INCOME TAXATION

I. INCOME TAX IN GENERAL

A. INCOME
Q. What is meant by income tax?
Ans. The term "income tax" means a tax imposed on taxable income in one taxable year. It is
based on the gross income/taxable income payable yearly by individual persons or corporations.
In income tax on the yearly profit arising from property, profession, trades and offices (Fisher v.
Trinidad, 43 Phil. 981).
Q. (a) What are the systems of income taxation? (b) Discuss the meaning of the global
and scheduler system of taxation. (c) To which system would you say the method of taxation
under the National Internal Revenue Code belongs?
Ans. (a) There are two systems of income taxation: one, is global system; and the other is
schedular system.
(b) Global system of income taxation- is a system employed where the tax system views
indifferently the tax base and generally treats in common all categories of taxable income of the
individual (Tan v. Del Rosario, Jr. 237 SCRA 324, 331). It is a system which taxes all categories
of income except certain passive income and capital gains. It prescribes a unitary but
progressive rate for the taxable aggregate incomes and flat rates for certain passive incomes
derived by individuals.

On the other hand, schedular system of income taxation is a system employed where the
income tax treatment varies and is made to depend on the kind or category of taxable income of
the taxpayer (Tan v. Del Rosario, Jr. 237 SCRA 324, 331). It is a system which itemizes the
different incomes and provides for varied percentages of taxes, to be supplied thereto.
(c) The apparent intention of the current amendatory laws to the income tax law is to
increasingly shift the income tax system toward the schedular approach in the income taxation of
individual taxpayers. On the other hand, the apparent intent of the current amendatory laws to the
income tax law is to maintain, by and large the global treatment on taxable corporations.

Q. What are the basic features of the present income tax system?
Ans. The basic features are:
(1) Progressive.
(2) Global system for taxable corporations and schedular system for individuals.
(3) Uses gross compensation system.

Q. Distinguish between schedular treatment from global treatment as used in income

taxation.
Ans. The two are distinguished on the following points:
(1) Under the schedular treatment, there are different tax rates while under the global treatment
there is a unitary or single tax rate.
(2) Under the schedular treatment, there are different categories of taxable income while under
the global treatment there is no need for classification as all taxpayers are subject to a single rate;
(3) The schedular treatment is usually used in the income taxation of individuals while the
global treatment is usually applied to corporations.
BASIS OF TAXABILITY
Q. In general on what does taxability of income depend as regards individuals? Explain
your answer, citing the incomes taxable under our Income Tax Law.
Ans. The law in levying the tax adopts the most comprehensive tax situs of nationality and
residence of the taxpayer (that renders resident citizens subject to income tax liability on their
income from all sources) and of the generally accepted and internationally recognized income
taxable base (that can subject nonresident aliens and foreign corporations to income tax on their
income from Philippine sources (see Tan v. del Rosario, Jr. 237 SCRA 342, 334).
As regards individuals, the taxability of income depends upon:
(1) citizenship;
(2) residence of the recipient; or
(3) the place where such income is derived.

Q. Under NIRC, what are the kinds of income tax?

Ans. Income tax may be classified as follows:
(1) Tax on individuals (See Title II, Chapter 11, NIRC of 1997).
(2) Tax on corporations (See Title II, Chapter III).
Income tax on estates (i.e. decedent's estate under testate or intestate proceeding) and trust may
be taken into consideration as the third kind/classification.
Q. What are the types of income taxes? Explain the meaning of each.
Ans. They are:
(1) Presumptive income tax- a scale of income taxes is imposed in relation to a group of
person's actual expenditures and the presumed income (Encyclopedia of Social Sciences, Vol. 7,
p. 627).
(2) Composite income tax- a tax consisting of a series of separate quasi-personal taxes, assessed
on the particular source of income with a superimposed personal tax on the income as a whole.
(3) Unitary income tax- incomes are arranged according to source. The separate items are added
together and the rate applied to the resulting total income (Encyclopedia of Social Sciences, Vol.
7, p. 627)..
ACCOUNTING PERIODS
Q. What is an accounting period?
Ans. Accounting period is the taxable year. It is a fixed period of time, consisting of twelve
months, upon the basis of which they taxable income is computed and the income tax imposed.

Q. What are the two kinds of accounting period under the Tax Code?
Ans. They are:
(1) Calendar year- a period of 12 months beginning January 1 and ending December 31 of
every year.
(2) Fiscal year- a period of 12 months ending on the last days of any months other than
December. (Sec. 22 (N) (O) (P) (Q), Tax Code).

CHAPTER VIII Accounting Periods and Methods of Accounting (Tax Code)

SECTION 43. General Rule. The taxable income shall be computed upon the basis of the
taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in
accordance with the method of accounting regularly employed in keeping the books of such
taxpayer; but if no such method of accounting has been so employed, or if the method employed
does not clearly reflect the income, the computation shall be made in accordance with such
method as in the opinion of the Commissioner clearly reflects the income. If the taxpayer's
annual accounting period is other than a fiscal year, as defined in Section 22(Q), or if the
taxpayer has no annual accounting period, or does not keep books, or if the taxpayer is an
individual, the taxable income shall be computed on the basis of the calendar year.

CASES DIGEST
Under the accrual method of accounting, the taxpayer bears the burden of proof of establishing
the accrual of an item of income or deduction.
The correctness or propriety of an accrual must be judged by the facts that a taxpayer knew, or
could reasonably be expected to have known, at the closing of its books for the taxable year.
Accrual method of accounting presents largely a question of fact; such that the taxpayer bears
the burden of proof of establishing the accrual of an item of income or deduction.

C I R vs. Isabela Cultural Corp., G.R. No. 172231, February 12, 2007

Income realized within taxpayer's annual accounting period becomes the basis for computation
of the gross income and the tax liability.
Under the withholding tax system, income is viewed as a flow and is measured over a period of
time known as an "accounting period." An accounting period covers twelve months, subdivided
into four equal segments known as "quarters." Income realized within the taxpayer's annual
accounting period (fiscal or calendar year) becomes the basis for the computation of the gross
income and the tax liability.

Citibank, N.A. vs. Court of Appeals, et al., G.R. No. 107434, October 10, 1997

Accounting methods for tax purposes differentiated from methods for accounting purposes.
While taxable income is based on the method of accounting used by the taxpayer, it will almost
always differ from accounting income. This is so because of a fundamental difference in the ends
the two concepts serve. Accounting attempts to match cost against revenue. Tax law is aimed at
collecting revenue. It is quick to treat an item as income, slow to recognize deductions or losses.
Thus, the tax law will not recognize deductions for contingent future losses except in very limited
situations. Good accounting, on the other hand, requires their recognition. Once this
fundamental difference in approach is accepted, income tax accounting methods can be
understood more easily.

Consolidated Mines, Inc. vs. Court of Tax Appeals, et al., G.R. Nos.
L-18843 & 18844, August 29, 1974

SECTION 44. Period in which Items of Gross Income Included. The amount of all items of
gross income shall be included in the gross income for the taxable year in which received by the
taxpayer, unless, under methods of accounting permitted under Section 43, any such amounts are
to be properly accounted for as of a different period. In the case of the death of a taxpayer, there
shall be included in computing taxable income for the taxable period in which falls the date of
his death, amounts accrued up to the date of his death if not otherwise properly includible in
respect of such period or a prior period.
SECTION 45. Period for which Deductions and Credits Taken. The deductions provided for
in this Title shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred',
dependent upon the method of accounting upon the basis of which the net income is computed,
unless in order to clearly reflect the income, the deductions should be taken as of a different
period. In the case of the death of a taxpayer, there shall be allowed as deductions for the taxable
period in which falls the date of his death, amounts accrued up to the date of his death if not
otherwise properly allowable in respect of such period or a prior period.

CASES DIGEST
ACCRUAL METHOD OF ACCOUNTING
FACTS: The BIR disallowed respondent's claimed expense deductions for professional and
security services for the taxable year 1986; hence, it issued Assessment Notices for deficiency
income tax. The BIR contended that, since respondent uses the accrual method of accounting,
expenses for professional services which accrued in 1984 and 1985, should have been declared
as deductions during said years and failure of respondent to do so bars it from claiming said
expenses as deduction for the taxable year 1986. Both the CTA and the CA cancelled the
Assessment Notices holding that the claimed deductions were properly claimed in 1986 because
it was only in said year when the bills demanding payment were sent to respondent; hence, even
if these professional services were rendered in 1984 or 1985, respondent could not declare the
same as deduction for said years as the amount thereof could not be determined at that time
ISSUE: For taxpayers adopting the accrual method of accounting, when is an expense deemed
to have accrued for purposes of availing the deduction allowed therefor under Sec. 34 of the Tax
Code?
HELD: The accrual method relies upon the taxpayer's RIGHT TO RECEIVE amounts or its
OBLIGATION TO PAY them, in opposition to actual receipt or payment, which characterizes the
cash method of accounting. Amounts of income ACCRUE where the right to receive them
become FIXED; where there is created an ENFORCEABLE liability. Similarly, liabilities are
accrued when fixed and determinable in amount, without regard to indeterminacy merely of time
of payment. The accrual of income and expense is permitted when the ALL-EVENTS TEST has
been met. This test requires: (1) fixing of a right to income or liability to pay; and (2) the
availability of the reasonable accurate determination of such income or liability.
The test does not demand that the amount of income or liability be known absolutely, only that a
taxpayer has at his disposal the information necessary to compute the amount with reasonable
accuracy In the instant case, the expenses for legal services pertain to the 1984 and 1985 legal
and retainer fees of the law firm BengzonZarragaNarcisoCudalaPecsonAzcuna&Bengson. The
firm has been respondents counsel since the 1960s. Respondent can be expected to have
reasonably known the retainer fees charged by the firm as well as the compensation for its legal
services. Failure to determine the exact amount of the expense during the taxable year when they
could have been claimed as deductions cannot thus be attributed solely to the delayed billing of
these liabilities by the firm. For one, respondent, in the exercise of due diligence, could have
inquired into the amount of their obligation to the firm, especially so that it is using the accrual
method of accounting. For another, it could have reasonably determined the amount of legal and
retainer fees owing to its familiarity with the rates charged by their long time legal consultant
Similarly, the professional fees of SGV & Co. for auditing the financial statements of respondent
for the year 1985 cannot be validly claimed as expense deductions in 1986 because respondent
failed to present evidence showing that even with only "reasonable accuracy," as the standard to
ascertain its liability to SGV & Co. in the year 1985, it cannot determine the professional fees
which said company would charge for its services.
The accrual method presents largely a question of fact and the taxpayer bears the burden of
establishing the accrual of an expense or income. Respondent failed to discharge this burden.
Hence, per Revenue Audit Memorandum Order No. 1-2000, they cannot be validly deducted
from respondent's gross income for 1986 and were therefore properly disallowed by the BIR.
C I R vs. Isabela Cultural Corp., G.R. No. 172231, February 12, 2007

SECTION 46 Change of Accounting Period If a taxpayer, other than an individual, changes

his accounting period from fiscal year to calendar year, from calendar year to fiscal year, or from
one fiscal year to another, the net income shall, with the approval of the Commissioner, be
computed on the basis of such new accounting period, subject to the provisions of Section 47.

BIR ISSUANCES
REVENUE REGULATIONS NO. 003-11 March 7, 2011
Policies, Guidelines and Procedures on the Application for Change in Accounting Period of a
Taxpayer
Change of Accounting Period Pursuant to Section 46 of the NIRC of 1997, as amended, if a
taxpayer, other than an individual, changes his accounting period from fiscal year to calendar
year, from calendar year to fiscal year, or from one fiscal year to another, the net income shall,
with the approval of the Bureau of Internal Revenue (BIR), be computed on the basis of such new
accounting period. Whenever a taxpayer changes its accounting period, the taxpayer is required
to file with the BIR a separate final or adjustment return for the period between the close of the
original accounting period and the date designated as the close of the new accounting period.

SECTION 47 Final or Adjustment Returns for a Period of Less than Twelve (12) Months.
(A) Returns for Short Period Resulting from Change of Accounting Period. If a taxpayer,
other than an individual, with the approval of the Commissioner, changes the basis of computing
net income from fiscal year to calendar year, a separate final or adjustment return shall be made
for the period between the close of the last fiscal year for which return was made and the
following December 31. If the change is from calendar year to fiscal year, a separate final or
adjustment return shall be made for the period between the close of the last calendar year for
which return was made and the date designated as the close of the fiscal year. If the change is
from one fiscal year to another fiscal year, a separate final or adjustment return shall be made for
the period between the close of the former fiscal year and the date designated as the close of the
new fiscal year.
(B) Income Computed on Basis of Short Period. Where a separate final or adjustment return is
made under Subsection (A) on account of a change in the accounting period, and in all other
cases where a separate final or adjustment return is required or permitted by rules and regulations
prescribed by the Secretary of Finance, upon recommendation of the Commissioner, to be made
for a fractional part of a year, then the income shall be computed on the basis of the period for
which separate final or adjustment return is made.
SECTION 48. Accounting for Long-term Contracts. Income from long-term contracts shall
be reported for tax purposes in the manner as provided in this Section. As used herein, the term
'long-term contracts' means building, installation or construction contracts covering a period in
excess of one (1) year. Persons whose gross income is derived in whole or in part from such
contracts shall report such income upon the basis of percentage of completion. The return should
be accompanied by a return certificate of architects or engineers showing the percentage of
completion during the taxable year of the entire work performed under contract. There should be
deducted from such gross income all expenditures made during the taxable year on account of
the contract, account being taken of the material and supplies on hand at the beginning and end
of the taxable period for use in connection with the work under the contract but not yet so
applied. If upon completion of a contract, it is found that the taxable net income arising
thereunder has not been clearly reflected for any year or years, the Commissioner may permit or
require an amended return.

Q. What is the rule relative to accounting period in relation to the method of accounting
of a taxpayer?
Ans. The taxable income shall be computed upon the basis of the taxpayer's annual
accounting period (fiscal/calendar) in accordance with the methods of accounting regularly
employed in keeping the books of the taxpayer, but if no such method of accounting has been so
employed or if the method does not reflect clearly the income, the computation shall be made in
accordance with the method as in the opinion of the Commissioner of Internal Revenue does not
clearly reflect the income (Sec. 77, Tax Code).
Q. Is there a uniform method of accounting being prescribed for all taxpayers?
Ans. No. The law contemplates that each taxpayer subject to tax under the Tax Code shall
adopt any form or system of accounting as may fit his purpose and judgment (Sec. 167, Rev.
Regs. No. 2).

Q. (a) What is the general rule on accounting period? (b) Are there exception if any?
Ans. (a) Generally, the taxable income shall be computed in accordance with the method of
accounting regularly employed in the books of the taxpayer.
(b) Yes. The taxable income shall be computed in such a manner as in the opinion of the
Commissioner of Internal Revenue reflects the income:
(1) Where the taxpayer has not employed any method of accounting; and
(2) Where the method of accounting employed by the taxpayer does not really reflect his
income (Sec. 37, Sec.166, Regs. No. 2).

Q. What are the essential requirement in keeping accounting records?

Ans. They are:
(1) Classification of capital and income expenditures.
(2) Where the cost of capital assets is being recovered.
(3) Inventories.
Expenditures made during the year should be properly classified as between capital and
income; that is, the expenditures for items of plant equipment, etc. which have useful life
extending substantially beyond one year should be charge to a capital account and not to an
expense account.
In any case in which the cost of capital assets is being recovered through deductions for wear
and tear, depletion, or obsolescence (other than ordinary repairs) or charge against the
appropriate reserve and not to current expenses.
In all cases to which production purchase or sale of merchandise of any kind is an income
producing factor, inventories of the merchandise on hand including finished goods, work in
process, raw materials and supplies) should be taken at the beginning and end of the year and
used in computing the taxable income of the year (Sec. 167, Regs. No. 2.).
Q. Who are the taxpayers who are to compute their taxable income on the basis of the
calendar year only?
Ans. They are:
(1) Individual taxpayer; (Secs. 46,47. Tax Code).
(2) Estates or trusts (Sec. 6, Tax Code). And
(3) General professional partnerships (Secs. 46,47, Tax Code).

Q. Who are authorized to establish fiscal year as basis for filing their income and
computing their net income?
Ans. Only corporate taxpayers. However, if a corporation does not have an annual
accounting period or does not keep books of accounts, it is required to file return on calendar
year (Sec. 43, Tax Code).

Q. What is taxable year?

Ans. The calendar year, or the fiscal year ending during such calendar year, upon the basis of
which the net income is computed for income tax purposes.
Taxable year includes, in the case of a return made for fractional part of the year, under the
provisions of the Tax Code or under rules and regulations prescribed by the Secretary of Finance
upon recommendation of the Commissioner of Internal Revenue, the period for which such
return is made [Sec. 22(P) Tax Code].

Q. Under the Tax Code and implementing Income Tax Regulations, what are the
recognized accounting methods?
Ans. They are:
(1) Principal methods-
(a) Cash receipts and disbursements methods or cash basis;
(b) Accrual basis; and
(c) Hybrid methods.
(2) Crop year basis (applicable to farmers);
(3) In case of deferred payment sales:
(a) Installment basis;
 (b) Deferred payment basis
(4) In case of long- term contracts- i.e., percentage of completion basis.
(5) In case of leasehold improvements
(a) Income over the term of the lease basis; and
(b) Income in the year of competition basis.
(6) Generally, any method of accounting that correctly reflects the income of the taxpayer for
each taxable year.