Chapter 1 - Income Taxation

General Principles of Taxation

Inherent Powers of State

1. Taxation

2. Power of Eminent Domain

3. Police Power

Taxation

power by which the sovereign raises revenues to defray the necessary expenses of the government.

Power of Eminent Domain

refers to the power of the government or those to whom the power has been delegated to take private property and convert it into public use upon paying the owners a just compensation to be ascertained by law.

Police power

enact laws in relation to persons  or property to promote public health, public morals, public safety and general welfare of the people.

Inherent Powers of State - Similarities

• They are inherent in the state

• They exist independently of the Constitution

• They constitute the three methods by which State interferes with private rights and property

• They are legislative in nature and character

• Each presupposes equivalent compensation

As to purpose

Taxation: Support of government

Police power: General welfare

Eminent Domain: Public purpose

As to authority who exercises the power

Taxation: Government only

Police power: Government only

Eminent Domain: Government and Public Service companies or public utilities

As to persons affected

Taxation: Community of class of Individuals

Police power: Community of class of Individuals

Eminent Domain: Individuals as owners of property

As to benefits received

Taxation: In form of protection/ benefit

Police power: No direct benefit

Eminent Domain: MV of property taken-compensation

As to effect

Taxation: Taxes become public funds

Police power: Regulate rights/property

Eminent Domain: Transfer of ownership

As to imposition

Taxation: No limit

Police power: Limited to cost of license or regulation

Eminent Domain: No imposition. Owners is paid by Government

As to relationship to NON IMPAIRMENT of Obligation Clause of Constitution

Taxation: Inferior to the clause

Police power: Superior

Eminent Domain: Inferior to the clause

Taxation

A process or act of imposing a charge by the government authority on property, individuals or transactions to raise money for public purposes.

It is also defined as the act of levying a tax, i.e. the process or means by which the sovereign, through its law-making body, raises income to defray the necessary expenses of government. It is a method of apportioning the cost of government among those who, in some measure, are privileged to enjoy its benefits and must therefore bear its burdens.

Purposes of Taxation

1. Revenue or fiscal

2. Non-revenue or regulatory

Revenue or fiscal

The primary purpose of taxation on the part of the government is to provide funds or property with which to promote the general welfare and the protection of its citizens and to enable it to finance its multifarious activities.

Non-revenue or regulatory

Taxation may also be employed for purposes of regulation or control.

a) Imposition of tariffs on imported goods to protect local industries.

b) The adoption of progressively higher tax rates to reduce inequalities in wealth an income.

c) The increase or decrease of taxes to prevent inflation or ward off depression. 

Theory and basis of taxation

• Necessity Theory

• Benefits received principle

• Life blood

• Benefit-received principle

Necessity Theory

The power of taxation proceeds upon the theory that the existence of government is a necessity; that it cannot continue without means to pay its expenses; and that for these means, it has a right to compel all its citizens and property within its limits to contribute.

Benefits received principle

The basis of taxation is found in the reciprocal duties of protection and support between the State and its inhabitants. In return for his contribution, the taxpayer received benefits and protection from the government.

Life blood

The theory constitutes the theory of taxation, which provides that the existence of government is a necessity; that government cannot continue without means to pay its expenses; and that for these means it has a right to compel its citizens and property within its limits to contribute.

Benefit-received principle

This principle serves as the basis of taxation and is founded on the reciprocal duties of protection and support between the State and its inhabitants. 

Also called “symbiotic relation” between the State and its citizens.

Essential elements of a tax

1. It is an enforced contribution.

2. It is generally payable in money.

3. It is proportionate in character.

4. It is levied on persons, property, or the exercise of a right or privilege.

5. It is levied by the State which has jurisdiction over the subject or object of taxation.

6. It is levied by the law-making body of the State.

7. It is levied for public purpose or purposes.

Principles of Sound Tax System

1. Fiscal Adequacy

2. Equality or Theoretical Justice

3. Administrative Feasibility

Fiscal Adequacy

It states that sources of revenues of govt must be sufficient to meet the demand of public expenditures regardless of business condition.

Equality or Theoretical Justice

States that tax burden must be proportionate to taxpayers ability to pay. In accordance with Constitutions’ mandate that application of taxation should be equitable.

Administrative Feasibility

Tax laws must be convenient, uniform and effective in their administration

Non-observance of the canon of this principle will not render a tax imposition invalid “except to the extent that specific constitutional or statutory limitations are impaired. 

Principles of Sound Tax System

Non-observance of these principles will not automatically render a tax law unconstitutional or invalid. 

A tax law will continue to be valid even if it does not observe the principles of fiscal adequacy and administrative feasibility since the Constitution does not expressly require so. However, a tax law may be held unconstitutional if it runs afoul of the principle of theoretical justice since the Constitution expressly requires that tax laws should be uniform and equitable. 

Stages of Taxation

1. Levy / Imposition

2. Assessment

3. Collection

Scope of Power of Taxation

The power of taxation is comprehensive, plenary, unlimited and supreme.

Strongest among the Inherent powers of State

Limitation of Power to Tax

Nature of the Power of Taxation

1. It is inherent in sovereignty; hence, it may be exercised although it is not expressly granted by the Constitution.

2. It is legislative in character; hence, only the legislature can impose taxes (although the power may be delegated).

3. It is subject to Constitutional and Inherent limitations; hence, it is not an absolute power that can be exercised by the legislature anyway it pleases.

Inherent limitations

1. Purpose must be public in nature

2. Prohibition against delegation of the taxing power

3. Exemption of government entities, agencies and instrumentalities except gov’t entities performing proprietary functions such as PNR

4. International comity

5. Limitation of territorial jurisdiction

Purpose must be public in nature

A tax must always be imposed for a public purpose, otherwise, it will be declared as invalid

Prohibition against delegation of the taxing power

General rule – The power to tax is exclusively vested in the legislative body, hence, it cannot be delegated. (Delegata potestas non potest delegari)

Delegata potestas non potest delegari

The power to tax is exclusively vested in the legislative body, hence, it cannot be delegated.

General rule

The power to tax is exclusively vested in the legislative body, hence, it cannot be delegated. (Delegata potestas non potest delegari) 

Exemption of government entities, agencies and instrumentalities

If the government taxes itself or if Local Government Units tax the national government, it would be akin to taking money from one pocket to the other. 

Entities or agencies exercising sovereign functions (acta jure imperii) are tax exempt, unless expressly taxed, agencies performing proprietary functions are subject to tax unless expressly exempted. 

Section 27(C) of RA 8424 as amended by RA 9337 and RA 10963

Exempted government owned and controlled corporation performing proprietary functions are subject to taxes namely: GSIS, SSS, PHIC and local water district.

Acta jure imperii

Entities or agencies exercising sovereign functions

International comity

A state must recognize the generally accepted tenets of international law, they must accord each other as sovereign equals. This limits the authority of a government to effectively impose taxes on a sovereign state and its instrumentalities, as well as on its property held, and activities undertaken, in that capacity. (Vitug) For example, a property of a foreign State or government may not be taxed by another State. 

Government entities exempt from income tax

1. Government Service Insurance System (GSIS)

2. Social Security System (SSS)

3. Philippine Health Insurance Corporation (PHIC)

4. Philippine Charity Sweepstakes Office (PCSO)

5. Local water district

Philippine Charity Sweepstakes Office (PCSO)

removed from tax exempt GOCCs under the TRAIN law (effective Jan 1, 2018)

TRAIN LAW; Sec 7, amending Sec 27 of NIRC

(C) Government-owned or -Controlled Corporations, Agencies or Instrumentalities - The provisions of existing special or general laws to the contrary notwithstanding, all corporations, agencies, or instrumentalities owned or controlled by the Government, shall pay such rate of tax upon their taxable income as are imposed by this Section upon corporations or associations engaged in similar business, industry, or activity.

Constitutional limitations

1. Due process of law

2. Equal protection of laws

3. Rule of uniformity and equity in taxation

4. Prohibition against imprisonment for non-payment of poll tax

5. Prohibition against impairment of obligation of contracts

6. No public money shall be appropriated for religious purposes

7. Prohibition against appropriation of proceeds of taxation for the use, benefit, or support of any church

8. Prohibition against taxation of religious, charitable and educational entities

9. Prohibition against taxation of non-stock, non-profit educational institutions

10. Others

11. Prohibition on use of tax levied for special purpose 

12. President’s veto power on appropriation, revenue, and tariff bills

13. Flexible tariff clause

Others

a. Grant of tax exemption- Majority of all members of Congress shall grant tax exemption

b. Veto of appropriation, revenue, tariff bills by the President

c. Non-impairment of the SC jurisdiction

d. Revenue bills shall originate exclusively from the House of Representatives

e. Infringement of press freedom

f. Judicial power to review legality of tax

Grant of tax exemption

Majority of all members of Congress shall be granted

Due process of law

Deprivation of life, liberty and property is with due process of law when:

a). It is done under the authority of law that is valid

b). After compliance with fair and reasonable methods or procedures prescribed by law.

Art III

No person shall be deprived of life, liberty, or property without due process of law

Equal protection of laws

All person subject to legislation shall be treated alike under circumstances and conditions both in the privileges conferred and liabilities imposed. No violation of equal protection when there is proper classification made 

Valid/Allowed Classification

a). There is substantial distinction

b). Classification is germane to the issue or purpose of law

c). Classification does not applies not only to existing conditions but future conditions as well

d). Classification is applicable to all members of same class.

Rule of uniformity and equity in taxation

A tax is considered uniform when it operates with the same force and effect in every place where the subject may be found.

Under the Constitution, Congress to evolve progressive system of taxation; meaning, that tax shall place emphasis on DIRECT rather than INDIRECT taxation (regressive system) with ability to pay as principal criterion.

Article VI, Sec 28

The rule of taxation shall be uniform and equitable

Due process (Sec. 1, Art. III, Constitution)

No state may tax anything not within its jurisdiction without violating the due process clause; the taxing power of a state does not extend beyond its territorial limits, but within such it may tax persons, property, income, or business

Prohibition against imprisonment for non-payment of poll tax

Example is Community tax

No public money shall be appropriated for religious purposes

Based on principle that taxes are for public proposes AND on principle of Separation of church and State.

Prohibition against taxation of religious, charitable and educational entities

Art VI, Sec 28, par 3 of the Constitution

provides that Charitable institutions, churches, parsonages or convents appurtenant thereto, mosques and non profit cemeteries and all lands and buildings and improvements actually, directly and exclusively used for religious , charitable and educational purposes shall be exempt from taxation

Exemption from property taxation only (RPT only).

Thus, sale of land by a religious institutions is subject to CGT.

Prohibition against taxation of non-stock, non-profit educational institutions

Art XIV, Sec 4

Provides that all revenues and assets of non stock, non profit educational institutions used actually, directly and exclusively for educational purposes shall be exempted from taxes and duties.

Exemption covers income, real estate tax, donor’s tax, and customs duties (distinguished from the previous provision, (Sec. 28[3], Art. VI, Constitution), which pertains only to real property tax exemption granted to real properties that are used for religious, charitable, or educational purposes) 

Proprietary

educational institutions (Preferential tax rate of 10%)

Government

educational institutions (Tax-exempt, e.g., UP)

Prohibition on use of tax levied for special purpose

All taxes must be used to defray the necessary expenses of the government.

President’s veto power on appropriation, revenue, and tariff bills

The President shall have the power to veto any particular item or items in an appropriation, revenue, or tariff bill, but the veto shall not affect the item or items to which he does not object. 

Flexible tariff clause

Art. VI, Sec. 28 [2] Constitution

The Congress may, by law, authorize the President to fix within specified limits, and subject to such limitations and restrictions as it may impose, tariff rates, import and export quotas, tonnage and wharfage dues, and other duties or imposts within the framework of the national development program of the Government. 

Substantive

• Should not be harsh, oppressive or confiscatory (reasonableness)

• By authority of valid law

• Must be for a public purpose

• Imposed within territorial jurisdiction

Procedural

• No arbitrariness in assessment and collection

• Right to notice and hearing

Doctrines in taxation

1. Prospectivity of Tax laws

2. Imprescriptibility of taxes

3. Double taxation

4. Escape from taxation

Prospectivity of Tax laws

This principle provides that a tax law must only be applicable and operative prospectively, except when expressly provided by law to be imposed retroactively.

Imprescriptibility of taxes

Although the NIRC provides for the limitation in the assessment and collection of taxes imposed, such will only be applicable to those taxes where a tax return is required. Unless otherwise provided by the tax law itself, taxes in general are imprescriptible.

Double taxation

a. Indirect Duplicate taxation

b. Direct Duplicate taxation

Indirect Duplicate taxation

This is double taxation when tax is already deducted to your salary and another tax is deducted when you buy goods (VAT).

Direct Duplicate taxation

This is double taxation in strict sense. It is prohibited because it comprises imposition of tax to –same property/person- same period-same purpose- same tax rate- and same taxing authority.

Escape from taxation

a. Tax evasion

b. Tax avoidance

Tax evasion

use of unlawful means

Tax avoidance

use of unlegal means

also called Tax Minimization

Indirect Double taxation (Broad sense)

The SC held that there is no constitutional prohibition against double taxation in the Philippines. Therefore, it may not be a valid defense against the validity of a tax measure. What is prohibited is direct double taxation.

Modes of eliminating Double Taxation

Tax treaties as relief from double taxation 

i. Provide for exemptions or allowance of deduction or tax credit for foreign taxes; 

ii. Enter into treaties with other states (e.g., former Phil-Am Military Bases Agreements as to income tax); or 

iii. Apply the principle of reciprocity. 

Situs of Taxation (Income)

power to tax is limited to the territorial jurisdiction of the taxing state. It is the place or authority that has the right to impose and collect taxes. 

Situs

place of taxation

Classification of Taxes

• As to Subject Matter or Object

• As to Purpose

• As to Who bears the burden

• As to Scope of the Tax

• As to the Determination of Amount

• As to Gradation or Rate

As to Subject Matter or Object

1. Personal, poll or capitation tax

2. Property tax

3. Excise tax

Personal, poll or capitation tax

Tax of a fixed amount imposed on persons residing within a specified territory, whether citizens or not, without regard to their property or the occupation or business in which they may be engaged.

Example: Community tax

Property tax

Tax imposed on property, real or personal, in proportion to its value or in accordance with some other reasonable method of apportionment.

Example: Real estate tax 

Excise tax

A charge imposed upon the performance of an act, the enjoyment of a privilege, or the engaging in an occupation. This is different from the excise tax of Title VI of the NIRC.

Example: Income tax, VAT, estate tax, donor’s tax

As to Purpose

1. General/fiscal/revenue tax

2. Special/regulatory tax

General/fiscal/revenue tax

imposed for the purpose of raising public funds for the service of the government.

Special/regulatory tax

imposed primarily for the regulation of useful or non-useful occupation or enterprises and secondarily only for the purpose of raising public funds.

As to Who bears the burden

1. Direct tax

2. Indirect tax

Direct tax

is demanded from the person who also shoulders the burden of the tax.  It is a tax which the taxpayer is directly or primarily liable and which he or she cannot shift to another.

Indirect tax

is demanded from a person in the expectation and intention that he or she shall indemnify himself or herself at the expense of another, falling finally upon the ultimate purchaser or consumer.  A tax which the taxpayer can shift to another.

As to the Scope of the Tax

1. National tax

2. Local tax

National tax

is imposed by the national government. 

Local tax

is imposed by municipal corporations or local government units (LGUs).

As to the Determination of the Amount

1. Specific tax

2. Ad valorem tax

Specific tax

a tax of a fixed amount imposed by the head or number or by some other standard of weight or measurement.  It requires no assessment other than the listing or classification of the objects to be taxed.

Ad valorem tax

a tax of a fixed proportion of the value of the property with respect to which the tax is assessed. It requires the intervention of assessors or appraisers to estimate the value of such property before the amount due from each taxpayer can be determined.

As to Gradation or Rate

1. Proportional tax

2. Progressive or graduated tax

3. Regressive tax

Proportional tax

Tax based on a fixed percentage of the amount of the property receipts or other basis to be taxed. Example: real estate tax.

Progressive or graduated tax

Tax the rate of which increases as the tax base or bracket increases.

Example: Income tax

Digressive tax rate

progressive rate stops at a certain point. Progression halts at a particular stage.

Regressive tax

Tax the rate of which decreases as the tax base or bracket increases. There is no such tax in the Philippines.

Regressive tax system

more indirect taxes is imposed than direct taxes.