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INCOME TAXATION

Income refers to all earnings derived from service rendered, from


capital, or both including gain derived from sale or exchange of personal
or real property classified as either ordinary or capital asset.
Capital denotes the original investment or fund used in order to
generate earnings.
Revenue pertains to all funds accruing to the treasury of the
government derived from tax, donation, grants and any other source.
Taxable income means the pertinent items of gross income specified
in the Tax Code less the deductions, if any, and/or personal and
additional exemptions authorized by such types of income by the Tax
Code or other special laws.
Net worth is equal to total assets minus total liabilities.
Receipts are considered cash collected over a business period.

GROSS INCOME
Gross Income means all income derived from whatever source.
Classification of Gross Compensation Income:
*other classifications not specified*
1. Retirement pay refers to a lump sum payment received by an
employee who has served a company for a considerable period of time
and has decided to withdraw from work into privacy.
2. Separation pay taxable if voluntary and not if involuntary.
3. Thirteenth month pay and other benefits as general rule are taxable
and are not taxable if the total amount received is 30K or less, any
amount exceeding is taxable. [NIRC, Sec. 32 (7)(e)]
4. Fringe Benefits any good, service, or other benefit furnished or
granted by an employer, in cash or in kind, in addition to basic salaries
of an individual.

Characteristics of Taxable Income


1. There must be gain or profit.
2. The gain must be realized or received.
3. The law or treaty does not exclude the gain from taxation.

Passive Income

Income from Sources Within the Philippines

Interest Income is an earning derived from depositing or lending of


money, goods, or credits.

Income Within - comprises earnings from within the Philippine territory.


(Sec. 42 (A) NIRC)
1. Interest
2. Dividends
3. Services
4. Rentals and Royalties
5. Sale of Real Property
6. Sale of Personal Property
Note: As a rule, if income is derived within the Philippines,
such income is taxable within.
Income from Sources Outside the Philippines
Income Without - refers to earnings coming from outside the
Philippines or income derived from foreign countries. (Sec. 42(C) NIRC)
1. Interests
2. Dividends received from nonresident foreign corporation.
3. Compensation for labor or service rendered by overseas contract
workers.
4. Rentals or Royalties from property located outside the Philippines.
5. Gains, profits and income from sale of real property as well as from
personal property located outside the Philippines.
Note: In general, income earned outside the Philippines is taxable only
when the taxpayer is a resident Filipino Citizen or a Domestic
Corporation. Conversely, earnings derived outside the Philippines by
nonresident Filipino Citizens and Foreign Corporations are not subject to
tax in the Philippines.
Income Partly Within and Partly Outside the Philippines
Income Partly Within and Partly Without are earnings from sources
partly within and partly without the Philippines includes gains, profits
and income derived:
a. Transportation or other services rendered partly within and partly
outside
b. Dividend received by a resident citizen from resident foreign
corporation. (Sec. 42 (E) NIRC)
Note: In general, when a income is earned partly from within
and without, only income within is taxable in the Philippines,
except if the taxpayer is a resident citizen or domestic
corporation.
Filipino citizen or a domestic corporation whose income is
derived within and without is generally subject to tax.
Classifications of Income
1. Compensation Income the gain derived from labor.
2. Profession or Business income the value derived from an exercise of
profession, business or utilization of capital including profit or gain
derived from sale or conversion of assets.
3. Passive Income an income in which the taxpayer merely waits for
the amount to come in. (examples provided in Sec. 24 (B) NIRC)
4. Capital gain an income derived from the sale of assets not used in
trade or business.
Tax Accounting Periods
1. Calendar period covers a period from January 1 to December 31 of
the taxable year.
2. Fiscal period covers a period of 12 months which ends on the last
day of any calendar month other that December 31.

Trust Fund is any estate, especially stock, securities, or money which


is held in trust by a person in behalf of another person.

Classifications of Interest Income:


1. Exempt from income tax
2. Subject to final withholding tax 20%
3. Subject to normal tax Corporation-30% while Individual is based on
graduated tax rates 5% - 32%.
Dividend Income is a form of earnings derived from the distribution
made by a corporation out of its earnings or profits and payable to its
stockholders, whether in money or in other property.

Cash Dividend the most common form of dividend. It is valued


and taxable to the extent of amount of money received by the
stockholder. [ 10% final tax ]
Property Dividend a dividend payable in property of an issuing
corporation. It is usually valued and taxable to the extent of the fair
market value of then received at the time of declaration.
Stock Dividend as a general rule, pure stock dividend are not
subject to tax because they simply involve a transfer of the
retained earnings to the paid-in capital account.

Redemption of Stock Dividend


The amount so distributed in redemption or cancellation of the
stock is considered taxable income to the extent that it represents a
distribution of earning or profits. [ Sec. 73 (B) NIRC ]
Bad Debt Recovery
Requisites for deductibility of bad debts:
1.
There must be a valid and existing debt arising from business or
trade of the taxpayer
2.
The debt must be actually ascertained to be worthless and
uncollectible during the taxable year
3.
The debt must be charged off during the taxable year.
Tax Refund or Credit
As a general rule, refunds from taxes paid are taxable except
for the following: Estate or donors tax, Philippine income tax, Stock
transaction tax and VAT, claimed as input tax
Fringe Benefit Tax
.
It is a final tax on the employees income (other than rankand-file) to be withheld by the employer [Sec. 33 (A); Sec. 75 (A),
NIRC].
DEALINGS IN PROPERTY
Dealings in Property refers to the disposal through sale or exchange
of (a) ordinary assets, or (b) capital assets.
A. Ordinary Assets
1. Stock in trade intended for sale in the normal course of business.
2. Real properties acquired by real estate dealers or developers.
3. Properties used in business subject to depreciation provided in
Section 34 (F) of NIRC.
4. Real properties used in trade or business including real property held
for rent.
B. Capital Assets are property of a taxpayer other than ordinary
assets.

1. Stock and securities held by taxpayers other than dealers in


securities.
2. Interest in partnership and joint venture.
3. Goodwill.
4. Real and personal properties not used in trade or business like
residential house and lot, car, jewelries &etc.
5. Investment property

exclusively in international trade shall be


treated as an overseas contract worker.
(ii) Aliens
(a)
Resident aliens
One

who permanently stays in the


Philippines or goes out less than 183
days.
(b) Non-resident aliens
(1) Engaged in trade or business
One who stays in the
Philippines for more
than 180 days.
(2) Not engaged in trade or business
TN: These persons are taxable only on income
derived from sources within.

Note: The sale of real properties and sale of securities are subject to
final taxes. The gain on sale of capital assets other than real properties
and securities is subject to regular income tax.
II. National Internal Revenue Code of 1997, as amended (NIRC)
A. Income taxation
Income is the flow of wealth which goes into the hands of the
taxpayer other than the return of capital.
1. Income tax systems

(iii) Special class of individual employees


(a) Minimum wage earner
The statutory minimum wage earners are
no longer taxable. They are exempted
from payment of income tax.
The
determination of statutory wages is
determined on a regular basis by the
RTWPB. (R.A. 9504, July 2008)

a) Global tax system


This is also known as the totality or the aggregate
approach.The Global System of Taxation of Income follows the
principle that all income are one and the same. There is no
variance as to the type, the purpose, the character and the
kind of income.

(i)
(ii)

b) Schedular tax system


This is also known as differentiated or segregated approach.
The Schedular System of Taxation recognizes that income are
different from each other.
There is a distinction and
differentiation on tax treatment and character. A type of
income is to be differentiated from another type of income.
All income are not one and the same.Also includes the system
of pay-as-you-go

(iii)
c.
d.

c) Semi-schedular or semi-global tax system

3. Criteria in imposing Philippine income tax


a) Citizenship principle
b) Residence principle
c) Source principle
4. Types of Philippine income tax
a) Compensation income
b) Business/Trade/Professional Income
c) Passive Income
One which the taxpayer merely waits for the
amount/income to come in. Examples: Royalties,
Interests, Prizes.
d) Capital Gains
Derived from sale of capital assets (Sec. 22, NIRC)
or properties
5. Taxable period
a) Calendar period
b) Fiscal period
c) Short period
6. Kinds of taxpayers and taxes imposed (Sec. 23, NIRC)
a) Individual taxpayers
(i) Citizens
(a) Resident citizens
Taxable on all income derived from sources
within and without the Philippines.
(b) Non-resident citizens
Taxable only on income derived from sources
within the Philippines. But if working
abroad, taxable only on income derived
from sources within. TN: Seamen who
receives
compensation
for
services
rendered abroad as a member of the
complement of a vessel engaged

Partnerships
In the case of business partnerships, they are taxed like
corporations.
General professional partnerships

e.

Estates and trusts


In the case of estates and trusts, they are taxable like
individuals.
f. Co-ownerships

2. Features of the Philippine income tax law


a) Direct tax
b) Progressive
c) Comprehensive
d) Semi-schedular or semi-global tax system

b) Corporations
Domestic corporations
Foreign corporations
(b) Resident foreign corporations
(c) Non-resident foreign corporations
Joint Venture and Consortium

A.

7. GROSS INCOME
(Sec. 32, NIRC) Sources of income but not limited to the
following:
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 profession;
3.
Gains derived from dealings in property;
4.
Interests;
5.
Rents;
6.
Royalties;
7.
Dividends;
8.
Annuities;
9.
Prizes and winnings;
10. Pensions; and
11. Partner's distributive share from the net income of the general
professional partnership.

B) Exclusions from Gross Income (Exempt from Tax):


(1) Life Insurance.- When you are indemnified for such loss or insurance
proceeds are paid for such loss, what you have is a return of capital.
That is excluded and not subject to income tax.
a.
But if such amounts are held by the insurer under an agreement to
pay interest, then, income is earned by way of the interest but not
on the principal amount covering the proceeds of the policy.
(2) Amount Received by Insured as Return of Premium. - These are
return of premiums. They represent return of capital. They are not
income.
(3) Gifts, Bequests, and Devises. - The value of property acquired by
gift, bequest, devise, or descent: Provided, however, That income
from such property, as well as gift, bequest, devise or descent of
income from any property, in cases of transfers of divided interest,
shall be included in gross income.
(4) Compensation for Injuries or Sickness. - These are forms of
indemnity. These are return of capital. Actual damages in payment
for hospitalization and other medical expenses are not income.
Moral damages are not income. But if they are damages for
payment of loss of income or loss of earning capacity, then, they are
taxable income.
(5) Income Exempt under Treaty. - Income of any kind, to the extent
required by any treaty obligation binding upon the Government of
the Philippines.
(6) Retirement Benefits, Pensions, Gratuities, etc.-

Retirement benefits received under Republic Act No. 7641 (Labor Code)
and those received by officials and employees of private firms, whether
individual or corporate, in accordance with a reasonable private benefit
plan maintained by the employer
REQUIREMENTS FOR EXCLUSION:
(1) The private benefit plan must be registered by the employer of with
the BIR.
(2) Length of service the retiring official or employee has been in the
service of the same employer for at least ten (10) years
(3) Age the retiring official or employee is not less than
fifty
(50)
years of age at the time of his retirement
(4) That the benefits shall be availed of by an official or employee only
once.
Absence of one, the said retirement benefits are taxable.
Suppose there is a higher standard of retirement, which will prevail? If
the employer sets up a higher standard than the one set up by your tax
code, it will be standards of the employer that will be prevail. If you
retire lower than the standards set up required by the tax code, your
retirement it will be taxable.

Any amount received by an official or employee or by his heirs


from the employer as a consequence of separation of such
official or employee from the service of the employer because
of death, sickness or other physical disability or for any cause
beyond the control of the said official or employee.
This refers to separation pay.As a rule, separation pay is taxable. It
becomes excluded when it is payment by reason of death, sickness or
other physical disability or for any cause beyond the control of the said
official or employee.
If you resign and you are given a separation pay, that is taxable
because that is a cause within the control of the employee.
There are resignations which are beyond the control of the
employee such as in the case of mergers or consolidations. The
separation pay given in such circumstances is excluded because despite
the resignation, it is a cause beyond the control of the employee.

The provisions of any existing law to the contrary


notwithstanding,
social
security
benefits,
retirement
gratuities, pensions and other similar benefits received by
resident or nonresident citizens of the Philippines or aliens
who come to reside permanently in the Philippines from
foreign government agencies and other institutions, private or
public.

Payments of benefits due or to become due to any person


residing in the Philippines under the laws of the United States
administered by the United States Veterans Administration.

Benefits received from or enjoyed under the Social Security


System in accordance with the provisions of Republic Act No.
8282.

Benefits received from the GSIS under Republic Act No. 8291,
including retirement gratuity received by government officials
and employees.
As a rule, prizes and awards are taxable. They are excluded in the
instances provided.
(7) Prizes and Awards in Sports Competition. - All prizes and
awards granted to athletes in local and international sports competitions
and tournaments whether held in the Philippines or abroad and
sanctioned by their national sports associations.As a rule, prizes and
awards in sports competition are taxable. They are excluded under the
conditions aforementioned.
(8) 13th Month Pay and Other Benefits. - Gross benefits received
by officials and employees of public and private entities: Provided,
however, That the total exclusion under this subparagraph shall not
exceed Thirty thousand pesos (P30,000) which shall cover:
(i) Benefits received by officials and employees of the national
and local government pursuant to Republic Act No. 6686;
(ii) Benefits received by employees pursuant to Presidential
Decree No. 851, as amended by Memorandum Order No. 28,
dated August 13, 1986;
(iii) Benefits received by officials and employees not covered by
Presidential decree No. 851, as amended by Memorandum Order
No. 28, dated August 13, 1986; and
(iv) Other benefits such as productivity incentives and Christmas
bonus: Provided, further, That the ceiling of Thirty thousand
pesos (P30,000) may be increased through rules and regulations
issued by the Secretary of Finance, upon recommendation of the
Commissioner, after considering among others, the effect on the
same of the inflation rate at the end of the taxable year.
(9) GSIS, SSS, Medicare and Other Contributions. - GSIS, SSS,
Medicare and Pag-ibig contributions, and union dues of individuals.
(10) Gains from the Sale of Bonds, Debentures or other Certificate
of Indebtedness. - Gains realized from the same or exchange or
retirement of bonds, debentures or other certificate of indebtedness with
a maturity of more than five (5) years.
(11) Gains from Redemption of Shares in Mutual Fund. - Gains
realized by the investor upon redemption of shares of stock in a mutual
fund company as defined in Section 22 (BB) of this Code.
8. Optional Standard Deduction:

Before, only individuals engaged in business or practice their


profession, who are citizens and resident aliens (excluding non-resident
aliens) can avail of OSD. The availment of the OSD is also now allowed
to corporations.
It used to be 10% of the gross income. It is now 40% of the gross
income.
9. Personal Exemptions:
Before, we used to have the scaling of the status of the individual
single, head of the family or married. Now, regardless of your status,
you have a personal exemption of P 50,000.

Additional Exemptions:
It used to be P 8,000, maximum of 4. It is now increased to P
25,000, maximum of 4.
10. Resident Citizens income from outside the Philippines:
The foreign income of the resident citizen is not anymore treated as
schedular. It will be treated as global. All income from foreign source is
taxed at 5% to 32%. There is no distinction as to the kind of income, as
long as they are from a foreign source.
11. Corporate income tax
Income in general the rate is 35%. Beginning January 1, 2009),
the corporate income tax will be reduced to 30%.
The rate of 30% of non-resident foreign corporations is at gross
(without the benefit of deductions). For the domestic and resident
foreign corporations, the 30% tax is based on taxable income, with the
benefit of deductions.
The treatment of the foreign source income of a domestic
corporation, regardless of the nature of that income, is at a global rate
of 30%.
In the case of GOCCs, the rule is that they are taxable. Those
which are not taxable are GSIS, SSS, PhilHealth and PCSO. PAGCOR has
been removed under RA 9337 as being exempted. So, PAGCOR is
already taxable.
In the case of proprietary educational institutions and hospitals,
they are subject, as a rule, to the regular corporate income tax. Unless,
under the predominance test, where they are entitled to a 10% tax on
their taxable income provided that the predominant income is the
educational or hospital income. If the predominant income (more than
50%) of the proprietary educational or hospital is from unrelated income
or unrelated business, then, it will be subject to regular rates.
12. MINIMUM CORPORATE INCOME TAX or MCIT
Minimum Corporate Income Tax on Domestic Corporations. (Sec. 27,
NIRC)
A minimum corporate income tax of two percent (2%) of the gross
income as of the end of the taxable year, as defined herein, is hereby
imposed on a corporation taxable under this Title, beginning on the
fourth taxable year immediately following the year in which such
corporation commenced its business operations, when the minimum
income tax is greater than the tax computed under Subsection (A) of
this Section for the taxable year.
Minimum Corporate Income Tax on Resident Foreign Corporations. (Sec.
28, NIRC)
A minimum corporate income tax of two percent (2%) of gross income,
as prescribed under Section 27(E) of this Code, shall be imposed, under
the same conditions, on a resident foreign corporation taxable under
paragraph (1) of this Subsection.

The MCIT applies to both domestic corporations and to the


resident foreign corporations.

In its application, the tax due computed during the tax year at
35% is compared to the 2% of gross income. The tax due
payable is whichever is higher.

When we say that the MCIT applies beginning on the 4 th


taxable year immediately following the year in which the
corporation commenced business, it means that newly
established corporations will not yet be subject to the MCIT.
When the corporation has been in the business and operating
for 4 years or more at the time this tax became effective,
then, that provision is covered.

Prior to RA 9337, the MCIT was annualized you determine


the tax to be paid, whether MCIT or 35%, at the end of the
year. When RA 9337 took effect in 2005, the application of
the MCIT is now on a quarterly basis.

Corporations are required to file quarterly returns. In the case


of corporations subject to MCIT, they have to determine at the
end of the quarter the taxable income computed under the
MCIT and under the 35% rate.

There is no 4th quarter return for you will have the annual
return.
13. Imposition of Improperly Accumulated Earnings Tax. (Sec. 29, NIRC)
The improperly accumulated earnings tax is in addition to your
income tax. This actually operates more as a penalty tax or a surtax. It
is imposed on the improperly accumulated taxable income of the
corporation.
For improperly accumulating earnings beyond the
reasonable needs of the business, the corporation will be subject to 10%
on the improperly accumulated taxable income.
When corporations are set up and it continues to accumulate
profits beyond the reasonable means of the business, the tax code

penalizes these corporations because corporations should not


accumulate beyond its business needs.
It should distribute their
earnings to the stockholders, to the owners of the corporations, whether
individuals or corporations.
Otherwise, if they would accumulate
earnings beyond the reasonable means of the business, then, it would
be penalized and subject at 10% improper accumulated earnings tax on
the basis of improperly accumulated taxable income. This is in addition
to the regular corporate income tax that it will pay.
The improperly accumulated earnings tax shall apply to every
corporation formed or availed for the purpose of avoiding the income tax
with respect to its shareholders or the shareholders of any other
corporation by permitting earnings and profits to accumulate instead of
being divided or distributed.
So as not to be penalized, the corporation has to declare dividends.
If the corporation accumulates earnings, there must be a business
purpose for it not to be penalized.

This penalty tax will not apply to:


Publicly-held corporations; (corporations which are traded in the
stock exchange)
2
Banks and other non-bank financial intermediaries
3
Insurance companies
1

Remember that the distribution of dividends to the individual


taxholders is a taxable distribution, except when the distribution is made
to another corporation where it is tax-free distribution of dividends.
14. DEDUCTIONS (See Sec. 34, 35, 37, and 61)

Prior to RA 9504, corporate taxpayers were only entitled to


avail of the itemized deductions. Now, under RA 9504, both
the individual and corporate taxpayers may avail the itemized
or the optional standard deduction (OSD).