by a Board of directors and such persons may transfer their share/s without the consent of others, and somewhat a partnership because it is an association, and persons or members of the same contribute fund, money to a common fund. Emergency Operation – these may be formed by 2 corporations with separate personalities. If they form that emergency operation (it is a really a special activity) to engage in a joint venture. Corporation 1 may be taxed only from the income derived from such business. The income derived from such emergency operation should also be included in that taxable income subject to corporate income tax. In the same way, that corporation 2, has a separate and distinct personality; if it’s a part of that emergency operation, the income derived from such special activity should also be included in the income of that corporation 2, subject to corporate income tax, even if it is not registered with the Securities and Exchange Commission. -

Joint Venture: it is between 2 corporations placed under one sole management for sometimes, a special operation.

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Joint Account: it is between 2 persons forming or creating a common fund for profit. It is usually an unregistered association. They do not need to register that with the SEC.

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Joint Stock Companies: probably, the only time this will come out is when you are asked to define what it is.

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Is a co-ownership a taxable entity? o

General rule: A co-ownership is tax-exempt. It is not considered as a corporation, not a partnership.

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Exception: when the co-owners in a co-ownership are earning profits, it will be considered as an unregistered partnership, subject to 30% tax. 

When you say earning profits, does elevating their status as an unregistered partnership, does it include sharing in the income of the estate left to them by the decedent?

o

If a co-owned property produces income and enjoyed by the co-owners, it is not automatic that it will be subject to the corporate tax rate of 30% as an unregistered partnership.

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It will only be considered as an unregistered partnership if co-owners themselves have undertaken steps to infuse investment and make it a profitable business.

B. Taxable Corporations – DC, RFC, NRFC 1. Domestic Corporations (DC) See Section 27 A corporation formed or organized under Philippine laws. It is subject to tax on its net taxable income from sources WITHIN and WITHOUT the Philippines. 2. Resident Foreign Corporation (RFC), See Section 28A ***In broken line borders are outline notes.


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A corporation formed, organized, authorized or existing under the laws of any foreign country, and engaged in trade or business WITHIN the Philippines. It is subject to tax on its net taxable income from sources within the Philippines. There is no fixed criterion as to what constitutes “engaged in trade or business”. Being “engaged in business” implies continuity of commercial transactions or dealings - continuity of business or continuity of intention to conduct continuous business. 3. Non-Resident Foreign Corporations (NRFC), See Section 26B A corporation formed, organized, authorized, or existing (foae) under the laws of any foreign country. It is subject to tax on its gross income from sources WITHIN the Philippines. Such gross income may include interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic, or casual gains, profits, and income and capital gains, EXCEPT, capital gains from the sale of shares of stock not traded in the stock exchange. -

Who are the taxable corporations? How do we classify corporations in the Philippines, as taxpayers?

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Illustration of Atty. In the board: (explanation below the illustration) CORPORATE DOMESTIC

FOREIGN

1. Philippine Laws

1. Foreign Laws

2. Within and Without

2. Abroad

3. NET (allowed to deduct expense within and without)

3. Within If allowed to deduct expense depends on: Resident Foreign Corporation 1. 2. 3.

Non-Resident Foreign Corporation

Taxed at NET Allowed to deduct expenses WITHIN Tax Rate: 30%

1. 2. 3.

Taxed at GROSS NOT Allowed to deduct expenses Tax Rate: 30%

Tax Rates: Domestic Corporation 30% 

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Resident Foreign Corporation 30%

Non-Resident Foreign Corporation 30%

Domestic corporations 1. formed and organized under Philippine laws 2. income is taxable within and without 3. In so far as computing their tax due, they are allowed to deduct expenses, and taxable on their net taxable income 4. Tax rate – 30% IN CONTRAST WITH: Foreign corporations 1. Formed and organized under laws of a foreign country 2. Income is taxable within



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3. In so far as computing their tax due and whether they can deduct expenses, it depends whether they are: a. Resident foreign corporation 1. Allowed to deduct expenses but only those in relation to income generated within the Philippines. 2. Since resident foreign corporations are taxable only on income generated within, therefore, NET, meaning they are allowed to deduct expenses; the expenses that they are allowed to deduct against their income would only be expenses within the Philippines or those which they have incurred in relation to producing the income that is taxable under Philippine laws; 3. As to tax rate – 30% b. Non-resident foreign corporation 1. NOT allowed to deduct expenses. 2. Therefore, they are taxed at GROSS, meaning there are no deductions; “expenses within and without” have no bearing because it is subject to tax at gross. 3. tax rate – 30% -

You see, under the diagram shown above, corporate tax payers are simpler to understand. There are only 3 kinds of taxable corporations. They do receive some other source of income which is passive income, we don’t have the 25% for non-resident not engaged in trade or business. All of them are taxable at 30%. The main difference is that this is taxable worldwide and no expenses allowed for NRFC.

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What makes a foreign corporation “Resident” and what makes it a “non-resident” corporation? What is the simplest way of determining whether it is resident or non-resident? o

If we go to the legal phase, a foreign corporation would like to do business in the Philippines, to register itself as a resident foreign corporation in the Philippines. So if it is registered as a Philippine branch of a foreign company, it is automatically considered as a resident foreign corporation.

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But NON-REGISTRATION of a foreign corporation does not mean that you can never be classified as a resident foreign corporation. Why? 

Because the criteria really is not the registration for tax purposes, or your official registration in the Philippines. But it is WON you are doing business in the Philippines.

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“Doing business in the Philippines” would require the determination of whether the activity you are doing in the Philippines is done in a continuous basis or regular basis.

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So you cannot escape taxation simply by not registering. Because non-resident foreign corporations are foreign corporations not doing business in the Philippines. If they are considered as not doing business in the Philippines, why do we have to discuss them, as a corporate taxpayer? o


Notwithstanding that this foreign corporation, organized or incorporated abroad, not doing business in the Philippines, we also consider them as part of the 3 types of corporate taxpayers because in some cases, foreign corporations not registered in the Philippines, not doing business in the Philippines enters into isolated transactions with a domestic corporation or an individual. Therefore, just for the purpose of knowing what their taxability is in the Philippines, to consider them as part of the taxpayer “NOT DOING BUSINESS”, meaning not regular or not on a continuous basis, but taxable still to the same 30%. The problem is, they are taxable on the gross. In straight line borders are codal provisions.

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Filing of an Income Tax Return (ITR) -

Domestic corporations are liable for 30% on the net income (because they are allowed expenses incurred within and without), are they required to file an ITR at the end of the year or on a quarterly basis and finalize at the end of the year? o

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Resident foreign corporations: Are they required to file an ITR at the end of the year? o

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Corporations, especially domestic corporations, it abounds in the Philippines, they are required to declare their income in a quarterly basis. These are mere estimates and at the end of the year it is annualized. On their own, they have to do that, this is called self-assessment (you assess yourself as to how much your income is, how much expenses and what is your tax liability to the government). YES, being resident foreign corporations, they are categorized still having the same obligation of filing the ITR at the end of the year and/or a quarterly basis.

But what about Non-resident foreign corporations. These are corporations organized abroad; not doing business in the Philippines. When they enter into one isolated transaction in the Philippines, are they required to file an ITR at the end of the year or on a quarterly basis? o

If you are from the BIR, what ways are there available to collect the 30% tax on the gross income? 

Any payments made to non-resident foreign corporations, just like payment to nonresident aliens NOT engaged in trade or business of 25%, since they are not considered as doing business in the Philippines, they would have to be withheld of the tax. Payments to: o

Non-RFC - withhold 30% of the tax

o

Non-resident aliens not engaged in trade or business – withhold 25% (they will receive 70% free from tax already or 75%)


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REASON: the Philippine government does not have jurisdiction over these taxpayers, hence, the government cannot expect them to declare their income at the end of the year or on a quarterly basis.

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What it expects is that, any payor of the income, meaning to whom these persons is transacting with has the obligation of a withholding agent. As a withholding agent, he will be liable for non-withholding.

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Is this a final tax or a creditable tax? Is the tax withheld from a nonresident foreign corporation, including non-resident alien not engaged in trade or business a final withholding tax or creditable withholding tax? 

A final withholding tax.

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Is a non-resident foreign corporation expected to file an ITR at the end of the year? No, because he is not doing business in the Philippines, and not even registered as a business in the Philippines. Therefore, not being required to file an ITR everytime payment is being made to them, it should be taxed with finality.

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What is the “Withholding with finality” – it is the final withholding tax considered as the full and final payment of the tax.


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Contrarily, the nature of a creditable withholding tax is that it is a tax withheld to approximate the liability of the taxpayer/payee at the end of the year. We don’t expect these foreign corporations to file at the end of the year.

Example: if you have a domestic corporation, and you enter into a contract with a foreign corporation for them to render repairs to your machinery in the Philippines, is that subject to tax? Yes. If the contract fee is 1 Million US dollars, how much will you pay to them? 

General Rule: You only pay them 700 US dollars. 300 US dollars will be remitted to the government. That is the general rule, there is always an exception.

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In some schools, they are required to read at least 1 tax treaty. Usually in a tax treaty, there is a provision on business profits, which says that “If a foreign corporation not doing business in the Philippines transacts business with a domestic corporation, the payment to the foreign corporation is not taxable as long as that foreign corporation has no permanent establishment here in the Philippines (meaning no office or any branch in the Philippines). In that case, if we go by the Tax Code, that is taxable of 30%, deduct, it’s a final tax. But the tax treaty is something that gives a relief from double taxation.

Why does it give relief from double taxation? In what way does it give relief from double taxation if you would not be required to withhold the 30%? 

That foreign corporation who came to the Philippines for 1 week to repair the equipments of Ms. Dumagat will surely be taxable in the country where it is a resident. Being a resident abroad, it is taxable within and without, and we will tax that foreign corporation, that is double taxation already. Although not in a strict sense, because these are 2 different taxing jurisdictions.

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Under the Tax Code, it is 30%.

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But if we invoke the Tax Treaty, that is totally tax free.

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In cases of conflict between the (Municipal law) Tax Code and Tax Treaty, usually the Tax treaty will prevail because we respect agreements with other countries. Only in case where the Tax treaty is more burdensome, do we follow the Tax Code. In more cases than not, the tax treaty is there in order to give relief, that is the purpose why the tax treaty is there, to ease the burden of that corporation from 2 taxations in 2 different taxing jurisdictions.

SEC. 28. Rates of Income Tax on Foreign Corporations. – (B) Tax on Non resident Foreign Corporation. – (1) In General. - Except as otherwise provided in this Code, a foreign corporation not engaged in trade or business in the Philippines shall pay a tax equal to thirty-five percent (35%) of the gross income received during each taxable year from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and



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income, and capital gains, except capital gains subject to tax under subparagraphs (C) and (d): Provided, That effective 1, 1998, the rate of income tax shall be thirty-four percent (34%); effective January 1, 1999, the rate shall be thirty-three percent (33%); and, effective January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%). -

If you read through SEC. 28 B on non-resident foreign corporations, the gross income of non-resident foreign corporations includes the same gross income that has been enumerated in non-resident aliens not engaged in trade or business, such as: 1. Interests 2. Dividends 3. Rents 4. Royalties 5. Salaries 6. Premiums 7. Annuities, etc Except: Capital gains on sale of shares of stocks, which will be subject to the same rate of: 5% and 10% 

Why did it not mention, “except capital gains on the sale of real property”? 

Non-resident aliens not engaged in trade or business are subject to 25% final tax on gross income, for all types of gross income including interest, etc. except capital gains on sale of shares of stock and sale of real properties classified as capital assets. In this case, exception is only capital gains on sale of shares of stock. The reason is that non-resident foreign corporations are not expected to have probably real properties in the Philippines.

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These are the general rules, the 30%.

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Towards the end of the outline, you will see special domestic corporations and special resident foreign corporations and non-resident foreign corporations. The tax rates are different, it is not the 30%.

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As of now, let us concentrate on income being subject to 30%.

C. Income Tax Exempt Entities, Section 30 1. General Professional Partnership 2. Joint venture for the purpose of undertaking construction projects. 3. Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government 4. Labor, agricultural or horticultural organization not organized principally for profit 5. Mutual savings bank not having capital stock represented by shares and cooperative bank without capital stock organized and operated for mutual purposes and without profit 6. A beneficiary society, order or association, operating for the exclusive benefits of the members such as fraternal organization operating under the lodge system (one which must operate under a parent and subsidiary associations), or a payment of life, sickness, accident, or other benefits exclusively to the members of such society, order or association, or non-stock corporation or their dependents 7. Cemetery company owned and operated exclusively for the benefit of its members (must be a non-profit cemetery) ***In broken line borders are outline notes.


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8. Non-stock 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 income or asset shall belong to or inure to the benefit of any member, organizer, officer, or any specific person 9. Business league, chamber of commerce, or board of trade, not organized for profit, and no part of the net income of which insures to the benefit of any private stockholder or individual Requisites: a. This must be established for common business interest b. No part of the income shall inure to the benefit of a particular individual 10. Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare 11. Farmers associations or like associations, 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 produce finished by them (must be a non-profit association) 12. Farmers cooperative or other mutual typhoon or fire insurance company, mutual ditch or irrigation company, or like organization of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members of the sole purpose of meeting its expenses 13. Government educational institution 14. Non-stock and non-profit educational institution General Rule: All corporations, agencies or instrumentalities owned and controlled by the government shall pay such rate of tax upon their taxable income as are imposed upon corporations or associations engaged in a similar business, industry of activity. Exception: 15. GSIS (Government Service Insurance System) 16. SSS (Social Security System) 17. PHIC (Philippine Health Insurance Corporation) 18. PCSO ( Philippine Charity Sweepstakes Office) 19. NAPOCOR (Special Law) -

Give me 1 entity not subject to tax.

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Example of an educational institution owned by the government. o

Government educational institutions are among the income tax exempt entities. In outline letter C you will see several enumerations of entities not subject to income tax, found in section 30, for those associations or entitites not made for profit. Section 22, definition of a corporation in the Tax Code. And from 15-19 in the outline, these are government controlled corporations which are among the exceptions not subject to income tax.

SEC. 30. Exemptions from Tax on Corporations. - The following organizations shall not be taxed under this Title in respect to income received by them as such: (A) Labor, agricultural or horticultural organization not organized principally for profit; (B) Mutual savings bank not having a capital stock represented by shares, and cooperative bank without capital stock organized and operated for mutual purposes and without profit; ***In broken line borders are outline notes.


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(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 members; (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 private stock-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 imposed under this Code. (TAKE NOTE: in the outline there are additional… like from number 1 – 3): -

Are the collections made by a condominium corporation subject to 30% income tax? No.

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What is a condominium corporation? o

This is a condominium building. ABC is the developer. The income of ABC is from the sales of the condominium units. Is ABC the condominium corporation that we are talking about? 

NO.

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Once a condominium building is set up, the developer is separate from this building and every unit owner is a separate taxpayer. So if he decides to lease it out, he will be subject to income tax on the rents.

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But there will be a condominium corporation composed by the different unit owners for the management of the entire building. You call it a condominium corporation. The proceeds or collections of a condominium corporation are: 1. Association dues 2. Electricity 3. Common charges expense 4. Water



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o

Are these collections collected by the condominium corporation subject to income tax imposable on the condominium corporation? Or would a condominium corporation fall under income tax exempt entity (Sec 30)?

o

Are these considered income collected for profit? And are condominium corporations made for profit? 

NO, these are not income and these are not collected for profit!!!

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Condominium corporations are not made for profit.

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Condominium corporations in so far as they collect association dues, membership dues, etc. so long as it is not made for mark-up or for profit, they are not subject to income tax, VAT, local business taxes.

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EXCEPTION: Once collections of condominium corporations exceed more than that which they require for the maintenance of the building, it will be subject to tax.

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Because in some areas, like IT Park, although it is not a condominium, but there is a corporation association of all the locators. If they collect for electricity to raise (atty said rise, but mura pud ug raise) the actual usage of that locator, or unit owner, then it is already income-earning, it is a profitable activity, it will already be subject to tax. But so long as it is only for minimum membership dues to maintain this, the maintenance of the building, and recover only for the common charges, it is not taxable.

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What is taxed, the excess or the entire amount?

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Whichever way, because if we have to declare the entire amount, you can deduct the actual cost. What will be paid of tax is only the difference.

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If there is a cemetery, and there is a big space rented out for a concert, will the proceeds be subject to tax?

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What if the proceeds will be used to repaint the gravestones? o

YES, it is taxable.

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Even if that leasing out would not fall under activities for profit, let’s say it is only for once a year or twice a year, still it is an income generated from the use of the real property.

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Legal basis 

There is a caveat in the last paragraph of Section 30, that notwithstanding that these exempt entities have been granted exemption from income taxes, they will still be subject to income tax if and when they realize income coming from any of these three: 1. The usage of a real property, whether it is regular or not. 2. The usage of a personal property, whether regular or not. 3. Any activity made for profit, which is regular. These are subject to income tax regardless of how the proceeds will be used or utilized. Even if it will be used for beautification purposes. Since the law is clear that it does not give any preference, whether it is used for the purpose or not, it will be subject to income tax.

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If you run through the income tax exempt entities, under Section 30, you will note that these are actually associations or entities which are made:



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o

NOT for profit. 

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Letter A: Labor, agricultural or horticultural organization not organized principally for profit.

It can be profitable in some sense, as long as it is not “principally” but other entities or associations are strictly requiring that it is not for profit. And some of these entities or associations should only cater for members.

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Once there is an activity or usage of any real or personal property defining the rule in the last paragraph automatically, it will be subject to income tax.

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How will the BIR expect payment from these types of organizations? What first comes to mind is that, if you make up a cemetery company, (not the one selling the lots because it is a corporation), a cemetery company is usually not for profit, can the BIR keep track of the liabilities of these corporations or entities? Or how will they keep track the liabilities of these entities? Are these entities required to file an ITR, if the default is that they are exempt from income tax, but once they venture 3 activities, they will be subject to income tax? o

YES, they will be required to file an ITR.

o

Once you register an association, entity or corporation with the SEC and with it comes the registration of the BIR, you are expected to be under the coverage reportorial requirements that have to be complied with before the BIR. Even if it is among the tax exempt entities, but you are registered for BIR purposes, you are expected to file an ITR year in year out. All you have to do is simply put there the details, whatever proceeds there is, the expense, and at the bottom that it is exempt.

o

If you want to avoid the reportorial requirements, anyway you are not liable for income tax, you have to prove before the BIR, get a ruling that you are exempt so that you will be taken out from the coverage of those who are required to file an ITR.

o

Once registered in the BIR, the default is whether you are exempt or not, you are expected to file an ITR, unless you have been given a special privilege of exemption of not filing an ITR.

o

This is one way of monitoring the activities of tax exempt entities, because if you do declare huge amounts of proceeds but still considered as exempt, it is one way for the tax authorities to examine the legality of the exemption being claimed. Because usually, when you are a tax exempt entity you don’t have huge amounts of proceeds and how the expenses will go as well. 

3 Categories of the Tax-exempt entities: 1. Those which do not come within the definition of a corporation 2. Tax-exempt entities under Section 30 3. From numbers 15-19 of letter C in the outline, their exemption does not come from Section 30, but from Section 27(c) which covers domestic corporations. GOCC are domestic corporations. Section 27 is domestic corporation. Section 28 is resident foreign corporation 

General Rule – GOCC are taxable.



Exception:

There are 4 GOCCs as specified under the tax code: 1. GSIS 2. SSS 3. PHIC 4. PCSO ***In broken line borders are outline notes.


13 | P a g e

o

-

NAPOCOR is not by virtue of the tax code, is a special law. And there are many special laws that we actually don’t need to study in taxation. Probably when you are in practice.

In individual income taxation, we identified what are the types of income that an individual may be earning. 1. Compensation income 2. Business income 3. Gains derived from dealings in property 4. Interests 5. Rents:

-

ATTY: I included here rents, because there is a bar question, on what is the difference between an operation lease and financial lease. When you say that you are spending rent payment of an office space, is that an operating lease or financial lease.

-

Example: You are renting an apartment in Cebu. Is that rental payment an operating lease or financial lease? Lease and rent are the same.

-

What distinguishes lease as operating lease and lease as financial lease? o

The basic difference between these 2 types of leases, I usually associate it with the word “nalang” (not clear what word Atty. means )

o

Operating Lease

o

-



Normal rent/lease that we know.



What you are paying is for the temporary use of property without the transfer of ownership at the end of the lease period.



The owner of the property does not foresee relinquishing ownership over it at the end of the contract period, while the one using it is only paying for the temporary usage of it.



It is for the operation of the business of the one leasing it.

Financial Lease (Full payout lease) 

“Lease to own” in common term.



A purchase of the property



The owner will relinquish ownership over the property at the end of the contract, while the one leasing it will become the owner of the property.



The owner of the property is expecting that over the lease period not to go below 730 days, he will recover the full value of the property. So if you’re in a financial lease, whatever you are paying to the lessor is a purchase price, you don’t recognize it as an expense in your books. If you’re into business and you lease out under financial lease, whatever payments you are making is not an expense, but is an advance payment, part of the purchase price.

F. Royalties o

There are many types of activities for which you can pay royalties.

o

Under Section 42, can you name some activities: 

In letter c, do you think the royalty payments made by XYZ to the Republic of Zimbabwe, classifies under any of the classification? It was more on extracting the economic rent or the privilege to extract natural resources in a foreign land.



14 | P a g e

o

Nonetheless, you will see that it is more of a right, privilege, or use. Use or privilege which can command the payment of royalties. It’s not the simple McDonald’s that we have been talking about. Royalty payments can be the transfer of technical knowledge.

o

If you purchase a software, it can be covered as royalty payment or not.

o



It will be royalty payment if what you purchase is customized, with the transfer of technical knowledge.



But the software you purchase is an offshelf available to all. You are not required to pay royalty fees for that. It is simply the purchase of an item.

So royalties are more on the privilege of having the right to use a scientific or technical knowledge.

-

G. Dividends

-

How many types of dividends do we have as of today? o

Under the Corporation code, a corporation can declare dividends in any form so long as it has unrestricted retained earnings, meaning, profits which have accumulated in the corporation are distributable to the owners. In what way this will be distributed, that we have the different kinds of dividends: 1. Cash dividends – given through cash 2. Property dividends o

All encompassing; whatever property you would wish to give to your stockholders it will be taxable.

o

Example: if you are Manny Villar and you have investors. You like to distribute dividends, in the form of subdivision units, is the subdivision units given to stockholders subject to tax? House and Lots Give 1 each as dividend VILLA MANNY There were 46 investors

o

This is Villa Manny. There are different subdivision units. 46 investors, aside from Manny Villar. After accumulating profits, instead of distributing cash, let’s say the financial statement of Villa Manny is in short of cash. It is not liquid, but it has enough properties to declare as dividends. He decided to give 1 each stockholder, is this subject to tax? 

Recall that dividend is a passive income. Income derived from an activity in which you don’t materially participate, and under the law, 10% tax shall be imposed on a cash and/or property dividend. Who is liable to remit the 10% tax on the government, you or Villa Manny? It is not given in cash, so how will we pay the tax on the dividends?  If you wish to receive this property as a stockholder, you better prepare 10% as the tax on the property dividends you will be receiving.



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a. Illustration: You are a stockholder. Corp A declared stock dividends and also gave you B shares. Corp A is the owner of Corp B. Instead of giving cash dividends, what Corp A did was to declare as dividends the shares it holds in Corp. B. The effect is that U V W X Y will be part-owners of Corp. B by virtue of the shares given by A to these stockholders. Is the issuance of B shares to U V W X Y Z to the stockholder, a property or stock dividend? Is it subject to tax? Is the owner B Shares

Company A

Company B

Ü V Company A declares is stock in B as dividend – PROPERTY DIVIDEN

W X Y Z

 Who is the income earner? UVWXY  Payor? Corporation A  Is Corp. B a part of the payor-payee relationship of UVXWY? B is the item. It is not the taxpayer or the withholding agent. B is simply the item given by A to its stockholders.  If Corp. A decides not to give in cash or any other property, but instead gives out the B shares that it holds to the stockholders. A is the payor of the dividend. UVXWY is the income earner of the dividend. B is the property given by A to UVWXY.  The difference is the shares. b. Is that a stock dividend? Because what are given are shares.  Take note of what shares will be declared by the corporation as dividends. RULES:  If what are declared as dividends are the shares of Corp. A (or its own shares); therefore increasing their ownership in the corporation – STOCK DIVIDEND, because what is given are the same corporation. Company A

Company B

B Shares

Ü 100 + 100 V 100 + 100 ***In broken line borders are outline notes.

In straight line borders are codalW provisions. 100

X 100 Y 100

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Stock Dividends

Example: If UVWXY owns 100 shares each and instead of giving cash, A said ok I will give another 100 A shares. These are stock dividends not yet realized income, unless it will be converted into cash, or under the exemptions given.  If what Corp. A will be giving out is the share of any other corporation, except its own, it is not a stock dividend, because it is not the stocks of Corp. A, rather it is the property investment of Corp. A. If other shares will be given, it is -PROPERTY DIVIDEND, subject to tax just like a cash dividend. 3. Stock Dividends 

Illustration: 10 years ago you formed a corporation. You are 46 all in all. You put 46 Million, 1 Million each. You are a part-owner, you have been given 1 Million shares each for the 1 Million investment that you put into the corporation. st

Assets Liabilities Net Worth Capital (less) Profits

1 Day of business

10 years

46 Million ------ (no liabilities yet) 46 Million 46 Million ----- (no profit yet)

500 Million 100 Million 400 Million 46 Million 364 Million



46Million For each to receive 1M



364 Million profit is distributable to all of you. It is part of the 500 Million asset. If you have a cash of 500 M you can distribute 364 M to the owners.



But what if this 500 M is in property, you cannot distribute in cash, unless you sell first the property. And selling property would entail tax on the income. So you don’t sell it, otherwise it will be double. You sell property in order to generate cash, then you are taxable on the income from selling. When you declare it as →cash dividends, taxable again. So might as well declare it automatically as →property dividends, because there is only 1 tax on the property dividend.


o

But as stockholders, if you don’t want to pay any tax to the BIR, all you have to do is declare →STOCK DIVIDENDS. And dividends can be declared out of the unrestrictive profits of the corporation.

o

How to declare stock dividend? Simply put in or transfer the profits to the capital.

o

If you have 1 M each, and you are given another or another 46 M will be transferred there. It means to say that you received 1 M stock dividends. Are you subject to tax?


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 Not yet, because there is simply a transfer of capital. Your ownership will increase but you have not realized the income as yet, unless you sell it or it is in cash.  General Rule: Stock Dividends are NOT taxable. Stock Dividend representing the transfer of surplus to capital account shall not be subject to tax.  Exception: when stock dividends will be taxable. 1. If subsequently cancelled and redeemed by the corporation - If in order to avoid the tax on dividends, you declare stock dividends and the corporation will cancel or redeem it right after. Imagine 46 M will be declared as stock dividend. As a rule, it is not taxable. But if behind that, there is already an agreement after declaration it will be cancelled or redeemed by the corporation, meaning as stockholders you will surrender that, and the corporation will redeem that, in lieu of 1 M each. You are circumventing the law, instead of outrightly declaring that, you went through the path of stock dividends first then exemption. That is subject to tax, as if it was an automatic declaration of cash dividends. 2. If it leads to a substantial alteration in the proportion of tax ownership in a corporation.



Capital

46 Million

Profits

364 Million

Declared 50 Million as Stock Dividends

Illustration: 50 M as stock dividend Beginiing Investment

+

Declared SD

=

Total New investment

45 (classmates)

= 1 Million each

1 Million

=

2 Million

1 (Ms. Cristoria)

= 1 Million

5 Million

=

6 Million

4 Million TAXABLE!!!

You decided to declare stock dividends awhile ago of 46 M. Let’s say you want 50 M to be declared as stock dividend. But the problem is, you are only 46. All of you 45 will receive 1 M each. But the 1 person Ms. Cristoria, will receive the 5 M remaining. It will lead to an alteration of the interest of proportional holdings in the corporation. Instead of all of you equally owning the corporation through shares, she will now have an edge. Her total investment will be 6 M. Her original 1 M plus ***In broken line borders are outline notes.


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the 5 M stock dividends. All the rest will be having only 2 M. Since it lead to a substantial alteration of delusion >???? in your interest or ownership, it will now be subject to tax. But what is subject to tax is only the difference of 1 M. Why is it subject to tax? Because she gave an income over the other stockholders. What she will be receiving is more than what you will be receiving in the future. Alteration -

Lovely’s question: When can we say it is “substantial” or any difference will be taxable already? o

-

Carlo’s question: Who pays for the final tax in property dividend? o

-

Corporation will remit it in behalf of the recipient. In case it is a pure property dividends, the corporation will have to collect in cash from the stockholders, your property dividends. Before the dividends will be given out, 10% will be remitted or else to be paid by the stockholder to the corporation, who will in turn remit it to the government.

Follow up Question of Carlo: What will be deducted from the retained earnings? o

-

In some books, it is simply delusional???(ambot unsa na word) The interest of the other stockholders it will already be taxable. Substantial, probably what it meant kung 1 share lang or 1 peso. But once the percentage of shareholdings will be different, automatically it will be subject to dividend’s tax or the final tax. Why? Because there is a rule in Corporation Code, that declaration of stock dividends must follow strictly the percentage of ownership of the stockholders that are to receive it. So if it is 1 over 46 all of you, it is 2 over 46 na that she will receive, it is already an alteration. She will have more interest in the corporation.

It’s really the value in the books, not the fair market value. For tax purposes, 10% will be computed in the fair market value. But for the books of the corporation, what will be deducted is the actual cost that went out of its ownership.

What are disguised dividends? What type of payment will be considered as disguised dividends? o

-So are you saying these are really dividends coming from the profits of the corporation?

o

The other dividends that we have discussed, in cash property and stock came from retained earnings and profit. But disguised dividends is something else, but it is called dividends.

o

Disguised dividends are payments made by the corporation to the stockholders in any other form, other than dividend payment.

o



1st Example: If the owners composed of the Board of Directors, and the honorarium for every meeting every month is 1 M for the presence of a 10-minute meeting, is that not a dividend distribution disguised as honorarium.



It may be any other kind of payment to the owners or stockholders not denominated as dividends but actually profit distribution simply to avoid tax.



2nd Example: Refer to previous illustration. 46 owners. Instead of declaring the 364 Million you will be given 1 motor vehicle each. It will be claimed by the company as an expense, not as a dividend distribution. The company will be benefited by the depreciation of the motor vehicle that they acquire.



The point is, whenever there are huge amounts of payments to the owners not considered as dividends, they are actually disguised dividends.

Are disguised dividends taxable? 

Example: There is a parent company abroad. There is a subsidiary in the Philippines. Whenever the subsidiary will declare dividends abroad it will be subject to 15% final



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withholding tax. But if the corporation will simply pay royalties of 5%, or royalties declared to foreign corporation, it will not be taxed of 15% final withholding tax in dividends. But once payments to its stockholder, which is its parent-company becomes too excessive, it will be considered as dividend distribution subject to the rate of? What rate is imposed on disguised dividends? 

The point is, once excessive payment of expenses is considered as a disguised dividend, the taxability of the disguised dividend would be the same as cash or property dividends being given.  If the recipient of the disguised dividend is an individual – follow: 10% - for Resident citizens, Non-resident citizens and resident aliens 20% - for non-resident aliens engaged in trade or business 25% - for non-resident aliens NOT engaged in trade or business  If the recipient is a domestic corporation – payments to domestic corporations of dividends ARE NOT AS YET TAXABLE. Why? Because it is still an umbrella before the ultimate owner will receive the dividends. If it is corporation to corporation domestically, no tax. Nonetheless, it is not yet part of the topic, but the point is, if a distribution of payment is found to be a disguised dividend, it is taxable just like cash or property dividends.

-

What is a liquidating dividend? o

When you decide, your corporation decides to stop operations, you ____. You dissolve, liquidate whatever remaining assets you may have. The distribution will be considered as liquidating dividend. Whatever you receive will be subject to tax. On what tax, it will be . . . . . . YOUR ASSIGNMENT!!! 

SEPT. 7, 2010 Tuesday DISGUISED DIVIDENDS -

Disguised dividends may be considered as distributed to an individual who is not a stockholder. Agree or disagree? o

Disagree. Dividends are only given to stockholders of a corporation.

o

Thus, whenever an excessive payment of honorarium (1M a month) is given to a President of the Company, who is not a stockholder, it will not be treated as disguised dividends. But what will happen to the payment? Taxable still? 

It will be taxable on the part of the President but not as dividends. Whatever income will be derived by an individual, it will be taxable. In what way? It depends on what is the treatment given by the Tax Code. In case excessive payment is made to an individual who is a stockholder, it will be treated as disguised dividends and subject to the usual rates of 10% for RC, NRC and RA, 20% for NRA-ETB, and 25% for NRA-NETB. But if it so happens that the individual who received excessive payouts or payments is not a stockholder, it will not be considered as disguised dividends. No dividends shall be given to a non-stockholder. But still, being an income or an inflow of wealth in the hands of such individual, it will be taxable subject to the ordinary rates to be withheld, if he’s an employee, of the 5-32% income tax according to the withholding tax on wages table.

LIQUIDATING DIVIDENDS -

Whenever a corporation dissolves, liquidates and winds up its business operations, it may happen that assets will be left after paying all the creditors and these assets will be distributed to the



20 | P a g e

stockholders in accordance with the proportion of ownership that they have in the business and it’s called liquidating dividends. It’s taxable. o

Liquidating dividends given, like cash, properties or other remaining assets after paying out all the creditors of the corporation, if distributed to the stockholders, will it be subject to FWT 10%, 20% or 25% depending on the classification of the taxpayer or the corporation? 

NO.



Do you think a stockholder will experience loss in receiving a liquidating dividend? YES. Assets Liabilities Net worth Capital stock Profits

46,000,000 -046,000,000 46,000,000 -0-

100,000,000 60,000,000 40,000,000 1,000,000

o

Example: 46M as invested by 46 people for 1M each 10 years ago and 0 liability. Net worth, therefore, is 46M. Capital stock of first day of operation is 46M and profits is 0. 10 years after, assets grew to 100M, liabilities to 60M. Net worth, therefore, is 40M. If you dissolve and wind up the affairs of the corporation, you distribute the 40M after you payout the liabilities to the creditors. Would the stockholders be receiving the same amount that they invested of 1M each? NO. The stockholders will receive less than 1M. Is there a gain subject to tax? NO, since there is a loss. Can we consider the less than 1M receipt of cash, property or assets as liquidating dividend? YES. Would such liquidating dividend be taxable? NO, it will be deductible.

o

So if it will happen that your receipt of liquidating dividend is less than what you have invested in the corporation, you actually suffered a loss from the investment. Whatever you received, considered as liquidating dividend, is not subject to tax.

Assets Liabilities Net worth Capital stock Profits

46,000,000 -046,000,000 46,000,000 -0-

400,000,000 60,000,000 340,000,000 1,000,000



But if it’s the other way around, there is a gain or you receive more than what you have invested. And whatever you have invested is the cost of your investment. Any difference of what you receive as liquidating dividend from such cost will be considered as taxable income subject to the rate of 5-32%.



So whenever you receive a liquidating dividend, just treat it as a capital income. Compute your tax liability together with all your other income. It’s never subject to FWT.



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

What happens if the stockholder receiving the liquidating dividend is a corporation? o

Example: Corporation XYZ is owned by A-F and JKL Corporation. If XYZ Corporation liquidates and distributes the remaining assets to all 6 individual stockholders and a corporate stockholder. Is such XYZ Corp. corporate stockholder subject to tax? A B C D E F JK Corp.



Whatever the taxability, on a normal basis, if the stockholder, whether he is subjected to 5-32% or 25% because he is a NRA-NETB, or the stockholder is a corporation subject to 30%, then use those rates in computing the tax due on the difference between your liquidating dividend and the initial investment or the cost of the investment that you put into the corporation. After all, it’s the income that matters. You shall not be taxed on the cost of the investment you put into unlike cash and property dividend, you get it out free from the cost as yet because the corporation is not winding up. Still whenever you receive cash and property dividends, your capital is intact in the corporation. But in liquidating dividends, it’s the end of the corporation and the end of your investment. Any income is taxable. Any loss is deductible.



NOTE: Losses from investment or income from investment, such as liquidating dividends, are capital losses and capital income, respectively. They’re only taxable as capital income and deductible against capital income if a loss is experienced.

E. DEDUCTIONS 1. Fundamental Principles -

Are corporations allowed deductions? YES. The same as the available deductions for individual taxpayers? NO. o

What types of deductions and/or exemptions are available to individual taxpayers? 

1. Personal and additional exemptions



2. Premiums on health and hospitalization insurance



3. Itemized deductions, or in lieu of such, optional standard deductions 


However, not all these three are available to all types of individuals. If an individual is purely a compensation income earner, only 1 and 2 would be deductible. But if the individual is into business already, whether together with ER-EE relationship, he can also claim any of the itemized deductions or optional standard deductions because itemized deductions is for In straight line borders are codal provisions.

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business expenses. But then, all three would not be available to an individual who is classified as a NRA-NETB. In so far as the corporation is concerned, which of the 3 deductions are available to a corporation?

-

-

o

REASON: Corporations venture into an activity which is for profit. Therefore, it is for business and with it comes the incurrence of business expenses. That’s why as a rule, corporations doing business in the Philippines, in fact, all corporations engaged in trade or business in the Philippines can deduct itemized deductions or optional standard deduction if it so chooses. But exemptions are not available because it covers for personal and family living expenses and corporations are not natural persons. And premiums on health and hospitalization insurance are not as well considered as deductions.

o

i. The taxpayer must prove that there is a law authorizing deductions

o

ii. The taxpayer must prove that he is entitled to deductions

o

iii. If the law provides for requirement that the amount or the expense payment needs to be withheld of tax, a tax should have been withheld, otherwise, the deduction is not allowed

o

iv. Always, we construe it strictly against the taxpayer

But what about OSD? Can corporations really claim OSD? YES, except NRFC. 

-

Itemized deductions, or in lieu of such, optional standard deductions

What are the underlying principles that need to be followed before a corporation can deduct itemized deductions?

o

-

o

REASON for exception: Such corporation, its tax base is at gross. And the mere fact that a NRFC is construed as a corporation NETB, there is no deductions allowed from their income. Whatever they earn in the Phil. is subject to 30% income tax except those capital gains from the sale of shares of stocks in a domestic corporation.

Can OSD be allowed as a deduction if the corporation is not allowed to claim itemized deductions? o

NO, OSD is in lieu of itemized deductions. So if a corporation or any taxpayer is not allowed to claim itemized deductions, there is no OSD allowed. But there are cases or exceptions when itemized deduction is allowed but OSD is not allowed, such as when the taxpayer is a NRA-ETB since OSD can be claimed by any individual except NRA but NRAETB can claim itemized deductions because they are subject to tax on net income.

o

OSD example: If your gross income is 1M, you can automatically deduct OSD of 400K. Pay tax as a corporation on the 600K. Itemized deduction is only 300K, go for OSD. You don’t need to substantiate it with receipts. You don’t even have to incur such expense. But if your itemized deduction is 900K, forget about OSD. Claim such itemized deduction as an expense. The only problem is that your books will be audited to determine whether you really have incurred 900K in total expenses and whether it is substantiated with official receipts, or invoices or in contracts.

Who are not allowed to claim itemized deductions? o

1. Individuals, whoever that individual is, if he is purely earning income from ER-EE relationship, forget about itemized deduction because itemized deduction is only in business, trade, or profession.



23 | P a g e

-

o

2. If the individual is a NRA-NETB, no itemized deduction.

o

3. NRFC are never allowed itemized deduction or OSD.

Itemized deduction becomes the default of every businesses. Every business, whether individual taxpayer or a corporation, is required to report on a quarterly basis the income tax liability of that business. o

If the taxpayer forgets to choose which option is it taking, whether it is itemized deduction (ID) or OSD, automatically, the default is ID. But once in the first quarter, the taxpayer has already chosen OSD, you can no longer shift back to or revert back to ID for the entire year. So that means, OSD, as an option, is irrevocable for the year at issue.

o

Can the taxpayer choose ID the following year? YES because irrevocability of an OSD is only for the current year. It’s on a year-to-year basis.

o

If a GPP, who is not taxable, elects to report its taxable income choosing OSD, then the partners who have to report their tax liability and paid will also be liable under OSD. If the GPP elects ID, the partners don’t have any other choice but to go for ID. So GPPs and the individual partners are taken as a single entity for tax purposes. Not one of the taxpayers, GPP or the partners, can choose the other and the other one go for the other option.

EXPENSES -

-

What are ordinary and necessary expenses? o

Ordinary expenses (OE) – refers to the expenses which are normal, usual or common to the business, trade or profession of the taxpayer.

o

Necessary expenses (NE) – one which is useful and appropriate in the conduct of the taxpayer’s trade or profession.

Can a NE of one business be a NE of another business? Or is it always the case that if the expense is necessary in this business, it is always necessary expense for another? o

NO.

o

Example: If you’re into banking business and your friend is into siomai business. What expense is necessary for your business but is not necessary for your friend’s business? Banking business has to hire security guards and rent armored car for its business as a NE, which is not a NE in a siomai business.

o

So what is necessary, useful and appropriate for one type of business may not be useful and appropriate for another kind of business. So there is no standard rule for what type of expenses may be deductible for this corporation or another corporation. You can name more than a hundred expense accounts in your business, but may not be found in another type of business. But so long as the classification of that business is that it’s necessary, useful, appropriate and it’s ordinarily incurred in the business operations, for those who are similarly situated, then it is classified as a deductible business expense.

o

Is a capital expense deductible? YES. 

What are capital expenses (CE)? 



They are expenditures for the extraordinary repairs which are capitalized and subject to depreciation. These are extraordinary expenses which tend to increase the value or prolong the life of the taxpayer’s property.

What important requisite for the deductibility of an expense is not complied with by a capital expenditure making it non-deductible on the year of incurrence? 


Capital expenditures are extraordinary expenses which prolong the life of an asset that has been repaired. It either increases the value or increases the life or prolongs the life of the asset such that it violates the rule for an In straight line borders are codal provisions.

24 | P a g e

expense to be deductible, it must be paid or incurred during the taxable year.

-



When you say “paid”, it is expense but it must also pertain to the year for which that expense is related to the income generated by the business. If it’s incurred during the year, if the CE would prolong the life of an asset over which the asset would be useful for 10 years, then the expense of the CE should be distributed over 10 years as well to benefit the company. It’s the matching principle wherein you only deduct the expenses which is related to the business activity. If it’s only 1/10 every year, then only 1/10 of the expense is deductible.



The reason why it is deductible but not in the year of payment or not in the year when the year it was constructed, purchased, repaired, etc….

What are the common requisites to make an ordinary or necessary expense deductible? o

o

i. The expenses must be ordinary and necessary 

It’s ordinary when it’s normal, usual and common. Although sometimes it does not necessarily need to be incurred day-in, day-out but so long as it’s usual in the type of business or the industry to which that business is in then it can be considered as OE, not unusual.



It’s NE when it’s useful and appropriate for the business activities.

ii. It must be paid or incurred during the taxable year (whether calendar or fiscal year) 

Exception: net operating loss carry-over



If the expense that you’re claiming as a deductible item this year is an expense for the operation of the previous year, it is not deductible expense. So your expense claims must be paid this year or if not paid this year, it must have been incurred.



What’s the difference between paying an expense and incurring an expense? 

In the Phil., we do not usually follow the cash method in determining whether your income is already taxable or not. We follow the accrual method of accounting. Cash method of accounting, whatever you receive in cash is considered as sales and whatever you have paid for in your expense, is deductible and the difference is taxable under the cash accounting method. But the accrual method, whatever you have sold, so long as you have completed the transaction, whether it has been paid by your customer or not, is reported as sales already and whatever you have paid as an expense including those expenses for which you have effected already the transaction, the services have already been performed in your favor, and it’s payable, meaning, the other party, your supplier, has already the legal right to demand payment from you but not as yet. Probably, there is a period within which you can pay. It’s already deductible. It simply follows the “all-events test”. You have all the events to complete the transaction, then the sale has been perfected, whether paid or not, taxable. Expense, whether paid or not, so long as service has been performed, goods have been delivered, it’s deductible.



So in the expense, so long as it has been paid this year or has been incurred and it pertains to this year’s operations, the expense is deductible.



If you’re claiming an expense which is for the future, advance rental payments, is it deductible? o


Under the accrual method, it would be deductible.


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

o

o

NO. All the expenses must be paid or incurred during the year except net operating loss carry-over.

o

NET OPERATING LOSS CARRY-OVER (NOLCO) 

If the business incurs a loss, it’s deductible. But once a business incurs NOL, meaning, the bottomline figure for the entire year’s operations is a loss, there is an option for the business to carry it over to the next 3 years.



So, it means to say if it’s carried over to the next 3 years, in the next 3 years, it’s not the expense during those years. It pertains to the previous years. But since it is mandated by law to be deductible, it’s an exception to the rule that it does not really have to pertain for this year’s operations.

iii. It must be paid or incurred in connection with the trade, business or profession of the taxpayer 

o

Is the expense pertaining to last year’s activity deductible?

Example: In you’re in 3 businesses. One manufacturing corporation. One real estate business. And the other is a siomai business. You don’t mix the expenses. You cannot claim the expenses of this business to that business. It should necessarily be connected with the business that you’re in.

iv. It must be reasonable in amount; 

If you are the president of the corporation earning 100K a month, it may be reasonable in so far as that business is concerned but your 100K will be unreasonable in another type of corporation.



So there is no fix amount within which we can determine whether this type of expense claimed is reasonable or not. No fix amount but you have to consider it in so far as the operation is concerned.



But there is one type of expense that is regulated by the tax authorities and that expense is Entertainment, Amusement and Recreation expense (EAR expense). 

Why? Because this type of expense as a deduction has been abused. Many businesses claim representation expense – bringing clients to clubs. And the amount is unreasonable. Instead of distributing as dividends, they claim it as representation expense – they require stockholder or employee to bring in receipts and thy can even ask receipts from you and have it reimbursed, such as medical representatives.



EAR expense has been abused.



There is already a regulation that sets a quota for such expense. What is the ceiling set by the Secretary of Finance?


o

EAR expense – to the extent only of 1% of the net sales if the corporation is engaged in services. And 0.5% of the net sales if the corporation is into the sale of goods or properties.

o

REASON for the difference: Because those engage in services usually needs representation expense to entertain their clients or treat them over meetings, lunch meetings, etc. But if it is goods or properties, so long as you have the product, you can sell it.

o

What happens if you are both engaged in the sale of service or in the sale of goods? Which will you follow?


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





Example: So it means to say that if the corporation, net sales is 1M and it is engaged in the sale of service and goods, the maximum EAR expense for services is only 10K while for goods or properties, it’s only 5K.



If the corporation has 50K expense, automatically, 45K is not deductible for goods or properties since only 5K is the maximum deductible amount.

In so far as salaries are concerned or bonuses of directors, it’s provided under the Corporation Code that Board of Directors, as honorarium, should not exceed 10% of the net income of the corporation because if it exceeds, it will be considered already as disguised dividends. o

o

You still have to follow the formula – 1% for the service and 0.5% for the goods and properties.

Example: If the net income is only 1M, only 100K should be given to the Board of Directors for the entire year – for all of them. Any excess will be considered as unreasonable.

v. It must be substantiated by sufficient evidence such as official receipts and other official records; and 

Official receipts



Adequate records



Amount of expense being deducted



Date and place where such expense is paid or incurred



Nature of expense – direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business, or profession of the taxpayer 

The evidence must be recognized or produced by the third party. If the evidence solely comes from the company – you made it, you drafted it, no signature from the other party, it is self-serving so it is not sufficient evidence.



Example: You’re in the business of manufacturing wooden toys for export in Europe. And for cost-cutting purposes, you don’t have a large pool of employees so that you sub-contract the raw materials to the different homeworkers. And those homeworkers are actually not registered in the business. They just do what they’re required to do and when they bring it back to you, you pay them. Homeworkers, not being registered with the tax authorities because they’re not really into business, cannot produce an O.R. nor an invoice. What proof will you present to the tax authorities in order to claim the payments you made to these homeworkers? o


A contract or an acknowledgment receipt will do. They can surely sign. It’s not always in all cases that you can require your supplier to produce an O.R. In one of the major cases that we have in the Philippines is those in the business of manufacturing “carajinan”. You purchase it from different suppliers to grow such but they are not registered in the business of supplying. They cannot produce an O.R. The problem is that if they do not produce an O.R., what proof do you present to the government that indeed that you’ve made payments for these when it cost millions?


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

So in one of the companies here, the only thing that they can produce is the proof that it had been weighed by a reputable weighing company, the deposit that they made in millions to an individual in Mindanao. But if you really want them to produce an O.R., they can show you their guns. So as a business man, you don’t force them to issue an O.R. So how to prove to the BIR that these are valid and legitimate expenses? 



In this type of requisite, is it necessary when you want to claim OSD? o

o

There’s already a SC actually following the Cohan Rule in the U.S. that some expenses need not be supported by O.R. but so long as it can be substantiated with other adequate records proving that in fact it has been purchased by the company and the goods received by the company which were actually converted to the product sold, can be proof enough that expenses have been paid or incurred. But not in all instances.

NO, because the law in OSD says “whether or not you have incurred actual expenses”. So this requisite applies only in so far as ID is concerned.

vi. It must not be against law, morals, public policy or public order 

Example: Bribes and kickbacks given to government personnel 

You have an assessment of 10M in unpaid taxes or delinquent taxes. You come into a compromise or common grounds. You will only pay 5M and you will be issued a tax clearance. And for the 5M that you will pay, only 2.5M will be receipted as received by the government. Wherever the other 2.5M will go, we do not know. How much is deductible from your business operations? 10M, 5M, 2.5M or none of the above? o

NONE of the above. Whatever payments you made to the government, as kickbacks or bribes, even to the members of the BOC or BIR or DOF, so long as it’s not a legitimate payment of an expense, it is not deductible.

o

How about payments to rebels as revolutionary taxes? Telecommunications towers, so that it will not be blown up, you have to pay a certain amount. Is that deductible? 

NO. All taxes, as a rule, are deductible, except income tax paid to the Phil. government, income tax paid to the foreign government, estate tax, donor’s tax and VAT. All the other taxes are deductible. However, even if they call it as a formal tax that is paid to the rebels, it doesn’t go to the government, therefore, however media will try to make it legal in the news, it’s still a non-deductible expense because it’s contrary to law and public order.

ADVERTISING AND PROMOTIONAL EXPENSE (APE) -

As a rule, APE are deductible unless it borders to creation of goodwill for the company or creating a name for the company, future recall, etc…



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o

Example: Dandruff shampoos – we have Guard, Head and Shoulders. We’ve been through that for years already. When Clear came in, almost all actors and actresses became endorsers for it. How much did they have as a budget for that? It’s 1B. Is it deductible as APE in the year it was incurred? 

NO. It’s excessive and the purpose of actually of Clear is not to make it as an expense in the year of entry but rather its purpose was to give a brand and give a name recall for the customers and it’s expected to benefit a number of years for the company, therefore, whatever expense it had paid during the year of entry will be amortized over future years. Let’s say, for 5 years.

TRAVEL EXPENSES (TE) -

TE are deductible even if it’s not receipted because they’re TE that we incur without having a receipt from the carriers, etc…

OPTION TO PRIVATE EDUCTIONAL INSTITUTION (OPEI) -

PEIs have the option to deduct capital expenditures in the year it was paid or incurred or the other option is to depreciate the expense over the useful life of the asset. o

Example: USC would purchase a 100M value building. It can opt to deduct entirely the 100M in the year of purchase or amortized the 100M over its useful life. In any case, whatever the option chosen by USC, since it’s not subject to tax, it won’t have any effect. It doesn’t need to match the expense incurred today against the income for today or year-toyear basis.

INTERESTS EXPENSE (IE) -

What is interest? o

It’s the amount paid for the use or forbearance of money. 

Example: If you have a business and you obtained a loan for the working capital of your operation and you are to pay 10K monthly as interest. Is the 120K for the entire year be deductible as a business expense if it’s related to the business? 

YES.



As a rule, IE incurred by a business, corporation, company or PP is deductible so long as the common requisites are complied with: o

1. The interest must be ordinary and necessary. 

o

2. It must be reasonable. 


So if you obtained a loan to use it as a working capital of your operations, the interest paid is deductible. Reasonableness would depend on the size of the business operation.

o

3. It must be paid or incurred during the taxable year

o

4. It must be paid or incurred in connection with the business

o

5. It must be substantiated by the contract itself and payment vouchers, etc.

o

6. It must not be contrary to law

o

Other additional requisites to make IE deductible: 

i. There must be an obligation which is valid and subsisting



ii. There must be an agreement in writing to pay interest


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

-



iii. This must observe the limitation under the arbitrage rule



iv. This must not be between related taxpayers

IE which are non-deductible: (See outline) o

Corporation to corporation where only one individual is maintaining the controlling interest, the interest is not deductible. 

o

Example: Co. A (parent company) and Co. B (subsidiary company). Usually the parent company grants a loan to a subsidiary company for operational purposes. If the agreement is stated that interest shall be paid in writing, is the individual, according to the grandfather rule… If Co. A is owning Co. B 100% and the loan is granted to the subsidiary company where interest is stipulated to be paid, is the interest payments made by the subsidiary to the parent company deductible? NO. Here, Co. A is a holding company of Co. B. When one is a holding company of the other and extends loans, the IE becomes a non-deductible expense. The 50%-rule (controlling interest rule) is only applicable to non-existing holding companies.

Interest expense on preferred stock 

Example: A company declares dividends. Dividends comes out from your shareholdings and shareholdings, usually, shares that you have can be classified as common shares or preferred shares. Whenever you organize a corporation, you may say that this group has common shares, this group will have preferred shares. The term preferred shares, you will have a preference in the distribution of dividends, as a rule. If there comes a point in time that the business, in a certain year, cannot declare a dividend, some dividend would accrue to them but not totally paid out, nothing would accrue to you. Meaning, they have a collectible. In the following year, when distribution happens, they will get their prior-year accrual dividends plus interest, you will receive yours for the year. Will the interest on the preferred shares be considered as deductible IE? 

-

Otherwise, not in writing, no IE deduction, whether or not you have actually paid an interest

The concept of paying interest and interest as a deducible expense item is it must be payment for the use of someone else’s money – the forbearance of money. You temporarily borrow money, use it and for the use, you are to pay interest in addition to the principal payments that you will make. But dividend declaration is not an obligation of the corporation. In fact, under the Corporation Code, a dividend can only be declared if there is enough unrestricted retained earnings or corporate profits that a corporation has. If it is not dependent upon corporate profits on the preferred shares, it is deductible. If it is dependent upon corporate profits, as a rule, it is not deductible expense. REASON: The corporation did not really loan any money coming from the stockholders. The corporation is obligated to pay out dividends once it has profits.

What is the Arbitrage Rule? o

The taxpayer’s allowable deduction for IE shall be reduced by an amount equal to 33% of the interest income earned by him which has been subjected to final tax.

o

The arbitrage rule automatically limits the deductibility of the IE by reducing 33% of the interest income subject to final tax, whether or not engaged in back-to-back loan transactions.



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

o

Co. A cannot claim fully the 600K as a deductible IE but only 567K (600K – [33% x 100K]). The arbitrage rule applies since Co. A is earning interest income subjected to final tax. If none, the arbitrage does not apply, automatically full interest payment can be deductible.



Co. B can fully claim the 600K as a deductible IE since its interest income is not subjected to final tax. Interest income subjected to final tax is only those coming from the banking institutions.



Co. C can fully claim the 600K as a deductible IE since it is not earning interest income.

To discourage Back-to-Back loan transactions – obtaining loan from one bank and invest it to another bank in order to benefit the difference between the tax due on interest income and the tax benefit from the IE.

o

If the IE is 100K, interest income subject to final tax is 100K, do you have a deductible IE? YES. You have a deductible IE of 67K (100K – [33% x 100K]).

o

If the interest income is 500K subject to final tax, IE is 100K, do you have a deductible IE? NO. 33% of 500K is 165K. So the 165K will be deducted to 100K, which results to no deductible IE.

What is theoretical interest? Is it deductible? o

-



The principle why such rule exists: 

-

Example: Let’s say that the company has an IE of 600K but it has no interest income, is the IE deductible fully? YES. Say for example, Co. A (earning interest income of 100K subject to 20% final tax), Co. B (earning 100K interest income from loans to employees) and Co. C (no interest income). All of them obtained the 1M loan running for 10 years wherein they would be liable each for 600K annually as IE. Which of the 3 corporations can claim the full 600K as expense and which cannot?

It’s an interest which is computed or calculated, not paid or incurred, for the purpose of determining the opportunity cost of investing in a business. It’s not real. There’s no payment at all. Thus, it’s not deductible nor taxable.

What is imputed interest? Is it deductible? Is it an actual expense? o

Sec. 50 of the tax code – Allocation of Income and Deductions – In the case of 2 or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades or businesses.

o

Such provision is powerful in the sense that the BIR can do anything with it so long as it sees relationships between corporations. 

Example: If Co. A is related to Co. B as the controlling or fully owning the other corporation, any expense loan (let’s say 1M) to Co. B, which is interest-free, so Co. A did not earn any interest income. Can Co. B deduct IE? Automatically, no IE because IE must be stipulated in writing and there is no interest payment made. But the BIR can impute an interest based on the legal rate of 12% and subject such interest income on the part of Co. A to tax. But Co. B is absolutely not allowed to claim the IE for no interest has been paid and there is no stipulation in writing.



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-

Can payment of interest for delinquent taxes be deductible? o

-

YES. Whenever a taxpayer, corporate or individual, is assessed of delinquent taxes, that taxpayer is not only liable to pay the basic tax but also has to pay surcharges of 25% and 50% if it is found to be fraudulent plus interest of 20% pa and additional compromise penalties. So whether or not these payments are deductible, is interest deductible? YES, because it’s an indebtedness to the government. You temporarily withheld the payment of taxes to the government for the use of money during the time which you have not paid properly your taxes. But in so far as penalties, surcharges and compromise penalties are concerned, on top of the tax , these are not deductible. The taxpayer cannot benefit from a violation that he committed against the government. It is only the interest that is deductible.

Optional treatment of IE (OTIE) o

At the option of the taxpayer, interest incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure. 

Example: Co. A obtained a loan for working capital purposes. Co. B obtained a loan for construction of a building. Both of them paid 1M in interest. 1M in IE and no interest income subject to final tax. Thus, the IE not limited with the arbitrage rule. Does Co. A or Co. B have an option in treating the IE, whether deductible now or deductible in the future? 

Co. A, the incurrence of expense is for working capital purposes, day-in day-out operations, the IE incurred, if it’s not subjected to arbitrage rule, would be fully deductible as an expense for the year of incurrence. But since Co. B obtained a loan to construct a property that is a capital expenditure, the IE can also be considered as a capital expenditure. Where the principal cost goes, the accessory interest expense can also join the principal cost. So if the building has an estimated life of 10 years or 20 years, the IE can be considered as capital added to the cost of the building and it will be considered as an expense over the estimated life of the asset that was acquired using the loan amount.

3. TAXES -

GR: All taxes, national or local, paid or incurred within the taxable year in connection with the taxpayer’s trade, business or profession are deductible from gross income. o

E: 

i. Special assessment – tax imposed on the improvement of a parcel of land



ii. Income tax – includes foreign income tax 

Philippine income tax – absolute rule: totally not deductible



Foreign income tax o


Paid by domestic corporations and resident citizens (taxable within and without) – may be claimed as a deduction if it opts for tax deduction, otherwise, it becomes non-deductible if it uses the foreign tax paid as tax credits. 

If the foreign tax is claimed as a tax credit, you cannot claim it as a tax expense. But if you claim it as a tax expense, you cannot claim it as a tax credit.



Claiming it as a tax credit, you can claim the full benefit of the tax paid abroad since tax credit is a deduction from


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Philippine income tax. But if you claim it as an expense, only to the extent of 30% of that foreign tax will it reduce the tax due since tax deduction, as an expense, is a deduction from gross income in computing the net income. Thus, tax credit is more beneficial. 

iii. Taxes which are not connected with the trade, business or profession of the taxpayer 

-

Whatever type of tax that is, since it’s not connected with the trade, business or profession of the taxpayer, automatically, it’s not deductible.



iv. Estate tax, donor’s tax



v. VAT

Is the real property tax (local tax) payment made by the corporation on its real property used in trade or business a deductible expense for purposes of computing income tax liability, not real property tax liability? o

YES. Real property taxes are deductible so long as: 

1. It is ordinary and necessary



2. Reasonable in amount



3. It has been paid or incurred during the taxable



4. It has been paid or incurred in connection with trade, business or profession



5. Substantiated with O.Rs



6. It’s not contrary to law, public policy or morals

-

Example of national tax that is deductible: Customs duties when the corporation is engaged in importation of goods.

-

All taxes, whether national or local tax, will be considered as deductible from gross income in computing the net taxable income so long as it follows the requisites of being paid or incurred during the taxable year in connection with the trade, business or profession of the taxpayer subject to the exceptions.

-

What type of taxpayer can offset the foreign taxes directly by 100% against the Philippine tax due? o

i. Resident Citizens – since liable of income within and without to avoid double taxation 

-

NRC – not included because liable of income within only – no double taxation

o

ii. Domestic corporations – since liable of income within and without to avoid double taxation

o

iii. Members of GPPs

o

iv. Beneficiaries of estates and trusts

If the tax paid in China is 10M and the tax due on your entire income here in the Philippines is 30M, can Co. B (which operates 80% in the Philippines and 20% in China with 100M total income. Thus, 20M from China and 80M from the Philippines), can Co. B fully deduct the 10M against the 30M? o

NO, since the foreign income tax paid to the foreign country is not always the amount that may be claimed as tax credit because under the limitation provided under the tax code, it must not be more than the ratio of foreign income to the total or global income multiplied by the Phil. income tax due.



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o

Thus, 20M (foreign income)/100M (global income) = 20% x 30M (Phil. income tax) due = 6M limit. Therefore, only 6M can only be claimed as a tax credit.

o

Had it been the other way around, if the limit is higher than the actual tax payment abroad, you claim whichever is lower in favor of the government.

September 14, 2010 -

Q: What have we discussed in taxes as a deductible expense. What are the taxes that are deductible and what are those that are not deductible expense? o

Generally taxes are deductible, however there are exceptions. 

o

1. Philippine income tax

o

2. Value added taxes

o

3. Capital gains tax/final taxes

o

4. Estate and donor’s taxes, taxes – local benefit.

They are not deductible because they are not related to the business of the taxpayer.

Why is value-added tax not deductible, when in fact it is related to selling your product or services? 

-

o

Why is estate and donors taxes not deductible? 

o

They are not deductible if it is:

Value added tax is not deductible for computing gross income because VAT is an indirect tax, not only that, the VAT that the corporation is paying to the government is a tax that has been shouldered by the customer or consumer. While the VAT that the corporation actually pays on its purchased product are not considered as part of the cost of the product but offset-able against the tax payable to the government.

Special assessments of levy – are they deductible? No. Is real property tax a deductible tax? Yes, it is deductible but special assessments are not deductible. o

Special levies are imposed on the improvement or the fact that a parcel of land has been benefited by an improvement. It’s some form of a real property tax. 

Why is it not deductible? What’s the difference? o



The special assessment is a tax on the improvement on a property but that improvement is not owned by the owner of the property. Special assessment is that being paid or collected by the government from landowners whose property has been benefited by an improvement made by the government, which makes it some kind of a tax on the property.

What makes it different from real property tax being deductible taxes? o

Real property tax is a tax on the land itself while assessment is a tax directed against the land for the benefit derived from the improvement made by the government.

o

It is not deductible because this is not the basic real property tax. All real properties are subject to real property taxes, and whenever real properties are used in trade or business, the real property taxes due from these real properties are rightfully deductible against the gross income of the corporation.

o

But special assessments are one kind, only happens when there are improvements, and these are only premium fees that you need to pay



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whenever you have derived any benefit – which is not directly related to the operation of the business itself which makes it non deductible. -

Mr X, a non resident citizen, has income within and income without. Income within amounted to 1M, income without amounted to 1M. Tax due paid in the respective countries amounted to 300,000 and 300,000 as well. Is this income tax paid to the Philippine government a deductible tax? Is this a deductible tax? NO. Philippine income taxes are not deductible against gross income. o

The tax paid to the US government is a foreign income tax. Is it deductible? If this has already been paid to the US, this 300,000 tax on 1M income earned abroad, what benefit will Mr X get out of the 300,000 income tax? Is there any benefit? Do you think it is proper for Mr X to claim as deduction the 300,000 paid to the US as an expense deduction or at his option as a tax credit against his Philippine tax due? MR. X, Non-resident Corporation: Tax Due Within = 1,000,000 = 300,000 Without = 1,000,000 = 300,000

Not Deductible  Because NRC



It is not deductible, in computing whether an expense is deductible or not, we are only concerned with what is within the jurisdiction of the Philippines. Being a non resident citizen, the jurisdiction of the Philippine taxing authority pertains only to income within. It means to say that only expenses within the Philippines are deductible, expense related to the income generated by the taxpayer.



If it is not a deductible expense, can the foreign income tax paid be offsetted against the Philippine income tax due? NO, cannot be claimed as tax credit. o

-

Not Deductible  Because income tax not allowed

Foreign income tax has only been computed directly against the foreign income, and the Philippine income tax has been exclusively computed only against the Philippine income. No component of this Philippine tax due pertains to any foreign income. Exclusively Philippine tax, exclusively foreign tax.

What’s the difference between allowing it as a tax credit or allowing it as a deductible expense? Are they in the same direction? o

The deductibility of an expense is always premised on whether or not it is related to the trade, business or profession or whether it is directly related to the income of the taxpayer.

o

Foreign tax credit can only be claimed or offsetted against the Philippine tax due if the Philippine tax due is that of a resident citizen or domestic corporation because these two types of taxpayers are taxable on income within and income without. If you say within and without, the Philippine tax already comprises of tax on the Philippine income and the foreign income. Therefore, component of that is a foreign tax, which should rightfully be managed.

o

Say for example, this is a resident citizen, would your answer be different or the same? Let’s say income within is 1M, income without is 1M. Philippine tax is still at 300,000, for income within and without. Foreign tax paid is 300,000. Can the taxpayer claim the foreign income tax as an expense deduction or offsetted as a tax credit? Can he claim it as an expense?

o



Yes, since a resident citizen is taxable within and without, and required to declare the total global income, he can also claim it as an expense.



His other option is to claim it as a tax credit, directly offsetted against the Philippine income tax due.

Same facts, can Mr X claim 300,000 as foreign tax credit? MR. X, Resident Corporation: In straight line Taxborders Due are codal provisions. Within = 1,000,000 = 300,000 Without = 1,000,000 = 300,000


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Therefore, ½ of 300,000 is recognized by Philippine government.



He can claim in part, not the whole 300,000.



How much can he claim? Since this is only one foreign country, you can directly go to global limitation. If there are more than two foreign countries, you go for both limitations, whichever is lower.



Since this is only one foreign country, what is the formula? So, you will not forget the formula.

o

-

Formula: -

The tax credit that shall be allowed to the taxpayer Mr X shall only be to the extent of the foreign tax component in the Philippine tax due.



Imagine this being the entire Philippine tax due of his global income. What is the component recognized by the Philippine tax authorities as forming part in this tax? 

What is that foreign component? It is the proportion of his foreign income against his entire income multiplied by his Philippine income tax.



How much is his income abroad? 1M.



How much is his total income? 2M.



You will note that if this is the amount collected by the Philippine tax authorities, and the ratio is one-half, one-half of this is a foreign tax recognized by the Philippine tax authority.



Therefore, the maximum limit that can be claimed as a tax credit is only 150,000, this cannot be claimed totally as a tax credit. Mr X cannot claim fully, because tax credit claim shall not exceed the limit provided by law.

Let us change the facts. If the tax paid abroad is 100,000, and the limit still remains the same. One-half proportion , one-half the proportion of the foreign income against the entire global income against the Philippine tax due so the component is still 150,000 foreign. The limit is still 150,000. How much can Mr X claim as a foreign tax credit? MR. X, Resident Corporation: Tax Due Within = 1,000,000 = 300,000 Without = 1,000,000 = 100,000

1 million 150,000 X 300,000 = Max 2 million 150,000

Therefore, claim only Php 100,000 whichever is lower

o

100,000. It shall not exceed the maximum limit or the actual payment abroad, whichever is lower. You will see there a per country limitation. Per country limitation would still be the same. This means to say, what the resident citizen or domestic corporation has more than one foreign source, in considering what is the maximum limit, for a taxpayer who has more than two foreign sources, he has to consider the global limitation and the per country limitation.



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Per country, the taxpayer should know per country how much is the maximum total, in global limitation, foreign income against worldwide income.

Per Country Limit 150,000 150,000 300,000

Global Limitation 400,000

Actual Within 200,000

Therefore, claim only Php 200,000 (?).

o

If there are two foreign countries and the limit is 150K, 150K, this is 300,000. This is what will come out.

o

So global limitation, we don’t compute the limit per country. You don’t have this formula for every country. In the global limitation, you “pull in???” all the foreign countries here, maintain the same. So if the total of the global limitation is 400,000, and your actual tax payment is 200,000, your tax credit would only be 200,000. Per Country Limit 150,000 150,000 300,000

Global Limitation 400,000

Actual Within 500,000

Therefore, claim only Php 400,000.

-

o

If your actual tax payment abroad is 500,000, you can only claim 300,000.

o

If there is more than one foreign country, compute the limit per country, compute it globally using still the same formula, and compare it to the actual. Whichever is the lowest is the available tax credit. Use the principle. The government f the Philippines would only allow you to claim a foreign tax credit to the extent of what you have actually paid or to the extent of what it recognizes as a foreign component of the Philippine tax that it is trying to collect, whichever is lower in all cases. Lifeblood doctrine.

In order to claim foreign tax credits, what are the proofs that you need to show? o

-

The taxpayer must establish to the satisfaction of the Commissioner the following: 

(1) the total amount of income from sources without the Philippines,



(2)the amount of income derived from each country, the tax paid or incurred to which is claimed as a credit, and



(3) all other information necessary for the verification and computation of such credits.

The reason there in letter C in the outline, who may claim tax credits for taxes of foreign countries: o

Resident citizens

o

domestic corporations

o

We may as well mention members of general professional partnerships in the Philippines,

o

Beneficiaries of estates and trusts. 

Why member of GPPs in the Philippines – they should still be resident citizens.



As a rule, we only have Filipino practitioners, foreign individuals cannot engage in the practice of law. Beneficiaries of estates and trusts- they are allowed to claim foreign tax credit, but we will discuss that when we reach estate taxation.



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-

-

Foreign income tax, if you look at the tax code, It is one of the exceptions to the rule that it is deductible unless if it is claimed as a tax deduction. The topic is itemized deductions- the topic is expense, can it be claimed as an expense? o

As a rule, probably you can say foreign income tax is not deductible as an expense unless the taxpayer is a resident citizen or a domestic corporation, wherein he has the option to claim it as an expense or a tax credit. Because the tax credit benefit always is available to domestic corporation and resident citizens. He can always forego claiming the tax credit and opt for expense. So it’s a little bit complicated if you don’t know the principle. You try to memorize it.

o

Again, let’s restate it. Foreign income tax is one of the exceptions to the deductibility of taxes. But it can be a deductible tax if the taxpayer is a resident citizen or a domestic corporation, because the option lies with him either to claim it as a tax credit or a tax expense.

Because it is more strict to claim the tax paid abroad as a credit, can a tax subsequently refunded to a taxpayer be taxable? Say for example you have overpaid taxes, you sought for a refund, you were refunded. Is that a taxable refund or inflow of money or not?

Tax Refund Sales 10,000,000 Cost 8,000,000 Gross Income 2,000,000 Less: Expenses 1,000,000 Net Taxable Income 1,000,000

o

+ 1,000,000

Let’s put that into illustration. In 2007, you have overpaid 1M in income taxes. You are a resident citizen, no income abroad. The 1M tax that you have overpaid pertains strictly to Philippine income. In 2008, you immediately applied for a refund. In 2009 you were granted the refund. In filing your income tax return for 2009, would you take into consideration the inflow of 1M cash that has been refunded to you for overpaid taxes? 

Yes, you will be taxable. You will have additional 30% tax, you will have additional 300,000 taxes on the 1M.



No exception to that? o

You have to answer the question: Have you been benefited previously? Because the taxability of a tax that has been subsequently refunded would lie on whether you have been benefited in prior years.

o

Remember, bad debts that have been subsequently refunded can only be taxable to the extent that you have been benefited by the expense that you have previously claimed. In this case, would all tax refunds be taxable? Were you benefited by the foreign tax that you have overpaid prior?




Remember bad debts expense. Bad debts expense is an expense that you claim, it will reduce your income tax due.



If it is subsequently refunded because your debtor has funds to pay you, all you need to know is whether in the year that you claimed it as an expense, or in the year that you decided it’s no longer collectible, did your tax liability decrease? If it did, then it will be taxable at the year that you will collect it or you are able to recover it from your debtor.


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o

In this case it is the same, in the tax that you have subsequently been refunded, did it decrease your tax liability in the prior years? Did you ever claim income tax as an expense before? No. 

Therefore – Remember the tax benefit rule? If this is your finances, gross income 2M, your expenses is 1M, your taxable income is 1M, therefore you’re liable for 300,000.



If within the same year you decide to claim as an expense the bad debts amounting to 1M also, this will be your other expenses plus the uncollectible loan of your debtor. This will become zero. Your tax would be zero. If in the subsequent year this was recovered, the 1M is fully deductible. 

o

That is the same principle in tax refund. Now, if the tax that has been refunded to you is not a deductible tax, there is never any taxable income at the time that it is refunded. 

-

Why? The government will seek to recover the tax that it failed to collect because you claimed it as an expense. So if it is subsequently recovered by you, you have to pay 300,000.

Why? Because you never claimed it as an expense. It never reduced your tax liability. Income tax is not a deductible tax, so if it subsequently refunded by the government, it’s not taxable.

If its real property tax (RPT) that has been refunded to you, will the RPT subsequently refunded be taxable? You overpaid Real Property Taxes after filing a claim for refund, you are given Php1M refund in cash, will the Php 1M subsequently received as a tax refund be subject to tax? Yes or no? o

Yes, to the extent of the benefit that you have derived.

o

For example, So that if you deducted Php1M real property tax here, which erased your tax liability, if subsequently that expense that you claimed has been refunded because it was a wrongful tax that you’ve paid, that will be taxable because that RPT which you erroneously paid before, effectively reduced your tax liability. The government will only try to recover that which you have not paid.

o

But if the RPT only benefited to the extent to the portion of the tax, only to that extent will the refund of taxes be taxable. It is entirely the same principle as bad debts that you subsequently recovered, in all aspects. The only difference is that (in all aspects daw but there is a difference): 

In bad debts, so long as you can prove that it’s worthless, uncollectible, you have taken legal actions, etc., is deductible expense.



As for taxes, you have to be very aware what kind of taxes has been refunded. If it’s a deductible tax, follow the bad debts principle. If it’s not a deductible tax, forget about the principle.

4. Losses -

Are all losses deductible losses? No.

-

What losses are deductible? What’s the opposite of ordinary losses? o

For tax purposes, we have ORDINARY losses, for those losses arising from ordinary transactions involving ordinary assets. Capital losses are those losses arising from capital transactions and capital transactions involve capital assets. SO you know that ordinary losses are those that which have been sustained ordinarily in the course of trade, business or profession. And these are deductible.



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-

-

What is a net operating loss? In our formula, change it to an operating loss. What will you change in the formula? Change the cost to 3M and it will become net operating loss. Because if you change the sales to 12M, this will be gross loss. But usually you don’t go into business selling at a loss. o

Example, if you have this, you purchase siopao at Php 10, you don’t sell it at Php 6 pesos or Php 8 pesos. You usually sell it at a mark up. Let’s say, you bought it at Php 10, you sold it at Php 12, you still have gross income of Php 2. But you may suffer a net operating loss because the salary of your tinder is Php 10,000 a month. This is what will produce the net operating loss because ordinarily, tax authorities would expect this (gross income) to be positive. On this level only.

o

The cost. This is the house that you are selling (Sales Portion). Cost is the construction of the house.

What is net operating loss carry over? Let’s make the expenses Php5Million your net operating loss. Because usually in the initial stages of your business, we will suffer a loss. If your operating loss is Php 3Million, the law provides that it can be carried over to the next 3 succeeding years. And it is the exception to the rule that expenses or deductions shall only pertain during the year, paid or incurred during the year. In this case, if the Php 3million is carried over as a deduction, it is a valid deduction notwithstanding that this Php3Million is not incurred in year 2, not incurred in year 3, nor incurred in year 4 because that is the exception.

-

YEAR 1

YEAR 2

YEAR 3

Sales Less: Cost Gross Income Less: Expenses Net Taxable Income

10,000,000 8,000,000 2,000,000 5,000,000 (3,000,000)

10,000,000 8,000,000 2,000,000 4,000,000 (3,000,000)

10,000,000 4,000,000 6,000,000 2,000,000 4,000,000

Taxable Income

-0-

-0-

-0-

No taxable income because: Net Taxable Income: 4,000,000 Less: Loss on Year 1: 3,000,000 Loss on Year 2: 1,000,000 No Taxable Income -0-

-

In year 2, assuming expenses exclusive of losses, can you carry over the Php3M, suffered in year 1? Can you carry over or can you utilize the Php3Million net operating loss in year 1 to year 2? Can you use the Php3Million loss in year 2? We are done with year 1, the losses or whatever net operating loss that you have suffered, you can carry it over to the next 3 succeeding years. If in year 2, you suffered still a loss, can you use the loss of Php3Million in year 1? No. Why? Because you still suffered a loss in year 2.

-

For year 3, given the facts, how much is your net taxable income? Php 4million. So you have to pay 30% of Php 4 million as a corporation? How much will you pay? How much is your tax liability in year 3? ZERO because you used used up Php3Million for year 1 and Php 1Million for year 2. o

You accumulated losses at the end of year 1 is Php 3Million. Your accumulated losses as of year 2 is already 5 million. At this point in year 2, you cannot use the Php3 million because you are at a loss. Therefore, your losses will only accumulate.

o

In year 3, when you already earned positive income, you can utilize the loss in year 1. Because the loss in year 1 is usable in year 2, year 3 and year 4. This has a life of 3 years. It does mean that you should use the loss in year 1 in year 2, that you should use it consecutively. If it has no use in the next year, then the next succeeding year, until the 3rd year.

o

So in year 3, you already used Php 4million of losses, your accumulated loss is only 1 million. And 1 million is taken from year 2. Year 1 has been entirely used up already.

o

So this is on a first in, first out. Whatever came in first as an accumulated loss, will have to go out and offsetted against the income.



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-

Point is, whatever loss that you suffered, is already a deductible loss.

-

Is it favourable to the government? You might think it is not. But of course the government has devised a way to still collect taxes notwithstanding that you are losing. You may be at a loss at the level of net income but you still have to pay taxes at the level of gross income, whichever is higher. We will discuss this once we reach minimum corporate income tax. Let us not combine the 2 as yet.

-

For losses only, if the loss in the first year, is not used up the next 3 years, whether fully or partially, it goes down the drain, it is no longer usable in the 4th year after it has been suffered as a loss. Only 3 years at a time. Year 1 is allowed 3 years. Year 2 has a life of 3 years.

-

Let’s change the facts. This is XYZ Corporation, it has been given 4 years income tax holiday. For the first 4 years of operation, it totally suffered annual operating losses. In the 5th year of operation, it earned income. Can the losses suffered in the previous years be used up to offset against the taxable income in the 5th year? No.

-

o

Why? What’s the reason? Whenever a corporation is at a stage or it is granted exemption from income taxes, any losses suffered during those years covered by the exemption cannot be considered as a loss or carry over. It will not benefit years that the corporation will subsequently be taxable.

o

Meaning or which means to say that net operating losses that can be carried over can only arise when a corporation is subject to income tax.

XYZ Corporation and ABC Corporation, both companies owned 80% by A. Shown below are the list of shares in each company. A 80%

A 80% U 5%

XYZ Corporation

V 5%

Year 1

W 5%

LOSS

ABC Corporation Year 1 INCOME

o

o

C 5% D 5% E 5%

X 5% Year 5

B 5%

Year 5

A total of 100% ownership for both companies. Year 1 until year 5, operate at a loss. Year 1 to year 5 for ABC Corporation operated positive. The stockholders of XYZ Corporation could not use the losses suffered in year 1 to the next 3 years nor the losses in year 2 to the next years. Why? Because it consistently operated at a loss. 

In this case, ABC has been paying huge income taxes. So what stockholders of both corporation decided was to merge in the hope of using the losses of XYZ Corporation to offset against the income of ABC Corporation and claim it as a deductible expense.



Is it allowed? Yes as long as the change in ownership is not less than 75%.



Should it be more than 75%? Which means? Not less than 75% is 75% or above.

So if the facts above is changed to 75% ownership: Can the loss be considered as deductible in the merged corporation? Yes. It is still deductible because the merger because the ownership is still owned by A at 75%.



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o

o

Combining corporations in order to use up the losses suffered by 1 corporation is allowed so long as there is no substantial change in ownership from the individual corporations down to the merged corporation. 

Substantial ownership, no change in substantial ownership means that at least 75% of the paid up capital of the corporation is still held by, or in behalf of the same person(s).



So in that case, it is still Mr. A who is still holding the same percentage prior to merger. So long as after merger, it is still A who is holding atleast 75%.

In cases, where it does not reach 75% or there is a substantial change in the ownership, the opposite, substantial change meaning there is already a change of more than 25%. It means to say that the loss suffered by 1 corporation cannot be used by the merged corporation. When it merges, or there is a merger of corporation, there is only 1 surviving entity will remain.

-

CAPITAL LOSS CARRY OVER

-

What is meant by capital loss carry over? Losses from sale or exchange of capital assets. o

So can you say that there can be capital losses on sale of real properties classified as capital assets? NO. 

You do not disturb these rules class. There are only 3 types of capital assets which can give rise to capital transactions. o

Sale of real properties classified as capital assets.

o

Sale of shares of stock wherein you are not a broker of securities subject to capital gains tax.

o

And ALL other capital assets.



Real properties are taxable on the gross selling price or fair market value whichever is higher. So any loss that you suffered from the sale of this property cannot be carried over because it is on a per transaction basis and you are never taxed on the profit alone. You are taxable on the gross selling price or the fair market value itself.



But on the other 2, you can have capital losses. (Meaning capital losses can only arise in sales of shares of stocks and all other capital assets. Never on the sale of real properties.) o

Motor vehicle that you personally own. So if you sell a motor vehicle that you personally own. You are not in the business of leasing or buying or selling of motor vehicles. You bought it at Php 4million and sold it at Php 2Million, you suffered a loss. This is capital loss. And there is also what we call as, NET CAPITAL LOSS CARRY OVER.

o

The loss that you suffer in a capital transaction excluding the sale on real properties can be carried over only to the NEXT YEAR. Not 3 years.

CAPITAL ASSETS: Applicable NCLCO? 1. Real Property  6% Capital Gains Tax X ***In broken line borders are outline notes. In straight line borders are codal provisions. 2. Shares of Stock  5% / 10%  3. All other MV (personally own)  Bought 4Million Sold 2Million

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Carry this

-

Does this rule apply, for capital losses to be carried over, is this available to corporate taxpayers? It is NOT. As provided in the outline, it’s not available to corporate taxpayers. Therefore, we will discuss the mechanics of this one once we reach capital transactions towards the end of the semester. o

Can you give me some example of capital losses? 

-

Securities becoming worthless simply means to say that if you are a corporate tax payer and have invested in another corporation which that investing corporation, the other corporation which you have invested in, is suffering a loss, insolvent or dissolved, etc. Your shares or securities held in that corporation, your ownership is already worthless. So the losses that you suffer is a capital loss. This is not, you are not into active trading of shares.

How about liquidating loss? o

When the corporation in which you have invested in as a stockholder has given you a liquidating dividend lower than your initial investment or your investment cost. Is the loss a capital loss? 

Losses from liquidation of corporations are in the same category as securities becoming worthless. It’s a capital loss. And whoever the tax payer experiencing a loss, it would have to depend whether or not he can carry over such loss. Only individual taxpayers experiencing capital losses have the option to carry it over to the next succeeding year. Without an S.



In the outline, losses arising from failure to exercise privilege to sell or buy property like option money that you have for which you did not exercise the option, it’s a loss if you are the one who put up the option money. It’s a capital loss.

-

Abandonment losses in the case of natural resources wherein you have invested in a property hoping to find natural resources or minerals only to find out that there is none. So abandonment losses is a capital loss because you are not yet in the operation of the mining business. It’s still under exploratory stage.

-

Losses from wash sales or stock securities, I want you to read that class. We will discuss that once we reach capital transactions. o

Wash sales or stock securities are just like I think a simulated sale. Is this a simulated sale? Wherein a sale and a purchase of the same type of stocks or securities happens within 30 days. No deduction of capital losses experienced will be allowed unless the one experiencing it is a dealer of stock securities. Because wash sales are type of simulated sales of securities in order to influence the stock market. 

So as to make it appear that the shares of this company is actively traded in the market in order to increase its value, some person in trading, within the span of 30 days, would buy himself for the same but it is simply simulated in order to influence the value of the shares in the market, its not any loss that is deductible.



Unless you really are a dealer in shares. Because if you really are a dealer in stock securities, your eyes really is on the stock market. You buy and sell shares many times within the day.



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-

Are gambling losses deductible? Can you deduct the excess of your gambling loss over your gambling gains? Can you deduct the excess against your ordinary business income? You cannot deduct? o

-

Say for example your gambling gain is Php2million, your gambling loss is Php5 million, separate days. Your net gambling loss is Php 3million. Can you offset the 3 million against your business income of Php100million? 

Capital losses can NEVER BE DEDUCTED AGAINST ORDINARY INCOME. Capital losses are off settable against capital gains to the extent of the gain. Any excess so long as its NOT ILLEGAL losses can be carried over as an individual taxpayer to the next year.



Corporate forget about it! No carry over of net capital losses.



Ordinary income can only cater to ordinary expenses and ordinary losses because one of the common requisites that we have in order for an expense to be deductible, is that it must be incurred or paid directly in relation to the trade, business or profession. Your gambling losses is NOT really related to your business.



Therefore, you put a border line but in the end, as a individual taxpayer or corporate tax payer, you report under 1 income tax return your ordinary income, ordinary losses, bottom line, you pay for the tax. As long as you don’t cross over. Capital for capital and ordinary for ordinary.



Casualty Loss

What is the casualty loss? And what are the requisites to make it deductible? o

Number 1, whenever you, whenever the business suffers a casualty loss and casualty losses are those major losses really, fire, storm, shipwreck, robbery, embezzlement, and theft losses. It must be duly reported within 45 days by a sworn statement to the tax authorities.

o

The loss must be incurred in trade or business

o

It must be actually sustained during the year in which you want the charge it off against your income.

o

Evidenced by a close and completed transaction.

o

Actually sustained

o

Must not be compensated by an insurance. In case there is an insurance, remember that only the difference between that that has not been compensated by the Insurance Company is deductible. And we know for a fact that property can only be insured to the extent of the value otherwise, any excess will become over insurance. It will not be paid by the insurance company. 

So we don’t actually have to discuss the excess of the insurance over the loss because these are property losses, casualty losses. Unless of course if its….ok! (Wala gi tiwas n atty. Iya sentence..:( )



Which leads me to princess of the stars. Is the loss deductible in so far as sulpicio lines is considered? Deductible fully or does it have..? Is it still floating class? Here, class interacts na no na daw. So it will be total loss not floatable na. Deductible? o

It happened in 2008. And insurance companies will only pay when everything has been cleared. The finding of the fault, etc., etc., in so far as the shipping company is concerned. 


When do you think is the casualty loss deductible? In 2008 or in 2009, assuming that it is only in 2009 that everything has been settled with the insurance company. It is only in 2009 that the insurance company admitted that it is liable to pay. If it remains unclear by 2008 whose fault was it leading the insurance company to suspend the payment of


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the payment or the face value. Do you think you can charge it still in 2009? Or it would depend if you are for the government or for the company in that case?

o



In 2009, because only then there is a closed and completed transaction of the loss.



Diba you know that it sunk in 2008 but if its still under investigation as to whose fault is it, the government will not allow you to deduct fully in 2008 when you are expecting to be compensated by the insurance company in 2009. So, unless and until, in Atty.’s opinion, everything has been settled with the insurance company, only then can you determine how much is your deductible loss.



Because only to the extent of the value that is not compensated by the insurance company can you claim the loss. You cannot claim fully the loss.



Probably that’s the reason why Atty. has heard that it has or it should not still float. Atty .does not know the reason.



Gaboobs: Is there a prescription?



T: I think that is the problem of Sulpicio Lines because if the investigation would drag on, to claim the exemption, it should at least approximate the time when the loss was suffered.



So I think that has to be settled because this is a special case which needs to be settled, I heard with the BIR that Sulpicio Lines, their hands should not be tied in claiming the exemption this year or next year. It would have to be based on the agreement with the insurance company and the tax authorities as to when really there is a closed and completed transaction of the loss.



Because if you wait forever for the insurance company, and its 10 years after already, it will not be deductible already because there is no matching of the losses that occurred in 2008 and 10 years after.

Nonetheless, you have an idea that in case casualty loss is suffered, you should act within 45 days to report the loss. Non reporting of the loss would result to non deductibility. 

Hopefully nalang, when its covered by insurance, there is no real loss.

5. BAD DEBTS -

Bad Debts. What are bad debts?

-

These are debts due to the taxpayer which are usually ascertained to be worthless and charged off within the taxable year.

-

When can you say that it is already worthless?

-

If you are a credit card company, if you are the bank. We know that there are many credit card holders who don’t pay or settle their accounts. You will hire a lawyer for the collection case. And if the credit card holder will not pay even upon receipt by the demand letter issued by the lawyer, is it enough for you as a credit card company to claim the unpaid account as a deductible bad debt? If the loan is only Php10,000 pesos, is the filing of the case needed?



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o

In many supreme court cases, there are had been many instances that the Supreme Court actually denied the claiming of a bad debt or a debt unpaid as a deductible expense.

o

For example, if the debtor is already dead is it enough for you to say that it is an uncollectible and worthless loan? Can you automatically deduct the unpaid debt of that decedent who just recently died? 

o

So unless probably that when you are declared as insolvent. 

-

In 1 SC case, No! Because you still have the estate against which to collect. It’s not yet bad, you call it bad na if you cannot collect the unpaid debt. When can you become insolvent again class? When your liabilities will exceed your assets. If your liability is equal your asset, your still mid solvent, you are still solvent. You will become insolvent only after when your liabilities exceed Php1 over your asset.

What are the requisites to make a debt a deductible bad debt? 

1. So number 1, must arise from a valid and subsisting obligation.



2. Number 2, arising from trade, business, or profession.



3. Number 3, it must have been ascertained to be worthless, and to be worthless, there are steps that we need to undertake:



o

Sending statements of accounts.

o

A collection letter.

o

Referral to lawyer

o

Demand letter

o

And if the debtor still fails to pay, you file an action in court.

4. And once you determine it to be worthless this year, automatically charge it against your income this year. Otherwise, it will no longer be deductible in the subsequent years. o



o

So, when you are able to determine it to be worthless, that is the only year when you charge it against your income as an expense.

5. The final requisite, number 5, is that it must be uncollectible in the near future. o

So it probably will be collectible in the far future but not in the near future.

o

Atty. Tiu does not know what is near. As long as not next year, not two years from now. Far away.

Say for example, you and your seat mate, you have separate businesses. But during the election, you placed your bet on Brother Eddie. The other party placed her bet on President Noy. You won. So you tried to collect as agreed, Php1Million. She failed to pay despite persistent collections. Can you claim the Php1million as a bad debt expense? 

First, It is not related to the trade or business or profession that you are in.



Second, it did not arise from any valid and subsisting obligation to pay. Remember it’s just a betting game.

6. DEPRECIATION -

What is depreciation?

-

The gradual diminution of the useful value of the property used in trade, business, or profession of the taxpayer arising from wear and tear or natural obsolescence. The term is also applied to amortization of the value of intangible assets, the use of which in trade or business is definitely limited in duration.



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-

As against depletion, what is the difference? -

-

-

-

Depletion is the exhaustion of natural resources like mines and oil and gas wells as a result of production or severance from such mines or wells. These are non-replaceable assets.

We all know that all properties and assets, as a general rule would diminish in value unless of course if it pertains to parcels of land, which as a rule, opposite, will appreciate in value. Is there an instance where a parcel of land will diminish in value? Wear or tear? Is it really wear and tear? 

It does not depreciate as a rule but the value may decrease in some instances. Like if the volcano near by will erupt. Lahar-filled, the value will go down.



What happens if the parcel of land that you are holding becomes a red district? Ermita for example in Manila. Does it appreciate in value or depreciate? As a rule, it will increase in value because of the trade and profession.

So when you are talking about depreciation, we refer to properties or assets which depreciate or whose value gradually diminish naturally. The wear and tear, obsolescence, etc. o

So a machinery will depreciate in value.

o

Even your personal laptops. You bought it for this much, after probably a year, only ½ of its price. Your resale value is only ½.

Depletion refers only to natural resources. It is easier to depreciate than to deplete. Because depreciation is an exact computation. You only have a formula. If it will exist for 10 years, then divide it for ten years. o

But natural resources sometimes is undetermined. You will have to depend on how much the estimated produce from that parcel of land. 

If you think you can produce 10 truck loads of diamonds in 10 years, you cannot divide it for over 10 years. The only thing that you can do if you expect 10 truckloads of diamonds is if you can produce this year 2 truckloads, over 10 expected, then 20% of your cost of your property should be depleted already. o

o -

If you produce 5 truckloads in the first year, estimated is 10. So ½ of the natural resources should be depleted as of that year.

So its dependent on the natural resource.

How different is this against amortization? (Did it ring already? So she can finish amortization) Amortization is applied to intangible assets. o

What asset can be amortized? You can amortize intangible properties that you have for example: 

There are new rules already, for goodwill, that’s an intangible property. For accounting properties, goodwill is no longer deductible. But for tax purposes, it may be deductible if you really PURCHASED the good will. If you PURCHASED. o



But if it’s a goodwill that you just put up your business without any extra cost. It’s not deductible. It’s not amortizable.

Another instance wherein you can amortize an expenses is when you under go research. Research and development, during those stage you accumulate cost for coming up with a model or a prototype. The cost of your research and development can be amortized over 5 years once you go full production. Anyway, research and development is not really tangible. So its amortized rather than depreciated or depleted.

September 21, 2010 BAR EXAM RESULTS: ***In broken line borders are outline notes.


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-

Have you read the bar exam for tax? There are around 40 items. So for those who have read, how did you find it? Let’s go through the items that we have discussed. Let us see how you will fare if you have taken the bar exam.

-

True or False. o

A . Gains realized by the investor upon redemption of the shares of stock in a mutual fund company are exempt from income tax. Are they exempt? Exclusion from gross income class. In the outline.

o

B. A corporation can claim the optional standard deduction equivalent to 40% of its gross sales or receipts as the case may be. = FALSE. 

Against gross sales or gross income? Gross income. What is stated here is gross sales or receipts. What is the difference? Remember the formula that we have had before?



(Sales – Cost = Gross Income) less Expense = Taxable income



What is optional standard deduction for? It’s in lieu of – Itemized deductions. So since this is what you don’t want to claim, 40% OSD is applicable.

o

C. premium payments for health insurance of an individual who is an employee in an amount of PhP2500 per year may be deducted from gross income if his gross salary per year is not more than PhP250,000. False. PhP2400.

o

D. The tax code allows an individual taxpayer to pay in two equal installments, the first installment- we will discuss that towards the end. This is true.

o

An individual taxpayer can adopt either the calendar or fiscal year period for purposes of filing his income tax return = False. 

o

The Capitalization rules may be resorted – this will be discussed, I think next week.

o

Informer’s Reward is subject to final withholding tax of 10%. Yes this is true. 

o

If you report someone and it will lead to collection of taxes, you will be given informer’s reward, which reward is still subject to 10% tax.

This one, interesting. A non-resident alien who stays in the Philippines for less than 180 days during the calendar year will be entitled to personal exemption not to exceed the amount allowed to citizens of the Philippines in the country of which he is a citizen. FALSE! 

-

Individual taxpayer, in all cases, an individual can never chose to be taxable in the fiscal year basis. Always his taxability begins January 1 and ends December 31. Only corporate taxpayers have the option to be taxable on a taxable year which starts on any day other than January 1, ending 365 days thereafter.

False, because only non-resident aliens engaged in trade more than 180 days in the Philippines are allowed through reciprocity rule to claim personal exemptions.

ABC, a domestic corporation entered into a software license agreement with XYZ, a non resident foreign corporation based in the United States. Under the agreement, which the parties forged in the US, XYZ the nonresident foreign corporation granted ABC the domestic corporation the right to use the computer system program and to avail of the technical know-how relative to such program. In consideration for such rights, ABC agreed to pay 5% of the revenues it receives from the customers who will use and apply the program in the Philippines. Discuss the tax implication of the transaction. Is the payment by the domestic corporation ABC to the non-resident foreign corporation XYZ which is 5 % of its revenues received from customers. o

What are these payments? Royalty payments abroad.

o

Who is the income earner? The non-resident foreign corporation.

o

Is it taxable in the Philippines? Yes. Royalties will have situs in the country where it is used.



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o

-

And where is the technical knowledge imparted by the non-resident foreign corporation. Where is it used? In the Philippines, where the customers of the domestic corporation are using it.

In 2009, a resident Filipino citizen received dividend income from a US based corporation which owns a chain of Filipino restaurants in the West Coast US. SO who is the income earner? 

The resident citizen - Filipino.



From where is his income? From a non-resident foreign corporation. The dividend remitted to the resident citizen is subject to US withholding tax with respect to the United States, him being a non resident alien in the US.

What will be your advice to him in order to lessen the income and possible double taxation on the same income? o

Tax credit or avail of the tax treaty provisions under the RP-US tax treaty.

Would your answer in letter A be the same if he became a US immigrant in 2008 prior to receiving the dividends and had become a non resident Filipino citizen. o

-

-

It would be different because if he becomes a non resident citizen, he is only taxable on income within and the dividends given by the non-resident foreign corporation based in the US is an income without so it is totally subject to US tax only, no Philippine tax. No use of tax credits, no use in availing tax treaty.

A is a travelling salesman working full time for new (NU) skin products. (I know you have read losses na, losses is a deductible expense). He receives a monthly salary plus 3% commission on his sales in the Southern province where he is based. He regularly uses his own car to maximize his visits even to far-flung areas. One fine day, a group of militants seized his car. He was notified the following day by the police that the marines and the militants had a bloody encounter in his car and his car was completely destroyed after a grenade hit it. A wants to file a claim for casualty loss (losses from theft, robbery , embezzlement etc). Explain the legal basis for your tax advice. o

What’s your tax advice – can A file for casualty loss? NO.

o

What is the status of A? A is a salesman working full-time as an employee and as an employee.

o

What are the deductions or exemptions that he can claim? Personal exemptions, additional exemptions, premiums and health and hospitalization insurance. Unless and until the taxpayer claiming casualty losses has a business, trade or profession , he wouldn’t have that expense deductible for him.

A inherited a two storey building in Makati from his father a real estate broker in the 60s (?). A group of monks approached A and offered to lease the building in order to use it as a venue for their Buddhist rituals and ceremonies. A accepted the rental of 1M for the whole year. The following year the city assessor issued assessment against A for non payment of real property taxes. Is the assessor justified in assessing A’s deficiency real property taxes? o

The question here is: Is it correct for the city assessor to collect real property tax? Question is real property tax – if a real property is actually, directly, and exclusively used for religious purposes, it will be exempt from real property tax? 

But – the assessment is for real property tax, not income tax.



Local government code exemption from real property taxes – Yes, this is exempt from real property tax based on Use and not ownership. Ownership is for the government property.

September 21, 2010 LAST WEEK’S QUIZ: ***In broken line borders are outline notes.


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-

Last week’s quiz, many of you didn’t get it right. XYZ Corporation obtained a loan from a bank, wholly owned by a foreign government. It paid interest of Php1M for the entire taxable year. But no withholding of tax was made. Does it make any relevance class? Doesn’t. This is just a recap of what we have learned before midterms. o

That whenever an interest is paid on a loan made from a bank that is wholly owned from a foreign government, it is not subject to tax therefore, there is no need to withhold. It’s just a matter of fact.

o

Question is the interest a deductible expense? I am referring to the interest payments made to the foreign bank. On the part of the domestic corporation if during the same taxable year it earned interest income of Php2M from loans of affiliate companies. Discuss your answer briefly. 

So the question was simple, is the interest deductible in light of the existence of the interest income earned from loans extended to affiliate companies. There were less than 5 who got it right. o

Answer is it’s deductible because it is a valid expense.

o

Some were saying that it’s not deductible because the loans were to affiliate companies. How could you relate the bank as an affiliate company when the interest expenses were being paid to a foreign bank, interest income was earned from an affiliate company. 

o

The issue was or is it fully deductible in light of the income that was earned from loans to affiliate companies? What did we say about interest? Interest is deductible subject to the arbitrage rule. In the assumption that all other requisites are present, interest expense is fully deductible unless the arbitrage rule will apply. 



The only issue is if the interest expenses were being paid to the affiliate companies? Here, it’s actually the other way around. The interest expense were valid payments.

Does the arbitrage rule will apply if the interest income that the company is earning comes from loans extended to affiliate companies? No. Because arbitrage rule will only apply if the interest income earned by the company is subject to final tax. And interst income that is subject to final tax are those interests incomes earned from deposits and investments or placements in banking institutions and financial institutions or intermediaries.

So FULLY DEDUCTIBLE!

o

Many answered subject to the arbitrage rule. Diba we made illustrations gani, Company ABC, one earning interest income subject to final tax. One earning interest income not subject to final tax. One not totally earning interest income. And in so far in our discussion, we were all in the same track.

o

As to the rule wherein you cannot deduct if you did not withhold taxes? Okay Section 34K(?) of the tax code says that in so far as it is required that it needs to be withheld, it should be withheld, otherwise, it will not be deductible. Many answer this. 

To whom were interest payments made? It was made to the foreign government. To the bank that is fully owned by the foreign government. Section 32B, says of the exclusion that investments of the foreign government which includes loans extended to domestic corporations is not subject to tax, therefore no withholding is necessary.



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-

One more area, ABC Corporation declared dividends in favor of its stockholders. The dividends were given in form of XYZ shares of stock held by ABC corporation. Will the dividends be subject to final withholding tax? Many said it is not subject to withholding tax because it is a stock dividend. o

-

Did we not say that stock dividends would only refer to dividends given in the form of shares issued by the issuing company? If the shares given by the company is the shares held as in an investment of another corporation, it is just like a property of that company and if given, making the stockholders, the stockholders of the investing company, it will be considered as property dividends. And property dividends are subject to tax just like cash dividends.

True or false, regional operating headquarters are exempt from income tax except if it derives income from any of its real or personal properties or from any of its activities conducted for profit. FALSE. o

Regional operating headquarters are NOT exempt. That’s the only statement that we need to address. Regional AREA headquarters are the ones that are exempt from tax.

-

ABC Corporation, a resident foreign corporation paid Php5M income taxes to the United states for the taxable year 2010. Is this an expense deductible, why or why not? Totally, the expense is NOT deductible because the Php 5M income taxes paid to the US is for taxes on income that is earned outside the Philippines. Resident foreign corporations are not taxable for income outside. Therefore, the Php5M income taxes are not deductible not even for tax credit or expense.

-

Mr. A invested Php1M in XYZ. 5 years after he received Php5M in case dividends. After another 5 years, the business was dissolved and its remaining assets were distributed to the creditors and after which stockholders got properties in proportion to the interest they hold in the corporation. To which Mr. A received Php1M in properties. Is it subject to income tax or final withholding tax? o

It is not subject to income tax because the corporation is already in the process of liquidation. Whatever will be received will be considered as liquidating dividends which is not a guarantee that tax will be imposed. Liquidating dividends if the value of the properties received in time of liquidation is more than the investment made in the company.

o

And if the investment is only pHp1M and what he received thereafter is Php1M, there is no gain, no tax.

o

What about the Php5M that was received throughout the existence of the corporation and given as dividends? It was already subjected to final withholding tax as passive income. It will not be considered in determining whether gain was earned or not.

Start of Classes: 6. Depreciation -

Depreciation is the gradual diminution of the useful value of a property that is used in trade, business, or profession of the taxpayer, corporation or individual which gradual diminution of the useful value refers to the gradual wear and tear or the natural obsolescence of the property that is depreciated.

-

And whenever a property, I heard this came out in the mockbar exam last Sunday, what are the methods for depreciating a property as provided in the tax code, the easiest that we can determine is the straight line method. But if you are asked to enumerate. But I doubt it if you will be asked to explain. If you are asked to enumerate, there are 4: o

Straight-line method. So the number of years that the property is estimated to be useful is the factor with in which we spread out the value of the property. So if its 100 years, then you depreciate the property over a hundred years.

o

Declining Balance Method.

o

Sum of years digit method. This is for accountants.

o

Last method is any other method that can be agreed upon or prescribed by the Secretary of Finance which would include double declining method, etc2x.



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

Whenever a corporation comes into an agreement as to the depreciation mode or method of depreciating a property, it shall be used as long as that property shall exists in the books unless you will apply for a new method that will be used for that same property. Apply where? Apply with the Bureau of Internal Revenue for approval that you will be using another method. o

-

-



So, if you have come into an agreement with the Bureau of Internal Revenue that you would be using the sum of years digit method for a particular machinery, you should use it all through out the existence of the machinery. If you intend to change it say for example to straight line method – why do you have to change it class? Sometimes you need to change in order to make do with your financials. If you want to claim more expenses, minimize the expenses, you can do something with the method of depreciating the assets.



So if you need to change it, it’s a change in the method of depreciation, it requires approval by the Bureau of Internal Revenue. No approval, depreciation shall not be allowed. No expense shall be deductible.

How about if your property will be obsolete already? What are the kinds of properties that may become obsolete in a few years time? Software, electronics (Class ni answer ni. Ingon Atty: Exactly!). These properties should not exist for more than 5 years in the business. o

Probably, if at the point that there will be no introduction of new technology and you think that your asset is already obsolete even if you have not fully utilized the number of years intended for it to be useful, you can claim it as an obsolete product and you can claim an expense in addition to the depreciation that you are already claiming.

o

For example, you put it a new technology and expected it to last for 5 years. So its Php5million, Php1million per year through the straight line method. If on the 3rd year, you determine, that it is no longer usable forever, then the remaining value of the asset can be claimed as obsolescence of the property. It’s a deductible expense so long as it can be proven.

And we said that depletion of assets would only refer to assets which are referred to as natural resources. And we have actually illustrated that depleting a natural resource would depend on some factors:

o

-

Example: If you purchase a building or machinery, let’s say machinery nalang because probably a building will have an equal and gradual diminution of the value diba? But machineries do not have. In the first few years machineries would have maximum use, towards the end, it will have minimal use. So the proper depreciation for machineries that will be used fully in the earlier years will either be the double declining method or the sum of year digit method.



The basis of property



The estimated total recoverable units in the property



And the number of units recovered during the taxable year.

Diba remember, if you expect that this is the number of units that you can recover and these are the number of units that you actually recovered, it’s the percentage of the ratio that you can deplete the natural resource.

And finally we said that amortization is as well available to intangible properties. If and when you purchased an intangible, you have ACTUALLY SPENT or shelled out money for an intangible, such as patent, goodwill, copyright, etc, you spend for it, can be depreciated over its useful life. o

But if the intangible is built solely on goodwill for which you cannot truly identify the actual cost that you have spent, it is not a deductible expense. Only for those intangibles in which you have actually incurred an expense. That is amortized over its useful life.



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7. Charitable Contributions -

Are contributions and donations deductible in, say for example you have a business, and you have this concern for social welfare. Are your contributions and donations deductible for purpose of computing your tax liability to the government? What are the requisites to make a charitable contribution deductible? o

1. The contribution must actually be paid or made to the Philippine Government or any political subdivision or to any of the domestic corporations or associations specified by the Tax Code.

o

2. No part of the net income of the beneficiary must inure to the benefit of any private stockholder or individual;

o

3. It must be made within the taxable year;

o

4. It must not exceed 10% in the case of an individual and 5% in the case of a corporation of the taxpayer’s taxable income except where the donation is deductible in full to be determined without the benefit of the contribution; and 

10% of what? Of taxable income.



Would all contributions and donations and limitations be subject to the limitation that it shall not exceed 10% for individuals, 10% of the taxable income of individuals or 5% of taxable income of corporations? No. o

o -



Deductible in full



It may be deductible partially subject to the limitations of 5% or 10%



Or it may be totally not deductible expense.

5. It must be evidenced by adequate records or receipts

First, fully deductible. We call these special contributions. What are the fully deductible contributions? Or rather to whom will the contributions, because class in our outline, we have said that contributions will be classified into 2:

o



Special Contributions



Ordinary Contributions

The easiest to think is that, if and when a contribution is made to particular persons which qualify to special contributions, then, your contribution is fully deductible, whatever amount it is. If you decide to contribute or donate your entire taxable income to a specific entity that is among the recipients of these special contributions, totally that is deductible.

1 2 3 4 5

-

There are actually 3 cases class that a contribution or donation may be

Special Contributions Deductible Recipients Not inure to a private stockholder Within Taxable Year Sufficient Records Fully Deductible

Ordinary Contributions Deductible Recipients Not inure

Contributions NonDeductible All others

Within Taxable Year Sufficient Records Partially Deductible

But nonetheless, special contributions, ordinary contributions, and contributions which are not deductible.



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o

First, you have to know who the recipients are. All others which do not qualify to the recipients in the special and ordinary contributions.

o

No. 2 whatever you make contributions that you make your recipients in order to be dedutible, it must not inure to a private stockholder or an individual. Otherwise, you will just be transferring funds, avoiding taxation.

o

No. 3, it must, as all other common requisites, it must be made within the taxable year.

o

No. 4, sufficient records.

o

No. 5, the main difference, special contributions are fully deductible and ordinary contributions are partially deductible, requirements no. 2, 3, and 4, are in order for a contribution and donation to be deductible, both contributions specially made or ordinarily made must not inure to any private individual or stockholder, it must be made within the taxable year within which you want to charge off the expense. There must be sufficient records to support your contribution or donation. 

-

But in so far as who the recipients are, there is a difference. In so far, as the tax wise or the benefit, special contributions are fully deductible and ordinary contribution is not fully deductible or just partially deductible.

Who, for special contributions, who are the recipients? o

1. Government or to any of its agencies or political subdivisions, including GOCCs, exclusively to finance, to provide for, or to be used in undertaking PRIORITY PROJECTS. 

What do you call these (sports, health, and educational, etc)?



What areas would all contributions to a local government unit be fully deductible for tax purposes? It must for priority projects. Priority projects would be SHE:



o

Sports development, science and invention

o

Health and human settlement

o

Educational and economic development

So what happens if your donation is made to the Government or political subdivisions or GOCC and it Is intended to finance a non-priority project? Is that deductible? Yes. However not fully deductible.

2. Foreign government or institution and international civic organizations. 

o

o

Give me an example of an international, civic organization? Wherein you make a donation that is fully deductible? Unicef. International Rights Research Institute, etc.

3. Accredited NGO. 

What must be registered?



Would all donations to a non-government organization that is organized for education be fully deductible? The NGO class, NOT ALL donations to non-government organizations would be fully deductible, you have to determine whether the NGO is accredited or not.



And accreditation would mean that it has been accredited by the duly appointed accrediting entity. o

Prior it has been the Philippine Council for NGO Certification which is PCMC. But there is already a new accrediting entities, DSWD, CHED. So it would actually depend on what type of NGO it is. Formed or organized for educational purposes, then you know that the accrediting body would refer to CHED or DECS.



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o 

-

o

If its non-government for civic purposes, it should be for specific purposes and to benefit other people not the stockholders, not the members.

You only have three categories of recipients of donations or contributions: 

(1) the Philippine government, political subdivisions, GOCCs for priority projects,



(2) foreign governments or international civic organizations,



(3) non government organizations which are duly accredited for purposes of health, education, research, charitable, sports, etc.

When the donation is given to a non-accredited NGO, because if it were an accredited NGO, the deduction is fully deductible.

I don’t think so. The accreditation is only needed for the amount of deductions, but regardless of that, it should be made to an NGO (?).

You’re saying that A donation to a particular group of individuals that is not organized properly is not a deductible expense? Totally? So what’s the difference between (white board)? o

-

Imagine class if you are allowed to use the donation, if you are an organization and allowed to use the donation without any limit for administrative purposes, you can make the entire 90% as your salary, to run the organization, which is not actually addressing the issue.

Question: so if it is given to an NGO that is not accredited, it is still a deductible expense but not fully – meaning subject to limitations? Would a donation or a contribution to a particular group of individuals that is not organized as an association, not an entity, not an NGO, be deductible contributions? o

-

o

So give an example of a recipient of a donation wherein a donation is covered only as ordinary but not special donation: o

-

Accrediting would mean, the process of accreditation is that these accrediting bodies would determine whether indeed that NGO has complied with all the requirements that it is, example education, that it is to address or to support indigent students, etc. The activities itself and that no member of that organization would be directly or indirectly benefited by any fundings made by outsiders. Not more than 30% of its funding or donations or contributions would be used for administrative purposes.

If we only have 3 categories of recipients in order to make a donation fully deductible, who are the recipients wherein the donation is subject to limitations? o

-

If its for Science then it should be DOST. And its for social welfare, DSWD.

NGO is a non profit corporation, so any group of individuals who have convened under a charitable cause does not necessarily mean that they are a non-profit corporation. In the law, it may only be deductible, whether fully or partially if it is formed as a non profit corporation.

So, class, when you say that there is a donation, you cannot automatically conclude that it is either partially deductible or fully deductible. It may be not deductible. Because for a donation to be deductible, it must be made to the government, its political subdivisions, GOCCs, or to a social welfare institution or to an NGO whether accredited or not. o

The difference lies in that if you give your contributions or donations to these kind of entities, the only question that you have is – does it belong to an ordinary donation or a special donation.

o

But if the recipient of your donations is beyond those identified in the tax code, not the government etc, any donation outside of those will NOT be deductible.

o

If you give it to the government, political subdivisions, etc, it’s fully deductible if you fund it for a priority project.



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

If it’s not a priority project, it’s partially deductible.

o

Donation to a foreign government or international civic organization always fully deductible because there is no qualification made under the tax code.

o

But for NGOs, it will be fully deductible if it is accredited for the purpose of research, health, education, charitable and sports. 

If it’s an NGO that is not accredited by an accrediting body, the donation will still be deductible but subject to limitations.



If it’s a social welfare institution that is still not accredited, it will belong (deductible). Other than that, all others are not deductible. If fully deductible:

Sales Cost Gross Income Less: Expenses Taxable/ Net Income CD Tax Due

-

11Million 9 Million 2 Million 1 Million 1 Million (1Million) - 0 c-

If OC-D:

Note: Expenses here do not include charitable donations

Sales Cost Gross Income Less: Expenses Taxable/ Net Income CD Tax Due

11Million 9 Million 2 Million 1 Million 1 Million 50,000 950,000

So when you say that it is subject to a limitation, (illustration) you have sales of 11M, you have cost of 9M, your gross income is 2M, expenses is 1M. Where do you base your limited deductibility of the expense? Under Taxable income. o

So if this is a corporation, what is the extent of the donation that you can make to a nonaccredited NGOs? 

It must not be more than 5% of 1M which is the taxable income or 50,000.

o

The basis of the limit for a corporation, they can actually donate everything. They can donate the 1M, but if they donate the entire 1M because they want to avoid paying the tax to these kind of recipients, it will be fully deductible – no tax due, zero - assuming this expense does not include yet the donations.

o

If the recipient of the 1M donation is recipient no 1 (government, political subdivisions, etc) for priority projects, it’s fully deductible as expense, you report zero taxable income, you pay zero tax dues.

o

If the recipient is a non-accredited NGO, you donated the entire 1M (same facts and figures), will you be liable to tax? 

Yes, you will get a deduction but you will still be liable for tax.



What’s the basis for your tax liability? You made 1M contribution, you contributed the entire 1M to an NGO that is not accredited, you said you are still liable for tax to the BIR. What is the basis of your 30% tax due? o

o

950,000 is the basis for your tax due.

OK class, even if you donate the entire 1M, but since your donation is subject to limitation because the recipient is not one of those reported as fully deductible donation, you will still be liable for tax. 

The basis would be the net taxable income less the maximum limit that you can actually contribute which is 5% of your net taxable income, it’s not based on gross. You pay 30% of the 950,000 regardless of zero cash.



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

What usually happens now is that every NGO is striving to have itself accredited in order to encourage donors, because donors would only be encouraged to donate to NGOs that are accredited because they can claim full deduction of expense and they can also be exempt from paying the donors’ tax.

-

Another exception provided by your special law is when you adopt a school. There is what we call as adopt-a-school program. You provide books, computer equipments etc, and whenever you do that, have yourself accredited and whatever your donation to that school is, it’s fully 100% deductible plus 50% deductible. This is beyond the tax code, this is special law. So if you donate 1M in books to a school that you have adopted, your deductible donation is 1.5M.

-

I think we discussed already research and development, there are some research and development expenses that you can fully claim as an expense in the year that you have incurred it or those that you can chose to amortize over 5 years so long as it is attributable to a capital asset or capital account.

-

Question: for that donation to be deductible, is acceptance necessary?

-

o

There can be no donation if the donation is not perfected, and perfection of the donation can only happen if there’s acceptance which is different on a case to case basis depending on what is being donated.

o

If it’s a real property, it should be accepted in writing in the document or in a separate document..

o

If it’s more than 5000 - in another document, if it’s less than 5000 in cash – oral acceptance is allowed.

o

When you have a perfected donation because there’s acceptance, donors tax is imposed depending on whether or not exemption is allowed.

You remember our discussion on retirement plans? Every corporation is encouraged to have a retirement plan in order to address the need if someone in the company would be retired.

Corporation

Retirement Plan

Employees

Separate Entity Deductible Expense? Yes!

o

This is the retirement plan, this is the corporation. If you have a retirement plan, any money that is placed by the corporation here, for whose benefit is this? For the employees. This is a separate entity from the corporation. If the corporation puts in money to this retirement plan for the exclusive benefit of its employees, this is totally a separate entity and any income earned from this plan is not an income of the corporation. Mind you, the income of this retirement plan is totally tax free. Would the transfer of funds to this retirement plan by the corporation be a deductible expense? 

Yes. In order for the contributions to be deductible, the amount contributed to the plan must be: o

Reasonable, the contribution must be given by the employer and the amount contributed must no longer be under the control of the corporation. Once the corporation has transferred the money, the corporation may no longer get back the money or use it in their operations.

o

Second requisite, the payment has not yet been allowed as a deduction – it cannot be deducted twice. And plan is for the benefit of the employees and



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deductions apportioned in equal portions over 10 consecutive years beginning in the year in which the transfer was first made. o

Whenever the corporation gives out money for the retirement plan for the benefit of the employees, it is already considered as an expense because it will not go back to the coffers of the corporation. This is a separate entity so whatever comes out of the corporation is an expense. Whether or not it is deductible is another issue.

o

Are all contributions made by a corporation to a retirement plan deductible? No. 

If it is for that year, it can be deductible if it is considered as ordinary expense for that year. But if such deductions were made for services that have been rendered for the past years, you can have it amortized over a period of 10 years. Divide the amount to be paid over the next 10 years.

o

Whenever a corporation sets up a retirement plan, the money is given to an insurance company or whoever is considered to hold the money in trust. Whenever an employee retires, the funds will not be taken from the corporation but from the plan.

o

Do you know actuaries? Those who compute the retirement fees of individuals, they will compute how many individuals are there in the company, what is the average length of service they will render, etc. 

So if they will determine that there are 100 employees and the corporation need to put in 1M every year, this 1M every year will be deductible expense.



Why? This is for the current year service of the employees. If 1M will be placed in the funds this year, then the 1M is entirely and fully deductible for that year. This is not like other expenses, this will only be deductible if it is paid – meaning there is an actual contribution. If the corporation does not contribute this year, there will be no deduction of expense. 2010

Contribution:

-

2011 1Million – For Current Year 1Million – For Past year 2Million

100% Deductible 1/10 DR

Let us say the following year, the corporation made a contribution of 2M, 1M for the year which it failed to contribute and 1M for the current year. How much contribution did the corporation give to the retirement plan? 2M. o

The details: 2010 the corporation is required to contribute 1M. This is for the current service of the employees covered by the plan. In 2011, it is required to contribute another 1M.

o

How much is deductible for next year? 1M which is for the current year and 1/10th of the 1M. 

Why? If the corporation does actually contribute 1M this year, this will be fully deductible because this year pertains to the current year service of the employees covered by the plan.



If it foregoes contributing and decides to contribute next year 2M, it is allowed but the problem is that if it contributes only next year, what is current for next year? o

This one only (1M), the other (1M) is for the past year’s service of the employees. And since we said that expense can only be deducted in the year that it pertains, this is 100% deductible (1m current year) and this is only 1/10th deductible (1M past year).

o

How about the 9/10?



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

It will be spread out for the next years. What will happen if the corporation does not contribute for 10 years, there’s no deduction for 10 years of 1M.



If on the 11th year, it decides to put in bulk of 11M, only 1M is current and fully deductible , while the 10M will only be deductible 1/10 every year. This still addresses the common requisite that an expense must pertain to the taxable year for it to be deductible.

G. Tax Rates -

Let’s go to tax rates. We’re already familiar that the tax rate for all corporations is always at 30%. Unless if it falls under special corporations. The general rule is 30% tax of the net taxable income and there is an option not to be taxed at 30%. The option is given to the domestic corporations and resident foreign corporations where they can choose to be taxed at the preferred rate of 15% gross income taxation, provided that certain conditions are met. That, the ratio of the cost to their gross sales or receipts from all sources should not exceed 55%, and if they shall elect that option, it shall be irrevocable for three years.

-

What is 15% gross income taxation? Where shall you apply the 15%? Sales Cost 15% Gross Income Less 30% Net Income

o

11,000,000 9,000,000 2,000,000 = 300,000 500,000 1,500,000 = 400,000

55% of 11M is 605,000. This is the cost to avail.

In the 2M (gross income/same illustration). Using this data, would you want to be subjected to the 30% net taxable income or would you want to pay 15% of the gross income? 

What’s 30% of 1M – 300,000. What is 15% of gross income 2M – 300,000.



You don’t actually benefit in choosing either. You should only opt for the 15% gross income taxation if it is more beneficial to you.

o

Now (refer to lower part of illustration) still the gross income is 2M, expenses 500,000, therefore net taxable income of 1.5M. 30% of 1.5M is 450,000. She wants to chose gross income taxation of 15%, because 15% of 2M gross income is only 300,000. Are you allowed to pay 300,000? Assuming that all the ratios, the GDP rate etc, are present? Yes.

o

Would everybody be allowed to choose 15% gross income taxation? NO.

o

o



Only available to domestic corporations and resident foreign corporations.



Non-resident foreign corporations are not expected to file these tax returns and are subject to final withholding tax of 30%.

Assuming illustration is a domestic corporation, can the domestic corporation chose to pay 15% based on gross income? 

Yes, only available if the ratio of cost of sales to gross sales or receipts should not exceed 55%.



Does this satisfy that requirement? NO.



Does 9M (costs) exceed 55% of 11M (sales)? OK, 55% of 11M is 6.05M. This (costs) should not exceed 6M.

You don’t have the complete liberty of choosing 15% gross income. The only time that you can opt to pay the 15% gross income taxation, assuming that all conditions are present is that: 

(1) you must either be a domestic corporation or resident foreign corporation,



(2) the ratio of the cost to your sales must not exceed 55%.



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o

Otherwise, if you have no limit here, for example this is 10M (costs) which is almost 100%, you will surely be benefited by gross income taxation. Lifeblood doctrine still dictates that you have to pay more.

Minimum Corporate Income Tax -

-

When are you required to pay the minimum corporate income tax? MCIT is 2% from the gross income of the corporation. o

Is that income tax? Yes.

o

Does the corporation have to pay MCIT always? No.

o

When is a corporation required to pay the MCIT? A corporation is required to pay the MCIT if the normal corporate income tax is less than the 2% gross income tax which is the MCIT.

Minimum corporate income tax is a 2% tax on the gross income of a corporation. o

Whether or not a corporation is liable at all times for MCIT, the answer is No. 

o

Why? If the corporation is not subject to the 30% normal corporate income tax, then it will not also be subject to the MCIT.

Can it happen that a corporation may be liable for both the 30% regular/normal corporate tax and the 2% MCIT? No. 

What is the relationship of these two types of taxes? It excludes the other. If one is used, the other is excluded from being applied. The 2% MCIT will apply if the 2% MCIT is higher than the 30% normal rate of gross income.



So:



o

(1) if the 2% MCIT is higher than the 30% normal corporate tax, the MCIT will apply and

o

(2) if the corporation is operating at a loss then the MCIT will apply. 2% MCIT which is 2% of the gross income, not the net taxable income, is only a tax that is made in lieu of the 30%.

Your actual tax liability to the government is always the 30% tax. But in years wherein the corporation is operating at a loss, you don’t have 30% tax, you will have to pay the 30% MCIT. Or in years wherein the corporation’s regular tax on net income is lower than 2% MCIT, you have to pay the 2% MCIT. Whichever is more favorable and higher in taxes to the government for your operations, you have to pay it to the government.

-

What is the principle of imposing the MCIT, prior to 1998, this was not imposed, because corporations are abusing expenses. They bloat the expenses resulting to either minimal net taxable income or they bloat this to the extent of reporting a loss, therefore there will be no income tax. And normally you don’t exist for 10 years at a loss, you should have closed your business already. This is what the BIR was looking into, there are corporations which were operating at a loss for more than 10 years. The problem was there was over-claiming of expenses but the BIR would not believe you if you would report this at a loss at this level. Now at least the BIR is assured, if you report a loss, the BIR is assured of collection.

-

Can the 2% MCIT be imposed if you are not liable for the 30% normal corporate income tax? o

NO, it will only be applicable if you are liable for 30% tax so those entities which are exempt from the 30% tax are not liable for the MCIT.

o

If you are a corporation that has been granted income tax holiday for 4 or 6 years, during those years when you are not liable for the 30% normal corporate income tax , you will not as well be liable for the 2% MCIT.



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-

How about non-profit hospitals or proprietary educational institutions? They are subject to 10% tax on net income. o

-

Are they liable for 2% MCIT in case they operate at a loss. No, MCIT also not applicable because the 30% normal tax is not applicable to them.

Next example, a corporation that is registered with the Philippine Economic Zone Authority or the Subic Bay Free Port Enterprise, they are subject to 5% tax on gross income in lieu of all taxes, are they subject to the 2% MCIT? o

Not subject to 2% MCIT, unless if it refers to another activity or they are doing another activity in which they are not registered.

o

Those corporations that are located inside the economic zone and even in IT Park, if they opt to be subject to 5% income tax based on gross income in lieu of all taxes, they are not liable for VAT, not liable for other taxes, they will not be liable to MCIT at all because it is only imposed if you are subject to 30%.

o

These corporations within the economic zones however are only allowed to pay 5% tax on activities that have been registered with the government. If they venture into activities that are not covered by the 5% tax, then –Timex Imagine Timex, it’s within the zone.

MCIT:

o

5 Million Selling FF, E, M 30% 

Timex has 100M sales of registered activities (watch manufacturing and sales etc). And they earn 5M income from selling old furniture, equipments, motor vehicles, etc, is this covered by the registration? 

-

100 Million Registered 5% X

No, this is not subject to 5% tax, this will be subject to 30%. As to whether MCIT applies to these activities, it would depend on whether MCIT is higher or normal corporate tax rate is higher.

Question: does that rule apply also to proprietary educational institutions? Proprietary Educational Institutions MCIT YES GR: 10% on NTI NO Exc: 30% on NTI

o

Proprietary educational institutions are those private institutions which are owned and administered by individuals and organized for profit. These are not nonstock nonprofit.

o

Are they subject to tax? Yes, general rule is that they are subject to 10% tax rates on their net taxable income. 

Exception is if the profits are a result of engaging in activities that are not related to the trade and it exceed 50% of their income – the rate is 30% normal tax on net taxable income. Gross Income: 100,000,000 from Tuition Fees 100,000,000 from Rental Fees 200,000,000 Total




Subject to 10%


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o

If you own a school, and your gross income, a proprietary educational institution, is 100M from tuition fees and 100M from rental fees. You have 200M total income. What is the tax rate applicable? 

It is still 10% because it did not exceed 50% of the gross income. 10% tax on the entire net taxable income.



Proprietary educational institutions and nonprofit hospitals are subject to 10% tax on their net taxable income as preferred or special corporations.



But once they violate the predominance test, meaning once their income from other activities (other than educational or other than hospital services), the entire income will be subject to the regular rate of 30%. You do not divide the income.



Say for example the gross income from tuition fees is 100M and from rental fees is 100M, total of 200M. It did not violate the rule that it should not exceed 50%, it’s 5050. Therefore, the entire taxable income of this school is subject to 10% tax. Gross Income: 100,000,000 from Tuition Fees 100,000,000 from Rental Fees 200,000,000 Total



o

If this becomes 101M (from rentals, other income), what rate shall apply? Once the other income (other sources) exceeds 50% of the total income, 30% would apply on the whole net taxable income. It’s either 10 or 30 applied to the whole income.

o

Question, still on MCIT: if the school is still under 10% tax, is MCIT applicable? NO. 

o -

If the corporation surpasses the 50% boundary, subject to 30%, will MCIT apply? YES.

Just simple class (!), whenever 30% is present, 2% is lurking around. So MCIT will only be present if the school is 30% taxable.

When do you begin to impose the MCIT, on the first year of operations? No, in the fourth taxable year beginning after the year the corporation has commenced (pertains to registration with BIR) business operations. o

So, in 2005 December 24: you registered your business. When should you start comparing your 2% MCIT against your 30% normal corporate tax? In 2009. 

o -

Subject to 10%

Why? It’s the fourth year after 2005. Beginning the fourth taxable year following the year in which you commenced your business operations.

You registered your business with BIR in 2005, assuming you follow the calendar year, when is the year after you commenced business operations – 2006.

The 2% MCIT is based is on gross income. When you say gross income, what is gross income as a general rule and what is gross income for a corporation that is engaged in the sale of service and a corporation that is engaged in the sale of merchandise? o

So when you actually want to know what is gross income for purposes of computing the 2% MCIT, it would only refer to the definition found in Sec. 27(e) of the Tax Code. But if you’re engaged into merchandising or trading business, the cost that you can deduct on your sales in order to arrive at the gross income would only pertain to the products that you actually trading plus the insurances plus the costs to put that product into the location or sale.

o

So if you’re selling siomai, what would be the cost is the siomai that you bought, if it’s trading, and the transportation cost from getting it from the supplier down to your business. Of course,



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the transportation that would pertain from the delivery to your consumers or customers would no longer form part of the cost. It would already form part of your selling expenses.

-

o

The cost would pertain to the expenses for bringing the product into the location or sale.

o

And it would also depend if you’re into one type of business. If it’s manufacturing business – the cost of the raw materials, the cost of buying the raw materials, the freight/shipment, the insurance, the commission from buying it, and of course, the processing of the product. So these are, in short, the direct expenses – the direct cost to put the product available for sale, whether the product be goods or services.

o

You cannot deduct the expenses which are already for operation and for selling or for marketing. When you say transportation cost, it would refer to transportation from buying or transportation from selling.

o

So gross income is very restrictive. That is the reason why the tax rate of MCIT is very low – 2% lang unlike 30% taxable income of normal corporate income tax (NCIT) because you’re allowed to deduct all the business expenses that you’re incurring.

The MCIT is only a tax temporarily in lieu of the income tax that you cannot pay probably because you’re losing or the NCIT is low. It’s a temporary tax that you have to pay but eventually, you are allowed to credit the excess of the MCIT that you’ve paid beyond the NCIT. o

What is that rule again? 

Any excess of the MCIT over the NCIT can be carried over to the next 3 consecutive years and offsetted against the NCIT.



Can it be offsetted against MCIT? o



-

NO.

So any excess or the excess of your MCIT over your NCIT, dba when are you required to pay MCIT? Only if your NCIT is lower than the MCIT or when you’re totally at a loss wherein you don’t pay any NCIT. So what you’ll have to pay is MCIT – any excess over the NCIT can be used up as a credit against your future NCIT in the succeeding 3 years. It’s an offset.

Tiu: I will illustrate how it works…… 4th year Sale Less: Cost Gross income (2% MCIT) Less: Expenses Net taxable income (30% NCIT) 30% tax due (NCIT) MCIT (2%) Paid to the government Excess MCIT

-

6th year

7th year

8th year

9th year

10M 5M 5M

5th year 10M 2M 8M

10M 2M 8M

10M 3M 7M

10M 4M 6M

10M 4M 6M

5M 0

7.8M 200K

7.7M 300K

6.8M 200K

5.5M 500K

5.6M 400K

0 0 0

60K 160K 160K

90K 160K 160K

60K 140K 140K

150K 120K 0

120K 120K 20K

0

100K

170K

250K

100K

0

Given the table above, in the 4th year, how much are you going to pay to the government? o

Remember, when do we commence computing MCIT?



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

-

-

o

So in the 4th year, how much is your tax liability? 0. MCIT is 0. At this point, you’re not yet liable to MCIT because MCIT will commence at the 4th taxable year following the year that you commence business operations, which in fact is the 5th year. In this case, it is still the 4th year.

o

Since here, your NCIT is also 0, your payment to the government is 0. Your excess MCIT is 0.

Let’s go to the 5th year. How much is your liability to the government? How much are you going to pay to the government? o

160K. So the government will receive 160K because MCIT is higher than NCIT.

o

How much is your excess MCIT? 100K. At this point, you have a reserve nah! Your true tax liability to the government is only the NCIT, but you paid the MCIT of 160K because MCIT is higher than NCIT. Therefore, you have a reserve of 100K that is creditable against your future tax liability in the succeeding 3 consecutive years.

Let’s go to the 6th year. How much will you pay to the government? o

160K because MCIT is higher than NCIT.

o

Can you not deduct your reserve of 100K? 

o -

-

-

NO, because excess MCIT is only offsettable against the NCIT. It cannot be credited against the MCIT. You always have to pay the MCIT, whatever it is. But once you reach to the point that your liability is already the NCIT, it’s when you can use the reserve. In this case, your payment to the government is MCIT so, therefore, you cannot deduct the reserve yet.

So how much is your reserve at this point? 170K.

Let’s go to the 7th year. How much is MCIT? o

140K.

o

How much are you going to pay to the government? 140K because MCIT is higher than the NCIT.

o

How much is your reserve now? 250K.

In the 8th year, how much will you pay to the government? o

-

Beginning the 4th taxable year following the year that you commence business operations or which means to say, following the year you registered your business for BIR purposes.

0. Here, the NCIT is higher than the MCIT, therefore, you don’t need to pay the MCIT. You pay the NCIT supposedly. But since in this case, you have an existing 250K total of excess MCIT, thus, such excess is offsettable against the 150K NCIT, so the remaining reserve is 100K [250K-150K].

In the 9th year, how much will you pay to the government? o

How much is your MCIT? 120K.

o

How much is your NCIT? 120K.

o

So, therefore, you pay 20K to the government [120K-100K]

o

You only pay the MCIT if the company is operating at a loss or when NCIT is lower than MCIT. In this case, it’s equal, so you still pay the NCIT. But since you have an excess reserve still of 100K coming from the prior years, you can offset it against the 120K, which is the NCIT, so therefore, you only pay 20K.

At any point, did any excess MCIT expire? Was there an expiration of excess MCIT, meaning, it was carried forward for 3 years but was never used?



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-

o

NO.

o

Let’s look at the 5th year. Was the 100K used within the 3 succeeding years? YES, it was used in the 8th year [first in-first out dba?]. So the 100K excess in the 8th year pertains to a portion of the excess MCIT in the 6th year and 7th year. Therefore, nothing expired.

How much is your total tax due (NCIT) from the 5th year to the 9th year? o

480K.

o

How much did you actually pay to the government? 480K still.

o

The difference is that your true tax liability is always the 30% NCIT. But at any point that you operated at a loss or your NCIT is lower than MCIT, you will be required by the government to pay MCIT as an advance payment for future years. Why an advance payment for future years? Because whatever excess MCIT that you pay to the government will be creditable to the next 3 years.

o

So instead of paying 60K in the 5th year, you are required to pay 160K. In the 6th year, instead of 90K, you are required to pay 160K. In the 7th year, instead of 60K, you are required to pay 140K. But in the 8th year, instead of paying 150K, you paid actually 0. In the 9th year, instead of paying 120K, you only paid 20K.

o

So bottomline, your true tax liability (NCIT) for these years is only 480K. The amount that you actually paid is also 480K. So long as no MCIT expires, meaning nothing is unused, you will always arrive at equal amounts. But if at any point, there will be an unused MCIT, that expired MCIT will be the amount that you have overpaid the government.

o

So assuming that the excess 100K in the 5th year is not used at any time because you operated MCIT all throughout, your actual payment would be higher than your true tax liability (NCIT).

o

So MCIT is not really your tax liability. It’s not. It’s just an advance payment of your NCIT offsettable against your future NCIT because the government would want to collect regularly from you.

Example: Where MCIT expires 4th year 10M 5M 5M

-

5th year 10M 2M 8M

6th year 10M 2M 8M

7th year 10M 3M 7M

8th year 10M 4M 6M

9th year 10M 4M 6M

Sale Less: Cost Gross income (2% MCIT) Less: Expenses 5M 7.8M 7.7M 6.8M 5.7M 5.4M Net taxable 0 200K 300K 200K 300K 600K income (30% NCIT) 30% tax due 0 60K 90K 60K 90K 180K (NCIT) MCIT (2%) 0 160K 160K 140K 120K 120K Paid to the 0 160K 160K 140K 120K 0 government Excess MCIT 0 100K 170K 250K 180K 0 Given the table above, let’s start-off with the 8th year. How much will you pay to the government in the 8th year? o

120K because MCIT is higher than the NCIT.

o

What will happen to your excess MCIT in the 8th year? How much is your total reserve for the 8th year that is usable or that can be carried forward in the 9th year?



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-

-

-

-



180K [(250K-100K) + 30K]. 250K is the total reserve of the 7th year and you deduct the 100K from 250K because the 100K excess MCIT of the 5th year has already expired. Then you add 30K which is the excess MCIT in the 8th year. So therefore, the total reserve would now be 180K.



The 100K excess MCIT of the 5th year can only be carried forward in the 6th, 7th and 8th year. Since at the end of the 8th year, we’re looking at the excess MCIT that will be applied in the 9th year, you only cover the excess MCIT from the 6th year. The excess MCIT of the 5th year has already expired because you were unable to use the excess MCIT of 100K of the 5th year. The life of the 100K excess MCIT of the 5th year would only exist for 3 years after. Since such excess was not used because in the 8 th year, you paid MCIT, it’s no longer usable in the 8th year, so you have to take it out on the total reserves in the 8th year. So you only have 180K, which comes from 30K excess MCIT of the 8th year + 80K excess MCIT of the 7th year + 70K excess MCIT of the 6th year.

If we have the same figures in the 9th year, how much will you pay to the government in the 9th year? o

0.

o

In this case, it is only in the 9th year wherein you benefited from the excess MCIT payments because it was only in the 9th year that you have a higher NCIT.

How much did you actually pay to the government from the 5th year to the 9th year? o

580K.

o

How much is your true tax liability (NCIT)? 480K.

o

REMEMBER: Your true tax liability is only the NCIT. So long as no MCIT excess will expire, your actual payment to the government will equal your NCIT liability.

o

But in this case, we have an expiry of excess MCIT in the 8th year. The first 100K excess MCIT of the 5th year was not being utilized. Therefore, although your true tax liability is 480K, you actually paid 580K because you failed to utilize your excess MCIT or advance payments to the government.

o

So that’s the difference when there is an expired excess MCIT.

o

So if you feel that on the 3rd year, something is expiring, report a higher NCIT so you can utilize your excess MCIT.

What are the instances wherein you can ask temporary relief from the payment of MCIT? o

1. Prolonged labor dispute

o

2. Force majeure

o

3. Legitimate business reverses

MCIT means that you are required to pay regularly to the government. It’s just an advance payment. You can utilize it afterwards. It’s in order to plug the loophole in the tax code wherein the taxpayer is abusing the expenses that they claim as deductible. You can zero out your net taxable income by claiming huge expenses then when you zero out your net taxable income, you’re not required to pay any income tax due. But because of the MCIT, you will be paying MCIT due. And in order to avoid expiring the MCIT, at some point, in the 3rd year, you will be honest enough to declare your true income tax in order to be liable for NCIT.

SPECIAL DOMESTIC CORPORATIONS -

Proprietary Educational Institutions (PEI) – what are the requirements? Or should it be a formal EI for you to avail of the 10% special rate? o

YES, it must have been issued a permit to operate from the DECS or CHED, or TESDA, as the case may be.



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o

-



Tax rate is 10% if its income derived from unrelated trade, business or activity does not exceed 50% of its gross total income.



Tax rate is 30% ordinary tax rate is its income from unrelated trade, or business or activity exceeds 50% of its gross income.



So we have to consider that if this is the gross total income of the PEI, how much of it comes from unrelated trade, business or activity. If more than 50%, then automatically, the net taxable income of that PEI would be subject to 30%. You don’t apportion 10% to tuition fees and related educational income and 30% to other income. It’s either all the net income will be subject to 10% because it did not exceed 50% on unrelated trade, business or activity or all the net income will be subject to 30%.



But for purposes of determining whether the predominance test has been violated or not, you look into the gross total income, not the net income, because the net income of educational activities and the net income of commercial activities is different. You have lots of expenses that you can claim in commercial activities but for educational, tuition lang, etc… it’s not many.

NPH – same rule as PEI o

-

What are the rules on the taxability of PEI or Non-Profit Hospital (NPH)?

But if it’s profitable? It’s subject to the 30% ordinary tax rate.

PEI and NPH are special domestic corporations, which are taxable from sources within and without.

SPECIAL RESIDENT FOREIGN CORPORATIONS -

-

International Air Carrier (IAC) and International Shipping (IS) are taxable within on their tax base of Gross Phil. Billings (GPB) at the tax rate of 2.5%. o

For purposes of IAC, GPB refers to the amount of gross revenue derived from carriage of persons, excess baggage, cargo and mail originating 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 or passage document. Tickets revalidated, exchanged, and/or endorsed to another international airline form part of the GPB is the passenger boards a plane in a port or point in the Philippines.

o

For purposes of IS, GPB means gross revenue whether from passenger, cargo or mail originating from the Philippines up to final destination, regardless of the place of sale or payments of the passage or freight documents.

Lets say a corporation, SILKAIR, which is based in Singapore, opens an agency in the Philippines to accept purchase of tickets for Singapore airlines. Would it be subject to the 2.5% tax on GPB? The outlet caters to all sales of SILKAIR tickets. o

It’s an outlet – a sale of tickets – whether or not originating in the Philippines.

o

If you register a foreign corporation here and it ventures on the sale of tickets from whatever point of origin or airport of origin, would the sales be considered as subject to 2.5% tax as GPB?

o

What is the basic requirement for a foreign corporation to be allowed to avail of the lower rate of 2.5%?

o

Would all foreign corporations selling tickets here in the Phil. be subject to the 2.5% on GPB? 

NOT NECESSARILY. So what is the requirement? What is that basic requirement that makes the tax rate a lower rate of 2.5% on GPB?



GPB would not apply to all sales of airways or airlines or transport companies. GPB would only apply, specifically, to the amount of gross revenues derived from the



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carriage of passengers, excess baggage, cargo and mail ORIGINATING FROM THE PHIL. in a continuous and uninterrupted flight regardless of where the ticket is sold.

-



Now, if and when a foreign corporation, like SILKAIR or QATAR AIRWAYS, open up an agency or outlet here in the Phil. selling tickets, whatever the destination is or the port of origin or airport of origin, it will already be covered by the normal tax rate for RFC, not the special rate. Why? It’s already engaged in selling tickets. On the normal basis, it becomes subject to the 30% tax.



If the existence of such corporation is really to sell tickets, whatever the port of origin or airport of origin is, it will be subject to the normal tax of 30% because the 2.5% on GPB refers only to the revenues based on a flight originating from the Phil. in a continuous and uninterrupted flight. It would also include ticket sales made elsewhere other than the Phil. so long as the origin of the flight is in the Philippines.



So it’s different. When you put up a corporation and register it here and you sell tickets, it does not guaranty you 2.5% on GPB. It would really depend on what you’re selling and what is covered by GPB.

Regional Operating Headquarters (ROHQs), subject to tax on what? o

They are subject to 10% tax.

o

Why 10%? 

A ROHQ is defined in your Sec. 22 of the tax code, maybe engaged in operations in the Phil., therefore, being operational, it will generate profits, and any profits, the taxable income of which, will be subject to the special rate of 10%, in the same manner that the employees of these ROHQs of multinational corporations are given the preferential rate of 15% so long as they’re occupying, if foreigner, managerial or technical, if Filipino, managerial and technical positions, ROHQs as well are granted the preferential rate as a corporation at 10%.

-

ROHQs are just like any other corporations. It has employees. It will be liable for other taxes. It’s just that as far as income tax is concerned, it will be subject to the preferential rate of 10%. The question as to whether it will be required to withhold taxes on the employees’ compensation? YES. Will it be required to remit? YES. Everything is the same except to the preferential rate of 10% to the corporation and 15% to its employees occupying managerial and/or technical positions.

-

In so far as RAHQs are concerned, are Regional Area Headquarters (RAHQs) liable for income tax as a special RFC? o

-

NO. Being non-operational, it will not be subject to income tax.

How about Off-shore Banking Units (OBUs)? o

As RFC also, OBUs are only taxable on income derived within.

o

But what type of income is subject to tax? 

Income derived by the OBUs from foreign currency loans to residents is subject to the preferential rate of 10%. But if the income is derived from foreign currency loans or transactions to non-residents, other OBUs, local commercial banks, it will be exempt. And if it’s an income derived from investments or deposits or other loans to nonresidents, whether individual or corporation, is exempt.



Easy recall would be – if the income is derived by the OBUs from residents, individual residents, taxable at 10%. If the income is derived from non-residents, whether individuals, corporations, OBUs, exempt. But there is one EXCEPTION to the rule – if the income is derived from a Phil. commercial bank or a local commercial bank, it is still exempt.



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

OBUs are just an extension of foreign banks. When it grants foreign currency loans to also non-residents, it’s as if off-shore. It’s beyond the Phil. jurisdiction. That’s why it’s exempt. But if the foreign currency loan to residents, dba what is the situs of interest or income from loan transactions? It’s where the debtor resides. And if the loan is granted to a resident and a resident of the Phil., the situs is in the Phil. It’s an income within for OBUs. That’s why it’s taxable at 10%.

BRANCH PROFITS REMITTANCE TAX -

Branch Profits Remittance Tax (BPRT), what is that? When are they required to pay it? What does it imply? Would a DC be liable for the 15% BPRT before it pays off to a FC? What kind of relationship must exist for the 15% BPRT to apply? o

Illustration: There is A International Corp. There is B Corp. (domestic), which is 100% fullyowned by A International Corp., and C, which is a Phil. Branch of A International Corp. Which relationship must exist? The relationship between A and B or A and C? 

A and C relationship.



BPRT will only be applied in the A and C relationship and not A and B relationship.



The A and B relationship – when a NRFC fully owns a corporation, you call such relationship as the parent-subsidiary relationship. Here, B is a separate corporation distinct from the parent company. B is registered with its own set of stockholders and own set of Board of Directors. A as well has its own set of stockholders and own set of Board of Directors.



The A and C relationship – you call it a home-office branch under the single entity concept. A and C are one and the same. Since C is a mere branch of the home-office abroad established in the Philippines as a RFC, C doesn’t have any stockholders. In the absence of the stockholders, it means to say that the owner of C is the owner of A. There is no set of Board of Directors. Just a general management because the set of Board of Directors is found in the home office, which is A International Corporation.



If let’s say A invested in B corporation and A put up a branch, C. Both are performing well (B and C). How would B distribute the profits to A and how would C distribute the profits to A? How would B corporation give profits to its stockholders? Or how would A get profits from B? o

B corporation will declare dividends. B, whenever it has unrestricted retained earnings, the next step for it is to declare the profits in favor of its ownerstockholders. So it will go outside of the country. You call this declaring dividends to its stockholders.




The dividends that will be declared by B in favor of A as stockholder, who is a NRFC, what is its taxability? Dividends declared by a DC to a DC is exempt. Dividends declared by a DC to a RFC is exempt. But once dividends will be declared to a NRFC, it is subject to tax.



Illustration: DC, owned by 5 individuals (I1, I2, I3, I4 and I5). Another DC. Another RFC. If the DC will declare dividends to I1 – I5, all individuals, it’s subject to 10% FWT on dividends if it’s cash or property to RC and NRC, 20% if it’s NRA-ETB and 25% if it’s NRANETB. But what about a stockholder who is DC and a stockholder who is RFC? Both are exempt. Why exempt? In order to avoid double taxation because DCs are also owned by corporations. At the point that the DC declared dividends to another DC of property and cash dividends, it is exempt to avoid double taxation. The profit is simply transfer to the other DC. Taxability would only arise once it goes out to an individual. Because if you tax the dividend given to the other DC and


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the ultimate distribution to the latter’s individual stockholders, there would be now 2 stages of tax nah. There should only be one. Thus, the dividends given to a DC is simply a transfer of profits. In the same way that RFCs are also exempt for further distribution to its individual stockholders. 

But in receiving the dividends from a DC, when the recipient is NRFC, it follows the general rule that all incomes of a NRFC are subject to the 30% tax except on capital gains from capital gains on sale of shares. It means to say that dividends received by a NRFC are subject to the normal rate of 30%. But what is that special rule on dividends being given to NRFC? 

If a foreign government grants or allows tax credits to Phil. corporations abroad, what credit does it give? At least how much? If the foreign country grants tax credits of at least 15% to Filipino corporations deriving income from any domestic corporations abroad, the NRFC will be subject to 15% intercorporate dividends.



Example: If the DC gives dividends to another DC or to a RFC, it’s exempt. But if the recipient is a NRFC, it’s 15%, which is 30% tax rate for NRFC minus 15% credit granted by the foreign government. This is just to put the same relationship, same taxability. Whether you are a foreign corporation investing in a branch in the Phil. or investing in its subsidiary that is totally distinct from itself, any profit going outside the Phils. will be subject to the same tax rate.

o

C, since it has no stockholders on its own, it would simply merge its income with A. It will remit whatever profits it has received. You call this remitting profits of the branch to the head office. Here, the profit that is earmarked for abroad to be remitted to its head office will be subject to 15% BPRT.

o

Would all Phil. branches be subject to the 15% BPRT on remittances made abroad? 

The tax code provides that if and when the Phil. branch is located within the economic zone, any remittances made to its home office will not be covered by the 15% BPRT. In order to totally avoid the 15% BPRT and totally avoid the 15% intercorporate tax dividends, you locate yourself as a Phil. branch within the economic zone (Tax avoidance scheme). That’s why there were some subsidiaries within the economic one that converted itself into Phil. branches so that to avoid the 15% BPRT. So everything that goes outside the Phil. branch office will be totally tax-free.

October 5, 2010 Tuesday -

Can a DC be liable for the 15% BPRT? NO. BPRT is only applicable to RFC.

-

When is BPRT due to the government? o BPRT is due to the government when a RFC, which is a home-office branch here in the Philippines of a NRFC under the single-entity concept, remits profits to such NRFC.



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o

-

So is it possible that a DC be liable for 15% BPRT? Is it possible for the government to collect BPRT on a profit-distribution made by a DC to a NRFC? NO, since BPRT is only applicable to a home-office branch relationship under the single-entity concept between a RFC and NRFC.

BPRT vis-à-vis intercorporate dividends or under the tax sparing credit rule. What is the difference between the two? NRFC

100%

DC RFC

Subsidiary Corp.

Phil. Branch

Illustration: If a NRFC puts two investments in the Phils. One in a DC, fully-owning it and one establishing a Phil. branch. A DC, being a subsidiary corporation, will have entirely different sets of officers, its own capital stock, etc… only that 100% of it is owned by a parent company. So any distribution made by a DC is called dividends-distribution. It’s not remittance of profits because for every capital stock that is owned by a stockholder, the fruit of that capital stock is a dividend. But when that NRFC, likewise, establishes or opens up a Phil. branch, such branch is not a separate entity from the NRFC. It is simply a branch – an extension of its home-office – and any profit of the branch is directly a profit of the home-office. It’s just that for every instance that there will be profits earmarked for remittance abroad, it will cross borders – territorial jurisdiction – it will already be subject to the 15% BPRT in order to equal the tax on the dividends that will be declared by the subsidiary corporation. So in both cases, a NRFC, whether he chooses the parentsubsidiary type of investment or the home-office branch type of investment, will be subject at the same rate of 15%, differently termed. One is intercorporate dividends. The other is a BPRT. In BPRT, this involves 2 countries – the Philippines and one from abroad, a foreign country. There will be no BPRT of a DC having a branch anywhere in the Phils. because it’s one and the same entity covered by one jurisdiction – the Phil. jurisdiction. So BPRT should involve the Phils. and another foreign country. o Would all Phil. branches of a NRFC, when it earmarks profits for remittance abroad, be liable for the 15% BPRT? As a rule, Phil. branches of a NRFC is liable for 15% BPRT on the total profits that it earmarks for remittance abroad except if the Phil. branch is located within the economic zone that is legally recognized by the government. Intercorporate dividends. What is the general rule of the taxability of a NRFC? o All income received by a NRFC will be subject to 30% tax except capital gains from the sale of shares of stock, not traded in the stock exchange. o But would dividends declared and paid by a subsidiary corporation to a NRFC be subject to the 30% tax? If the foreign government of such NRFC allows or grants tax credit to Phil. corporations located abroad, the intercorporate dividends would be subject to 15% tax, not the 30% tax. o The reason why intercorporate tax on dividends is at 15% is because: o

-

-



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 

1. In order to equal the rate of the BPRT 2. As a rule, NRFC will be taxed at 30% on gross income including dividends earned from a DC. But if there is a tax credit that is granted by the foreign country to Phil. corporations, not a resident there, equivalent to 15% then, we can only impose tax of 15% as well. It means to say that 30% tax rate of NRFC less the tax credit that is expected to be granted by the foreign country to Phil. corporations at 15% - so the difference is 15%. The difference of 15% is the rate of intercorporate tax on dividends.

-

RAHQs are not taxable because they’re not expected to be performing any profitable activities in the Phils.

-

What about ROHQs? o They are subject to 10% tax on their taxable income derived within. ROHQ is operating activities within the Phils. in favor of its affiliates within the Asia Pacific Region. It is considered as a special RFC subject only to 10%, instead of the 30% tax, on the income coming from within the Phils. The tax base is only the taxable income because it’s regarded as a RFC and RFCs are taxed at net income. o And if ever a ROHQ remits profits abroad to its home-office, it will also be subject to the 15% BPRT. o The 10% is income tax. The 15% is the tax on the profits remitted abroad. It’s just like a corporation taxable on its income and a corporation required to withhold on the dividends or the profits that it will remit abroad.

SPECIAL NRFC -

-

-

Non-resident cinematographic film owner, lessor or distributor – taxed at 25% on their gross income derived from within. o A cinematographic film owner, lessor or distributor – it does not include leasing out DVDs or CDs. What it includes is only films – one which is used probably for movies. Non-resident owner or lessor of vessels chartered to Filipino Nationals or Corporations – taxed at 4.5% on gross rentals, lease or charter fees derived from within o The Charter Agreement of which is approved by Maritime Industry Authority. o Some DCs would lease out vessels from foreign owners in order to ship in the raw materials that they’re purchasing. So whatever the arrangement is with the lease, whether it be by bareboat charter or demise charter, whether it’s with crew or not, it’s covered by the 4.5% on gross income for the lease payments. Non-resident owner or lessor of aircraft, machinery and equipment – taxed at 7.5% on gross rentals or fees derived from within

PASSIVE INCOME -

Individuals, as a rule, are subject to the 20% tax withheld on the interest income that they earn, except that if they’re NRA. When we look at corporate taxpayers, they’re, as a rule, subject to the 20% tax withheld on the interest income that they earn – DC and RFC. o How about NRFC? Are they subject to the general rule of 30%? Or are they given the preference as well of 20% tax on interest income?



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 

 

-

-

-

-

Let’s say that you are the manager of the bank. A NRFC places a time deposit in your bank. Are you going to withhold on the interest income? YES. At what rate? 30%. Let’s say the NRFC placed its time deposit in an OBU. Subject to tax or not? NO, since they’re exempted. Can we consider it as a passive income subject to FWT? Or what is covered by passive income of corporations subject to FWT? When you say passive income of corporation that is subject to FWT, it must be an income that is derived within the Phils. in order for us to have jurisdiction over the withholding agent. If the income, whether it is a kind of passive income, is earned abroad or has situs abroad, it will not be considered as income subject to FWT but the income, if applicable, will just simply form part of the other income of the taxpayer, whether corporate or individuals. An interest income is a passive income. An income derived from inactivity. When a DC or a RFC derives interest income from bank deposits, it will still be subject to the same 20% imposed on individuals. When a NRFC derives interest income on bank deposits, it’s 30%. But interest income on loans, 20% final tax.

Under the expanded FCDU, it’s 7.5% for RFC and DC while NRFC is exempt just like placing your deposit or investment in an OBU. It’s offshore. It’s outside the jurisdiction of the Phils. so, although it’s located in the Phils., as a special treatment, it is exempt if the depositor and the bank that is accepting the deposit are treated as non-residents. Royalties derived within the Phils., if the income-earner is a DC or a RFC, it’s both at 20%. It does not negate from the rates that is applicable to individual taxpayers. But if the royalty income that’s considered as passive income, the earner is NRFC, it’s 30% because as a rule, NRFCs are taxable at 30%. o NOTE: Royalties should be considered first as a passive income before you apply the special rates of 20% and 30%. If the royalty income is already an active income that is earned in the usual course of trade or business of the corporation, it will be subject to the ordinary tax rate of 30%. For capital gains derived from the sale of shares of stock: o If it is listed and traded thru local stock exchange: ½ of 1% of the GSP o If it is not listed or traded thru local stock exchange: Not over 100K – 5% and over 100K – 10%  Is this the same rate applicable to individual taxpayers? YES.  Would the rates differ if the seller is a NRFC? NO. This is one income or one type of gain – capital gain – wherein the rate holds true or the same for all types of corporate taxpayers. If you look into Sec. 28(b) – NRFC are subject to 30% tax on gross income…. Blah, blah, blah… all types of income have been mentioned, except capital gains on sale of shares of stock, which means that it will be subject to the 5 and 10%. Capital gains derived from the sale of real property. What is the taxability of the different corporate taxpayers? o For DC – 6% of the GSP or Zonal Value, whichever is higher o For RFC and NRFC – should be treated as OTHER INCOME subject to 30%

NRFC (STU)

100% RFC (JKL) ***In broken line borders are outline notes.

Phil. Branch


DC (ABC)

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-

Illustration: Based on the illustration above, what is the relationship between DC (ABC) corporation and NRFC (STU)? Parent-subsidiary relationship. How about RFC-Phil. branch (JKL) and NRFC (STU)? Home-office branch relationship.

NRFC (STU)

Single-entity (15% BPRT) 60% RFC (JKL) Phil. Branch 20% 20%

DC (XYZ)

DC (ABC) Subsidiary Corp. Profits – 100M Declaration Dividends

-

of

Another illustration: Based on the illustration above, let’s say DC (ABC) is not 100% owned by RFC (STU). DC (ABC) was setup by the NRFC (STU). There is also a RFC, which is a Phil. branch of NRFC (STU). Such NRFC setup a Phil. branch, RFC-Phil. branch (JKL). Afterwards, both of them (the NRFC (STU) and RFC-Phil. branch (JKL)) invested in the DC (ABC). DC (ABC) is 60% owned by NRFC (STU), 20% owned by RFC-Phil. Branch (JKL)OW and 20% owned by another DC (XYZ). Now DC (ABC) earned profits and it would like to distribute the profits. How will it distribute the profits? Declaration of dividends or remittance of profits? o Declaration of dividends. Dividends will have to be declared and distributed to all stockholders. o If 100M will be distributed as the total dividends, 20M will go to XYZ. Is ABC required to withhold tax on the dividends to XYZ?  NO, since it is exempted from tax on dividends received from a DC (Sec. 27).  The law already provides, under Sec. 27, that dividends declared by a DC to another DC is not subject to tax as yet. Only when the dividends would be ultimately declared to individual stockholders will the tax rates apply of 10%, 20% or 25% applicable to individual taxpayers o How about the 20M dividends to JKL? Will it be subject to withholding tax?  NO, since it is also exempted from tax on dividends received from a DC (Sec. 28(a)).



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Sec. 28(a) (7) also provides that the dividends declared by DC to a RFC is as well exempt from tax. How about the 60M dividends to STU?  Liable for tax at 30% but subject to the tax sparing credit rule (Sec. 28(b)).  Here, the tax sparing credit rule can be applied. If the foreign government of STU grants or allows tax credit, the intercorporate tax of 15% shall be imposed on the dividends received by STU from ABC.  No actual grant is necessary so long as it can be seen that the foreign country allows a tax credit to Philippine corporations in such country, therefore, it’s automatic that we can apply the tax sparing credit rule – instead of the 30% general rate on NRFC, we can actually imposed the 15% intercorporate tax on dividends declared by a DC to a NRFC.  Sec. 28(b) provides that the dividends declared by a DC to a NRFC, subject to the tax sparing credit rule, will be subject to 15% tax.  Can the NRFC raise the argument that under the single-entity concept, it will also be exempt just like a RFC?  NO. According to the SC, the NRFC cannot use the single-entity concept in avoiding the tax of 15% on dividends declared to it in comparison to the dividends declared by the subsidiary corporation to a RFC of which it owns. If we pull out such 15% tax just so to equalize the exemption granted to RFC, there will be no tax that can be collected by the government. The reason why the RFC is exempt and why the NRFC is taxable is because the NRFC is already a given state – it’s direct dividends. Unlike RFC, it’s still exempt. Once the RFC receives the dividends from a DC, it will still remit the profits abroad subject to the 15% BPRT. And the SC clearly stated that for purposes of investing in a corporation in the Phils., the single-entity concept will not apply wherein a NRFC and its Phil. branch, both investing in the same corporation, they will be considered as separate entities for purposes of taxing the dividends.  And BPRT is only directed to a RFC. So DC is not subject to the 15% BPRT. With more reason that a NRFC is not subject to BPRT since a foreign branch is not within our jurisdiction. 

o

TAX ON IMROPERLY ACCUMULATED EARNINGS -

IAET – Improperly Accumulated Earnings Tax, what is this IAET? o It is a 10% tax imposed for each taxable year on the improperly accumulated taxable income of each corporation. o There’s a principle why IAET has to be imposed.

Assets

100M

Liabilities

80M

Net worth

20M

Capital Stock – 1M

1M as capital stock

Profits (retained earnings) – 19M 18M for future expansion



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Illustration: The net worth of your business is broken down into capital stock and profits (earnings that you retain in the business or in the corporation). You accumulate earnings improperly. When you accumulate the earnings of your business improperly, you might be imposed of the 10% IAET. If your asset is 100M. Liabilities is 80M. Your net worth is 20M. If your capital or investment from the start of your business is only 1M. It means to say that the profits that you have accumulated is 19M. Have you accumulated profits unreasonably? Is there a chance that the BIR will impose the IAET?  What’s the principle behind imposing the IAET? Why is the BIR taxing a profit that is already exempt from the tax? Dba class, when you earn income, you will be subject to the income tax. Whatever remains is the profit that you will accumulate and will only be taxable again once it will be distributed to the stockholders. So this is the current state – you did not distribute the 19M worth of profits to your stockholders. Why is the BIR taxing the profits that you have accumulated? o The reason why there is IAET is to actually penalized corporations that have been unreasonably withholding the profits from being distributed to the stockholders. Why? Because had it been distributed to the stockholders, at what rate can the BIR collect the tax on the distribution of dividends to stockholders? Dba, generally, if the recipient is a RC, NRC and RA, it would have been subjected to 10% tax. The BIR could have collected tax on the profits had this profits been distributed. Being unreasonably accumulated (the profits), the BIR is going to penalize the corporation.  Case scenario: If you will be subjected to the 10% IAET for unreasonably withholding of profits and you decide later on to distribute the profits as dividends to all of your stockholders, who are all RC, would you still be required to withhold another 10% tax on the dividends subsequently declared to such stockholders after being penalized of the 10% IAET?  YES. There is no double taxation here. Even if your profits which you have unreasonably accumulated have been exposed already and you have paid the 10% IAET, subsequent distribution as dividends would still entail withholding of the regular rates of 10% to RC, 20% to NRA-ETB, and 25% to NRA-NETB. It doesn’t means that if you have already shouldered the 10% IAET, it will already cover for the normal 10% FWT on dividends. These taxes (IAET and FWT on dividends) are entirely separate. They have different purposes. One (IAET) is imposed as a penalty and the other one (FWT) is simply a tax on the income earned by the stockholders.  Average for the dividends or accumulated earnings that is a probable area for imposing the 10% IAET would only start from 1998. Your dividends or accumulated earnings from Dec. 31 down would still be free from the IAET because this kind of tax has already been effective Jan. 1, 1998. And if you’re operating on a fiscal year basis, which means that you start at any day other than Jan. 1, your free coverage from IAET would be starting from the last month in 1998 – the end of your fiscal year. So if your fiscal year is Nov. 1 ending in Oct. 31. Oct. 31, 1998 down would still be free from IAET. If you’re from the BIR, do you have the figure or taxable base within which you can impose the IAET? Is it readily available in the given illustration above? Where do you have to pick out the taxable base for the 10% IAET? 

-



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o

o

The 10% IAET will be computed according to the formula given in Sec. 29 of the tax code. The 19M accumulated retained earnings given in the illustration above is only an indicator, a red light, for the BIR to assess. The moment that the retained earnings would exceed 100% of your capital stock, it will try to compute the IAET. But it is not a guaranty that the BIR will actually collect the IAET. The retained earnings is not the base. It is just an indicator that you have improperly accumulated your earnings. Under Sec. 29, computing IAET would start-off from your taxable income for the year that the BIR is considering imposing the IAET.  FORMULA: Taxable income adjusted by: ADD  Income exempt from tax  Income excluded from gross income  Income subject to final tax  Amount of net operating loss carry-over deducted (NOLCO)  And reduced by the sum of: MINUS  Dividends actually or constructively paid; and  Income tax paid for the taxable year  TAX BASE (IAE – Improperly Accumulated Earnings) = taxable income + income exempt from tax + income excluded from gross income + income subject to final tax + NOLCO – [dividends actually or constructively paid + income tax paid for the taxable year]  So the basis of the 10% IAET is not the retained earnings given from the formula in the illustration given above but the formula on the TAX BASE (IAE).  So if your taxable income for the year that is covered by the assessment of the IAET is 0. You have no exempt income, 0 as well. And you have not paid any tax. Therefore, you have no IAET, even if you have retained earnings because again, such retained earnings is only an indicator for audit and assessment, not necessarily the payment of 10% IAET because 10% IAET is based on the TAX BASE (IAE) formula.  But the BIR is not so unreasonable as to not allow you to accumulate profits. There are instances when you are allowed to accumulate profits even beyond your capital stock. What are the instances when you have the free time to accumulate the profits more than 100% of your capital stock? What are the instances when you are allowed to accumulate profits beyond 100% of your capital stock?  If it is justified under the “reasonable needs of the business”. How do you justify the “reasonable needs of the business” according to Rev. Reg. 2-01? o 1. Allowance for the increase in the accumulation of earnings up to 100% of the paid-up capital of the corporation as of Balance Sheet date, inclusive of accumulations taken from other years;  So you can retain profits up to 100% of your capital stock. o 2. Earnings reserved for definite corporate expansion projects or programs requiring considerable capital expenditure as approved by the Board of Directors or equivalent body  So for definite corporate expansion projects o 3. Earnings reserved for building, plants or equipment acquisition as approved by the Board of Directors or equivalent body o 4. Earnings reserved for compliance with any loan covenant or preexisting obligation established under a legitimate business agreement  This only means that if you have an existing loan agreement with any national banks or domestic banks or international banks wherein it is required that you have to maintain a ratio of your profits against capital stock, therefore, you have to comply with that provision strictly, and so therefore, you will not be liable, to the extent of the



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o o

-

-

compliance, for IAET. It simply means that if the bank requires you to maintain – not disposing of your retained earnings, not declaring it as dividends – then you are allowed to accumulate profits beyond 100% of your capital stock. 5. Earnings required by law or applicable regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution 6. In the case of subsidiaries of FCs in the Phils., all undistributed earnings intended or reserved for investments within the Phil. as can be proven by corporate records and/or relevant documentary evidence.

When you say that you would want to accumulate profits for expansion projects, what are the steps that you need to make? Is it enough that you will tell the BIR that you are planning to expand your business? How will you prove? What if for 10 years already you have been placing in your financial statements that this is for future expansion projects, etc…. but it never really took place? Can you now be imposed on the IAET? o Proven by a Board resolution, blue prints, etc….. But it should be definite expansion projects proven by sufficient documentary evidence o If at the end of this year, you have an inkling that you will be audited or assessed by the BIR so you decided to put into record, prepare a board resolution by your Board of Directors that 18M of the retained earnings will be declared as dividends, within how many months or years should you actually pay out the 18M? What is the time frame that is given you by the tax authorities to realize the actual distribution of dividends?  At the end of every taxable year, you are given the leeway on how to distribute your accumulated earnings. If you want to avoid the IAET, maintain 100% of your capital stock and the excess, either for future expansion projects or dividend distribution. But it cannot stay forever as is. It should actually be distributed within 1 year from the close of the taxable year wherein you declare the dividends. So it should be paid out within 1 year, otherwise, you will pay the IAET. What corporations or entities are not covered by the IAET? o 1. Publicly held corporations  What is a publicly held corporation? Is that the same as a publicly listed corporation? NO, because a publicly held corporation means that which is not covered by the definition of a closely held corporation  What is a publicly listed corporation? It is a publicly listed corporation if its stocks are listed in the stock exchange. Publicly listed corporations are corporations wherein the stocks are listed and offered to the public. So automatically, a publicly listed corporation is a publicly held corporation because being listed, it would normally have numerous stockholders. It’s open to the public.  But a publicly held corporation is different because publicly held corporations are corporations which are not closely-held. And for purposes of the IAET, you have to know the definition first of what a closely-held corporation is. What is not covered by a closely-held corporation becomes a publicly held corporation.  Closely-held corporations are those corporations at least 50% in value of the outstanding capital stock or at least 50% of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than 20 individuals. DCs not falling under the aforesaid definition are, therefore, publicly held corporations.



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50%

50%

more than 20 individuals



CLOSELY-HELD CORPORATION

1 individual

Illustration: A DC, 50% of its capital stock is owned by more than 20 individuals, and the other 50% is owned by 1 individual.  By your definition of closely-held, is the illustration above closely-held, that is 50% of the voting stock is owned by not more than 20 individuals? o YES, having complied the definition of closely-held that 50% of the voting stock is owned by not more than 20 individuals, then it is closely-held for purposes of IAET. Therefore, the illustration above is not a publicly held corporation. Consequently, whenever such corporation in the illustration above will unreasonably or improperly accumulate its earnings, it will be subject to the 10% IAET. o Any corporation, which does not fall within the definition of a closely-held corporation, will automatically be considered as publicly held. o When can we say in the illustration above be publicly held?




49%

51%

1 individual

21 individuals

PUBLICLY HELD CORPORATION

Example: If the ownership of the corporation is at 49%, which is not at least 50%, owned by 1 individual. While 51% is owned by 21 individuals. This is already a publicly


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held corporation. Being a publicly held corporation, this is not covered by the IAET.



 

 o

o o

49%

51%

21 individuals

1 individual

CLOSELY HELD CORPORATION

Another illustration: A DC, 49% of its capital stock is owned by 21 individuals and 50% of its capital stock is owned by 51% of 1 individual.  Is the illustration above publicly held or closely held? o CLOSELY-HELD because at least 50% is owned by not more than 20 individuals. Purpose for the difference between a publicly held and a closely held corporation:  Publicly held corporations are not exposed to liability for IAET while closely held corporation are exposed to such liability. Is a closely held corporation a family corporation?  NO. But a family corporation is a closely held corporation.  Would all closely held corporations be family corporations? o NO.  Not all closely held corporations are family corporations because so long as a corporation satisfies at least 50% owned by not more than 20 individuals, it is considered a closely held corporation. RULES – (See Mamalateo on p. 466)

2. Banks and other non-bank financial intermediaries  Why is it not covered by the IAET?  Because they’re required to maintain a certain level of cash or liquidity 3. Insurance companies  Not covered by IAET because they’re required to maintain some reserves and regulated with the Insurance Commission 4. PEZA-registered companies  Not covered by IAET because they’re liable, instead of the 30% corporate tax, to a special rate of 5% tax on gross income in lieu of all taxes, whether national tax or local tax, which includes the exemption from the payment of IAET.  As a rule, PEZA-registered companies are subject to the 5% special rate or preferential rate on gross income in lieu of all national or local taxes. Therefore, these companies within the economic zone are not liable to pay 30% on their taxable income. But the option is still given to them. PEZA-registered may opt to be liable for 30% on taxable income instead of the 5% on gross income. How would that happen? Or why would it happen? Why would the PEZA company choose to be liable of 30% instead of 5%?



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

o

o

o

The reason is simple. The 5% tax is based on the gross income and gross income for companies located within the economic zone is heavily regulated wherein they can only deduct 9 types of expenses or costs from the sales. [Gross total sales – costs = gross income]. For PEZA, the costs is regulated to 9 types of expenses that is directly related. Whereas if they choose to be liable for 30%, it’s based on the taxable income – all expenses related to the trade, business or profession of the taxpayer can be deducted.  If the PEZA-registered company opts to be taxed at 30%, which is an irrevocable choice, will it be liable for IAET or not? o YES. Rev. Reg. 2-01 on IAET provides that a corporation registered with the PEZA (Philippine Economic Zone Authority) is not covered by the IAET if it enjoys the preferential rate or special rate given to it. Now, if it does not opt to be subject to the special rate of 5% tax in lieu of all taxes, if it maintain the 30% regular rate, then the IAET will still apply. 5. Foreign corporations  Is a RFC covered by the IAET? Will a Phil. branch of a NRFC be liable for IAET?  NO, because a Phil. branch does not have a capital stock. 6. Taxable business partnerships  It’s not covered by the IAET because it does not have a capital stock  Not taxable joint ventures are as well not covered by the IAET because it is not considered as a corporation for tax purposes. 7. General professional partnerships  It’s also not covered by the IAET because it is not considered as a corporation for tax purposes.

CAPITAL TRANSACTIONS -

-

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2 types of assets: o Capital asset – capital income o Ordinary asset – ordinary business income or trade income Capital transactions are transactions arising from the use of capital assets. When you say capital loss, it’s the loss that you suffered from transacting using capital assets. What’s an Ordinary Asset (OA)? (Sec. 39 – negative definition of what capital assets are) o 1. Stock in trade or property of the taxpayer which may be properly included in the inventory at the end of the taxable. o 2. Property primarily held for sale to customers in the ordinary course of trade or business o 3. Property used in trade or business subject to depreciation, which means that this must be depreciable property o 4. Real property used in trade or business What are Capital Assets (CA)? o 1. Properties not considered as ordinary assets. o 2. Properties used in trade or business classified as capital assets:  i. accounts receivable  Unless you are in a business of selling accounts receivable, it is considered as capital asset.  If you have an accounts receivable or collectible from your customer and you are short of cash and would like to assign that receivable or collectible to another corporation by selling your right to collect. Even if it’s part of



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your trade, business or profession but because you’re not into selling receivable or collectible, it’s still considered as capital transaction.  ii. property for investment in stock  If you have a business and you’d like to invest in another business, so long as you’re not a holding company into investing another businesses, that particular asset – the investment in capital stock – is still considered as capital asset while you are not into trading shares. But if you’re a broker of shares, that’s automatically considered as ordinary assets.  iii. subdivision of lots to tenants at the instance of the government  iv. Interest of a partner in a partnership Can an OA be converted into a CA? o YES. o Example: The properties of a taxpayer engaged in real estate business are considered as OA. If the taxpayer dies, these properties will be transmitted to the heirs. Should the heirs discontinue the real estate business of the deceased parent, such properties which are ordinarily held for sale to customers may be converted into CA. Conversely, can a CA be converted into an OA? o YES. o Example: Land inherited by the heirs from their deceased parents is considered as CA. In the event that this property is substantially improved by the heirs and sold at profit, said CA may be converted into an OA. The profit derived from the sale of the land is already considered as ordinary gain. Lets say for example you got interested in buying a certain parcel of land and sold it to your seatmate. After a month, you bought a house and lot, improved it, and sold it again to your other seatmate. This went on monthly during the year. You’re not registered in any business. The first sale – is that a capital transaction or ordinary transaction? Or can you say that your income is subject to the 6% CGT or you’re already covered by the 5-32% OT (Ordinary Taxes)? Can you now be considered at the end of the year that you’re now already into ordinary transactions of buying and selling real properties? Is registration of a real estate business necessary to make your real estate transactions ordinary transactions? o NO. Therefore, if you sold house and lots 12 times last year every month, can you already be subject to the OT of 5-32% as an individual or will you still be covered 6% CGT?  Because of the regularity and the continuity of the conduct of the buying and selling of real estate properties, you will already be considered into engaging ordinary transactions of buying and selling real estate properties. CGT of 6% will no longer apply.  Registration of activities is not necessary for you to be covered by OT rates.  Viewing the tax rates of 6% and 5-32% on a property, which is more favorable?  It depends. 6% is based on the GSP (Gross Selling Price) or FMV (Fair Market Value), whichever is higher. The 5-32% is based on the net taxable income. The difference in rates would actually have to depend on how much your actual cost is and the selling price.  If you’re selling a property that you acquired 50 years ago and you sell it today. You better be subjected at 6% CGT because if you sell that property you purchased 50 years ago, the difference in the selling price and the cost is very wide wherein you can already be subject to the highest tax bracket in the individual tax table of 5-32%. And ordinary transactions are liable for VAT while capital transactions, no VAT.  It is really better to stick selling pure pieces of real properties every year in order to be still covered by CGT.  BIR has already set the limit. If you are able to sell at least 6 real properties in one year on your individual capacity without registration, you will be considered as in the regular conduct of selling real properties – ordinary



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transactions. If you sell lower than 6 during the calendar year, still capital transactions, without BIR registration. So you stop at 5. -

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What is the difference between wash sale and short sale? o Wash sale  It’s like selling the shares today but 30 days before, you acquired the same or substantially similar shares or 30 days after, you acquired the same or substantially similar shares.  Your reckoning point is WON 30 days before the sale, you acquired the same or substantially similar shares or 30 days after. It’s a wash sale. It’s a simulated sale. Is the gain taxable or is the loss deductible in this kind of transaction?  In all cases, the question whether the gain is taxable or not, lifeblood doctrine, the gain is taxable and the loss, being a simulated sale, is not deductible. o Short sale  It’s just like advance selling but just make sure that at the time you need to deliver the shares that you have sold prior, you already have the ownership of such shares – still valid basta so long as he has the ownership at the time that he needs to deliver.  It’s a transaction wherein a person sells securities which he does not own yet, provided, however, that he has ownership of the securities at the time of delivery – he has the right to transfer ownership.  Is the gain taxable and is the loss deductible?  YES. The gain is taxable and the loss is deductible.  Is there an instance where a capital loss arising from a sale wherein 30 days prior, you acquire the same or substantially similar shares, be deductible? Is there an instance wherein your capital loss is deductible in such case? o YES, if the seller is a dealer in securities or shares of stock, in which case, you’re into ordinary transactions of buying and selling shares whether it’s within 30 days, within 1 day or within 2 days that you have acquired substantially similar shares or the same shares, you can deduct the losses and offset it with your other capital gains. o Basta the rule is, in capital transactions, whenever a loss is deductible, only offset it against the capital gains. Do not cross the border of offsetting the capital losses from ordinary income. There are 3 rules governing capital transactions which are not applicable to ordinary transactions, what are these? o 1. Holding-period rule  Applies only to individual taxpayers – because the capital gain derived from capital transaction of corporate taxpayers is always 100% recognized irrespective of the number of months during which the property was in the possession of the corporate taxpayer.  If the property has been held by the taxpayer for a period of not more than 12 months, the gain or loss is 100% recognized.  If the property has been held for more than 12 months, the gain or loss is 50% recognized. 2 Lands

June 31, 2009 Cost 1M Gain

1) December 31, 2009 Selling price 1.5M


100% of 500K

500K

50% of 1M

500K


2) October 5, 2010 Selling price 2M

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Example: You have 2 parcels of land. You’re not engaged in the real estate business or in any other businesses wherein the land is used in trade or business. You purchased such lands Jan. 31, 2009 for a cost of 1M each. The 1ST parcel of land, you sold it at Dec. 31, 2009 for the selling price of 1.5M. The 2nd parcel of land, you sold it today, Oct. 5, 2010 for the selling price of 2M.  For individual taxpayers holding capital assets which they sell, you have to consider the period within which the property was with the seller – the holding period (for how many months was it with the taxpayer who’s selling it). If the taxpayer sold it within a few months, 12 months or less, everything is taxable and deductible (100%). If the property has been held on to by the taxpayer for more than 12 months, only 50% is taxable or 50% is deductible.  In the case of the 1st parcel of land, you gained 500K and 100% of 500K, which is 500K, is taxable because such land was held on to for 12 months. While the 2nd parcel of land, you gained 1M but only 50% of 1M, which is 500K, is taxable because such land was held on to for more than 12 months.  The reason for such rule is that whenever you purchase a personal property, you are not expected to dispose of it easily. When you dispose of personal property more often within 1 year, you are considered to be in trade or business but not necessarily. So gain – 100% is taxable or 50% is taxable. It’s the same way that the loss is only 50% deductible or 100% deductible. Another example: Lets change the facts. The 2nd parcel of land was sold for .5M. Other facts are the same with the preceding example. What will happen?  In this case, the sale of the 2nd parcel of land constitutes a loss of (500K). 50% of (500K) is (250K). Is the (250K) recognized loss deductible on the capital gain of 500K from the sale of the 1st parcel of land? o NO. The loss is deductible but not against such 500K. The loss is deductible against the capital gain that has been earned in 2010 but not against the 500K because such 500K was earned a year ago, in 2009. o Assuming that you had no other transactions in 2010, no other sale, you have a loss of (250K), can you carry forward such loss?  NO. The net capital loss carry-over rule cannot be applied.



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

  

o

o

The net capital loss carry-over rule provides that if any individual taxpayer sustains in any taxable year a net capital loss, such loss (in an amount not in excess of the net income for such year) shall be treated in the succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than 12 months. In this case, since the loss of (250K) was from the sale of a capital asset held for more than 12 months, the net capital loss carry-over rule cannot be applied. In net capital loss carry-over rule, how many years can you carry forward a net capital loss?  In the succeeding taxable year only. So 1 year only. The difference between NOLCO and net capital loss carryover is that NOLCO can be carried over for the succeeding 3 consecutive years but net capital loss carry-over can be carried only to the next year. Another distinction is that NOLCO involves loss arising from ordinary transactions while net capital loss carry-over involves loss arising from capital transactions. Another distinction also is that net capital loss carry-over can only be availed of by individual taxpayers while NOLCO can be availed of both by individual and corporate taxpayers so long as they’re registered for business.

2. Capital loss limitation rule  Capital losses are deductible only to the extent of capital gains during the year – on a yearly basis.  Can capital loss limitation rule apply to corporations as well? o YES. Such rule applies to both individual and corporate taxpayers, EXCEPT on banks and trust companies (because they are considered as dealer in securities) 3. Net capital loss carry-over rule  Net capital loss carry over rule is very complicated:  1. It’s a capital loss. It’s the excess of the loss over the capital income or capital gains.  2. It can be carried over only to the succeeding next year by an individual. If it remain unutilized, it will no longer be usable the 2nd year.  3. The amount that can be carried over is not exactly the same amount that you will see as the net capital loss for the year for capital assets held on to for not more than 12 months. You have to consider that it should not exceed the net income from the ordinary transactions of the year when such loss is incurred. You have to look into how much is the net income from ordinary transactions. o Example: Assuming that the (250K) net loss arose from the sale of capital assets held on to for not more than 12 months. If the ordinary net income is 250K, you can carry-over such (250K) loss in the succeeding taxable year. If the ordinary net income is 200K, you can carry-over only 200K. If the ordinary net income is 500K, you can carry-over 250K – it should not exceed.

GAINS DERIVED FROM DEALINGS IN PROPERTY -

The basic formula in determining the gain that you derived from selling your real property or property, in general, is the “amount that you received as consideration for the property“. This is basically the GSP or any consideration. It may be exchange of property or may be sale of property.



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But as to how much is subject to tax, you have to determine what is the cost of your property. The cost of your property that you’re selling or exchanging would differ according to how you acquired your property. So how do you determine the cost of the property that you’re selling? o 1. If it was acquired through purchases – the cost of the property o 2. If the property sold was previously acquired through inheritance – the FMV of the property at the time of the acquisition (the time you’ve inherited such property). o 3. If the property sold was acquired through donation – the same as if it would be in the hands of the donor (so, it’s the same amount at the time the donation was made) BUT:  Exception: If the basis is greater than the FMV of the property at the time of the donation/gift then, for the purpose of determining loss, the basis shall be such FMV.  It simply means that if you’re selling a property today, Oct. 5, 2010. You’re selling it at 1M. The property that you’re selling has been donated to you. The law says that the amount that you have to deduct as cost in determining your income subject to tax would be the amount as if it is in the hands of the donor. It means at the time it was donated. If at the time it was donated, its value was 500K. Then you deduct it from the 1M, so you get an income of 500K – taxable.  But there’s an exception to the rule. If the 500K that you’re deducting (FMV at the time of donation) is greater than the FMV today, Oct. 5, 2010, say for example, the FMV of the property today is 200K – so you use such 200K. Lifeblood doctrine. Why? If you use 200K, the taxable income is 800K.  What type of property do you think that the FMV is lower today than the time it was donated? o Depreciable assets.  Example: Motor vehicles. o 4. If the property sold was acquired for less than an adequate consideration in money or money’s worth – the amount paid by the transferee for the property  Example: If you purchase it at an amount that is inconsiderably low as compared to the FMV, lifeblood doctrine states that the cost in determining your income for tax purposes would have to be the amount that you’ve given up. So if you bought a 1M car for 1 peso and you sold it for 1M, you can only deduct as cost 1 peso. The general rule is that for every sale of property, you have to be taxed if there is an income after costs has been deducted from the selling price or consideration for all types of exchanges in property. o Example: You have a parcel of land in Alabang. The other person has a parcel of land in Muntinlupa. Both lands have the same square meters – 1 ha or 10K sq. m. There is an exchange of property without any cash involved. Will there be tax?  YES, subject to CGT or OT, as the case may be.  Both properties do not actually have the same value in so far as the owners are concerned. There are instances wherein no gain and no loss is recognized for certain types of exchange. What are these? o 1. Transactions made pursuant to plan of merger or consolidation  This happens when you gave out your properties in exchange for the shares of the surviving/absorbing corporation or when you exchange shares for the shares of the other corporation. o 2. If a person alone or together with other, not exceeding 4 (so total of 5), exchanges his property for stock in a corporation and this person or persons, after this exchange, acquired controlling interest over that corporation. This means to say that they acquired at least 51% of the shares of stock of such corporation. (Sec. 40(c)(2))  This is also a transaction solely in kind.



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ABC 46M

Corp.

5M 51M 46

46 people

U & 45

1 person 51 people LAND 46M

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Example: Lets say there is ABC Corp. It has existing capitalization of 5M owned by 5 people at 1M shares each. You and your classmates, 46 of you, want to invest in such corporation. So the 46 of you invested 46M worth of land co-owned by 46 of you. If you put such land as an investment in ABC Corp., the total capitalization would now be 51M (5M + 46M) and the total owners would be 51 people. (5 + 46). This is a case of an exchange of property. You gave out land to ABC Corp. in exchange of 46M shares. Land for shares – shares for land. Is the 46M parcel of land subject to 6% CGT?  YES (apply the “first-highest-5-rule”, which will be discussed later; in this case, applying the first-highest-5-rule, the interest of the first 5 would only be 10.87%, thus, they did not acquire controlling interest, so therefore, all the gains of the 46 people from the exchange of property will be subject to 6% CGT) o NOTE: [the “first-highest-5-rule” kay g-himo-himo ra nko na rule.. wala jud na na term actually… hehe.. para short-cut lng sa transcription…. Anyways mkasabot ramo later as you go on reading… I hope…]  So, how do we make the facts non-taxable? ABC 46M

Corp.

5M 51M 5

5 people

U&4

1 person 6 people



LAND 46M

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o

o

So that the facts would be that there are 5 people who invested 46M parcel of land in exchange for the 46M shares in ABC Corp. So the total capitalization is 51M and there are already 6 people owning ABC Corp. In this case, the 5 people acquired controlling interest over ABC Corp. because they own 46M shares out of the total 51M shares from the exchange of property (more than 51%), so therefore, this case is covered by the exception, and as such, the 46M parcel of land is exempted from the 6% CGT and documentary stamp tax.

ABC 7M

Corp.

2M 9M 7

7 people

U&6

5 people 12 people LAND 7M



Change of facts: ABC Corp. has a capitalization of 2M owned equally by 5 people/stockholders. You together with 6 others have a 7M parcel of land. You want to invest in ABC Corp. So you want to put in the parcel of land so you’ll be given 7M worth of shares of stock. So the total capitalization of ABC Corp. is 9M [2M + 7M] owned by 12 people [5 + 7]. Is the gain from the exchange of property subject to CGT? Is it covered under the tax-free exchange?  YES, but partially.  [Mao nani siya ang “first-highest-5-rule”]  Consider first whether the first 5 transfers acquired controlling interest over the capital stock of the corporation.  In this case, the first 5 transfers amounts to 5M. 5M over 9M total capital stock is 55.55%. [5M/9M = 55.55%]. Thus, the first 5 transfers acquired more than 51% so that they have acquired controlling interest over the capital stock of ABC Corp. Therefore, even if the transfer numbers more than 5 people, so long as the first highest 5, would acquire controlling interest over the new capital stock of the corporation, they (the first



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highest 5) will be granted exemption from the 6% CGT. Since in this case, the 7M is equally owned by the 7 people, so you know that the first 5 would have 5M. And 5M/9M is more than 51%. Therefore, the gains from the exchange of property will not be subject to the 6% CGT with respect only to the first 5.  What will happen is if of the many, 5 will acquire controlling interest, 5 will be exempt, the rest will be subject to 6% CGT. o Consider first the first highest 5, so that the first highest 5 will be exempted from CGT. o If they own the stocks equally, then, there would be a problem. It depends actually on their agreement whether they will share the burden of tax or whether who will be exempted and who will be subjected to CGT. Instances where gain is recognized and loss is not recognized: o 1. Wash sale o 2. Illegal transactions o 3. Those transactions involving related taxpayers o 4. Transactions not solely in kind  It means to say that transactions not solely in kind is when the transfer involves cash. If cash, in addition to property, is transferred, in exchange for shares, it’s no longer exchange solely in kind, therefore, no exemption from CGT.

ACCOUNTING PERIOD; METHODS OF ACCOUNTING; TAX RETURNS AND PAYMENT OF TAX -

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Returns and Payment of tax o Individuals required to file returns (General Rule):  1. Every Filipino citizen residing in the Phils.  2. Every Filipino citizen residing outside the Phils., on his income from sources within the Phils.  3. Every alien residing in the Phils., on income derived from sources within the Phils.  4. Every NRA-ETB or in the exercise of a profession in the Phils.  Who has not been mentioned here? What type of individual taxpayer is not required to file ITR? o NRA-NETB o Why? Because they’re subject to a FWT rate of 25%. Thus, every payor of that NRA-NETB is required to withhold a final tax. Withholding of a final tax is a tax with finality. There’s no requirement for that income-earner to report the income already subjected to final tax as part of his ITR. o So in all instances, a NRA-NETB is never expected to file an ITR. What are the instances when individuals are not required to file an ITR? o 1. An individual whose gross income does not exceed his total personal and additional exemptions  Example: If your income is 1K a month, you have 12K in a year. Your personal and additional exemption is 50K. That’s below minimum wage. You’re not required to file an ITR. o 2. An individual with respect to pure compensation income derived from sources within the Phils., the income tax on which has been correctly withheld.  If you have only 1 employer and your tax has been correctly withheld by your employer, no need to file an ITR. How do you call that? What’s the correct term for that?



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o o -

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Example: You’re the president of ABC Corp. You earn 100K a month. Are you required to file an ITR or not? o NO, if the income tax has been correctly withheld by the employer and your only income is the 100K you earn a month as the president of ABC Corp. o This is called the SUBSTITUTED FILING OF ITR. 3. An individual whose sole income has been subjected to a FWT 4. An individual who is exempt from income tax

What is the substituted filing of ITR? o It is when an employee is no longer required to file an ITR at the end of the year so long as he is a pure-compensation income earner, regardless of the amount that he’s earning, and he has only one employer who has been correctly withholding the tax. o When you say pure-compensation income earner, he does not have any other income from any source, whether from trade, business or profession.  Example: Once this is violated, meaning to say, if you’re the President of the corporation, you have 100K income monthly. You only have one employer who has been correctly withholding you but during break time, you sell siopao to your officemates, that’s already other income. And being other income, you have to combine that with your income from your employment. Maybe your income from siopao business will escalate your bracket of income. The reason why you’re required to combine your income is to determine what bracket you really belong to. That’s why every income should be consolidated. And substituted filing is very strict in a sense that:  1. You only have to have 1 employer  2. Pure-compensation income earner  3. Correct withholding of tax  4. No other income. o If the requirements are not met, all of them are not met or one of them is not met, at the end of the year, you have to file an ITR. Who are the individuals not qualified for substituted filing? o See outline. o NOTE: Letter c of outline is no longer applicable in the advent of RA 9504 – individuals who are minimum-wage income earners are exempt from income tax so they’re no longer required to file an ITR. o Illustration: You were employed by ABC Corp. from Jan. 1, 2010-Oct. 5, 2010. By November, you applied and got hired by XYZ Corp. There was no overlapping of employment. Both employers, according to their own records, correctly withheld the taxes. Are you qualified for substituted filing?  NO, because the requirement must have to be only 1 employer. If you have 2 employers now, whether 2 employers employing at the same time or 2 employers employing successively, you’re not qualified for substituted filing because they’re may be a chance that the correct tax when the combined income is computed has not been correctly withheld by those employers. o Another illustration: You’re the President of a multi-national corporation. You only have 1 employer. Your tax has been correctly withheld by your employer. But your husband is selling siomai. Are you qualified for substituted filing?  NO, because you are no longer required for substituted filing if and when any of the spouses would not as well qualify with the full requirements.  So in order for you to be qualified for substituted filing, make sure that your spouse is also qualified for substituted filing.  If you’re qualified for substituted filing but your spouse is earning business income, like siomai business, no substituted filing for you both. Why? Because at



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the end of the year, in so far as it is practicable to combine both your income – husband and wife – it (the filing of ITR) has to be done for purposes of determining the true tax bracket that you belong to. Self-employed individuals. o So if you are a practicing lawyer with no law firm, etc. You are required to file your ITR (professional or trade income) on a quarterly basis still. Corporations. When are corporations required to file an ITR? o Quarterly – 3 times. 60 days after the end of every quarter and the last is on or before the 15th day of the 4th month following the close of the taxable year. o To make it easy, corporations can follow the calendar year or the fiscal year. o What is fiscal year?  Starts on any day other than Dec. 31 and ends 365 days after. o So if the corporation follows the calendar year, quarterly ITR has to be filed 60 days after March 31, after June 30, after Sept. 30 and the final ITR has to be filed on or before the 15th day of the 4th month following the end of the calendar year, which is April 15 – the 4th month. o If it’s fiscal year, it’s a little bit complicated. o But for individual taxpayers, can we have fiscal year basis?  NO. Always we have to follow calendar year basis and the quarterly ITR is 45 days after the end of every quarter except first quarter. First quarter ITR has to be filed April. 15, 2ND quarter of June 30 has to be filed 45 days after, 3rd quarter of Sept. 30 has to be filed 45 days after, and the final ITR has to be filed April 15 – No other date. Why? Because we only follow calendar basis. So it would appear that on April 15, we individuals (individual business income earners) would file 2 ITRs – one is for full year and one is for 1st quarter of the new year. CGT return has to be filed within 30 days after the transaction and paid within 30 days after the transaction. o Can we pay on installment basis on income taxes due?  YES for individuals and if their income tax due is more than 2K.  NO for corporations. Corporations have to pay the taxes on due dates. o How many times is a business taxpayer required to file an ITR?  4 (3 quarterlys and 1 final ITR)



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Taxation I - PreFinals - Corporation Income Taxation

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