Income and Income Taxation

A. Income – all wealth that flows into the taxpayer other than as mere return of capital

a.1. Income v. Capital

• capital is fund while income is flow
• capital is wealth while income is service of wealth
• capital is the tree while income is the fruit
• return of capital is not subject to income tax while income is subject to income tax

a.2. Income Tax Systems adopted in the Philippines

• Global Tax System – all items of income earned during a taxable period is paid under a single set of income tax rate
• Schedular Tax System – different types of incomes are subject to different sets of graduated or flat income tax rates, thus requiring separate tax returns; tax is computed on a per return or per schedule basis
• Semi-Schedular or Semi-Global Tax System – the compensation income, business or professional income, capital gain and passive income not subject to final tax, and other income are added together to arrive at the gross income, and after deducting the sum of allowable deductions from business or professional income, capital gain and passive income not subject to final tax, and other income, in the case of corporations, as well as personal and additional exemptions, in the case of individual taxpayers, the taxable income is subjected to one set of graduated tax rates; method of taxation under the NIRC

a.3. Characteristics of Philippine Income Tax Law

• Direct – tax is imposed on the income-earner
• Progressive – tax base increases as the tax rate increases
• Comprehensive - the Philippines adopts the citizenship principle, residence principle, and the source principle
• Semi-schedular – more schedular with respect to individual taxpayers but more global treatment on corporations
• American origin

a.4. Criteria of Imposing Income Tax

• Citizenship Principle
• Residence Principle
• Source Principle

a.5. Test for Determination that Income is Earned (and therefore taxable)

• There is income, gain or profit
• The income, gain or profit is received, realized, or accrued during the taxable year; and
• The income, gain or profit is not exempt from income tax

a.6. Taxable Income defined – the pertinent items of gross income specified in this Code, less the deductions and/or personal and additional exemptions, if any, authorized for such types of income by this Code or other special laws

NOTA BENE: Capital contribution is capital investment and therefore not income as contemplated by the NIRC. Partnership contribution given by a partner to a general partnership fund is another form of capital investment, not part of the taxable income.

B. Persons Subject to Income Tax

b.1. Taxpayer defined – person subject to tax

b.2. Person defined – individual, estate, corporation, or trust

b.3. Classification of Taxpayers

Individuals
1. Citizens

Resident Citizens – all sources inside and outside; net income.

• Engaged in trade or business or profession – entitled to deductions on his business income and personal and additional exemptions
• Purely compensation income earners – not entitled to deductions; only personal and additional exemptions

Non-resident Citizens – all sources inside

2. Aliens – gross income
Resident Aliens – all sources inside
Non-resident Aliens – all sources inside

• Engaged in trade or business in the Philippines – 180 days
• Not engaged in trade or business in the Philippines

NOTA BENE: For purposes of income tax, an overseas contract worker who is a Filipino citizen and deriving income from abroad is deemed a non-resident citizen and therefore taxed only on income sourced within the Philippines. However, in order to qualify as a non-resident citizen, the worker must be physically present abroad most of the time or at least 183 days (continuous or not) during the calendar year.

ADDENDUM: Certain aliens are entitled to preferential tax rates if they are employed by: (1) regional or area headquarters and regional operating headquarters of multinational companies in the Philippines; (2) offshore banking units established in the Philippines; and (3) foreign service-contractor or sub-contractor engaged in petroleum operations in the Philippines. This is provided that their Filipino counterparts are also afforded the same preferential tax rate. These Filipinos have the option to be taxed under the preferential tax rate or under the graduated tax rates.

3. Estates and Trusts – entitled to personal exemption of P20,000

NOTA BENE: Co-ownership is considered a separate taxable entity like estates and trusts. The co-owners are subject to income tax on their individual distributive share only. However, if the co-owners, after partition of property invest the income of co-ownership in any income-producing properties, this constitutes an unregistered partnership and subject to income tax as a corporation. But if it is merely an isolated transaction, then it cannot be said that a partnership has been formed.

Corporations – net taxable income
Domestic – all sources inside and outside the Philippines

Foreign
a. Resident Foreign Corporations – engaged in trade or business in the Philippines; ex. a Philippine branch of a foreign corporation

ENTITLED TO PREFERENTIAL TAX RATES (Engaged in trade or business in the Philippines):

1. regional operating headquarters of multinational corporations in the Philippines
2. offshore banking units and foreign currency deposit units of Philippine branches of foreign banks international air carriers whether online or offline and international shipping lines
3. foreign service-contractors or sub-contractors engaged in petroleum operations in the Philippines
4. registered enterprises with the PEZA and SBMA

b. Non-resident Foreign Corporations – not engaged in trade or business in the Philippines; gross income from sources within the Philippines paid to NRFC subject to final withholding tax (withheld by payor)

3. Partnerships
Taxable Partnership – treated as corporations

NOTA BENE: The “principle of constructive receipt of income” is applied in partnerships. This means that the partners are taxable on their distributive shares in the taxable year that the profit was made, regardless of whether or not such has already been distributed and received by the partners.

Exempt Partnership

• General professional partnership – partnerships formed by persons for the sole purpose of exercising their common profession; exempt from income tax but must still file an income tax return - the partners are the ones liable for income tax based on their respective distributive shares
• Joint venture or consortium undertaking construction activity, or engaged in petroleum operations with operating contract with the government

QUESTIONS:
(1) Why is it important to distinguish between resident and non-resident citizens?
(2) Why is it important to distinguish between a person engaged in trade or business or exercises of profession and salaried employees?
(3) What are the three types of non-resident citizens?

b.4. General Principles of Income Taxation

C. Gross Income

Gross Income – income, gain or profit subject to tax, including compensation for personal and professional services, business income, profits and income derived from any source, UNLESS exempt from tax under the Constitution, tax treaty or statute, and other or miscellaneous income of the corporation such as gain from non-recurring sale of equipment

Net Income – gross income less statutory deductions and exemptions; taxable income

Taxable Year – for individual taxpayers, period is twelve months ending Dec. 31 of every year; corporations are taxed on a fiscal year basis

c.1. Sources of Income

Gross Income from Sources within the Philippines (Sec. 42, NIRC)

1. Interests – derived from sources within the Philippines, and interests on bonds, notes or other interest-bearing obligation of residents, corporate or otherwise; residence of the debtor
2. Dividends – from a) domestic corporations; and b) foreign corporations, UNLESS less than 50% of the gross income of FC for the 30-year period ending with the close of its taxable year preceding the declaration of dividends was derived from sources within the Philippines; residence of the corporation paying dividend
3. Services – compensation for labor or personal services performed in the Philippines; place of performance of the service
4. Rentals and Royalties – property located in the Philippines
5. Sale of Real Property – property located in the Philippines
6. Sale of Personal Property – if purchased in the Philippines and sold abroad or vice versa; includes gains from sale of shares of stock of a domestic corporation, regardless of where the shares were sold

c.2. Gross Income in General

Items of Gross Income (Sec. 32, NIRC) (code: C G2IP3 R2AD)

1. Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions and similar items;
2. Gross income derived from the conduct of trade or business or the exercise of a profession;
3. Gains derived from dealings in property;
4. Interests;
5. Pensions;
6. Prizes and winnings;
7. Partner’s distributive share from the net income of a GPP;
8. Rents
9. Royalties
10. Annuities; and
11. Dividends

c.2.1. COMPENSATION FOR SERVICES (Sec. 78, NIRC)

Compensation – all remuneration for services performed by an employee for his employer under an employer-employee relationship, unless specifically excluded

Compensation Income – all remuneration for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash

Q: What items are not included as compensation income?
A: Compensation shall not include remuneration paid (1) for agricultural labor paid entirely in products of the farm where the labor is performed; or (2) for domestic service in a private home; or (3) for casual labor not in the course of the employer’s trade or business; or (4) for services by a citizen or resident of the Philippines for a foreign government or an international organization.

Q: Who is liable to pay compensation income?
A: As a general rule, the income recipient is the person liable to pay the income tax. But for convenience, the law mandates that employers withhold the tax upon payment of the compensation income so that employees do not pay the tax at the end of the year but merely file a return, the tax liability having already been withheld.

c.2.2. FRINGE BENEFITS (Sec. 33, NIRC)
- although considered as part of “wages,” fringe benefits are taxed differently
- not subject to compensation income tax, but fringe benefit tax

Fringe Benefits – any good, service or other benefit furnished or granted in case or in kind by an employer to an individual employee (except rank and file employees), such as, but not limited to, the following: (code: HEV HIM HEEL)

1. housing
2. expense account
3. vehicle of any kind
4. household personnels, such as maid, driver and others
5. interest on loan for less than market rate to the extent of the difference between the market rate and the actual rate granted
6. membership fees, dues and other expenses paid by employer for the employee in social or athletic clubs or other similar organizations
7. holiday and vacation expenses
8. expenses for foreign travel
9. educational assistance to employee’s dependents
10. life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows

CIR v. CA, 203 SCRA 72

FACTS:

Efren Castaneda retired from the government service as Revenue Attache in the Philippine Embassy in London, England, under the provisions of Sec. 12(c), CA 186. Among the retirement benefits he received is terminal leave pay. The CIR withheld P12,557.13 of the terminal leave pay, alleging that it represented income tax.

ISSUE: W/N terminal leave pay is subject to withholding (income) tax

HELD: The Court has already ruled that the terminal leave pay received by a government official or employee is not subject to withholding (income) tax. The rationale behind the employee’s entitlement to an exemption from withholding (income) tax on his terminal leave pay is as follows:

“…commutation of leave credits, more commonly known as terminal leave, is applied for by an officer or employee who retires, resigns or is separated from the service through no fault of his own. In the exercise of sound personnel policy, the Government encourages unused leaves to be accumulated. The Government recognizes that for most public servants, retirement pay is always less generous if not meager and scrimpy. A modest nest egg which the senior citizen may look forward to is thus avoided. Terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits.”

In fine, not being part of the gross salary or income of a government official or employee but a retirement benefit, terminal leave pay is not subject to income tax.

Q: Why would an employer give fringe benefits instead of increasing the wages of employees?
A: Wage of an employee is used as basis for retirement, separation pay, etc. while fringe benefits are generally not considered as part of the employee’s wage. Moreover, fringe benefits may be reported by the employer as business expense and hence he is allowed to deduct it from his gross income.

- granted to managerial and supervisory employees; subject to fringe benefit tax (32%), not income tax

- if granted to rank-and-file employees, they are considered as part of their wages (compensation for services) and part of their gross income, subject to income tax

Q: What fringe benefits are exempted from fringe benefit tax?
A: (1) Those exempted under the law; (2) those contributions made by the employer for the benefit of the employee to retirement, insurance and hospitalization benefit plan; (3) those given to rank-and-file employees (subject to income tax instead); (4) de minimis benefits (also exempted from income tax); and (5) those given for the convenience of the employer.

Q: What are de minimis benefits?
A: De minimis benefits are benefits given in cash or in kind to employees (whether managerial, supervisory or rank-and-file) but are not subject to fringe benefit tax or considered part of compensation income because of their small amounts. These are:

(1) Housing allowance – within 50-meter radius of the workplace
(2) Motor vehicle – purchased by employer for the employee
(3) Expense account – for the employer’s business
(4) Loans interest – less than 12% interest
(5) Membership fees and dues in social and athletic clubs or other similar organizations
(6) Expenses for travel – average of $300; business or economy class plane ticket
(7) Educational assistance for employee’s dependents – if it is the subject of a contract between the employee and employer, then not subject to fringe benefit tax
(8) Insurance premium paid by employer for employee – group insurance

NOTA BENE: If the benefits, including facilities or privileges, are furnished by the employer to the employee for the benefit of the employer, they are not considered income and are not subject to income tax.


c.2.3. GROSS INCOME FROM BUSINESS

Business Income – generally comes from sales of goods, properties or services;

(1) Manufacturing, merchandising and mining
- total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources
- beginning inventory + purchases + ending inventory = cost of goods sold
(2) Long-Term Contracts
- building, installation or construction contracts covering a period in excess of one year

Q: What are the two methods of accounting used to compute taxes on long term contracts? Explain.
A: (1) Completed Contract Method – taxable in the year the construction is completed; (2) Percentage of Completion Method – as used by the NIRC; [(contract price x percentage of completion in a given tax year) – (cost of construction)] – income tax paid = taxable income for that year. In effect, the contract is taxed for every year for the entire duration of the contract.

(3) Professional Income
- fees received by professionals from practice of profession; no employer-employee relationship
- distinguish from compensation income: deductions are allowed in professional income
- in the nature of a business

(4) Gross Income from Farming
- paid on cash basis (amount of cash received from the sale of livestock raised in the farm) or crop basis
- inventory value end + sales of livestock and farm products + miscellaneous receipts from rents of machinery – beginning inventory - livestock and farm products raised in the farm – livestock and farm products in previous year + cost of livestock purchased during the year = net income

(5) Lease of Real Property
- rental income from lease of property is treated as business income of the lessor (subject allowable deductions)

c.2.4. GAINS DERIVED FROM DEALINGS IN PROPERTY

• Sale of patents and copyright
• Sale of good will
• Sales or exchanges of real property - subject to capital gains tax based on the FMV

c.2.5. Interest Income

Interest – payment for the use of money; subject to final tax and normal income tax; passive investment income

Q: What are the guidelines to consider in taxing interest income?
A: First, determine whether it is taxable in the Philippines (source rules apply). If so, what kind of income tax and what rate of tax shall apply to it?

Deposit Substitutes – an alternative form of obtaining funds from the public, other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower’s own account, for the purpose of relending or purchasing the receivables and other obligations, or financing their own needs or the needs of their agent or dealer; e.g. promissory notes; subject to 20% final withholding tax (as with other loans)

Foreign Currency Deposits – with an offshore banking unit in the Philippines, subject to 7.5% final withholding tax

Long-term Deposits – five years or more; individuals (citizens, resident aliens and non-resident aliens engaged in trade or business in the Philippines) are exempt from income tax, provided that the long-term deposit is evidenced by a certificate in the form prescribed by the BSP and provided further that the taxpayer does not pre-terminate the deposit. In case of pre-termination, income tax shall be imposed on the entire income.

CIR v. Mitsubishi, G.R. No. L-54908, Jan. 22, 1990

FACTS:

Atlas entered into a Loan and Sales Contract with Mitsubishi for the installation of a new concentrator for copper production. Atlas, in turn, undertook to sell to Mitsubishi all the copper concentrates produced from said machine for a period of 15 years. To provide Atlas the loan money needed, Mitsubishi borrowed from a consortium of Japanese banks as well as Eximbank.

Pursuant to the contract, Atlas made interest payments to Mitsubishi for the years 1974 and 1975, the corresponding 15% tax thereon withheld pursuant to Sec. 24(b)(1) and Sec. 53(b)(2) of the NIRC, and duly remitted to the Government.

On March 5, 1976, Atlas and Mitsubishi applied for tax credit to be applied against their existing and future tax liabilities. But on Aug. 27, 1976, Mitsubishi executed a waiver and disclaimer of its interest in the claim for tax credit in favor of Atlas. Thus, Atlas filed a petition grounded on the claim that Mitsubishi was a mere agent of Eximbank, which is a financing institution owned and controlled by the Japanese Government. Atlas claimed that because of Eximbank’s governmental status, it is exempt from paying tax on the interest payments on the loan.

ISSUE: W/N the interest income from the loans extended to Atlas by Mitsubishi is excludible from gross income taxation pursuant to Sec. 29(b)(7)(A) of the tax code and, therefore, exempt from withholding tax

HELD:

The loan and sales contract between Mitsubishi and Atlas does not contain any direct or inferential reference to Eximbank whatsoever. The agreement is strictly between Mitsubishi as creditor in the contract of loan and Atlas as the seller of the copper concentrates. Surely, Eximbank had nothing to do with the sale of the copper concentrates since all that Mitsubishi stated in its loan application with the former was that the amount being procured would be used as a loan to and in consideration for importing copper concentrates from Atlas. There was no contract of agency established.

The contract between Eximbank and Mitsubishi is entirely different. It is complete in itself, does not appear to be suppletory or collateral to another contract and is, therefore, not to be distorted by other considerations aliunde.

The allegation that the interest paid by Atlas was remitted in full by Mitsubishi to Eximbank, assuming the truth thereof, is too tenuous and conjectural to support the proposition that Mitsubishi is a mere conduit. Furthermore, the remittance of the interest payments may also be logically viewed as an arrangement in paying Mitsubishi’s obligation to Eximbank. Whatever arrangement was agreed upon by Eximbank and Mitsubishi as to the manner or procedure for the payment of the latter’s obligation is their own concern. It should also be noted that Eximbank’s loan to Mitsubishi imposes interest at a rate of 75% per annum, while Mitsubishi’s contract with Atlas merely states that the “interest on the amount of the loan shall be the actual cost beginning from and including other dates of releases against loan.”

Laws granting exemption from tax are construed strictissimi juris against the taxpayer and liberally in favor of the taxing power. Taxation is the rule and exemption is the exception. The burden of proof rests upon the party claiming exemption to prove that it is in fact covered by the exemption so claimed. This CIR failed to discharge. Significantly, private respondents (Mitubishi and Atlas) are not even among the entities which, under Sec. 29(b)(7)(A) are entitled to exemption.

c.2.6. Prizes and Winnings
- prizes less than P10,000 are not subject to 20% final withholding tax but only to normal income tax
- winnings, regardless of amount, are subject to 20% final withholding tax, EXCEPT PCSO and lotto winnings

2 KINDS (excluded):

1. In recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only if: a) the recipient was selected without any action on his part to enter the contest or proceeding; and b) the recipient is not required to render substantial future service as a condition to receiving the prize or award
2. In sports competition – granted to athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned by their national sports association (accredited by the Philippine Olympic Committee)

c.2.7. Rental Income
- passive income and subject to normal income tax
- rental income from lease of property is treated as business income of the lessor and entitles him to allowable deductions

Q: What constitutes rent income?
A: (1) Real property tax – borne by the lessor but if shouldered by lessee, then it is rent income of the lessor; (2) advance payment – if consumable, then it is taxable as rent income in the year it is received (provided that: in case of pre-termination, it is taxable as rent income in the year it is pre-terminated); (3) rent in cash; and (4) leasehold improvement.

- advance payment is in the form of security deposit for faithful performance of the obligation and if there is no breach, then it is not taxable as rent income of the lessor since the amount shall be returned to the lessee at the end of the lease

Q: How are leasehold improvements taxed?
A: There are two methods used at the option of the taxpayer: (1) Outright Method – taxed at the time of completion, based on the market value of the construction; and (2) Spread-Out Method – spread over the life of the lease the estimated depreciated value of the construction at termination of the lease and report as income for each year of the lease an aliquot part thereof. This applies when a building is erected by a lessee in the leased premises in the pursuance of an agreement with the lessor that the building becomes the property of the lessor at the end of the lease.

ESTIMATED DEPRECIATED VALUE (book value) = cost – accumulated depreciation
ACCUMULATED DEPRECIATION = cost / estimated useful life

c.2.8. Royalty Income

(1) Royalty Paid by a Domestic Corporation
a. To a C, RA, NRA engaged, DC, RFC: 20% final withholding tax, except royalty on books, other literary works and musical compositions which are subject to 10% final tax
b. To a NRA not engaged: 25% final withholding tax, unless a lower tax rate is allowed
c. To a NRFC: 32% final withholding tax, unless a lower rate is allowed

(2) Royalty Paid by a Foreign Corporation
a. To a RC, DC: graduated rates of tax ranging from 5% to 32% (RC) or at 32% (DC)
b. To a NRC, A, FC: exempt


c.2.9. Annuities
- including insurance policies
- any excess of the return of premiums is taxable
- return of insurance premiums are not taxable because they are considered as return of capital and not income

Annuities – payments to the annuitant after a certain period (maturity) has lapsed

NOTA BENE: Corporate sinking funds, which are used by corporations as a form of trust fund or insurance fund, are not deductible as business expense since they are not considered as an ordinary expense. They are part of the taxable income of the corporation.

c.2.10. Dividend Income (Sec. 73, NIRC)

Dividend – any distribution made by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, whether in money or in other property
- corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time; GR: included in the gross income of shareholder

KINDS:

1. Cash Dividend – disbursement to the stockholder of the accumulated earnings of a corporation; subject to income tax
2. Property Dividend – dividend payable in property, which may be investments in shares of stocks of a corporation, or real property, or some other property owned by the corporation, paying the dividend; subject to income tax
3. Stock Dividend – dividend payable in the shares of stock of the corporation declaring such stock dividend; generally income tax exempt because it represents capital; in a loose sense, it is unrealized gain and cannot be subjected to income tax until that gain has been realized

- EXCEPTION: the redemption or cancellation of stock dividends, depending on the “time” and “manner” it was made, is essentially equivalent to a distribution of taxable dividends, making the proceeds thereof “taxable income” to the extent it represents profits (see CIR v. A. Soriano Corp., G.R. No. 108576, Jan. 20, 1999)

PROPERTY DIVIDEND v. STOCK DIVIDEND

• PD declared by one corporation is actually shares of stock of another corporation to which the corporation paying the dividend has investments and is shown as assets in its balance sheet. SD is a dividend payable in the shares of stock of the corporation declaring such stock dividend.
• PD may be investments in shares of stocks or real property. SD is merely a certificate of stock which evidences the interest of the stockholder in the increased capital of the corporation.

CASH DIVIDEND v. STOCK DIVIDEND

• As to manner of disbursement: CD is disbursement to the stockholder of the accumulated earnings, and the corporation parts irrevocably with al interest therein. SD involves no disbursement, and the corporation parts with nothing to the stockholders who receive, not an actual dividend but a certificate of stock.
• As to ownership/execution: When CD is declared and paid to the stockholders and such cash becomes the absolute property of the stockholders and cannot be reached by creditors of the corporation in the absence of fraud. SD, still being the property of the corporation and not of the stockholder, may be reached by an execution against the corporation and may be sold as a part of the corporate property.
• As to taxability: CD is subject to income tax. SD is generally not subject to income tax.

CIR v. Wander Philippines, Inc. 160 SCRA 573

FACTS:

Wander, a domestic corporation, is a wholly-owned subsidiary of Glaro, a Swiss corporation not engaged in trade or business in the Philippines. Twice, BIR withheld 35% withholding tax on the dividends paid to Glaro by Wander. Later, Wander filed a claim for refund and/or tax credit, contending that it is liable only to 15% withholding tax in accordance with Sec. 24(b)(1) of the tax code.

ISSUE: W/N Wander is entitled to the preferential rate of 15% withholding tax on dividends declared and remitted to its parent corporation, Glaro

HELD:

Is Wander the proper party to claim the refund?

Wander, first and foremost, is a wholly-owned subsidiary of Glaro. The fact that it became a withholding agent of the government which was not by choice but by compulsion cannot by any stretch of the imagination be considered as an abdication of its responsibility to its mother company. Therefore, as the Philippine counterpart, Wander is the proper entity who should file for refund or credit of overpaid withholding tax on dividends paid or remitted by Glaro.

Does Switzerland allow as tax credit the “deemed paid” 20% Philippine Tax on such dividends?

Under Sec. 24(b)(1) of the tax code, the tax shall be 15% of the dividends received, subject to the condition that the country in which the non-resident foreign corporation is domiciled shall allow a credit against the tax due from the non-resident foreign corporation taxes deemed to have been paid in the Philippines equivalent to 20% which represents the difference between the regular tax (35%) on corporations and the tax (15%) dividends.

In the case, the fact that Switzerland did not impose any tax on the dividends received by Glaro from the Philippines should be considered as a full satisfaction of the given condition.

Marubeni Corp. v. CIR, G.R. No. 76573, March 7, 1990

FACTS:

AG&P of Manila has been paying cash dividends and withheld 10% final dividend tax thereon to Marubeni Corporation of Japan. AG&P, as withholding agent, directly remitted cash dividends to Marubeni’s head office in Tokyo, not only of the 10% final dividend tax but also of the withheld 15% profit remittance tax based on the remittable amount after deducting the final withholding tax of 10%.

Marubeni is claiming for refund or tax credit, alleging that the dividends remitted were not subject to the 15% profit remittance tax as they are not income arising from sources within the Philippines. CIR denied the claim on the ground that since Marubeni is a non-resident foreign corporation, it is nevertheless subject to 25% tax pursuant to Art. 10(2) of the Philippines-Japan Tax Treaty.

Marubeni now claims that it is a resident foreign corporation because of its principal-agent relationship with its Philippine Branch and, therefore, subject only to 10% intercorporate final tax on dividends.

ISSUE: W/N Marubeni is a resident or a non-resident foreign corporation

HELD:

The general rule is that a foreign corporation is the same juridical entity as its branch office, so that it is understood that the branch becomes its agent in the Philippines. However, when the foreign corporation transacts business in the Philippines independently of its branch, the principal-agent relationship is set aside. The transaction becomes one of the foreign corporation, not of the branch. Consequently, the taxpayer is the foreign corporation, not the branch or the resident foreign corporation. Corollarily, if the business transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign corporation.

In other words, Marubeni cannot now avail itself of the lower tax rate of 10% by pushing its principal-agent relationship with the Philippine branch (and hence claim the increments as ordinary consequences of its trade or business in the Philippines) when it has made this independent investment attributable only to the head office. Marubeni Japan and Marubeni Philippines are separate and distinct income taxpayers.

Q: What is the tax-sparing rule?
A: This is otherwise known as the “tax sparing credit.” Under this rule, the foreign taxes paid by the non-resident foreign corporation are deemed paid and deducted (in short, credited) from the domestic taxes that would have been paid by that corporation. This rule only applies if the foreign country likewise provides the same tax sparing credit to the Philippines under a treaty.

Q: What are the rules on taxation of dividends?
A: (1) From DC to C or RA – 10% final withholding tax; (2) From DC to NRAeB – 20% final withholding tax; (3) DC to NRAneB – 25% final withholding tax; (4) DC to DC or RFC – exempt; (4) DC to NRFC – 15% final withholding tax


c.2.11. Other Income

(1) Income from whatever source
- all income not expressly exempted within the class of taxable income under our laws, irrespective of the voluntary or involuntary action of the taxpayer in producing the gains

(2) Liquidating dividends
- distributions to shareholders after dissolution and liquidation; they are returns of the capital contributions
- 2 VIEWS: (1) any excess of the original contributions are subject to normal income tax; (2) the contributions are capital assets and subject to capital gains tax

(3) Tax refund
- under the “Tax Benefit Rule,” if there is a tax benefit (i.e., the tax liability of the taxpayer is reduced), then the tax refund shall form part of the gross income in the year that it is received

(4) Forgiveness of indebtedness
- if purely out of liberality of the creditor, then it is in the nature of a gift and subject to donor’s tax not income tax
- if actually made because of some service performed, then it is compensation for service