(A). BUSINESS EXPENSES:
1. Illegal expenses are not deductible whether business is legal or illegal;
2. Legitimate expenses whether business is legal or illegal are deductible;
3. Capital expenditures are not deductible.
4. Ordinary means commonly incurred, necessary means appropriate and helpful to the taxpayer or intended to realize profit or to minimize loss;
5. Rentals on lease of property provided taxpayer does not acquire interest other than as a mere possessor, thus rentals on lease to own scheme are not deductible as they are capital expenditures already;
6. Real estate tax on the property leased and shouldered by the lessee is deductible expense on the part of the lessee BUT treated as taxable income on the part of the lessor;
7. Cost of improvements introduced by lessee in an ordinary asset are not deductible expense on the part of the lessee as these are capital investment on his part but maybe depreciated by the lessee;
8. Travel and transportation expenses or expenses while away from home incurred by employers and given to employees pursuant or trade or business when necessary and reasonable;
9. advertising expenses designed to stimulate the current sale of merchandise or use of services are deductible business expenses;
Examples of non-deductible business expenses:
1. compensation to public relations firm for services rendered in carrying on campaign to sell additional capital stock;
2. expenses relating to recapitalization and reorganization of corporation;
3. promotion or marketing expenses which are tantamount to purchase of goodwill;
4. bribes and kickbacks;
5. expenses for major repairs are not deductible but expenses for minor repairs are deductible;
6. personal and living expenses of the taxpayer as they are already allowed to claim for personal and additional exemptions;
7. advertising expenses designed to stimulate the future sale of merchandise or use of services as these are already considered as capital outlay;
Tax Benefit Rule: applies to
(1). Taxes claimed and allowed as deductions from gross income when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction;
(2). Bad debts claimed and allowed as deductions from gross income deducted but subsequently paid or recovered;
(3). Casualty losses deducted as such but later recovered;
(B). Taxes as deduction: ( income and estate tax)
Income Tax Estate Tax
Only taxes previously paid may be deducted (unpaid taxes can never be deducted)
Taxes which remain unpaid and
accruing until the time of death may be deducted from the gross estate
The taxes must be in connection with The taxes need not be in connection
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Page 62 of 77taxpayer‟s trade/business with decedent‟s trade or business
©. Bad Debts/Interest on Loans: ( income and estate tax)
Facts: X borrowed P100,000 from Y with 10% interest per annum. Total amount due is P110,000.
1. X paid Y P110 000.
Is it income on the part of Y? Only the 10% interest is income and taxable.
Can X deduct the 10% as interest on loan? Yes, provided that the loan was in relation to X‟s trade or business and subject further to the 33% limitation of the interest earnings of the said debtor;
2. X was not able to pay Y
Tax consequence: Y may declare the P110,000 as bad debt. It will be deductible if: (1) Y is engaged in trade/business and (2) the amount of bad debt is in relation to his trade or business. There are no tax consequences on X.
NOTE:There can be no deduction if X and Y are related to each other under Sec. 36(B), NIRC.
3. If X dies before paying his debt
Tax consequences: Y will have to file a claim during settlement of X‟s estate. It will be considered as a claim against the estate (CAE) and the entire amount may be deducted from the estate whether or not the loan is in connection with X‟s trade or business.
If the estate subsequently pays Y, is it income on his part? Only the interest is income and taxable.
What if prior to X‟s death, Y claimed the debt as a deduction (bad debt) and during the settlement of the estate, the court ordered that Y be paid the amount of the loan + interest? Apply the tax benefit rule.
4. If Y dies before X pays the debt.
Tax consequences:
a. The estate of Y should include the debt as part of Y‟s gross estate (a debt is an intangible personal property, hence should be included in the gross estate as provided under Section 85 of the NIRC)
b. The debt is an allowable deduction from the gross estate of Y as a claim against an insolvent person (CAIP)
If the estate of Y is allowed to deduct and X subsequently pays the debt + interest, the tax benefit rule cannot be applied. The payment will form part of the income of the estate subject to Net Income Tax. Remember that the estate is considered as a taxpayer.
(D). Casualty Loss: (income and estate tax)
The property lost (1) must not be compensated by insurance and (2) must be lost due to theft, robbery, embezzlement or other natural calamity . The loss is characterized by suddenness;
LOSSES IN INCOME TAX LOSSES IN ESTATE TAX Property lost must be in relation to
trade/business of taxpayer The property lost may or may not be in relation to trade/ business of deceased The loss must occur during the taxable period The loss may occur until 6 months after
death
NOTE: If the loss of property is previously deducted for income tax purposes, it cannot be deducted for estate tax purposes.
(E). DEPRECIATION
Depreciation is allowed only for taxpayers engaged in trade or business . Depreciation period for personal properties is five (5) years while the period for real properties ranges from 15 to 25 years depending on the economic or useful life of the asset.
Rules:
(1). A taxpayer who is purely earning purely compensation income is not allowed to claim depreciation as a deduction;
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Page 63 of 77(2). In case a taxpayer purchases an asset used in his trade or business, he is not entitled to claim the amount as deductible business expense considering that the same is a capital expenditure, but the taxpayer is allowed to claim depreciation of the asset as a deduction;
(3). Under a Build Operate Transfer agreement, the builder is allowed to depreciate the asset until the time of transfer and after transfer, the transferee can also claim depreciation of the asset based on the FMV of the property at the time of acquisition;
(4). Under a lease agreement with provision that all permanent improvements shall accrue to the lessor upon end of lease contract, the lessee who is engaged in t/b can claim depreciation of the improvements while the lessor can claim depreciation of the leased property excluding the improvements;
(5). Under a lease to own contract, the lessee who introduces the improvements shall have the right to claim depreciation of the improvements only while the lessor claims depreciation of the leased property only. The lessee cannot claim rentals for the lease as deductible business expenses because he acquires interest other than as a mere possessor of the property; Upon expiration of the contract, the lessee owns the property in full and lessor loses all rights over the property;
(F). PREMIUM ON HEALTH AND HOSPITALIZATION INSURANCE (PHHI)
This deduction is allowed to both taxpayers who are engaged in trade or business and those who are not engaged in trade or business in the amount of P 2,400.00 per family provide that the gross annual income does not exceed P 250,000.00.
(G). RESEARCH AND DEVELOPMENT
Expenses for research and development to be deductible from the gross income are limited to those which are related to the trade and business of the taxpayer.
(H). PERSONAL EXEMPTIONS/ADDITIONAL EXEMPTIONS (effective 01 July 2008)
Individual taxpayers regardless of status are entitled to P50,000 personal exemption. Additional exemption is at P 25,000.00 per child. Dependent pertains to a child of whatever kind and status, not more than 21 years of age, not married, not gainfully employed, chiefly dependent and living with the taxpayer, and regardless of age, if incapable of self-support by reason of physical or mental defect.
The husband shall be the proper claimant of the additional exemption for qualified dependent children unless he explicitly waives his right in favor of his wife in the Application for Registration (BIR Form No. 1902) or in the Certificate of Update of Exemption and of Employer‟s and Employee‟s Information (BIR Form No. 2305), whichever is applicable . Provided, however, that where the spouse of the employee is unemployed or is a non-resident citizen deriving income from foreign sources, the employed spouse within the Philippines shall be automatically entitled to claim the additional exemptions for children.
A NRA engaged in t/b in the Philippines is entitled to personal exemption subject to reciprocity rule.
(I). RECOGNITION OF GAINS/LOSSES IN EXCHANGES OF PROPERTY RULE:
(1). All gains and losses realized or incurred in exchanges of ordinary and capital assets are RECOGNIZED;
(2). In exchanges of capital assets with gains, the gains are not immediately included in the gross income but first charged against losses sustained in exchanges of capital assets. In recognizing the gains/losses, the taxpayer may apply the concept of holding period ( if held for more than one year- g/l recognized at 50%; if held for less than one year – g/l recognized at 50%); The holding period does not apply to a corporate taxpayer, thus, all gains/losses are recognized at 100%;
(3). After charging the gains against the losses and the taxpayer realizes Net capital gains, the same shall be included in the gross income of the taxpayer. After charging the gains against the losses and the taxpayer realizes net capital loss, then a taxpayer, other than a corporation, is allowed to carry over the same for three succeeding years (NCLCO);
(4). In exchanges of ordinary assets with gains, the gains are not immediately included in the gross income of the taxpayer but first charged against losses sustained in exchanges of ordinary assets. Holding period does not apply.
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Page 64 of 77After charging the gains versus the losses, if taxpayer realizes net ordinary gains, include the same in the gross income but if the taxpayer realizes net ordinary losses, no carry over will be allowed;
(5). Rule Nos. 1 to 4, are not applied in the following instances: (NO GAINS/ NO LOSS RECOGNIZED) (a). In case of valid merger and consolidation;
(b). In case a stockholder exchanges property for stocks in a corp wherein he, together with three others, acquires control over the corporation;
©. In wash sales of shares of stocks wherein the taxpayer sells shares of stocks wherein he realized gains, gains are always recognized but in case of loss sustained and 30 days prior to sale or 30 days after the sale, he acquires similar shares of stocks as the ones disposed of and for which sustained losses, ALL LOSSES WILL NOT RECOGNIZED;
(d). In sale of shares of stocks (capital in character), not traded thru local stock exchange, gains are always subject to either 5% or 10% FWT. If traded, gains or loss, the tax is % tax under Section 127 of the NIRC;
(e). In sale of real property located in the Philippines (capital in character), whether gains or loss, the taxpayer shall be subject to 6% CGT which is in the nature of FWT.
(H). COMPARISON BETWEEN NET CAPITAL LOSS CARRY OVER (NCLCO) AND NET OPERATING LOSS CARRY OVER ( NOLCO)
Rules:
(1). NOLCO refers to net operating loss carry over which is applicable only to a corporate taxpayer. If a corporate taxpayer has more deductions than gross income, the corporation sustains net operating losses which maybe carried over to the succeeding year only. Consequently, if during the succeeding year, the taxpayer realized taxable net income, this maybe reduced by the net operating loss carried over from the previous year;
(2). NCLCO refers to net capital loss carry over which is applicable only to individual taxpayers. This results from exchanges of capital assets wherein gains and losses have been recognized such that during the taxable period, after charging all capital losses from the capital gains, the taxpayer may either realize net capital gains (included in the gross income therefore taxable) OR net capital loss ( which maybe carried over for the succeeding 3 years);
(3). NOLCO pertains to expenses and deductions from gross income while NCLCO pertains to exchanges of capital assets;
(I). COMPARISON OF INCOME TAX, ESTATE TAX AND DONOR‟S TAX IN THE TREATMENT OF CAPITAL AND ORDINARY ASSETS [Please refer to Secs. 100, 85(B) and 24(D), NIRC]
Transfers for Insufficient Consideration:
Example: X has the following real properties all valued at P 3M each.
Within the Philippines: House and Lot Parlor
In the United States: Vacation house Parlor
Tax consequences if each real property was sold at P50,000:
Sale of House and Lot in Phils. - subject to CGT on sale of real property (6%) since it is a capital asset and CGT is tax on the presumed gains realized from the sale
Sale of Parlor located in the Phils. - subject to donor‟s tax or estate tax and not NIT since there is no income derived from the sale
Sale of Vacation house in the US - donor‟s tax or estate tax is imposed on the difference between the fair market value of P3M and the consideration of P 50,000
Sale of parlor in the US - donor‟s tax or estate tax is imposed on the difference between the fair market value of P 3M and the consideration of P 50,000
However, if the seller/taxpayer is an resident alien or a non-reside , the sale of real property outside the Philippines for insufficient consideration is not subject to NIT but still subject to donor‟s or estate tax taxable in the case of a resident alien;
Example: X has the following personal properties all valued at P1M each.
Within the Philippines: Car for personal use
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Page 65 of 77Car used for the parlor in the Phils.
In the United States: Car for personal use when on vacation abroad Car used for the parlor in the US
Tax consequence if each was sold at P50,000 - all will be subject to donor‟s tax
When property other than real property provided under Section 24(B) NIRC is transferred for insufficient consideration, the difference between the consideration and the fair market value at the time of transfer shall be considered as a donation subject to donor‟s tax (Section 100) or estate tax (Section 85g).
If the seller is a Non-Resident Alien at the time of transfer for insufficient consideration, only the property in the Philippines is taxable.
All kinds of donors except NRA are taxable for donations of property within and outside the Philippines.
Rules on determining taxability:
INCOME TAX (source of income determines taxability) Taxable
Income
RC NRC NA NRA
Income within the Phils.
Income outside the
Phils.
ESTATE AND DONOR‟S TAX (location of the property determines taxability)
RC NRC NA NRA
Located within the
Phils.
Located outside the Phils.
Transfers of property not subject to estate tax: (Section 87, NIRC) (A) The merger of usufruct in the owner of the naked title;
(B) The transmission or delivery of the inheritance or legacy by the fiduciary heir or legatee to the fideicommissary heir;
(C) The transmission from the first heir, legatee or donee in favor of another beneficiary, in accordance with the desire of the predecessor; and
(D) All bequests, devises, legacies or transfers to social welfare, cultural and charitable institutions, no part of the net income of which insures to the benefit of any individual: Provided, however, That not more than thirty percent (30%) of the said bequests, devises, legacies or transfers shall be used by such institutions for administration purposes;
Sale of Shares of Stocks:
Tax treatment if shares of stocks outside the Philippines are sold cheap and seller is NRA, do we impose CGT on shares of stocks outside the Philippines? Unfortunately, that is missing in the law.
Correlation with Sec. 85(B) NIRC:
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Page 66 of 77If the transfer for insufficient consideration is at the same time in contemplation of death in the nature of a revocable transfer, or property passing under a general power of attorney, CGT and donor‟s tax are not imposed. We impose estate tax.
Please take note that the transfer occurs during the lifetime of the transferor.
What happens if the donor‟s tax has been paid and transferor dies later on?
The payment shall be treated as part of the estate.
Upon death, if it is determined that the property was transferred for insufficient consideration and in contemplation of death, it shall be subject to estate tax.
Situs of Tax on Intangible Personal Property (from point of view of income, estate and donor‟s taxes) Income Tax:
General Rule: Mobilia sequuntur personam (movables follow the person)
Exceptions: 1. Wells Fargo Bank v. CIR (70 Phil. 325) – shares of stock are also taxable in the situs of their actual location
2. When the law itself provides for a different situs Example: Section 104, NIRC