PART I
A.1.
On October 5, 2016, the Bureau of Internal Revenue (BIR) sent KLM Corp. a Final Assessment Notice (FAN), stating that after its audit pursuant to a Letter of Authority duly issued thereof, KLM Corp. had deficiency value-added and withholding taxes. Subsequently, a warrant of distraint and/or levy was issued against KLM Corp. KLM Corp. opposed the actions of the BIR on the ground that it was not accorded due process because it did not even receive a Preliminary Assessment Notice (PAN) after the BIR’s investigation, which the BIR admitted.
a) Distinguish a PAN from a FAN. (2%)
SUGGESTED ANSWER:
The following are the distinctions between a PAN and FAN:
1. It is mandatory that a Notice of Informal Conference precedes the issuance of a PAN while a PAN must precede the issuance of a FAN, except in certain specific instances. (Revenue Regulation (RR) No. 18-2013; Section 228, National Internal Revenue Code of 1997, as amended (NIRC))
2. The reply to a PAN must be filed within fifteen (15) days from receipt while the protest to a FAN must be filed within thirty (30) days from receipt. (RR No. 12-99; Section 228, NIRC).
3. A taxpayer does not have to do anything after the BIR’s rejection of the taxpayer’s reply to a PAN while the denial of a protest against a FAN should be appealed by the taxpayer to the Court of Tax Appeals (CTA) Division. (RR No. 12-99; Section 228, NIRC).
b) Are the deficiency tax assessment and warrant of distraint and/or levy issued against KLM Corp. valid? Explain. (3%)
SUGGESTED ANSWER:
No. Both the deficiency tax assessment and the warrant issued are invalid. The deficiency tax assessment issued against KLM Corp. is invalid due to the absence of a PAN, which is required by law for the validity of the assessment. (Section 228, NIRC). Sending a PAN to the taxpayer to inform him of the assessment made is but a part of the “due process requirement in the issuance of a deficiency tax assessment,” the absence of which renders nugatory any assessment made by the tax authorities [Commissioner of Internal Revenue v. Metro Star Superama, Inc., G.R. No. 185371, December 8, 2010].
The warrant of distraint and/or levy cannot be issued to enforce an invalid assessment. An assessment is a preliminary step for the collection of taxes. If the preliminary step in the collection process is invalid, the entire collection process is also invalid which includes the warrant issued.
A.2.
For purposes of value-added tax, define, explain or distinguish the following terms:
a) Input tax and output tax (3%)
SUGGESTED ANSWER:
Input tax means the VAT due on or paid by a VAT-registered person on importation of goods or local purchases of goods, properties, or services, including lease or use of properties. It includes presumptive input tax and transitional input tax.
Output tax refers to the VAT billed by a VAT-registered or VAT- registrable seller on his sale of goods, properties and services.
b) Zero–rated and effectively zero-rated transactions (3%)
SUGGESTED ANSWER:
Zero-rated transactions are transactions that are immuned from the imposition of the VAT and the term includes export sales and effectively zero-rated sales. (Section 106(A)(2), NIRC).
A zero-rated sale of goods or properties (whether export sale or effectively zero-rated sale) is a taxable transaction for VAT purposes, although the VAT rate applied is 0%.
A sale by a VAT-registered taxpayer of goods and/or services taxed at 0% shall not result in any output tax, while the input tax on its purchase of goods or services related to such zero-rated sale shall be available as tax credit or refund [Atlas Consolidated Mining & Development Corporation v. Commissioner of Internal Revenue, G.R. Nos. 141104 & 148763, June 8, 2007].
An effectively zero-rated transaction is limited in its context because it does not cover export sales. More specifically, effectively zero-rated transactions refer to the local sale of goods or supply of services by a VAT-registered person to persons or entities who were granted tax exemption under special laws or international agreement to which the Philippines is a signatory [Commissioner of Internal Revenue v. Seagate Technology Phils., Inc., G.R. No. 153866, February 11, 2005].
c) Destination principle (2%)
SUGGESTED ANSWER:
The destination principle provides that “no VAT shall be imposed to form part of the cost of goods destined for consumption outside of the territorial border of the taxing authority.” Hence, exports are zero-rated while imports are subject to the 12% VAT. [Coral Bay Nickel Corporation v. Commissioner of Internal Revenue, G.R. No. 190506, June 13, 2016].
A.3.
All the homeowners belonging to ABC Village Homeowners’ Association elected a new set of members of the Board of Trustees for the Association effective January 2019. The first thing that the Board looked into is the need to increase the prevailing association dues. Mr. X, one of the trustees, proposed an increase of 100% to account for the payment of the 12% value-added tax (VAT) on the association dues which were being collected for services allegedly rendered “in the course of trade or business” by ABC Village Homeowners’ Association.
a) What constitutes transactions done “in the course of trade or business” for purposes of applying VAT? (2%)
SUGGESTED ANSWER:
“In the course of trade or business” means the regular conduct or pursuit of a commercial or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person engaged therein is a nonstock, nonprofit private organization (irrespective of the disposition of its net income and whether or not it sells exclusively to members or their guests), or government entity (Section 105, NIRC).
b) Is Mr. X correct in stating that the association dues are subject to VAT? Explain. (3%)
SUGGESTED ANSWER:
No, association dues are not subject to VAT. Under Section 109 (Y) of the NIRC (as amended by Republic Act 10963, “Tax Reform for Acceleration and Inclusion” or “TRAIN“), association dues, membership fees, and other assessments and charges collected by homeowners associations and condominium corporations are VAT- exempt.
A.4.
Due to rising liquidity problems and pressure from its concerned suppliers, P Corp. instituted a flash auction sale of its shares of stock. P Corp. was then able to sell its treasury shares to Z, Inc., an unrelated corporation, for P1,000,000.00, which was only a little below the valuation of P Corp.’s shares based on its latest audited financial statements. In connection therewith, P Corp. sought a Bureau of Internal Revenue ruling to confirm that, notwithstanding the price difference between the selling price of the shares and their book value, the said transaction falls under one of the recognized exemptions to donor’s tax under the NIRC.
a) Cite the instances under the NIRC where gifts made are exempt from donor’s tax. (3%)
SUGGESTED ANSWER:
Under the NIRC, the following gifts are exempt from the donor’s tax:
- Total net gifts not in excess of Two Hundred Fifty Thousand pesos (P250,000.00) made during the calendar year (Section 99, NIRC, as amended by RA 10963).
- Sale or exchange for insufficient consideration where said sale, exchange, or other transfer of property is made in the ordinary course of trade or business, a transaction which is bona fide, at arm’s length, and free from any donative intent (Section 100, NIRC, as amended by RA 10963).
- Gifts made to or for the use of the National Government or any entity created by any of its agencies which is not conducted for profit, or to any political subdivision of the said Government (Section 101(A)(1), NIRC).
- Gifts in favor of an educational and/or charitable, religious, cultural or social welfare corporation, institution, accredited non-government organization, trust or philanthropic organization or research institution or organization: Provided, however, That not more than thirty percent (30%) of said gifts shall be used by such donee for administration purposes (Section 101(A)(2), NIRC).
b) Does the above transaction fall under any of the exemptions? Explain. (2%)
SUGGESTED ANSWER:
Yes. The transaction is not subject to donor’s tax. Generally, the sale of property, other than real property held as capital assets, for less than its fair market value is subject to donor’s tax on the amount by which the fair market value exceeds the consideration received. However, if the sale of property is made in the ordinary course of business (i.e. (i) a transaction which is bona fide, (ii) at arm’s length, and (iii) free from any donative intent), the sale will be considered made for an adequate and full consideration in money or money’s worth and will not be subject to donor’s tax. (Section 100, NIRC, as amended by RA 10963).
In this case, the transfer was made in the ordinary course of business since it was done for a valid business purpose, which is to address liquidity problems and relieve pressure from P Corp.’s suppliers.
A.5.
A, a resident Filipino citizen, died in December 2018. A’s only assets consist of a house and lot in Alabang, where his heirs currently reside, as well as a house in Los Angeles, California, USA. In computing A’s taxable net estate, his heirs only deducted: 1. P1,000,000.00 constituting the value of their house in Alabang as their family home; and 2. P200,000.00 in funeral expenses because no other expenses could be substantiated.
a) Are both deductions claimed by A’s heirs correct? Explain.
(2%)
SUGGESTED ANSWER:
No. The claim of both deductions by the heirs is incorrect. Only the claim for the deduction of the family home worth P1,000,000.00 is correct, if the property is the decedent’s family home as of the time of his death (Section 86(A)(7) of the NIRC, as amended by RA 10963). As for the funeral expense, upon the amendment introduced by the TRAIN Law, funeral expense was not specified as a separate deductible item, hence, not allowed as a deduction from the gross estate of the decedent.
b) May a standard deduction be claimed by A’s heirs? If so, how much and what proof needs to be presented for the same to be validly made? (2%)
SUGGESTED ANSWER:
Yes. A standard deduction of P5,000,000.00 is allowed under Section 86(A)(1) of the NIRC, as amended by RA 10963. There is no further proof needed for the heirs to claim this.
(c) In determining the gross estate of A, should the heirs include A’s house in Los Angeles, California, USA? Explain. (2%)
SUGGESTED ANSWER:
Yes, the heirs should include A’s house in Los Angeles. Gross estate is defined as the value of all the properties, real or personal, tangible or intangible, wherever situated, provided that in the case of a non-resident alien decedent, only those properties located within the Philippines shall be included in the gross estate. (Section 85 NIRC)
In this case, A is a resident Filipino citizen at the time of his death, thus, the fair market value of the house located in Los Angeles, California, USA is included in the gross estate.
A.6.
XYZ Air, a 100% foreign-owned airline company based and registered in the Netherlands, is engaged in the international airline business and is a member signatory of the International Air Transport Association. Its commercial airplanes neither operate within the Philippine territory nor are its service passengers embarking from Philippine airports. Nevertheless, XYZ Air is able to sell its airplane tickets in the Philippines through ABC Agency, its general agent in the Philippines.
As XYZ Air’s ticket sales, sold through ABC Agency for the year 2013, amounted to P5,000,000.00, the Bureau of Internal Revenue (BIR) assessed XYZ Air deficiency income taxes on the ground that the income from the said sales constituted income derived from sources within the Philippines.
Aggrieved, XYZ Air filed a protest, arguing that, as a non- resident foreign corporation, it should only be taxed for income derived from sources within the Philippines. However, since it only serviced passengers outside the Philippine territory, the situs of the income from its ticket sales should be considered outside the Philippines. Hence, no income tax should be imposed on the same.
Is XYZ Air’s protest meritorious? Explain. (5%)
SUGGESTED ANSWER:
No. An offline international air carrier, such as XYZ Air, which is selling passage tickets in the Philippines, through a general sales agent, is a resident foreign corporation doing business in the Philippines. As such, it is taxable under Section 28(A)(1) of the NIRC [Air Canada v. Commissioner of Internal Revenue, G.R. No. 169507, January 11, 2016].
A.7.
Differentiate tax exclusions from tax deductions. (5%)
SUGGESTED ANSWER:
Tax exclusions refer to income received or earned but is not taxable as such since it is exempted by law or by treaty thus, the same is not included in the computation of gross income. Meanwhile, tax deductions are those which are subtracted from gross income to
arrive at the taxable income.
Alternative Answer:
The distinction between tax exclusions and tax deductions are as follows:
1. Tax exclusions refer to a flow of wealth to the taxpayer which are not treated as part of gross income for purposes of computing the taxpayer’s taxable income, due to the following reasons:
a. It is exempted by the fundamental law;
b. It is exempted by statute; and
c. It does not come within the definition of income (Section 61, RR No. 2); while tax deductions are the amounts which the law allows to be subtracted from gross income in order to arrive at net income.
2. Tax exclusions pertain to the computation of gross income, while deductions pertain to the computation of net income.
3. Tax exclusions are something received or earned by the taxpayer which do not form part of gross income, while deductions are something spent or paid in earning gross income.
A.8.
B transferred his ownership over a 1,000-square meter commercial land and three-door apartment to ABC Corp., a family corporation of which B is a stockholder. The transfer was in exchange of 10,000 shares of stock of ABC Corp. As a result, B acquired 51 % ownership of ABC Corp., with all the shares of stock having the right to vote. B paid no tax on the exchange, maintaining that it is a tax avoidance scheme allowed under the law. The BIR, on the other hand, insisted that B’s alleged scheme amounted to tax evasion.
Should B pay taxes on the exchange? Explain. (3%)
SUGGESTED ANSWER:
No, B shall not pay taxes on the exchange. Section 40 (c) (2) (2) of the NIRC provides that no gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stocks in such corporation wherein as a result of such exchange, such person, alone or together with others, not exceeding four, gains control of the corporation. When B transferred the properties for shares in ABC Corporation, he acquired control (51% of voting shares) over the corporation, thus, the transaction shall not be subject to income tax, capital gains tax, and value-added tax.
A.9.
GHI, Inc. is a corporation authorized to engage in the business of manufacturing ultra-high density microprocessor unit packages. After its registration on July 5, 2005, GHI, Inc. constructed buildings and purchased machineries and equipment. As of December 31, 2005, the total cost of the machineries and equipment amounted to P250,000,000.00. However, GHI, Inc. failed to commence operations. Its factory was temporarily closed effective September 15, 2010. On October 1, 2010, it sold its machineries and equipment to JKL Integrated for P300,000,000.00. Thereafter, GHI, Inc. was dissolved on November 30, 2010.
a) Is the sale of the machineries and equipment to JKL Integrated subject to normal corporate income tax or capital gains tax? Explain. (3%)
SUGGESTED ANSWER:
The sale of machineries and equipment is subject to normal corporate income tax and not to the capital gains tax. As explained by the Supreme Court in one case, the capital gains tax of 6% imposed under Section 27(D)(5) of the NIRC, as amended, is on the presumed gain from the sale of a land and/or building only (SMI-ED Philippines Technology, Inc. v. Commissioner of Internal Revenue, G.R. No. 175410, November 12, 2014).
b) Distinguish an ordinary asset from a capital asset. (2%)
SUGGESTED ANSWER:
Ordinary assets include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation, or a real property used in trade or business. Capital assets pertain to properties held by the taxpayer, whether or not connected with his trade or business, but which are not considered as ordinary assets, as above–enumerated (Section 39(A)(1), NIRC, as amended).
Alternative Answer:
The distinction between an ordinary asset and a capital asset is presented as follows:
- The term “ordinary asset” pertains to the following properties:
a. Stock in trade of the taxpayer/other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year.
b. Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.
c. Property used in the trade or business of a character which is subject to the allowance for depreciation; and
d. Real property used in the trade or business of the taxpayer, including property held for rent.
On the other hand, “capital asset” pertain to a property held by the taxpayer, (whether or not connected with his trade or business) which does not fall under any of the different classes of ordinary assets enumerated above (Section 39(A)(1), NIRC).
A.10.
In 2018, City X amended its Revenue Code to include a new provision imposing a tax on every sale of merchandise by a wholesaler based on the total selling price of the goods, inclusive of value-added taxes (VAT). ABC Corp., a wholesaler operating within City X, challenged the new provision based on the following contentions: 1. the new provision is a form of prohibited double taxation because it essentially amounts to City X imposing VAT which was already being levied by the national government; and 2. since the tax being imposed is akin to VAT, it is beyond the power of City X to levy the same.
Rule on each of ABC Corp.’s contentions. (5%)
SUGGESTED ANSWER:
1. ABC’s first contention is without merit. Considering that the taxing authorities are different and that the local tax is imposed on the total selling price, inclusive of VAT, and VAT is imposed on gross sales/receipts, the present situation could not be considered as double taxation. There is no double taxation since in order to constitute prohibited double taxation, it must constitute taxing the same property twice when it should be taxed only once. The two taxes must be imposed on 1) the same subject matter; 2) for the same purpose; 3) by the same taxing authority; 4) within the same jurisdiction; 5) during the same taxing period; and 6) the taxes must be of the same kind or character.
2. ABC’s second contention is meritorious. One of the common limitations of the local government unit’s (such as City X) taxing power under Section 133(i) of the Local Government Code (Republic Act No. 7160) (LGC) is that it may not levy VAT on sales, barters or exchanges on goods or services. Hence, ABC Corp. is correct in saying that the local tax, which is imposed on every sale transaction, is akin to VAT; and necessarily, it may not be imposed by City X.
END OF PART 1