Publishing the features of Executive Order No. 37 Amending Certain Provisions of the National Internal Revenue Code, as Amended Re: Income Tax

July 31, 1986 REVENUE MEMORANDUM CIRCULAR NO. 26-86 SUBJECT : Publishing the features of Executive Order No. 37 Amending Certain Provisions of the National Internal Revenue Code, as Amended Re: Income Tax TO : All Internal Revenue Officers and Others Concerned For the information and guidance of all concerned, Executive Order No. 37 amended the pertinent income tax provisions of the National Internal Revenue Code to reflect both the format and structural changes required under the 1986 Tax Reform Program in order to improve equity and efficiency in administrative implementation. A. Format Amendments Format changes are incorporated by grouping homogenous provisions together as follows: 1. The tax rate imposition provisions - Sections 21, 22, 24 and 25 prescribe exclusively the pertinent rates of income tax and the taxable base on which such rates are applied. Accordingly, the provisions imposing capital gains taxes on sales of real property and shares of stocks are transferred from Section 34 (which is a definition section) to the abovementioned sections. 2. References to the manner of collection of the tax are deleted from the rate imposition sections which are appropriately provided in Sections 50 and 51 on the payment of tax and withholding of tax at source, respectively . 3. The provision on tax liability of members of general professional partnership was transferred from Section 26 (under the Chapter on the Tax on Corporations) to Section 23 (under the Chapter on Tax on Individuals). 4. The format of the computational provisions are likewise amended. Section 28 is amended so as to define in broad terms the taxable base on which the appropriate income tax rates will be applied. Section 29 groups together all items of gross income. Section 30 is amended to include all deductions in arriving at taxable income, thus, the provisions of Section 21(f) allowing deductions in computing foreign sourced taxable income of nonresident citizens and Section 23 which allows for personal exemptions is transferred to Section 30. B. Structural Amendments 1. The switch from schedular to global system of taxing all categories of income, except certain passive incomes and capital gains, is provided basically in Section 21, which prescribes a unitary but progressive rate for the taxable aggregate income and flat rates for certain passive incomes derived by individuals. Tax on corporations with global features are provided in Sections 24 and 25. 2. Gross income concept is redefined in Section 29 to accommodate the global concept. The term "net income" or "taxable net income" appearing elsewhere in the income tax law is changed to "taxable income", which is now defined in Section 28 in order to clarify the legal concept that the amount on which the rates of tax prescribed in the rate imposition provisions connotes taxable income, whether gross, or net, as the taxable base. To maintain the taxability of gross compensation income without deductions (except personal exemptions) even if aggregated (globalized) with taxable income from other sources, Section 30 was amended to provide nondeductibility of itemized deductions from compensation income. 3. Provisions which are no longer relevant, such as those imposing tax on improper accumulation of surplus (Section 25) and on personal holding companies (Sections 63 to 69) which are intended to compel corporations to distribute their corporate earnings so as to be taxed to shareholders, are repealed. C. Specific Amendments , by section of the Code Sec. 20 : Paragraph (z), a new paragraph was added to clarify the distinction of ordinary income from capital gains the computation of taxable income. This is necessary in order to emphasize the special tax treatment of capital gains. aisa dc Sec. 21 : Paragraph (a) was restructured to effect the change in the system of taxing compensation, business and other income (except certain passive income) from schedular to global income tax system. Under the global system, gross compensation income will be aggregated (globalized) with the net income from business, trade, or profession to arrive at the global taxable income (after allowable exemptions) which taxable will be subjected to a unitary but progressive, graduated rate ranging from 0% to 35%. casia This provision also allows and prescribes the separate computation of the respective income taxes of husband and wife. Married individuals have the option either to consolidate their respective aggregate taxable income and deduct to personal and additional exemptions. Only one graduated rate structure will be applied on the consolidated aggregate taxable income. If they elect to compute their respective incomes separately, each spouse shall claim the personal exemption of P6,000 and either, but not both, may choose to claim the additional exemptions. The respective aggregate taxable income of each will be taxed at the graduated rates of 0%-35% and their total income tax payable is the sum of their individual income tax determined separately. Both, however, should file only one consolidated return. Paragraph (b) is the tax rate proviso applicable to foreign sourced incomes of nonresident Filipino citizens. The portion allowing deductions to arrive at taxable income subject to tax under this paragraph was transferred to the provision, Section 30 as paragraph (m) thereof which allows deductions. Paragraph (c) restructures the tax on certain passive incomes, viz; 1. increasing the tax on interests and royalties from 17 1/2% to 20%. 2. providing for the gradual phase out of the tax on dividends received by an individual from domestic corporations, as well as on the share of an individual in a partnership income subject to corporate income tax: 15% in 1986; 10% in 1987; 5% in 1988; 0% in 1989 and thereafter. Paragraphs (d) and (e) imposing capital gains tax on gains derived from shares of stocks and real property are transferred from Section 34 (f) for clarity. Sec. 22: Paragraph (a) (2): The phrase referring to the manner of collecting the withholding tax is deleted because it is already provided in Section 51. Paragraphs (a) (3) and (b) specifically states that capital gains realized from sale of real property and shares of stock in domestic corporations by nonresident aliens whether or not engaged in trade or business in the Philippines are subject to the same tax on capital gains applicable to residents. Paragraph (e): Last paragraph clarifies that income derived by aliens referred to in paragraphs (c), (d) and (e) from sources, other than services performed for regional or area headquarters, offshore banking units and petroleum service contractors and subcontractors, are subject to the normal income tax rates. Sec. 23 : The provisions of this Section allowing personal and additional exemptions to individuals are transferred to Section 30 under paragraph (1) thereof. Being the nature of deductions, exemptions should be grouped together with the itemized and optional standard deductions allowed in Section 30. cdt The relocation includes the amendments for upward adjustment of personal and additional exemptions as follows: Personal Exemptions Allowable to Individuals EO 999 EO 97 I. Basic Exemption 1. Single individuals or married individuals judicially decreed as legally separated P4,000 P6,000 2. Married Individuals 8,500 12,000 3. Head of a Family (now includes married individuals judicially decreed as legally separated with qualified dependents) 5,500 7,500 II. Additional Exemption 1. For each qualified dependent not to exceed four 3,000 3,000 2. For each qualified dependent Prior to Jan. 1, 1980 1,000 1,000 The additional exemptions for qualified dependents may be availed of by only one of the spouses in cases of married individuals electing to compute their income tax separately. cd The proviso for special additional exemptions of P4,000 shall be allowed if the gross income of a single, married or legally separated individual, or head of family does not exceed the aggregate amount of P20,000. In case of married individuals electing to compute their income tax separately, the claimant shall be the spouse who claims the additional exemptions for dependents. Sec. 24 : Paragraph (a): Reflects the single (one-tier) rate of 35% tax to supersede the two-tier rate (25%-35%) on taxable income derived by domestic corporations. Paragraph (b): Retains the separate taxation of taxable income of private educational institutions at 10%. The amendment also introduces the predominance test for determining whether the income realized by the institution consists mainly of income from the operation of the educational institutions as such; otherwise the institution will be taxed at 35% on its entire taxable educational and non-educational income. Paragraph (c): Clarifies tax treatment of government educational institutions by specifying exemption of said institution under Section 27. This is formerly paragraph (h). Paragraph (d): Reflects different taxation of certain passive incomes of domestic mutual life insurance companies. This is formerly paragraph (f). Paragraph (e) (1): Reflects the increase in the tax of interest from bank deposits, deposit substitutes and royalties from 17 1/2% to 20%. This is formerly paragraph (d). Paragraph (e) (2): Incorporates the provisions of paragraph 34(g) which provides the tax treatment of capital gains from sale of shares of stock as part of the enumeration of all categories of income subject to tax payable by domestic corporations under Section 24. Paragraph (e) (3): This is formerly paragraph (g) (2) which prescribes the tax on incomes under the expanded foreign currency deposit system maintained by domestic corporations. Paragraph (3) (4): Imposes a 0% income tax on intercorporate dividends. This replaces paragraph 24(c) which is repealed. Sec. 25 : The tax on improper accumulation of surplus is essentially a penalty tax designed to compel corporations to distribute corporate earnings so that the said earnings will be taxed to the shareholders. The exemption of dividends from income tax renders the improperly accumulated surplus tax meaningless. Accordingly, the provisions of the tax on improper accumulation of surplus are repealed and replaced with provisions to govern the taxation of foreign corporations which are lifted from Section 24 (b) (2). Paragraph (a) (1) Provides the imposition of a single rate of tax at 35% on taxable income derived by resident foreign corporations from Philippine sources. Paragraph (a) (2): This is formerly a proviso of Section 24 (b) (2) (i) which provides for the taxation of international carriers. The amendment clarifies the definition of gross Philippine billings. Paragraph (a) (3): This is formerly a part of Section 24(f) which reflects the tax on resident foreign mutual life insurance companies. It is amended to reflect different taxation of certain passive incomes of these companies. Paragraph (a) (4): This portion of the present Section 24 (g) (1), providing taxation of offshore banking units was transferred to this paragraph of new Section 25 to reflect its taxation as foreign corporation. Paragraph (a) (6) (A): Reflects the increase in taxation of interest on bank deposits and royalties derived by resident foreign corporations from 15% to 20%. Paragraph (a) (6) (B): Reflects the tax treatment of income under the expanded foreign currency deposit units which is maintained and operated by foreign banks. Paragraph (a) (6) (C): Provides for the taxation of capital gains realized from sales of shares of stocks by resident foreign corporations. This is transferred from Section 34(h). Paragraph (a) (6) (D): Provides for a 0% income tax on dividends received by a resident foreign corporation from a domestic corporation. Paragraph (b): This is formerly Section 24(b) (1) which provides for the tax treatment of incomes of nonresident foreign corporations. Paragraph (b) (2), (3), (4): Provides for the separate tax treatment of certain nonresident foreign corporations. Formerly Section 24(b) (1) (iv), (v), and (vii). Section 24 (b) (1) (vi) referring to tax treatment of non-income earning regional or manila headquarters of multinational in the Philippines is deleted. Paragraph (b) (5) (A): This is formerly Section 24(b) (1) (ii). The amendment provides for the increase in rate of tax on interest on foreign loans received by nonresident foreign corporations from 15% to 20%. Paragraph (b) (5) (B): This is formerly Section 24(b) (1) (iii) which provides for the tax treatment of dividends received by nonresident foreign corporations. Paragraph (b) (5) (C): Provides for the taxation of capital gains realized by a nonresident foreign corporation from the sale or disposition of shares of stocks. This was transferred from Section 34, for clarity. Sec. 27 : Paragraph (1): New paragraph lifted and deleted from the former Section 24(h) to include government educational institutions among tax-exempt entities. Sec. 28 : Defines "taxable income" to clarify the taxable base on which the appropriate income tax rates will be applied. Sec. 29 : Defines gross income under the global concept as a starting point in the computation of taxable income; deletes the item of actual, moral, exemplary and nominal damages received by the employee or heirs pursuant to an agreement arising out of an employee-employer relationship from the enumeration of exclusions from gross compensation income from the exclusion provisions. Sec. 30 : Integrates the provisions of Section 23 as a deduction from gross income under Section 30 (1); reflects upward revision of basic personal exemptions; revises the definition of "head of family" to include legally separated individual with qualified dependents; specifies a proviso for a written agreement between the taxpayer and the Bureau of Internal Revenue as to useful life of property subject to depreciation under Section 30(f); deletes the proviso on non-deductibility of loss from a particular line of business from income derived by an individual from other line or lines of business; deletes the proviso on net-operating loss carryover for individuals. Sec. 35 : Clarifies computation of basis for gain or loss which is not adequately and clearly provided under present provision. Sec. 37 : Incorporates, with amendments, the provision in Section 30(b) regarding the non-deductibility of interest paid or incurred abroad from Philippine source gross income, unless the indebtedness was incurred to provide funds for use in trade or business in the Philippines by a foreign corporation. Sec. 43 : Specifies the manner of payment of capital gains tax on real property on installment basis. Sec. 45 : Amends the manner of filing income tax returns for husband and wife who may compute their income tax separately and takes into account the upward adjustment of personal and additional exemptions for those not required to file an income tax return. Sec. 46 : Specifies the manner of filing income tax returns covering capital gains tax on sales from real property in the case of corporate taxpayers. acd Sec. 50 : Amends the manner of payment of income taxes as affected by the tax reform package. Sec. 51 : Provides for the creditability of taxes withheld under the global system and the non-creditability of taxes withheld on certain passive incomes. Sec. 56 : Adjusts the exemptions applicable to taxable estate and trusts which are taxable in the same matter as individuals. Sec. 61 to 69 : Tax provisions on personal holding companies are deleted. Sec. 82 : Amendment takes into account the non-finality of taxes withheld from wages. The proviso relating to finality was deleted. Sec. 103 : Provides for the non-applicability of donors tax on transfer for insufficient consideration of real properties referred to in Section 21(e). C. Authority to codify . The Commissioner of Internal Revenue is authorized to renumber, codify, consolidate the provisions of the National Internal Revenue Code as amended by prior legislations and Executive Order No. 37, and publish official copies thereof. cd D. Effectivity The Executive Order shall take effect as follows: On August 1, 1986 with respect to the provisions of Sections 21(c), 24(e) (1), 24(e) (4), 25(a) (6) A, 25(a) (6)D, 25(b) (5) A and Section 103 of the National Internal Revenue Code, as amended by Executive Order No. 37; On January 1, 1986 with respect to all other provisions amended by Executive Order No. 37: On or after July 1, 1986 in case of corporation filing their income tax return on a fiscal year basis beginning after July 1, 1986. All Internal Revenue Officials, employees, and others concerned are hereby enjoined to give this Revenue Memorandum Circular the widest publicity possible. (SGD.) BIENVENIDO A. TAN, JR. Commissioner