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Rev. Regs. No. 2 (Income Tax Regs.)

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    February 10, 1940

    REVENUE REGULATIONS NO. 02-40

    INCOME TAX REGULATIONS

    SECTION 1. Scope. In accordance with the provisions of Sections 4

    (I) and 338 of Commonwealth Act No. 466, otherwise known as the National Internal

    Revenue Code, the following regulations affecting Sections 19 to 84 of the same

    Code relating to the income tax are hereby promulgated to supersede all circulars,

    precedents, rulings, and regulations heretofore published on the same subject, and

    they shall be known as Revenue Regulations No. 2, or the Income Tax Regulations:

    (Only the section numbers of the Code are given below as their texts will be

    found in the same Code. They serve as captions of the pertinent provisions of the

    Regulations.)

    (Section 20 of the Code)

    SECTION 2. Application of title. Section 20 provides that the

    provisions of Title II of the National Internal Revenue Code shall apply only toincome received from January 1, 1939.

    (Section 21 of the Code)

    SECTION 3. Persons considered citizens of the Philippines. The

    following shall be considered citizens of the Philippines:

    (1) Those who were citizens of the Philippines at the time of the adoption of

    the Constitution of the Philippines.

    (2) Those born in the Philippines of foreign parents who, before the adoptionof the Constitution, had been elected to public office in the Philippines.

    (3) Those whose fathers are citizens of the Philippines.

    (4) Those whose mothers are citizens of the Philippines and, upon reaching

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    the age of majority, elect Philippine citizenship.

    (5) Those who are naturalized in accordance with law. (Sec. 1, Article IV,

    Constitution of the Philippines.)

    Philippine citizenship may be lost or reacquired in the manner provided by

    law. A foreigner who has come to reside in the Philippines and has filed his petition

    to acquire Philippine citizenship but has not yet received the requisite naturalization

    certificate still remains an alien.

    SECTION 4. Tax on citizens and residents. Section 21 imposes

    progressive rates of income taxes on citizens and residents, starting from 3 per cent

    upon the amount by which the net income does not exceed P2,000 and rising

    gradually to 60 per cent upon the amount by which the net income exceeds P500,000.

    (Conforms with amendments by R.A. 2343, effective June 20, 1959.)

    The following is a table, showing the rates of income tax under Section 21, as

    amended by Section 1 of R.A. No. 2343, applicable to income received from Jan. 1,

    1959 and for fiscal periods ending after June 30, 1959:

    1 2 3 4 5 6

    Exceeding Not Bracket Rate Tax on Each Cumulative

    Exceeding of Tax Bracket Amount of Tax

    P - P2,000 2,000 3% P60 P60

    2,000 4,000 2,000 6% 120 180

    4,000 6,000 2,000 9% 180 360 6,000 8,000 2,000 16% 320 680

    8,000 10,000 2,000 20% 400 1,080

    10,000 20,000 10,000 24% 2,400 3,480

    20,000 30,000 10,000 30% 3,000 6,480

    30,000 40,000 10,000 36% 3,600 10,080

    40,000 50,000 10,000 40% 4,000 14,080

    50,000 60,000 10,000 42% 4,200 18,280

    60,000 70,000 10,000 44% 4,400 22,680

    70,000 80,000 10,000 46% 4,600 27,280

    80,000 90,000 10,000 48% 4,800 32,080 90,000 100,000 10,000 50% 5,000 37,080

    100,000 120,000 20,000 52% 10,400 47,480

    120,000 140,000 20,000 53% 10,600 58,080

    140,000 160,000 20,000 54% 10,800 68,880

    160,000 200,000 40,000 55% 22,000 90,880

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    200,000 250,000 50,000 56% 28,000 118,880

    250,000 300,000 50,000 57% 28,500 147,380

    300,000 400,000 100,000 58% 58,000 205,380

    400,000 500,000 100,000 59% 59,000 264,380

    500,000 - - 60% - -

    Note: Taxable income is arrived at after deducting personal and additional

    exemptions to which taxpayer is entitled. IcEaST

    (Section 22 of the Code)

    SECTION 5. Definition. A "non-resident alien individual" means an

    individual

    (a) Whose residence is not within the Philippines; and

    (b) Who is not a citizen of the Philippines.

    An alien actually present in the Philippines who is not a mere transient or

    sojourner is a resident of the Philippines for purposes of the income tax. Whether he

    is a transient or not is determined by his intentions with regard to the length and

    nature of his stay. A mere floating intention indefinite as to time, to return to another

    country is not sufficient to constitute him a transient. If he lives in the Philippines and

    has no definite intention as to his stay, he is a resident. One who comes to the

    Philippines for a definite purpose which in its nature may be promptly accomplished

    is a transient. But if his purpose is of such a nature that an extended stay may benecessary for its accomplishment, and to that end the alien makes his home

    temporarily in the Philippines, he becomes a resident, though it may be his intention

    at all times to return to his domicile abroad when the purpose for which he came has

    been consummated or abandoned.

    SECTION 6. Loss of residence by alien. An alien who has acquired

    residence in the Philippines retains his status as a resident until he abandons the same

    and actually departs from the Philippines. An intention to change his residence does

    not change his status as a resident alien to that of a nonresident alien. Thus an alien

    who has acquired a residence in the Philippines is taxable as a resident for theremainder of his stay in the Philippines.

    SECTION 7. Taxation of aliens in general. For purposes of income

    tax, alien individuals are divided generally into two classes, namely, resident aliens

    and non-resident aliens. Resident aliens are taxable in the same manner as citizens of

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    the Philippines, that is, a resident alien is taxable on income derived from all sources

    including sources without the Philippines. Non-resident aliens are taxable only on

    income from sources within the Philippines.

    SECTION 8. Taxation of non-resident aliens; classification. Non-resident alien individuals are divided into two classes: (1) Those engaged in

    trade or business within the Philippines, and (2) those not engaged in trade or

    business within the Philippines. Non-resident aliens falling within the first class are

    subject to the graduated rates established in Section 21 with respect to their net

    income from sources within the Philippines. Non-resident aliens falling within the

    second class are subject to a flat rate of 20 per cent on their total income from sources

    within the Philippines, if such total income does not exceed P23,800, otherwise, the

    graduated rates established in Section 21 will apply to the total income if it exceeds

    P23,800. (Conforms with amendments by R.A. 2343, effective June 20, 1959.)

    The phrase "engaged in trade or business within the Philippines" includes the

    performance of personal services within the Philippines. Whether a non-resident alien

    has an "office or place of business," however, implies a place for the regular

    transaction of business and does not include a place where casual or incidental

    transactions might be, or are, effected. Neither the beneficiary nor the grantor of a

    trust, whether revocable or irrevocable, is deemed to be engaged in trade or business

    in the Philippines or to have an office or place of business therein, merely because the

    trustee is engaged in trade or business in the Philippines or has an office or place of

    business therein. (Test of "office or place of business" was deleted by R.A. 2343.)

    (Section 23 of the Code)

    SECTION 9. Personal exemption. Personal exemption is an arbitrary

    amount allowed for personal, living, or family expenses of the taxpayer. It is allowed

    to citizens of the Philippines, to resident aliens, and to non-resident aliens in certain

    cases. The procedure of arriving at the tax due after giving effect to the exemptions

    allowable is set forth in Section 4 of these regulations. EHcaDT

    SECTION 10. Personal exemption of single individuals. A single

    individual is entitled to a personal exemption of P1,800.

    SECTION 11. Personal exemption of married persons and heads of

    family. A married person is entitled to a personal exemption of P3,000. Only one

    exemption of P3,000 is allowed with respect to the aggregate income of both husband

    and wife. (Conforms with amendments by R.A. 2343, effective June 20, 1959.)

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    A head of family is an individual who actually supports and maintains in one

    household one or more individuals, who are closely connected with him by blood

    relationship, relationship by marriage, or by adoption, and whose right to exercise

    family control and provide for these dependent individuals is based upon some moralor legal obligation. In the absence of continuous actual residence together, whether or

    not a person with dependent relatives is a head of a family within the meaning of the

    statute must depend on the character of the separation. If a father is absent on

    business, or a child or other dependent is away at school or on a visit, the common

    home being still maintained, the additional exemption applies. If, moreover, through

    force of circumstances a parent is obliged to maintain his dependent children with

    relatives or in a boarding house while he lives elsewhere, the additional exemption

    may still apply. If, however, without necessity, the dependent continuously makes his

    home elsewhere, his benefactor is not the head of a family, irrespective of the

    question of support. A resident alien with children abroad is not thereby entitled tocredit as the head of a family. Chief support means principal or main support. Partial

    support not amounting to chief support will not entitle the taxpayer to claim

    exemption as a head of a family.

    Under the law the following persons are entitled to P3,000 exemption: (a) a

    married man; (b) a married woman; and (c) an unmarried man or woman with one or

    both parents, or one or more brothers or sisters, or one or more legitimate, recognized

    natural, or adopted children living with and dependent upon him or her for their chief

    support, where such brothers, sisters, or children are not more than 23 years of age,

    unmarried and not gainfully employed or where such children are incapable ofself-support because mentally or physically defective. (Conforms with amendments

    by R.A. 2343, effv. June 20, 1959.)

    SECTION 12. Additional exemption for dependents. The taxpayer is

    entitled to an additional exemption of P1,000 for each legitimate, recognized natural,

    or adopted child wholly dependent upon and living with such person, if such

    dependent is not more than 23 years of age, unmarried and not gainfully employed or

    incapable of self-support because mentally or physically defective, provided that the

    person claiming additional exemption is a head of family. The children with respect to

    whom additional exemption is claimed must be wholly dependent upon the taxpayerfor support. (Conforms with amendments by R A. 2343, effv. June 20, 1959.)

    SECTION 13. Change of status. If the status of the taxpayer, insofar as

    it affects the personal and additional exemptions, changes during the taxable year by

    reason of his death, the amount of the personal and additional exemptions shall be

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    apportioned, in accordance with the number of months before and after such change.

    For the purpose of such apportionment, a fractional part of a month shall be

    disregarded unless it amounts to more than half a month in which case it shall be

    considered as one month. (Conforms with amendment by R.A. 590, effv. Sept. 22,

    1950.)

    SECTION 14. Personal exemption of non-resident aliens. A

    non-resident alien is entitled to a personal exemption in an amount equal to the

    exemptions allowed by the income tax law in the country of which he is a citizen or

    subject to citizens of the Philippines. The exemption allowed to non-resident aliens is

    a reciprocal one; that is, it is only allowed if the country of said non-resident aliens

    allows similar exemptions to Filipinos not residing in such country but deriving

    income from sources therein. If the country of which the non-resident alien is a

    citizen or subject does not have any income tax law, such non-resident alien will not

    be entitled to personal exemption.

    (Section 24 of the Code)

    SECTION 15. Income tax on corporations. The law imposes an annual

    income tax of 22per centumupon that portion of the net income of every corporation

    not in excess of P100,000 and 30 per cent on the excess. The term "corporation"

    includes partnership no matter how created or organized, joint-stock companies,

    joint-account (cuentas en participacion), association, or insurance companies but

    does not include duly registered general co-partnership (companias colectivas). The

    tax is upon net income, which is undetermined by subtracting from the gross income,as defined in the law, the allowable deductions. (Conforms with amendments by R.A.

    2343, effv. June 20, 1959.)

    SECTION 16. Corporations liable to tax. Every corporation, domestic

    or foreign, not otherwise exempt from tax under Title II or any other law, is liable to

    tax. A domestic corporation is taxed on its income from sources within and without

    the Philippines, but a foreign corporation is taxed only on its income form sources

    within the Philippines.

    The tax imposed by law on corporations is not imposed only upon suchcorporations as are organized and operated for profit. Any corporation, firm or

    association, no matter how created or organized, or what the purpose of its

    organization may be, is subject to the tax, except as provided in Section 27, relative to

    exemptions from tax on corporations. A corporation is not exempt simply and only

    because it is primarily not organized and operated for profit.

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    SECTION 17. Dividends received by a corporation from a domestic

    corporation. Dividends received by a domestic or resident foreign corporation

    from a domestic corporation subject to tax are taxable only to the extent of 25 per cent

    thereof. All other classes of income (except net capital gains, Section 34) ofcorporations are taxable in full. Likewise dividends from a foreign corporation,

    whether resident or non-resident, are taxable in full. (See Sections 250 to 256 of these

    regulations relative to taxation of dividends and other distributions.)

    SECTION 17-A. Tax on life insurance companies. Every life insurance

    company organized in or existing under the laws of the Philippines, or foreign life

    insurance company authorized to carry on business in the Philippines are taxable on

    their total net investment income derived from interest, dividends and rents from all

    sources whether within or without the Philippines, to the flat rate of 6-1/2%.

    However, purely cooperative insurance companies or associations which areconducted by the members thereof with the money collected from among themselves

    and solely for their own protection and not for profit are exempt from income tax.

    The total net investment income of domestic life insurance companies means

    the gross investment income received during the taxable year from rents, dividends

    and interest less deductions for real estate expenses, depreciation, interest paid within

    the taxable year on its indebtedness except on indebtedness incurred to purchase or

    carry obligation the interest upon which is wholly exempt from taxation under

    existing laws, and such investment expenses paid during the taxable year as are

    ordinary and necessary in the conduct of its investment. The total net investmentincome of foreign life insurance companies doing business here is that portion of their

    gross world investment income which bears the same ratio to such income as their

    total Philippines reserve (whether kept in the Philippines or abroad) bears to their

    total world reserve less that portion of their total world investment expenses which

    bears the same ratio to such expenses as their total Philippine investment income

    bears to their total world investment income. The following equation simplifies this

    formula:

    PGI = PR/WR x WGI

    PIE = PGI/WGI x WIE

    PGI - PIE = PNI

    Legend:

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    PGI is Philippine Gross Investment Income

    PNI is Philippine Net Investment Income

    PR is Total Philippine Reserve

    WR is Total World Reserve

    WGI is World Gross Investment Income

    PGI is Philippine Gross Investment Income

    WIE is Total World Investment Expenses

    PIE is Philippine Investment Expense

    In both cases, the deductible expenses must be connected with the investment

    income subjected to tax. For the proper determination of the income tax liability of

    resident foreign life insurance companies, they should submit the necessary financial

    statement reflecting the nature of the investment income and corresponding expenses.

    These financial statements must be duly certified by an independent certified public

    accountant and authenticated by a Philippine consular official. STcHDC

    Foreign life insurance companies not doing business in the Philippines are

    subject to the normal income tax on their income received from sources within the

    Philippines. They are subject to tax at the rate of 30% like any other foreigncorporation.

    Domestic life insurance companies and foreign life insurance companies doing

    business in the Philippines are not allowed to deduct from their gross income the net

    additions, if any, required by law to be made within the year to reserve funds and the

    sums other than dividends paid within the year on policy and annuity contracts.

    (Proposed by the BIR. If adopted, this will supersede Sec. 124 of existing

    regulations.)

    (Section 25 of the Code)

    SECTION 18. Taxation of corporation formed or utilized for avoidance of

    tax. Section 25 imposes for each year, in addition to the tax imposed by Section 24

    a tax of 25 per cent on the undistributed portion of the profits or surplus of a

    corporation which is formed or availed of for the purpose of preventing the

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    imposition of the tax upon its shareholders or members or the shareholders or

    members of any other corporation through the medium of permitting gains or profits

    to accumulate instead of dividing or distributing them. However, banks, insurance

    companies, personal holding companies and foreign personal holding companies as

    defined in Chapter VIII, are excepted from taxation under Section 25. The taximposed by Section 25 applies whether the avoidance was accomplished through the

    formation or use of only one corporation or a chain of corporations. For example, if

    the capital stock of the M Corporation is held by the N Corporation so that the

    dividend distributions of the M Corporation would not be returned as income subject

    to the tax on individuals until distributed in turn by the N Corporation to its individual

    shareholders, nevertheless the tax imposed by Section 25 applies to the M

    Corporation, if that corporation is formed or availed of for the purpose of preventing

    the imposition of the tax upon the individual shareholders of the N Corporation. A

    foreign corporation, whether resident or non-resident, is subject to the tax provided

    for under Section 25 in the same manner and under the same circumstances as a

    domestic corporation.

    SECTION 19. Purpose to avoid tax; evidence; burden of proof; definitions

    of holding or investment company. The Collector of Internal Revenue's

    determination that a corporation was formed or availed of for the purpose of avoiding

    the tax on its shareholders or members is subject to disproof by competent evidence.

    The existence or non-existence of the purpose may be indicated by circumstances

    other than the evidence specified in Section 25(b), and whether or not such purpose

    was present depends upon the particular circumstances of each case. In other words, a

    corporation is subject to taxation under Section 25 if it is formed or availed of for the

    purpose of preventing the imposition of the progressive rates of tax upon shareholders

    through the medium of permitting earnings or profits to accumulate, even though the

    corporation is not a mere holding or investment company 50 per cent or more of the

    outstanding stock of which is owned directly or indirectly by one person, and does

    not have an unreasonable accumulation of earnings or profits; and on the other hand,

    the fact that a corporation is such a company or has an accumulation is not absolutely

    conclusive against it if, by clear and convincing evidence, the taxpayer satisfies the

    Commissioner of Internal Revenue that the corporation was neither formed nor

    availed of for the purpose of avoiding the tax on individuals. All the othercircumstances which might be construed as evidence of the purpose to avoid the tax

    on shareholders cannot be outlined, but among other things the following will be

    considered: (1) Dealings between the corporation and its shareholders, such as

    withdrawal by the shareholders as personal loans or the expenditure of funds by

    corporation for the personal benefit of the shareholders, and (2) the investment by the

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    corporation of undistributed earnings in assets having no reasonable connection with

    the business. The mere fact that the corporation distributed a large part of its earnings

    for the year in question does not necessarily prove that earnings were not permitted to

    accumulate beyond reasonable needs or that the corporation was not formed or

    availed of to avoid the tax upon shareholders.

    If the Commissioner of Internal Revenue determined that the corporation was

    formed or availed of for the purpose of avoiding the progressive rates of tax on

    individuals through the medium of permitting earnings or profits to accumulate, and

    the taxpayer contests such determination of fact by litigation, the burden of proving

    the determination wrong by a preponderance of evidence, together with the

    corresponding burden of first going forward with evidence, is on the taxpayer under

    principles applicable to income tax cases generally, and this is so even though the

    corporation is not a mere holding or investment company and does not have an

    unreasonable accumulation of earnings or profits. However, if the corporation is amere holding or investment company, then the law gives further weight to the

    presumption of correctness already arising from the Commissioner of Internal

    Revenue's determination by expressly providing an additional presumption of the

    existence of a purpose to avoid the tax upon shareholders, while if earnings or profits

    are permitted to accumulate beyond the reasonable needs of the business then the law

    adds still more weight to the Commissioner of Internal Revenue's determination by

    providing that irrespective of whether or not the corporation is a mere holding or

    investment company, the existence of such an accumulation is determinative of the

    purpose to avoid the tax upon shareholders unless the taxpayer proves the contrary by

    such a clear preponderance of all the evidence that the absence of such a purpose is

    unmistakable.

    SECTION 20. Holding and investment companies. A corporation

    having practically no activities except holding property, and collecting the income

    therefrom or investing therein, shall be considered a holding company within the

    meaning of Section 25. If the activities further include, or consist substantially of,

    buying and selling stocks, securities, real estate, or other investment property

    (whether upon an outright or a marginal basis) so that the income is derived not only

    from the investment yield but also from profits upon market fluctuations, the

    corporation shall be considered an investment company within the meaning of

    Section 25.

    SECTION 21. Unreasonable accumulation of profits. An accumulation

    of earnings or profits (including the undistributed earnings or profits of prior years) is

    unreasonable if it is not required for the purposes of the business, considering all the

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    circumstances of the case. It is not intended, however, to prevent accumulations of

    surplus for the reasonable needs of the business if the purpose is not to prevent the

    imposition of the tax upon shareholders. No attempt is here made to enumerate all the

    ways in which earnings or profits of a corporation may be accumulated for the

    reasonable needs of the business. Undistributed income is properly accumulated ifretained for working capital needed by the business; or if invested in additions to

    plant reasonably required by the business; or if in accordance with contract

    obligations placed to the credit of a sinking fund for the purpose of retiring bonds

    issued by the corporation. The nature of the investment of earnings or profits is

    immaterial if they are not in fact needed in the business. Among other things, the

    nature of the business, the financial condition of the corporation at the close of the

    taxable year, and the use of the undistributed earnings or profits will be considered in

    determining the reasonableness of the accumulations.

    The business of a corporation is not merely that which it has previously carriedon, but includes in general any line of business which it may undertake. However, a

    radical change of business when a considerable surplus has been accumulated may

    afford evidence of a purpose to avoid the tax. If one corporation owns the stock of

    another corporation in the same or a related line of business and in effect operates the

    other corporation, the business of the latter may be considered in substance although

    not in legal form the business of the first corporation. Earnings or profits of the first

    corporation put into the second through the purchase of stock or otherwise may,

    therefore, if a subsidiary relationship is established, constitute employment of the

    income in its own business. Investment by a corporation of its income in stock and

    securities of another corporation is not of itself to be regarded as employment of the

    income in its business. The business of one corporation may not be regarded as

    including the business of another unless the other corporation is a mere

    instrumentality of the first; to establish this it is ordinarily essential that the first

    corporation own all or substantially all of the stock of the second.

    The Commissioner of Internal Revenue may require any corporation to furnish

    a statement of its accumulated earnings and profits, the name and address of, and

    number of share held by each of its shareholders or members, and the amounts that

    would be payable to each, if the income of the corporation were distributed.

    (Section 26 of the Code)

    SECTION 22. General co-partnerships. General co-partnerships, when

    duly registered, are not subject to income tax, but are required to file returns of their

    income on B.I.R. Form No. 17.04 for the purpose of furnishing information as to the

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    share in the gains or profits which each partner shall include in his individual return.

    Individuals carrying on business in general co-partnership are, however, taxable upon

    their distributive shares of the net income of such partnership, whether distributed or

    not, and are required to include such distributive shares in their individual returns.

    The returns of duly registered general co-partnerships should be rendered on or beforeApril 15 of each year or within sixty days after the end of their fiscal year depending

    on whether their books are kept on the calendar or on the fiscal year basis. (Conforms

    with amendments by R.A. 2343, effv. June 20, 1959.)

    SECTION 23. Distributive shares of partners. The distributive share of

    the net profit of a general co-partnership must be included in the individual returns of

    the partners. But where the result of partnership operation is a loss, the loss will be

    divisible by the partners in the same proportion as the net income would have been

    divisible (or, if the partnership agreement provides for the division of a loss in a

    manner different from the division of a gain, in the manner so provided) and may betaken by the individual partners in their respective returns of income.

    (Section 27 of the Code)

    SECTION 24. Proof of exemption. In order to establish its exemption,

    and thus be relieved of the duty of filing returns of income and paying the tax, it is

    necessary that every organization claiming exemption file an affidavit with the

    Commissioner of Internal Revenue, showing the character of the organization, the

    purpose for which it was organized, its actual activities, the sources of its income and

    its disposition, whether or not any of its income is credited to surplus or inures or mayinure to the benefit of any private shareholder or individual, and in general, all facts

    relating to its operations which affect its right to exemption. To such affidavit should

    be attached a copy of the charter or articles of incorporation, the by-laws of the

    organization, and the latest financial statement showing the assets, liabilities, receipts,

    and disbursement of the organization.

    Upon receipt of the affidavit and other papers by the Commissioner of Internal

    Revenue, the organization will be informed whether or not it is exempt. When an

    organization has established its right to exemption, it need not thereafter make and

    file a return of income as required under Section 46 of the Tax Code. However, theorganization should file on or before April 15 of each year, an annual information

    return under oath, stating its gross income and expenses incurred during the preceding

    year, and a certificate showing that there has not been any substantial change in its

    By-Laws, Articles of Incorporation, manner of operation and activities as well as

    sources and disposition of income. (As amended by Revenue Regulations No. 7-64,

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    approved November 25, 1964.)

    SECTION 25. Agricultural and horticultural organizations. The

    organizations contemplated by subsection (a) of Section 27 of the Code as entitled to

    exemption from income taxation are those which (1) have no net income inuring tothe benefit of any member; (2) are educational or instructive in character; and (3)

    have as their objects the betterment of the conditions of those engaged in such

    pursuits, the improvement of the grade of their products, and the development of a

    higher degree of efficiency in their respective occupations. Organizations such as

    provincial fairs and like associations of a quasi-public character, which are designed

    to encourage the development of better agricultural and horticultural products through

    a system of awards, prizes, or premiums, and whose income derived from gate

    receipts, entry fees, donations, etc., is used exclusively to meet the necessary

    expenses of upkeep and operation, are thus exempt. On the other hand, associations

    which have for their purpose, for example, the holding of periodical race meets, theprofits from which may inure to the benefit of their shareholders, are not exempt.

    Similarly, corporations engaged in growing agricultural or horticultural products or

    raising live stock or similar products for profits are not exempt from tax under this

    paragraph. ITScHa

    SECTION 26. Mutual savings bank. In order that a corporation may be

    entitled to exemption as a mutual savings bank, it must appear that it is an

    organization (1) which has no capital stock represented by shares, and (2) whose

    earnings less only the expenses of operation, are distributable wholly among the

    depositors. If it appears that the organization has shareholders who participate in the

    profits, the organization will not be exempt from income tax.

    SECTION 27. Fraternal beneficiary societies. A fraternal beneficiary

    society is exempt from tax only if operated under the "lodge system", or for the

    exclusive benefit of the members of a society so operating. "Operating under the

    lodge system" means carrying on its activities under a form of organization that

    comprises local branches, chartered by a parent organization and largely

    self-governing, called lodges, chapters, or the like. In order to be exempt, it is also

    necessary that the society should have an established system for payment to its

    members or their dependents of life, sick, accident, or other benefits.

    SECTION 28. Building and loan associations. (Now subject to tax, as

    amended by Sec. 4, R.A. 82.)

    SECTION 29. Cemetery companies. A cemetery company may be

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    entitled to exemption, (1) if it is owned by and operated exclusively for the benefit of

    its lot owners, or (2) if it is not operated for profit. Any cemetery corporation

    chartered solely for burial purposes and not permitted by its charter to engage in any

    business not necessarily incident to that purpose, is exempt from income tax,

    provided that no part of its net earnings inures to the benefit of any privateshareholder or individual. A cemetery company which fulfills the other requirement

    of the statute may be exempt, even though it issues preferred stock entitling the

    holders to dividend at a fixed rate, provided that its articles of incorporation require

    (a) that the preferred stock shall be retired at par as soon as sufficient funds are

    realized from sales, and (b) that all funds not required for the payment of dividends

    upon or for the retirement of preferred stock shall be used by the company for the care

    and improvement of the cemetery property.

    A cemetery company having a capital stock represented by shares, or which is

    operated for profit or for the benefit of persons other than its members, does not comewithin the exempted class.

    SECTION 30. Religious, charitable, scientific, athletic, cultural, and

    educational corporations. A corporation falling among those enumerated in

    subsection (e) of Section 27 is exempt from tax on its income (other than income of

    whatever kind and character from its properties, real or personal) if such corporation

    meets two tests: (a) It must be organized and operated for one or more of the specified

    purposes; and (b) no part of its net income must inure to the benefit of private

    stockholders or individuals.

    The income of such corporation which is considered as income from their

    properties, real or personal, generally consists of income from corporate dividends,

    rentals received from their properties, interests received from such capital loaned to

    other persons, income from agricultural lands owned by such corporations, profits

    from the sale of property, real or personal, and other similar income.

    Income not derived from their properties, real or personal, are exempt. For

    example, in the case of a religious corporation, income from the conduct of strictly

    religious activities, such as fees received for administering baptismals, solemnizing

    marriages, attending burials, holding masses, and other like income, is exempt. In thecase of an educational corporation, income from the holding of an educational fair or

    exhibit is exempt. However, if such exempt income is invested by the corporation, the

    income from such investment, as interests from the capital where the capital has been

    loaned or dividends on stock where the capital has been invested in shares of stock,

    will constitute taxable income. Donations and other similar contributions received by

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    such corporation from other persons are exempt.

    The clause "except income expressly exempt by this Title" appearing in

    subsection (e) of Section 27 refers to those classes of income which, in accordance

    with subsection (b) of Section 29, are exempt from taxation under Title II.

    Charitable corporations include an association for the relief of the families of

    clergymen, even though the latter make a contribution to the fund established for this

    purpose; or for furnishing the services of trained nurses to persons unable to pay for

    them; or for aiding the general body of litigants by improving the efficient

    administration of justice. Educational corporations may include associations whose

    sole purpose is the instruction of the public. But associations formed to disseminate

    controversial or partisan propaganda are not educational within the meaning of the

    law. Scientific corporations include an association for the scientific study of law with

    a view to improving its administration.

    It does not prevent exemption that private individuals, for whose benefit a

    charity is organized, receive the income of the corporation or association. The law

    refers to individuals having a personal and private interest in the activities of the

    corporation, such as stockholders. If, however, a corporation issues "voting shares",

    which entitle the holders upon the dissolution of the corporation to receive the

    proceeds of its property, including accumulated income, the right to exemption ceases

    to exist, even though the by-laws provide that the shareholders shall not receive any

    dividend or other return upon their shares.

    SECTION 31. Business leagues. A business league is an association of

    persons having some common business interest, which limits its activities to work for

    such common interest and does not engage in a regular business of a kind ordinarily

    carried on for profit. Its work need not be similar to that of a chamber of commerce or

    board of trade. If it engages in a regular business of a kind ordinarily carried on for

    profit, the fact that the business is conducted on a cooperative basis or produces only

    sufficient income to be self-sustaining, is not ground for exemption. An association

    engaged in furnishing information to prospective investors, to enable them to make

    sound investments, is not exempt, since its members have no common business

    interest, even though all of its income is devoted to the purpose stated. A clearinghouse association, not organized for profit, no part of the net income of which inures

    to any private shareholder or individual, is exempt provided its activities are limited

    to the exchange of checks, and similar work for the common benefit of its members.

    An association of persons who are engaged in the transportation business, whether by

    land or water, which is designed to promote the legitimate objects of such business,

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    and all of the income of which is derived from membership dues and is expended for

    office expenses is exempt from tax. DSITEH

    SECTION 32. Civic leagues. Civic leagues entitled to exemption

    comprise those not organized for profit but operated exclusively for purposesbeneficial to the community as a whole. In general, organizations engaged in

    promoting the welfare of mankind are exempt from tax.

    SECTION 33. Social clubs. The exemption applies to practically all

    social and recreation clubs which are supported by membership fees, dues, and

    assessments. If a club, by reason of the comprehensive powers granted in the charter,

    engages in business or in agriculture or horticulture, for profit, such club is not

    organized and operated exclusively for pleasure, recreation, or social purposes, and

    any profit realized from such activities is subject to tax.

    SECTION 34. Mutual insurance companies and like organizations. It is

    necessary to exemption that the income of the company be derived solely from

    assessments, dues, and fees collected from members. If income is received from other

    sources, the corporation is not exempt. Income, however, from sources other than

    those specified does not prevent exemption where its receipt is a mere incident of the

    business of the company. Thus the receipt of interest upon a working bank balance, or

    of the proceeds of the sale of badges, office supplies, or equipment, will not defeat the

    exemption. The same is true of the receipt of interest upon Government bonds, where

    they were purchased and were afterwards sold. Where, however, such bonds are

    bought as a permanent investment, the receipt of the interest destroys the exemption.The receipt of what is, in substance, an entrance fee, charged by a mutual fire

    insurance company as a condition of membership, does not render the company

    taxable, although this fee is called a premium. If an organization issues policies for

    stipulated cash premiums, or if it requires advance deposits to cover the cost of the

    insurance and maintains investments from which income is derived, it is not entitled

    to exemption. On the other hand, an organization may be entitled to exemption,

    although it makes advance assessment for the sole purpose of meeting future losses

    and expenses, provided that the balance of such assessments remaining on hand at the

    end of the year is retained to meet losses and expenses or is returned to members. An

    organization of a purely local character is one whose business activities are confined

    to a particular community, place, or district, irrespective, however, of political

    subdivisions.

    SECTION 35. Farmers' cooperative marketing and purchasing

    association. Cooperative associations, acting as sales agents for farmers or others,

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    in order to come within the exemption must establish that for their own account they

    have no net income. Cooperative dairy companies, which are engaged in collecting

    milk and disposing of it or the products thereof and distributing the proceeds, less

    necessary operating expenses, among their members upon the basis of the quantity of

    milk or of butter fat in the milk furnished by such members are exempt from the tax.If the proceeds of the business are distributed in any other way than on such a

    proportionate basis, the company will be subject to tax. A farmers' association is not

    exempt from taxation where in accounting to farmers furnishing produce for the

    proceeds of sales it deducts more than the necessary selling expenses incurred.

    Cooperative associations acting as purchasing agents are not expressly exempt from

    tax, but rebates made to purchasers, whether or not members of the association, in

    proportion to their purchases may be excluded from gross income in computing the

    net income subject to tax. Any profits made from non-members and distributed to

    members in the guise of rebates are, of course, subject to tax.

    Cooperative marketing associations duly incorporated under Act No. 3425,

    known as the Cooperative Marketing Law are exempt from income tax. (See also

    R.A. 702 exempting cooperative marketing associations.)

    (Section 28 of the Code)

    SECTION 36. Meaning of net income. The tax imposed by law is upon

    income. In the computation of the tax, various classes of income must be considered:

    (a) Income, in the broad sense, meaning all wealth which flows into the tax-payer

    other than as a mere return of capital. It includes the forms of income specificallydescribed as gains and profits, including gains derived from the sale or other

    disposition of capital assets. Income cannot be determined merely by reckoning cash

    receipts, for the statute recognizes as income determining factor other items, among

    which are inventories, accounts receivable, property exhaustion, and accounts payable

    for expenses incurred. (b) Gross income, meaning income (in the broad sense) less

    income which is by statutory provision or otherwise exempt from the tax imposed by

    law. (c) Net income, meaning gross income less statutory deductions. The statutory

    deductions are, in general, though not exclusively, expenditures other than capital

    expenditures, connected with production of income. (d) In the case of a taxpayer other

    than a corporation as defined in Section 84 (b) of the Code, net income means gross

    income less exemptions. Ordinarily the net income is to be computed in accordance

    with the method of accounting regularly employed in keeping the books of the

    taxpayer.

    SECTION 37. Computation of net income. Net income must be

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    computed with respect to a fixed period. That period is twelve months ending

    December 31st of every year except in the case of a corporation filing returns on a

    fiscal year basis in which case net income will be computed on the basis of such fiscal

    year. Items of income and of expenditures, which as gross income and deductions, are

    elements in the computation of net income, need not be in the form of cash. It issufficient that such items may be appraised in terms of money. The time as of which

    any item of gross income or any deduction is to be accounted for must be determined

    in the light of the fundamental rule that the computation shall be made in such a

    manner as would clearly reflect the taxpayer's income. If the method of accounting

    regularly employed by him in keeping his books clearly reflects his income, it is to be

    followed with respect to the time as of which items of gross income and deductions

    are to be accounted for, otherwise the computation of net income shall be made in

    such manner as in the opinion of the Commissioner of Internal Revenue would clearly

    reflect it.

    SECTION 38. Bases of computation. Approved standard methods of

    accounting will be ordinarily regarded as clearly reflecting income. A method of

    accounting will not, however, be regarded as clearly reflecting income unless all

    items of gross income and all deductions are treated with reasonable consistency. All

    items of gross income shall be included in the gross income for the taxable year in

    which they are received by the taxpayer and deductions taken accordingly, unless in

    order clearly to reflect income such amounts are to be properly accounted for as of a

    different period. For instance, in any case in which it is necessary to use an inventory,

    no accounting in regard to purchases and sales will correctly reflect income except an

    accrual method. A taxpayer is deemed to have received items of gross income which

    have been credited to or set apart for him without restriction. On the other hand,

    appreciationin value of property is not even an accrual of income to a taxpayer prior

    to the realizationof such appreciation through sale or conversion of the property. (For

    methods of accounting and determination of accounting period, see Sections 166 to

    169 of these regulations.)

    (Section 29(a) of the Code)

    SECTION 39. What gross income includes. Gross income includes, in

    general, compensation for personal and professional services, business income, profits

    from sales of and dealings in property, interests, rents, dividends, and gains, profits,

    and income derived from any source whatever, unless exempt from tax by law. In

    general, income is the gain derived from capital, from labor, or from both combined,

    provided it be understood to include profit gained through a sale or conversion of

    capital assets. Profit of citizens, resident aliens, or domestic corporations derived from

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    sales in foreign commerce must be included in their gross income. Income may be in

    the form of cash or of property. IHDCcT

    For the treatment of dividends for purposes of the tax, see Sections 250 to 256

    of these regulations. For the treatment of capital gains, see Sections 132 to 135 ofthese regulations.

    SECTION 40. Compensation for personal services. Where no

    determination of compensation is had until the completion of the services, the amount

    received is ordinarily income for the taxable year of its determination, if the return is

    rendered on the accrual basis; or, for the taxable year in which received, if the return

    is rendered on a receipts and disbursements basis. Commissions paid salesman,

    compensation for services on the basis of a percentage of profits, commissions on

    insurance premiums, tips, and pensions or retiring allowances paid by private persons

    or by the Government of the United States or of the Philippines (except pensionsexempt by law from tax) are income to the recipients; as are also marriage fees,

    baptismal offerings, sums paid for saying masses for the dead, and other contributions

    received by a clergyman, evangelists, or religious worker for services rendered.

    However, so-called pensions awarded by one to whom no services have been

    rendered are mere gifts or gratuities and are not taxable.

    SECTION 41. Compensation paid other than in cash. Where services

    are paid for with something other than money, the fair market value of the thing taken

    in payment is the amount to be included as income. If the services were rendered at a

    stipulated price, in the absence of evidence to the contrary, such price will bepresumed to be the fair value of the compensation received. Compensation paid an

    employee of a corporation in its stock is to be treated as if the corporation sold the

    stock for its market value and paid the employee in cash. When living quarters are

    furnished in addition to cash salary, the rental value of such quarters should be

    reported as income.

    SECTION 42. Compensation paid in promissory notes. Promissory

    notes or other evidence of indebtedness received in payment for services, and not

    merely as security for such payment, constitute income to the amount of their fair

    market value. A taxpayer receiving as compensation a note regarded as good for itsface value at maturity, but not bearing interest, shall treat as income as of the time of

    receipt the fair discounted value of the note at that time. Thus, if it appears that such a

    note is or could be discounted on a 6 per cent basis, the recipient shall include such

    note in his gross income to the amount of its face value less discount computed at the

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    prevailing rate for such transactions.

    If the payment due on a note so accounted for are met as they become due,

    there should be included as income in respect of each such payment so much thereof

    as represents recovery for the discount originally deducted.

    SECTION 43. Gross income from business. In the case of a

    manufacturing, merchandising, or mining business, "gross income" means the total

    sales, less the cost of goods sold, plus any income from investments and from

    incidental or outside operations or sources. In determining the gross income,

    subtractions should not be made for depreciation, depletion, selling expenses or

    losses, or for items not ordinarily used in computing the cost of goods sold.

    SECTION 44. Long term contracts. Income from long-term contracts is

    taxable for the period in which the income is determined, such determinationdepending upon the nature and terms of the particular contract. As used herein the

    term "long-term" contracts means building, installation, or construction contracts

    covering a period in excess of one year. Persons whose income is derived in whole or

    in par 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 deductedfrom 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 of Internal Revenue 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 sotreat 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.

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    Where 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 to either of the methods above

    set forth. If a taxpayer desires to change his method of accounting in accordance withparagraphs (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.

    SECTION 45. Gross income of farmers. A farmer reporting on the basis

    of receipts and disbursements (in which no inventory to determine profits is used)

    shall include in his gross income for the taxable year (1) the amount of cash or the

    value of merchandise or other property received from the sale of live stock and

    produce which were raised during the taxable year or prior years, (2) the profit from

    the sale of any live stock or other items which were purchased, and (3) gross incomefrom all other sources. The profit from the sale of live stock or other items which

    were purchased is to be ascertained by deducting the cost from the sales price in the

    year in which the sale occurs, except that in the case of the sale of animals purchased

    as draft or work animals, or solely for breeding or dairy purposes and not for resale,

    the profit shall be the amount of any excess of the sales prices over the amount

    representing the difference between the cost and the depreciation theretofore

    sustained and allowed as a deduction in computing net income.

    In the case of a farmer reporting on the accrual basis (in which an inventory is

    used to determine profits), his gross profits are ascertained by adding to the inventoryvalue of live stock and products on hand at the end of the year the amount received

    from the sale of live stock products, and miscellaneous receipts for hire of teams,

    machinery, and the like, during the year, and deducting from this sum the inventory

    value of live stock and products on hand at the beginning of the year and the cost of

    live stock and products purchased during the year. In such cases all live stock raised

    or purchased for sale shall be included in the inventory at their proper valuation

    determined in accordance with the method authorized and adopted for the purpose.

    Also, live stock acquired for drafts, breeding, or dairy purposes and not for sale may

    be included in the inventory, instead of being treated as capital assets subject to

    depreciation, provided such practice is followed consistently by the taxpayer. In caseof the sale of any live stock included in an inventory their cost must not be taken as

    an additional deduction in the return of income, as such deduction will be reflected in

    the inventory.

    In every case of the sale of machinery, farm equipment, or other capital assets

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    (which are not to be included in an inventory if one is used to determine profits) any

    excess over the cost thereof less the amount of depreciation theretofore sustained and

    allowed as a deduction in computing net income, shall be included as gross income.

    Where farm produce is exchanged for merchandise, groceries, or the like, the market

    value of the article received in exchange is to be included in gross income. Rentsreceived in crop shares shall be returned as of the year in which the crop shares are

    reduced to money or a money equivalent. Proceeds of insurance, such as fire and

    typhoon insurance on growing crops, should be included in gross income to the

    amount received in cash or its equivalent for the crop injured or destroyed. If a farmer

    is engaged in producing crops which take more than a year from the time of planting

    to the time of gathering and disposing, the income therefrom may be computed upon

    the crop basis; but in any such cases the entire cost of producing the crop must be

    taken as a deduction in the year in which the gross income from the crop is realized.

    EaICAD

    As herein used the term "farm" embrace the farm in the ordinarily accepted

    sense, and includes stock, dairy, poultry, fruit, and truck farms, also plantations,

    ranches, and all land used for farming operations. All individuals, partnerships, or

    corporations that cultivate, operate, or manage farms for gain or profit either as

    owners, or tenants, are designated farmers. A person cultivating or operating a farm

    for recreation or pleasure, the result of which is a continual loss from year to year, is

    not regarded as a farmer.

    SECTION 46. Sale of patents and copyrights. A taxpayer disposing of

    patents or copyrights by sale should determine the profit or loss arising therefrom bycomputing the difference between the selling price and the cost. The taxable income

    in the case of patents or copyrights acquired prior to March 1, 1913, should be

    ascertained in accordance with the provisions of section 136 of these regulations. The

    profit or loss thus ascertained should be increased or decreased, as the case may be,

    by the amounts deducted on account of depreciation of such patent or copyrights

    since March 1, 1913, or since the date of acquisition if subsequent thereto.

    SECTION 47. Sale of goodwill. Gain or loss from a sale of goodwill

    results only when the business, or a part of it, to which the goodwill attaches is sold,

    in which case the gain or loss will be determined by comparing the sale price with the

    cost or other basis of the assets, including goodwill. If specific payment was not made

    for goodwill acquired after March 1, 1913, there can be no deductible loss with

    respect thereto, but gain may be realized from the sale of goodwill built up through

    expenditures which have been currently deducted. It is immaterial that goodwill may

    never have been carried on the books as an asset but the burden of proof is on the

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    taxpayer to establish the cost or fair market value on March 1, 1913, of the goodwill

    sold.

    SECTION 48. Annuities and insurance policies. Annuities paid by

    religious, charitable, and educational corporations under an annuity contract aresubject to tax to the extent that the aggregate amount of the payments to the annuitant

    exceeds the amounts paid by him as consideration for the contract. An annuity

    charged upon devised land is taxable to a donee-annuitant, whether paid by the

    devisee out of the rents of the land or from other sources. The devisee is not required

    to return as gross income the amount of rent paid to the annuitant, and he is not

    entitled to deduct from his gross income any sums paid to the annuitant. Amounts

    received by an insured as a return of premiums paid by him under life insurance,

    endowment, or annuity contracts, such as the so-called "dividends" of a mutual

    insurance company, which may be credited against the current premium, are not

    subject to tax. Distributions on paid-up policies which are made out of earnings of theinsurance company subject to tax are in the nature of corporate dividends and should

    be included in the taxable income of the individual, without any credit for the amount

    of tax paid by the corporation at source.

    SECTION 49. Improvements by lessees. When buildings are erected or

    improvements made by a lessee in pursuance of an agreement with the lessor, and

    such buildings or improvements are not subject to removal by the lessee, the lessor

    may at his option report the income therefrom upon either of the following bases;

    (a) The lessor may report as income at the time when such buildings orimprovements are completed the fair market value of such buildings or improvements

    subject to the lease.

    (b) The lessor may spread over the life of the lease the estimated depreciated

    value of such buildings or improvements at the termination of the lease and report as

    income for each year of the lease an aliquot part thereof.

    If for any other reason than a bona fide purchase from the lessee by the lessor

    the lease is terminated, so that the lessor comes into possession or control of the

    property prior to the time originally fixed for the termination of the lease, the lessorreceives additional income for the year in which the lease is so terminated to the

    extent that the value of such buildings or improvements when he became entitled to

    such possession exceeds the amount already reported as income on account of the

    erection of such buildings or improvements. No appreciation in value due to causes

    other than the premature termination of the lease shall be included. Conversely, if the

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    building or improvements are destroyed prior to the expiration of the lease, the lessor

    is entitled to deduct as a loss for the year when such destruction takes place the

    amount previously reported as income because of the erection of such buildings or

    improvements, less any salvage value subject to the lease to the extent that such loss

    was not compensated for by insurance. If the buildings or improvements destroyedwere acquired prior to March 1, 1913, the deduction shall be based on the cost or the

    value subject to the lease to the extent that such loss was not compensated for by

    insurance.

    SECTION 50. Forgiveness of indebtedness. The cancellation and

    forgiveness of indebtedness may amount to a payment of income, to a gift, or to a

    capital transaction, dependent upon the circumstances. If, for example, an individual

    performs services for a creditor, who, in consideration thereof cancels the debt,

    income to that amount is realized by the debtor as compensation for his services. If,

    however, a creditor merely desires to benefit a debtor and without any considerationtherefor cancels the debt, the amount of the debt is a gift from the creditor to the

    debtor and need not be included in the latter's gross income. If a corporation to which

    a stockholder is indebted forgives the debt, the transaction has the effect of the

    payment of a dividend.

    SECTION 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 a judgment therefore in a later year, income is realized in that year,

    assuming that the money or property would have been income in the earlier 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.

    SECTION 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

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    account to another. If the income is not credited, but is set apart, such income must be

    unqualifiedly 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.

    SECTION 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 co-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 neverenforced, 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 taxable status as income for the year of the credit. When 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 maturity of the share. TaSEHC

    SECTION 54. Creation of corporate sinking fund. If a corporation in

    order solely to secure payment of its bonds or other indebtedness, places property in

    trust, or sets aside certain amounts in a sinking fund under the control of a trustee who

    may be authorized to invest and reinvest such sums from time to time, the property or

    fund thus set aside by the corporation and held by the trustee is an asset of the

    corporation, and any gain arising therefrom is income of the corporation and shall be

    included as such in its annual return.

    SECTION 55. Acquisition or disposition by a corporation of its own

    capital stock. Whether the acquisition or disposition by a corporation of share of

    its own capital stock gives rise to taxable gain or deductible loss depends upon the

    real nature of the transaction, which is to be ascertained from all its facts and

    circumstances. The receipt by a corporation of the subscription price of shares of its

    capital stock upon their original issuance gives rise to neither taxable gain nor

    deductible loss, whether the subscription or issue price be in excess of, or less than,

    the par or stated value of such stock.

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    But if a corporation deals in its own shares as it might in the shares of another

    corporation, the resulting gain or loss is to be computed in the same manner as though

    the corporation were dealing in the shares of another. So also if the corporation

    receives its own stock as consideration upon the sale of property by it, or insatisfaction of indebtedness to it, the gain or loss resulting is to be computed in the

    same manner as though the payment had been made in any other property. Any gain

    derived from such transaction is subject to tax, and any loss sustained is allowable as

    deduction where permitted by the provisions of Title II.

    SECTION 56. Contributions by shareholders. Where a corporation

    requires additional funds for conducting its business and obtains such needed money

    through voluntary pro rata payments by its shareholders, the amounts so received

    being credited to its surplus account or to a special capital account, will not be

    considered income, although there is no increase in the outstanding shares of stock ofthe corporation. The payments in such circumstances are in the nature of voluntary

    assessments upon, and represent an additional price paid for, in shares of stock held

    by the individual shareholders, and will be treated as an addition to and as a part of

    the operating capital of the company.

    SECTION 57. Sale and retirement of corporate bonds. (1) (a) If bonds

    are issued by a corporation at their face value, the corporation realizes no gain or loss.

    (b) If thereafter the corporation purchases and retires any of such bonds at a price in

    excess of the issuing price or face value, the excess of the purchase price over the

    issuing price or face value is a deductible expense for the taxable year. (c) If,however, the corporation purchases and retires any of such bonds at a price less than

    the issuing price or face value, the excess of the issuing price or face value over the

    purchase price is gain or income for the taxable year.

    (2) (a) If bonds are issued by a corporation at a premium, the net amount of

    such premium is gain or income which should be prorated or amortized over the life

    of the bond. (b) If thereafter the corporation purchases and retires any of such bonds

    at a price in excess of the issuing price minus any amount of premium already

    returned as income, the excess of the purchase price over the issuing price minus any

    amount of premium already returned as income (or over the face value plus anyamount of premiums not yet returned as income) is a deductible expenses for the

    taxable year. (c) If, however, the corporation purchases and retires any of such bonds

    at a price less than the issuing price minus any amount of premium already returned

    as income, the excess of the issuing price minus any amount of premium already

    returned as income (or of the face value plus any amount of premium not yet returned

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    as income) over the purchase price is gain or income for the taxable year.

    (3) (a) If bonds are issued by a corporation at a discount, the net amount of

    such discount is deductible and should be prorated or amortized over the life of the

    bonds. (b) If thereafter the corporation purchases and retires any of such bonds at aprice in excess of the issuing price plus any amount of discount already deducted, the

    excess of the purchase price over the issuing price plus any amount of discount

    already deducted (or over the face value minus any amount of discount not yet

    deducted), is a deductible expense for the taxable year. (c) If, however, the

    corporation purchases and retires any of such bonds at a price less than the issuing

    price plus any amount of discount already deducted, the excess of the issuing price

    plus any amount of discount already deducted (or of the face value minus any amount

    of discount not yet deducted) over the purchase price is gain or income for the taxable

    year.

    SECTION 58. Income of corporation from leased property. Where a

    corporation has leased its property in consideration that the lessee shall pay in lieu of

    other rental an amount equivalent to a certain rate of dividend on the lessor's capital

    stock or the interest on the lessor's outstanding indebtedness, together with taxes,

    insurance or other fixed charges, such payments shall be considered rental payments

    and shall be returned by the lessor corporation as income, notwithstanding the fact

    that the dividends and interest are paid by the lessee directly to the shareholders and

    bondholders of the lessor. The fact that a corporation has conveyed or let its property

    and has parted with its management and control, or has ceased to engage in the

    business for which it was originally organized, will not relieve it from liability to the

    tax. While the payments made by the lessee directly to the bondholders or

    shareholders of the lessor are rentals as to both the lessee and lessor (rentals paid in

    one case and rentals received in the other), to the bondholders and the shareholders,

    such amounts are interest and dividend payments received as from the lessor and as

    such shall be accounted for in their returns.

    SECTION 59. Gross income of a corporation in liquidation. When a

    corporation is dissolved, its affairs are usually wound up by a receiver or trustee in

    dissolution. The corporate existence is continued for the purpose of liquidating the

    assets and paying the debts, and such receiver or trustee stands in the stead of the

    corporation for such purposes. Any sales of property by them are to be treated as if

    made by the corporation for the purpose of ascertaining the gain or loss.

    SECTION 60. Gross income of foreign corporations. The gross income

    of a foreign corporation subject to tax consists of its gross income from sources

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    estate, and other beneficiaries. Any damages recovered by suit or agreement on

    account of such injuries or sickness are similarly excluded from the gross income of

    the individual injured or sick, if living, or of his estate or other beneficiaries entitled

    to receive such damages, if dead.

    SECTION 64. Gifts and bequests. Property received as a gift or

    received under a will or testament or through legal succession, is exempt from the

    income tax, although the income therefrom or income derived from its investment,

    sale, or otherwise is not. An amount of principal paid under a marriage settlement is a

    gift. Neither alimony nor an allowance based on a separation agreement is taxable

    income.

    (Section 30(a) of the Code)

    SECTION 65. Business expenses. Business expenses deductible fromgross income include the ordinary and necessary expenditures directly connected with

    or pertaining to the taxpayer's trade or business. The cost of goods purchased for

    resale, with proper adjustment for opening and closing inventories, is deducted from

    gross sales is computing gross income. Among the items included in business

    expenses are management expenses, commissions, labor, supplies, incidental repairs,

    operating expenses of transportation, equipment used in the trade or business,

    traveling expenses while away from home solely in the pursuit of a trade or business,

    advertising and other selling expenses, together with insurance premiums against fire,

    storm, theft, accident, or other similar losses in the case of a business, and rental for

    the use of business property. A taxpayer is entitled to deduct the necessary expensespaid in carrying on his business from his gross income from whatever source.

    SECTION 66. Traveling expenses. Traveling expenses as ordinarily

    understood, include transportation expenses and meals and lodging. If the trip is

    undertaken for other than business purposes, the transportation expenses are personal

    expenses, and the meals and lodging are living expenses, and therefore, not deducible.

    If the trip is solely on business, the reasonable and necessary traveling expenses,

    including transportation expenses, meals and lodging, become business instead of

    personal expenses.

    (a) If, then, an individual, whose business requires him to travel receives a

    salary as full compensation for his services, without reimbursement for traveling

    expenses, or is employed on a commission basis with no expense allowance, his

    traveling expenses, including the entire amount expended far meals and lodging, are

    deductible from gross income.

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    (b) If an individual receives a salary and is also repaid his actual traveling

    expenses, he shall include in gross income, the amount so repaid and may deduct such

    expenses. aDcHIC

    (c) If an individual receives a salary and also an allowance for meals and

    lodging, as for example, a per diem allowance in lieu of subsistence, the amount of

    the allowance should be included in gross income and the cost of such meals and

    lodging may be deducted therefrom.

    A payment for the use of a sample room at a hotel for the display of goods is a

    business expense. Only such expenses as are reasonable and necessary in the conduct

    of the business and directly attributable to it may be deducted. A taxpayer claiming

    the benefit of the deductions referred to herein must attach to his return a statement

    showing (1) the nature of the business in which he is engaged; (2) the number of days

    away from home during the taxable year on account of business; (3) the total amount

    of expenses incident to meals and lodging while absent from home and business

    during the taxable year; (4) the total amount of other expenses incident to travel and

    claimed as a deduction.

    Claim for the deductions referred to herein must be substantiated, when

    required by the Commissioner of Internal Revenue by record showing in detail the

    amount and nature of the expenses incurred.

    SECTION 67. Cost of materials. Taxpayers carrying materials and

    supplies on hand should include in expenses the charges for materials and suppliesonly to the amount that they are actually consumed and used in operation during the

    year for which the return is made, provided that the cost of such materials and

    supplies has not been deducted in determining the net income for any previous year.

    If a taxpayer carries incidental materials or supplies on hand for which no record of

    consumption is kept or of which physical inventories at the beginning and end of the

    year are not taken, it will be permissible for the taxpayer to include in his expenses

    and deduct from gross income the total cost of such supplies and materials as were

    purchased during the year for which the return is made, provided the net income is

    clearly reflected by this method.

    SECTION 68. Repairs. The cost of incidental repairs which neither

    materially add to the value of the property nor appreciably prolong its life, but keep it

    in an ordinarily efficient operating condition, may be deducted as expense, provided

    the plant or property account is not increased by the amount of such expenditure.

    Repairs in the nature of replacement, to the extent that they arrest deterioration and

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    appreciably prolong the life of the property should be charged against the

    depreciation reserves if such account is kept.

    SECTION 69. Professional expenses. A professional may claim as

    deductions the cost of supplies used by him in the practice of his profession, expensespaid in the operation and repair of transportation equipment used in making

    professional calls, dues to professional societies and subscriptions to professional

    journals, the rent paid for office rooms, the expenses of the fuel, light, water,

    telephone, etc.; used in such offices, and the hire of office assistants. Amounts

    currently expended for books, furnitures, and professional instruments and

    equipment, the useful life of which is short, may be deducted. But amounts expended

    for books, furniture, and professional instruments and equipment of a permanent

    character are not allowable as deductions. SEHTIc

    SECTION 70. Compensation for personal services. Among theordinary and necessary expenses paid or incurred in carrying on any trade or business

    may be included a reasonable allowance for salaries or other compensation for

    personal services actually rendered. The test of deductibility in the case of

    compensation payments is whether they are reasonable and are, in fact, payments

    purely for service. This test and its practical application may be further stated and

    illustrated as follows:

    (1) Any amount paid in the form of compensation, but not in fact as the

    purchase price of services, is not deductible. (a) An ostensible salary paid by a

    corporation may be a distribution of dividend on stock. This is likely to occur in thecase of a corporation having few shareholders, practically all of whom draw salaries.

    If in such a case the salaries are in excess of those ordinarily paid for similar services,

    and the excessive payment correspond or bear a close relationship to the

    stockholdings of the officers or employees, it would seem likely that the salaries are

    not paid wholly for services rendered, but that the excessive payments are a

    distribution of earnings upon the stock. (b) An ostensible salary may be in part

    payment for property. This may occur, for example, where a partnership sells out to a

    corporation, the former partners agreeing to continue in the service of the corporation.

    In such a case it may be found that the salaries of the former partners are not merely

    for services, but in part constitute payment for the transfers of their business.

    (2) The form or method of fixing compensation is not decisive as to

    deductibility. While any form of contingent compensation invites scrutiny as a

    possible distribution of earnings of the enterprise, it does not follow that payments on

    a contingent basis are to be treated fundamentally on any basis different from that

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    insurance or otherwise. When the amount of the salary of an officer or employee is

    paid for a limited period after his death to his widow or heirs, in recognition of the

    services rendered by the individual, such payments may be deducted. Salaries paid by

    employers to employees who are absent in the military, naval or otherservice of the

    Government, but who intend to return at the conclus