TAXATION LAW

(R.A. No. 8424, as amended by R.A. No. 10963; R.A. No. 11534)

GENERAL PRINCIPLES OF TAXATION

Taxation
An inherent power by which the sovereign through its law-making body raises revenue to defray
the necessary expenses of the government. It is merely a way of apportioning the cost of the
government among those who in some measures are privileged to enjoy its benefits and must
bear its burden.

- It may refer to the power to tax or the act or process by which the taxing power is exercised.
- Such is considered as inherent by reason of the lifeblood doctrine: taxes are the lifeblood of
the government and so should be collected without unnecessary hindrance

Tax—obligation created by law

- An enforced proportional contribution from persons and properties levied by the law-making
body of the state by virtue of its sovereignty for the support of the government and all its public
need.
- Taxation is the subject; taxes are the object.

TWO NATURES OF TAXATION

1. Inherent attribute of the sovereignty
- The moment the state exists, the power to tax automatically exists.
- It is inherent in the power to tax that a state be free to select the subjects of taxation, and it
has been repeatedly held that “inequalities which result from a singling out of one particular
class for taxation or exemption infringe constitutional limitation. (Lutz vs Araneta)
- The power is inherent to the national government but not to the LGUs*.
*LGUs are mere agent of the State; it can only impose taxes when it is expressly granted to
them by the 1) Constitution and the 2) laws enacted by Congress.

2. Legislative in character
- Tax is a grant of the people who are taxed and the grant must be made by the immediate
representatives of the people* and where the people have laid the power, there it must remain
and be exercised.
- As the protection and promotion of the sugar industry is a matter of public concern, the
Legislature may determine within reasonable bounds what is necessary for its protection and
expedient for its promotion (Lutz vs Araneta)
- Legislature is responsible for the amount/weight of tax, its purposes, situs, and grant of tax
exemption and condonation

CHARACTERISTICS OF TAXATION
1. Comprehensive in the sense that it covers all persons, businesses, activities, professions,
rights, and privileges
2. Unlimited since a tax does not cease to be valid merely because it regulates or discourages;
the power to impose taxes is so unlimited in force and that the courts scarcely venture to
declare that it is subject to any restrictions.
3. Plenary since it is complete; with remedies available to the BIR to ensure collection of taxes
4. Supreme insofar as to the selection of the subject of taxation is concerned.
*not superior to the other inherent limitations of the government.

PURPOSES OF TAXATION
Primary purpose:
Revenue raising- raise fund or property to enable the state to promote the general welfare and
protection of its citizens
Secondary purposes:
1. Promote general welfare- taxation may be used as an implement of police power in order to
promote the general welfare of the people;
2. Regulation- rehabilitation and stabilization of threatened industry which is affected with public
interest like the oil and sugar industry.
3. Reduction of social inequality- progressive tax system prevents the undue concentration of
wealth in the hands of few individuals. (Redistribution of wealth)
4. Encouraged economic growth- the grant of incentives or exemptions encourages investment
5. Protectionism- in case of foreign importations, protective tariffs and customs are imposed for
the benefit of local industries

PRINCIPLES OF A SOUND TAX SYSTEM

1. Fiscal adequacy—sources of government revenue must be sufficient to meet government
expenditures and other public needs.
2. Administrative feasibility—tax laws must be capable of being effectively enforced with the
least inconvenience to the taxpayer—tax laws should be clear and plain to taxpayers;
convenient as to time and manner of payment, and it shall not be burdensome to the taxpayer.
3. Theoretical justice—must be based on the taxpayer’s ability to pay and that taxes must be
reasonable, fair, just, and conscionable. ~uniform and equitable

Notes:
- 1 and 2—not required to be followed under the constitution, still tax law is valid but it would
be unsound.
- For 3, it would be contrary to law if not followed; unconstitutional not to follow the ability to pay
theory~ which is based on the progressive tax system imposed by the Constitution. A violation
of the theoretical justice principle is a violation of equitability and uniformity.
- The Constitution requires tax laws to be equitable and uniform, otherwise, it will be a violation
of the theoretical justice

THEORY AND BASIS OF TAXATION

1. Lifeblood Doctrine
The government will not survive without the revenue raised from taxation since taxes are the
lifeblood of the government; without taxes, the government would be paralyzed. Thus, every
person who is able, must contribute his share in the running of the government.
2. Necessity Theory
The existence of the government is a necessity that it cannot continue without means to pay
its expenses, thus, it has a right to compel all citizens and property within its limits to
contribute.
3. Benefits-Protection Theory
Taxes are what we pay for a civilized society. The State demands and receive taxes from the
subjects of taxation so that it can be enabled to carry its mandate into effect and perform the
functions of the government.
4. Doctrine of Symbiotic Relationship
This principle serves as the basis of taxation and is founded on the reciprocal duties of
protection and support between the State and its inhabitants.

JURISDICTION OVER SUBJECT AND OBJECTS -situs/within its territory

It may not tax property lying outside its borders or lay an excise or privilege tax upon the exercise
or enjoyment of a right or privilege derived from the laws of another state and therein exercised
or enjoyed.

Subject—person to pay
Object— object taxable
i.e. income tax: subject is the individual or business; object is the income

DOCTRINES OF TAXATION
1. Doctrine of Prospectivity—the general rule under the Civil Code that laws shall have
prospective application applies to tax laws.
General Rule: Prospective in nature
Exception:
a. Provided expressly or is clearly the intent of the legislative; and
b. It will not amount to denial of due process.
2. Imprescriptibility
General Rule: Taxes are imprescriptible as they are the lifeblood of the government.
Exception: Tax statutes may provide otherwise—the National Internal Revenue Code and the
Local Government Code has provided prescriptive period as to assessment and collection of
taxes as to those taxes that were returnable.
Prescription:
Assessment: ordinary: 3 years; extraordinary (non-filing/fraud): 10 years
Collection: 5 years
**Prescriptive period shall start from the time the taxpayer files the tax return and declares his
liability.

3. Double Taxation—means taxing the same subject or object twice within the same taxable
year and for the same purpose by the same taxing power.

Kinds:
a. Direct duplicate/obnoxious- objectionable kind of double taxation in its prohibited sense
since it violates the equal protection clause of the Constitution
Elements:
1. Same property or subject matter is taxed twice when it should be taxed only once;
2. Both taxes are levied for the same purpose
3. Imposed by same authority
a. Same jurisdiction
b. Same taxing period
c. Same kind or character of tax

b. Indirect Duplicate Taxation- permissible kind of double taxation; arises in the absence
of one or more of the above-mentioned elements of double taxation

Notes:
- No double taxation if the tax is levied by the LGU and another by the National Government,
since the two are different taxing authority.
- As to constitutionality- double taxation has no constitutional prohibition but it is something not
favored, but nevertheless permissible.
- Unconstitutional: taxpayer is taxed twice for the benefit of the same governmental entity or by
the same jurisdiction for the same purpose.
- No constitutional prohibition, but it will not be allowed if it will result in a violation of the equal
protection clause

Modes of eliminating double taxation

-measures that are normally adopted by sovereign taxing authorities in order to avoid the resulting
inequalities of double taxation:
a. Tax Credits- amount subtracted from an individual’s tax liability.
b. Tax Deductions- amount of tax written or treated as deduction.
c. Reduction of the Philippine income tax rate (Tax Sparring Rule)- reciprocity with other country
d. Tax Exemptions- grant of immunity to particular persons or corporations from the obligation
to pay taxes
e. Tax Treaties- agreement between two countries specifying what items of income will be taxed
by the authorities of the country where the income is earned.

ESCAPE FROM TAXATION

1. Shifting- the transfer of the burden of tax by the original payer or the one on whom the tax
was assessed or imposed (impact; seller) to another or someone else (incidence; buyer)

Ways of shifting:
a. Forward- burden is transferred from a factor of production
b. Backward- burden is transferred from the consumer through the factors of distribution to
the factors of production.
c. Onward- tax is shifted 2 or more times either forward or backward
Kind of tax in which it is applied: indirect tax only- those that are demanded in the first instance
from one person in the expectations and intention that he can shift the burden to someone else
not as a tax but as a part of the purchase price.
Example: VAT and other percentage tax (business tax)
**liability remains with the taxpayer but the burden is shifted to the purchaser.

Note: Direct taxes cannot be shifted since these are exacted from the very person who it is
intended or desired.

IMPACT vs INCIDENCE
Impact (stat liability) Incidence (burden)
Tax is formally assessed Tax burden finally rests
Seller Consumer/buyer
Remitting the vat (actually paying) Indirectly paying; shifted to the purchase price

2. Tax Avoidance (tax minimization)

- Exploitation by the taxpayer of legally permissible alternative tax rates or methods of
assessing taxable property or income in order to avoid or reduce tax liability.
- Tax saving device within the means sanctioned by law and should be used by the taxpayer
in good faith and at arm’s length
- Example: donation to charitable institution
3. Tax Evasion (illegal; tax dodging)—defeats the purpose of taxation
- Illegal means of escaping taxation
- Connotes fraud through the use of pretenses and forbidden devices to lessen or defeat
taxes.
- It subjects the taxpayer to further or additional civil or criminal liabilities
- Elements:
1) End to be achieved is payment of less than what is legally due from the taxpayer or no
tax to be paid at all;
2) Accompanying state of mind which is described as being evil in bad faith; and
3) Course of action which is unlawful.

PROHIBITION ON COMPENSATION AND SET-OFF

Compensation or set-off takes place when two persons, in their own right, are creditors and
debtors of each other.

General rule: No set-off is admissible against the demands for taxes levied for general or local
governmental purposes since a tax liability is a legal not a contractual obligation.
n Taxes are not in the nature of contracts between the parties but grow out of duty to and
are positive acts of the government to the making and enforcing of which the personal
consent of the individual taxpayer is not required.
Exception: compensation may be allowed if the refund/tax debt due from the government to the
taxpayer has already been appropriated for public purpose—it may set up compensation in the
form of tax credit to the taxpayer.

COMPROMISE
- Amicable settlement of differences between two or more persons to avoid lawsuit.
- It is allowed and enforceable when the subject matter is NOT prohibited from being
compromised and the person entering into it is duly authorized to do so.

Who are the persons allowed to enter into compromise?

1. Commissioner of Internal Revenue—may enter, under certain conditions into a compromise
for both the civil and criminal liabilities of the taxpayer
2. Collector of Customs—customs duties limited to cases where legitimate authority is
specifically granted: remission of duties
3. Customs Commissioner—subject to the approval of the Secretary of Finance: on cases
involving imposition of fines, surcharges, and forfeitures
4. Local Government Units by virtue of the Local Government Code—no provision but it tax
liability is not prohibited from being compromised.
Tax Amnesty vs Tax Exemption
Tax amnesty is the immunity from all criminal, civil, and administrative liabilities arising from
nonpayment of taxes and it will apply to past tax periods, thus, retroactive.
Tax exemption on the other hand is immunity from civil liability only and has a progressive
application.

CONSTRUCTION AND INTERPRETATION OF TAX LAWS, RULES, AND REGULATIONS

How are tax laws construed?
- Since taxation is a destructive power which interferes with the personal and property rights of
the people and takes from them a portion of their property for the support of the government,
tax statutes must be construed strictly against the government and liberally in favor of the
taxpayer.
- However, if the provision of the law is clear and speaks categorically, the need for
interpretation is obviated, no plausible pretense being entertained to justify non-compliance.
All that has to e done is to apply it in every case that fails within its terms.
- As to tax exemptions, it is strictly construed against the taxpayer since this is a form of tax
exceptions, and liberally in favor if the government. These derogates the sovereign authority
to collect taxes, since this is the lifeblood of the government.
- TAXATION IS THE RULE, EXEMPTION IS THE EXCEPTION.

DISTINGUISH TAXATION, POLICE POWER, EMINENT DOMAIN

Taxation Police Power Eminent Domain
Purpose Raise revenue Promote public welfare Facilitate taking of private
through regulations property for public use
Amount of Unlimited in amount Limited only to the cost There is no exaction, but
Exaction of regulation, issuance private property is taken by
of license or surveillance State for public purpose
Benefits No special or direct No direct benefit Direct benefit results in form
Received benefit is received by received but a healthy of just compensation to
taxpayer, merely economic standard of property owner
general benefit of society is attained
protection
Non- Contracts may not be Contracts may be impaired
impairment of impaired
Contracts
Transfer of Taxes paid become There is no transfer but Transfer is effected in favor
Property part of public funds only restraint in its of the State
Rights exercise
Scope Covers all persons, Covers all persons, Covers only a particular
property and excises property, rights and property
privileges
Who may Only exercised by the Government or its political May be exercised by private
Exercise the subdivisions entities
Power

Police power is the most supreme of all these powers. Taxation is inferior to the non-impairment
of obligations and contracts.
SCOPE AND LIMITATIONS OF TAXATION
Legislative taxing power or discretion extends to the following:
1. Person, property, or occupation to be taxed;
2. Amount or rate of the tax;
3. Purposes for which taxes shall be levied provided they are public purposes;
4. Apportionment of the tax, whether the tax shall be general or limited to a particular locality or
partly general and partly local;
5. Situs of taxation; and
6. Method of collection.

Inherent Limitations of Taxation:

1. Public purpose;
2. Non-delegability of the taxing power;
3. Territoriality or situs;
4. International comity; and
5. Exemption of the Government

Public Purpose
It persons not only to the essential government functions such as building, roads, and delivery of
basic services, but also includes purposes designed to promote social justice.
Public money may now be used for the relocation of illegal settlers, low-cost housing, and urban
agrarian reform.
n Purpose will determine the public character of the tax law

Non-delegability of the taxing power

The power to tax is exclusively vested in the legislative body. Taxes are a grant of the people who
are taxed and the grant must be made by the immediate representatives of the people.

Exceptions:
1. Delegation to Local Governments—the Constitution grants each LGU the power to create
its own sources of revenue and to levy taxes, fees, and charges which shall accrue
exclusively to the LGU
2. Delegation to the President—delegation of:
a. Tariff powers by Congress under the Flexible Tariff Clause
b. Emergency powers
c. Enter into executive agreements and to ratify treaties which may contain tax
exemption provisions subject to the concurrence by the Senate in the ratification
made by the President.
3. Delegation to Administrative Agencies—also known as the power of subordinate
legislation. It is subject to the following tests:
a. Completeness test—the law must be complete in all its essential terms and
conditions when it leaves the legislature so that there will be nothing left for the
delegate to do when it reaches him except to enforce it.
b. Sufficient standard test—the law must offer a sufficient standard to specify the
limits of the delegate’s authority, announce legislative policy, and specify the
conditions under which it is to be implemented.

Territoriality or Situs of Taxation

Situs—the place or authority that has the right to impose and collect taxes.

Rules on situs of income tax

1. From sources within the Philippines—all kinds of taxpayers are subject to income tax on
income derived from sources within the Philippines. Income is derived from the Philippines
if it is derived from activity within the Philippines.
2. From sources without the Philippines—only Resident Citizens and Domestic Corporations
are liable to income tax on income derived from sources without the Philippines.
3. Partly within and partly without the Philippines—taxable income attributable to sources
within the Philippines may be determined by processes or formulas of general
apportionment prescribed by the Secretary of Finance. Gains, profits, and income from
 the sale of personal property produced by the taxpayer within and sold without the
Philippines shall be treated as derived partly from sources without the Philippines.

International Comity
The Philippines adopts the generally-accepted principles of international law as part of the law of
the land. The property or income of a foreign state or government may not be the subject of
taxation by another state.

Principles which this is based on:

1. Equality among states—states are juridically equal, enjoy the same rights, and have equal
capacity in their exercise; and
2. Par in parem non habeat imperium—even the strongest state cannot assume jurisdiction
over another.

Exemption of Government Entities, Agencies, and Instrumentalities

The inherent limitation of exemption of government from tax covers:
1. Government entities;
2. Government agencies; and
3. Government instrumentalities.

Government entities—the Government of the Republic of the Philippines

This refers to the corporate governmental entity through which the functions of the government
are exercised throughout the Philippines, including save sa the contrary appears from the context,
the various arms through which political authority is made effective in the Philippines, whether
pertaining to the autonomous regions, the provincial, city, municipal, or barangay subdivisions or
other forms of local government.

Rationale for its exemption: properties of the National Government as well as those of the LGUs
are not subject to tax, otherwise, it will result in the absurd situation of the government taking
money from one pocket and putting it in another.

Government agencies—it refers to any of the various units of the government, including a
department, bureau, office, instrumentality, or government-owned or controlled corporation, or a
local government or a distinct unit.

Notes:
1. Agencies performing governmental functions are exempt from tax unless expressly taxed;
2. Proprietary functions are subject to tax unless expressly exempted.

Government-owned or controlled corporation—this refers to any agency organized as a stock or

non-stock corporation vested with functions relating to public needs whether governmental or
proprietary in nature, and owned by the government directly through its instrumentalities either
wholly, or where applicable as in the case of stock corporations to the extent of at least 51% of
its capital stock.

GOCC is generally subject to taxation except:

1. Government Service Insurance System
2. Social Security System
3. Philippine Health Insurance System
4. Philippine Charity Sweepstakes Office

Instrumentalities of the government—it refers of any agency of the National Government, not
integrated within the department framework, vested with special functions or jurisdiction by law,
endowed with some if not all corporate powers, administering special funds, and enjoying
operational autonomy, usually through a charter.
Constitutional Limitations of Taxation:
Provisions directly affecting taxation:
1. Prohibition against imprisonment for non-payment of POLL TAX
2. Uniformity and equality of taxation
3. President’s power to impose tariff rates
4. Prohibition against taxation of religious, charitable, and educational entities
5. Non-taxability of non-stock non-profit educational institution
6. Votes required for grant of exemptions
7. Prohibition on use of tax levied for special purpose
8. President’s veto power
9. Non-impairment of Supreme Court’s jurisdiction
10. LGUs power to create its own sources of revenue; and
11. Non-appropriation or use of public money for religious purposes

Provisions indirectly affecting taxation:

1. Due process
2. Equal protection
3. Religious freedom; and
4. Non-impairment of obligations of contracts

Prohibition against imprisonment for non-payment of POLL TAX

Can a taxpayer be imprisoned for non-payment of taxes?
Yes. A tax creates civil liability on the part of the delinquent taxpayer, and the non-payment
whether it be on account of the taxpayer’s failure or refusal to pay it creates criminal liability which
could be the subject of criminal prosecution under existing laws. However, no person shall be
imprisoned for non-payment of poll tax.

Poll tax is imposed on a per head basis without any qualification and one cannot be imprisoned
for non-payment because payment is not mandatory.

Uniformity and equality of taxation

The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive
system taxation.

All taxable articles or kinds of property of the same class shall be taxed at the same rate. A tax is
considered to be uniform when it operates with the same force and effect in every place where
the subject may be found. When the tax law applies equally well to all persons, firms, and
corporations placed in similar situation, there is no infringement of the rule on equality.

President’s power to impose tariff rates

What is the Flexible Tariff Clause?
The Congress may by law authorize the President to fix within specified limits, and subject to such
limitations and restrictions as it may impose, tariff rates, import and export quotas tonnage and
wharfage dues, and other duties and imposts within the framework of the national development
program of the Government.

Prohibition against taxation of religious, charitable, and educational entities

Charitable institutions, churches, and personages or convents appurtenant thereto, mosques,
non-profit cemeteries, and all lands, buildings, and improvements, actually, directly, and
exclusively used for religious, charitable, or educational purposes shall be exempt from taxation.

What kind of tax is covered by the exemption?

Real property tax.

Test of exemption: it is the use of the property and not ownership. The properties must be actually,
directly, and exclusively used for religious, charitable, or educational purposes.

Define actually, directly, and exclusively.

Actually is truly. Directly means in a direct way without anything intervening. Exclusively means
apart from all others without admission of others to participation.

Non-taxability of non-stock non-profit educational institution

Educational institution shall include:
a. private or proprietary educational institutions;
b. government educational institutions; or
c. non-stock, non-profit educational institutions

Notes:
- Private or proprietary educational institutions are subject to income tax, real property tax,
donor’s tax, and estate tax.
- Government educational institutions are exempt from income tax, real property tax, and
donor’s tax.
- All revenues and assets of non-stock, non-profit educational institutions used actually, directly,
and exclusively for educational purposes shall be exempt from taxes and duties—real
property tax, income tax, and donor’s tax.

Votes required for grant of exemptions

Majority concurrence of all the members of the Congress. Majority means at least ½ plus 1 of all
the members voting separately.

Prohibition on use of tax levied for special purpose

All money collected on any tax levied for a special purpose shall be treated as a special fund and
paid out for such purpose only. If the purpose for which a special fund was created has been
fulfilled or abandoned, the balance, if any, shall be transferred to the general funds of the
Government.

President’s veto power

The president shall have the power to veto any particular item or items in an appropriation,
revenue, or tariff bill but the veto shall not affect the item or items to which he does not object.

Non-impairment of Supreme Court’s jurisdiction

The Supreme Court shall have the power to review, revise, reverse, modify, or affirm on appeal
or certiorari judgments or orders of lower courts in all cases involving the legality of any tax,
impost, assessment, or toll; and the legality of any penalty imposed in relation thereto.

LGUs power to create its own sources of revenue

Each local government unit shall have the power to create its own sources of revenues and to
levy taxes, fees, and charges, subject to such guidelines and limitation as the Congress may
provide consistent with the basic policy of local autonomy. Such taxes, fees, and charges shall
accrue exclusively to the local governments.

Non-appropriation or use of public money for religious purposes

No public money shall be appropriated for religious purposes except if the priest, preacher,
minister, or dignitary is assigned to the armed forces, any penal institution, government
orphanage, or leprosarium.

Due Process
No person shall be deprived of life, liberty, or property without due process of law. The tax statue
must be within the constitutional authority of Congress and that it must be fair, just, and
reasonable (substantive due process). It shall require notice and hearing or at least an opportunity
to be heard (procedural due process).

Equal Protection
Equal protection requires neither equal rates of taxation on different classes of property, nor
prohibits unequal taxation so long as the inequality is not based upon arbitrary classification. It
merely requires that all persons subjected to such legislation shall be treated alike under like
circumstances and conditions both in the privileges conferred and in the liabilities imposed.
There must be valid classification, and the following are the requisites:
1. It must be based on substantial distinction;
2. It must apply to both present and future conditions;
3. It must be germane to the purposes of the law; and
4. It must apply equally to all members of the same class.

Religious Freedom
No law shall be made respecting an establishment of religion, or prohibiting the free exercise and
the free exercise and enjoyment of religious profession and worship without discrimination or
preference shall be forever allowed.

A municipal license tax on sale of bibles and religious articles by non-stock profit missionary
organization at minimal profit constitutes curtailment of religious freedom and worship which is
guaranteed by the Constitution.

Non-impairment of obligations of contracts

No law impairing the obligations of contracts shall be passed.

Notes:
- When the state grants an exemption on the basis of a contract, consideration is presumed to
be paid to the State, and the public is supposed to receive the whole equivalent therefrom.
- It applies to the power of taxation but not to police power and eminent domain.

STAGES OF TAXATION
1. Levy/Imposition- act of imposition by the legislature of tax on persons, property, or excises
2. Assessment/Collection- act of administration and implementation of the tax law by the
executive; assessment- means notice and demand for payment of tax liability
3. Payment- act of compliance by the taxpayer
4. Refund- recovery of any tax alleged to have been erroneously or illegally assessed or
collected.

Taxes
Enforced proportional contribution from persons and properties by the law-making body of the
State by virtue of its sovereignty for the support of the government and for public need.

Characteristics:
1. Levied by the state which has jurisdiction over the person or property
2. Levied by the law-making body
3. Enforced contribution
4. Generally payable in money
5. Proportionate in character
6. Levied on persons and property
7. Levied for public purpose

Requisites of a valid tax:

1. Either the person or property taxed be within the jurisdiction of the taxing authority;
2. Assessment and collection of certain kinds of taxes guarantee against injustice to individuals
3. Should be for a public purpose
4. Tax must not impinge on the inherent and constitutional limitations on the power of taxation
INCOME TAXATION

Kinds of Taxpayers
1. Individual taxpayers
2. Corporations
3. Partnerships
4. General professional partnerships
5. Estate and trusts
6. Co-ownership

Individual taxpayers
1. Citizens
2. Aliens
3. Special class of individual employees

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 law

Classification of Citizens:
a. Resident citizen – a Filipino citizen residing in the Philippines, without the intention of
transferring his physical presence abroad
b. Non-resident citizen includes:
i. 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;
ii. 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;
iii. 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;
iv. A citizen who has been previously considered as non-resident citizen and who arrived in
the Philippines at any time during the taxable year to reside permanently in the Philippines
with respect to his income derived from sources abroad until the date of his arrival in the
Philippines.

*Filipinos working in Philippine embassies or Philippine consulate offices are not considered
non-resident citizens.
“MOST OF THE TIME” means at least 183 days, but need not be continuous.

Alien
Classification of Aliens
a. Resident alien – an individual who is residing in the Philippines but is not a citizen thereof,
such as:
i. An alien who lives in the Philippines without definite intention as to his stay;
ii. One who comes to the Philippines for a definite purpose which in its nature would require
an extended stay and to that end makes his home temporarily in the Philippines, although
it may be his intention at all times to return to his domicile abroad.
iii. One who has stayed in the Philippines for more than one (1) year.

b. Non-resident Alien—an individual whose residence is not within the Philippines and who is
not a citizen thereof.
i. Engaged in trade or business in the Philippines—if the aggregate period of stay in the
Philippines exceeds 180 days for each calendar year; or
 ii. Not engaged in trade or business in the Philippines—if the aggregate period of stay in the
Philippines does not exceed 180 days for each calendar year.

Corporations
It shall include:
1. Partnerships, no matter how created or organized;
2. Joint stock companies
3. Joint accounts
4. Associations or insurance companies

But it does not include

1. General professional partnerships; and
2. Joint venture or consortium formed for the purpose of undertaking construction projects
or engaging in petroleum, coal, geothermal, and other energy operations pursuant to an
operation or consortium agreement under a service contract with the government.

Notes:
1. Domestic corporation is liable for income from all sources within and without the
Philippines
2. Foreign corporation which may include:
a. Resident foreign corporation or one engaged in trade or business in the Philippines
is liable for income from all sources within the Philippines; or
b. Non-resident foreign corporation or one not engaged in trade or business in the
Philippines is liable for income from sources within the Philippines.

Partnership
By contract of partnership, two or more persons bind themselves to contribute money, property,
or industry to a common fund, with the intention of dividing the profits among themselves.

No matter how created or organized, except general professional partnerships and joint ventures
engaged in construction or energy related operations are taxable as corporations.

General Professional partnerships

One that is formed by persons for the sole purpose of exercising their common profession. No
part of the income of which is derived from engaging in any trade or business.

Estate and Trusts

Estate refers to the mass of properties left by a deceased person. The status of the estate is
determined by the status of the decedent at the time of his death, so an estate as an income
taxpayer can be a citizen or an alien.

Co-ownership
Two or more heirs inherit an undivided property from a decedent; or a donor makes a gift of an
undivided property in favor of two or more donees.

It is not taxable when the activities are limited merely to the preservation of the co-owned property
but co-owners are liable for income tax in their separate and individual capacities.

It is taxable when the income of the co-ownership is invested by the co-owners in business
creating a partnership.
Income
It means all wealth which flows into the taxpayer other than a mere return of capital. It includes
the form of income specifically described as gains and profits including gains derived from the
sale or disposition of capital assets.

Nature of income
Income is a flow of service rendered by capital by the payment of money from it or any other
benefit rendered by the fund through a period of time. Income is the fruit of capital or labor severed
from the tree.

Income Tax
It is a tax on all yearly profits arising from property, professions, trades, or offices, or as a tax on
a person’s income, emoluments, profits, and the like.

Nature of Income Tax

It is an excise tax and not a tax on property. It is levied upon the privilege of receiving income or
profit.

Taxability of the taxpayers

Income within the Philippines Income without the Philippines
Resident Citizen Yes Yes
Non-resident Citizen Yes No
Resident Alien Yes No
Non-resident Alien
engaged in trade or Yes No
business
Non-resident Alien
not engaged in trade Yes No
or business
Domestic
Yes Yes
Corporation
Resident Foreign
Yes No
Corporation
Non-resident
Yes (final tax: 25%) No
Foreign Corporation

When is income taxable?

An income is taxable when there is income, gain, or profit; the income, gain, or profit is received
during the taxable year; and the income, gain, or profit is not exempt from income tax.
Regular Income Tax
- tax imposed on the income of an individual other than those passive income and capital gains
subjected to final tax and those specifically exempted by law

Characteristics of the Regular Income Tax

1. General in coverage- it is the catch-basin of all items of gross income other than those
passive income and capital gains subjected to final tax.
2. Net Income Tax- it is imposed on the residual profit or the gross income after deducting the
allowable deductions and personal exemptions.
3. Annual Tax- it is applied on the annual profits and gains of a taxpayer.
4. Creditable Withholding Taxes- most items of regular income are subject to creditable
withholding tax (CWT). CWT is withheld at source by customers or clients but is not a final
tax. It is an advance tax deductible against the annual income tax due of the taxpayer. This is
to minimize the cash flow problems of to the taxpayers and collection problems of the
government. See list given for the Summary Rules for Individuals.

The Regular Income Tax Model

Gross Income xx
(excluding passive income and capital gains subject to final tax)
Less: Allowable Deductions (xx)
Net Taxable Income xx
Apply Tax Rates (multiply tax rates) %
Net Income Tax Due xx
Less: Tax Credit, if any (xx)
Tax Still Due, if any xx

Progressive Income Tax

Prior to TRAIN Law
Over But Not Over
P0.00 P 10,000.00 5%
10,000.00 30,000.00 P500 plus 10% of excess over P 10,000.00
30,000.00 70,000.00 P2,500 plus 15% of excess over 30,000.00
70,000.00 140,000.00 P8,500 plus 20% of excess over 70,000.00
140,000.00 250,000.00 P22,500 plus 25% of excess 140,000.00
over
250,000.00 500,000.00 P50,000 plus 30% of excess 250,000.00
over
500,000.00 Infinite P125,000 plus 32% of excess 500,000.00
over

Upon Amendment of the TRAIN Law (Effective January 1, 2018 until December 31, 2022)
Over But Not Over
P0.00 P 250,000.00 0%
250,000.00 400,000 P250,000 plus 20% of excess P
over 250,000.00
400,000.00 800,000 P30,000 plus 25% of excess 400,000.00
over
800,000.00 2,000,000 P130,000 plus 30% of excess 800,000.00
over
2,000,000.00 8,000,000 P490,000 plus 32% of excess 2,000,000.00
over
8,000,000.00 Infinite P2,410,000 plus 35% of excess 8,000,000.00
over
Gross Income
Total income of a taxpayer subject to tax. It includes the gains, profits, and income derived from
any source, whether legal or illegal. The definition of the gross income in the Tax Code is broad
enough and it also covers the passive income and capital gains subject to final tax, however, it
should be noted that for tax purposes, the gross income being referred to in the tax model
excludes such items.

EXCLUSIONS FROM GROSS INCOME

Income or receipts which are excluded from the gross income. Hence, these incomes or
receipts are not subject to income tax. However, despite their non-inclusion from gross income,
such income items may be subject to taxes other than income tax. Their exclusions is provided
by the NIRC.

A. Proceeds from a Life Insurance Policy

The proceeds of a life insurance policies paid to the heirs or beneficiaries upon death of the
insured shall be excluded in the gross income of the life insurance holder.

An insurance policy is a contract of indemnity. Hence, the proceeds of life insurance are
treated more as an indemnity instead of as gain, profit, or income. However, the proceeds of
life insurance shall form part of the decedent’s gross estate which may be subject to estate
tax.

B. Amount Received by Insured as Return of Premium

The amount received by the insured, as a return of premiums paid by him under the life
insurance, endowment, or annuity contracts, either during the term, or at the maturity of the
term mentioned in the contract, or upon surrender of the contract.

Illustration (for A and B)

Marie took out a life insurance policy for P200,000 with her husband as beneficiary. Under
the policy, the insurer will pay Marie the amount of P200,000 when Marie reaches the age of
45 years or to her beneficiary husband in case she dies before the maturity of the policy.
The total premiums that would be paid upon maturity of the policy is P100,000.

Required:
a. The policy matured when Marie reached age 45, and the insurer paid her the amount of
P200,000. Determine the nature of the amount of P200,000 which Marie received under
the policy.

The gross profit or gross income realized from the insurance transaction is P100,000,
the excess of the amount received under the policy over the premiums paid, shall be
included in the gross income of Marie. The premiums paid of P100,000 represent the
cost of the insurance, hence, the return of capital, which shall be excluded in the
gross income.

One requisite in order for the proceeds of life insurance to be excluded in the gross
income is the death of the insured.

b. Assume Marie died four years before the maturity of the policy and the insurer paid
P200,000 to the beneficiary husband. The premiums already paid when Marie died was
P50,000. Determine the nature of the amount of P200,000 which the beneficiary husband
received under the policy.

The proceeds of life insurance paid to the beneficiary husband upon death of the
insured is not subject to income tax. It is not an income to the beneficiary; it is an
indemnity which makes it excluded in the gross income.
C. Gifts, Bequests, and Devices
The value of property acquired by gift, bequest, devise, or descent, provided however, that
income from such property shall be included in the gross income.

Illustration:
Ruben Reyes is a manager of Piso-Piso Bank with an annual salary of P260,000. On
August 1, 2013, he inherited from an aunt a lot with a 5-door apartment valued at P750,000.
The apartment, which is fully tenanted, has a monthly rental income of P60,000. Determine
the gross income of Ruben Reyes for 2013.

Salary P260,000
Rental income of the apartment (P60,000 x 5 months) 300,000
Gross Income P560,000

The value of the property inherited is an exclusion from the gross income, however,
any income or fruit from the property inherited shall be included in the gross income
of Ruben.

D. Compensation for Injuries or Sickness

Amounts received through accident or health insurance or under Workmen’s Compensation
Acts as compensation for personal injuries or sickness, plus the amounts of any damages
received, whether by suit or agreement, on account of such injuries or sickness.

The phrase “personal injury or sickness” does not only include awards for sickness and
physical injury, but also nonphysical injury such as personal embarrassment, injury to
personal reputation in the community, mental pain and suffering, fright, serious anxiety,
wounded feelings, moral shock, defamation, slander, breach of promise to marry, or libel.

Illustration:
Ex suffered serious physical injuries in a vehicular accident and was hospitalized for 60
days. He recovered damages as follows:
Cost of hospitalization P 112,000
Recovery of lost income (P2,000 x 60 days) 120,000
Moral damages 10,000 Exemplary damages 5,000
Total P247,000
Which recoveries are taxable and which are not?

The recovery of lost income is taxable, while the cost of hospitalization, moral damages,
and
exemplary damages are excluded in the gross income of
Ex.

E. Income Exempt Under Treaty**

Income of any kind, to the extent required by any treaty obligation binding upon the
Government of the Philippines. They are excluded by international agreement to which the
Philippine government is a signatory are excluded from income tax.

F. Retirement Benefits, Pensions, Gratuities, and Other Benefits

a. Retirement benefits and pensions
Generally these are taxable and they form part of the gross income. However, such
amounts received by officials and employees of private firms, whether individual or
corporate, shall be exempt from income tax when the requisites for exclusion in the Tax
Code are complied with.

Requisites for exemption:

1. There must be a reasonable private benefit plan maintained by the employer. This
means that the employer has a pension gratuity, stock bonus or profit sharing plan
maintained by the employer for the benefit of his employees, where contributions are
 made by the employer or by both, for the purpose of distributing the principal and the
earnings accumulated to the exclusive benefit of the said officials and employees;
2. The retiring official or employee has been in the service of the same employer for at
least ten
(10) years. This can be in cumulative;
3. The retiring official or employee must not be less than 50 years old at the time of his
or her retirement;
4. The retiring official or employee should not have previously availed of the exemption
of the retirement benefit plan.

*The money value of accumulated leave credits and terminal leaves given to retiring
government official or employee is not subject to income tax because these are likewise
vied as a retirement gratuity to the official or employee.

Illustration:
Alma received P120,000 retirement pay from Concepcion Industries. Indicate whether
her income is subject to tax or not based on the following independent cases:
Case Private Benefit Plan Years in Retirement Age Answer
Service
1 Yes 12 40 Taxable
2 Yes 9 60 Taxable
3 None 15 65 Taxable
4 Yes 11 55 Not Taxable

b. Separation Pay
Any amount receive by an official or employee, or by his heirs, from the employer as a
consequence of separation of such official or employee from the service of the employer
due to:
1. Death, sickness, or physical disability; or
2. Any cause beyond the control of the said official or employee:
a. Redundancy
b. Retrenchment
c. Closure of employer’s business
d. Employee lay-off
e. Downsizing of the employer’s business
The term “beyond the control of the employee” means involuntariness of separation
on the part of the official or employee.

Illustration:
In view of the heavy losses being suffered by Ballad Corporation, Watanabe and Abe
were advised by the manager to resign as they would be retrenched to make it appear
that they voluntarily resigned instead of having been involuntarily separated as the latter
would have implications of inefficiency on their part.

Required:
1. Suppose Watanabe resigned and received P50,000 separation pay. Is the P50,000
taxable to him?
Yes, because Watanabe voluntarily resigned from the service. The principal reason
for termination is his resignation and not the losses being suffered by the
corporation. Resignation is an act that is within the control of the employee.

2. Due to refusal of Abe to resign, the corporation was forced to terminate him and was
paid P60,000. Is this amount taxable to her?
No, because the cause of his severance from employment was termination due to
retrenchment, a cause which is not within her control.
 Separation pay and retirement should be distinguished from each other in the sense
that while the latter is received by employees in view of severance from employment
after reaching a certain age or a specific number of years in service, the former is
received due to termination of employment for causes other than age or length of
service.

F. Social security benefits, retirement gratuities, and other similar benefits from foreign
government agencies received by resident or non-resident citizens or aliens who come to
settle permanently in the Philippines
G. United States Veterans Administration (USVA) benefits due to residents of the Philippines
H. Benefits from SSS and GSIS
I. Mandatory contributions of employee to GSIS, SSS, PhilHealth, Pag-ibig, and Union Dues
of Individuals
J. Prizes and Awards in recognition of religious, charitable, scientific, educational,
artistic, literary, or civic achievements but only if a) the recipient was selected without any
action on his part to enter the contest or proceeding; and b) the recipient is not required to
render substantial future services as a condition to receiving the prize or award.
K. Prizes and Awards in Sports Competitions granted to athletes a) in local or international
competitions and tournaments; b) whether held in the Philippines or abroad; and c)
sanctioned by their national sports associations.
L. Gains from Sale of bonds, debentures or other certificate of indebtedness with a maturity of
more than 5 years.
M. Gains realized from redemption of shares in mutual fund by the investor.
N. 13th Month Pay and other benefits not exceeding P90,000 (prior to TRAIN Law, P82,000)
O. De minimis benefits (to be discussed further under Fringe Benefits) These are fringe
benefits to employees subject to limits:
With updates of the TRAIN Law (Revenue Regulations 11-2018)
De Minimis Benefits Threshold
Old Law TRAIN Law
(RR 5-2011) (RR 11-2018)
1. Monetized unused vacation
Not to exceed 10 days Not to exceed 10 days
leave credits of private
during the year during the year
employees
2. Monetized unused vacation
and sick leave credits of
No limit No limit
government officials and
employees
Not exceeding P750 per Not exceeding P1,500
employee per semester or per
3. Medical cash allowance to P125 per month employee per semester
dependents of employees or
P250 per
month
P1,500 or 1 sack 50-kg rice P2,000 or 1 sack 50-kg rice
4. Rice subsidy per month amounting to not per month amounting to not
more than P1,500 more than P2,000
5. Uniform and clothing Not exceeding P5,000 per Not exceeding P6,000 per
allowance annum annum
Not exceeding P10,000 per Not exceeding P10,000 per
6. Actual Medical Cash Benefit
annum annum
Not exceeding P300 per Not exceeding P300 per
7. Laundry allowance
month month
 Must be in the form of tangible personal property
8. Employee achievement other than cash or gift certificate with annual monetary
award (length of service, value not to exceed P10,000 received by an employee
safety achievement) under an established written plan which does not
discriminate in favor of highly paid employees
9. Gifts given during Christmas
Not exceeding P5,000 per Not exceeding P5,000 per
and major anniversary
employee per annum employee per annum
celebrations
10. Daily meal allowance for Not exceeding 25% of the Not exceeding 25% of the
overtime work and basic minimum wage on a basic minimum wage on a
night/graveyard shift per region basis per region basis
a) Air fare tickets of economy and business class except
11. Travel abroad First class which 30% thereof is deemed taxable; b) Hotel
accommodation of US$300/day; and c) Inland Travel
Not exceeding P10,000 per employee per taxable year,
12. Productivity Bonus
provided there is a collective bargaining agreement

Note: The excess of these de minimis benefits over their maximum limits are included in
the 13th month and other benefits. The totality of the benefits is compared with the limit
(P90,000 or P82,000) and the excess shall be treated as compensation income subject to
regular income tax for rank and file employees or treated as fringe benefit subject to fringe
benefit tax for managerial and supervisory employees.

INCLUSIONS/SOURCES OF GROSS INCOME

A. Compensation received under an employer-employee relationship, whether paid in cash or
in kind

Types of Employee as to Taxability

1. Minimum Wage Earners- an individual who is a recipient of a minimum wage as fixed by
the Department of Labor and Employment. They are exempt from income tax on the
minimum wage including holiday pay, overtime pay, night shift differential, and hazard pay.
2. Special Aliens- employees holding a managerial or technical position in an RHQ, offshore
banking units, or petroleum service contractors or subcontractors. They are subject to 15%
final income tax on their gross income. Filipinos who are occupying the same position as
those held by special aliens may opt to be taxed at 15% final income tax or the regular
income tax.
3. Regular Employees- employees who are subject to regular progressive income tax.

B. Gross income from profession, trade or business

Gross income means the total sales less cost of goods sold, plus any income from
investments and from any incidental or outside operations or sources. Total sales or gross
sales in Taxation means the same to the net sales in Accounting.
C. Gains from dealings in property classified as ordinary assets and property classified as
capital assets except those subject to capital gains tax
D. Interest Income other than the passive interest income subject to final tax
E. Rents paid by the lessee for the use or lease of property
a. Obligations of the lessor that are assumed by the lessee are additional rental income to
the lessor
b. Advance rentals are items of gross income upon receipt if it is unrestricted or if it is
restricted but to be applied in future years or upon termination of the lease. It shall not
form part of the gross income if it is a loan or it is a security deposit to guarantee payment
or rent subject to contingency which may or may not happen.
c. Leasehold improvements made by the lessee shall be considered income by the lessor.
F. Royalties that are considered active royalties and royalty income earned outside the
Philippines
G. Dividends declared by foreign corporations
H. Prizes and winnings other than those subject to final tax
Prizes earned in the Philippines which do not exceed P10,000 and winnings from PCSO
which shall not exceed P10,000* shall be subject to regular income tax. *effective after
TRAIN Law
I. Pensions which failed to meet the exclusion criteria (to be discussed in the Exclusions)
J. Partner’s share in the net income of the General Professional Partnership
The income of the General Professional Partnership is exempt from income tax but the
share of the partners for such is subjected to regular income tax.

Drills (Inclusions/Exclusions)
1. Mr. Basilio insured his life with his estate as beneficiary. In 2016, after Mr. Basilio had paid
P65,000 in premium, he assigned the policy to Mr. Jose Llamado for P60,000, and Mr.
Llamado continued paying the premiums. Mr. Basilio died and Mr. Llamado collected the total
proceeds of P200,000. Mr. Llamado, after the assignment and before Mr. Basilio’s death, paid
a total premium of P80,000. As a result of the above transaction, Mr. Llamado derived an
income of _______________.

2. Mr. Monte was injured in a vehicular accident in 2015. He incurred and paid medical expense
of P20,000 and legal fees of P10,000 during the year. In 2016, he received P170,000 as
settlement from the insurance company which insured the car owned by the other party
involved in the accident. From the above payments and transactions, the amount of taxable
income of Mr. Monte in 2016 is _______________.

3. Tony was hit by a wayward bus while on his way home. He survived but had to pay P150,000
for his hospitalization. He was unable to work for 6 months and did not receive her usual
P10,000 monthly salary. He sued the bus company and was awarded by a final judgment a
sum of P460,000- P150,000 as reimbursement for his hospitalization, P60,000 for her lost
salaries, and P250,000 as moral damages for his pain and suffering. How much income did
he realized from the judgment?
4. During 2017, Mrs. Imelda Juanito retired from her job at Golden Manpower Services, Inc. She
joined Golden Manpower Services, Inc. in 1991, when she was 38 years old, until 2000;
resigned in 2000 but returned to the company's employ in 2002. Golden Manpower Services,
Inc. maintains a reasonable private benefit plan which is also approved by the BIR. This was
her first time availment of retirement benefit exemption. Is the retirement benefit taxable?
5. After resigning in 2017, Mrs. Imelda Juanito immediately joined another company with a
reasonable pension plan but she was terminated in 2019 due to retrenchment. Is the
separation pay exempt?

A resident citizen, widower, with a dependent minor brother, had the following data on income
and expenses for 2018:
Gross business income P 500,000
Business expenses 200,000
Interest from savings deposit, BPI-Makati, Philippines 50,000
Prize in a literary contest he joined 100,000
Prize received for achievement in literature (did not join the contest) 10,000
Gain from sale of bonds (maturity is 6 years) 5,000

Separation pay form his former job (resigned) 250,000

Cash he inherited from his uncle 300,000

Proceeds of his wife’s life insurance (irrevocable beneficiary) 1,000,000

Amount received as return of premium (premium paid, 200,000

P150,000)
Tax informer’s reward 500,000
 Interest income from Government bonds 10,000

Winnings from illegal gambling 20,000

6. Compute the total amount of excluded or exempted income.
7. Compute the taxable net income.

A taxpayer derived the following income during 2010:

Philippines Abroad

Compensation income, net of P500 SSS, P250 PhilHealth

and P10,000 withholding tax
P 200,000
Rental of house to student boarders 400,000
Gross profit on sale of Bagoong 300,000 P 200,000
Interest income from bank deposit 18,000 27,000
Gain on sale of bonds with 5 year maturity 50,000
Prizes in a singing competition 80,000 120,000
Interest received from loan to an Overseas Contract Worker 100,000
SSS Benefits received 20,000
8. Compute the total income to be reported assuming the taxpayer is a resident citizen.
9. Compute the total income to be reported assuming the taxpayer is a non-resident citizen.

A certain taxpayer, who is employed in a private company, had the following income in 2018:
Salary, gross of withholding tax P 480,000
Allowances 20,000
Thirteenth month pay 20,000
Christmas bonus 20,000 Reimbursement for transportation expense 5,000
Payroll deductions:
SSS contributions P 4,000
PhilHealth contributions 3,000
Pag-Ibig contributions 2,400
Loan payment 20,000
10. Compute the total exclusions from gross income.

The following data for the year 2018 of a resident rank-and-file employee who works in a private
company.
She has four qualified dependent children are made
available:

Annual Salary, net of P10,000 withholding tax, P2,400 SSS contributions, P2,000
Philhealth contributions and P1,500 union dues P 206,000
13th month pay 18,000
Rice subsidy (P1,500 x 12) 18,000
Uniform and clothing allowance 5,000 Monetized unused vacation leave credits (12 days)
6,000
Actual medical benefits 15,000
Christmas gift 10,000
Laundry allowance (P400 x 120) 4,800
Separation pay from a previous employer (terminated due to redundancy) 150,000
Interest income from an 8-year deposit which was pre-terminated
(remaining maturity is 4 years) 40,000
Dividend from regional operating headquarter of a multinational corporation
in the Philippines 10,000

11. Compute the tax-exempt de minimis benefits.

ALLOWABLE DEDUCTIONS
Deductions are items or amounts allowed to be subtracted from the gross income to arrive at
the taxable income. A taxpayer can deduct an item or amount from the gross income only if
there is a law authorizing such deduction. In the absence of a law, the expense of the taxpayer,
whether business-related, reasonable, or equitable, cannot be deducted from the gross income.

Distinction Between Exclusions and Deduction

Exclusions Deductions
Refer to flow of wealth which are not treated as Refer to the amounts which the law allows to
part of gross income due to: be subtracted from the gross income in order
1) exempted by the fundamental law; to arrive at the net income
2) exempted by the statute; or
3) not under the definition of gross income
Pertains to the computation of the gross income Pertains to the computation of the net income
Something earned or received by the taxpayer Something spent or pain in earning of gross
which do not form part of gross income income

Substantiation Requirements
The burden of proving legality and correctness of the deductions claimed rests upon the
taxpayer. The taxpayer has the obligation to substantiate with receipts and other evidences
every item of deduction claimed when required. The Commissioner of Internal Revenue has the
right to allow or disallow the deduction of the taxpayer’s expenses.

For income tax purposes, deductions are classified as follows:

1. Personal Exemptions*;
2. Itemized deductions; and
3. Optional Standard Deduction (OSD).
*Applicable prior to the implementation of the TRAIN Law

Summary of Allowable Deductions

Individual
Individuals Engaged in
Employees
Trade or Business
(except NRA- Estate or Trust Corporations
(except NRA-NETB
NETB and Special
and Special Aliens)
Aliens)
Itemized deduction or Itemized deduction or Itemized deduction or
None
OSD OSD OSD
1. Individuals engaged in trade, profession, or business can select the kind of deduction he will
use in computing his taxable income each year. He may select the itemized deductions or in
lieu thereof, the optional standard deductions.
2. Individuals earning purely compensation income arising from personal services rendered
under an employer-employee relationship are not allowed the itemized deductions or optional
standard deductions.
3. Nonresident aliens not engaged in trade or business in the Philippines and Special Aliens
cannot avail of deductions from the gross income since they are subject to final tax.

Personal Exemption*
The amount exempted by law in lieu of the personal, living, and family expenses of an individual
taxpayer.
This has been discussed in the prior topics.
*Applicable prior to the implementation of the TRAIN Law

Itemized Deductions
A taxpayer shall specify the expenses and other items it is deducting from gross income.
Generally, these are reflected in the profit and loss statement.
Who may claim the Itemized Deductions?
Individuals engaged in trade, profession, or business (except NRA-NETB and Special Aliens)

The Itemized deductions consist of the following items:

1. Ordinary and necessary expenses
2. Interest
3. Taxes
4. Losses
5. Bad debts
6. Depreciation of property
7. Depletion of oil and gas wells and mines
8. Charitable and other contributions
9. Research and development
10. Pension trust contributions of employees

Optional Standard Deduction

The optional standard deduction (OSD) is in lieu of the itemized deductions allowed. It is an
amount not exceeding forty percent (40%) of the gross sales* or receipts of the taxpayer. *Net
sales in Accounting

The OSD shall be a minimum of 40% of the gross sales if the taxpayer is on the accrual basis of
accounting and 40% of the gross receipts if the individual is on the cash basis of accounting.
This amount shall be in lieu of the a) itemized deductions; and b) cost of sales.

The Itemized Deductions

In detail

A. Ordinary and Necessary Trade, Business, or Professional Expenses

Ordinary Expense- normal or usual in relation to the taxpayer’s business and the
surrounding circumstances.
Necessary Expenses- appropriate and helpful in the development of taxpayer’s business
and are intended to minimize losses or to increase profits. These are the day-to-day
expenses.

Requisites for Deductions of Business Expenses

1. The expenses must be ordinary and necessary;
2. It must be paid or incurred during the taxable year;
3. It must be connected with the trade, profession, or business;
4. It must be substantiated with official receipts or other adequate records.
5. It must be reasonable, when the expense is not lavish, extravagant, or excessive under
the circumstances; and
6. If subject to withholding taxes, proof of payment to the BIR must be shown.

Notes:
1. While illegal income will form part of the income of the taxpayer, expenses which constitute
bribe, kickback, and other similar payment, being against law and public policy, are not
deductible from gross income.
2. Capital expenditures that benefits not only the current period but also future periods are
not deductible but depreciable, except, if the taxpayer is a non-profit proprietary educational
institution which may elect either to deduct the capital expense or depreciate it.

B. Interest Expense
The amount of interest paid or incurred within a taxable year on indebtedness in connection
with the taxpayer’s profession, trade, or business shall be allowed as deduction from gross
income.
 Requisites for Deduction of Interest Expense
1. There is indebtedness of the taxpayer;
2. There should be an interest paid or incurred upon such indebtedness;
3. The indebtedness is connected with the taxpayer’s profession, trade, or business;
4. The interest expense must have been paid or incurred during the taxable year;
5. The interest must have been stipulated in writing;
6. The interest must be legally due;

Notes:
1. The taxpayer’s allowable deduction for interest expense shall be reduced by an amount
equal to 33% (beginning January 1, 2009) of the interest income subjected to final tax.
2. Interest expense is deductible in full if the taxpayer or business do not have interest income
subjected to 20% final tax and if the interest expense is paid to the government.
3. At the option of the taxpayer, interest incurred to acquire property used in trade or business
may be allowed as a deduction or treated as capital expenditure.
4. Interest from tax delinquency and from scrip dividends are deductible interest expense.

Illustration:
A taxpayer incurred a deductible interest expense of P180,000 in 2013. In the same year, his
bank deposit realized interest income of P50,000 on which the 20% final tax was withheld by
the bank. Determine the amount of interest expense to be deducted from the gross income.

C. Taxes
Taxes paid or incurred within the taxable year in connection with the taxpayer’s profession,
trade, or business purposes. As a general rule, taxes are deductible with the exception of
those with respect to which the law does not permit deduction.

Requisites for Deduction of Taxes

1. It must be paid or incurred within the taxable year;
2. It must be paid or incurred in connection with the taxpayer’s profession, trade, or
business; and
3. The tax must be imposed directly upon the taxpayer.

Non-deductible Taxes
1. Income tax- these are not costs of earning income but are impositions on net income
accruing only after the income is earned, hence, they are non-deductible.
2. Estate and donor’s tax;
3. Value Added Tax1;
4. Special assessments
5. Excess electric consumption tax;
6. Foreign income tax2, war profits, and excess profit tax, if the taxpayer makes use of tax
credit; and
7. Final taxes, being in the nature of income tax.

1Business taxes include VAT, percentage tax, and excise tax, however, the only non-
deductible tax is the VAT. All business tax are viewed as a business liability in acquiring
sales, however, this principle is only applied to VAT, hence making it non-deductible. For
percentage tax, current regulatory developments treated it as a deductible expense. Excise
taxes are normally included in the selling price, hence it will be a deductible tax expense. For
buyers, business taxes form part of the purchase cost, therefore, deductible through the cost
of sales or other expense categories but not as tax expense.

2ForeignIncome tax can either be claimed as

1. Deduction (the foreign taxes paid are deducted on the taxable income); or
2. Tax credit (the foreign taxes paid are deducted against the income tax due on the world
income).
 Who can claim tax credit?
1. Resident citizens of the Philippines
2. Resident aliens under the principle of reciprocity
3. Domestic corporations which include partnerships except GPP
4. Beneficiaries of estate and trust
5. Members of beneficiaries of local partnerships

Determination of Foreign Tax Credit

The allowable tax credit is the lower amount between the tax credit limit computed or the
actual tax.
1. One Foreign Country
𝐹𝑜𝑟𝑒𝑖𝑔𝑛 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒
𝑥 𝑃ℎ𝑖𝑙𝑖𝑝𝑝𝑖𝑛𝑒 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑎𝑥
𝐷𝑢𝑒 = 𝑇𝑎𝑥 𝐶𝑟𝑒𝑑𝑖𝑡 𝐿𝑖𝑚𝑖𝑡 𝑊𝑜𝑟𝑙𝑑 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒
2. Multiple Foreign Country
𝑇𝑜𝑡𝑎𝑙 𝐹𝑜𝑟𝑒𝑖𝑔𝑛 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒
𝑥 𝑃ℎ𝑖𝑙𝑖𝑝𝑝𝑖𝑛𝑒 𝐼𝑛𝑐𝑜𝑚𝑒 𝑇𝑎𝑥
𝐷𝑢𝑒 = 𝑇𝑎𝑥 𝐶𝑟𝑒𝑑𝑖𝑡 𝐿𝑖𝑚𝑖𝑡 𝑊𝑜𝑟𝑙𝑑 𝑇𝑎𝑥𝑎𝑏𝑙𝑒 𝐼𝑛𝑐𝑜𝑚𝑒
Notes:
1. Taxes allowed as deductions, when refunded or credited, shall be included as part of
gross income in the year of the receipt to the extent of the income tax benefit of said
deduction.
2. Only the basic tax of a deductible tax is allowable as deduction. Tax surcharges for late
payments are avoidable and unnecessary expense, hence, they are non-deductible.
However, interests for late payment of tax was held deductible by the Supreme Court
but as interest expense rather than as tax expense.
3. Only taxpayers with world taxable income can claim foreign income tax as deduction
or tax credit.

Illustrations:
Aries, a resident citizen, reported the following result of operations:
Taxable income from the Philippines P 1,800,000
Taxable income from Japan 1,200,000
Quarterly estimated income tax paid in the Philippines 200,000
Income tax paid in Japan 300,000 d
Required:
1. How much is the income tax payable under the deduction approach?
2. How much is the income tax payable under the tax credit approach?
3. Assuming Aries also has a taxable income from Taiwan of 1,000,000 and an income
tax paid of P100,000?, how much is the tax payable under the tax credit approach?

D. Losses
Losses which do not come under the category of bad debts, inventory losses, depreciation,
and which arise in taxpayer’s profession, trade, or business.

Requisites for Deduction of Losses

1. Actually sustained during the taxable year
2. Connected with the trade, business, or profession
3. Evidenced by a close and completed transaction
4. Not compensated for by insurance or other form of indemnity
5. Not claimed as a deduction for the estate tax purposes
6. Notice must be file with the BIR within 45 days from the date of discovery of the casualty
or robbery, theft, or embezzlement.

Illustration:
A taxpayer engaged in farming incurred the following losses:
Loss on destruction of residence by a storm P 1,200,000
Loss on sale of old farm equipment 50,000
 Loss on assignment of receivables to a bank 40,000
Purchase cost of a bull lost during a storm 30,000
Value of animal offspring killed by Black leg disease 20,000
The following are deductible losses:
Loss on sale of old farm equipment 50,000
Purchase cost of a bull lost during a storm 30,000
Total Deductible Loss 80,000
Losses from ordinary assets are deemed normal to the taxpayer’s trade, business, or
profession; hence, these are deductible in full. Losses on capital assets are deemed by law
unnecessary expenses; hence, these are deductible only up to the extent of capital gains.

Deductible Losses:
1. Loss incurred in trade, profession or business
2. Loss due to fire, storm, shipwreck or other casualty of property connected with trade,
profession or business
3. Loss due to theft, robbery, or embezzlement if the property is connected with trade,
profession or business

Measure of the Loss:

1. Total Loss – book value of the property
2. Partial Loss – replacement cost of the damaged portion of the asset or the book value
thereof at the time of loss, whichever is lower.
Note: The asset must be written-off before a loss can be claimed as a deduction.

Abandonment Losses
1. Petroleum operation – all accumulated exploration and development expenditures
pertaining to partially or wholly abandoned of contract area shall be allowed as a deduction,
provided notice of abandonment shall be filed with the Commissioner of Internal Revenue
2. Producing wells – the unamortized costs thereof, as well as the undepreciated costs of
equipment directly used therein , shall be allowed as a deduction in the year such well,
equipment or facility is abandoned by the contractor

Note: if the abandoned well is re-entered and production is resumed, or if such equipment is
restored into use, the same cost claimed as deduction shall be reverted back into gross
income subject to the income tax benefit rule.

Capital losses are deductible only to the extent of capital gains. But a net capital loss carry-
over can be deducted in the following year it arose for non-corporate taxpayers. (Please
check handouts in Dealings in Properties.)

E. Bad Debts
It refers to debts due to the taxpayer which were actually ascertained to be worthless and
were charged off within the taxable year.

Requisites for Deduction of Bad Debts

1. There must be valid and subsisting debt due to the taxpayer.
2. It must be connected with the taxpayer’s trade, profession or business
3. The debt is actually ascertained to be worthless
4. It must be charged-off within the taxable years

Recovery of bad debts

1. Taxpayers under cash basis – Taxable but subject to Income Tax Benefit Rule
2. Taxpayers under accrual basis – Always taxable

Non-deductible bad debts:

1. Those incurred under cash basis of reporting gross income
2. Those sustained in a transaction entered into by related parties
3. For taxpayers not taxable on world income, those that represents loss of foreign income.
 The rules on bad debts may be applicable to debt securities becoming worthless for dealers
in securities only such as domestic banks and trusts companies whose major part of
business are dealing with securities. For other taxpayers where such security is a capital
asset, the rules on capital loss apply and are deductible subject to limit.

F. Depreciation

Requisites for Deductible Losses

1. The property must be used in trade, profession or business
2. The property must have a limited useful life
3. The provision must be charged off during the taxable year
4. The provision must be reasonable

Special Option with depreciation:

1. For a proprietary or private educational institution
only 2. May either choose to:
a. charged off as capital outlays of depreciable asset in the year of acquisition; or
b. deduct allowance for depreciation

Basis of Depreciation
The fair market value at the time of acquisition

1. The taxpayer and the Commissioner of Internal Revenue shall agree in writing about
the useful life and rate of depreciation. Such agreement shall be binding upon the
taxpayer and the National Government in the absence of circumstances not taken into
consideration during the adoption of the agreement.
2. Any change in the agreed rate and useful life shall operate prospectively.
3. In default of such agreement, the adoption of the taxpayer of useful life and
depreciation rate for depreciable assets without the objection of the Commissioner or
his duly authorized representative shall be considered binding.

Methods of Depreciation
1. Straight line
2. Declining balance
3. Sum of the years
4. Other methods which may be prescribed by the Secretary of Finance upon
recommendation of the Commissioner of Internal Revenue

Petroleum Operation:
- The taxpayer may choose either declining-balance method or straight line method
at the option of the contractor. Useful life of depreciable asset:
1. used in or related to the production of petroleum – 10 years or shorter as may be
permitted by the Commissioner of Internal Revenue
2. not used in or not related to the production of petroleum – 5 years under straight
line method

Mining Operations:
- For all properties used in mining operations, other than petroleum operation:
1. 10 year useful life or less – At normal rate of depreciation
2. More than 10 years useful life – depreciated over any number of years between 5
and the expected life. Provided the taxpayer notifies the CIR at the beginning of the
deprecation period of the rate to be used.
G. Depletion (Cost Depletion) – available only for oil and gas wells and mines.

Exploration Expenditure – expenditures paid or incurred in ascertaining the existence,

location and extent, or quality of any deposit or ore or other minerals before the beginning
of the development stage of the mine or deposit.
Development Expenditure – paid or incurred during the development stage of the mine.
The development stage begins when ore or other minerals are shown to exist in
commercial quality and quantity and end upon commencement of actual commercial
extraction.

Method to Use: Cost-Depletion Method

Depletion should be provided only up to the extent of capital investment in the mine only.
Capital investment in the mine

Unit depletion charge = Units

expected recoverable

Oil and Gas Wells or Mines: Treatment of

Intangible Exploration and Development Drilling Costs

Provided that production in commercial quantities has commenced, if intangible

development drilling cost are incurred for:
1. Non-producing wells and or mines – deductible in the year incurred
2. Producing wells and or mines – at the option of the taxpayer, deduction in full in the
year paid or incurred, or capitalized and amortized

Note: tangible development costs are capitalized and are subject to depreciation

If intangible exploration, drilling and development expenses are claimed as deductions,

they should not be added to the adjusted cost basis of the mining property for purposes
of computing the cost depletion.

Irrevocable Alternative Deduction: Applicable to Mining Operation only

The taxpayer may, at his option, deduct exploration and development expenditures
accumulated as cost or adjusted basis for cost depletion as of date of prospecting, as
well as exploration and development expenditures paid or incurred during the taxable
year.

Limit: the amount of deductible exploration and development cost shall not exceed 25%
of taxable income, without the benefit of any tax incentive under existing laws.

Once elected, the scheme shall be binding and irrevocable in succeeding taxable years.

Deductibility of Depreciation or Depletion on Mining Properties:

Taxpayers who are taxable on:

Depreciable or Depletable World income Philippine income

Asset only
Located abroad Deductible Non-deductible
Located in the Philippines Deductible Deductible
H. Charitable and Other Contributions
Requisites:
1. the contribution or gift must be actually paid
2. the contribution of property must be measured based on acquisition cost
3. it must be given to an organization specified by law
4. net income of the specified institution must not inure to the benefit of any private
stockholder or individual
5. the person making the contribution must be engaged in trade, business or profession

Note: if the taxpayer is not engaged in trade, business or profession, the rules on Donor’s
taxation applies. Similar gifts are usually exempt under donor’s taxation provided that not
more than 30% of the donation is used for administrative purposes by such done non-
profit entity.

Classification of contributions
A. Fully deductible contributions
1. Donation to the government or political subdivisions including fully owned
government and controlled corporations to be used exclusively in undertaking
priority activities in:
1. Education 4. Human settlements
2. Health 5. Culture and sports
3. youth and sport development 6. Economic developments

Provided, donation to the government that are not in accordance with priority activities are
subject to limit.

2. Donation to foreign institution or international organization in compliance with

agreement or treaties.
3. Donations to accredited domestic non-government organizations. These includes
organizations exclusively for:
1. Scientific 6. Health
2. Research 7. Social welfare
3. Educational 8. Cultural
4. character building 9. Charitable
5. youth and sports development 10. Any combination of the listed purposes

Requisites:
1. the donation must be utilized by the donee institution not later than the 15th day of
the third month following the close of the taxable year
2. the administrative expense must not exceed 30% of the total expenses
3. Upon dissolution, assets must be distributed to another non-profit domestic
corporation of to the Government
- if these conditions are not complied with, the donation is subject to limit

B. Contributions subject to limit

1. Donations to the Government of the Philippines or political subdivisions exclusively
for public purposes (non-priority activities)
2. Donation to non-government organization or to domestic corporations organized
exclusively for the following purposes:
1. Religious 5. Cultural
2. Charitable 6. Educational
3. Scientific 7. Rehabilitation of veterans
4. Youth and sports development 8. Social welfare

Limit of deduction:
Based on the taxable income derived from business or profession prior to the
deduction of contributions (either fully deductible or subject to limit)
 1. 10% for Individual
2. 5% for Corporations

Deductible Contribution subject to limit

The deductible contribution subject to limit shall be whichever is lower of the actual
contribution with the limit as set forth herein.

I. Contribution to Pension Trust

Current Service Cost – actually computed value of services rendered by a plan
employee during the year
Past Service Cost – value of services rendered by employees in the past that partially
satisfy vesting conditions

Rules for Pension Expense:

1. Payments to the trust to cover pension liability accruing during the year (current service
cost) are fully deductible expense for the taxable year.
2. Payment to the trust in excess of the current period costs is attributed to past service
cost up to the balance of unfunded past service cost. Funding of past service cost is
amortized over a period of 10 years starting from the year in which the contribution was
made.

Actuarially, costs that accrue during the current year include the value of services
rendered currently (current service cost and interest cost).

Note: Deductions claimed for non-vesting employees should be reversed to gross

income.

J. Research and Development Cost

Requisites:
1. It must be paid or incurred during the taxable year
2. it must be connected with the trade, profession or business of the taxpayer
3. it is not chargeable to capital accounts (capitalizable expenditure)
Amortization of Capitalizable Research and Development Costs that are not
chargeable to a property of a kind that is subject to depreciation or depletion: 1. the
taxpayer should treat the expenditure as a deferred charge
2. amortized over a period of not less than 60 months starting from the month in which
the taxpayer first derived benefits from such deferred expense

Non-deductible research and development expenditures:

1. expenditure for the acquisition of improvement of a land ( in connection with research
projects)
2. any expenditure for the improvement of property to be used in connection with
research and development of a kind which is subject to depreciation and depletion;
and (these items are capitalized then charged off to depreciation)
3. any expenditure paid or incurred for the purpose of ascertaining the existence,
location, extent, or quality of any deposit of ore or other mineral, including oil and gas.
(exploration costs are non-deductible, only development costs)

K. Expenses, in general Requisites:

1. it must be ordinary and necessary
2. it must be paid or incurred during the taxable year
3. it must be directly attributable to the development, operation, management and or
conduct of the trade, profession or business
4. it must be reasonable
5. the amount paid shall be allowed as deduction only if it is shown that the tax required
to be deducted and withheld therefrom has been paid to the BIR
6. it must be supported by official receipts or adequate records
 A. Compensation
Requisites:
1. personal services must have been actually rendered
2. the compensation for such services must be reasonable, including the grossed-up
monetary value of fringe benefit furnished to the employee and the applicable final
tax remitted to the BIR

B. Traveling Expenses
Requisites:
1. must be incurred while away from home
2. in pursuant of a trade, profession or business

C. Entertainment, Amusement or Recreation Expenses (EAR)

Requisites:
1. it must be directly related to the furtherance of the conduct of trade, profession or
business
2. it must not be contrary to law, morals, good customs, public policy or public order
3. it must not have been paid directly or indirectly to an official or employee of the
Government (local or national, including government-owned and controlled
corporations) or of a foreign government, or to a private individual, corporation,
General Professional Partnership or a similar entity, if it constitute bribe, kickback
or other similar payments
4. the official receipts, invoices, bills or statement of accounts should be in the name
of the taxpayer claiming the deduction

Limit of deductible amount for EAR:

A. Taxpayers deriving income from either sales of properties or sale of services:
Whichever is lower of the following and the actual EAR expense
1. Taxpayers engaged in sale of goods or properties – ½ of 1% ( or .5%) of net sales (i.e.:
sales less sales returns, allowances and discounts)
2. Taxpayers engaged in sale of services (profession, lessors) – 1% of net revenue (i.e.:
gross revenue less discounts)
B. Taxpayers deriving income from both sale of properties and services, the deductible
amount shall be whichever is lower between the two tests below:

1st Limit Test:

Note: The tentative deductible amounts are first determined using rule 1 and 2 above for
each respective class of business (service or sales).

The final deductible amounts shall be whichever is lower of the respective tentative
deductible amount and the respective amounts which the total sales or revenue bears to
the total sales and revenue bears to the actual entertainment, amusement or recreation
expenses.

2nd Limit Test:

Net Sales x Actual total EAR
1.) for sales and
Total Net Sales and Revenue service
Net Revenue
2.) x Actual total EAR for
Total Net Sales and Revenue sales and
service
OPTIONAL STANDARD DEDUCTIONS (OSD)
- This deduction equivalent to 40% of the gross income (corporations) or sales (individuals)
may be opted to in lieu of the itemized deductions as discussed above.
- Can be claimed only by individual taxpayers only, self-employed or engaged in a
profession, except non-resident aliens (whether engaged in business or not).
- The qualified individual taxpayer must signify in his annual income tax return his intention
to elect the optional standard deduction.
- Election of OSD shall be irrevocable for the taxable year for which the return was made.
- Cannot be chosen by to by the taxpayer simply because he cannot substantiate his items
of deductions already claimed. The choice must be made and indicated in the return.
- Also apply to other items of gross income received by the taxpayer even not actually
engaged in business, for example: share of the net income of a co-ownership if the
individual has no business expenses.

Points to Remember with Optional Standard Deductions

OSD substitutes business deductible expenses of an individual taxpayer. It therefore
substitutes NOLCO which is a business deductible but not Premium on Health and
Hospitalization Insurance, being an additional personal exemption.

EXAMPLES OF NON-DEDUCTIBLE ITEMS FROM GROSS INCOME

A. personal, living, or family expenses
B. any amount paid out for new buildings or for permanent improvements, or betterments
made to increase the value of any property or estate (this rule don’t apply to intangible
drilling and development costs incurred in petroleum operations)
C. any amount expended in restoring property or in making good the exhaustion thereof for
which an allowance is or has been made; or
D. premiums paid on any life insurance policy covering the life of any officer or employee, or
of any person financially interested in any trade or business carried on by the taxpayer,
individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such
policy losses from sales or exchanges of property directly or indirectly between related
parties.