SEC. 32. Gross Income. -
(A) General Definition. - Except when otherwise provided in this Title, gross income means all
income derived from whatever source, including (but not limited to) the following items:
(1) Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items;
(2) Gross income derived from the conduct of trade or business or the exercise of a
(3) Gains derived from dealings in property;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of the general professional
Brief Fact Summary. Wood was president of the American Woolen Company. The company adopted a resolution wherein they would pay the tax obligations of
Wood and other officers.
Synopsis of Rule of Law. The discharge of a taxpayer’s obligation by a third party is equivalent to direct receipt by the taxpayer.
Facts. William Wood was president of the American Woolen Company for the years 1918 through 1920. The company instated a policy for 1919 and 1920 wherein
the company would pay the taxes of the president and other company officers. The company paid $681,169.88 for 1918 and $351,179.27 for 1919 on behalf of
Wood. The Board of Tax Appeals held that these amounts paid were income of Wood.
Issue. Were the taxes paid by the company additional income of Wood?
Held. The Supreme Court of the United States affirmed the lower court and holding that the taxes paid were income to Wood.The
Court notes that Wood and other employees received a direct benefit when their tax obligation was discharged by the company.
Wood received a benefit in exchange for his services to the company. This was clearly a taxable gain.
Facts: A landlord repossessed land from a tenant who had defaulted in the eighteenth year of a 99-year lease. During the course of
the lease, the tenant had torn down an old building (in which the landlord’s adjusted basis was now $12,811.43) and built a new one
(whose value was now $64,245.68). The lease had specified that the landlord was not required to compensate the tenant for these
improvements. Thus, the government argued that upon repossession the landlord realized a gain of $51,434.25. The landlord
argued that there was no realization of the property because no transaction had occurred, and because the improvement of the
property that created the gain was not "severable" from the landlord's original capital.
Issue: Whether a landlord does realize a taxable gain when he repossesses property improved by a tenant.
Held:The court held for the government: the value of the improvements was realized by the taxpayer in the year in which the
The improvements, the Court observed, were received by the taxpayer "as a result of a business transaction," namely, the leasing of
the taxpayer's land. It was not necessary to the recognition of gain that the improvements be severable from the land; all that had to
be shown was that the taxpayer had acquired valuable assets from his lease in exchange for the use of his property. The medium of
exchange—whether cash or kind, and whether separately disposable or "affixed"--was immaterial as far as the realization criterion
was concerned. In effect, the improvements represented rent, or rather a payment in lieu of rent, which was taxable to the landlord
regardless of the form in which it was received.
"Severance" is not necessary for realization:
"It is not necessary to recognition of taxable gain that he should be able to sever the improvement begetting the gain from
his original capital. If that were necessary, no income could arise from the exchange of property, whereas such gain has
always been recognized as realized taxable gain."
The Court added that, while not all economic gain is "realized" for taxation purposes, realization does not require that the
economic gain be in "cash derived from the sale of an asset". Realization can also arise from property exchange; relief of
indebtedness; or other transactions yielding profit—e.g. by receiving an asset with enhanced value in a transaction, even
where severance does not occur (i.e. even where "the gain is a portion of the value of property received by the taxpayer in the
Facts: This case is about the refund of a 1971 income tax amounting to P324,255. In its 1971 original income tax return, Smith Kline
declared a net taxable income of P1,489,277 and paid P511,247 as tax due. Among the deductions claimed from gross income was
P501,040 as its share of the head office overhead expenses. However, in its amended return filed on March 1, 1973, there was an
overpayment of P324,255 "arising from underdeduction of home office overhead". It made a formal claim for the refund of the
alleged overpayment. It appears that sometime in October, 1972, Smith Kline received from its international independent auditors,
Peat, Marwick, Mitchell and Company, an authenticated certification to the effect that the Philippine share in the unallocated
overhead expenses of the main office for the year ended December 31, 1971 was actually P1,427,484. It further stated in the
certification that the allocation was made on the basis of the percentage of gross income in the Philippines to gross income of the
corporation as a whole. By reason of the new adjustment, Smith Kline's tax liability was greatly reduced from P511,247 to P186,992
resulting in an overpayment of P324,255. On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on
its claim Smith Kline filed a petition for review with the Court of Tax Appeals. In 1980, the Tax Court ordered the Commissioner to
refund the overpayment or grant a tax credit to Smith Kline. The Commissioner appealed to this Court.
Issue: Whether or not the claim for refund is in order.
Held: Yes. The governing law is found in section 37 of the old National Internal Revenue Code, Commonwealth Act No. 466, which
is reproduced in Presidential Decree No. 1158, the National Internal Revenue Code of 1977 and which reads:
SEC. 37. Income form sources within the Philippines. —
(b) Net income from sources in the Philippines. — From the items of gross income specified in subsection (a) of
this section there shall be deducted the expenses, losses, and other deductions properly apportioned or
allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be
allocated to some item or class of gross income. The remainder, if any, shall be included in full as net income
from sources within the Philippines.
Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to be made to
determine the net income from Philippine sources:
SEC. 160. Apportionment of deductions. — From the items specified in section 37(a), as being derived
specifically from sources within the Philippines there shall be deducted the expenses, losses, and other
deductions properly apportioned or allocated thereto and a ratable part of any other expenses, losses or
deductions which can not definitely be allocated to some item or class of gross income. The remainder shall be
included in full as net income from sources within the Philippines. The ratable part is based upon the ratio of
gross income from sources within the Philippines to the total gross income.
From the foregoing provisions, it is manifest that where an expense is clearly related to the production of Philippine-derived income
or to Philippine operations (e.g. salaries of Philippine personnel, rental of office building in the Philippines), that expense can be
deducted from the gross income acquired in the Philippines without resorting to apportionment. The overhead expenses incurred by
the parent company in connection with finance, administration, and research and development, all of which direct benefit its
branches all over the world, including the Philippines, fall under a different category however. These are items which cannot be
definitely allocated or Identified with the operations of the Philippine branch. For 1971, the parent company of Smith Kline spent
$1,077,739. Under section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can claim as its deductible
share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross income, worldwide,
of the multinational corporation.