PART 7
II. SITUS OF TAXATION – SOURCES FROM WITHIN AND WITHOUT THE PHILIPPINES
SEC. 42, NIRC Income from Sources Within the Philippines. —
A. Gross Income From Sources Within the Philippines. — The following items of gross income shall he treated as gross income from sources within the Philippines:
(1) Interests. — Interests derived from sources within the Philippines, and interests on bonds, notes or other interest-bearing obligations of residents, corporate or otherwise;
(2) Dividends. — The amount received as dividends:
(a) From a domestic corporation; and
(b) From a foreign corporation, unless less than fifty percent (50%) of the gross income of such foreign corporation for the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the Philippines as determined under the provisions of this Section; but only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period derived from sources within the Philippines bears to its gross income from all sources.
(3) Services. — Compensation for labor or personal services performed in the Philippines;
(4) Rentals and Royalties. — Rentals and royalties from property located in the Philippines or from any interest in such property, including rentals or royalties for —
(a) The use of or the right or privilege to use in the Philippines any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right;
(b) The use of, or the right to use in the Philippines any industrial, commercial or scientific equipment;
(c) The supply of scientific, technical, industrial or commercial knowledge or information;
(d) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b) or any such knowledge or information as is mentioned in paragraph (c);
(e) The supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from such nonresident person;
(f) Technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme; and
(g) The use of or the right to use:
(i) Motion picture films;
(ii) Films or video tapes for use in connection with television; and
(iii) Tapes for use in connection with radio broadcasting.
(5) Sale of Real Property. — Gains, profits and income from the sale of real property located in the Philippines; and
(6) Sale of Personal Property. — Gains, profits and income from the sale of personal property, as determined in Subsection (E) of this Section.
B. Taxable Income From Sources Within the Philippines. —
(1) General Rule. — From the items of gross income specified in Subsection (A) of this Section, there shall be deducted the expenses, losses and other deductions properly allocated thereto and a ratable part of expenses, interests, losses and other deductions effectively connected with the business or trade conducted exclusively within the Philippines which cannot definitely be allocated to some items or class of gross income: Provided, That such items of deductions shall be allowed only if fully substantiated by all the information necessary for its calculation. The remainder, if any, shall be treated in full as taxable income from sources within the Philippines.
(2) Exception. — No deductions for interest paid or incurred abroad shall be allowed from the item of gross income specified in Subsection (A) unless indebtedness was actually incurred to provide funds for use in connection with the conduct or operation of trade or business in the Philippines.
C. Gross Income From Sources Without the Philippines. — The following items of gross income shall be treated as income from sources without the Philippines:
(1) Interests other than those derived from sources within the Philippines as provided in paragraph (1) of Subsection (A) of this Section;
(2) Dividends other than those derived from sources within the Philippines as provided in paragraph (2) of Subsection (A) of this Section;
(3) Compensation for labor or personal services performed without the Philippines;
(4) Rentals or royalties from property located without the Philippines or from any interest in such property including rentals or royalties for the use of or for the privilege of using without the Philippines, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties; and
(5) Gains, profits and income from the sale of real property located without the Philippines.
D. Taxable Income From Sources Without the Philippines. — From the items of gross income specified in Subsection (C) of this Section there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expense, loss or other deduction which cannot definitely be allocated to some items or classes of gross income. The remainder, if any, shall be treated in full as taxable income from sources without the Philippines.
E. Income From Sources Partly Within and Partly Without the Philippines. — Items of gross income, expenses, losses and deductions, other than those specified in Subsections (A) and (C) of this Section, shall be allocated or apportioned to sources within or without the Philippines, under the rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner. Where items of gross income are separately allocated to sources within the Philippines, there shall be deducted (for the purpose of computing the taxable income therefrom) the expenses, losses and other deductions properly apportioned or allocated thereto and a ratable part of other expenses, losses or other deductions which cannot definitely be allocated to some items or classes of gross income. The remainder, if any, shall be included in full as taxable income from sources within the Philippines. In the case of gross income derived from sources partly within and partly without the Philippines, the taxable income may first be computed by deducting the expenses, losses or other deductions apportioned or allocated thereto and a ratable part of any expense, loss or other deduction which cannot definitely be allocated to some items or classes of gross income; and the portion of such 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 (in whole or in part) by the taxpayer within and sold without the Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines, shall be treated as derived partly from sources within and partly from sources without the Philippines.
"Gains, profits and income derived from the purchase of personal property within and its sale without the Philippines, or from the purchase of personal property without and its sale within the Philippines shall be treated as derived entirely from sources within the country in which sold: Provided, however, That gain from the sale of shares of stock in a domestic corporation shall be treated as derived entirely from sources within the Philippines regardless of where the said shares are sold. The transfer by a nonresident alien or a foreign corporation to anyone of any share of stock issued by a domestic corporation shall not be effected or made in its book unless: (1) the transferor has filed with the Commissioner a bond conditioned upon the future payment by him of any income tax that may be due on the gains derived from such transfer, or (2) the Commissioner has certified that the taxes, if any, imposed in this Title and due on the gain realized from such sale or transfer have been paid. It shall be the duty of the transferor and the corporation the shares of which are sold or transferred, to advise the transferee of this requirement.
F. Definitions. — As used in this Section the words 'sale' or 'sold' include 'exchange' or 'exchanged'; and the word 'produced' includes 'created,' 'fabricated, 'manufactured,' 'extracted,' 'processed,' 'cured' or 'aged'.
Sec 152-165, RR-2
Sec 152. Income from sources within the Philippines. – The law divides the income of taxpayers into three classes:
(1) Income which is derived in full from sources within the Philippines;
(2) Income which is derived in full from sources without the Philippines; and
(3) Income which is derived partly from sources within and without the Philippines.
Nonresident alien individuals and foreign corporations are taxable only upon income from sources within the Philippines. Citizens and residents of the Philippines and domestic corporations are taxable upon income derived from sources both within and without the Philippines.
The taxable income from sources within the Philippines include that derived in full from sources within the Philippines and that portion of the income which is derived partly from sources within and partly from sources without the Philippines which is allocated or apportioned to sources within the Philippines.
Sec 153. Interest – Interest on bonds or notes or other interest-bearing obligations of residents, corporations or otherwise, constitutes income from sources within the Philippines.
Sec 154. Dividends. – Gross income from sources within the Philippines includes dividends, defined by Sec 83 of the Code:
(a) From a domestic corporation; and
(b) From a foreign corporation unless less than 50 per cent of its gross income for the three-year period ending with the close of its taxable year preceding the declaration of such dividends, or for such part of such period as it has been in existence, was derived from sources within the Philippines; but only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period derived from sources within the Philippines bears to its gross income from all sources.
Dividends will be treated as an income from sources within the Philippines unless the taxpayer submits sufficient data to establish to the satisfaction of the Commissioner of Internal Revenue that they should be excluded from gross income under section 37 (a) (2) (B).
Sec 155 Compensation for labor or personal services. – Gross income from source within the Philippines includes compensation for labor or personal services performed within the Philippines regardless of the residence of the payor, of the place in which the contract for service was made, or of the place of payment. If a specific amount is paid for labor or personal services performed within the Philippines, such amount shall be included in the gross income. If no accurate allocation or segregation of compensation for labor or personal services performed in the Philippines can be made, or when such labor or service is partly made within and partly without the Philippines, the amount to be included in the gross income shall be determined by an appointment of time basis, i.e, there shall be included in the gross income an amount which bears the same relation to the total compensation as the numbers of days of performance of the labor or services within the Philippines bears to the total number of days of performance of labor or personal services for which the payment is made. Wages received fore services rendered inside the territorial limits of the Philippines and wages of an alien seaman earned on a costwise vessel are to be regarded as from sources within the Philippines.
Sec 156 Rentals and Royalties – Rentals and royalties from property located in the Philippines from any interest in such property, includes rentals or royalties for –
(A) the use of, or privilege to use in the Philippines any copyright, patent, design, or model, plan, secret, formula or process, goodwill, trademark, trade brand of other like property or right;
(B) the use, the right to use in the Philippines any industrial, commercial or scientific equipment;
(C) the supply of scientific, technical, industrial or commercial knowledge or information;
(D) the supply of any assistance that is ancillary and subsidiary to , and furnished as a means of enabling the application or enjoyment of , any such property, or right as is mentioned in paragraph (A), any such equipment as is mentioned on paragraph (B) or any such knowledge or information as is mentioned in paragraph (C); or
(E) the supply of services by a nonresident person or his employee in connection with the use of the property or rights belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from, such nonresident person;
(F) any other amounts paid in consideration of technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme, and
(G) the use of the right to use –
(i) motion picture films
(ii) films or video tapes for use in connection with television; or
(iii) tapes for use in connection with radio broadcasting. (As amended by section 9 paragraph (4) of Revenue Memorandum Circular No. 80-78 dated August 15, 1978 publishing the amendments effected by PD No. 1457 to Title II, Income Tax of the National Internal Revenue Code of 1977, as amended.)
Sec 157Sale of Real Property – Gross income from sources within the Philippines includes gain, computed under the provisions of section 35, derived from the sale or other disposition of real property located in the Philippines. For the treatment of capital gains and losses, see sections 132 to 135 of these regulations.
Sec 158 Income from sources without the Philippines – Gross Income from sources without the Philippines includes:
Interest other than that specified in section 37 (a)(1), as being derived from sources without the Philippines
Dividends other than those derived from sources within the Philippines as provided in section 37 (a)(2);
Compensation for labor or personal services performed without the Philippines;
Rentals or royalties derived from property without the Philippines or from any interest in such property, including rentals or royalties for the use of or the privilege for using without the Philippines, patents, copyrights, secret process and formulas, goodwill, trademarks, trade brands, franchises, and other like property; and
Gains derived from the sale of real property located without the Philippines.
Sec 159 Sale of personal property – Income derived from the purchase and sale of personal property shall be treated as derived entirely from the country in which sold. The word “sold” includes “exchanged”. The “country in which sold” ordinarily means the place where the property is marketed. This section does not apply to income from the sale of personal property produced (in whole or in part) by the taxpayer without and sold within the Philippines. (See section 162 of these regulations.)
Sec 160 Apportionment of deductions - From the items specified in section 37 (a) as being derived specifically from sources within the Philippines there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and ratable part of any expenses, losses or deductions which can not definitely be allocated to some item or class of gross income. The remainder shall be included in full as net income from sources within the Philippines.
Sec 161 Other income from sources within the Philippines – Items of gross income other than those specified in section 37 (a) and (c) shall be allocated or apportioned to sources within or without the Philippines as provided in section 37 (e).
The income derived from the ownership or operation of an farm, mine, oil or gas well, other natural deposit, or timber, located within the Philippines, and from the sale by the producer of the products thereof within or without the Philippines, shall ordinarily be included in gross income from sources within the Philippines. If, however, it is shown to the satisfaction of the Commissioner of Internal Revenue that due to the peculiar condition of production and sale in a specific case of for other reasons all of such gross income should not be allocated to sources within the Philippines, in apportionment thereof to sources within the Philippines and to source without the Philippines shall be made as provided in section 162 of these regulations.
Where items of gross income are separately allocated to sources within the Philippines, there shall be deducted therefrom, in computing net income, the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of other expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income.
Sec 162 Income from the sale of personal property derived from sources partly within and partly without the Philippines. – Items of gross income not allocated by sections 152 to 159 or 161 of these regulations to sources from within or without the Philippines shall (unless unmistakably from a source within or a source without the Philippines) be treated as derived from sources partly within and partly without the Philippines.
The portion of such income derived from sources partly within the Philippines and partly within a foreign country which is attributable to sources within the Philippines shall be determined according to the following rules and cases:
Personal property produced and sold. – Gross income derived from the sale of personal property produced (in whole or in part) by the taxpayer within the Philippines and sold within a foreign country, or produced (in whole or in part) by the taxpayer within a foreign country and sold within the Philippines shall be treated as derived partly from sources within the Philippines and partly from sources within a foreign country under one of the cases below. As used herein, the word “produced” includes created, fabricated, manufactured, extracted, processed, cured or aged.
Case 1. Where the producer or manufacturer regularly sells a part of his output to wholly ____ distributors or other selling concerns in such a way as to establish fairly an independent factory or production price – or shows to the satisfaction of the Commissioner of Internal Revenue that such an independent factory or production price has been otherwise established, unaffected by considerations of tax liability, and the selling or distributing branch or department of the business is located in a different country from that in which the factory is located or the production carried on, the net income attributable to sources within the Philippines shall be computed by an accounting which treats the products as sold by the factory or productive department of the business to the distributing or selling department as the independent factory price as established. In all such cases the basis of the accounting shall be fully explained in a statement attached to the return.
Case 2. Where an independent factory or production price has not been established as provided under Case 1, the net income shall first be computed by deducting from the gross income derived from the sale of personal property produced (in whole or in part) by the taxpayer within the Philippines and sold within a foreign country or produced (in whole or in part) by the taxpayer within a foreign country and sold within the Philippines, the expenses, losses, or other deductions properly apportioned or allocated thereto ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. Of the amount of net income so determined, one-half shall be apportioned in accordance with the value of the taxpayer’s property within the Philippines and within the foreign country, the portion attributable to sources within the Philippines being determined by multiplying such one-half by a fraction the numerator of which consists of the value of the taxpayers property within the Philippines, the denominator of which consists of the value of the taxpayer’s property both within the Philippines and within the foreign country. The remaining one-half of such net income shall be apportioned in accordance with the gross sales of the taxpayer within the Philippines and within the foreign country, the portion attributable to sources within the Philippines being determined by multiplying such one-half by a fraction the numerator of which consists of the taxpayer’s gross sales for the taxable year or period within the Philippines and the denominator of which consists of the taxpayer’s gross sales for the taxable year or period within the Philippines and within the foreign country. The “gross sales of the taxpayer within the Philippines” means the gross sales made during the taxable year which were principally secured, negotiated, or effected by employees, agents, offices, or branches of the taxpayer’s business resident or located in the Philippines. The term “gross sales” as used in this paragraph refers only to the sales of personal property produced (in whole or in part) by the taxpayer within a foreign country and sold within the Philippines, and the term “property” includes only the property held or used to produce income which is derived from such sales. Such property should be taken at its actual value, which in the case of property valued or appraised for purposes of inventory, depreciation, depletion, or other purposes of taxation shall be the highest amount at which so valued or appraised, and which in other cases shall be deemed to be its book value in the absence of affirmative evidence showing such value to be greater or less than the actual value. The average value during the taxable year or period shall be employed. The average value of property as above prescribed at the beginning and end of the taxable year or period ordinarily may be used, unless by reason of material changes during the taxable year or period such average does not fairly represent the average for such year or period, in which event the average shall be determined upon a monthly or daily basis. Bills and accounts receivable shall (unless satisfactory reason for a different treatment is shown) be assigned or allocated to the Philippines when the debtor resides in the Philippines.
Case 3. Application for permission to base the return upon the taxpayers books of account will be considered by the Commissioner of Internal Revenue in the case of any taxpayer who, in good faith and unaffected by considerations of tax liability, regularly employs in his books of account a detailed allocation of receipts and expenditures which reflects more clearly than the process or formulas herein prescribed, by income derived from source within the Philippines.
Sec 163 Foreign steamship companies – Repealed by section 12 of Revenue Regulations No. 8-75 dated October 29, 1975. “Section 1. Definition of gross Philippine Billing – “Section 2 (b) (1) of Revenue Regulations No. 8-75 is hereby amended to read as follows:
International carriers shall pay a tax of 2 ½ of their gross Philippine billings.
For the purpose of section 24 (b) (2) of the National Internal Revenue Code, “gross Philippine billings” means the gross revenue realized from uplifts anywhere in the world by any international carrier doing business in the Philippines of passage documents sold therein, whether for passenger, excess baggage, cargo or mail, provided the cargo or mail originates from the Philippines. The gross revenues realized from the said cargo or mail shall include the gross freight charges up to the final destination.
The gross freight charges in the airway bills, bills of lading and/or value of tickets sold by each international carrier doing business in the Philippines shall be prima facie evidence of its gross lifted revenue.
For the purpose of this definition, the phrase “doing business in the Philippines” include the regular sale of tickets in the Philippines by off-line international airlines either by themselves or through its agents.
In the case of off-line airlines, the general sales agents (GSA) or duly authorized representatives in the Philippines are hereby constituted as withholding agents pursuant to section 53 of the National Internal Revenue Code. Revenue Regulations No. 3-76 amending RR No. 8-75, dated March 15, 1976.
Sec 164 Telegraph and cable service – A foreign corporation carrying on the business of transmission of telegraph or cable messages between points in the Philippines and points outside the Philippines derives income partly from sources within and partly from sources without the Philipines.
(1) Gross Income – The gross income from sources within the Philippines derived from such service shall be determined by adding (a) its gross revenues derived from messages originating in the Philippines and (b) amounts collected abroad on collect message originating in the Philippines and deducting from such sum amounts paid or accrued for transmission of messages beyond the company’s own circuit. Amounts received by the company in the Philippines with respect to collect messages originating without the Philippines shall be excluded from the gross income.
(2) Net Income – In computing net income from sources within the Philippines there shall be allowed as deductions from gross income determined in accordance with paragraph (1): (a) all expenses incurred in the Philippines (not including any general overhead expenses), incident to the carrying on of the business in the Philippines, (b) all direct expenses incurred abroad in the transmission of messages originating in the Philippines (not including general overhead expense, maintenance, repairs, and depreciation of cable and not including any amount already deducted in computing gross income); (c) depreciation of property (other than cables) located in the Philippines and used in the trade or business therein; and (d) a proportionate part of the general overhead expenses (not including any items incurred abroad corresponding to those enumerated in (a), (b) and (c), and of maintenance, repairs and depreciation of cables of the entire cable system of the enterprise based on the ratio which the number of words originating in the Philippines bears to the total words transmitted by the enterprise.
Sec 165 Computation of Income – If a taxpayer has a gross income from sources within or without the Philippines as defined by section 37 (a) or (c) together with gross income derived partly from sources within and partly from sources without the Philippines, the amounts thereof, together with the expenses and investment applicable thereto, shall be aggregated, and the net income from sources within the Philippines shall be separately computed therefrom.
1. Gross income from sources within the Philippines
BOAC v Commissioner (149 SCRA 395)
BOAC is a 100% British Government-owned corporation organized and existing under the laws of the United Kingdom. It is engaged in the international airline business and is a member-signatory of the Interline Air Transport Association (IATA). As such, it operates air transportation service and sells transportation tickets over the routes of the other airline members. During the periods covered by the disputed assessments, it is admitted that BOAC had no landing rights for traffic purposes in the Philippines, and was not granted a Certificate of public convenience and necessity to operate in the Philippines by the Civil Aeronautics Board (CAB), except for a nine-month period, partly in 1961 and partly in 1962, when it was granted a temporary landing permit by the CAB. Thus, it did not carry passengers and/or cargo to or from the Philippines but it maintained a general sales agent in the Philippines — Warner Barnes and Company, Ltd., and later Qantas Airways — which was responsible for selling BOAC tickets covering passengers and cargoes.
(First CTA Case) On 7 May 1968, CIR assessed BOAC for deficiency income taxes covering the years 1959 to 1963. BOAC protested. After subsequent investigation, a new assessment was issued for the years 1959 to 1967 amounting to P858+k which BOAC paid under protest. On 7 October 1970, BOAC filed a claim for refund of the said amount but was denied by the CIR. But before said denial, BOAC had already filed a petition for review with the CTA , assailing the assessment and praying for the refund of the amount paid.
(Second CTA Case) On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and penalty for the fiscal years 1968/1969 to 1970-1971 in the aggregate amount of P549+k, and compromise penalties for violation of Section 46 (requiring the filing of corporation returns) penalized under Section 74 of the NIRC.
BOAC requested that the assessment be set aside but was denied. BOAC filed the second case.
The Tax Court reversing the CIR. It held that the proceeds of sales of BOAC passage tickets in the Philippines by Warner Barnes and Company, Ltd., and later by Qantas Airways, during the period in question, do not constitute BOAC income from Philippine sources "since no service of carriage of passengers or freight was performed by BOAC within the Philippines" and, therefore, said income is not subject to Philippine income tax. The CTA position was that income from transportation is income from services so that the place where services are rendered determines the source. The CIR filed a petition for certiorari.
ISSUES:
1. Whether or not the revenue derived by private respondent British Overseas Airways Corporation (BOAC) from sales of tickets in the Philippines for air transportation, while having no landing rights here, constitute income of BOAC from Philippine sources, and, accordingly, taxable. YES
2. Whether the revenue sales by BOAC in the Philippines constitute income from Philippine sources. YES
HELD: 1)Under Section 20 of the 1977 Tax Code:
The term 'resident foreign corporation' applies to a foreign corporation engaged in trade or business within the Philippines or having an office or place of business therein.
The term 'non-resident foreign corporation' applies to a foreign corporation not engaged in trade or business within the Philippines and not having any office or place of business therein.
BOAC is a resident foreign corporation. There is no specific criterion as to what constitutes "doing" or "engaging in" or "transacting" business. Each case must be judged in the light of its peculiar environmental circumstances. The term implies a continuity of commercial dealings and arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of some of the functions normally incident to, and in progressive prosecution of commercial gain or for the purpose and object of the business organization. 2 "In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character.
BOAC maintained a general sales agent in the Philippines. That general sales agent was engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of trips — each trip in the series corresponding to a different airline company; (3) receiving the fare from the whole trip; and (4) consequently allocating to the various airline companies on the basis of their participation in the services rendered through the mode of interline settlement. Those activities were in exercise of the functions which are normally incident to, and are in progressive pursuit of, the purpose and object of its organization as an international air carrier. In fact, the regular sale of tickets, its main activity, is the very lifeblood of the airline business, the generation of sales being the paramount objective. There should be no doubt then that BOAC was "engaged in" business in the Philippines through a local agent. It is a resident foreign corporation subject to tax upon its total net income received in the preceding taxable year from all sources within the Philippines.
2) The source of an income is the property, activity or service that produced the income. For the source of income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In BOAC's case, the sale of tickets in the Philippines is the activity that produces the income. The tickets exchanged hands here and payments for fares were also made here in Philippine currency. The situs of the source of payments is the Philippines. The flow of wealth proceeded from, and occurred within, Philippine territory, enjoying the protection accorded by the Philippine government. In consideration of such protection, the flow of wealth should share the burden of supporting the government.
A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the contract between the ticket-holder and the carrier. It gives rise to the obligation of the purchaser of the ticket to pay the fare and the corresponding obligation of the carrier to transport the passenger upon the terms and conditions set forth.
Section 37(a) of the Tax Code, which enumerates items of gross income from sources within the Philippines, does not mention income from the sale of tickets for international transportation. However, that does not render it less an income from sources within the Philippines. Section 37, by its language, does not intend the enumeration to be exclusive.
The absence of flight operations to and from the Philippines is not determinative of the source of income or the situs of income taxation. BOAC was an off-line international airline at the time of the case. The test of taxability is the "source"; and the source of an income is that activity . . . which produced the income. The passage documentations in these cases were sold in the Philippines and the revenue therefrom was derived from a business activity regularly pursued within the Philippines. Even if the BOAC tickets sold covered the "transport of passengers and cargo to and from foreign cities", it cannot alter the fact that income from the sale of tickets was derived from the Philippines. The word "source" conveys one essential idea, that of origin, and the origin of the income herein is the Philippines.
BOAC was ordered to pay by the Supreme Court.
Note: International carriers are now taxed as follows: international carriers shall pay a tax of 2-1/2 per cent on their gross Philippine billings. (Sec. 24[b] [2], Tax Code).
Gross Philippine billings' includes gross revenue realized from uplifts anywhere in the world by any international carrier doing business in the Philippines of passage documents sold therein, whether for passenger, excess baggage or mail, provided the cargo or mail originates from the Philippines. . . ." The foregoing provision ensures that international airlines are taxed on their income from Philippine sources. The 2-1/2% tax on gross Philippine billings is an income tax. As distinguished from common carriers tax, -
The common carrier's tax, it is an excise tax, being a tax on the activity of transporting, conveying or removing passengers and cargo from one place to another. It purports to tax the business of transportation and the same can be levied by the State only when the acts, privileges or businesses are done or performed within the jurisdiction of the Philippines.
2. Taxable income from sources within the Philippines
Commissioner v. CTA and Smith Kline & French Overseas 127 SCRA 9
This case is about the refund of a 1971 income tax amounting to P324+k. Smith Kline and French Overseas Company, a multinational firm domiciled in Philadelphia, Pennsylvania, is licensed to do business in the Philippines. It is engaged in the importation, manufacture and sale of pharmaceuticals, drugs and chemicals.
In its 1971 original ITR, Smith Kline declared a net taxable income of P1.4+M and paid P511+k as tax due. Among the deductions claimed from gross income was P501+k as its share of the head office overhead expenses. However, in its amended return filed on March 1, 1973, there was an overpayment of P324+k arising from underdeduction of home office overhead. It made a formal claim for the refund of the alleged overpayment.
In October, 1972, Smith Kline received from its international independent auditors an authenticated certification to the effect that the Philippine share in the unallocated overhead expenses of the main office for the year ended December 31, 1971 was actually P1.4+M.On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on its claim, Smith Kline filed a petition for review with the CTA. The CTA ordered the CIR to refund the overpayment or grant a tax credit to Smith Kline. The Commissioner appealed to the SC.
HELD: The governing law is found in section 37 of the old NIRC which reads:
Xxx (b) Net income from sources in the Philippines. — From the items of gross income specified in subsection (a) of this section there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income from sources within the Philippines.
Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to be made to determine the net income from Philippine sources: SEC. 160. Apportionment of deductions. — From the items specified in section 37(a), as being derived specifically from sources within the Philippines there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any other expenses, losses or deductions which can not definitely be allocated to some item or class of gross income. The remainder shall be included in full as net income from sources within the Philippines. The ratable part is based upon the ratio of gross income from sources within the Philippines to the total gross income.
"Example: A non-resident alien individual whose taxable year is the calendar year, derived gross income from all sources for 1939 of P180,000, including therein:
Interest on bonds of a domestic corporation P9,000
Dividends on stock of a domestic corporation 4,000
Royalty for the use of patents within the Philippines 12,000
Gain from sale of real property located within the Philippines 11,000
————
Total P36,000
========
that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of the gross income was from sources without the Philippines, determined under section 37(c).
The expenses of the taxpayer for the year amounted to P78k.. Of these expenses the amount of P8k is properly allocated to income from sources within the Philippines and the amount of P40k is properly allocated to income from sources without the Philippines.
The remainder of the expense, P30k cannot be definitely allocated to any class of income. A ratable part thereof, based upon the relation of gross income from sources within the Philippines to the total gross income, shall be deducted in computing net income from sources within the Philippines. Thus, there are deducted from the P36k of gross income from sources within the Philippines expenses amounting to P14k [representing P8k properly apportioned to the income from sources within the Philippines and P6k a ratable part (1/5) of the expenses which could not be allocated to any item or class of gross income]. The remainder, P22k, is the net income from sources within the Philippines.
Thus, it is manifest that where an expense is clearly related to the production of Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building in the Philippines), that expense can be deducted from the gross income acquired in the Philippines without resorting to apportionment.
The overhead expenses incurred by the parent company in connection with finance, administration, and research and development, all of which directly benefit its branches all over the world, including the Philippines, fall under a different category however. These are items which cannot be definitely allocated or identified with the operations of the Philippine branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can claim as its deductible share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross income, worldwide, of the multinational corporation.
The weight of evidence bolsters Smith Kline’s position that the amount of P1.4+M represents the correct ratable share, the same having been computed pursuant to section 37(b) and section 160. Therefore, it is entitled to a refund.
Income from Constructive Trading with Multinationals
REVENUE AUDIT MEMORANDUM ORDER NO. 1-86
Subject: Procedure for tax audit of Philippine branches of foreign corporations
To: All internal revenue officers and others concerned.
1. Background
1.1 Some branches of foreign corporations engage in business in the Philippines by soliciting orders from local importers. These branches are called “liaison offices or branches”. Sales made from such solicitations are not reported to these branches as their own sale purportedly because the branch office merely relays to its head office abroad purchase orders from local importers and it is purportedly its head office that actually consummates the sale. At the end of the taxable period, the branch office simply reports for income tax purposes its purported share of the income generated from sales but the allocation of this purported share is left entirely at the discretion of the head office. The revenue service is completely at the mercy of multi-national companies.
1.2 Some branches engage in business in the Philippines by soliciting orders from local importers and relay this information to its head office abroad. The head office in turn solicits prospective exporters for compensation. At the end of the taxable period, the head office allocates a certain portion of the compensation to its branch in the Philippines. The branch in turn reports its purported share for income tax purposes but does not pay the commercial broker’s tax thereon purportedly because the compensation was received from its head office and purportedly because the branch cannot be legally considered a commercial broker in relation to its head office since the branch and its head office possesses only a single legal personality (Philipp Brothers Oceanic, Inc. v. CIR, CTA Case No. 3140, March 8, 1984).
Again, in this second situation, allocation of the compensation is left as the discretion of the head office – the revenue service also left at the mercy of these multi-national companies.
2. Legal Consequences
2.1 The foregoing scope of activities of these branch offices is considered under R.A. 5455 as business acts. “Doing business” shall include soliciting orders, purchases, service contracts, opening offices, whether called “liaison” offices or branches… any other act or acts that imply a continuity of commercial dealings or arrangements, and contemplate to that extent the performance of acts or works, or the exercise of some of the functions normally incident to, and in progressive prosecution of, commercial gain or of the purpose and object of the business organization. (Sec 1(1), RA 5455).
2.2 These branch offices, like any other businesses, are required by law to account for their business operations in accordance with generally accepted accounting practices (NIRC). Thus a branch office although not possessing a separate and distinct juridical personality is, however, considered under generally accepted accounting practices as a distinct character, a separate business unit and should be “supplied by the home office with cash and merchandise and other such assets as may be needed” (Advance Accounting by Simons and Korrenbrock, 4th ed., p. 202). Generally accepted accounting practices also dictate that income and expenses of the branch shall be segregated from those of the home office in order to clearly reflect their respective operating results (ibid).
2.3 The doctrine of corporate fiction is not absolute – the veil of corporate fiction may be legally pierced should it be used to subvert just application of laws.
“…Where the corporate form of organization is adopted or a corporate entity is asserted in an endeavor to evade a statute or to modify its intent, courts will disregard the corporation or its entity. This has been applied to violations of tax laws” (Fletcher, 170-171, Commentaries and Jurisprudence on the Commercial Laws of the Philippines by Agbayani, Vol. 3, 1970 ed., p.21).
“…Where the corporation is a dummy, is unreal or a sham and serves no business purposes and is intended only as a blind, the corporate form may be ignored for the law cannot countenance a form that is bald and a mischivious fiction.” (Id. page 20).
“…To allow a taxpayer to deny tax liability on the ground that the sales were made through another and distinct corporation when it is proved that the latter is virtually owned by the former or that they are practically one and the same is to sanction a circumvention of our tax laws.” (Id.)
Corporate fiction may be inquired upon where there is “inadequacy of capital…, confusion of affairs… and direct intervention in management causing inequitable results (Ballantine, 314, Rorhlick, 417-422).
3. Branch Operation and Consequences
3.1 The Philippine branch solicits purchase orders from local buyers, relays the information to its home office abroad, and the home office purportedly directly makes the sale.
In this type of operation,: (i) Sales purportedly consummated abroad by the home office shall be treated as sales constructively consummated in the Philippines and made by the branch office, hence, income therefrom shall be considered income from sources within the Philippines; (ii) the branch shall record and report the gross selling price of commodities sold thru its home office; and (iii) report for income tax purposes its net income therefrom. (iv) since under this situation the import taxes, duties and charges have already been paid by the local buyers, the same shall not anymore be chargeable against the branch.
Under this paragraph, these transactions are treated sales constructively consummated by the branch office in accordance with the generally accepted accounting practices required under section 38 of the Tax Code since the branch solicitations are actually trading acts. Accordingly, the home office is obligated to supply its branch with merchandise in pursuing its trading business in the Philippines. Hence, sales purportedly made directly by its home office shall be considered no more than merely constructive supplying of the merchandise to its branch which eventually constructively sells the same to Philippine buyers.
3.2 The branch solicits purchase orders from local buyers, relays the information to its home office, the home office solicits prospective sellers abroad and eventually receives compensation for services rendered.
In this second type of operation: (i) the branch shall be considered “a commercial broker” or indentor; (ii) its share from compensation as allocated by its home office shall be subject to commercial broker gross receipts tax; (iii) the branch shall provide itself with corresponding fixed tax as a commercial broker; and (iv) pay income tax on its share of compensation.
Under this paragraph, the branch office shall be considered a commercial broker since its activities are well within the ambit of the term “broker”. Brokers are “… those who are engaged for others in the negotiation of contracts relative to property with custody of which they have no concern. They act as negotiators in bringing other persons together to bargain; generally, they ought not to sell in their own names, have no implied authority to receive payment, are not entrusted with the physical possession of the principal’s goods when engaged to buy and sell, and have no special property therein or lien thereon.” (Philipi Brothers, Id.)
4. Audit procedure
xxx
REVENUE REGULATIONS NO. 16-86
Subject: Amendment to Section 160 of Income Tax Regulations (RR-2) regarding the basis of determining ratable part of overseas overhead expenses apportioned under section 37(b) of the NIRC.
Pursuant to Sections 4 and 277 of the NIRC, the first paragraph of Section 160 of RR-2, otherwise known as the Income Tax Regulations, is hereby amended as follows:
Section 160. (a) Apportionment of deductions. From the items specified in Section37(a) as being derived specifically from sources within the Philippines, there shall be deducted the expenses, losses, and other deductions properly allocated thereto and a ratable part of any other expenses, losses and other deductions effectively connected with the business or trade conducted “exclusively within the Philippines which cannot definitely be allocated to some items or class of gross income. The remainder shall be included in full as net income from sources within the Philippines. The ratable part shall be based upon the following ratios consistently followed from year to year:
1. Gross income from sources within the Philippines to the total gross income.
2. Net sales in the Philippines to total net sales.
3. If any other method of allocation is adopted, a written permission from the CIR shall first be secured.
(b) External Auditor’s Certificate – The income tax return to be filed should be accompanied by a certification from an independent and reputable CPA containing the following information:
1. The home office deductions for the year involved have been examined in accordance with generally acceptable auditing standards and accordingly included such tests of accounting records and such other auditing procedures as were considered necessary in the circumstances.
2. The deductions pro-rated to the Philippine Branch do not include –
(a) net losses of any operating unit or branch;
(b) income tax payment;
(c) capital expenditures; and
(d) expenses directly chargeable to any branch.
3. The amount of allocable overhead expenses used in the pro-rata allocation to the Philippine branch is the same amount used in the pro-ration to all branches worldwide and the amount disallowed in other countries because of governmental requirement is not added back to the allocable amount.
4. should there be exception or qualification on the above-requested certification, an explanation with supporting documents should be submitted.
REVENUE AUDIT MEMORANDUM ORDER NO. 4-86
Subject: Audit Guidelines in the Allocation of Home Office Overhead Expenses Under Section 37(b) of the NIRC
In order to avoid delay and conflict in the determination of Philippine sources taxable net income of foreign taxpayers for purposes of Philippine Income tax, this RAMO is issued.
1. Background
1.1 In computing net income from sources within the Philippines, Section 37(b) provides that from the gross income from sources within the Philippines “x x x there shall be deducted the expenses, losses and other deductions properly allocated thereto and a ratable part of any expenses, interests and losses and other deductions effectively connected with the business or trade conducted exclusively within the Philippines which cannot be definitely allocated to some items or class of gross income x x x.”
1.2 These deductions are difficult to verify because substantial amounts thereof are incurred in the head office or elsewhere and the corresponding supporting documents and books of accounts are not accessible to local taxing authorities.
1.3 Heretofore only an audit certificate is presented to substantiate the deductions incurred abroad which are allocated and pro-rated to Philippine source gross income.
1.4 In implementing the above provision of the NIRC, there is a need for adequate and satisfactory proof and explanations in order that the claimed deductions of the foreign taxpayer may be allowed for income tax purposes.
2. Audit Procedure
2.1 Functional Analysis – At the start of investigation there should be a detailed examination of the functions performed both by the Home Office and the Local Branch. For this purpose, an organization and functional chart of the home office and local branch should be secured.
2.1.1 The functions should be determined and then listed. Who does what? What is required to do it? Who needs who from what?
2.1.2 After having listed the functions performed by each entity, the functions themselves must be analyzed. Could anyone else perform these functions? How difficult are they? What skill, equipment and processes are needed?
2.2 On the basis of the functional analysis, the claimed deduction properly allocable can now be determined by applying the tests of (a) relevance (necessary) to the local branch and (b) reasonable (ordinary) charges, keeping always in mind the arm’s length principle in transactions between related parties.
2.3 As to the deductions which cannot be definitely allocated, the following are required:
2.3.1 Breakdown or Schedule of Home or Foreign Office expenses being pro-rated, together with an explanation of the nature of each expense. Take note of the deductions which are directly allocable to income earned outside the Philippines.
2.3.2 Basis of pro-ration – (a) Determine if the basis and method of pro-ration are being applied consistently from year to year. (b) is the same amount of Home Office expense being allocated worldwide?
Audit guidelines on determination of income tax of branches of multinationals
REVENUE AUDIT MEMORANDUM ORDER NO. 1-95
Subject: Audit guidelines and procedures on the proper determination of the income tax liability of Philippine branches and liaison offices, of Multi-National Enterprises (MNEs) engaged in soliciting orders, purchases, service contracts, trading, construction and other activities in the Philippines.
II. Objectives
This Order is issued to:
a) amend and supersede RAMO No. 1-86 dated April 25, 1986 which provides for the procedures for tax audit of Philippine branches of foreign corporations.
b) Address the issue on the proper determination of the income tax liability of Philippine branches and liaison offices of MNEs pursuant to Section 43 of the NIRC wherein the CIR is authorized to distribute, apportion or allocate gross income or deduction among organizations in order to clearly reflect the income of any such organization.
Xxx
III. Coverage
a) This order shall apply only to Philippine branches and liaison offices of Japanese trading firms which are members of the Sogo Shosas and registered with the Japanese Chamber of Commerce and Industry (JCCI), and also all other foreign trading companies similarly situated as determined by the CIR.
b) Furthermore, the contents of this Order will apply only to income tax liabilities of Philippine branches and liaison offices of MNEs and will not affect the withholding, including branch profit remittance, and business tax obligations of the same Philippine branches and liaison offices of MNEs which shall be subject to the provisions of the NIRC.
IV. Guidelines
1. The Philippine income tax due from soliciting orders, purchases, service contracts, trading, construction and other activities of the Philippine branches and liaison offices of MNEs will be ascertained using the following formula:
For solicitation and trading activities:
{(Worldwide Operating Sales to the Philippines attribution to tax)}
{(Income X Worldwide Sales X rate X rate)}
For construction and other activities:
Plus {(Net Income from Construction and other activities X tax rate)}
2. In implementing the above formula, the following terms shall be construed to mean as follows:
(a) Worldwide (W/W) shall include head office accounts and those of branches located in different countries but shall exclude subsidiary accounts.
(b) W/W Operating Income shall include the Gross Income minus Selling , General & Administrative expenses. Operating Income does not include non-operating and extraordinary items like interest expense, exchange profit/loss, capital gains/losses or other income/loss not related to operation.
(c) Sales to the Philippines shall be defined as the aggregated amount of exports and offshore transactions to the Philippines by the Head Office , all branches and liaison offices and shall include the amount of indent transactions from which commissions are generated. These shall also include imported materials and equipment of construction projects undertaken in the Philippines, but shall exclude local service income from construction projects or onshore income from local construction.
(d) W/W sales shall consist of domestic, export, import and offshore transactions which include not only principal transactions but also indent transactions from which commissions are generated.
(e) Attribution rate shall mean a rate of 75% to be applied against the formula
(f) The tax rate to be applied shall be in accordance with Section 25(a) of the NIRC which is 35%.
(g) Net income on construction shall consist of local service income from construction projects or onshore income from construction projects or onshore income from construction projects including the cost of locally purchased materials and equipment, if any.
(h) Net income on all other activities shall consist of income such as management consultancy services and other undertakings that Philippine branches and liaison offices of MNEs are engaged in, net of costs and expenses associated with such income.
3. In the application of the formula, no offsetting of losses from one line of business to the detriment of the other line of business shall be allowed. This would mean that the tax due from each line of business shall be computed independently from the other line of business.
V. Procedures
1. Request documents containing information of the nature of the business transactions of the taxpayer as follows:
a) the structure of the Philippine branch or liaison office, the Home Office, other branches or more than 50% owned or controlled subsidiaries located outside the Philippines dealing with the local branch;
b) the ownership, relationship, extent of control, directors and officers of the Philippine branch or liaison office or Home Office;
c) the business activity of the MNE and how it relates to the activity of the local branch or liaison office and other branches or more than 50% owned or controlled subsidiaries dealing with the local company.
3. Gross income from sources without the Philippines [Supra]
4. Income from sources partly within or without the Philippines [Supra]
5. Situs of sale of stocks of domestic corporation [Supra]
6. Definition of Royalties – Philamlife CA-GR Sp No. 31283, April 25, 1995 (includes services as to investment, training and education accounting) [this is a Sleuth. I cannot find this case. Sorry!]
7. Commissioner v. Marubeni Corp., (372 SCRA 576), effect of Turn Key Projects
CIR v. Marubeni Corp.
Marubeni Corp is a foreign corp. organized and existing under the laws of Japan. It is engaged in general import and export trading, financing and construction business. It is duly registered to engage in such business in the Philippines and maintains a branch office in Manila.
In November 1985, CIR issued a letter of authority to examine the books of accounts of Marubeni. It was found that that Marubeni has undeclared income from 2 contracts completed in 1984, the NDC contract and the Philphos contract. In March 1, 1986, BIR examiners recommended an assessment for deficiency income, branch profit remittance, contractor’s and commercial broker’s taxes. Marubeni questioned such assessment.
The CIR found that the NDC and the Philphos contracts were made on a “turn-key” basis and the gross income from the 2 projects amounted to P967+k. Each contract was for a piece of work and since the projects called for the construction and installation of facilities in the Philippines, the entire income therefrom constituted income from Philippine sources, hence, subject to Internal Revenue Taxes. Marubeni filed 2 petitions in the CTA – one questioning the deficiency income, branch profit remittance, contractor’s tax assessments and the other questioning the deficiency contractor’s and commercial broker’s taxes.
On August 2, 1986, E.O. No. 41, declaring a one-time amnesty covering unpaid income taxes for the years 1981 to 1985 was issued. Marubeni availed of such amnesty and complied with the prescribed requirements therein. On November 17, 1986, the scope and coverage of the amnesty was expanded to include estate, donors and business taxes.
After 10 years from the filing of the case, the CTA rendered a decision stating that Marubeni had properly availed of the amnesty and the case is deemed cancelled. The CIR challenged the CTA decision in the CA. The CA dismissed the petition.
ISSUE: Whether or not Marubeni lawfully availed of the amnesty
HELD: There are 3 types of taxes involved herein – income tax, branch profit remittance tax and contractor’s tax. The CIR contends that Marubeni cannot avail of the amnesty granted because it falls on the exceptions in Sec 4(b) of EO 41 which states that those with income tax cases already filed in Court as of the effectivity of the law cannot avail of the amnesty.
As for the income tax and deficiency branch profit remittance tax assessment, Marubeni properly availed of the amnesty because the case was not yet already filed in court when the law took effect.
However, as for the contractor’s tax, since it is a business tax, its amnesty program only became effective when EO 41 was amended by EO 64. the general rule is that amendatory acts operate prospectively. It may not be given a retroactive effect unless it is so expressly provided expressly or by necessary implication and no vested right or obligations of contract are thereby impaired. Therefore, when the amnesty for business taxes took effect, the case of Marubeni was already filed in Court. It is therefore disqualified to avail of the said amnesty.
It is Marubeni’s argument that it is not liable for the deficiency contractor’s tax because the income from the projects came from the “Offshore Portion” of the contracts. The 2 contracts were divided into 2 parts – the Onshore and the Offshore Portion. All materials and equipment in the contract under the “Offshore Portion” were manufactured and completed in Japan, not in the Philippines, and are therefore not subject to Philippine taxes.
Under the Philippine Onshore Portion, Marubeni does not deny its liability for the contractor’s tax on the income from the 2 projects. It is with regard to the gross receipt from the Foreign Offshore Portion of the two contracts that the liabilities involved in the assessments subject of this case arose. CIR argues that since the two agreements are Turn-Key (A job or a contract in which the contractor agrees to complete the work of the building and installation to the point of readiness for operation or occupancy), they call for the supply of both materials and services to the client, they are contracts for a piece of work and are indivisible. The situs of the 2 projects is in the Philippines, and the materials provided and services rendered were all done and completed within the territorial jurisdiction of the Philippines. Accordingly, respondent’s entire receipts from the contracts, including its receipts from the Offshore Portion, constitute income from the Philippine sources. The total gross receipts covering both labor and materials should be subjected to contractor’s tax.
An independent contractor is a person whose activity consists essentially of the sale of all kinds of services for a fee, regardless of whether or not the performance of the service calls for the exercise or use of the physical or mental faculties of such contractors or their employees. The word “contractor” refers to a person who, in the pursuit of an independent business, undertakes to do a specific job or a piece of work for other persons using his own means and methods without submitting himself to control as to the petty details.
A contractor’s tax is a tax imposed upon the privilege of engaging in business. It is generally in the nature of an excise tax on the exercise of a privilege of selling services or labor rather than a sale on products; and is directly collectible from the person exercising the privilege. Being an excise tax, it can be levied by the taxing authority only when the acts, privileges, or business are done or performed within the jurisdiction of said authority. It cannot be imposed on an occupation or privilege outside the taxing district.
It is undisputed that Marubeni is an independent contractor but it argues that the work therein were not all performed in the Philippines because some of them were completed in Japan in accordance with the provisions of the contracts. The service of “design engineering, supply and delivery, construction, erection and installation, supervision, direction and control of testing and commissioning, coordination…” of the two projects involved 2 taxing jurisdictions. These acts occurred in 2 countries – Japan and the Philippines. While the construction and installation work were completed within the Philippines, the evidence is clear that some pieces of equipment and supplies were completely designed and engineered in Japan. All services for the design, fabrication, engineering and manufacture of the materials and equipment under the Japanese Yen Portion I were made and completed in Japan. These services were rendered outside the taxing jurisdiction of the Philippines and are therefore not subject to contractor’s tax.
CIR’s petition is denied.
III. ACCOUNTING PERIODS AND METHODS
NIRC - 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.
SEC. 47. Final or Adjustment Returns for a Period of Less than Twelve (12) Months. —
"(A) Returns for Short Period Resulting from Change of Accounting Period. — If a taxpayer, other than an individual, with the approval of the Commissioner, changes the basis of computing net income from fiscal year to calendar year, a separate final or adjustment return shall be made for the period between the close of the last fiscal year for which return was made and the following December 31. If the change is from calendar year to fiscal year, a separate final or adjustment return shall be made for the period between the close of the last calendar year for which return was made and the date designated as the close of the fiscal year. If the change is from one fiscal year to another fiscal year, a separate final or adjustment return shall be made for the period between the close of the former fiscal year and the date designated as the close of the new fiscal year.
"(B) Income Computed on Basis of Short Period. — Where a separate final or adjustment return is made under Subsection (A) on account of a change in the accounting period, and in all other cases where a separate final or adjustment return is required or permitted by rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, to be made for a fractional part of a year, then the income shall be computed on the basis of the period for which separate final or adjustment return is made.
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 rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, be returned on the basis and in 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.
SEC. 50. Allocation of Income and Deductions. — In the case of two or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned or controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any such organization, trade or business.
RR-2
Sec 166 General Rule – The method of accounting regularly employed by the taxpayer in keeping his books, if such method clearly reflects his income is to be followed with respect to the time as of which items of gross income and deductions are to be accounted for. If the taxpayer does not regularly employ a method of accounting which reflects his income, the computation shall be made in such manner as in the opinion of the Commissioner of Internal Revenue clearly reflects it. (See section 137 of these regulations for computation of net income, and section 38 for bases of computation. For the use of inventories, see sections 144 to 151 of these regulations.)
Sec 167 Methods of accounting – It is recognized that no uniform method of accounting can be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purpose. Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so. Any approved standard method of accounting which reflects taxpayer’s income may be adopted. Among the essential are the following:
(1) In all cases in which the production, purchase, or sale of merchandise of any kind is an income-producing factor, inventories of the merchandise in hand (including finished goods, work in process, raw materials, and supplies) should be taken at the beginning and end of the year and used in computing the net income of the year in accordance with sections 144 to 151 of these regulations.
(2) Expenditures made during the year should be properly classified as between capital an income; that is to say, expenditures for items of plant, equipment, etc. which have a useful life extending substantially beyond they year should be charged to capital account and not to expense account; and
(3) In any case in which the cost of capital assets is being recovered through deductions for wear and tear, depletion, or obsolescence, any expenditure 9other than ordinary repairs) _____ restore the property or prolong its useful life should be added to the property account or charged against the appropriate reserve and not to current expenses.
Sec 168 Changes in accounting methods – The true income, computed under the law, shall in all cases be entered in the return. If for any reason the basis of reporting income subject to tax is changed, the taxpayer shall attach to is return a separate statement setting forth for the taxable year and for the preceding year the classes of items differently treated under the two systems, specifying in particular all amounts duplicated or entirely omitted as the result of such change.
A taxpayer who changes the method or recounting employed in keeping his book shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner of Internal Revenue. For the purpose of this section, a change in the method of accounting employed in keeping books means any change in the accounting treatment of items of income or deduction, such as a change from cash receipts and disbursement methods to the accrued method, or vice versa; a change involving the basis of valuation employed in the computation of inventories (see sections 144 to 151 of these regulations); a change from the cash to accrual method to the long-term contract method, or vice versa; a change in the long-term contract method from the percentage of computation basis to the completed contract basis, or vice versa (see section 44 of these regulations); or a change involving the adoption of, or a change in the use of, any other specialized basis of computing net income such as the crop basis. Application for permission to change the method accounting employed and the basis upon which the return is made shall be filed within 90 days after the beginning of the taxable year to be covered by the return. The application shall be accompanied by a statement specifying all amounts which would be duplicated or entirely omitted as a result of the proposed change. Permission to change the method of accounting will not be granted unless the taxpayer and the Commissioner of Internal Revenue agree to the terms and conditions under which the change will be effected.
Sec 169 Accounting Period – Income tax returns, whether for individual of for corporations, associations, or partnerships, are required to be made and their income computed for each calendar year ending on December 31st of every year. However, corporations, associations or partnerships may with the approval of the Commissioner of Internal Revenue ___ secured, file their returns and compute their income on the basis of a fiscal year which means an accounting period of twelve months ending on the last day of any month other than December. But in no instance shall individual taxpayers be authorized to establish fiscal year as basis for filing their returns and computing their income. (For authority to file on fiscal year basis see section 172 of these regulations).
Sec 170 When included in gross income – Except as otherwise provided in section 39 in the case of the death of the taxpayer, gains, profits, and income are to be included in the gross income for the taxable year in which they are received by the taxpayer, unless they are included as of a different period in accordance with the approved method of accounting followed by him. If a taxpayer has died there shall also be included in computing for the taxable period in which he died amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period, regardless of the fact that the decedent may have kept his books and made his returns on the basis of cash receipts and disbursements.
(For income not reduced to possession but considered as constructively received and for examples of constructive receipt, see sections 52 and 53 of these regulations. For the treatment of income long term contracts, see section 44 of these regulations.)
Sec 171 “Paid or incurred” or “paid or accrued” – (a) The terms “paid or incurred” and “paid or accrued” will be construed according to the method of accounting upon the basis of which the net income is computed by the taxpayer. The deductions and credits must be taken for the taxable year, in which “paid or accrued” or ‘paid or incurred”, unless in order clearly to reflect the income such deductions or credits should be taken as of a different period. If a taxpayer desires to claim a deduction or a credit as of a period other than the period in which it was “paid or accrued” or “paid or incurred”, he shall attach to his return a statement setting forth his request for consideration of the case by the Commissioner of Internal Revenue together with a complete statement of the facts upon which he relies. However, in his income tax return he shall take the deduction or credit only for the taxable period in which it was actually “paid or incurred”, or “paid or accrued”, as the case may be. Upon the audit of the return, the Commissioner of Internal Revenue will decide whether the case is within the exception provided by law, and the taxpayer will be advised as to the period for which the deduction or credit is properly allowable.
(b) The provision of paragraph (a) of this section in general are not applicable with respect to the taxable period during which the taxpayer dies. In such case there shall also be allowed as deductions and credits for such taxable period amounts accrued and credits for such taxable period, amounts accrued up to the date of his death if not otherwise allowable with respect to such period or a prior period, regardless of the fact that the decedent was required to keep his books and make his returns on the basis of cash receipts and disbursements.
Sec 172 Change of accounting period. – If a corporation, including a duly registered general partnership, desires to change its accounting period from the fiscal year to calendar year or from calendar year to fiscal year, or from one fiscal to another, it shall at any time not less than thirty days prior to the date fixed in section 46 (b) of the Code for the filing of its return on the basis of its original accounting period submit a written application to the Commissioner of Internal Revenue designating the proposed date for the closing of its new taxable year, together with a statement of the date on which the books of account were opened and closed each year for the past three years, the date on which the taxable year began and ended as shown on the returns filed for the past three years, and the reasons why the change in accounting period is desired.
Sec 173 Returns for periods of less than twelve months – No returns can be made for a period of more than twelve months. A separate return for the fractional part of a year is therefore required whenever there is a change, with the approval of the Commissioner of Internal Revenue, in the basis of computing net income from one taxable year to another taxable year. The periods to be covered by such separate returns in the several cases stated in section 42 (a). The requirements with respect to the filing of a separate return and the payment of tax for a part of a year are the same as for the filing of a separate return and the payment of tax for a part of a year are the same as for the filing of a return and the payment of tax for a full taxable year closing at the same time.
Sec 174 Sale of personal property on installment plan. – Dealers in personal property ordinarily sell either for cash or on the personal credit of the purchaser or on the installment plan. Dealers who sell on the installment plan usually adopt one of four ways of protecting themselves in case of default –
(a) By an agreement that title is to remain in the vendor until the purchaser has completely performed his part of the transaction
(b) By a form of contract in which title is conveyed to the purchaser immediately, but subject to a lien for the unpaid portion of the selling price;
(c) By a present transfer of title to the purchaser, who at the time executes a reconveyance in the form of chattel mortgage to the vendor; or
(d) By conveyance to a trustee pending performance of the contract and subject to its provisions.
The general purpose and effect being the same in all these cases, the same rule is uniformly applicable. The general rule prescribed is that a person who regularly sells or otherwise disposes of personal property on an installment plan, whether or not title remains in the vendor until the property is fully paid for, may return as income therefrom in any taxable year that proportion of the installment payments actually received in the year which the total of gross profit (that is, sales less cost of goods sold) realized or to be realized when the property is paid for, bears to the total contract price. Thus income of a dealer in personal property on the installment plan may be ascertained by taking as income that proportion of the total payments received in the taxable year from the installment sales (such payments being allocated to the year against the sales of which they apply) which the total or gross profit realized or to be realized on the total installment sales made during each year bears to the total contract price of all such sales made during that respective year. No payments received in the taxable year shall be excluded in computing the amount of income to be returned on the ground that they were received under a sale the total profit from which was returned as income during a taxable year or years prior to the change by the taxpayer to the installment basis of returning income deductible items are not to be allocated to the years in which the profits from the sales of a particular year are to be returned as income, but must be deducted for the taxable year in which the items are “paid or incurred” or “paid or accrued” as provided by section 40 and 84 (q) of the Code. A dealer who desires to compute his income on the installment basis shall maintain books of account in such a manner as to enable accurate computation to be made on such basis in accordance with the provisions of this section.
The income from a casual sale or other casual disposition of personal property (other than property of a kind which should properly be included in inventory) may be reported on the installment basis only if (1) the sale price exceeds P1,000 and (2) the prior payments do not exceed 25 per cent of the selling price.
If for any reason the purchaser defaults in any of his payments, and the vendor returning income on the installment basis repossesses the property sold whether title thereto had been retained by the vendor or transferred to the purchaser, gain or loss for the year in which the repossession occurs is to be computed upon any installment obligations of the purchaser which are satisfied or discharged upon the repossession or are applied by the vendor to the purchase or bid price of the property. Such gain or loss is to be measured by the difference between the fair market value of the property reposed and the basis in the hands of the vendor of the obligations of the purchaser which are so satisfied, discharged, or applied, with proper adjustment for any other amounts realized or costs incurred in connection with the repossession. The basis in the hands of the vendor of the obligations of the purchaser satisfied, discharged or applied upon the repossession of the property shall be the excess of the face value of such obligations over an amount equal to the income which would be returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on account of any portion of the obligations of the purchaser which are treated by the vendor as not having been satisfied, discharged or applied upon the repossession, unless it is clearly shown that after the property was repossessed the purchaser remained liable for such portion; and in no event shall the amount of the deduction exceed the basis in the hands of the vendor of the portion of the obligations with respect to which the purchaser remained liable after the repossession. If the property repossessed is bid in by the vendor at a lawful public auction or judicial sale, the fair market value of the property shall be presumed to be the purchase or bid price thereof in the absence of clear and convincing proof to the contrary. Then property repossessed shall be carried on the books of the vendor at its fair market value at the time of the repossession.
If the vendor chooses as a matter of consistent practice to return the income from installment sales on the straight accrual or cash receipts and disbursement basis, such a course is permissible.
Sec 175 Sale of real property involving deferred payments. – Under section 43 deferred payment sales of real property include (a) agreements of purchase and sale which contemplate that a conveyance is not to be made at the outset, but only after all or a substantial portion of the selling price has been paid, and (b) sales in which there is an immediate transfer of title, the vendor being protected by a mortgage or other lien as to deferred payments. Such sales either under (a) or (b), fall into two classes when considered with respect to the terms of sale, as follows:
(1) Sales of property on the installment plan, that is, sales in which the payments received in cash or property other than evidence of indebtedness of the purchaser during the taxable year in which the sale made do not exceed 25 per cent of the selling price;
(2) Deferred payment sales not on installment plan, that is sales in which the payments received in cash or property other than evidence of indebtedness of the purchaser during the taxable year in which the sale is made exceed 25 per cent of the selling price;
In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as part of the “selling price” but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall not be considered as part of the “initial payments” or of the “total contract price,” as those terms are used in section 43 of the Code, in sections 174 and 176 of this regulations, and in this section. The term “initial payments” does not include amounts received by the vendor in the year of sale from the disposition to a third person of notes given by the vendee as part of the purchase price which are due and payable in subsequent years. Commissions and other selling expenses paid or accrued by the vendor and not to the deducted or taken into account in determining the amount of the “initial payments,” the “total contract price,” or the “selling price.” The term “initial payments” contemplates at least one other payment in addition to the initial payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no payment during the year, the income may not be returned on the installment basis. Income may not be returned on the installment basis where no payment in cash or property, other than evidence of indebtedness of the purchaser, is received during the first year, the purchaser having promised to make two or more payments in later years.
Sec 176 Sale of real property on installment plan. – In transactions included in class (1) in the preceding section the vendor may return as income from such transactions in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the property is paid for bears to the contract price.
If the purchaser defaults in any of his payments, and the vendor returning income on the installment basis reacquires the property sold whether title thereto had been retained by the vendor or transferred to the purchaser, gain or loss for the year in which the reacquisition occurs is to be computed upon any installment obligations of the purchaser which are satisfied or discharged upon the reacquisition or are applied by the vendor to the purchase or bid price of the property. Such gain or loss is to be measured by the difference between the fair market value of the property acquired (including the fair market value of any fixed improvements placed on the property by the purchaser) and the basis in the hands of the vendor of the obligations of the purchaser which are so satisfied, discharged, or applied, with proper adjustment for any other amounts realized or costs incurred in connection with the reacquisition. The basis in the hands of the vendor of the obligations of the purchaser satisfied, discharged or applied upon the reacquisition of the property will be excess of the face value of such obligations over an amount equal to the income which would be returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on account of any portion of the obligations of the purchaser which are treated by the vendor as not having been satisfied, discharged or applied upon the reacquisition of the property, unless it is clearly shown that after the property was reacquired the purchaser remained liable for such portion; and in no event shall the amount of the deduction exceed the basis in the hands of the vendor of the portion of the obligations with respect to which the purchaser remained liable after the acquisition. If the property reacquired is bid in by the vendor at a foreclosure sale, the fair market value of the property shall be presumed to be the purchase or bid price thereof in the absence of clear and convincing proof to the contrary. If the property reacquired is subsequently sold, the basis for determining gain or loss is the fair market value of the property at the date of the reacquisition including the fair market value of any fixed improvements placed on the property by the purchaser).
If the vendor chooses as a matter of consistent practice to turn the income from installment sales on the straight accrual or cash receipts and disbursement basis, such a course is permissible, and the sales will be treated as deferred-payment sales not on the installment plan.
Sec 177 Deferred payment sale of real property not on installment plan. – In transactions included in class (2) in section 175 of these regulations, the obligations of the purchaser received by the vendor are to be considered as the equivalent of cash.
If the vendor has retained title to the property and the purchaser defaults in any of his payments, and the vendor repossesses the property, the difference between (1) the entire amount of the payments actually received on the contract and retained by the vendor plus the fair market value at the time of repossession of fixed improvements placed on the property by the purchaser and (2) the sum of the profits previously returned as income in connection therewith and an amount representing what would have been a proper adjustment for exhaustion, wear and tear, obsolescence amortization and depletion of the property during the period the property was in the hands of the purchaser had the sale not been made will constitute gain or loss, as the case may be, to the vendor for the year in which the property is repossessed, and the basis of the property in the hands of the vendor will be the original basis at the time of the sale plus the fair market value at the time of repossession, of fixed improvements placed on the property by the purchaser. If the vendor has previously transferred title to the purchaser, and the purchaser defaults in any of his payments and the vendor reacquired the property, such reacquisition shall be regarded as a transfer by the vendor, in exchange for the property for such of the purchaser’s obligations as are applied by the vendor to the purchaser or bid price of the property. Such an exchange will be regarded as having resulted in the realization by the vendor of gain or loss, as the case may be for the year of the reacquisition, measured by the difference between the fair market value of the property including improvements placed by the purchaser on the property, and the amounts of the obligations of the purchaser which were applied by the vendor to the purchase or bid price of the property. The fair market value of the property reacquired shall be presumed to be the amount for which it is bid in by the vendor in the absence of a clear and convincing proof to the contrary. If the property reacquired is subsequently sold the basis for determining the gain or loss is the fair market value of the property at the date of reacquisition including the fair market value of the fixed improvements placed on the property by the purchaser.
Sec 178 Sale of real estate in lots. – Where a tract of land is purchased with a view to dividing it into lots or parcels of ground to be sold as such, the entire fair market value as of March 1, 1913, or the cost, if acquired subsequently to that date shall be equitably apportioned to the several lots or parcels and made a matter of record on the books of the taxpayer, to the end that any gain derived from the sale of any such lots or parcels may be returned as income for the year in which the sale was made. This rule contemplates that there will be a measure of gain or loss for every lot or parcel sold, and not that the capital invested in the entire tract shall be extinguished before any taxable income shall be returned. The sale of each lot or parcel will be treated as a separate transaction and shall be dealt with accordingly.
Sec 178-A – In all cases where a taxpayer sells during the year real or personal property on the installment basis, there should be attached to the income tax return a statement of each sale made during the year containing the following information:
(a) Name of the buyer
(b) Address of the buyer
(c) Date of sale
(d) Selling price
(e) Payments received during the year corresponding to such sale (As amended by Revenue Regulations No. 8-65 dated June 1, 1965).
Sec 179 Determination of the taxable net income of a controlled taxpayer. – (a) Definitions. – When used in this section-
(1) The term “organization” include any organization of any kind, whether it be a sole proprietorship, a partnership, a trust in an estate, or a corporation or an association, irrespective of the place where organized, where operated, or where its trade or business is conducted, and regardless of whether domestic or foreign, whether exempt or taxable, or whether affiliated or not.
(2) The terms “trade” or “business” include any trade or business activity of any kind, regardless of whether or where organized, whether owned individually or otherwise, and regardless of the place where carried on.
(3) The term “controlled” includes any kind of control, direct or indirect, whether legally enforceable, and however exercisable or exercised. It is the reality of the control which is decisive, not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.
(4) The term “controlled taxpayer” means any one of the two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests.
(5) The terms “group” and “group of controlled taxpayers” mean the organizations, trades or businesses owned or controlled by the same interests.
(6) The term “true net income” means in the case of a controlled taxpayer, the net income (or, as the case may be, any item or element affecting net income) which would have resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the particular contract, transaction; arrangement, or other act) dealt with the other member or members of the group at arm’s length. It does not mean the income, the deductions, or the item or element of either, resulting to the controlled taxpayer by reason of the particular contract, transaction, agreement, the controlled taxpayer, or the interests controlling it, chose to make (even though such contract, transaction, or arrangement be legally binding upon the parties thereto).
(b) Scope and Purpose. – The purpose of section 44 is to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining according to the standard of an uncontrolled taxpayer, the true net income from the property and business of a controlled taxpayer. The interests controlling a group of controlled taxpayers are assumed to have complete power to cause each controlled taxpayer so to conduct its affairs that its transactions and accounting records truly reflect the net income from the property and business of each of the controlled taxpayers. If, however, this has not been done, and the taxable net incomes are thereby understated, the statute contemplates that the Commissioner of Internal Revenue shall intervene, and, by making such distributions, apportionments, or allocations as he may deem necessary of gross income or deductions, or of any item or element affecting net income, between or among the controlled taxpayers constituting the group, shall determine the true net income of each controlled taxpayer. The standard to be applied in every case is that of an uncontrolled taxpayer. Section 44 grants no right to a controlled taxpayer to apply its provisions at will, nor does it grant any right to compel the Commissioner of Internal Revenue to apply such provisions.
(c) Application – Transaction between the controlled taxpayer and another will be subjected to special scrutiny to ascertain whether the common control is being used to reduce, avoid, or escape taxes. In determining the true net income of a controlled taxpayer, the Commissioner of Internal Revenue is not restricted to the case of improper accounting, to the case of a fraudulent, colorable, or sham transaction, or to the case of a device designed to reduce or avoid tax by shifting or distorting income by deductions. The authority to determine true net income extends to any case in which either by inadvertence or design the taxable net income in whole or in part, of a controlled taxpayer, is other than it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer dealing at arm’s length with another controlled taxpayer.
RR-2
Sec 51 When income is to be reported.- Gains, profits and income are to be included in the gross income for the taxable year in which they are received by the taxpayer, unless they are included when they accrue to him in accordance with the approved method of accounting followed by him. If a person sues in one year on a pecuniary claim or for property, and money or property is recovered on judgment therefore in a later year, income is realized in that year, assuming that the money or property would have been income in the earliest year if then received. This is true of a recovery for patent infringement. Bad debts or accounts charged off subsequent to March 1, 1913, because of the fact that they were determined to be worthless, which are subsequently recovered, whether or not by suit, constitute income for the year in which recovered, regardless of the date when amounts were charged off.
Sec 52 Income constructively received. – Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case the income must be credited to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made. A book entry, if made, should indicate an absolute transfer from one account to another. If the income is not credited, but is set apart, such income must be qualifiedly subject to the demand of the taxpayer. Where a corporation contingently credits its employees with bonus stock, but the stock is not available to such employees until some future date the mere crediting on the books of the corporation does not constitute receipt.
Sec 53 Examples of constructive receipt. – When interest coupons have matured and are payable, but have not been cashed, such interest payment, though not collected when due and payable, is nevertheless available to the taxpayer and should therefore be included in his gross income for the year during which the coupons matured. This is true if the coupons are exchanged for other property instead of eventually being cashed. Defaulted coupons are income for the year in which paid. The distributive share of the profits of a partner in a general partnership duly registered is regarded as received by him, although not distributed. Interest credited on savings bank deposits, even though the bank nominally has a rule, seldom or never enforced, that it may require so many days notice in advance of cashing depositors’ checks, is income to the depositor when credited. An amount credited to shareholders of a building and loan association, when such credit passes without restriction to the shareholder, has a taxable status as income for the year of the credit. Where the amount of such accumulations has not become available to the shareholder until the maturity of a share, the amount of any share in excess of the aggregate amount paid in by the shareholder is income for the year of the maturity of the share.
i. General Rule [Supra]
ii. Accounting Period [Supra]
iii. Accounting Method – cash (actual or constructive) or accrual
Hybrid Method – Consolidated Mines, Inc. v. CTA L-18844, Aug 19, 1974
The Company, a domestic corporation engaged in mining, had filed its income tax returns for 1951, 1952, 1953 and 1956. In 1957 BIR examiners investigated the income tax returns filed by the Company because on August 10, 1954, its auditor, claimed the refund of the sum of P107+k representing alleged overpayments of income taxes for the year 1951. After the investigation the examiners reported that (A) for the years 1951 to 1954 (1) the Company had not accrued as an expense the share in the company profits of Benguet Consolidated Mines as operator of the Company's mines, although for income tax purposes the Company had reported income and expenses on the accrual basis; (2) depletion and depreciation expenses had been overcharged; and (3) the claims for audit and legal fees and miscellaneous expenses for 1953 and 1954 had not been properly substantiated; and that (B) for the year 1956 (1) the Company had overstated its claim for depletion; and (2) certain claims for miscellaneous expenses were not duly supported by evidence.
As a result, the CIR sent the Company a demand letter requiring it to pay deficiency income taxes for the years 1951 to 1954, and for 1956. Deficiency income tax assessment notices for said years were also sent to the Company. The company requested a reconsideration of the assessment, but was the CIR denied. The Company appealed to the CTA, which ordered the Company to pay the amounts of P107+k, P134+k and P71+k as deficiency income taxes for the years 1953, 1954 and 1956, respectively. CTA nullified the assessments for the years 1951 and 1952 on the ground that they were issued beyond the five-year period prescribed by Section 331 of the NIRC. The Company appealed and the CTA reduced the deficiency income tax liabilities. The CTA subscribed to the theory of the Company that Benguet Consolidated Mining Company, hereafter referred to as Benguet, had no right to share in "Accounts Receivable," hence one-half thereof may not be accrued as an expense of the Company for a given year.
The Company and the CIR to the SC. The Company questions the rate of mine depletion adopted by the CTA and the disallowance of depreciation charges and certain miscellaneous expenses. The CIR, on the other hand, questions what he characterizes as the "hybrid" or "mixed" method of accounting utilized by the Company, and approved by the CTA, in treating the share of Benguet in the net profits from the operation of the mines in connection with its income tax returns.
With respect to methods of accounting, the Tax Code states:
"Sec. 38. General Rules. The net 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 methods as in the opinion of the Commissioner of Internal Revenue does clearly reflect the income . . .
"Sec. 39. 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 the methods of accounting permitted under section 38, any such amounts are to be properly accounted for as of a different period . . .
"Sec. 40. 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 . . ."
It is said that accounting methods for tax purposes comprise a set of rules for determining when and how to report income and deductions. The U.S. Internal Revenue Code allows each taxpayer to adopt the accounting method most suitable to his business, and requires only that taxable income generally be based on the method of accounting regularly employed in keeping the taxpayer's books, provided that the method clearly reflects income.
The Company used the accrual method of accounting in computing its income. One of its expenses is the amount paid to Benguet as mine operator, which amount is computed as 50% of "net income." The Company deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the end of each calendar year what the Commissioner alleges is "50% of the share of Benguet" in the "accounts receivable." However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid. It would seem, therefore, that the Company has been deducting a portion of this expense (Benguet's share as mine operator) on the "cash & carry" basis.
ISSUE: Whether or not the accounting system used by the Company justifies such a treatment of this item; and if not, whether said method used by the Company, and characterized by the Commissioner as a "hybrid method," may be allowed under the aforequoted provisions of our tax code.
HELD: The Company has certain mining claims located in Masinloc, Zambales. Because it wanted to relieve itself of the work and expense necessary for developing the claims, the Company, on July 9, 1934, entered into an agreement with Benguet, a domestic anonymous partnership engaged in the production and marketing of chromite, whereby the latter undertook to "explore, develop, mine, concentrate and market" the pay ore in said mining claims.
There is a 90%(Benguet) –10% (Consolidated) sharing of profits and Benguet was being reimbursed the expenses disbursed during the period it was trying to put the mines on a profit-producing basis. By 1953 Benguet had completely recouped said advances, because they were then dividing the profits share and share alike.
It is of the CIR’s view that there were years when the Company had been overstating its income (1951 and 1952) and there were years when it had been understating its income (1953 and 1954). The Commissioner is not interested in the taxes for 1951 and 1952 (which had prescribed anyway) when the Company had overstated its income, but in those for 1953 and 1954, in each of which years the amount of the "Accounts Receivable" was less than that of the previous year, and the Company, therefore, appears to have deducted, as expense, compensation to Benguet bigger (than what the Commissioner claims is due) by one-half of the difference between the year's "Accounts Receivable" and the previous year's "Accounts Receivable," thus apparently understating its income to that extent.
According to the agreement between the Company and Benguet the net profits "shall be computed by deducting from gross income all operating expenses and all expenses of any nature whatsoever." Periodically, Benguet was to furnish the Company with the statement of accounts for a given month "as soon as practicable after the close" of that month. The Company had ten days from receipt of the statement to register its objections thereto. Thereafter, the statement was considered binding on the Company. And all payments due the Company "with respect to the expeneditures made and ore settlements received during the calendar month shall be payable on or before the twentieth of each month."
The agreement does not say that Benguet was to share in "Accounts Receivable." But may this be implied from the terms of the agreement? The statement of accounts and the payment that Benguet must make are both with respect to "expenditures made and ore settlements received." "Expenditures" are payments of money. This is the meaning intended by the parties, considering the provision that Benguet agreed to "provide such funds from its own resources, etc."; and that "such expenditures from its own resources" were to be reimbursed first as provided in the agreement. "Settlement" does not necessarily mean payment or satisfaction, though it may mean that; it frequently means adjustment or arrangement. The term "settlement" may be used in the sense of "payment," or it may be used in the sense of "adjustment" or "ascertainment," or it may be used in the sense of "adjustment" or "ascertainment of a balance between contending parties," depending upon the circumstances under which, and the connection in which, use of the term is made. In the term "ore settlements received," the word "settlement" was not used in the concept of "adjustment," "arrangement" or "ascertainment of a balance between contending parties," since all these are "made," not "received." "Payment," then, is the more appropriate equivalent of, and interchangeable with, the term "settlement." Hence, "ore settlements received" means "ore payments received," which excludes "Accounts Receivable." Thus, both par. VIII and par. XIV refer to "payment," either received or paid by Benguet.
According to the agreement, the 50-50 sharing should be on "net profits;" and "net profits" shall be computed "by deducting from gross income all operating expenses and all disbursements of any nature whatsoever as may be made in order to carry out the terms of the agreement." The term "gross profit" was not defined. In the accrual method of accounting "gross income" would include both "cash receipts" and "Accounts Receivable." But the term "gross income" does not carry a definite and inflexible meaning under all circumstances, and should be defined in such a way as to ascertain the sense in which the parties have used it in contracting. According to par. VIII the "division of net profits shall be based on the receipts and expenditures." The term "expenditures" we have already analyzed. As used, "receipts" means "money received." The same par. VIII uses the term "expenditures, advances and disbursements." "Disbursements" means "payment," while the word "advances" when used in a contract ordinarily means money furnished with an expectation that it shall be returned. 16 It is thus clear from par. VIII that in the computation of "net profits" (to be divided on the 90%-10% sharing arrangement) only "cash payments" received and "cash disbursements" made by Benguet were to be considered. On the presumption that the parties were consistent in the use of the term, the same meaning must be given to "net profits" as used in par. X, and "gross income," accordingly, must be equated with "cash receipts." The language used by the parties show their intention to compute Benguet's 50% share on the excess of actual receipts over disbursements, without considering "Accounts Receivable" and "Accounts Payable" as factors in the computation. Benguet then did not have a right to share in "Accounts Receivable," and, correspondingly, the Company did not have the liability to pay Benguet any part of that item. And a deduction cannot be accrued until an actual liability is incurred, even if payment has not been made.
Here we have to distinguish between (1) the method of accounting used by the Company in determining its net income for tax purposes; and (2) the method of computation agreed upon between the Company and Benguet in determining the amount of compensation that was to be paid by the former to the latter. The parties, being free to do so, had contracted that in the method of computing compensation the basis were "cash receipts" and "cash payments." Once determined in accordance with the stipulated bases and procedure, then the amount due Benguet for each month accrued at the end of that month, whether the Company had made payment or not (see par. XIV of the agreement). To make the Company deduct as an expense one-half of the "Accounts Receivable" would, in effect, be equivalent to giving Benguet a right which it did not have under the contract, and to substitute for the parties' choice a mode of computation of compensation not contemplated by them.
Since Benguet had no right to one-half of the "Accounts Receivable," the Company was correct in not accruing said one-half as a deduction. The Company was not using a hybrid method of accounting, but was consistent in its use of the accrual method of accounting.
In resume, the SC finds:
(1) that the Company was not using a "hybrid" method of accounting in the preparation of its income tax returns, but was consistent in its use of the accrual method of accounting;
Percentage of completion method
NIRC Sec 48 (Supra)
RR-2,
Sec 44 Long term contracts. – Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used herein the term “long-term” contracts mean building, installation or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon the following bases:
(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. In such case there should accompany the 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 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 CIR may permit or require an amended return.
(b) Gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of the completion.
When a taxpayer has filed his return in accordance with the method of accounting regularly employed by him in keeping his books and such method clearly reflects the income, he will not be required to change either of the methods above set forth. If a taxpayer desires to change his method of accounting in accordance with paragraphs (a) and (b) above, a statement showing the composition of all items appearing upon his balance sheet and used in connection with the method of accounting formerly employed by him, should accompany his return.
iv. Change of accounting period [Supra]
v. Installment Basis
gross profit
x installment paid = reportable income
contract price
vi. Allocation of income and deductions
Yutivo and Sons Hardware Co. v. CIR (1 SCRA 160)
Yutivo Sons Hardware Co. is a domestic corporation, organized under the laws of the Philippines, with principal office at 404 Dasmariñas St., Manila. Incorporated in 1916, it was engaged, prior to the last world war, in the importation and sale of hardware supplies and equipment. After the liberation, it resumed its business and until June of 1946 bought a number of cars and trucks from General Motors Overseas Corporation, an American corporation licensed to do business in the Philippines. As importer, GM paid sales tax prescribed by sections 184, 185 and 186 of the Tax Code on the basis of its selling price to Yutivo. Said tax being collected only once on original sales, Yutivo paid no further sales tax on its sales to the public.
On June 13, 1946, the Southern Motors, Inc. was organized to engaged in the business of selling cars, trucks and spare parts. Its shares were subscribed in 5 equal proportions by the descendants of the founders of Yutivo. When GM withdrew from the Philippines in the middle of 1947, the cars and trucks purchased by Yutivo from GM were sold by Yutivo to SM which, in turn, sold them to the public in the Visayas and Mindanao. GM appointed Yutivo as importer for the Visayas and Mindanao, and Yutivo continued its previous arrangement of selling exclusively to SM. In the same way that GM used to pay sales taxes based on its sales to Yutivo, the latter, as importer, paid sales tax prescribed on the basis of its selling price to SM, and since such sales tax, as already stated, is collected only once on original sales, SM paid no sales tax on its sales to the public.
Yutivo was investigated by the BIR and was assessed P1.8+M as deficiency sales tax plus surcharge covering the period from July 1, 1947 to December 31, 1949, claiming that the taxable sales were the retail sales by SM to the public and not the sales at wholesale made by Yutivo to the latter inasmuch as SM and Yutivo were one and the same corporation, the former being the subsidiary of the latter.
Yutivo disputed the assessment and thereafter a reinvestigation was made. The CIR redetermined that the aforementioned tax assessment was lawfully due the government and in addition assessed deficiency sales tax due from petitioner for the four quarters of 1950; the CIR’s last demand was in the total sum of P2.2+M.
The second assessment was contested by Yutivo before the CTA, alleging that there is no valid ground to disregard the corporate personality of SM and to hold that it is an adjunct of petitioner Yutivo; (2) that assuming the separate personality of SM may be disregarded, the sales tax already paid by Yutivo should first he deducted from the selling price of SM in computing the sales tax due on each vehicle; and (3) that the surcharge has been erroneously imposed by respondent. The CTA ruled in favor of CIR and ruled that the creation of SM is for Yutivo to evade taxes, as it is owned by and controlled by Yutivo and is a mere subsidiary, branch, adjunct conduit, instrumentality or alter ego of the latter.
ISSUE: Whether or not SM has a personality separate and distinct from Yutivo
HELD: YES. It is an elementary and fundamental principle of corporation law that a corporation is an entity separate and distinct from its stockholders and from other corporations to which it may be connected. However, "when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime," the law will regard the corporation as an association of persons, or in the case of two corporations merge them into one. When the corporation is the "mere alter ego or business conduit of a person, it may be disregarded." However, SM was not organized purposely as a tax evasion device. Moreover, it runs counter to the fact that there was no tax to evade. The intention to minimize taxes, when used in the context of fraud, must be proved to exist by clear and convincing evidence amounting to more than mere preponderance, and cannot be justified by a mere speculation. This is because fraud is never lightly to be presumed.
The SC however agree that SM was actually owned and controlled by petitioner as to make it a mere subsidiary or branch of the latter created for the purpose of selling the vehicles at retail and maintaining stores for spare parts as well as service repair shops.
Consideration of various other circumstances, especially when taken together, indicates that Yutivo treated SM merely as its department or adjunct. For one thing, the accounting system maintained by Yutivo shows that it maintained a high degree of control over SM accounts. All transactions between Yutivo and SM are recorded and effected by mere debit or credit entries against the reciprocal account maintained in their respective books of accounts and indicate the dependency of SM as branch upon Yutivo.
The SC also found meritorious the contention that the Tax Court erred in computing the alleged deficiency sales tax on the selling price of SM without previously deducting therefrom the sales tax due thereon. The sales tax provisions (secs. 184-186, Tax Code) impose a tax on original sales measured by "gross selling price" or "gross value in money." These terms, as interpreted by the respondent Collector, do not include the amount of the sales tax, if invoiced separately. Thus General Circular No. 431 of the Bureau of Internal Revenue dated July 29, 1939, which implements sections 184-186 of the Tax Code provides:
". . . 'Gross selling price' or 'gross value in money' of the articles sold, bartered, exchanged, or transferred as the term is used in the aforecited sections (sections 184, 185 and 186) of the National Internal Revenue Code, is the total amount of money or its equivalent which the purchaser pays to the vendor to receive or get the goods. However, if a manufacturer producer, or importer, in fixing the gross selling price of an article sold by him has included an amount intended to cover the sales tax in the gross selling price of the articles, the sales tax shall be based on the gross selling price less the amount intended to cover the tax, if the same is billed to the purchaser as a separate item.
General Circular No. 440 of the same Bureau reads:
"Amount intended to cover the tax must be billed as a separate item so as not to pay a tax on the tax. - On sales made after the third quarter of 1939, the amount intended to cover the sales tax must be billed to the purchaser as separate items in the invoices in order that the deduction thereof from the gross selling price may be allowed in the computation of the merchants' percentage tax on the sales. Unless billed to the purchaser as a separate item in the invoice, the amount intended to cover the sales tax shall be considered as part of the gross selling price of the articles sold, and deductions thereof will not be allowed." (Cited in Dalupan, Nat. Int. Rev. Code, Annoted, Vol. II, pp. 52-53.)
Yutivo complied with the above circulars on its sales to SM, and as separately billed, the sales taxes did not form part of the "gross selling price" as the measure of the tax. Since Yutivo has previously billed the sales tax separately in its sales invoices to SM. General Circulars Nos. 431 and 440 should be deemed to have been complied with.
Note: Sorry, I really can’t find the allocation of income and deductions part… this is the closest thing…
vii Networth Method
Perez v. CTA (103 Phil 1167) L-10507, May 30, 1958
Appeal by certiorari to review the decision of the Court of Tax Appeals in case B.T.A. 189, wherein petitioner was ordered to pay the sum of P41,547.77 as deficiency income taxes and surcharges corresponding to the years 1947, 1948, 1949 and 1950. This amount was arrived at on the basis of petitioner's increase in net worth. The three-year prescriptive period under section 51 (d) of the National Internal Revenue Code constitutes a limitation to the right of the government to enforce the collection of income taxes by summary proceedings of distraint and, levy, though it can proceed to recover the taxes due by instituting the corresponding civil action. The Collector concedes that the summary distraint and levy to collect the deficiency income taxes assessed against appellant for 1947, 1948 and 1949 was invalid. Nevertheless, the appeal of the taxpayer vested jurisdiction on the Court of Tax Appeals to review and determine his tax liability for the aforesaid period. On the application of the net worth method of determining taxable income, used by the collector and upheld by the court below, it must he explained that the method is based upon the general theory that money and other assets in excess of liabilities of a taxpayer (after an accurate and proper adjustment of non-deductible items) not accounted for by his income tax returns, leads to the inference that part of his income has not been reported. The authority to use this method in determining income is rooted in or stems from section 41 of the Internal Revenue Code of 1939 of the United States. No cogent reason is shown for deviating from this practice in the Philippines. In fact section 38 of the National Internal Revenue Code authorizes the application of the Net Worth Method in this jurisdiction.
The decision appealed from, requiring appellant to pay the sum of P41,547.77, is affirmed, with the sole modification that the Collector's resort to summary distraint to enforce the taxpayer's liability for 1947, 1948 and 1949 is declared improper and void.
Collector of Internal Revenue v. Reyes
L-11534, November 25, 1958
Appeal from the decision of the Court of Tax Appeals, ordering respondent-appelIant to pay the aggregate amount of P210,759.20, representing deficiency income tax and 50% surcharge corresponding to the taxable years 1946, 1947, 1948, and 1950.
Note: Sorry again but for some reason, this is the only thing written in the decision…
I. ESTATES AND TRUSTS
SEC. 60. Imposition of Tax. -
(A) Application of Tax. - The tax imposed by this Title upon individuals shall apply to the income of estates or of any kind of property held in trust, including:
(1) Income accumulated in trust for the benefit of unborn or unascertained person or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust;
(2) Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian of an infant which is to be held or distributed as the court may direct;
(3) Income received by estates of deceased persons during the period of administration or settlement of the estate; and
(4) Income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries or accumulated.
(B) Exception. - The tax imposed by this Title shall not apply to employee's trust which forms part of a pension, stock bonus or profit-sharing plan of an employer for the benefit of some or all of his employees (1) if contributions are made to the trust by such employer, or employees, or both for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, and (2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees: Provided, That any amount actually distributed to any employee or distributee shall be taxable to him in the year in which so distributed to the extent that it exceeds the amount contributed by such employee or distributee.
(C) Computation and Payment. -
(1) In General. - The tax shall be computed upon the taxable income of the estate or trust and shall be paid by the fiduciary, except as provided in Section 63 (relating to revocable trusts) and Section 64 (relating to income for the benefit of the grantor).
(2) Consolidation of Income of Two or More Trusts. - Where, in the case of two or more trusts, the creator of the trust in each instance is the same person, and the beneficiary in each instance is the same, the taxable income of all the trusts shall be consolidated and the tax provided in this Section computed on such consolidated income, and such proportion of said tax shall be assessed and collected from each trustee which the taxable income of the trust administered by him bears to the consolidated income of the several trusts.
SEC. 61. Taxable Income. - The taxable income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that:
(A) There shall be allowed as a deduction in computing the taxable income of the estate or trust the amount of the income of the estate or trust for the taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the taxable income of the beneficiaries, whether distributed to them or not. Any amount allowed as a deduction under this Subsection shall not be allowed as a deduction under Subsection (B) of this Section in the same or any succeeding taxable year.
(B) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the taxable income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir or beneficiary but the amount so allowed as a deduction shall be included in computing the taxable income of the legatee, heir or beneficiary.
(C) In the case of a trust administered in a foreign country, the deductions mentioned in Subsections (A) and (B) of this Section shall not be allowed: Provided, That the amount of any income included in the return of said trust shall not be included in computing the income of the beneficiaries.
SEC. 62. Exemption Allowed to Estates and Trusts. - For the purpose of the tax provided for in this Title, there shall be allowed an exemption of Twenty thousand pesos (P20,000) from the income of the estate or trust.
SEC. 63. Revocable trusts. - Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested (1) in the grantor either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, the income of such part of the trust shall be included in computing the taxable income of the grantor.
SEC. 64. Income for Benefit of Grantor.-
(A) Where any part of the income of a trust (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be held or accumulated for future distribution to the grantor, or (2) may, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor, or (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be applied to the payment of premiums upon policies of insurance on the life of the grantor, such part of the income of the trust shall be included in computing the taxable income of the grantor.
(B) As used in this Section, the term 'in the discretion of the grantor' means in the discretion of the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of the part of the income in question.
SEC. 65. Fiduciary Returns. - Guardians, trustees, executors, administrators, receivers, conservators and all persons or corporations, acting in any fiduciary capacity, shall render, in duplicate, a return of the income of the person, trust or estate for whom or which they act, and be subject to all the provisions of this Title, which apply to individuals in case such person, estate or trust has a gross income of Twenty thousand pesos (P20,000) or over during the taxable year. Such fiduciary or person filing the return for him or it, shall take oath that he has sufficient knowledge of the affairs of such person, trust or estate to enable him to make such return and that the same is, to the best of his knowledge and belief, true and correct, and be subject to all the provisions of this Title which apply to individuals: Provided, That a return made by or for one or two or more joint fiduciaries filed in the province where such fiduciaries reside; under such rules and regulations as the Secretary of Finance, upon recommendation of the Commissioner, shall prescribe, shall be a sufficient compliance with the requirements of this Section.
SEC. 66. Fiduciaries Indemnified Against Claims for Taxes Paid. - Trustees, executors, administrators and other fiduciaries are indemnified against the claims or demands of every beneficiary for all payments of taxes which they shall be required to make under the provisions of this Title, and they shall have credit for the amount of such payments against the beneficiary or principal in any accounting which they make as such trustees or other fiduciaries.
Sec. 207-213, RR-2
Sec. 207. Estates and Trusts. – "Fiduciary" is a term which applies to all persons or corporations that occupy positions of peculiar confidence toward others, such as trustees, executors, or administrators; and a fiduciary, for income tax purposes, is any person or corporation that holds in trust an estate of another persons or persons. In order that fiduciary relationship may exist, it is necessary that a legal trust be created.
In general, the income of a trust for the taxable year which is to be distributed to the beneficiaries must be returned by an will be taxed to the respective beneficiaries, but the income of a trust which is to be accumulated or held for future distribution, whether consisting of ordinary income or gain from the sale of assets included in the corpus of the trust, must be returned by and will be taxed to the trustee. Three exceptions to this general rule are found in the law: (1) in the case of revocable trusts (sec. 59); (2) in the case of a trust the income of which, in whole or in part, may be held or distributed for the benefit of the grantor (sec. 60); and (3) in the case of a trust administered in a foreign country (sec. 57c). in the first case, the income from such part of the trust estate title to which to which may be revested in the grantor should be included ion the grantor's return. In the second case, part of the income of the trust, which may be held or distributed for the benefit of the grantor, should be included in the grantor's return. In the third case, the trustee is not entitled to the deduction mentioned in subsections (a) and (b) of section 57 and the net income of the trust undiminished by any amounts distributed, paid or credited to beneficiaries will be taxed to the trustees; however, the income included in the return of the trustees is not to be included in computing the income of the beneficiaries.
Sec, 208. Consolidation of incomes of two or more trusts. – Section 56 (b) (2) expressly requires the consolidation of the income of two or more trusts where the creator of the trust in each instance is the same person and the beneficiary in each instance is the same. The tax due on the consolidated income sill be collected from the trustees in proportion to the net income of the respective trusts.
Sec. 209. Estates and trusts taxed to fiduciary. – In the case of a decedent's estate the settlement of which is the object of testamentary or intestate proceedings, the fiduciary, executor, or administrator is required to file an annual return for the estate up to the final settlement thereof. In the same manner, the fiduciary is required to file a yearly return covering the income of a trust, whether created by will or deed, for accumulation of income, whether for unascertained persons or persons with contingent interests or otherwise. In both cases the income of the estate or trust is taxed to the fiduciary. Where under the terms of a will or deed, the trustee may, in his discretion, distribute the income or accumulate it, the income is taxed to the trustee, irrespective of the exercise of his discretion. The imposition of the tax is not affected by the fact that an ultimate beneficiary may be a person exempt from tax.
Sec. 210. Estates and trusts taxed to beneficiaries. – In the case of (a) a trust the income of which is to be distributed annually or regularly; (b) an estate of a decedent the settlement of which is not the object of judicial testamentary or intestate proceedings; and (c) properties held under ownership or tenancy in common, the income is taxable directly to the beneficiary or beneficiaries. Each beneficiary must include in his return his distributive share of the net income of the trust, estate, or co-ownership. In the case of trusts which are in whole or in part subject to revocation by the grantor, or which are for the benefit of the grantor, the income of the trust is to be included in computing the net income of the grantor.
Sec. 211. Decedent's estate administration. – The "period of administration or settlement of the estate" is the period required by the executor or administrator to perform the ordinary duties pertaining to administration, in particular, the collection of assets and the payment of debts and legacies. Estates during the period of administration have but one beneficiary and that beneficiary is the estate.
No taxable income is realized from the passage of property to the executor or administrator on the death of the decedent, even though it may have appreciated in value since the decedent acquired it. In the event of delivery of property in kind to a legatee or distributee, no income is realized. Where, however, prior to the settlement of the estate, the executor or administrator sells property of a decedent's estate for more than the appraised value placed upon it at the death of the decedent, the excess is income, taxable to the estate. Where property is sold after the settlement of the estate by the devisee, legatee or heir at a price greater than the appraised value placed upon it at the time he inherited the property from the decedent, he is taxable individually on any profit derived. An allowance paid a widow or heir out of the corpus of the estate is not deductible from gross income.
Sec. 212. Liability for tax on estate or trusts. – Liability for payment of the tax attaches to the person of an executor or administrator up to and after the discharge, where prior to distribution and discharge he had notice of his tax obligations or failed to exercise due diligence in determining whether or not such obligations existed. Liability for the tax also follows the estate itself, and when the estate has been distributed, the heirs, devisees, legatees, and distributors may be requires to discharge the amount of the tax due and unpaid, to the extent of and in proportion to any share received. The same consideration apply to other trusts. Where the tax has been paid on the net income of an estate or trust by the fiduciary, the net income on which the tax is paid is free from tax when distributed to the beneficiaries.
Sec. 213. Exemption allowed to estate or trusts. – An estate or trust is allowed a personal exemption of P 1,800 (P3,000 under BP 135). Each beneficiary is entitled to but one personal exemption no matter from how many trusts he may receive income.
1. General Rule on Taxability: Fiduciary or Beneficiary
The following rules apply in computing and paying the income tax of an estate or trust:
(a) The taxable income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual. Special deduction is allowed to an estate or trust for any amount of income paid, credited or to be distributed to the beneficiaries.
(b) The exemption of an estate or trust is P20,000
(c) The income tax rates for individual taxpayers apply
(d) The ITR shall be filed by the executor or administrator or fiduciary if the gross income is P20,000 or more
(e) Where two or more trusts are created by the same grantor, and the beneficiary in each instance is the same person, the trustees should each make a separate return for each trust, but the CIR shall cause the income tax to be computed on the consolidated taxable income of the several trusts, allowing one exemption only of P20,000. The income tax computed on the consolidated taxable income shall be allocated between the several trusts in proportion to their respective taxable incomes. There shall be an income tax still due from each of the several trusts.
The tax imposed shall apply to the income of estates or of any kind of property held in trust, including—
(a) Income accumulated in trust for the benefit of unborn or unascertained person or persons with contingent interests, and income accumulated or held for future distribution under the terms of a will or trust
(b) Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian for an infant which is to be held or distributed as the court may direct
(c) Income received by estates of deceased persons during the period of administration or settlement of the estate
(d) Income which, in the discretion of the fiduciary, may either be distributed to the beneficiaries or accumulated
(e) Exceptions: The income taxis not imposed on employees' trust which forms part of a pension, stock bonus or profit sharing plan of an employer for the benefit of some or all of his employees (a) if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan; and (b) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for part of the corpus or income to (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of the employees. Any amount, however, actually distributed to any employee or distributee shall be taxable to him in the year in which so distributed to the extent that it exceeds the amount contributed by such employee or distributee.
2. Personal Exemption Allowed:
Ÿ There shall be allowed an exemption of P20,000 from the income of the estate or trust.
3. Decedent's Estate Administration; Revocable Trusts
The tax is imposed on the net income of the estate or trust computed in the same manner and on the same basis as in the case of an individual, except that—
(a) There shall be allowed as a deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by the guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the taxable income of the beneficiaries whether distributed to them or not.
(b) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in case of income which, in the discretion of the fiduciary, may either be distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the taxable income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir or beneficiary.
(c) These deductions do not apply to trusts administered in a foreign country, but the amount of any income included in the return of said trust shall not be included in computing the income of the beneficiaries.
Revocable trusts—Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, the income of such part of the trust shall not be included as taxable income on the part of the trust; it shall be included in computi9ng the taxable income of the grantor.
4. Income for Benefit of Grantor
The rules on revocable trust shall also apply to trust income for the benefit of the grantor. Thus, where any part of the income of a trust (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be held or accumulated for future distribution to the grantor; or (2) may, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be applied to the payment of the premiums upon policies of insurance on the life of the grantor, such part of the income of the trust shall be included in computing the taxable income of the grantor. The term "in the discretion of the grantor" means that of the grantor alone or in conjunctions with any person not having a substantial adverse interest in the disposition of the part of the income in question
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