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Exclusions are to blame, too.

Exclusions, like deductions from gross income which the President in a policy address said she wanted Congress to eliminate, are significant causes of much of the inequity and distortions in our income tax system. Exclusions are receipts which do not go into the computation of gross income; deductions are items claimed in order to reduce gross income and arrive at net income. Both lower the tax base. But while deductions must be declared in the taxpayer’s return, exclusions do not show up at all. Thus, there is no way fiscal authorities can determine how much revenues the government foregoes by allowing exclusions from gross income.

Exclusions from gross income are enumerated in Section 32(B) of the Tax Code. Some are in the list because they are conceptually not income but are instead mere returns of capital; others because, although conceptually income, they are exempted from tax for some compelling reason; and, still a few because the cost of collecting is too much for so little revenue. A review of the entire list is called for at this time, if only because the government needs to identify new sources of revenue to meet its burgeoning deficit. Definitely, some modifications, if not elimination, is in order.

Take, for example, proceeds of life insurance. Since 1939, proceeds of a life insurance policy paid to beneficiaries upon the death of the insured, despite the obvious increase in the capacity to pay on the part of the beneficiaries, have been not been considered income. In the old case of El Oriente Fabrica de Tobacos v. Posadas (56 Phil. 147), the Supreme Court, following American rulings, held that life insurance was a contract of indemnity and that the benefit to be gained by death has no periodicity. For this reason, Congress did not consider life insurance proceeds income.

Periodicity, however, has long since been abandoned as an essential feature of what is income and the argument that one buys insurance on his own life to indemnify his beneficiary is dubious at best. No man would insure himself and name his wife as beneficiary if he is told that the expected proceeds will not be considered income to his wife because the life of the husband is capital of the wife. But more important, the civil indemnity for life taken in the commission of a crime is now at the level of only P50,000 (People v. Ramirez, G.R. No. 136094, April 20, 2001). Even assuming that the amount judicially fixed is too low and should be multiplied ten-fold, then a persuasive case can be made for exempting from the income tax only the first P500,000 proceeds and subjecting the difference to income tax, even if only to a low rate of 10 percent.

In addition, returns of premiums have also, since 1939, enjoyed exemption from income taxation. The theory is premiums when returned are capital and therefore not subject to a tax on income. The justification, however, ignores the structure of premiums paid for insurance with cash value, say an ordinary life policy. The premiums of cash value is composed in part of payment for protection and in part for savings, which make up the cash value. It is understandable that the part of the premium representing savings, if returned, is not income. But when the cost of protection (which is imbedded in a premium payment) is returned, then the insured in effect got a benefit (i.e. protection) for free. In any language, that benefit should be considered income.

Gifts, bequests, and devises complete the original class of exclusions from gross income since 1939. Again, the reason for their exclusion is the now-abandoned characteristic of periodicity. Others by way of feeble justification also cite the fact that they are subject to either the donor’s tax or the estate tax. Neither rationale is convincing. The reality that cannot be glossed over in that gifts, bequests and devises increase one’s capacity to consume. At the very least, a supplemental tax, additional to the estate and donor’s taxes, should be considered.

At the other end of the exclusion spectrum are items added barely two years ago by the so-called Comprehensive Tax Reform Law. Among these are gains realized from the sale or exchange or retirement of bonds, debentures, and other certificates of indebtedness with a maturity of more than five years and gains realized by the investor upon redemption of shares of stock in a mutual fund.

These items are clearly income and were exempted from tax, upon the advocacy of the financial institutions involved, on the promised objective of our capital market.

The grant of exemption without the necessary changes in the legal environment under which they operate as well as in the practices they follow is fundamentally flawed since capital markets do not develop due to tax concessions alone. A major missing element in our capital development is structural reform that build and enhance investor confidence. The industries that lobbied for these exemptions and got what they wanted must now be asked to demonstrate what they had done along these lines to merit the tax exemption granted to them. My gut feel is that these new exclusions benefited only a few and addressed no more than a one-time need. The capital market is in the quagmire it is in because the major players are not prepared to give up their advantage at the common good.