Why is income subject to tax?

-regarded as the best measure of

taxpayers ability to pay
Chapter 3
Introduction to Income Taxation
Reviewer

Kristel Mae N. Lobas

BS A II-C

What is income for taxation

purposes?
-referred to as gross income
under the NIRC
-gross income simply means
taxable income in laymans term
-Taxable income was defined to
refer to certain itmes of gross
income less deductions and
personal exemptions
-Gross income is any inflow of
wealth to the taxpayer that
increases net worth
Elements of Gross Income
1. It is a return on capital that
increases net worth.
2. It is a realized benefit.
3. It is not exempted by law,
contract or treaty.
Return on Capital
-the return on capital that
increases net worth is income
subject to income tax
-the return of capital merely
maintains net worth hence, not
taxable

Prof. Sonnie Ramos, CPA

The Concept of Income

Capital items deemed with

infinite value
-there are capital items that have
infinite
value
and
anythinh
received as compensation for
their loss is deemed a return of
capital
Examples:
1. Life
2. Health
3. Human Reputation

3. Receipt of money or property

to be held in trust for, or to be
remitted to, another person
Recovery of lost capital vs
Recovery of lost profits
Lost Capital
Decrease net
worth
Recovery of it
merely
maintains
networth

Lost Profits
Does not
decrease net
worth
Recovery of it
increases net
worth, therefore
it is a return on
capital

Taxable recovery of lost profits

-the recovery of lost profits
through insurance, indemnity
contracts or legal suit constitutes
a taxable return on capital
The
following
are
taxable
recoveries of lost profit:
1. Proceeds of crop or livestock
insurance
2. Guarantee payments
3. Indemnity
received
from
patent infringement suit
Realized Benefit
The benefit concept
-the term benefit means any
form of advantage derived by the
taxpayer
-there is benefit when there is an
increase in net worth
-occurs
when
one
receives
income, donation or inheritance
The following are not benefits,
hence not taxable:
1. Receipt os a loan
2. Discovery of lost properties

The realized concept

-the term realized means
earned, meaning there is a
degree of undertaking or sacrifice
from the taxpayer to be entitled
of the benefit.
Requisites
of
a
realized
benefit:
1. There must be an exchange
transaction
2. The transaction involves
another entity, and
3. It increases the net worth of
the recipient
Types of Transfers
1. Bilateral transfers or
exchange, such as:
a) Sale
b) Barter
*referred to as onerous
transactions
2. Unilateral transfers, such
as:
a) Succession - transfer of
property upon death
b) Donation
*referred to as gratuitous
transactions
Under current usage, unilateral
transfers are referred to as
transfers
while
bilateral
transfers are called exchanges.
Benefits derived from onerous
transactions
are
earned
or
realized,
hence,
subject
to

income tax.
Benefits derived from gratuitous
transactions re subject to transfer
tax.

do not cause a loss of capital,

hence compensation income or
service fees is an item of gross
income.

Complex Transactions
-partly gratuitous and partly
onerous
-the gratuitous portion is subject
to transfer tax while the benefit
from onerous transaction is
subject to income tax
What is meant by another
entity?

Basis
of
Exemption
of
Unrealized Income
-income realized in non-cash
properties are, in effect received
in cash
-income received in non-cash
considerations is taxable at the
fair value of the property
received
-exempting income realized in
non-cash considerations would
open a wide avenue for tax
evasion

Natural persons - living persons

Juridical persons - those created
by law
e.g partnership,
corporation
*An entity may be taxable entity
or exempt entity.

Mode of
Benefits

Benefits in the absence of

transfers
-the increase in the wealth of a
taxpayer in the absence of a sale
or barter transaction is not
taxable.
-referred to as unrealized gains
or holding gains

1. Actual receipt
-involves
actual
physical
taking of the income in the form
of cash or property

Examples:
1. Increase
in
value
of
investments in equity or debt
securities
2. Increase in value of real
properties held
3. Increase in value of foreign
currencies held or receivable
4. Increase in value of land due to
dicovery of mineral reserves
Rendering of service
-the rendering of services for
consideration is an exchange but

Receipt/Realization

2. Constructive receipt
-involves no actual physical
taking of the income but the
taxpayer is effectively benefited
Example:
A. Offset
of
debt
in
consideration for the sale of
goods or service
B. Deposit of the income to
the taxpayers checking account
Inflow of wealth without
increase in net worth
-the inflow of wealth to a person
that does not increase his net
worth is not income due to the
total absence of benefit

corporations
Examples:
1. Receipt of property in trust
2. Borrowing of money under an
obligation to return
Not
Exempted
by
Law,
Contract or Treaty
-an item of gross income is not
exempted by the Constitution,
law, contracts or treaty from
taxation
The ff items of income are
exempted by law, hence, not
considered
items
of
gross
income:
1. Income of qualified emloyee
trust fund
2. Revenues of non-profit nonstock educational institution
3. PCSO or lotto winnings
4. SSS, GSIS, Pag-IBIG, PhilHealth
benefits
5. Wages of minimum wage
earners

Classification of citizens:
A. Resident citizen - a Filipino
citizen residing in the Philippines
B. Non-resident citizen
Classification of aliens:
A. Resident alien - an individual
who is residing in the Philippines
but is not a citizen thereof
B. Non-resident alien - individuals
who is not residing in the
Philippines and who is not a
citizen thereof
1. Non-resident aliens
engaged in business (NRAETB) -stay in the Philippines
for more than 180 days
2. Non-resident aliens not
engaged in business (NRANEBT) -with a definite
purpose; stay for not more
than 180 days

Types of Income Taxpayers

A. Individuals
1. Citizen
a. Resident citizen
b. Non-resident citizen
2. Alien
a. Resident alien
b. Non-resident alien
i. engaged in trade or
business
ii. not
engaged
in
trade or business
B. Corporations
1. Domestic Corporations
2. Foreign Corporations
a) Resident
foreign
corporations
b) Non-resident foreign

The General Classification

Rule for Individuals
1. Intention
-the intention of the taxpaper
regarding the nature his stay
within or outside the Phil shall
determine his appropriate
residency classification
2. Lenght of stay
a) stay in abroad for atleast
183 days - non-resident
citizen
b) aliens who stayed for more
than 1 year - resident alien
c) aliens who are staying for
not more than 1 year but
more than 180 days - NRA-

EBT
d) aliens who stayed for not
more than 180 days - NRANEBT
Taxable Estates and Trusts
1. Estate
-refers to the properties,
rights and obligations of a
deceased person not
extinguished by his death
Under judicial
settlement

Under
extrajudicial
settlement
exempt entities

treated as
individual
taxpayer
taxable
*income of properties of the
estate is taxable to the heirs

2. Trust
-arrangement whereby the
grantor transfers property to
the beneficiary, which will be
held ender the management
of a trustee.
Irrevocable
Revocable
trusts
trusts
individual
not taxable
taxpayer
entities, income
taxable on
taxable to the
income
grantor
*when trust agreement is silent
as to revocability, it is considered
as revocable
Corporate Income Taxpayers
Domestic Corporation
-is a corporation that is organized
in accordance with Philippine
laws.
Foreign Corporation

-one organized in a foreign law

1. Resident foreign corporations
(RFC)
-operates
and
conducts
business
in
the
Philippines
through
a
permanent
establishment
2. Non-resident
foreign
corporations (NRFC)
-does not operate or conduct
business in the Philippines
Special Corporations
-are
domestic
or
foreign
corporations which are subject to
special tax or preferentail tax
rates
Other Corporate Taxpayers
1. Partnership
a) General
Professional
Partnership
-excercise of a common
profession, not a taxable
entity
b) Business Partnership
-formed for proft, taxable
2. Joint Venture -a business
undertaking for a particular
purpose, maybe organized as a
partnership or corporation
a) Exempt joint ventures under a service contract
with the govt, tax exempt
like in GPP
b) Taxable joint ventures - all
other
joint
ventures
taxable
3. Co-ownership
-joint ownership of a property
-a co-ownership that is limited
to property preservation/income
collection is not a taxable entity,
the one that reinvests the income
is taxable corporation.
The
General
Rules
in

Income

Taxation

Taxable on income earned

The
Residency
and
Citizenship Rule
Resident citizen and domestic
corporations are taxable on all
income within and without the
Philippines.
Situs of Income
-the place of taxation of income,
the jurisdiction that has the
authority to impose tax upon the
income
Income Situs Rules
Types of income Place
of
taxation
1.
Interest Debtors
Income
residence
2. Royalties
Where the
intangible is
employed
3. Rent income Location of the
property
4.
Service Place where the
income
service
is
rendered

Individual
Within
Witho
Corporate
Withi Withou
Taxpayers
Taxpayers
n
t ut
Resident citizen

Domestic

corporation
Non-resident

Resident
foreign

citizen
corporation
Resident alien

Non-resident

Non-resient
foreign
alien
corporation