Chapter 1 Introduction

Introduction to Taxation

CHAPTER 1
INTRODUCTION To TAXATION

Chapter Overview and Objectives

This chapter discusses the fundamental principles of taxation.

After this chapter, readers must be able to comprehend and demonstrate mastery of the following:
1. Concept of taxation and its necessity for every government
2. Lifeblood doctrine and its implication to taxation
3. Theories of government cost allocation
4. Inherent power of the State
5. Scope of the taxation power
6. Limitations of the taxation power
7. Stages of taxation
8. Concept of situs in taxation
9. Fundamental principles surrounding taxation
10. Various escapes from taxation
11. Concept of tax amnesty and condonation

WHAT IS TAXATION?
Taxation may be defined as a State power, a legislative process, and a mode of government cost distribution.

1. As a state power
Taxation is an inherent power of the State to enforce a proportional contribution from its subjects
2. As a process
Taxation is a process of levying taxes by the legislature of the State to enforce proportional contributions from its
subjects for public purpose.
3. As a mode of cost distribution
Taxation is a mode by which the State allocates its costs or burden to its subjects who are benefited by its
spending.

The Theory of Taxation

Every government provides a vast array of public services including defense, P—licorder-an-dsafety, health,
education, and social protection among others.
ill

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 Chapter 1 - Introduction
Introduction to Taxation

A system of government is indispensable to every society. Without it, the people will not relish the
benefits of a civilized and orderly society. However, a government cannot exist without a system of
funding. The government's necessity for funding is the Theory of taxation.

The Basis of Taxation

The government provides benefits to the people in the form of public services, and the people provide the
funds that finance the government. This mutuality of support between the people and the government is
referred to as the basis of taxation.

This mutuality is illustrated as follows:

Public services

Receipt of benefits is conclusively presumed

Every citizen and resident of the State directly or indirectly benefits from the public services rendered by
the government. These benefits can be in the form of daily free usage of public infrastructures, access to
public health or educational services, the protection and security of person and property, or simply the
comfort of living in a civilized and peaceful society which is maintained by the government.

While most public services are received indirectly, their realization by every citizen and resident is
undeniable. In taxation, the receipt of these benefits by the people is conclusively presumed. Thus,
taxpayers cannot avoid payment of taxes under the defense of absence of benefit received. The direct
receipt or actual availment of government services is not a precondition to taxation.

THEORIES OF COST ALLOCATION

Taxation is a mode of allocating government costs or burden to the people. In distributing the costs or
burden, the government regards the following general considerations in the exercise of its taxation power:
1. Benefit received theory
2. Ability to pay theory
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Benefit received theory
The benefit received theory presupposes that the more benefit one receives from the government, more taxes he
should pay.

Ability to pay theory

The ability to pay theory presupposes that taxation should also consider the taxpayer’s ability to-pay. Taxpayers
should be required to contribute based on their relative capacity to sacrifice for the support of the government.

In short, those who have more should be taxed more even if they benefit less from the government. Those who
have less shall contribute less even if they receive more of the benefits from the government.

Aspects of the Ability to Pay Theory

 Chapter 1 Introduction to Taxation
1. Vertical equity
Vertical equity proposes that the extent of one's ability to pay is directly proportional to the level of his tax
base.
For example, A has P200,000 income while B has P400,000. In taxing income, the government should tax
B more than A because B has greater income; hence, a greater capacity to contribute.

2. Horizontal equity

Horizontal equity requires consideration of the particular circumstance of the taxpayer.

For example, Businessmen A and B both have P300,000 income. A incurred P200,000 in business
expenses while B incurred only P50,000 business expenses. The government should tax B more than A
because he has lesser expenses and thus greater capacity to contribute taxes.

Vertical equity is a gross concept while horizontal equity is a net concept.

The Lifeblood Doctrine

Taxes are essential and indispensable to the continued subsistence of the g overnment. Without taxes, the
government would be paralyzed for lack of motive power to activate or operate it. (CIR vs. Algue)

Taxes are the lifeblood of the government, and their prompt and certain availability are an imperious need.
Upon taxation depends the government’s ability to serve the people for whose benefit taxes are collected. (Vera
vs. Fernandez)

Implication ofthe lifeblood doctrine in taxation:

1. Tax is imposed even in the absence of a Constitutional grant

2. Claims for tax exemption are construed against taxpayers.
3. The government reserves the right to choose the objects of taxation.
4. The courts are novallowed to interfere with the collection of taxes.
5. In income taxation:

a. Income received in advance is taxable upon receipt.

b. Deduction for capital expenditures and prepayments is not allowed as it effectively defers the
collection of income tax.
c. A lower amount of deduction is preferred when a claimable expense is subject to limit.
d. A higher tax base is preferred when the tax object has multiple tax bases.

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 Chapter 1 - Introduction Taxation
INHERENT POWERS OF THE STATE
A government has its basic needs and rights which co-exist with its creation. It has rights to sustenance, protection,
and properties. The government sustains itself by the power of taxation, secures itself and the well-being of its
people by police power, and secures its own properties to carry out its public services by the power of eminent
domain.

These rights, dubbed as "powers" are natural, inseparable, and inherent to every government. No government can
sustain or effectively operate without these powers. Therefore, the exercise of these powers by the government is
presumed understood and acknowledged by the people from the very moment they establish their government.
These powers are naturally exercisable by the government even in the absence of an express grant of power in the
Constitution.

The Inherent Powers of the State

1. Taxation power is the power of the State to enforce proportional contribution from its subjects to sustain
itself.

2. Police power is the general power of the State to enact laws to protect the well-being of the people.

3. Eminent domain is the power of the State to take private property for public( use after paying just
compensation.
Comparison of the three powers of the State
Point of Eminent Domain
Difference
Taxation Police Power
Exercising Government Government Government and
Authority private utilities
Purpose For the support of the To protect the For public use
government general welfare of the
people

Persons affected Community or Community or Owner of the property

class of class of
individuals individuals

Amount of Unlimited Limited No amount imposed.

Imposition (Tax is based on (Imposition is (The government pays
government needs.) limited to cover cost just compensation.)
of regulation.)

Importance Most important Most superior Important

Relationship with Inferior to the "Non- Superior to the Superior to the
the impairment "Non-impairment "Non-impairment
Constitution Clause" of the Clause" of the Clause" of the
Constitution Constitution Constitution
Chapter 1 Introduction to Taxation
Limitation Constitutional and Public interest and due Public purpose and
inherent limitations process just com ensation

Similarities of the three powers of the State

1. They are all necessary attributes of sovereignty.

2. They are all inherent to the State.

3. They are all legislative in nature.

4. They are all ways in which the State interferes with private rights and properties.
5. They all exist-independently Of the Constitution and are exercisable by the government even without a
Constitutional grant. However, the Constitution may impose conditions or limits for their exercise.

6. They all presuppose an equivalent form of compensation received by the persons affected by the exercise of
the power.

7. The exercise of these powers by the local government units may be limited by the national legislat

SCOPE OF THE TAXATION POWER

The scope of taxation is widely regarded as-comprehensive, plenary, unlimited and supreme.

However, despite the seemingly unlimited nature of taxation, it is not absolutely unlimited. Taxation has its
own inherent limitation and limitations impose by the Constitution.

THE LIMITATIONS OF THE TAXATION POWER

A. Inherent limitations
1. Territoriality of taxation
2. International comity
3. Public purpose
4. Exemption of the government
5. Non-delegation of the taxing power

B. Constitutional Limitations
1. Due process of law
2. Equal protection of the law
3. Uniformity rule in taxation
4. Progressive system of taxation
5. Non-imprisonment for non-payment of debt or poll tax
6. Non-impairment of obligation and contract
7. Free worship rule
8. Exemption of religious or charitable entities, non-profit cemeteries churches and mosque from
property taxes

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Chapter 1 - to Taxation
9. Non-appropriation of public funds or property for the benefit of any church, sect or system of
religion

10. Exemption from taxes of the revenues and assets of non-profit, non-stock educational institutions

11. Concurrence of a majority of all members of Congress for the passage of a law granting tax
exemption
12. Non-diversification of tax collections
13. Non-delegation of the power of taxation

14. Non-impairment of the jurisdiction of the Supreme Court to review tax cases
15. The requirement that appropriations, revenue, or tariff bills shall originate exclusively in the House
of Representatives
16. The delegation of taxing power to local government units

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 Chapter 1 - Introduction to Taxation
INHERENT LIMITA TION OF TAXATION
Territoriality of taxation
Public services are normally provided within the boundaries of the State. Thus, the government can only
demand tax obligations upon its subjec or residents within its territorial jurisdiction. There is
no basis in taxing foreign subjects abroad since they do not derive benefits from our government.
Furthermore, extraterritorial taxation will amount to encroachment of foreign sovereignty.

Two-fold obligations of taxpayers:

1. Filing of returns and payment of taxes
2. Withholding of taxes on expenses and its remittance to the government
These obligations can only be demanded and enforced by the Philippine government upon its citizens and
residents. It cannot enforce these upon subjects outside its territorial jurisdiction as this would result in
encroachment of foreign sovereignty.

Exception to the territoriality principle

1. In income taxation, resident citizens and domestic corporations are taxable on income derived both within
and outside the Philippines.
2. In transfer taxation, residents or citizens such as resident citizens, nonresident citizens and resident aliens are
taxable on transfers of properties located within or outside the Philippines.

International comity
In the United Nations Convention, countries of the world agreed to one fundamental concept of co-equal
sovereignty wherein all nations are deemed equal With one another regardless of race, religion, culture,
economic conditidn or military power.

No country is powerful than the other. It is by this principle that each country observes international comity or mutual
courtesy br reciprocity between them.

Hence,
1. Governments tax the income and properties of other governments.
2. Governments give primacy to their treaty öbligations over their own domestic tax laws.

Embassies or censu.@pfficesof foreign governments in the Philippines including international organizations

and their non-Filipino 9ta(f are not Subject to income taxes or property taxes. Under the National Internal
Revenue Code (NIRC), the

income an&foreign government-owned and controlled corporations ar not sub• to income tax.
When a state enters into treaties with other states, it is bound tp_ honor the agreements as a matter of mutual
courtesy with the treaty partners even if the same conflicts with its local tax laws.

Public purpose
Tax is intended for the common good. Taxation must be exercised absolutely for

public purpose. It cannot be exercised to further any private interest.

Exemption of the government

The taxation power is broad. The government can exercise the power upon anything including itself.
However, the government normally does not tax itself as this will not raise additional funds but will only
impute additional costs.

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 Chapter 1 - Introduction to Taxation
Under the NIRC, government properties and income from essential public functions are not subject to
taxation. However, the income of the government from its properties and activities conducted for profit,
including income from government-owned and controlled corporations is subject to tax.

s Non-delegation of the taxing power

The legislative taxing power is vested exclusively in Congress and is non• delegable, pursuant to the doctrine
of separation of the branches of the government to ensure a system of checks and
balances.

The power of lawmaking, including taxation, is delegated by the people to the legislature. So as not to spoil
the purpose of delegation, it is held that what has been delegated cannot be further delegated.

Exceptions to the rule of non-delegation

1. Under the Constitution, ocargovernmén units are allowed to exercise th e power to tax to enable them to
exerci r fiscal autonomy.

2. Under the Tariff and Customs Code, the residenus empowered to fix the amount of tariffs to be flexible to
trade conditions.
3. Other cases that require expedient and effective administration and imp ementation of assessment and
collection of taxes.

CONSTITUTIONAL LIMITA TIONS OF TAXATION

Observance of due process of law

No one should be de rived of his life, liberty, or property without due process law. ax laws should neither be
harsh nor oppressive.
Aspects of Due Process

1. Substantive due process

Tax must be imposed only for publjc_purpose, collected only under authority of a valid law and only by the
taxing power having jurisdiction. An assessment without a legal basis violates the requirement of due process.

2. Procedural due process

There should be o •trarines in assessment and collection of taxes, and the government shall observe the taxpayer's
bright to notice and hearingI The law

established procedures which must be adhered to in making assessments and in enforcing collections.

Under the NIRC, assessments shall be made within three years from the due date of filing of the return or from
the date of actual filing, whichever is later. Collection shall be made within five years from the date of
assessment. The fai re of the government to observe these rules v• the re ces .

Equal protection of the law

No person shall be denied the equal protection of the law. Taxpayers should be treated equally both in terms of rights
conferred and obligations imposed.

This rule applies where taxpayers are under the same circumstances and conditions. This requirement would
mean Congress cannot exempt sellers of "bald' while subjecting sellers of "penoy" to tax since they are
essentially the same goods.

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 Chapter 1 - Introduction to Taxation

Uniformity rule in taxation

The rule of taxation shall be uniform and equitable. Taxpayers under dissimilar
Circumstances should not be taxed the same. Taxpayers should be classified according to
commonality in attributes, and the tax classification to be adopted should be based on substantial
distinction. Each class is taxed differently, but taxpayers falling under the same class are taxed the same.
Hence, uniformity is relative equality.

Progressive system of taxation

Congress shall evolve a progressive system of taxation. Under the progressive system, tax rates incr ease as
the tax base increases. The Constitution favors Progressive tax as it is consistent with the taxpayer's ability to
pay. Moreover, the
Progressive system aids in an equitable distribution of wealth to society by taxing

th ore tha
Non-imprisonment for non-payment of debt or poll tax
As a policy, no one shall be imprisoned because of his poverty, and no one shall be
imprisoned for mere inability to pay debt.

However, this Constitutional guarantee applies only when the debt is acquired by the debtor in good faith. Debt
acquired in bad faith constitutes estafa, a criminal offense punishable by imprisonment.

Is non-payment of tax equivalent to non-payment of debt?

Tax arises from law and is a demand of sovereignty. It is distinguished from debt which arises from private
contracts. Non-payment of tax compromises public interest while the non-payment of debt compromises
private interest. The noll. payment of tax is similar -to a crime The Constitutional guarantee on non.
imprisonment for non-payment of-debt does not extend to non-payment of tax, except poll tax.

Poll, personal, community or residency tax

Poll tax has two components:
a. Basic community tax
b. Additional community tax

The constitutional guarantee of non-imprisonment for non-payment of poll tax applies only to the basic
community tax. Non-payment of the additional community tax is an act of tax evasion punishable by
imprisonment.

Non-impairment of obligation and contract

The State should set an example of good faith among its constituents. It should not set aside its obligations
from contracts by the exeréise of its taxation power. Tax
should be honored and should not be cancelled by a unilateral government action.
Free worship rule
The Philippine government adopts free exercise of religion and does not subject its exercise to taxation.
Consequent y, e properties and revenues of religious institutions such as tithes or offerings are not subject to
tax. This exemption, however, does not extend to income from properties or activities of religious institutions
that are proprietary or commercial in nature.
Exemption of religious, charitable or educational entities, non-profit cemeferies, churches and mosques,
lands, buildings, and improvements from property taxes
The constitutional exemption from property tax applies for properties actually, directly, and exclusively
(i.e. primarily) used for charitable, religious, and educational purposes.

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Chapter 1 - Introduction to Taxation
In observing this Constitutional limitation, the Philippines follows the doctrine of wherein only
properties actually devoted for religious, charitable, or educational activities are exempt from eal property
tax.

Under the Voctrine of ownership, the properties of religious, charitable, or educational entities whether or
not used in their primary operations are exempt from real property tax. This, however, is not applied in the
Philippines.

Non-appropriation of public funds or property for the benefit of any church, sect, or system of
religion

This constitutional limitation is intended to highlight the separation of religion and the State. To support
freedom of religion, the government should no.t favor _any particular system of religion by appropriating
public funds or property in support thereof.
It should be noted, however, that compensation to priests, imams, or religious ministers working with the
military, penal institutions, orphanages, or leprosarium is not considered religious appropriation.

Exemption from taxes of the revenues and assets of non-profit, non-stock educational institutions
including grants, endowments, donations, or contributions for educational purposes
The Constitution recognizes the necessity of education in state building by granting on revenues and assets
of non-profit educational institutions. Thi exempti however, applies onl on revenues and assets that are
actually, directly, an exc usively devoted for educationa purp
Consistent with this constitutional recognition of education as a necessity, the NIRC also e xempts
government educational institutions from income tax and subjects private educationa institutions to a
minimal income tax.

Concurrence of a majority of all members of Congress for the passage of a law granting tax exemption
Tax exemption. law counters against the lifeblood doctrine as it deprives the government of revenues.
Hence, the grant of tax exemption must proceed only upon a valid-basis. As a safety net, the Constitution
requires the vote of the

majority of all members.of Congress in the grant of tax exemption.

In the approval of an exemption law, an absolute majority or the majority of all members of Congress, not
a relative majority or quorum majority, is required. However, in the withdrawal of tax exemption, only a
relative majority is required.
Non-diversification of tax collections
Tax collections should be used only for public purpose. It should never be diversified or used for private
purpose.

Non-delegation of the power of taxation

The principle of checks and balances in a republican state requires that taxation power as part of lawmaking
be vested exclusively in Congress.

However, delegation may be made on matters involving the expedient and effective administration and
implementation of assessment and collection of taxes, Also, certain aspects of the taxing process that are
non-legislative in character are delegated.

Hence, implementing administrative agencies such as the Department of Finance and the Bureau of Internal
Revenue (BIR) issues revenue regulations, rulings, orders, or circulars to

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Chapter 1 - Introduction to Taxation
interpret and clarify the application of the law. But even so, their functions are merely intended to interpret
or clarify the proper application of the law. They are not allowed to introduce new legislations within their
quasi, legislative authority.

13 Non-impairment of the jurisdiction of the Supreme Court to review tax cases

Notwithstanding the existence of the Court of Tax Appeals, which is a special court, all cases involving taxes can
be raised to and be finally decided by the Supreme Court of the Philippines.

14. Appropriations, revenue, or tariff bills shall originate exclusively in the House of Representatives, but
the Senate may propose or concur with amendments.
Laws that add income to the national treasury and those that allows spending therein must originate from the
House of Representatives while Senate may concur with amendments. on of
oes not necessarily_ mean that the House bill must become the final law. It
was held cons b the Su reme Court when Senate chan ed t h version of a tax
bill.

15. Each local government unit shall exercise the power to create its own sources of revenue and shall
have a just share in the national taxes
This is a constitutional recognition of the local autonomy of local governments and an express delegation of
the taxing power.

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 to axation
STAGES OF THE EXERCISE OF TAXATION POWER
1. Levy or imposition
2. Assessment and collection

evy or imposition
This process involves the enactment of a tax law by Congress and is called impact of_cgxation. It is also
referr&dfto as
Congress is composed of two bodies:
1. The House of Representatives, and
2. The Senate

As mandated by the Constitution, tax bills must originate from the House of Representatives. Each may,
however, have their own versions of a proposed law which is approved by both bodies, but tax bills cannot
originate exclusively from the Senate.

Matters of legislative discretion in the exercise of taxation

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

ssessment and Collection

The tax law is implemented by the administrative branch of the government. Implementation involves
assessment or the determina Ion of the tax liabilities of collection. This stage is
referred to as incidence of taxation or the administrative act of taxation.

SITUS OF TAXATION itus is the place of taxation. IQ is the tax jurisdiction that has the
power to levy taxes upon the tax object. Situs rules serve as frames of referenc ing n or outsi e
t e tax jurisdiction of the taxing authority.
withiExamples of Situs Rules:

1. Business tax situs: Businesses are subject to tax in the place where the business is conducted.
Illustration
A taxpayer is involved in car dealership abroad and restaurant operation in the Philippines.
(Onapter I tion

'l'he vestaucant business will be subject to business tax in the Philippines since the business is
conducted herein, but the eat' dealing business is exetnpt because the business is conducted abroad.

2. Inconte tax situs on services: Service Jibes are subject to tax where they rendered
Illustration
A foreign corporation leases a residential space to a non: resident Filipino abroad,

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Chapter 1 - Introduction to Taxation
'l'he rent inconte will be exentpt ironi l'hilippine taxat ion as the leasing service is abroad.

3. Income tax situs on sale ol' goods: The gain on sale is subject to tax in the place o/ sale.
Illustration
While in China, a non-resident ()FW cit i7.en agreed with a Chinese Ii•iend to sell his diatnoti(l
necklace to the latter. "I'ltey st ipulated that the delivecv the itetn and the paytnent will be tn.l(le a
week later t he I'hilippines. 'Che sale was consumtnated as agreed.
The contract 01 sale is consensual and is periected 1b' the uneetitll'. 01 the Illinds of the contracting
parties. 'l'he perfection ol' the cont ract 01 sale is in China. "I'lte situs Of taxation is China. The gain on
the sale ol' the necklace will be taxable abroad exernpt in tile Philippines.

4. Property tax situs: Properties are taxable in their 10' •at ion.
Illustration
An overseas Filipino worker has a residential lot in the Philippines.
Ile will still pay real property tax despite his absence in the Philippines becauSC his property is
located herein.

5. Personal tax situs: Persons are taxable in their place o/ residence.

Illustration
Aluned Lofti is a Sudanese studying nu•dicine in the Philippines.
CAhme(l Will pay personal tax in the Philippines even if he is an alien because he is residing in the
Philippines.

OTHER FUNDAMENTAL DOCTRINES IN TAXATION

1. Marshall Doctrine - 'l'axati00 power can be used as an instrument of power. It can be used to
i undesirable activities or occc ation. As such, taxation power carries with
it the power t'6ilestroy.
However, the taxation power does not include the power to destroy if it is used solely for the purpose of
raising revenue. (Roxas vs. CTA)

2. Holme's Doctrine "Taxation power is not the power to destroy while the court sits." Taxation power may be
used to build or encourage beneficial activities or industries by the grant of tax incentives.

While the Marshall Doctrine and the Holme's Doctrine appear to contradict each other, both are actually
employed in practice. A good manifestation of the Marshall Doctrine is the imposition of excessiywtax
om cigarettes while applications of the Holme's Doctrine include the creation ofEcozones with tax
holidays and provision of incentives, such as the Omnibus Investment Code (E.O. 226) and the
Barangay Micro-Business Enterprise (BMBE) Law.

3. Prospectivity of tax laws

Tax laws are generally prospective in operation, An ex postfacto law or a law that retroacts is prohibited by
the Constitution.
Exceptionally, income tax laws may operate retrospectively if so intended by Congress under certain
justifiable conditions. For example, Congress can levy tax on income earned during periods of foreign
occupation even after the war.

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4. Non-compensation or set-off
Taxes are not subject to automatic set-off or compensation. The taxpayer cannot delay payment of tax to
wait for the resolution of a lawsuit involving his pending claim against the government. Tax is not a
debt; hence, it is not subject to set-off. This rule is important to allow the government sufficient period
to evaluate the validity of the claim. (See Philex Mining Corporation vs. CIR, C.R. 125704)

Exceptions:
a. Where the taxpayer's claim has already become due and demandable such as when the government
already recognized the same and an appropriation for refund was made
b. Cases of obvious overpayment of taxes
c. Local taxes

5. Non-assignment of taxes
Tax obligations cannot. be to another entity by contract. Contracts
executed by the taxpayer to such effect shall not prejudice the right of the government to collect.

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Chapter 1 - Introduction to Taxation
6. Imprescriptibility in taxation
Prescription is the lapsixwea—righedue-tomthe- passage oftime. When one sleep on his right over an
unreasonable period of time, he is presumed to b waiving his right. The government's right to collect
taxes does not prescribe unless the law itself provides for such prescription.
Under the NIRC, tax prescribes if not collected within years from the date of its assessment. In the
absence of an assessment, tax prescribes if not collected by judicial action within years from the date the
return is required to be filed. However, taxes due rom taxpayers who did not file a return or those who
filed fraudulent returns do not prescribe.

7. Doctrine of estoppel
Under the doctrine of estoppel, any misrepresentation made by one put! toward another who relied therein
in good faith will be held true and binding against that person who made the misrepresentation.
The-governmen is nov subject to estoppel. The error of any government employee does not bind the
government. It is held that the neglect or omission of government officials entrusted with the collection of
taxes should not be allowed to bring harm or detriment to the interest of the people. Also, erroneous
applications of the law by public officers do not block the subsequent correct application of the same.

8. Judicial Non-interference
Generally, courts ace not allowed to issue injunction against the governmen(s pursuit to collect tax as this
would unnecessarily defer tax collection. This rule is anchored on the Lifeblood Doctrine.

9. Strict Construction of Tax Laws

When the law clearly provides for taxation, taxation is the general rule unless there is a clear exemption.
Hence the maxim, "Taxation is the rule, exemption is the exception. "
is.glear and categorical, there is no room for
interpretation. There is only room for application. However, when taxation laws are vague, the doctrine
of strict legal construction is observed.

Vague tax laws

Vague tax laws are construed against the government and in favor of th e taxpayers. A vague tax law
means no tax law. Obligation arising from law not presumed. The Constitutional requirement of due
process requires laws be sufficiently clear and expressed in their ro
to

Vague exemption laws

Vague tax exemption laws are construed against the taxpayer and in favor of the government. A vague tax
exemption law means no exemption law. The

claim for exemption is construed strictly against the taxpayer in accordance with the lifeblood doctrine.

The right of taxation is inherent to the State. It is a prerogative essential to the perpetuity of the
government. He who claims exemption from the common burden must justify his claim by the clearest
grant of organic or statute law.
(Iloilo, et al. vs. Smart Communications, Inc., G.R. No. 167260, February 27, 2009)
 Chapter 1 - Introduction to Taxation
When exemption is claimed, it must be shown indubitably to exist. At the outset, every presumption is
against it. A well-founded doubt is fatal to the claim; it is only when the terms of the concession are too
explicit to admit fairly of any other construction that the proposition can be supported. (Ibid)

Tax exemption cannot arise from vague inference. Tax exemption must be clear and unequivocal. A
taxpayer claiming a tax exemption must point to a specific provision of law conferring on the taxpayer, in
clear and plain terms, exemption from a common burden. Any doubt whether a tax exemption exists is
resolved against the taxpayer. (see Digital Telecommunications, Inc. vs. City Government of Batangas, et
al)

DOUBLE TAXATION
Double taxation occurs when the same taxpayer is taxed twice by the same tax jurisdiction for the same thing.
Elements of double taxation
1. Primary element.' Same object
2. Secondary elements:
a. Same type of tax
b. Same purpose of tax
c. Same taxing jurisdiction
d. Same tax period

Types of Double Taxation

1. Direct double taxation

This occurs when all the element of double taxation exists for hotly impositions.

Examples:
a. An income tax of 10% on monthly sales and a 2% income tax on the annual sales qtotal of
monthly sales)
b. A 5% tax on bank reserve deficiency and another 1% penalty per day-as a consequence of such
reserve deficiency

2. Indirect double taxation

This occurs when at least one of the secondary elements of double taxation is not common for both
impositions. Examples:
a. The national goyernuyent levies business tax on the sales or gross receipts of business while the
local government levies business tax upon the same sal or receipts.
b. The national_government collects income tax from a taxpayer on his income

while the local government collects comnmnity tax upon the same income.
c. The Philippine government taxes foreign income of domestic corporations and resident citizens
while a foreign government also taxes the same income (international double
taxation).

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Chapter 1 - Introduction Taxation
Nothing in our law expressly prohibits double taxation. In fact, indirect doubl taxation is prevalent in
practice. However, direct double taxation is discouragq because it is oppressive and burdensome to
taxpayers. It is also believed tå counter the rule of equal protection and uniformity in the Constitution.

How can double taxation be minimized?

The impact of double taxation can be minimized by any one or a combination 01 the following:

a. Provision of tax exemption — only one tax law is allowed to apply to the object while the other tax
law exempts the same tax object
b. Allowing foreign tax credit — both tax laws of the domestic country and foreign country tax the tax
object, but the tax payments made in the foreig tax law are deductible against the tax due of the
domestic tax law

Allowing reciprocal tax treatment — provisions in tax laws imposing a reduced tax rates or even
exemption if the country of the foreign taxpayer also gives the same treatment to Filipino non-residents
therein
d. Entering into treaties or bilateral agreements — countries may stipulate fori lower tax rates for their
residents if they engage in transactions that art taxable by both of them
to

ESCAPES FROM TAXATION

Escapes from taxation are the means available to the taxpayer to limit or even avoid the impact of taxation.

Categories of Escapes from Taxation

A. Those that result to loss ofgovernment revenue

1. Tax evasion, also known as tax dodging, refers to any act or trick that

tends to illegally reduce or avoid the payment of tax.

Examples:
a. This can be achieved by gross understatement of income, nondeclaration of income, overstatement
of expenses or tax credit.
b. Misrepresenting the nature or amount of transaction to take advantage of lower taxes.

2. Tax avoidance, also known as tax minimization, refers to any act or trick that reduces or totally
escapes taxes by any legally permissible means.
Examples:
a. Selection and execution of transaction that would expose taxpayer to lower taxes.
b. Maximizing tax options, tax carry-overs or tax credits
c. Careful tax planning

17
Chapter 1 - Introduction to Taxation
3. Tax exemption, also known as tax holiday, refers to the immunity, privilege or freedom from being
subject to a tax which others are subject to. Tax exemptions may be granted by the Constitution,
law, or contract.

All forms of tax exemptions can be revoked by Congress except those granted by the Constitution and
those granted under contracts.

B. Those that do not result to loss ofgovernment revenue

I. Shifting - This is the process of transferring tax burden to other taxpayers—
Forms of shifting
a. Forward shifting -This is the shifting of tax which follows the normal

(i.e. from manufacturerto-wholesalers, retailers to consumers).

Forward shifting is common with essential commodities an services such
as food and fuel.

Backward shifting 'l'his is the reverse of forward shifting. Backward shifting is comjnon
with non-essential commodities where buyers have considerable market power
arWcommodities with numerous substitute products.
c. Onward shifting -- This refers to any tax shifting in the distribution channel
that exhibits forward shifting or backward shifting.
Shifting is common with business taxes where taxes imposed on business
revenue can be shifted or passed-on to customers.

2, Capitalization - This pertains to the adjustment of the value of an asset caused by

changes in tax rates.
For instance, the value of a mining property will correspondingly decrease when mining output is
subjected to higher taxes. This is a form of backward shifting of tax.

3. Transformation - This pertains to the elimination of wastes or losses by the taxpayer to form savings to
compensate for the tax imposition or increase in taxes.

Tax Amnesty
Amnesty is a: general pardon granted by the government for erring taxpayers give them a chance to reform
and enable them to have a fresh start to be part ofö society with a clean slate. It is an absolute forgiveness
or waiver by the government on its right to collect and is retrospective in application.

Tax Condonation
Tax condonation is forgiveness of the tax obligation of a certain taxpayer undel certain justifiable grounds.
This is also referred to as tax remission.

Because they deprive the government of revenues, tax exemption, tax refund, tal amnesty, and tax
condonation are construed against the taxpayer and in favor d the government.

Tax Amnesty vs. Tax Condonation

Amnesty Covers both civil_and criminal liabilities, but condonation covers on) civil liabilities of the taxpayer.
Amnesty operates retrospectively by forgiving past violations. Condonati0!

18
Chapter 1 - Introduction Taxation
applies prospectively to any unpaid balance of the tax; hence, the portion paid by the taxpayer will not
be refunded.
Amnesty is also conditional upon the taxpayer paying the government a portion the tax whereas condonation
requires no payment.

19
 Chapter 1 Introduction to Taxation

Discussion Questions
1. Define taxation.

2. Distinguish the theory and the basis of' taxation,

3. What are the theories of government cost allocation"/ Explain each.

4. Differentiate vertical and horizontal equity.
5. Discuss the Lifeblood Doctrine.
6. Enumerate and explain the inherent powers of the State.
7. Distinguish the three powers of the State and enumerate their similarities.
8. Describe the scope of the power of taxation.
9. Distinguish substantive due process from procedural due process.
10. Distinguish the concept of equality from the concept of uniformity in taxation.
Il. Distinguish non-payment of debt versus non-payment of tax in terms of consequences.
12. What institutions are exempt from real property tax in the Constitution?
13. Which of the constitutional limitations are also classified as inherent limitations?
14. Explain the stages of the exercise of taxation power.
15. Explain the concept of situs.
16. Distinguish the Marshall Doctrine from the Holme's Doctrine.
17. Discuss the doctrine of strict construction of tax laws.
18. Explain double taxation, its elements, and its types.

19. What are the categories of escapes from taxation? Enumerate and explain each means of escape under each
category.
20. Distinguish tax amnesty from tax condonation.

Exercise Drills
In the space provided for, indicate whether the statement relates to a Constitutional limitation (C) or inherent limitation
(I). If it is not a limitation to the taxing power, indicate (N).

20
1. Non-assi nment of taxes
2. Territoriali of taxation
3. Taxes must be for ublic use
4. Exemption of the property of religious institutions from income tax

5. Exemption of the revenues and assets of non-profit, nonstock educational

institutions
6. Non-dele ation of the taxin ower
7. Non-a ro riation for reli ious ur ose
8. The requirement of absolute majority in the passage of a tax exem tion law.

9. Non-im risonment for non- a ment of tax or debt

10. Taxpayers under the same circumstance should be treated e ual both in
terms of rivile es and obli ations.
11. Exemption from property taxes of religious, educational, and charitable
entities.
12. Government income and properties are not objects of taxation.

13. Each local government shall have the power to create its own sources of
revenue.
14. 1m rescri tibili in taxation
15. Non-im airment of obli ation and contracts.
16. Guarantee of ro ortional s stem of taxation.
17. International courtes
18. Non-impairment of the jurisdiction of the Supreme Court to review tax
cases.
19. The overnment is not sub•ect to esto el.
20. 1m risonment for non- a ent of 011 tax.
True or False 1
I. There should be direct receipt of benefit before one could be compelled top
taxes.
2. Eminent omain involves confiscation of prohibited commodities to protecti well-being of the people.

3. Horizontal equity requires consideration of the circumstance of the taxpayer.

4. Taxes are the lifeblood of the government. •T
5. Taxation is a mode of apportionment of government costs to the people.

6. The exercise of taxation power requires Constitutional grant.

7. Taxation is inherent in sovereignty. T
8. Police power is the most superior power of the government. Its exercise nee to be sanctioned by the
Constitution.
9. All inherent powers presuppose an equivalent form of compensation. T

21
 Chapter 1 Introduction to Taxation
10. The reciprocal duty of support between the government and the peop underscores
the basis of taxation. -t
True or False 2
1. The scope of taxation is regarded as comprehensive, plenary, unlimited,

supreme. T
2. The Constitutional exemption of religious, charitable, and non-profit cemeter ii churches, and mosques
refers to income tax and real property tax.
3. Taxpayers under the same circumstance should be taxed differently.
4. Taxation is subject to inherent and Constitutional limitations.
5. International comity connotes courtesy between nations.
6. Collection of taxes in the absence of a law is violative of the Constituti 0Ø requirement for due process.
7. No one shall be imprisoned for non-payment of tax.

ro u Ion o axation

8. The lifeblood doctrine requires the government to override its obligations and contracts when necessary.
9. 2/3 of all members of Congress is required to pass a tax exemption law. F
10. The government should tax itself. F
Multiple Choice - Theory: Part 1
1. That courts cannot issue injunction against the government's effort to collect taxes justified by
a. the lifeblood doctrine.c. the ability to pay theory. imprescriptibility of taxes. d. the doctrine of estoppel.

2. The point at which tax is levied is also called

a. Impact of taxation c. Incidence of taxation Situs of taxatiow d. Assessment

3. Which of the following inappropriately describes the nature of taxation?

a. Inherent in sovereignty
b. Essentially a legislative function
c. Subject to inherent and constitutional limitation Generally for public purpose

4. Which is correct?
a. Tax condonation is a general pardon granted by the government.
b. The BIR has five deputy commissioners.
c. The government can still collect tax in disregard of a constitutional limitation because taxes are the
lifeblood of the government.
The President of the Philippines can change tariff or imposts without necessity of calling Congress to pass
a law for that purpose.

5. A. The power to tax includes the power to exempt. B. The power to license includes the power to tax.
Which is true?

a. A only c. A and B
B only d. Neither A nor B

22
6. International double taxation can be mitigated by any of the following except
a. Providing allowance for tax credit V
b. Provision of reciprocity provisions in tax laws Provision of tax exemptions
d. Entering into treaties to form regional trade blockage against the rest of the world

7. Which is not an object of taxation?

a. Persons ransactions
b. Business ublic properties
-

8. The power to enforce proportional contribution from the people for the support of the government is
Taxation c. Eminent domain
b. Police power d. Exploitation

9. This theory underscores that taxes are indispensable to the existence of the state.
a. Doctrine of equitable recoupment The Lifeblood Doctrine
c. The benefit received theory
d. The Holmes Doctrine

10. A. Taxation is the rule, exception is the exemption.

B. Vague taxation laws are interpreted liberally in favor of the government.
Which is false?
a. A only 00th A and B h/ B only d. Neither A nor B

11. Statement 1: The benefit received theory presupposes that some taxpayers withi: the territorial jurisdiction of
the Philippines will be exempted from paying tan long as they do not receive benefits from the government.
Statement 2: The ability to pay theory suggests that some taxpayers may b exempted from tax
provided they do not have the ability to pay the same.
Which statement is true?
a. Only statement 1 c. Both statements 1 and 2
Only statement 2 d. Neither statement 1 nor 2
12. Select the incorrect statement.
a. The power to tax includes the power to exempt.
b. Exemption is construed against the taxpayer and in favor of the government
c. Tax statutes are construed against the government in case of doubt. Taxes should be collected only for
public improvements.

13. Which is nota public purpose?

a. Public education c Transportation
b. National defense one of these

14. Which does not properly describe the scope of taxation?

a. Comprehensive c. Discretionary
b. Supreme Unlimited

15. All of these are secondary purposes of taxation except

23
 Chapter 1 Introduction to Taxation
a. To reduce social inequality b To protect local industries
c. To raise revenue for the support of the government
To encourage growth of local industries

24
Chapter 1 Introduction to Taxation

16. What is the theory of taxation?

a. Reciprocal duties of support and protection Necessity
c. Constitutionality
d. Public purpose

17. A. Taxes should not operate retrospectively. B. Tax is generally for public purpose.
Which is true?
a. A only c A and B
b. B only @)Neither A nor B
18. Which provision of the Constitution is double taxation believed to violate?
a. Equal protection guarantee
b. Progressive scheme of taxation
c. Uniformity rule
Either A or C

19. Which limitation of taxation is the concept of "situs of taxation" based?

a. Territoriality c. International comity
Public purpose d. Exemption of the government

20. Which tax exemption is irrevocable?

a. Tax exemption based on contract
b. Tax exemption based on the Constitution
c. Tax exemption based on law Both A and B

21. Which statement is incorrect?

a. Every person must contribute his share in government costs.
b. The existence of a government is expected to improve the lives of the people.
c. The government provides protection and other benefits while the people provide support.
Q) Only those who are able to pay tax can enjoy the privileges and protection of the government.

22. Which is the most incorrect statement regarding taxes?

a. Taxes are necessary for the continued existence of the government.
b. The obligation to pay tax does not rest upon the privilege enjoyed by or the protection afforded to the
citizen of the government, but upon the necessity of money for the support of the State.
c. There should be personal benefit enjoyed from the government before one is required to pay tax.
d. Taxes should be collected without unnecessary delay, but its collection should not be tainted with
arbitrariness.
liability.
 q

from
{With

déposit
tanks

for

current

If the gonta}9eFYLthq d?posjtf is pimply refunded.

H0',teyprf1ifJtheJ$uetomer containers, the deposit is considered the sale

price of the containers.
The excess of the deposit over the cost of the containers is considered as gain.
CHAPTER 2
TAXES, TAX LAWS, AND TAX ADMINISTRATION
Chapter Overview and Objectives

This Chapter discusses tax laws, taxes, and their distinction from similar items, and the administration of the tax system.

After this chapter, readers are expected to comprehend and demonstrate knowledge on the following:
1. The type of taxation laws
2. Distinction among tax laws, revenue regulations, and rulings
3. Tax, its elements, and classifications 4. Distinction of tax from similar items
5. Tax system and its types
6. The principles of a sound tax system
7. How tax is administered
8. The powers of the Bureau of Internal Revenue (BIR) and the Commissioner of
Internal Revenue (CIR) and the non-delegated powers of the CIR
9. The criteria for selection of large taxpayers

TAXATION LAW
Taxation law refers to any law that arises from the exercise of the taxation power of the State.
Types of taxation laws

1. Tax laws - These are laws that provide for the assessment and collection of taxes.
Examples:
a. The National Internal Revenue Code (NIRC)
b. The Tariff and Customs Code
c. The Local Tax Code
d. The Real Property Tax Code

2. Tax exemption laws - These are laws that grant

certain immunity from taxation.
Examples:
a. The Minimum Wage Law
b. The Omnibus Investment Code of 1987
c. Barangay Micro-Business
Enterprise
d. Cooperative Development Act

Sources Ol' Taxation Laws

1. Constitution
2. Statutes and li residcjit/;ij j)ecceetl

3. Judicial or
I t:xecutive and
 5, A(ltninist rative Issuances

Local ()rdinanccs
7. "l'ax 'lireaties an(l Conventions wit I) foreign countries

8. Reven ue Regulations
Types of Administrative Issuances
1. Revenue regulations
2. Revenue memorandurn orders
3. Revenue memoranclujji rulings
4. Revenue memorandum circulars
5. Revenue bulletins 6. BIR rulings

kevenue Regulations arc issuances signed Secretary of Finance upo recommendation of Il)C Revenue (CIR)
that specify prescribe, or define rules ('fféctive
Of tllt provisions of the National Internal
Revenue Code (NJ RC) and related statutes,
Revenue regulations are formal pronouncements intended to clarify or explain toe tal law and carry into effect
its general provisions by providing details of' administrati0t and procedure. Revenue regulation has the f'orce
and effect of' a law, but is not intended to expand or limit the application of' the law; otherwise, it is void.
Revenue Memorandum Orders (RM()s) ore issuances that provide directives J instructions; prescribe
guidelines; and outline processes, operations, activiti eS workflows, meLhodg, and procedures necessary in the
implementation of stated policies, goals, objectives, plans, and programs of' the Bureau in all areas of'
except auditing.
?evenve MemorandurnRulings (RMRs) are rulings, opinions and interpretations of the CIR with respect to
the provisions of' the 'J"ax Code and other tax laws as applied toa specific set of facts, with or without
established precedents, and which the CIR issue from time to time for the Of Providing taxpayers guidance
on the consequences in specific situatiorj%' R Ulings,ttheref'ore, cannot contravene duly issued RMRs;
otherwise, the Rulings are null.nwvold al) initjo.

Revenue Memorandum Circulars issuances that Publish pertinent all applica portions as weJJ as amplifications of laws,
rule%, e regulations, and precedents issued by the and other agencies/offices.
 2 Taxes, Tax Laws and Tax Administration
Chapter

ÄRevenue Bulletins (RB) refer to periodic issuances, notices, and official announcements of the Commissioner of
Internal Revenue that consolidate the Bureau of Internal Revenue'S position on
certain specific issues of law or administration in relation to the provisions of the Tax Code, relevant tax laws,
and other issuances for the guidance of the public.

positions of the Bureau to queries raised by taxpayers and other stakeholders relative
to clarification and interpretation of tax laws.

Rulings are merely advisory or a sort of information service to the taxpayer such that none of them is binding
except to the addressee and may be reversed by the BIR at anytime.

Types of rulings
1. Value Added Tax (VAT) rulings
2. International Tax Affairs Division (ITAD) rulings
3. BIR rulings
4. Delegated Authority (DA) rulings

Generally Accepted Accounting Principles (GAAP) vs. Tax Laws

Generally accepted accounting principles or GAAP are not laws, but are mere conventions of financial
reporting. They are benchmarks for the fair and relevant valuation and recognition of income, expense, assets,
liabilities, and equity of a reporting entity for general purpose financial reporting. GAAP accounting reports
are intended to meet the common needs of a vast number of users in the general public.

Tax laws including rules, regulations, and rulings prescribe the criteria for tax reporting, a special form of
financial reporting which is intended to meet specific needs of tax authorities.

Taxp?yers normally follow GAAP in recording transactions in their books. However, in the preparation and
filing of tax returns, taxpayers are mandated to follow the tax law in cases of conflict with GAAP.

NATURE OF PHILIPPINE TAX LAWS

Philippine tax laws are civil and not political in nature. They are effective even during periods of enemy
occupation. They are laws of the occupied territory and not by the occupying enemy. Tax payments made
during occupations of foreign enemies are valid.

Our internal revenue laws are not penal nature because they do not define crime. Their penalty provisions are
merely intended to secure taxpayers' compliance.
37
(j hopter I owe, T
TAX
Tax is on enforced ptoport ional contribution lcvjcd by the lawmaking body
State to raise rcvcnuc for public

Elements of a Valid "Itax

1, Tax mus•t be levied by the taxing power having jurisdiction over the object % taxation.
2. Tax must not violate Constitutional and inherent lirnitatiorj%.
3. Tax must bc uniform and equitable,
4. Tax must bc for public purpose.
 5. Tax must be proportional in character.
6. Tax is generally payable in money.
Classification of Taxes
A. As to purpose
1. Fiscal or revenue tax a tax imposed for general purpose
2. Regulatory -- a tax imposed to regulate business, conduct, acts q transactions
3. Sumptuary— a tax levied to achieve some social or economic objectives
B. As to subject matter
1, Personal, poll or capitation a tax on persons who arc residen of; particular territory
2. Property tax- a tax on properties, rdeaJ or personal

3. Excise or privilege tax — a tax imposed upon the performance of an ad eruungU_ofaprjviJege or

engagement in an occupation
C. As to incidence
1. Direct tax - When both the impact and incidence of taxation rest upon th i same taxpayer, the tax is
said to be direct. The tax is collected from th e person who is intended to pay the same. The
statutory taxpayer is the economic taxpayer. -v
2. Indirect tax - When the tax is paid by any person other than the one wh o is intended to pay the same,
the tax is said to be indirect. This occurs ID the case of business taxes where the statutory taxpayer
is not the economic taxpayer.
The statutory taxpayer is the person named by law to pay the tax. N economic taxpayer is the one
who actually pays the tax.

D, As to amount
1. Specific tax a tax of a Ixed amou per kilo, liter or
2. Ad valorem - a tax of pro ortion i a fixe posed upon the value of the tax object
010

E. As to rate
1. Proportional tax — This is a flat or fixed rate_tax. use of proportional tax emphasizes equality as it
subjects all taxpayers with the same rate without regard to their ability to pay.

2. Progressive or graduated tax - This is a tax which imposes increasing rates as the tax base increase.
The use of progressive tax rates results in 7@fåbTé-täkätiöfbéÄuse it gets more tax to those who are
more capable. It aids in lessening the gap between the rich and the poor.

3. Regressive tax - This tax imposes decreasing tax rates as the tax base increase. This is the total
reverse of progressive tax. Regressive tax is regarded as anti-poor. It directly violates the
Constitutional guarantee of progressive taxation.

4. Mixed tax - This tax manifest tax rates which is a combination of any of the above types of tax.

F. As to imposing authority
1. National tax - tax imposed by the national government
Examples:
a. Income tax - tax on annual income, gains or
profits
Chapter 2 Taxes, Tax Laws and Tax Administration
b. Estate tax - tax on gratui us transfer of properties by a decedent upon death onor's tax -
tax on gratuitous transfer of properties by a living donor
d. Value Added Tax consumption tax collected taxpayers
e. Other percentage tax consumption tax collected by non-VAT
business taxpayers
f. Excise tax - tax on sin products and non-essential commodities such as a cdfol, cigarettes and
metallic minerals. This should be differentiated with the privilege tax which is also called excise
tax.
g. Documentary sggmp_tax - a tax on documents, instruments, loan
agreements, and papers evidéfiCifig-tFäféftance, assignment, sale or transfer of an obligation,
right or property incident thereto.

2. Local tax - tax imposed by the municipal or local government

Examples:
a. Real property tax
b. Professional tax
c. Business taxes, fees, and charges D cox "c
 Tax
[awo arjcl Adli)irjistfation

d.
'l'ax on ban and
(Community tax
c,

DISTINCTION OF TAXES wrrll SIMILAR ITEMs

Tax vs. Revenue
Tax refers to the ijnposed by the government [Or public purpose. Rcvenué refers to all income collections 01
the govcrmncnt which includes taxcs, tariff, licenses, toll, penalties and others. "l'hc arnount ijnpo.scd is tax
but the amount collected is revenue.

Tax vs. License fee

Tax has a broader subject than license, Tax emanates from taxation power and is imposed upon any object
such as persons, propcrtics, or privileges to raise rcvcnuc.

License fee emanates from police power and is imposed to regulate the exercise of a privilege such as the
cornmcnccmcnt of' a business or a profession.

Taxes are imposed after the commencement of a business or profession whereas license fee is imposed before
engagement in those activities. In other words, tax is a post-activity imposition whereas license is a pre-
activity imposition.

Tax vs. Toll

Tax is a levy of government; hence, it is a demand of sovereignty. Tollis a charge for the use of' other's
property; hence, it is a demand of ownership.

The amount of' tax depends upon the needs of the government, but the amount Of toll is dependent upon the
value of the property leased.
Both the government and private entities impose toll, but private entities cannot impose taxes.

Tax vs. Debu

Tax arises from law while debt arises from private contracts. Non-payment of tax leads to imprisonment,
but non-payment of Debt can be subject to set-off but tax is not. Debt can be paid in kind [ dacion ell pago)

but tax is generally payable in money.

Tax draws interest only when the taxpayer is delinquent. Debt draws interest when it is so stipulated by the
contracting parties or when the debtor incurs a legal delay,

40
-

Tax vs. Special Assessment

Tax is an amount imposed upon persons, properties, or privileges. Special assessment is leviecU by the
government on lands adjacent to a public improvement. It is imposed on land only and is intended to
compensate the government for a part of the cost of the improvement.
 Chapter 2 Taxes, Tax Laws and Tax Administration
The basis of special assessment is the benefit in terms of the appreciation in land value caused by the public
improvement. On the other hand, tax is levied without expectation of a direct proximate benefit.
AsseSS

Unlike taxes, special assessment attaches to the land. It will not become a personal obligation of the land
owner. Therefore, the non-payment of special assessment will not result to imprisonment of the owner (unlike
in non-payment of taxes).

Tax vs. Tariff

Tax is broader than tariff. Tax is an amount imposed upon persons, privilege, transactions, or properties.
Tariff is the amount imposed on imported or exported commodities.

Tax vs. Penalty

Tax is an amount imposed for the support of the government. Penalty is an amount imposed to discourage an
act. Penalty may be imposed by both the overnment and private individuals. It may arise both from-law or
contract whereas tax anses om¯law.

TAX SYSTEM
The tax system refers to the methods or schemes of imposing, assessing, and collecting taxes. It includes all
the tax laws and regulations, the means of their enforcement, and the government offices, bureaus and
withholding agents which are part of the machineries of the government in tax collection. The Philippine tax
system is divided into two: the national tax s stem and the local tax system.

Types of Tax Systems According to Imposition

1. Progressive - employed in the taxation of income of individuals, and certain local business taxes
2, Proportional - employed in taxation of corporate income and business
3
. Regressive - not employed in the Philippines
T
ypes of Tax System According to Impact
1. Progressive system
A progressive tax system is one that emphasizes direct taxes. A direct tax cannot be shifted. Hence, it
encourages economic efficiency as it leaves no Other resort to taxpayers than to be efficient. This type of
tax system impacts more upon the rich.
41
2. Regressive system
A regressive tax system is one that emphasizes indirect taxes. Indirecttaxt are shifted by businesses to
consumers; hence, the impact of taxation upon the bottom end of the society. In effect, a regressive tax
system ant poor.

It is widely believed that despite the Constitutional guarantee of a progressil\ taxation, the Philippines has a
dominantly regressive tax system due to prevalence of business taxes.

TAX COLLECTION SYSTEMS

A. Withholding system on income tax - Under this collection system, the pay! of the income withholds or
deducts the tax on the income before releasing th same to the payee and remits the same to the government.
The following art the withholding taxes collected under this system:
1. Creditable withholding tax

a. Withholding tax on compensation - an estimated tax required by th e government to be

e
withheld (i.e. deducted) by employers against th compensation income to their employees
 Chapter 2 Taxes, Tax Laws and Tax Administration
b. Expanded withholding tax - an estimated tax required by t he overnment)to be deducted on certain
income payments made by taxpayers engaged in business
The creditable withholding tax is intended to support the self-assessment method to lessen the burden
of lump sum tax payment of taxpayer and also provides for a possible third-party check for the BIR
of non-compliant taxpayers.
Final withholding tax - a system of tax collection wherein payors-ae re__quiredto deductthe-fulltax on
certain income payments

The final withholding tax is intended for the collection of taxes frgnl income with high risk of non-
compliance.

Similarities of final tax and creditable withholding tax

a. In both cases, the income payor withholds a fraction of the income and remits the same to the over
nt.
b. By co ecting at the moment cash is available, both serve to minimize cash flow problems to the
taxpayer and collectionprgblems to the government•

Differences between FWT and CWT

Final Withholding Tax Creditable Withholding Tax

Income tax withheld Full Onl a ortion

Coverage of withholdin Certain passive income
Certain passive and active income
Who remits the actual tax Income payor Income payor for the CWT and the
tax a er for the balance
Necessity of income tax Not required Required
return or tax a er

B. Withholding system on business tax - when the national government agencies and instrumentalities including
government-owned and controlled corporations (GOCCs) purchase goods or services from private suppliers,
the law requires withholding of the relevant business tax (i.e. VAT or tax). Business taxation is discussed
under Business and Transfer Taxation by the same author.

C. Voluntary compliance system - Under this collection system, the taxpayer O)lmself determines his income,
reports the same through income tax returns and pays the tax to the government. This system is also referred
to as the
"Self-assessment method."

The tax due determined under this system will be reduced by:
a. Withholding tax on compensation withheld by employers
b. Expanded withholding taxes withheld by suppliers of goods or services

The taxpayer shall pay to the government any tax balance after such credit or claim refund or tax credit for
excessive tax withheld.
 Chapter 2 Taxes, Tax Laws and Tax Administration
D. Assessment or enforcement system - Under this collection system, the government identifies non-compliant
taxpayers, assesses their tax dues including penalties, demands for taxpayer's voluntary compliance or
enforces collections by egercive means such as a summary proceeding or judicial proceedings when
necessary.

PRINCIPLES OF A SOUND TAX SYSTEM

According to Adam Smith, governments should adhere to the following principles or canons to evolve a sound tax
system:
1. Fiscal adequacy
2. Theoretical justice
3. Administrative feasibility
Fiscal adequacy
Fiscal adequacy requires that the sources of government funds must be sufficie to cover government costs.
The government must not incur a deficit. A bud! deficit paralyzes the government's ability to deliver the
essential public servicest
the people. Jlence, taxes should increase in response to increase in governme spending.

Theoretical justice
Theoretical justice or equity suggests that taxation should consider the taxpayer ability to pay. It also suggests
that the exercise of taxation should not b oppressive, unjust, or confiscatory.

Administrative feasibility
Administrative feasibility suggests that tax laws should be capable of efficient aril effective administration to
encourage compliance. Government should make easy for the taxpayer to comply by avoiding
administrative bottlenecks ant reducing compliance costs.

The following are applications of the principle of administrative feasibility:

1. E-filing and e-payment of taxes
2. Substituted filing system for employees
3. Final withholding tax on non-resident aliens or corporations
4. Accreditation of authorized agent banks for the filing and payment of taxes

TAX ADMINISTRATION
Tax administration refers to the management of the tax system. Tai administration of the national tax system in
the Philippines is entrusted to the Bureau of Internal Revenue which is under the supervision and
administration Of the Department of Finance.

Chief Officials of the Bureau of Internal Revenue

1. 1 Commissioner
2. 4 Deputy Commissioners, each to be designated to the following:
a. Operations group
b. Legal Enforcement group
c. Information Systems Group
d. Resource Management Group

POWERS OF THE BUREA U OF INTERNAL REVENUE

Chapter 2 Taxes, Tax Laws and Tax Administration
1. Assessment and-collection of taxes cases

2. nforcement of all forfeitures, penalties and fines, and judgments in all decided in its favor by the courts
 Chapter 2 - Taxes, Tax Laws and Tax Administration
3. Giving effect to, and administering the supervisory and police powers conferred to it by the NIRC and other
laws
4. Assignment of internal revenue ffi s and other employees to other duties
5. provision and distribution of forms, receipts, certificates, stamps, etc. to proper officials

6. Issuance of receipts and clearances

7. Submission of annual report, pertinent information to Congress and reports to

the Congressiona versight Committee in matters of taxation

POWERS OF THE COMMISSIONER OF INTERNAL REVENUE

1. To interpret the provisions of the NIRC, subject to review by the Secretary of Finance

2. To decide tax cases, subject to the exclusive appellate jurisdiction of the Court of Tax Appeals, such as:
a. Disputed assessments
b. Refunds of internal revenue taxes, fees, or other charges
c. Penalties imposed
d. Other NIRC and special law matters administered by the BIR

3. To obtain information and to summon, examine, and take testimony of persons to effect tax collection
Purpose: For the CIR to ascertain:
a. The correctness of any tax return or in making a return when none has been made by
the taxpayer
b. The tax liability of any person for any internal revenue tax or in correcting any such liability
c. Tax compliance of the taxpayer

Authorized acts:
a. To examine any book, paper, record or other data relevant to such inquiry
b. To obtain on a regular basis any information from any person other than the person whose internal
revenue tax liability is subject to audit

c. To summon the person liable for tax or required to file a return, his employees, or any person having
possession and custody of his books of accounts and accounting records to produce such books,
papers,GZéGÖFds or other data and to give testimony
d. To take testimony of the person concerned, under oath, as may be relevant or material to the inquiry
e. To cause revenue officers and employees to make canvass of any revenue district
Administration

4. To make an assessment and prescribe additional requirement for administration and enforcement
5. To examine tax returns and determine tax due thereon
Chapter 2 - Taxes, Tax Laws and Tax
The CIR or his duly authorizeå representatives may authorize the examination of any taxpayer and the
assessment of the correct amount of tax, notwithstanding any law requiring the prior authorization of any
government agency or instrumentality. Failure to file a return shall not prevent the CIR from authorizing the
examination.
-Tax or deficiency assessments are due upon notice and demand by the CIR or his representatives.

Returns, statements or declarations shall not be withdrawn but may be modified, changed and amended by the
taxpayer within 3 years from the date of filing, except when a notice for audit or investigation has been
actually served upon the taxpayer.
When a return shall not be forthcoming within the prescribed deadline o r when there is a reason to believe
that the return is false, incomplete o r erroneous, the CIR shall assess the proper tax on the basis of best
evidence available.

In case a person fails to file a required return or other documents at the time prescribed by law or willfully
files a false or fraudulent return or other documents, the CIR shall make or amend the return from his own
knowledge and from such information obtained from testimony. The return shall be presumed prima facie
correct and sufficient for all legal purposes.

6. To conduct inventory taking or surveillance

7. To prescribe presumptive gross sales and receipts for a taxpayer when:

a. The taxpayer failed to issue receipts; or
b. The CIR believes that the books or other records of the taxpayer do not correctly reflect the declaration
in the return.
The presumptive gross sales or receipt shall be derived from the performance of similar business under
similar circumstances adjusted for other relevant information.

8. To terminate tax period when the taxpayer is:

a. Retiring from business
b. Intending to leave the Philippines
c. Intending to remove, hide, or conceal his property
d. Intending to perform any act tending to obstruct the proceedings for the collection of the tax or render
the same ineffective
The termination of the taxable period shall be communicated through a notice to the taxpayer together with a
request for immediate payment. Taxes shall be due and payable imm—djately

9. To prescribe real property values

The CIR is authorized to divide the Philippines into zones and prescribe real property values after
consultation with competent appraisers. The values thus prescribed are referred to as zonal value.

Zonal values are subject to automatic adjustment once every 3 years through rules and regulations issued by
the Secretary of Finance based on the current Philippine valuation standards. However, no adjustment in
zonal valuation shall be valid unless published in a newspaper of general circulation in the province, city or
municipality concerned, or in the absence thereof, shall be posted in the provincial capitol, city or municipal
Chapter 2 - Taxes, Tax Laws and Tax Administration
hall and in 2 other conspicuous public places therein. Furthermore, the basis of any valuation, including the
records of consultations done, shall be public records open to the inquiry of any taxpayer.
For purposes of internal revenue taxes, fair value of real property shall mean whichever is higher of:
a. Zonal value prescribed by the Commissioner
b. Fair market value as shown in the schedule of market values of the Provincial and City Assessor's
Office
The NIRC previously used the assessed value which is merely a fraction of the fair market value. Assessed
value is the basis of the real property tax in local taxation. The value to use now is the full fair value of the
property.

10. To compromise tax liabilities of taxpayers

11. To inquire into bank deposits, only under the following instances:
a. Determination of the gross estate of a decedent
b. To substantiate the taxpayer's claim of financial incapacity to pay tax in an application for tax
compromise

In cases of financial incapacity, inquiry can proceed only if the taxpayer waives his privilege under thfBånk
Deposit Secrecy Act.

12. To accredit and register tax agents

Chapter 2 - Taxes, Tax Laws and Tax Administration
The denial by the CIR of application for accreditation is appealable Departtuent of Finance. The failure
of the Secretary of Finance to act on appeal within 60 days is deemed an approval.

13. To refund or credit internal revenue taxes

14. To abate or cancel tax liabilities in certain cases

15. To prescribe additional procedures or documentary requirements

16. To delegate his powers to any subordinate officer with a rank equivalent division chief of an office

Non-delegated power of the CIR

The following powers of the Commissioner shall not be delegated:

1. The power to reconlmend the promulgation of rules and regulations to th Secretary of Finance.

2. The power to issue rulings offirst impression or to reverse, revoke or modifi any existing rulings of the
Bureau.

3. The power to comprotnise or abate any tax liability

Exceptionally, the Regional Evaluation Boards tnay compromise tax liabilitie under the following:
a. Assessments are issued by the regional offices involving basic deficienc tax of P500,000 or less,
and
b. Minor criminal violations discovered by regional and district officials

Composition of the Regional Evaluation Board

a. Regional Director as chairman
b. Assistant Regional Director
c. Heads of the Legal, Assessment and Collection Division
d. Revenue District Officer having jurisdiction over the taxpayer

4. The power to assign and reassign internal revenue officers to establishments where articles subject to
excise tax are produced or kept.

Rules in assignments of revenue officers to other duties

1. Revenue officers assigned to an establishment where excisable articles are kept shall in no case stay there
for more than 2 years.

2. Revenue officers assigned to perform assessment and collection function shall not remain in the same
assignment for more than 3 years.
 Chapter 2 - Taxes, Tax Laws and Tax Administration
3. Assignment of internal revenue officers and employees of the Bureau to special duties shall not exceed 1
year.

Agents and Deputies for Collection of National Internal Revenue Taxes

The following are constituted agents for the collection of internal revenue taxes:
1. The Commissioner of Customs and his subordinates with respect to collection of national internal revenue
taxes on imported goods.
2. The head of appropriate government offices and his subordinates with respect to the collection of energy tax.

3. Banks duly accredited by the Commissioner with respect to receipts of payments of internal revenue taxes
authorized to be made thru banks. These are referred to as authorized government depositary banl<s (AGDB).

OTHER AGENCIES TASKED WITH TAX COLLECTIONS OR TAX INCENTIVES

RELATED FUNCTIONS
1. Bureau of Customs
2. Board of Investments
3. Philippine Economic Zone Authority
4. Local Government Tax Collecting Unit
5. Fiscal Incentives Review Board

Bureau of Customs (BOC)

Aside from its regulatory functions, the Bureau of Customs is tasked to administer collection of tariffs on
imported articles and collection of the Value Added Tax on importation. Together with the BIR, the BOC is
under the supervision of the Department of Finance.

The Bureau of Customs is headed by the Customs Commissioner and is assisted by five Deputy Commissioners and
14 District Collectors.

Board of Investments (BOI)

The BOI is tasked to lead the promotion of investments in the Philippines by assisting Filipinos and foreign
investors to venture and prosper in desirable areas 0 economic activitiesn It supervises the grant of tax incentives
under the Omnibus ILygytment Code. The BOI is an attached agency of the Department of Trade and

Industry (DTI).

The BOI is composed of five full-time governors, excluding the DTI secretary as its Chairman. The President of
the Philippines shall appoint a vice chairman of the board who shall act as the BOI's managing head.
Philippine Economic Zone Authority (PEZA)
The PEZA is created to promote_investments in export-orientedananufactut industries in the Philippines
and, among other myriads Offunctions' supervise, grant of both fiscal and non-fiscal incentives.
PEZA registered enterprises enjoy tax holidays for certain years, exemption fro import and export taxes
including local taxes. The PEZA is also an attached of the DTI.

The PEZA is headed by a director general and is assisted by three dept directors.

Local Government Tax Collecting Units

Chapter 2 - Taxes, Tax Laws and Tax Administration
Provinces, municipalities, cities and barangays also imposed and collect variq local taxes, fees and charges to

rationalize their fiscal autonomy.

The special tax treatments of BOI-registered or PEZA-registered enterpris including the local taxes imposed
by local governments will be discussed unde Local & Preferential Taxation by the same author.

Fiscal Incentive Review Board (FIRB)

FIRB has oversight function on the administration and grant of tax incentives the Investment Promotion
Agencies and other government agencies administeri tax incentives. It approves or disapproves grant of tax
incentives to priv entities and tax subsidies to government-owned and controlled corporati0 government
instrumentalities, government commissaries, state universities colleges.

TAXPAYER CLASSIFICATION FOR PURPOSES OF TAX ADMINISTRATION For purposes of

effective and efficient tax administration, taxpayers are classifiei into:
1, Large taxpayers — under the supervision of the Large Taxpayer Service (LT5 of the BIR National Office.
2. Non-large taxpayers - under the supervision of the respective Revenue District Offices (RDOs) where the
business, trade or profession of the taxpayd is situated
Criteria for Large Taxpayers:
A. As to payment
1. Value Added Tax- At least P200,000 per quarter for the preceding year
2. Excise Tax-At least P 1,000,000 tax paid for the preceding year
 Chapter 2 Taxes, Tax Laws and Tax Administration

3. Income Tax - At least P 1,000,000 annual income tax paid for the preceding year
4. Withholding Tax - At least P 1,000,000 annual withholding tax payments or remittances from all
types of withholding taxes
5. Percentage tax - At least P 200,000 percentage tax paid or payable per quarter for the preceding year
6. Documentary stamp tax - At least P 1,000,000 aggregate amount per year

B. As to financial conditions and results of operations

1. Gross receipts or sales - P 1,000,000,000 total annual gross sales or receipts
2. Net worth - P 300,000,000 total net worth at the close of each calendar or fiscal year
3. Gross purchases - total annual purchases for the preceding year
4. Top corporate taxpayer listed and published by the Securities and Exchange Commission

Automatic classification of taxpayers as large taxpayers

The following taxpayers shall be automatically classified as large taxpayers upon notice in writing by the CIR:
1. All branches of taxpayers under the Large Taxpayer's Service
2. Subsidiaries, affiliates, and entities of conglomerates or group of companies of a large taxpayer
3. Surviving company in case of merger or consolidation of a large taxpayer
4. A corporation that absorbs the operation or business in case of spin-off of any
large taxpayer
5. Corporation with an authorized capitalization of at least registered with the SEC
6. Multinational enterprises with an authorized capitalization or assigned capital of at least
7. Publicly listed corporations
8. Universal, commercial, and foreign banks (the regular business unit and foreign currency deposit unit shall
be considered one taxpayer for purposes of classifying them as large taxpayer)
9. Corporate taxpayers with at least P 100,000,000 authorized capital in banking, insurance,
telecommunication, utilities, petroleum, tobacco, and alcohol industries
10. Corporate taxpayers engaged in the production of metallic minerals
Chapter

CHAPTER 3
INTRODUCTION To INCOME TAXATION

Chapter Overview and Objectives

This chapter discusses the concept of tax income, the situs of income, and the types of taxpayers.

After this chapter, readers are expected to comprehend and demonstrate knowledge on the following:
 3 - Introduction to Income Tax
1. The concept of gross income
2. The types of income taxpayers
3. The general rules in income taxation
4. The income tax situs rules

THE CONCEPT OF INCOME

Why is income subject to tax?
Income is regarded as the best measure of taxpayers' ability to pay tax. It is an

excellent object of taxation in the allocation of government costs.

What is income for taxation purposes?

The tax concept of income is simply referred to as "gross income" under the NIRC. A taxable item of income
is referred to as an "item ofgross Income" or "inclusion in gross income .
Gross income simply means income n layman's term. Under the NIRC however, the term "taxable income"
refers to certain items of gross income less deductions and personal exemptions allowable by law.
Technically, gross income is broader to pertain to any income that can be subjected to income tax.

Gross income s broadly defined as any to the taxpayer from w ateve source, legal or illegal, that increases net
worth. It inc udes income from employment, de, business or exercise of profession, income from properties,
and other sources such as dealings in properties and other regular or casual transactions.

ELEMENTS OF GROSS INCOME

1. It is a return on capital that increases net worth.

2. It is a realized benefit.
3. It is not exempted by law, contract, or treaty.
ON CAPITAL apital eans any
wealth or pypperty. property that increases the
taxpayer s
net worth.
Illustration
is a return on wealth 01
ABC purchased goods for P300 and sold them for P500. The P500 consideration analyzed as follows:

Selling price (total consideration received) P 500 Total return

Cost (value of inventory forgone) 300 Return of capital
Mark-up (gross income) P—2.00 Return on capital

Th return on capita that increases net worth is-incomesubjecEtoÄncome Return o apital merely
main!ains net worth; hence, it is taxable. improvement in net worth indicates an ability to
pay tax.

Capital items deemed with infinite value

63
 Chapter 3 - Introduction to Income Tax
There are capital items that have infinite-value and are incapable of pecunial) valuation. Anything received as
compensation for their loss is deemed a returnoj capital. Examples:
1. Life
2. Health
3. Human reputation

Life
The value of life is Under Sec. 32 of the NIRC, the proceeds of life insurance
d
policies paid to the heirs or beneficiaries upon death the insured, whether in a single sum or otherwise, are exempt
from income tax,
The proceeds of a life insurance contract collected by an employer as a beneficiar from the life insurance of an
officer or any person directly interested with trade are likewise exempt. These proceeds are viewed as advanced
recovery future loss.
However, the following are taxable return on capital from insurance policies:
a. Any excess amount received over premiums paid by the insured surrender or maturity of the policy (i.e.
the insured outlives the policy.)
b. Gain realized by the insured from the assignment or sale of his insuran policy
c. Interest income from the unpaid balance of the proceeds of the policy
d. Any excess of the proceeds received over the acquisition costs and premi payments by an assignee of a life
insurance policy
 Chapter 3 - Introduction to Income Tax
Health
Any compensation received in consideration for the loss of health such as compensation for personal injurieS Or
tortuous acts is deemed a return of capital.

Human Reputation
The cannot be measured financially. Any indemnity received as
compensation for its impairment is deemed a returmof capital exempt from income tax.

Examples include moral damages received from:

a. Oral defamation or slander
b. Alienation of affection
c. of promise to marry

Recovery of lost cppital vs. Recovery of lost profits

The loss of capital results in decrease in net worth while the loss of profits does not decrease net worth. The
recovery of lost capital merely maintains net worth while the recovery of lost profits increases net worth.
Therefore, the recovery of lost profits is a return on capital.

Taxable recovery of]ost profits

The recovery ofloSt profits through insurance, indemnity contracts, or legal suits constitutes a taxable return on capital.

The following are taxable recoveries of lost profits:

a. Proceeds of crop or livestock insurance
b. Guarantee payments
c. Indemnity received from patent infringement suit

Illustration 1
Mang Reyes insured his strawberry crop in a P 200,000 crop insurance coverage against calamities. The crop
was eventually destroyed by an unusual frost. Mang Reyes was paid the P200,000 insurance proceeds.
The P200,000 proceeds which is a reimbursementfor the lost value of the future harvest, is an item of gross
income. The value of the lost crops is, in effect, realized not through actual harvest but through the
insurancesontract.

Illustration 2
Mr. Ramos purchased a franchise. The franchisor guaranteed an annual franchise income of P 100,000 to Mr.
Ramos. In the first year of operation, Mr. Ramos'outlet only earned P60,000. The franchisor paid the 40,000
difference to Mr. Ramos.
The P40,OOO guarantee payment is not a gratuity but d recovery of lost profitn(grranchlse Ramos; hence,
subject to income tax, Mr. Ramos shall report PIOO,OOO as income.

Illustration 3
Davao Crocodile Inc. experienced an unusual decline in its income after a competitor copied its patented
invention. Davao Crocodile sued the competitor for patent infringement and was awarded an indemnity of
P3,0()0,00().

The P3,OOO,OOO indemnity is a compensation for the income not realized by Davao Crocodile due to the
patent infringement. The same is an item ofgross income
65
 Chapter 3 - Introduction to Income Tax
The recovery of lost income or profits is not intended to compensate for the loss of capital. It is as good as
realization of income; hence, it is an item ofgross income.

REALIZED BENEFIT
What is meant by realized benefit?
The "benefit" concept
The term "benefit' means any form of advantage derived by the taxpayer. There is benefit when there is an
increase in the net worth of the taxpayer. An increase in net worth occurs when one receives income,
donation or inheritance.

The following are not benefits, hence, not taxable:

a. Receipt of a loan - properties increase but obligations also increase resulting in an offsetting effect in net worth.
b. Discovery of lost properties - under the law, the finder has an obligation to return the same to the
owner.
c. Receipt of money or property to be held in trust for, or to be remitted to, another person.

If the taxpayer is entitled to keep for his account portion of a receipt, only th at portion is a benefit.
Illustration

1. An employee was granted P 20,000 transportation advance. He liquidated P18,0 00 transportation

expenses and was allowed by his employer to keep the P2,0 00' Only the P2,000 retained by the
employee is considered income since this was t hey extent he was benefited. (RR2-98)

2. A security agency receives P 120,000 from clients, P 100,000 of which is for the salaries of security
guards. Under RMC 39-2007, only attributable to the agency is considered income of the agency since
it is the extentit is
The P100,000 pertaining to salaries of security guards is recognized by the agend as a liability

upomreceipt,
The "realized" concept
The term realized means arne . t requires that there is a degree of undertaking or sacrifice from the taxpayer to be
entitled of the benefit.

Requisites of a realized benefit: Qeo)tl//, —

1. There must be an exchange transaction.

2. The transaction involves another entity. 3. It increases the net worth of the recipient.

Types of Transfers

1. Bilateral transfers or exchanges, such as:

a. Sale
 Chapter 3 - Introduction to Income Tax
b. Barter
These are referred to as "onerous transaction".

2. Unilateral transfers, such as:

a. Succession - transfer of upon death
property
b. Donation

These are also referred to as "gratuitous transactions".

Under current usage, unilateral transfers are simply referred to as "transfers" while bilateral transfers are called
"exchanges." Benefits derived from onerous transactions are "earned or realized"; hence, they are subject to
income tax. Benefits derived from gratuitous transactions are not realized because of the absence of an earning
process. Benefits derived from gratuitous transactions are subject to Cr_qnsferggx, not income tax.

3. Complex transactions
Complex transactions are partly gratuitous and partly onerous. These are commonly referred to as 'transfers for
less than full and adequate consideration" The a tuto portion of the transaction is subject to transfer tax while
the bene It rom the ibnerous portion is subject to income tax.

Illustration
A taxpayer sold his car which was previously purchased for P 100,000 and with a current fair value of P18U00 for
only P 130,000.
The transaction will be analyzed as follows:
Fair value P 180,000

P50,OOO - Su •ect to transfer tax

Selling price 130,000
P30,OOO - Subject to income tax
Cost 100,000
The gggss_oifair-value.oyerselliwprice is a gratuity or gift Whereas the excess of the selling price over the
cost is an item of gross income.

What is meant by another entity?

Every perso ural or juridical, is an entity. atural persons are living persons while ridical person are those
created by law suc artnerships and corporations. n entity may be a taxable entity or an exempt entity. A t
able item of gross income arises from transactions which involve another natural juridical entity.

Gains or income derived between relatives, corporations, and between a partner and the partnership are
taxable since it is made between separate entities, Likewise, the income between affiliated companies such
as between a holding or parent company and its subsidiaries and between sister companies are taxable
because each corporation is a separate entity. This applies regardless of the underlying economic
relationship.

67
 Chapter 3 - Introduction to Income Tax
However, the sales of a home office to its branch office are not taxable because

they pertain to one and the same taxable entity. Furthermore, the income between businesses of a proprie r
should not be taxed since proprietorship businesses are ptnnS on I taxable upon t e same- owner. Note that a
proprietorship business is not a juridical entity. gov)dl

Benefits in the absence of transfers

The increase in wealth of the taxpayer in the form of appreciation or increase in the value of his
properties or decrease in the value of his obligations in the absence of a sale or barter transaction is not
taxable.

These are referred to as unrealized gains orholding gains because they have yet materialized
imanexchange transaction.
Examples of GÄfiiLGfiÉöFholding_gains.
a. Increase in value of investments in equity or debt securities
b. Increase in value of real properties held (revaluation increment)
c. Increase in value of föFéiERÄÜFFencies held or receivable
d. Decrease in value of foreign currency denominated debt by virtue of favorable fluctuation in
exchange rates
e. Birth of animal offspring, accruals of fruits in an orchard or growth of vegetables
f. _oncrease in value of I d due to the discovery of mineral reserves

dering ofservice
The ren ering of services for a consideration is an exchange but does not cause) loss of capital. Hence,
the$ntire consideration received from rendering of sexN!cé such as compensation income or service féés
IS an item of gross income.

Illustration
Mr. Mendoza lists the following possible items of gross income:
Compensation income P 200,000 Winnings from gambling 1 oo,ooo

Increase in value of investments ! 50,000 Appreciation in the value of land owned

300,000 Debt of Saladin cancelled by creditors in consideration for services he
rendered to them 150,000
Debt of Saladin cancelled by his creditor out of'affcction 250,000 Loan received
from a bank 400,000 The items of gross income are:
Compensation income P 200,000
Winnings from gambling 1 oo,ooo
Debt of Mendoza forgiven in consideration for service rendered to his creditors
150,000
Note:
1. Gains from gambling and the forgiveness of debt in consideration of services or properties received are
realized gains from exchanges.
2. The forgiveness of debt out of affection or mere generosity of the creditor is a gratuitous transfer subject
to transfer tax.
3. The loan received from a bank constitutes a transfer but is not a benefit.
 Chapter 3 - Introduction to Income Tax
Basis of Exemption of Unrealized Income
Normally, taxpayers will have the ability to pay tax when their income materializes in an exchange transaction since
tax is generally payable in money.
This does not mean, however, that only income realized in cash is slibject to tax. Income realized in non-
cash properties are, in effect, received in cash but the taxpayer used the same to acquire the non-cash
property. Income received in noncash considerations is taxable at the fair value of the property received.
Moreover, exemptin income realized in non-cash considerations would open a wide avenue for x evasio
sincf taxpayers can easily divert their income in the form of noncash consideration.

Mode of Receipt/Realization Benefits

Taxable items of income may be realized by the taxpayer in two ways: 1, Actual receipt
Actual receipt involves actual physical taking of the income in the form of cash or property.
2. Constructive receipt
Constructive receipt involves noactual physical-taking of the income but the taxpayeris effectively benefited,

69
 Chapter 3 - Introduction to Income Tax
Examples:
a. Offset of debt of the taxpayer in consideration for the sale of goods servi e

c. (Matu düetachable interest coupons on coupon bonds not yet encashet

by the taxpayer
d. Increase-in-the capital of a partner from the profit of the partnership

Inflow of wealth without increase in net worth

The inflow of wealth to a person that does not increase his net worth is Act, income-due to the total
absence of benefit.
Examples:
a. Receipt of property in trust
b. Borrowing of money under an obligation to return

In law, the proceeds of embezzlement or swindling where money is taken without an original intention to
return are considered as income because of the increase in net worth of the swindler.

NOT EXEMPTED BY LAW, CONTRACT, OR TREATY

An item of gross income is not exempted by the Constitution, law, contracts or
treaties from taxation.

The following items of income are exempted by law from taxation; hence, they are not considered items
of gross income:
i. Income o qualified employee trust fund
2. Revenues educational institutions
3. SSS, GSIS, Pag-lBIG, or PhilHealt benefits
4. Salaries and wages of minimum wage earners and qualified senior citizen
5. Regular income of Barangay Micro-business Enterprises (BMBEs)
6. Income of foreign governments and foreign government-owned controlled corporations
7. Income of international missions and organizations with income tax immun iW

Items of gross income that are exempted from taxation are discussed extensively under Exclusions in
Gross Income in Chapter 8.

TYPES OF INCOME TAXPAYERS

A. Individuals
1. Citizen
a. Resident citizen
b. Non-resident citizen
Chapter

2. Alien
a. Resident alien

70
 3 - Introduction to Income Tax
b.

TAXPAYERS
Non-resident alien
a. engaged in
b. not engaged
3. Taxable estates
1
B. Corporations
1. Domestic corporation 2. Foreign corporation
a. Resident foreign
b. Non-resident NDIVIDUAL INCOME

Citizens
Under the Constitution, citizens are:
a. Those who are citizens of the Philippines at the time of adoption of the Constitution on February 2, 1987
b. Those whose fathers or mothers are citizens of the Philippines
c. Those born before January 17, 1973 of Filipino mothers who elected Filipino citizenship upon reaching the age
of majority
d. Those who are naturalized in accordance with the law

Classification of citizens:
A. Resident citizen - A Filipino citizen residing in the Philippines
B. Non-resident citizen includes:
1. A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his
physical presence abroad with a definite intention to reside therein;
2. A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad,
either as an immigrant or for an employment on a permanent basis;
3. A citizen of the Philippines who works and derives income from abroad and whose employment
thereat requires him to be physically present abroad most of the time during the taxable year;

4. A citizen who has been previously considered as non-resident citizen and who arrives in the
Philippines at anytime during the taxable year to reside permanently in the Philippines shall
likewise be treated as a non-resident citizen for the taxable year in which he arrives in the

71
 Chapter 3 - Introduction to Income Tax
Philippines with respect to his income derived from sources abroad until the date of his arrival in
the Philippines
Fjli@nos working in ilippine embassies or Philippine consulate_Qfüges are considered non-resident

Alien

A. Resident alien - an individual who is residing in the Philippines but citizen thereof, such as:

1. An alien who lives in the Philippines without definite intention as to $ay; or

2. One who comes to the Philippines for a definite purpose which in it} nature would require an
extended stay and to that end makes his horæ temporarily in the Philippines, although it may be
his intention at all tirnz to return to his domicile abroad;

An alien who has acquired residence in the Philippines retains his status z such until he ahandons the
same or actually departs from the Philippines.

B. Non-resident alien - an individual who is LUresiding in the Philippines and who i a citizen
hereof
1. Non-resident aliens €ng_gged in business (NRA-ETB)- aliens who stayed in the Philippines for an
aggregate period of more than 180 days during the year
2. Non-resident aliens not enga in business (NRA-NETB) - include:
a. Aliens who come o e Philippines for a definite purpose which in iC nature may be promptly
accomplished;
b. Aliens who shall come to the Philippines and stay therein for aggregate period of not more
than 180 days during the year

THE GENERAL CLASSIFICATION RULE FOR INDIVIDUALS

1. Intention
The intention of the taxpayer regarding the nature of his stay within outside the Philippines shall
determine his appropriate residenc classification. The taxpayer shall submit to the CIR of the BIR documentar
proofs such as visas, work contracts and other documents indicating sud intention.

Documents purporting short term stay such as tourist visa shall not result the the
taxpayer's normal residency. Documents purporting a long-term stay such as jmmigration.visa
or_working visa for an extended period would result in the automatic
reclassification of the taxpayer's residency.
Chapter

Examples:
a. An alien is normally non-resident. An alien who come to the Philippines with a tourist visa would still be
classified as non-resident alien.
b. A citizen is normally resident. A citizen who would go abroad under a tourist visa would still be considered
a resident citizen.
c. An alien who come to the Philippines with an immigration visa would be reclassified as a resident alien
upon his arrival.
d. A citizen who would go abroad With a two,year working visa would be reclassified as a non-resident citizen
upon his departure.

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 3 - Introduction to Income Tax
2. Length of stay
In default of such documentary proof, the length of stay of the taxpayer is considered:
a. Citizens staying abroad for a period of at(least 183 days are considered non,resident.
b. Aliens who stayed in the Philippines for more than 1 year as of the end of the taxable year are considered
resident.
c. Aliens who are staying in the Philippines for not more than 1 year but more than 180 days are deemed non-
resident aliens engaged in business.

d. Aliens who stayed in the Philippines for not more than 180 days are considered non-resident aliens not
engaged in trade or business.
Illustration 1
Daniel Mario Aresmendi, a Mexican actor, was contracted by a Philippine television company to do a project in
the Philippines. He arrived in the country on February 29, 2021 and returned to Mexico three weeks later upon
completion of the project.

Daniel Mario Aresmendi shall be classified as an NRA-NETB in 2021. His stay is for a definite purpose which in its
nature will be accomplished immediately.

Illustration 2
Mamoud Jibril, a Libyan national, arrived in the country on November 4, 2021 Mr. Jibril stayed in the Philippines
since then without any working visa or work permit.
For the year 2021, Mr. Jibril would be considered an NRA- NETB because he stayed in
the Philippines for less than 180 days as of December 31, 2021. If he is still within the
Philippines until December 31, 2022, he will qualify as a resident alien for 2022.

Illustration 3
Without any definite intention as to the nature of his stay, Juan Miguel, a Filipino citizen, left the Philippines and
stayed abroad from March 15, 2020 to April 1, 2021before returning to the Philippines.

For the year 020,Juan is a non-resident citizen because he is a sent for more than 183 days but he will be
classified as resident citizen for the yea/ 2021 ecause he is absentfor less than 183 days in 2021.

Taxable Estates and Trusts

1. Estate
Estate erties, rights, and
refers to the ro obligations of a deceased person (iJQ_€fYInguished byhis dea

Estates under judicial settlement are treated as individual taxpayers. The estate is taxable on the income of the
properties left by the decedent. Estates under extrajudicial settlement are exempt entities. The income of the
properties of the estate under extrajudicial settlement is taxable to the heirs,

2. Trust
A trust is an arrangement whereby one person (grantor or
trustor) transfers (i.e. donates) property to another person (beneficiary), which will be held unde the
management of a third party (trustee orfiduciary).
e a pea c!
A trust that_is • revocablSmåesignated by the grantor is treated in taxation as if it is an ndividual
taxpa r. The income of the property held in trust is taxable to the trust. s that are designated as

73
Chapter 3 - Introduction to Income Tax
revocable by the grantor are not taxable entities and are not considered as individual taxpayers. The
income of properties held under revocable trusts is taxable to the grantor not to the trust.
When the trust agreement is silent as to revocability of the trust, the trust is presumed to be revocable.

CORPORATE INCOME TAXPAYERS

The term 'corporation' shall include one person corporations (OPCs), partnerships, no matter how created
or organized, joint-stock companies, joint accounts, association, or insurance companies, except general
professional partnerships and a joint venture or consortium formed for the purpose Of
projects or engaging in petroleum, coal, geothermal,and other energy
operations pursuant to an operating consortium agreement under a

service contract with the government.

Hence, the term corporation includes profit-oriented and non-profit instituti0nS such as charitable
institutions, cooperatives, government agencies and instrumentalities, associations, leagues, civic or
religious and other organizations

Domestic Corporation
A domestic corporation is a corporation that is organized in accordance with Philippine laws. It includes
one-person corporations (OPC) owned and registered by resident citizens in the Philippines.

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 Chapter 3 - Introduction to Income Tax

Foreign Corporation
A foreign corporation is one organized under a foreign Jaw.

Types of foreign corporations:

1. Residentforeign corporation (RFC) - a foreign corporation which operates and conducts business
in the Philippines through a permanent estabJi%hrncnt (i.e. a branch).
2. ntforeign corporation (NRFC) a foreign corporation which does at or conduct business in
the
Note:
1. A corporåtion that incorporates jn the Philippines a domestic corporation under the Incorporation Test even
if the same js controlled by forejgners,
2. A foreign corporation that transacts business with througjj a resident branch i", taxable on such transactions
as a resident foreign corporation through branch, However, if it transacts directly to residents outside its
branch, it is t%'/.abje as a non-reoident foreign corporation on the direct transactions.
3. An individual that establishes a one-person corporation (()PC) shall be t;szable ac a co!tporate taxpayer for
the business transactions of the OPC but he shall be %ubject to taz aq an individual for his personal
transactions.

Special Corporations
Special corporations are domestic or foreign corporations which are subject to {P-SiaLtaxrulesor preferential tax rates.

OTHER CORPORA TE TAXPA VERS

1. One-person corporation
A one-person corporation is a corporation with a single stockholder who may be a natural person, trust or an
estate.

Banks and quasi-banks, preneed, trust, insurance, public and publicly-listed companies, and non-chartered
G()CCs may not incorporate as One-person corporations. A natural person who js licensed to exercise a
profession may not organize as a One Person Corporation for the purpose of exercising such profession
except as otherwise provided under special laws.

2. Partnership
A partnership is a business organization owned by two or more persons who contribute their industry or
resources to a common fund for the purpose of dividing the profits from the venture.

Types of partnership
a) General professional partnership (GPI))

A GPP is a partnership formed by persons for the sole purpose of exercising a common profession,
no part of the income of which is derived rom engaging in any trade or business.
A GPP is not treated as a cor oratientity. It is exempt not a taxablefrom incorne tax, but
the artners are taxabl in their individual capacity
with respect to their share in t e Income of the partnership:
b) Business partnership

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 Chapter 3 Introduction to Income Tax

A business partnership is one formed for profit. It is taxable as a corporation.

Examples:
a. A partnership between Atty. Mendoza, a lawyer, and Mark Santos, an accountant, to practice in
taxation advisory services would be a business partnership since theywopartners are not in the same
profession.
b. A partnership between accountants Khim and Vhinson to venture into a beauty parlor would be a
business partnership since the venture is not in practice of a common profession.

c. A partnership between accountants Juan and Miguel to venture into audit services would be a general
professional partnership.
d. Dentists Wency and Andy partnered to operate a dental clinic. During slack season, they are converting
their clinic into a beauty saloon. Their partnership is a business partnership since it is earning income from
business.

3. Joint venture
A joint venture is a business undertaking for a particular purpose. It may be organized as a partnership
oråcorporätlon.

Types of joint ventures:

a. Exemptjoint ventures

Exempt joint ventures are those formed for the purpose of undertaking

or engaging in petroleum, coal, geothermal an d other energy operations

pursuant to an operating consortium agreément underasgcyüce_gontractwith.the Government.

Simil oaGP.PcE%is type of joint venture is not treated a r oration

andi its regular income, but their enturer are tax le to their shareinihe net income of the joint
venture.

b. Taxablejoint ventures
All other joint ventures are taxable as corporations.
4. Co-ownership
A co-pwnership ris joint ownership of a property formed for the purpose of preserüiii@ihé same and/or dividing
its income.

A co-ovyn_ership that is limited to property preservation or income collection is not entity and
is exempt but the co-owners on their share on t e income of the co-owned property.

However, a co-ownership that reinvests the income of the co-owned property to other income-producing
properties or ventures will be considered an unregistered partnership taxable as a corporation.

THE GENERAL RULES IN INCOME TAXATION

 Chapter 3 - Introduction to Income Tax

Taxable on income earned

Individual a ers

Note:
1. Consistent with the territoriality rule, all taxpayers, except resident citizens and domestic corporations,
are taxable only on income earned within the Philippines.
2. The NIRC uses the term "without the Philippines" to mean outside the Philippines.

The Residency and Citizenship Rule

Taxpayers who are residents and citizens of the Philippines such as resident citizen and domestic corporations are
taxable on all income from sources within

and without the Philippines. A corporation is a citizen of the country of

incorporation. Thus, a domestic corporation is a citizen of the Philippines.

Basis of the extraterritorial taxation

Resident citizens and domestic corporations derive most of the benefits from the Phlhibfine governmen compare
to a other classes of taxpayers by v/r.Lue„of their proximity to the Philippine government.
 Chapter 3 Introduction to Income Tax
-

Under our laws, resident citizens and domestic corporations enjoy preferential privileges over aliens. Also,
between resident and non-resident citizens, resident citizens have full access of the public services of our
government because they are in the country. The taxation of foreign income of resident citizens and domestic
corporations properly reflects this difference in benefits consistent with the Benefit Received Theoo.'.

The extra-territorial tax treatment of resident citizens and domestic corporations is also intended as a safety net to
the potential loss of tax revenues brought by situs relocation or the practice of executing or structuring
transactions such that income will be realized abroad to avoid Philippine income taxes.

The issue of international double taxation

The rule on extraterritorial taxation on resident citizens and domestic corporaåons exposes these taxpayers to
double taxation. However, the NIRc allows a tax credit for taxes paid in foreign countries. In fact, resident
citizens and domesåc corporations pay minimal taxes in the Philippines on their foreign income because of the
tax credit.

SITUS OF INCOME
The situs of income is the place of taxation of income. It is the jurisdiction that has the authority to impose tax
upon the income.

Situs of income vs. source of income

Situs of income should be differentiated from the source of income. The latter pertains to the activity or
property that produces the income.

Situs is important in determining whether or not an income is taxable in th e Philippines. Situs is particularly
important to taxpayers taxable only on incom e within. However, it is also important to taxpayers taxable on
global income for purposes of the computation of the foreign tax credit.

INCOME SITUS RULES

Types of income
1. Interest income Debtor's residence
2. Royalties Where the intangible is employed
3. Rent incomeLocation of the property
4. Service income Place where the service is rendered
Illustration
A taxpayer had the following income:
Interest income from deposits in a foreign bank P 300,000
Interest from domestic bonds 50,000
Royalties from books published in the Philippines Rent income from 100,000
properties abroad (the lease
contracts were executed in the Philippines) 150,000
Professional fees for services rendered in the
Philippines to non-resident clients (paid in US J)ollars) 400,000

Applying the situs rules, the following are the situs of the aforementioned income:
Within Without World total
Interest on foreign deposits P 300,000 P 300,000

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 Chapter 3 - Introduction to Income Tax
Interest from domestic bonds 50,000 50,000
Royalties from books in the Philippines 100,000 100,000
Rent income on foreign properties 150,000 150,000
Professional fees Total
40
0.000 400.000
Resident citizen or domestic corporation taxpayers would be taxable on the world income while other
taxpayers would be taxable only on the income from within the Philippines.

OTHER INCOME SITUS RULES

A. Gain on sale of properties
1. Personal property
Domestic securities - presumed earned within the Philippines y/ Other personal properties -
earned in the place where the property is sold

2. Real property - earned where the property is located

Illustration
A taxpayer had the following income:

Gain on sale of domestic stocks P 200,000 Gain on sale of foreign bonds

100,000
Gain on sale of a commercial lot in Baguio City 500,000 Gain on sale of car in
Ontario, Canada 200,000
Gain on sale of machineries in Mexico, Pampanga 250,000
Interest income on foreign bonds 50,000
Dividends on domestic stocks 150,000
The following table summarizes the situs of the foregoing income:
Within Without
Gain on sale of domestic stocks P 200,000
Gain on sale of foreign bonds P 100,000
Gain on sale of commercial lot 500,000
Gain on sale of car in Canada 200,000
Gain on the sale of machineries 250,000
50,000
Interest on foreign bonds
Dividends on domestic stocks 150.000
Total
P 3501000
B. Dividend income from:

1. Domestic corporation - presumed earned Within the Philippines

2. Foreign corporation

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 Chapter 3 Introduction to Income Tax
a) Resident foreign corporation — depends on the pre-dominance test
The pre-dominance test
If the ratio of the Philippine gross income over the world gross income of the resident
foreign corporation in the three-year period preceding the year of dividend declaration is:
Y/ At least 50%, the portion of the dividend corresponding to the
(Philippine gross Income ratio is earned within
Less than 50%, the entire dividends received is
earned abroad

b) Nogzcesidentfgreigp_gorporation - earned abroad

Illustration
In 2021, Sarah received a P400,000 dividend income from ABC Corporation. ABC Corporation had the
following gross income in 2018 through 2020:
2018 -—2019— 2020 Total
Philippines P 100,000 P 200,000 P 300,000 P 600,000 Abroad 200.000100.000
100.000400 000 Total P 1,000.000

If ABC Corporation is a:
1. Domestic corporation - the entire P400,000 is earned within
2. Non-resident foreign corporation - the entire P400,000 is earned abroad
3. Resident foreign corporation - the P400,000 dividend shall be split
Gross Income Ratio =
Earned within the Philippines (60% x P400,000) P 240,000
Earned withoÜt the Philippines (40% x P400,000) 160.000 Total dividends

supposing that the ratio is, 49%, the entire P400,000 will be deemed earned outside the Philippines.

C. Merchandising income - earned where the property is sold

Illustration

Source of gross income Amount

Goods purchased and sold within P 200,000 D. Manufacturing
Goods purchased within and*Qld abroad 100,000 income - earned
where the goods are
Goods purchased abroad and sold within 150,000
manufactured and
Goods purchased and sold abroad 350,000 sold

The income earned within and without shall be:

Within Without
Purchased and sold within P 200,000
Purchased within and sold abroad P 100,000
Purchased abroad and sold within 150,000
Purchased abroad and sold abroad
350.000
Total P 350.000 P 450.000
Operations Remark

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 Chapter 3 - Introduction to Income Tax
Production Distribution
Within Within Total income from production and distribution is earned
within the Phili ines
Without Without Total income from production and distribution is earned
without the Phili ines
Within Without Production income is earned within,
Distribution income is earned without
Without Within Distribution income is earned within,
Production income is earned without
Illustration 1
Island, Inc. manufactures goods and sells them through its branch. Island bills its branch at established market
prices. Island reported the following gross income:

Home office Branch

Sales
Cost of goods sold 2,400.000 1.200000 3,600.000

Gross income
-

The following shows the situs of the gross income of Island under each of the following scenario:
Scenar-i.Q Home office Branch Within Without
No. 1 Philippines Philippines P 2,400,000 P 0
Abroad Abroad
No. 3 Philippines Abroad
Abroad Philippines
Note:
1. Both production and distribution are conducted by the same taxable entity, Island, Inc.
2. The branch is not a separate taxable entity, but an integral part of Island, Inc.; hence, its income is
taxable to Island Inc.

Illustration 2
Assuming production is conducted by a parent corporation and the distribution is

conducted by its subsidiary corporation:

Parent Subsidiary Total
Sales
Cost of goods sold 2 400 000 1 200 000 3 600 000

Gross income P 800,000 P 2400.000

The gross income recognized by each corporation is taxable to each corporation because each
corporation is a separate taxpayer. The situs of taxation shall be the place of sale without regard to
the seller or the supplier.

The following are the situs of income for the parent corporation:

Scenario Parent Subsidiary Within Without

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Chapter 3 Introduction to Income Tax
No. 1 Philippines Philippines P
No. 2 Abroad Abroad
Philippines Abroad
Abroad Philippines

The following are the situs of income for the subsidiary corporation:
Scenario Parent Subsidiary Within Without
No. 1 Philippines Philippines P 800,000 P
No. 2 Abroad Abroad 800,000
Philippines Abroad 800,000
No. 4 Abroad Philippines 800,000
Note to readers:
Readers are advised to master the situs rules as this have a significant effect on your
comprehension of advanced tax rules to be introduced in succeeding chapters.

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 Income Tax Schemes, Accounting Periods, Methods, and Reporting
Chapter 4 —

CHAPTER 4
INCOME TAX SCHEMES, ACCOUNTING PERIODS, ACCOUNTING METHODS, AND REPORTING

Chapter Overview and Objectives

This chapter provides an overview of the income tax schemes under the NIRC,

After this chapter, readers are expected to gain familiarization and demonstrau mastery of the following:
a. Types of taxation schemes and their scope
b. Concept of accounting period and its types
c. Concept of accounting methods and their accounting procedures
d. Types of tax returns, their deadline and place of filing

INCOME TAXATION SCHEMES

There are three income taxation schemes under the NIRC:
a. Final income taxation
b. Capital gains taxation
c. Regular income taxation

An item of gross income is taxable in any of these tax schemes.

Mutually exclusive coverage

The tax schemes are mutually exclusive. An item of gross income that is subject tax in one scheme will
not be taxed by the other schemes. Similarly, items income that are exempted in one scheme are not
taxable by the other schemeS
CLASSIFICATION OF ITEMS OF GROSS INCOME
Because of the different tax schemes, -items of gross income can be classified as follows:
1. Gross income subject to final tax
2. Gross income subject to capital gains tax

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 Chapter 4— Income Tax Schemes, Accounting Periods, Methods, and Reporting
3. Gross income subject to regular tax

Readers are advised to master the coverage of both final income tax and capital gains tax. A
thorough understanding of these exceptional tax treatments is vety essential to your mastery
ofIncome Taxation.

OilNAL INCOME TAXATION

Final income taxation is characterized by final taxes wherein full taxes are withheld b the income payor at
source. The recipient income taxpayer receive the income net of taxes. The payor is the one required by law to
remit the to the government. Consequently, the re • ient income taxpayer does not need to file income tax returns
because the withheld tax constitutes the and are erefore payments. This sys a Ion IS re erre to as the final
withholding tax sys e
fu tax ue
Final taxation eeme Ina is applicable only on certain passive income listed by the law.
Not all items of passive income are subject to final tax.

Passive income vs. active income

Passive incomes are earned with very minimal or even without active involvement of the taxpayer in the earmng
process.
Examples of passive income:
1. Interest income from banks—
2. Dividends from domestic corporations
3. Royalties

Active or regular income arises from transactions requiring a conslderable-degree of effort or undertaking
from the taxpayer. It is the direct opposite of passive income.

Examples of active income:

1. Compensation income /
2. Business income /
3. Professional income

Final income taxation will be discussed in detail in Chapter 5.

Chapter 4 —

CAPITAL GAINS TAXATION

Capital gains tax is imposed on the gain realized on the sale, dispositions of certain
capital asset<

Capital assets are assets not used in business, trade or profession. Capital asset! are the opposites of
ordinary assets. Ordinary assets are assets used in businey trade or profession such as inventory, supplies or
property, plant and equipment

Also, not all capital gains are subject to capital gains tax. Most of them are subjeq to regular income tax.

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 Income Tax Schemes, Accounting Periods, Methods, and Reporting
The NIRC identifies capital gains tax as a nal ta but they are hybrid forms of final taxes since it also
employs self-assessment method. The tg»ayer-stjll files capital ains tax return he ain o th ment
Ca i ins taxation applies only to two types of capital assets: gypestlcstpe and al property.

Capital gains taxation will be discussed in detail in Chapter 6.

REGULAR INCOME TAXATION

The regular income tax is the general rule in income taxation and covers all other income such as:
1. Active income
2. Other income
a. Gains from dealings in properties, not subject to capital gains tax
b. Other not subject to final tax

Items of gross income from these sources are valued or measured using accounting method, accumulated
over an accounting period, and reported government through an income tax return. Regular income
taxation makes use the self-assessment method.

ACCOUNTING PERIOD
Accounting period is the length of time over which income is measured reported.

Types of Accounting Periods

1. Regular accounting period - 12 months in length
a. Calendar
b. Fiscal
2. Short accounting period - less than 12 months
Calendar year
The calendar accounting period starts from January 1 and ends December 31. This accounting period is
available to both corporate taxpayers and individual taxpayers.

Under the NIRC, the calendar year shall be used when the:
1. taxpayer's annual accounting period is other than a fiscal year (i.e. longer than 12 months in length)
2. taxpayer has no annual accounting period (i.e. less than 12 months in length)
3. taxpayer does not keep books
4. taxpayer is an individual

Fiscal year
A fiscal accounting period is any 12-month period that ends on any day other than December 31. The fiscal
accounting period is available only to corporate income taxpayers and is not allowed to individual income
taxpayers.

Deadline of Filing the Income Tax Return

Under the NIRC, the return is due for filing on the fifteenth day of the fourth month following the close of
the taxable year of the taxpayer. The regular tax due is payable upon filing of the income tax return.
Illustration: Due date of the annual income return
1. Taxpayers under the calendar year must file their annual income tax return for the current period not later
than April 15 of the following year.

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Chapter 4— Income Tax Schemes, Accounting Periods, Methods, and Reporting
2. A corporate taxpayer with fiscal year ending June 30, 2021 must file its annual income tax return not later
than October 15, 2021.

INSTANCES OF SHORT ACCOUNTING PERIOD

1. Newly commenced business - The accounting period covers the date of the start of the business until the
désignated year-end of the business.
Illustration
Palawan Inc. started business operation on June 30, 2021 and opted to use the calendar year accounting
period.
Palawan should file its first income tax return covering June 30 to December 31, 2021 for the year 2021. The
return must befiled on or before April 15, 2022.

2. Dissolution of business - The accounting period covers the start of the current year to the date of dissolution
of the business.
Illustration

Tawi-tawi Inc. is on the fiscal year accounting period ending every March 31. It ceased business operation on
August 15, 2021.

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 Chapter Income Tax Schemes, Accounting Periods, Methods, and Reporting
4—

Tawi-tawi should file its last income tax return covering April 1 to August 15, 2021
Under the old NIRC, dissolving corporations shall file their return •thin 3() from the cessatiow of
activities-or%-days from the-Göbroval of merger by
Securities and Exchange Commission in the case of merger. (BPI vs. CIR,
144653, August 28, 2011). Hence, the return shall be filed on or before Septembe
UD2-r
For individuals„the return shall be due-on-or-before-April-15.2022. There is requirement for early
filing under the NIRC.

3. Change of accounting period by corporate taxpayers - The accountin; period covers the start of the
previous accounting period up to the designate year-end of the new accounting period. Note that BIR
approval is required changing an accounting period. It is not automatic.
Illustration 1
Effective February, 2021, Sulu Corporation changed its calendar accountin; period to a fiscal year
ending every June 30.

Sulu Corporation shallfile an adjustment return covering the income from January, to June 30, 2021
on or before October 15, 2021.

Illustration 2
Effective August 2021, Zamboanga Company changed its fiscal year accountl% period ending every
June 30 to the calendar year.
Zamboanga Company should file an adjustment return covering July I to Decembe 31, 2021 on or
before April 15, 2022.

4. Death of the taxpayer - The accounting period covers the start of calendar year until the death of the
taxpayer.

Illustration
Mr. Regonald died on November 2, 2021.
The heirs of Mr. Regonald or his estate administrators or executors shallfilefis income tax return
covering his income from January 1 to November 2, 2021. There: no requirement for early filing in
case of death of taxpayers. Hence, the income return shall befiled on or before the usual deadline,
April 15, 2022.

It must be noted that cut-off of income must be made at date--—egint oßde ab because properties such
as income accruing before death are part of the estate the decedent in Estate Taxation while those
income accruing after death are part thereof. Hence, it is mandatory for the accounting period of
the taxpayer to terminated exactly at the date of death.
5. Termination of the accounting period of the taxpayer by the Commissioner of Internal Revenue - The
accounting period covers the star-t-of-the-cuFFent year until the date of the termination of the
accounting period.

Illustration
Chapter 4— Income Tax Schemes, Accounting Periods, Methods, and Reporting
The accounting period of a taxpayer under the calendar year basis was terminated by the CIR on August 2,
2021.

The taxpayer must file an income tax return covering January 1 to August 2, 2021. The income tax return
and the tax shall be due and payable immediately.

ACCOUNTING METHODS
Accounting methods are accounting techniques used to measure income.

Types of Accounting Methods

1. The general methods
a. Accrual basis
b. Cash basis
2. Installment and deferred payment method
3. Percentage of completion method
4. Outright and spread-out method
5. Crop year basis

General Methods for income from sale of goods or service

1. Accrual basis
Under the accrual basis of accounting, income is reco ized when earned re—gard———Qf-when-
receiyed. less Expense is recognized when incurred regar less of when paid.
Income is said to have accrued when the right to receive is established or when an enforceable right to
secure payment is created against the counterparty.

2. Cash basis
Under the cash basis of accounting, income is recognized when received and expense is recognized when P?id.

Tax and accounting concepts of accrual basis and cash basis distinguished The financial accounting
concept of accrual basis and cash basis are similar to their tax counterparts, except only for the following
tax rules:
1. Advanced income is taxable upon receipt.
Income received in advance is taxable upon receipt in pursuant to the Lifeblood Doctrine and the Ability to Pay
Theory. The subsequent taxation of

4—

advanced income in the period earned will expose the government to risk non-collection. This rule is
applicable on the sale of ser-Y-ices not on goods.

2. Prepaid expense is non-deductible.

Prepaid expe».es are advanced payment for expenses of future taxable, pEFiödS7ThGe are not
deductible against gross income in the year paid. They are deducted against income in the future period
they expire or are used in the business, trade or profession of the taxpayer.

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 Chapter Income Tax Schemes, Accounting Periods, Methods, and Reporting
Normally, the expensing of prepayments does not properly reflect the income of the taxpayer. It also
contradicts the Lifeblood Doctrine as it effectively defers the recognition of income.

3. Special tax accounting requirement must befollowed.

There are cases where the tax law itself provides for a specific accounting treatment of an income or
expense. The specified method must be observed even if it departs from the basis regularly employed by
the taxpayer in keeping his books.

The tax accrual basis income is determined as follows:

Cash income P xxx,xxx
Accrued (uncollected) income xxx,xxx
Advanced income xxx.xxx Gross income

The tax accrual basis expense is determined as follows:

Cash expenses
Accrued (unpaid) expense P
xxx,xxx
Amortization of prepayments and depreciation of capital xxx,xxx
expenditures Deductions
xxx.xxx
The tax cash basis income is determined as follows:
Cash income
Advanced income
XXX.XXX

P xxx,xxx

Gross income
basis expense is determined as follows:

The tax cash

 2021 2022
Collections from services rendered p 4 500,000 P 800,000
Accrued income from services rendered 500,000 400,000
Collection from accrued Income
Chapter income ofTax
2021Schemes, Accounting Periods, Methods, 470,000 and Reporting
Collection for services not yet rendered 300,000 200,000
4—
Payment of expenses of current period 400,000 600,000
Accrued expenses 100,000 150,000 Illustration
Payment of accrued expenses of 2021 100,000 A taxpayer providing
Payment for expenses of the following year 200,000 300,000 services reported the
P 500,000 P 800,000 following in 2021 and
Tax Accrual Basis
500,000 400,000 2022:
300 000 200 000
2021 2022
Cash income
Accrued income
Collection for future services - advances
600,000
Total gross income 400,000 150,000
Less: Deductions P 100,000 P 200 000
Cash expenses
Accrued expense
Amortization of 2021 prepaid expense
Total deductions P 500 000 P 950 000
Net income P 800.000 P 450,000
Points to consider in converting GAAP Accrual Basis to Tax Accrual Basis
1. In accounting accrual basis, income is recognized when earned even if not yet received. Advanced income is
inherently not included in net income. For purposes of taxation, advanced income is taxable. Hence, it must
be added to accrual basis gross income.
2. In accounting, expense is recognized when accrued even if not yet paid. Prepaid expenses are inherently not
deducted. Hence, no adjustment for prepayments is necessary under accrual basis.
Tax Cash Basis

2021 2022
Collection from services rendered P 500,000
Collection for future services - advances 000 200.000
Total gross income Less: P 800.000 P 1,470.000
Deductions
Payments of expenses P 400,000
Amortization of 2021 prepayments200 000
Total deductions P 400.000 p 900.000
Net income P 400.000 P 570,000
Note: P800,OOO +

P470,OOO = + PIOO,OOO =
4B

Points to consider In converting GAAP basjN to Tax cash basis

1. Under tho accounting (,'0Nh baniN, incojne recognized when received not when it is earnq Advanced
income IN inherently recognized income, Hence, no adjustment is necessaryon income,
2. Under accounting cash basis, expenNe is deducted when paid including prepaid expenses Hence, the
deducted prepaid expenses must be reversed for purposes of taxation.

Sellers of goods
The gross income of taxpayers selling goods is determined as follows:

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 Chapter Income Tax Schemes, Accounting Periods, Methods, and Reporting
Sales p xxx,xxx
Less: Cost of' goods sold
Gross income xxx,xxx
The cost of sales is computed using the inventory method:

Beginning inventory P xxx,xxx

Add: Purchases xxx.xxx Total goods available for sale
xxx,xxx
Less: Ending inventory
Cost of goods sold

The expensing of 'the purchase cost of goods does not properly and fairly reflect the income Of the taxpayer
particularly when there are significant fluctuations in inventory levels between accounting periods. This could
expose the taxpayer to riskof BIR assessment. The use of the accrual method is suggested but of course
subjectto practical and cost considerations.

Hybrid basis
The hybrid basis
is any
er
combination of accrual basis, cash basié& and/or Oth methods of accounting. It is used when the taxpayer
has several businesses which emp oy different accounting methods.

Illustration
Mr. Roxas has two proprietorship businesses: a service business which uses cash ba sis and a trading business
which uses accrual basis.

The gross income as determined by cash basis in the service business and the gross income as determined by
the accrual basis in the trading business are simply combined' There is no requirement to measure the income
of different businesses under a single accounting method.

Sale of goods with extended payment terms

The sale of goods with extended payment terms may be reported using the accru basis, installment method, or
deferred payment method,

Chapter 4— Methods, and Reporting

Installment method
Under the installment method, gross income is recognized and reported in proportion to the collection from the
installment sales.

Installment method is available to the following taxpayers:

I. Dealers of personal property on the sale of properties they regularl sell
2. Dealers of real pro erties, only if their initial payment of t e selling price oes not excee
3. Casual sale of non-dealers in property, real or personal, when their selling price exceeds P 1,000 and their
initial payment does not exceed 25% of the

Initial payment
Initial payment means total payments by the buyer, in cash or property, in the taxable year the sale was
made. The term "initial payment" is broader than downpayment. It also includes the installment payments in
the year of sale.

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 Income Tax Schemes, Accounting Periods,
Selling price
Selling price means the entire amount for which the buyer is obligated to the seller. It is computed as follows:

Cash received and/or receivable P xxx,xxx

Fair market value of property received or receivable xxx,xxx
Mortgage or any indebtedness assumed by the buyer xxx xxx
Selling price P xxxxxx

Contract price
The contract price is the amount receivable in cash or other property from the buyer. It is usually the selling
price in the absence of an agreement whereby the debtor assumes indebtedness on the property.

Comprehensive Illustration
Malaybay Company, a car dealer, sold a machine with a tax basis of Plz200p000 on installment on January 3,
2021 Malaybay received a ment and a P 1,800,000 promissory note for the
balance payable in six installments of P300,000

every July 3 and January erea er.

The selling price and gross profit on the sale is computed as follows:
Cash downpayment P 200,000
Notes receivables Selling
1
price
.800.ooo
Less: Tax basis of machine sold (—1200.000)
Gross profit P 800,000
4

Accrual basis
Under the accrual basis, the entire gross profit shall be reported as income in 2021, the year of
sale,
Installment basis
Malaybay cannot readily use the installment method because it is a dealer rather than a dealer of machineries.
The sale of properties of which the seller is dealer is referred to as a "casual sale." Hence, the ratio of
initial payment shall tested first.

The initial payment of Malaybay can be computed as follows:

Cash downpayment (January 3, 2021) P 200,000 First installment (July 3, 2021) 300.000

Initial payment
Ratio of initial payment

Malaybay can use the installment method. The contract price or the amount due shal be determined next.
Since there is no mortgage assumed by the buyer, the selling prio is the contract price.

The gross profit will be reported in gross income throughout the installment period) the formula:

Malaybay shall recognize the following gross income:

At the date of sale: (P200K/P2M x P800,OOO)

Upon every installment: (P300K/P2M x P800,000)

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 Chapter Income Tax Schemes, Accounting Periods, Methods, and Reporting
If Malaybay is a dealer in machinery, it can avail of the installment method even jfth! ratio of its initial payment over
selling price exceeds 25% so long as the selling pric on the installment sale exceeds P 1,000.

With indebtedness assumed by the buyer

The application of the installment method will slightly vary when the buye assumes indebtedness on the
property sold.

In this case, the selling price is no longer the contract price. The contract prices the residual amount after
deducting the mortgage from the selling price. Thus

Selling price P xxx,xxx

Less: Mortgage assumed by buyer
Contract price

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 Schemes, Accounting Periods, Methods, and Reporting
Illustration
On January 3, 2021, Tagaytay, Inc., a real property dealer, sold a lot costing P 1,400,000 for The lot was
encumbered by a P 1,000,000 mortgage which was assume y the buyer. The buyer paid P200,000
d6W0fii5å9ifiéif.The balance is due over four installmentsoßP200j000æueryJuly 3

The gross profit can be computed as follows:

Selling price
Less: Tax basis of lot sold 1,400.000

Gross profit

Note that dealers of real properties are subject to limitation on the use of installment method. The ratio of initial
payment shall be determined first.
January 3, 2021 cash downpayment P 200,000
July 3, 2021 installment 200.000 Initial payment P 400,000
Ratio of initial payment 20%

Tagaytay is qualified to use the installment method. The contract price should be determined next.
Selling price

Less: Mortgage assumed by buyer I.ooo.ooo Contract price

Alternatively, the contract price can be computed directly as follows:

Cash downpayment P 200,000 Collectible balance (P200,000 x 4 installments) 800.000
Contract price

Tagaytay shall recognize the following gross income:

At the date of sale: (P200K/PIM x P600,OOO) P 120,000
Upon every installment: (P200K/PIM x P600,000)

Indebtedness assumed exceeds tax basis of property sold

When the indebtedness assumed by the buyer exceeds the tax basis of the property sold, the excess is an
indirect receipt realized by the seller. This is an indirect down payment which must be added as part of the
contract price and the initial payment. Note also that under this condition, all collection from the contract
including the excess mortgage is a collection of income.

Selling price xxx,xxx

Less: Mortgage assumed by buyer XXX.XXX
Cash collectible xxx,xxx
Add: Excess indebtedness - constructive receipt xxx.xxx
Contract price
The initial payment shall be computed as follows:

Downpayment xxx,xxx
Installment in the year of sale xxx,xxx
Excess of mortgage over tax basis xxx.xxx
Initial payment
111 p xxx,xxx
 Illustration
On July 1, 2021, a taxpayer made a casual sale of property with a tax basis of P 1,300,000 for
P2,000.Q00. The property was subject to a P 1,500,000 mortgage which was agreed to be assumed by the
buyer. The buyer paid a P 100,000 down payment with the balance due in two installments of P200,000
on December 31, 2021 and July 1, 2022.

The gross profit on the sale is determined as follows:

Selling price
Less: Tax basis of property sold 1.3001000
Gross profit P—7UOLOO
The initial payment shall be determined first:

Downpayment P 100,000
December 31, 2021 installment 200,000 Excess mortgage
200.000
Initial payment

Ratio of initial payment (P500K/P2,000,000)

The contract price shall be computed as:

Selling price
Less: Mortgage assumed by buyer
Cash collectible
Excess mortgage - P 1,300,000)
Contract price
Note that the gross profit on the sale is the same as the contract price. Hence'
any collection from the contract including the excess mortgage shall be recognized as gross income upon
collection.
Canlubang shall recognize the following gross income:

At the date of sale (P200K down + P 100K excess) P 300,000

Upon receipt of first installment - 12/31/2021 200,000
Upon receipt of second installment - 7/1/2022 200.000

Total gross profit on the contract P 700,000

Deferred payment method

The deferred payment method of the accrual basis and is used in reporting income when a n in a sale.

Under the deferred payment method, the gross income is computed based on the present value (discounted
value) of a note receivable from the contract. The discount interest on the note is amortized (i.e., spread) as
interest income over the installment term.
Illustration
On December 31, 2021, a taxpayer sold an office building costing P 1,400,000 for P2,000,000. The buyer
made P 1,000,000 downpayment and the balance,Ädénced by a riote, is due in 2 annual installments of
P500,000 every December 31 starting December 31, 2022.

Note that the installment method cannot be allowed since the ratio of initial payment is already 50%

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 Chapter Income Tax Schemes, Accounting Periods, Methods, and Reporting
Assume the note is non-interest bearing but can be discounted at a local bank for P900,000. Under the
deferred payment method, the reportable gross income for each year shall be:
2021 2022 2023
Cash downpayment
Present value of the note 900 000
Selling price
Less: Tax basis of the property 1 400 000
Gross income P 500.000

Interest income (P 1,000,000 – P 900,000 50.000 50.000

Note:
1. The difference between the face value and the present value of the note, known as discount, will not be
recognized in gross income at the date of sale but will be deferred and recognized as interest income.
2. The discount is amortized as interest income upon every collection on the balance of the note as
follows: P500,000 installment/P1,000,000 total note balance x P 100,000 discount

In the case of interest-bearing notes, the use of the deferred payment method will bear the same result as the
accrual basis of accounting.

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chapter 4 — Income Tax Schemes, Accounting Periods, Methods, and Reporting
The depreciated value of the leasehold improvement is computed as:
Cost of improvement x Excess useful life over lease return
Useful life of the improvement
Illustration
On January 1, 2021, Ivan leased a vacant lot to Greg under a 20-year lease contract. Greg immediately
constructed a building on the lot at a total cost of P4 500 000. The building has useful life of-3D-years.

Outright method
Under the plain wordings of Section 49 of Revenue Regulations No. 2, Ivan shall recognize the entire
fair value of the improvement as gross income upon completion of the improvement in
2021. This is not income in its totality, but this is the amount referred to by the regulation.

Spread-out method
The depreciated value of the property at the termination of the lease is the value of the years o usage of the
lessor. This can be computed by splitting the value of the
improvement as follows:

Years of
User usage
Allocation Cost
Lessee 20
Lessor 10
Total 30

The depreciated value of the improvement at the termination of the lease is an i

essor.

Under the spread-out method, Anderson shall spread the P 1,500 000 income over 20 periods or recognize
an annual income of P 75,0 0 from the leasehold improvement from Year 2021 through Year 2040.

Note to Readers
It should be pointed out that this rule exists only in the regulation and is absent in the NIRC. Some
taxpayers are questioning its validity pointing out lack of legal basis. However, it is fairly proper to
consider the depreciated value of the improvement that remains to the lessor upon termination of the lease
as income because it is an actual benefit to the lessor. These are, in effect, additional rental consideration
in kind.

However, the treatment specified by the outright method is perceived as unjust and abusive, and is an improper
introduction of legislation.
Chapter Income Tax

The depreciated value of the improvement at the termination of the lease should\ the proper value to be
recognized as gross income under the outright method

This view is supported by the fact that the spread-out method could not have an option if the
outright method intended to tax the entire fair value of improvement considering the huge
disproportion in the reportable gross under the two options.

The outright method as mandated by the regulation will best apply in cases when lessees pay the lessor
rentals in the form of leasehold improvements or leasehold improvements made by lessees are
treated as reductions to cash rental: In such cases, the fair value of the leasehold improvements upon
completion E unquestionably income to the lessor for taxation purposes.

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 4— Schemes, Accounting Periods, Methods, and Reporting
Agricultural or Farming Income
Farming income is commonly measured using the cash basis or accrual basis, as in the following:
a. Animal husbandry
b. Short-term crops
Illustration
Northern Barn had the following details of its agricultural activity during the year:

Total sales of fattened pigs, P 1,000,000 on credit

Increase in fair value of pig herd compared last year 2,700,000
Total costs of farm feeds and supplies bought
Total costs of farm feeds and supplies used
Administrative and selling expenses

Northern Barn shall compute its net income using either tnethod as follows:

Accrual method Cash basis

Sales
Direct farm costs 6.800.ooo 6.800.000

Gross profit from operations

Less: administrative and selling expenses 1.20Q.OOQ 1.20Q.QQQ Net income P 5,000.000

The accounting for long-term crops depends on the harvesting frequency:

a. Perennial crops- those that yield harvests through years
b. One-time crops - those that are harvested once after several years
The initial farm development costs of perennial crops like mangoes, mangostees,coconut and banana
are capitalized and amortized over the expected year’s harvest The harvests are accounted for using
cash basis or accrual basis. One-time crops are accounted for using the crop year basis.

Crop year basis

Under the crop year basis, farming income is recognized as the difference between the proceeds of harvest
and expenses of the particular crop harvested. The expenses of each crop are accumulated and deducted upon
the harvest of the crop.

Illustration
John de la Cruz, a farmer, plants a certain crop that takes more than a year to harvest. Juan had the following data
on his farming operations:
2021 2022 2023
Proceeds of harvest P 750,000 P 1,000,000
1st cropping expenses 400,000 200,000
2 nd cropping expenses 500,000 300,000
The reportable farming income using crop year method would be:

2021 2022 2023

Proceeds of harvest P 750,000 P 1,00,000
Less: Cropping expenses
Incurred last year 400,000 500,000
Incurred this year 200.000 300.000
Farming gross income P 150.000 P 200.000

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chapter 4 — Income Tax Schemes, Accounting Periods, Methods, and Reporting
Crop year basis is an accounting method and is not an accounting period.

Use of different accounting methods

Taxpayers with more than one type of business using different accounting methods can consolidate the
income reported using the different methods. There is no need to restate the income to a common
accounting method. However, the methods applied to each business should be applied consistently from
period to period.

Change in Accounting Period

The change in accounting period requires prior BIR notice. The following documentations are required:
1. A letter of request addressed to the RDO having jurisdiction over the place of business of the
taxpayer showing:
a. The original and the proposed new accounting period
b. The reason for desiring to change the accounting period
2. Certified true copy of the SEC approved amended by-laws showing change in accounting period

3. Sworn statement of "non-forum shopping' stating that such request has been previously acted upon
by the BIR National Office
4. Duly filed up BIR Form 1905
5. A sworn undertaking by an officer of the taxpayer to file a separate final adjustment return for the
period between the close of the original account period and the date designated as the close of the
new accounting period

The request for approval of the change in accounting period shall be filed at time not less than 60 days
prior to the beginning of the new accounting period The certification approving the adoption of a new
accounting period must release within 30 days from the date of receipt of the complete documentary
requirements.

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 Chapter 4 Income Tax Schemes, Accounting Periods, Methods, and Reporting

TAX REPORTING

Types of Returns to the Government

1. Income tax returns - provide details of the taxpayer's income, expense, tax due, tax-credit and tax
still due the government.
2. Withholding tax returns - provide reports of income payments subjected tax withholding tax by the
taxpayer-witholding agent.
3. Information returns

Information Returns
Certain taxpayers are also required to file information returns. Information returns do not involve any payment or
withholding of tax but are essential to government in its tax mapping efforts and in its evaluation of tax
compliance.

The non-filing of income tax returns, withholding tax returns, or informati0t returns is subject to penalties,
fines, and or imprisonment.

MODE OF FILING INCOME TAX RETURNS

1. Manual Filing System

The traditional manual system of filing income tax return is by paper documenE where taxpayers fill up
BIR forms to report income, expenses, or any declarati01 required to be filed with the BIR.
Under the NIRC, the income tax return shall be filed to the following ill descending order of priority,
within the revenue district office where the taxpayer is registered or required to register:
1. An authorized agent bank (AAB)
2. Revenue Collection Officer
3. Duly authorized city or municipal treasurer, if there is no BIR office in thi locality

2, e-BJR
The
fill up
and
assessment%,
and proceed
3, Electronic J/jJjng and 1
P;tyjnent
The CPP% js a
Tazpayere. fjjc "Z
through the

118
Taxpayers mandated to

Manufacture of electrical machinery, and apparatus NEC

f. Manufacture of fabricated metal products
g. Manufacture of foods, products, and beverages
h. Manufacture of machineries, and equipment NEC
i. Manufacture of medical, precision, and optical instruments
j. Manufacture of motor vehicles, trailers and semi-trailers
k. Manufacture of office, accounting, and computing machineries
I. Manufacture of other non-metallic mineral products
m. Manufacture of other transport equipment
n. Manufacture of other wearing apparel
o. Manufacture of papers, and paper products
p. Manufacture of radio, TV, and communication equipment, and apparatus
q. Manufacture of rubber and plastic products
r. Manufacture of textiles
 Chapter 4 Income Tax Schemes, Accounting Periods, Methods, and Reporti
s. Manufacture of tobacco products
t. Manufacture of wood and wood products
u. Manufacturing N.E.C.
v. Metallic ore mining
w. Non-metallic mining and quarrying

3. Group C
a. Retail sale
b. Wholesale trade and commission trade
c. Sale, maintenance, repair of motor vehicle, and sale of automotive fuel
d. Collection, purification, and distribution of water
e. Computer and related activities
f. Real estate activities
4. Group D
a. Air transport
b. Electricity, gas, steam, and hot water supply
c. Postal and telecommunications
d. Publishing, printing, and reproduction of recorded media
e. Recreational, cultural, and sporting activities
f. Recycling
g. Renting out of goods and equipment
h. Supporting and auxiliary transport activities

5. Group E
a. Activities of membership organizations Inc.
b. Health and social work
c. Private educational services
d. Public administration and defense compulsory social security
e. Public educational services
f. Research and development
g. Agriculture, hunting, and forestry
h. Farming of animals
i. Fishing
j. Other service activities
k. Miscellaneous business activities
l. Unclassified activities

PAYMENT OF INCOME TAXES

The general rule is "pay as you file". The capital gains tax and regular income tax are paid as the taxpayer files
his return. Installment payment of income tax is allowed on certain conditions.

Taxpayers under the eFPS system shall e-pay their tax online through internet banking service. The account of
the taxpayer will be auto debited for the amount of taxes to be paid.
Chapter 4 Income Tax Schemes, Accounting Periods, Methods, Reporting

BASIC COMPARISON OF FILING AND PAYMENT SYSTEMS

Manual e-BIR Forms eFPS
Data ent Manual Electronic Electronic
Filin Submission Manual Electronic Electronic
Tax payment Manual Manual Electronic
PENALTIES FOR LATE FILING OR PAYMENT OF TAX
The late filing and payment of taxes is subject to the following additional charges:
1. Surcharge -
a. 25% of the basic tax for failure to file or pay deficiency tax on time

b. 50% for willful ne lect to file and pay taxes

The non-filing is considered 'willful neglect' if the BIR discovered the non-filing first. This is the case
when the taxpayer received a notice from the BIR to file return prior to his actual filing. If the taxpayer
filed a return before the receipt of such notice, the same is considered simple neglect subject to the 25%
surcharge.

2. Interest — Double of the legal interest rate for loans or forbearance of any money in any absence o any express
stipulation

Since the legal interest is currently set at interest penalty is therefore 12% per annum effective January 1,
2018. Note that NIRC imposed an 20% per annum until December 31, 2017.

Under the new rules established by RR21-2018, the interest period shall be computed based on actual
days divided 365 days. The additional day in February during a leap year will be counted. The yearly-
monthly-daily counting method established in prior regulations is already abandoned.

A month normally has 30 days except the following:

31-day months January, March, May, July , August, October, December
28 28 or 29-day month February
The best way
to put 'this in mind is that 31-day and 30-day months alternating from January to July, but the sequence is reset in
August. Also, put in mind that February is a 28-day month, except on a leap year.

How to identify a leap year?

A year divisible by 4 with a whole number quotient without a decimal is a leap year. Years 2016,
2020, 2024, 2028 and so on are leap years. Leap years have 29 days in February hence the actual
number of days in a leap year is 366 not the usual 365. This is due to the fact that our planet
revolves around the sun is 365 % days. Hence, there is an extra one complete day in every four
calendar years.

Under the illustrative guidelines in RR21-2018, the new day counting system for the interest penalty
will be implemented for tax assessments effective January 1, 2018. This means it will be applied
even if the tax assessment pertains to 2017 and prior years.

Illustration 1: Basic procedure

121
 Chapter 4 Income Tax Schemes, Accounting Periods, Methods, and Reporti
The tax return of the taxpayer was due on April 15, 2Q21 but was filed on August 3ßO.2.L The tax
due per return of the taxpayer amounts to P 100,000.
The number of days would be counted as follows:

Period Days

April (30 - 15) 15

May 31
June 30
July 31
August 3
Total days
The interest penalty shall be computed as P 100, 000 x 12% x 110/365 = P3,61644'

Illustration 2: Interest in a leap year

A taxpayer-withholding agent failed to file his withholding tax return and failedto remit the P50,000 withholding
tax thereon on April 30, 2019. The taxpayer filed the return on July 16, 2020.

The number of days would be counted as follows:

Period Days

April 30, 2019 to April 30, 2020 366

May 2020 31
June 2020 30
July 2020 16
Total days 443
The interest penalty shall be computed as P 50,000 x 12% x 443/365 = P7,282.19.

Illustration 3: Interest in transition years

An individual taxpayer has a tax due of P40*Q00 for taxable year 2016 due on April 15, 2017. The
taxpayer settled his tax on February 10, 2018.

The interest in 2017 shall be computed using the old 20% interest penalty rate while the interest in
2018 shall be computed using the-T2%Öiferest penalty rate.

April 16, 2017 to December 31, 207 is 260 days. January 1, 2018 to February 10, 2018 is 41 days.
Hence, the interest shall be computed as follows:
2017 interest (P40,OOO x 20% x 260/365) P 5,698.63
2018 interest (P40,OOO x 12% x 41/365) 539.18
Interest penalty P 6,237.81
3. Compromise penalty -
Compromise penalty is an amount paid in lieu of criminal prosecution over a tax violation.
The schedules of compromise penalty related to income taxes are included in Appendix 4 for yqur
reference.

INTEGRATIVE ILLUSTRATION

122
Chapter 4 Schemes,
If the amount of taxAccounting
un aid Periods, Methods, and Reporting
Exceeds But not exceed Compromise is An individual taxpayer filed his
2020 income tax return with a
P 20,000 P 50,000 P 10,000 computed tax due of P 100,000 on
50,000 100,000 15,000
The total amount to be paid by the
100,000 500,000 20,000
Tax due P 100,000
44 Less: Tax credits (creditable withholding taxes) 20.000
Net tax due
Plus: Penalties 80,000
Surcharge (P80,000 x 25%) 20,000
Interest (P80,OOO x 12% x 91/365) 2,393
Compromise penalty* 15 000
Total tax due P 117,393
Note:
1. The deadline of the 2020 income tax return is April 15, 2021. April 15, 2021 to July 15, 2021 is a 91-
day period.
2. Interest is computed from the net amount of tax due before the 25% surcharge. Imposition of interest
upon the surcharge is illegal.
3. The compromise penalty is taken from the table of compromise penalties for failure to file and or pay
internal revenue tax at the time or times required by law, as follows:

You may check the schedule of compromise penalty for late payment of income tax in Appendix 4 for your
reference.

PENALTIES FOR NON-FILING OR LATE FILING OF INFORMATION RETURN

For each failure to file a separate information return, statement or list, or keep any record, or supply any
information required by the Code or by the Commissioner on the date prescribe therefor, unless it is shown that
such failure is due to reasonable cause not to willful neglect, shall be subject to a penalty off P 1,000 for each such
failure. Provided that the amount imposed for all such failure during a calendar year shall not exceed P 25,000.

123