DIGESTS
Income Tax
In General
Tax law and accounting.
As a science, accounting pervades many aspects of financial planning, forecasting, and decision making in business. Its reach, however, has also permeated tax practice.
To put it into perspective, although the foundations of accounting were built principally to analyze finances and assist businesses, many of its principles have since been adopted for purposes of taxation. In our jurisdiction, the concepts in business accounting, including certain generally accepted accounting principles (GAAP), embedded in the NIRC comprise the rules on tax accounting.
To be clear, the principles under financial or business accounting, in theory and application, are not necessarily interchangeable with those in tax accounting. Thus, although closely related, tax and business accounting had invariably produced concepts that at some point diverge in understanding or usage. For instance, two of such important concepts are taxable income and business income (or accounting income). Much of the difference can be attributed to the distinct purposes or objectives that the concepts of tax and business accounting are aimed at. Chief Justice Querube Makalintal made an apt observation on the nature of such difference. In Consolidated Mines, Inc. v. CTA [157 Phil. 608 (1974)], he noted:
While taxable income is based on the method of accounting used by the taxpayer, it will almost always differ from accounting income. This is so because of a fundamental difference in the ends the two concepts serve. Accounting attempts to match cost against revenue. Tax law is aimed at collecting revenue. It is quick to treat an item as income, slow to recognize deductions or losses. Thus, the tax law will not recognize deductions for contingent future losses except in very limited situations. Good accounting, on the other hand, requires their recognition. Once this fundamental difference in approach is accepted, income tax accounting methods can be understood more easily. (emphasis supplied)
While there may be differences between tax and accounting, it cannot be said that the two mutually exclude each other. As already made clear, tax laws borrowed concepts that had origins from accounting. In truth, tax cannot do away with accounting. It relies upon approved accounting methods and practices to effectively carry out its objective of collecting the proper amount of taxes from the taxpayers. Thus, an important mechanism established in many tax systems is the requirement for taxpayers to make a return of their true income. Maintaining accounting books and records, among other important considerations, would in turn assist the taxpayers in complying with their obligation to file their income tax returns. At the same time, such books and records provide vital information and possible bases for the government, after appropriate audit, to make an assessment for deficiency tax whenever so warranted under the circumstances.
The NIRC, just like the tax laws in other jurisdictions, recognizes the important facility provided by generally accepted accounting principles and methods to the primary aim of tax laws to collect the correct amount of taxes. The NIRC even devoted a whole chapter on accounting periods and methods of accounting, some relevant provisions of which we cite here for more emphasis:
CHAPTER VIII
ACCOUNTING PERIODS AND METHODS OF ACCOUNTING
Sec. 43. General Rule. – The taxable income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner clearly reflects the income.
If the taxpayer’s annual accounting period is other than a fiscal year, as defined in Section 22(Q), or if the taxpayer has no annual accounting period, or does not keep books, or if the taxpayer is an individual, the taxable income shall be computed on the basis of the calendar year.
Sec. 44. Period in which Items of Gross Income Included. – The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under Section 43, any such amounts are to be properly accounted for as of a different period.
In the case of the death of a taxpayer, there shall be included in computing taxable income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.
Sec. 45. Period for which Deductions and Credits Taken. – The deductions provided for in this Title shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or incurred,’ dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income, the deductions should be taken as of a different period. In the case of the death of a taxpayer, there shall be allowed, as deductions for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly allowable in respect of such period or a prior period.
Sec. 46. Change of Accounting Period. – If a taxpayer, other than an individual, changes his accounting period from fiscal year to calendar year, from calendar year to fiscal year, or from one fiscal year to another, the net income shall, with the approval of the Commissioner, be computed on the basis of such new accounting period, subject to the provisions of Section 47.
x x x x
Sec. 48. Accounting for Long-term Contracts. – Income from long-term contracts shall be reported for tax purposes in the manner as provided in. this Section.
As used herein, the term ‘long-term contracts’ means building, installation or construction contracts covering a period in excess of one (1) year.
Persons whose gross income is derived in whole or in part from such contracts shall report such income upon the basis of percentage of completion.
The return should be accompanied by a return certificate of architects or engineers showing the percentage of completion during the taxable year of the entire work performed under contract.
There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the material and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. If upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner may permit or require an amended return.
Sec. 49. Installment Basis. –
(A) Sales of Dealers in Personal Property. – Under rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year, which the gross profit realized or to be realized when payment is completed, bears to the total contract price.
(B) Sales of Realty and Casual Sales of Personality. – In the case (1) of a casual sale or other casual disposition of personal property (other than property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year), for a price exceeding One thousand pesos (P1,000), or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed twenty-five percent (25%) of the selling price, the income may, under the rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, be returned on the basis and ill the manner above prescribed in this Section.
As used in this Section, the term ‘initial payments’ means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.
(C) Sales of Real Property Considered as Capital Asset by Individuals. – An individual who sells or disposes of real property, considered as capital asset, and is otherwise qualified to report the gain therefrom under Subsection (B) may pay the capital gains tax in installments under rules and regulations to be promulgated by the Secretary of Finance, upon recommendation of the Commissioner.
(D) Change from Accrual to Installment Basis. – If a taxpayer entitled to the benefits of Subsection (A) elects for any taxable year to report his taxable income on the installment basis, then in computing his income for the year of change or any subsequent year, amounts actually received during any such year on account of sales or other dispositions of property made in any prior year shall not be excluded.” (emphasis in the original)
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Accounting methods; Crop year basis/method.
An accounting method is a set of rules for determining when and how to report income and deductions. The provisions under Chapter VIII, Title II of the NIRC cited above enumerate the methods of accounting that the law expressly recognizes, to wit:
(1) Cash basis method;
(2) Accrual method;
(3) Installment method;
(4) Percentage of completion method; and
(5) Other accounting methods.
Any of the foregoing methods may be employed by any taxpayer so long as it reflects its income properly and such method is used regularly. The peculiarities of the business or occupation engaged in by a taxpayer would largely determine how it would report incomes and expenses in its accounting books or records. The NIRC does not prescribe a uniform, or even specific, method of accounting.
Too, other methods approved by the CIR, even when not expressly mentioned in the NIRC, may be adopted if such method would enable the taxpayer to properly reflect its income. Section 43 of the NIRC authorizes the CIR to allow the use of a method of accounting that in its opinion would clearly reflect the income of the taxpayer. An example of such method not expressly mentioned in the NIRC, but duly approved by the CIR, is the ‘crop method of accounting’ authorized under RAMO No. 2-95. The pertinent provision reads:
II. Accounting Methods
x x x x
F. Crop Year Basis is a method applicable only to farmers engaged in the production of crops which take more than a year from the time of planting to the process of gathering and disposal. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops are realized.
The crop method recognizes that the harvesting and selling of crops do not fall within the same year that they are planted or grown. This method is especially relevant to farmers, or those engaged in the business of producing crops who, pursuant to RAMO No. 2-95, would then be able to compute their taxable income on the basis of their crop year. On when to recognize expenses as deductions against income, the governing rule is found in the second sentence of Subsection F cited above. The rule enjoins the recognition of the expense (or the deduction of the cost) of crop production in the year that the crops are sold (when income is realized).
In the present case, we find it wholly justifiable for Lancaster, as a business engaged in the production and marketing of tobacco, to adopt the crop method of accounting. A taxpayer is authorized to employ what it finds suitable for its purpose so long as it consistently does so, and in this case, Lancaster does appear to have utilized the method regularly for many decades already. Considering that the crop year of Lancaster starts from October up to September of the following year, it follows that all of its expenses in the crop production made within the crop year starting from October 1997 to September 1998, including the February and March 1998 purchases covered by purchase invoice vouchers, are rightfully deductible for income tax purposes in the year when the gross income from the crops are realized. Pertinently, nothing from the pleadings or memoranda of the parties, or even from their testimonies before the CTA, would support a finding that the gross income from the crops (to which the subject expenses refer) was actually realized by the end of March 1998, or the closing of Lancaster’s fiscal year for 1998. Instead, the records show that the February and March 1998 purchases were recorded by Lancaster as advances and later taken up as purchases by the close of the crop year in September 1998, or as stated very clearly above, within the fiscal year 1999. On this point, we quote with approval the ruling of the CTA En Banc , thus:
Considering that [Lancaster] is engaged in the production of tobacco, it applied the crop year basis in determining its total purchases for each fiscal year. Thus, [Lancaster’s] total cost for the production of its crops, which includes its purchases, must be taken as a deduction in the year in which the gross income is realized. Thus, We agree with the following ratiocination of the First Division:
Evident from the foregoing, the crop year basis is one unusual method of accounting wherein the entire cost of producing the crops (including purchases) must be taken as a deduction in the year in which the gross income from the crop is realized. Since the petitioner’s crop year starts in October and ends in September of the following year, the same does not coincide with petitioner’s fiscal year which starts in April and ends in March of the following year. However, the law and regulations consider this peculiar situation and allow the costs to be taken up at the time the gross income from the crop is realized, as in the instant case.
[Lancaster’s] fiscal period is from April 1, 1998 to March 31, 1999. On the other hand, its crop year is from October 1, 1997 to September 1, 1998. Accordingly, in applying the crop year method, all the purchases made by the respondent for October 1, 1997 to September 1, 1998 should be deducted from the fiscal year ending March 31, 1999, since it is the time when the gross income from the crops is realized.
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The matching principle; Provisions of the Tax Code should prevail over GAAP and GAAS.
Both petitioner CIR and respondent Lancaster, it must be noted, rely upon the concept of matching cost against revenue to buttress their respective theories. Also, both parties cite RAMO No. 2-95 in referencing the crop method of accounting.
We are tasked to determine which view is legally sound.
In essence, the matching concept, which is one of the generally accepted accounting principles, directs that the expenses are to be reported in the same period that related revenues are earned. It attempts to match revenue with expenses that helped earn it.
The CIR posits that Lancaster should not have recognized in FY 1999 the purchases for February and March 1998. Apparent from the reasoning of the CIR is that such expenses ought to have been deducted in FY 1998, when they were supposed to be paid or incurred by Lancaster. In other words, the CIR is of the view that the subject purchases match with revenues in 1998, not in 1999.
A reading of RAMO No. 2-95, however, clearly evinces that it conforms with the concept that the expenses paid or incurred be deducted in the year in which gross income from the sale of the crops is realized. Put in another way, the expenses are matched with the related incomes which are eventually earned. Nothing from the provision is it strictly required that for the expense to be deductible, the income to which such expense is related to be realized in the same year that it is paid or incurred. As noted by the CTA, the crop method is an unusual method of accounting, unlike other recognized accounting methods that, by mandate of Sec. 45 of the NIRC, strictly require expenses be taken in the same taxable year when the income is ‘paid or incurred,’ or ‘paid or accrued,’ depending upon the method of accounting employed by the taxpayer.
Even if we were to accept the notion that applying the 1998 purchases as deductions in the fiscal year 1998 conforms with the generally accepted principle of matching cost against revenue, the same would still not lend any comfort to the CIR. RMC No. 22-04, entitled “Supplement to Revenue Memorandum Circular No. 44-2002 on Accounting Methods to be Used by Taxpayers for Internal Revenue Tax Purposes” dated 12 April 2004, commands that where there is conflict between the provisions of the Tax Code (NIRC), including its implementing rules and regulations, on accounting methods and the generally accepted accounting principles, the former shall prevail. The relevant portion of RMC 22-04 reads:
II. Provisions of the Tax Code Shall Prevail.
All returns required to be filed by the Tax Code shall be prepared always in conformity with the provisions of the Tax Code, and the rules and regulations implementing said Tax Code. Taxability of income and deductibility of expenses shall be determined strictly in accordance with the provisions of the Tax Code and the rules and regulations issued implementing said Tax Code. In case of difference between the provisions of the Tax Code and the rules and regulations implementing the Tax Code, on one hand, and the generally accepted accounting principles (GAAP) and the generally accepted accounting standards (GAAS), on the other hand, the provisions of the Tax Code and the rules and regulations issued implementing said Tax Code shall prevail. (italics supplied)
RAMO No. 2-95 is clear-cut on the rule on when to recognize deductions for taxpayers using the crop method of accounting. The rule prevails over any GAAP, including the matching concept as applied in financial or business accounting.
In sum, … there is no legal justification for the disallowance of Lancaster’s expenses for the purchase of tobacco in February and March 1998.
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Capital asset vs. Ordinary asset.
Section 39(A)(1) of the NIRC provides that:
(1) Capital Assets. – the term ‘capital assets’ means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in Subsection (F) of Section 34; or real property used in trade or business of the taxpayer.
The distinction between capital asset and ordinary asset was further defined in Section 2(a) and (b) RR No. 7-2003, thus:
a. Capital assets shall refer to all real properties held by a taxpayer, whether or not connected with his trade or business, and which are not included among the real properties considered as ordinary assets under Sec. 39(A)(1) of the Code.
b. Ordinary assets shall refer to all real properties specifically excluded from the definition of capital assets under Sec. 39(A)(1) of the Code, namely:
1. Stock in trade of a taxpayer or other real property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; or
2. Real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or
3. Real property used in trade or business (i.e., buildings and/or improvements) of a character which is subject to the allowance for depreciation provided for under Sec. 34(F) of the Code; or
4. Real property used in trade or business of the taxpayer.
The statutory definition of capital assets is negative in nature. Thus, if the property or asset is not among the exceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary assets.
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Liability for capital gains taxes.
The taxpayer is liable to pay capital gains taxes for the sale, barter, exchange or other disposition of shares of stock in a domestic corporation except if the sale or disposition is through the stock exchange. For this purpose, the term disposition includes any act of disposing, transferring or parting with, or alienation of, or giving up of property to another.
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As the CTA aptly ruled, ” a tax on the profit of sale on net capital gain is the very essence of the net capital gains tax law. To hold otherwise will ineluctably deprive the government of its due and unduly set free from tax liability persons who profited from said transactions.”
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Taxable income; Gross income
Taxable income means the pertinent items of gross income specified in the Tax Code, less deductions and/or personal and additional exemptions, if any, authorized for these types of income. Under Section 32 of the Tax Code, gross income means income derived from whatever source, including compensation for services; the conduct of trade or business or the exercise of a profession; dealings in property; interests; rents; royalties; dividends; annuities; prizes and winnings; pensions; and a partner’s distributive share in the net income of a general professional partnership. Section 34 enumerates the allowable deductions; Section 35, personal and additional exemptions.
The definition of gross income is broad enough to include all passive incomes subject to specific rates or final taxes. However, since these passive incomes are already subject to different rates and taxed finally at source, they are no longer included in the computation of gross income, which determines taxable income.
Taxable income is defined under Section 31 of the NIRC of 1997 as the pertinent items of gross income specified in the said Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by the same Code or other special laws. The gross income, referred to in Section 31, is described in Section 32 of the NIRC of 1997 as income from whatever source, including compensation for services; the conduct of trade or business or the exercise of profession; dealings in property; interests; rents; royalties; dividends; annuities; prizes and winnings; pensions; and a partner’s distributive share in the net income of a general professional partnership.
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Basic corporate income tax and minimum corporate income tax (MCIT)
Income tax on domestic corporations is covered by Section 27 of the NIRC of 1997.
A domestic corporation must pay whichever is higher of: (1) the income tax under Section 27(A) of the NIRC of 1997, computed by applying the tax rate therein to the taxable income of the corporation; or (2) the MCIT under Section 27(E), also of the NIRC of 1997, equivalent to 2% of the gross income of the corporation.
Taxable income is defined under Section 31 of the NIRC of 1997 as the pertinent items of gross income specified in the said Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by the same Code or other special laws. The gross income, referred to in Section 31, is described in Section 32 of the NIRC of 1997 as income from whatever source, including compensation for services; the conduct of trade or business or the exercise of profession; dealings in property; interests; rents; royalties; dividends; annuities; prizes and winnings; pensions; and a partner’s distributive share in the net income of a general professional partnership.
Pursuant to the NIRC of 1997, the taxable income of a domestic corporation may be arrived at by subtracting from gross income deductions authorized, not just by the NIRC of 1997, but also by special laws.In comparison, the 2% MCIT under Section 27(E) of the NIRC of 1997 shall be based on the gross income of the domestic corporation. The Court notes that gross income, as the basis for MCIT, is given a special definition under Section 27(E)(4) of the NIRC of 1997, different from the general one under Section 34 of the same Code.
According to the last paragraph of Section 27(E)(4) of the NIRC of 1997, gross income of a domestic corporation engaged in the sale of service means gross receipts, less sales returns, allowances, discounts and cost of services. “Cost of services” refers to all direct costs and expenses necessarily incurred to provide the services required by the customers and clients including (a) salaries and employee benefits of personnel, consultants, and specialists directly rendering the service; and (b) cost of facilities directly utilized in providing the service, such as depreciation or rental of equipment used and cost of supplies. Noticeably, inclusions in and exclusions/deductions from gross income for MCIT purposes are limited to those directly arising from the conduct of the taxpayer’s business. It is, thus, more limited than the gross income used in the computation of basic corporate income tax.
In light of the foregoing, there is an apparent distinction under the NIRC of 1997 between taxable income, which is the basis for basic corporate income tax under Section 27(A); and gross income, which is the basis for the MCIT under Section 27(E). The two terms have their respective technical meanings, and cannot be used interchangeably.
Even if the basic corporate income tax and the MCIT are both income taxes under Section 27 of the NIRC of 1997, and one is paid in place of the other, the two are distinct and separate taxes.
Although both are income taxes, the MCIT is different from the basic corporate income tax, not just in the rates, but also in the bases for their computation.
That, under general circumstances, the MCIT is paid in place of the basic corporate income tax, when the former is higher than the latter, does not mean that these two income taxes are one and the same. The said taxes are merely paid in the alternative, giving the Government the opportunity to collect the higher amount between the two.
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Goodwill
Black’s Law Dictionary defines goodwill as business’ reputation, patronage and other intangible asset considered in appraising a business, especially for purchase. It is the ability of the business to generate income in excess of a normal rate on assets due to superior managerial skills, market position, new product technology, etc. In the purchase of business, goodwill represents the difference between the purchase price and the value of assets.
Goodwill has also been referred to as the advantage or benefit which is acquired by an establishment beyond the mere value of the capital stock, funds or property employed therein, in consequence of the general public patronage and encouragement which it receives from constant or habitual customers on account of its local position, or common celebrity, or reputation for skill, or affluence, or punctuality, or from other accidental circumstances or necessities, or even from ancient partialities or prejudices. It is derived from the assets associated with the business, inseparable from the business to which it added value, and exists where the business is carried on. It has also been said that goodwill has no meaning except in connection with some trade, business or calling; hence, cannot exist or be transferred apart from the business to which it is attached.
In accounting, goodwill is described as the future economic benefits arising from assets that are not capable of being individually identified and separately recognised. It arises as a result of property specific name and reputation, customer patronage, location, products, and similar factors, which generate economic benefits. It is inherent to the trade related property, and will transfer to a new owner on sale.
Parsed from the foregoing, goodwill is essentially characterized as an intangible asset derived from the conduct of business, and cannot therefore be allocated and transferred separately and independently from the business as a whole.
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The phrase “good will” is defined in 28 Corpus Juris, 729, section 1, as follows:
“Good will may be defined to be the advantage or benefit which is acquired by an establishment, beyond the mere value of the capital stock, funds, or property employed therein in consequence of the general public patronage and encouragement which it received from constant or habitual customers on account of its local position or common celebrity or reputation for skill, affluence, punctuality, or from other accidental circumstances or necessities, or even from ancient partialities or prejudices. . . .
According to the above-quoted definition, good will is the reputation or good name of an establishment. If the good will, that is, the good reputation of the business is acquired in the course of its management and operation, it does not form part of the capital with which it was established. It is an intangible moral profit, susceptible of valuation in money, acquired by the business by reason of the confidence reposed in it by the public, due to the efficiency and honesty shown by the manager and personnel thereof in conducting the same and on account of the courtesy accorded its customers, which moral profit, once it is evaluated and used, becomes a part of the assets.
The good will created by an incorporator in the course of the business of a corporation and appraised to pay the unpaid price of shares subscribed to by said incorporator, is a profit and is subject to the payment of income tax.
~~~Anderson vs. Posadas, Jr. (G.R. No. 44100, 22 September 1938, En Banc, J. Villareal)
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Purpose of tax treaties: The elimination of international juridical double taxation; Methods for such elimination.
The RP-US Tax Treaty is just one of a number of bilateral treaties which the Philippines has entered into for the avoidance of double taxation. The purpose of these international agreements is to reconcile the national fiscal legislations of the contracting parties in order to help the taxpayer avoid simultaneous taxation in two different jurisdictions. More precisely, the tax conventions are drafted with a view towards the elimination of international juridical double taxation, which is defined as the imposition of comparable taxes in two or more states on the same taxpayer in respect of the same subject matter and for identical periods. The apparent rationale for doing away with double taxation is to encourage the free flow of goods and services and the movement of capital, technology and persons between countries, conditions deemed vital in creating robust and dynamic economies. Foreign investments will only thrive in a fairly predictable and reasonable international investment climate and the protection against double taxation is crucial in creating such a climate.
Double taxation usually takes place when a person is resident of a contracting state and derives income from, or owns capital in, the other contracting state and both states impose tax on that income or capital. In order to eliminate double taxation, a tax treaty resorts to several methods. First, it sets out the respective rights to tax of the state of source or situs and of the state of residence with regard to certain classes of income or capital. In some cases, an exclusive right to tax is conferred on one of the contracting states; however, for other items of income or capital, both states are given the right to tax, although the amount of tax that may be imposed by the state of source is limited.
The second method for the elimination of double taxation applies whenever the state of source is given a full or limited right to tax together with the state of residence. In this case, the treaties make it incumbent upon the state of residence to allow relief in order to avoid double taxation. There are two methods of relief- the exemption method and the credit method. In the exemption method, the income or capital which is taxable in the state of source or situs is exempted in the state of residence, although in some instances it may be taken into account in determining the rate of tax applicable to the taxpayer’s remaining income or capital. On the other hand, in the credit method, although the income or capital which is taxed in the state of source is still taxable in the state of residence, the tax paid in the former is credited against the tax levied in the latter. The basic difference between the two methods is that in the exemption method, the focus is on the income or capital itself, whereas the credit method focuses upon the tax.
In negotiating tax treaties, the underlying rationale for reducing the tax rate is that the Philippines will give up a part of the tax in the expectation that the tax given up for this particular investment is not taxed by the other country.
As stated earlier, the ultimate reason for avoiding double taxation is to encourage foreign investors to invest in the Philippines – a crucial economic goal for developing countries. The goal of double taxation conventions would be thwarted if such treaties did not provide for effective measures to minimize, if not completely eliminate, the tax burden laid upon the income or capital of the investor. Thus, if the rates of tax are lowered by the state of source, in this case, by the Philippines, there should be a concomitant commitment on the part of the state of residence to grant some form of tax relief, whether this be in the form of a tax credit or exemption. Otherwise, the tax which could have been collected by the Philippine government will simply be collected by another state, defeating the object of the tax treaty since the tax burden imposed upon the investor would remain unrelieved. If the state of residence does not grant some form of tax relief to the investor, no benefit would redound to the Philippines, i.e., increased investment resulting from a favorable tax regime, should it impose a lower tax rate on the royalty earnings of the investor, and it would be better to impose the regular rate rather than lose much-needed revenues to another country.
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Income tax incidence on a sale or exchange of assets
Generally, a sale or exchange of assets will have an income tax incidence only when it is consummated. The incidence of taxation depends upon the substance of a transaction. The tax consequences arising from gains from a sale of property are not finally to be determined solely by the means employed to transfer legal title. Rather, the transaction must be viewed as a whole, and each step from the commencement of negotiations to the consummation of the sale is relevant. A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title. To permit the true nature of the transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.
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Laws/Provisions applicable in substantiating claims for deductions.
It bears noting that while the CIR issued the assessments on the basis of Section 34 of the 1997 NIRC, the CTA and PMFC are in agreement that the 1977 NIRC finds application.
However, while the CTA ruled on the basis of Section 238 of the 1977 NIRC (now Section 238, NIRC of 1997), PMFC now insists that Section 29 of the same code (now Section 34, NIRC of 1997) should be applied instead. Citing Atlas Consolidated Mining and Development Corporation v. CIR [190 Phil. 195 (1981)], PMFC argues that Section 29 imposes less stringent requirements and the presentation of official receipts as evidence of the claimed deductions dispensable. PMFC further posits that the mandatory nature of the submission of official receipts as proof is a mere innovation in the 19 NIRC, which cannot be applied retroactively.
PMFC’s argument fails.
The Court finds that the alleged differences between the requirements of Section 29 of the 1977 NIRC (now Section 34, NIRC of 1997) invoked by PMFC, on one hand, and Section 238 (now Section 238, NIRC of 1997) relied upon by the CTA, on the other, are more imagined than real.
In CIR v. Pilipinas Shell Petroleum Corporation, the Count enunciated that:
It is a rule in statutory construction that every part of the statute must be interpreted with reference to the context, i.e., that every part of the statute must be considered together with the other parts, and kept subservient to the general intent of the whole enactment. The law must not be read in truncated parts, its provisions must be read in relation to the whole law. The particular words, clauses and phrases should not be studied as detached and isolated expression, but the whole and every part of the statute must be considered in fixing the meaning of any of its parts and in order to produce a harmonious whole. (Citations omitted)
The law, thus, intends for Sections 29 and 238 of the 1977 NIRC (now Sections 34 and 238, NIRC of 1997) to be read together, and not for one provision to be accorded preference over the other.
It is undisputed that among the evidence adduced by PMFC on it behalf are the official receipts of alleged purchases of raw materials. Thus, the CTA cannot be faulted for making references to the same, and for applying Section 238 of the 1977 NIRC in rendering its judgment. Required or not, the official receipts were submitted by PMFC as evidence. Inevitably, the said receipts were subjected to scrutiny, and the CTA exhaustively explained why it had found them wanting.
PMFC cites Atlas to contend that the statutory test, as provided in Section 29 of the 1977 NIRC, is sufficient to allow the deductibility of a business expense from the gross income. As long as the expense is: (a) both ordinary and necessary; (b) incurred in carrying a business or trade; and (c) paid or incurred within the taxable year, then, it shall be allowed as a deduction from the gross income.
Let it, however, be noted that in Atlas, the Court likewise declared that:
In addition, not only must the taxpayer meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise, the same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction. (Citation omitted and italics ours)
It is, thus, clear that Section 29 of the 1977 NIRC (now Section 34, NIRC of 1997) does not exempt the taxpayer from substantiating claims for deductions. While official receipts are not the only pieces of evidence which can prove deductible expenses, if presented, they shall be subjected to examination. PMFC submitted official receipts as among its evidence, and the CTA doubted their veracity. PMFC was, however, unable to persuasively explain and prove through other documents the discrepancies in the said receipts. Consequently, the CTA disallowed the deductions claimed, and in its ruling, invoked Section 238 of the 1977 NIRC (now Section 238, NIRC of 1997) considering that official receipts are matters provided for in the said section.
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Deductions are matters of legislative grace.
The taxpayer must show that its claimed deductions clearly come within the language of the law since allowances, like exemptions, are matters of legislative grace.
~~~Aguinaldo Industries Corporation (Fishing Nets Divisions) vs. Commissioner of Internal Revenue, et al. (G.R. No. L-29790, 25 February 1982, 1st Div., J. Plana)
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Allowed deductions.
As a rule, for income tax purposes, interest is an income of the recipient and a deduction for the payor.
~~~Marinduque Mining and Industrial Corporation vs. Commissioner of Internal Revenue, et al. (G.R. No. L-60149, 19 June 1985, 2nd Div., J. Aquino)
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Non-deductible expenses.
Being fictitious, the expenses cannot be claimed as deduction from gross income.
~~~Tan Guan vs. The Court of Tax Appeals, et al. (G.R. No. L-23676, 27 April 1967, En Banc, J. J.P. Bengzon)
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Black, in his book, “Income Tax Digest,” section 355, page 166, states as follows:
“FINES AND PENALTIES. — Fines paid because of a violation of law are not deductible even if the violation is in connection with a trade or business. Items of this type are deemed not to arise from the ordinary and necessary conduct of business.”
It appears, therefore, that in the opinion of the writer Black and of the Department of Finance, fines imposed for violation of law cannot be considered taxes paid to the Government, which should be deducted from income subject to the payment of income tax. The tax under consideration is levied on income, while the fine is paid as penalty for violation of the Internal Revenue Law. The fine, therefore, cannot be considered a tax, inasmuch as it is not levied on income. In providing that the fine should be added to the tax and collected at the same time and as a part thereof, the law had for its purpose merely to facilitate the collection of the fine or surcharge.
~~~Anderson vs. Posadas, Jr. (G.R. No. 44100, 22 September 1938, En Banc, J. Villareal)
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Freedom to deduct a lesser amount, or not to claim any deduction at all.
For income tax purposes a taxpayer is free to deduct from its gross income a lesser amount, or not to claim any deduction at all. What is prohibited by the income tax law is to claim a deduction beyond the amount authorized therein.
~~~The Commissioner of Internal Revenue vs. Phoenix Assurance Co. Ltd., et seq. (G.R. Nos. L-19727 and L-19903, 20 May 1965, 3rd Div., J. J.P. Bengzon)
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