TAXATION

FAR EASTERN UNIVERSITY – MANILA

GROSS INCOME-EXCLUSIONS AND INCLUSIONS (2101)

A. Exclusions from Gross Income

Except when otherwise provided in this “Title”

The term “exclusions” refer to items that are not included in the determination of gross income either because:
• They represent return of capital or are not income, gain or profit;
• They are subject to another kind of internal revenue tax; or
• They are income, gain or profit that are expressly exempt from income tax under the constitution, tax treaty, tax code, or a general or special law.

Note:
Exclusions from gross income are not included in the amount of reportable gross income in the income tax return. The amount of deductions is
initially included in the amount of gross income but is separately presented as deduction against gross income in the income tax return.

ITEMS THAT ARE NOT INCLUDED:

1. Proceeds of life insurance – paid to the heirs or beneficiaries upon the death of the insured. BUT if such amounts are held by the insurer under an
agreement to pay interest thereon, the interest payments included in gross income.

Exercise: After two years from the death of her husband, Nancy Matyas received the proceeds of life insurance of her husband amounting to
P1,254,400 including 12% compounded interest per year. How much is the taxable amount?

2. Return of insurance premium – amount received by the insured, as a return of premiums paid by him, either during the term or at the maturity of
the term mentioned in the contract or upon surrender of the contract. BUT the excess over premiums paid (whether or not in the current year)
included in the gross income.

Exercise: Mrs. Vina Lucena was insured under an endowment policy with value of P500,000. Total premiums paid by her for life insurance policy
was P490,000 from which there was a return of premiums of P40,000. At the maturity of the policy, Mrs. Lucena received P500,000. The income
of Mrs Lucena under the policy is ____

3. Gift, bequest or devise – value of the property received excluded BUT the income from such property is included in gross income.

Exercise: On March 1, 200B, Mayumi received a building property from his parents as inheritance with fair market value of P10,000,000. This
property was acquired for P8,000,000 five years ago by his parents. The monthly rental income of the property is P100,000 with an average
monthly expense of P20,000.Mayumi’s income after expenses, subject to income tax for the year 200B is____

4. Compensation for personal injuries or sickness – amounts received, through accident or health insurance or under Workmen’s Compensation
Acts, plus the amount of damages received, whether by suit or agreement, on account of such injuries or sickness.

Exercise: Mr.Mario was injured in a vehicular accident in 200B. He incurred and paid medical expenses of P20,000 and legal fees of P10,000
during the year. In 200C, he received P70,000 as settlement from the insurance company which insured the car owned by the other party involved
in the accident.

From the above payments and transactions, what is the amount of taxable income accruing to Mr.Mario in 200C?

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, pension, gratuities, etc.

• Those received under R.A. 7641 – The Mandatory Retirement Law (for private firms without retirement trust fund)
• Those received by employees of private employers in accordance with a reasonable private benefit plan;
• Those received as a result of involuntary separation – causes beyond the control of the employee
• Social security benefits, retirement gratuities, pensions etc from foreign government agencies and other institutions, private or public
Benefits due to residents who are US veterans
• SSS benefits
• GSIS benefits

Retirement benefits received under R.A.
No. 7641 and those received by officials
and employees of private firm.
Retirement benefits pursuant to RA 4917 (Private Retirement Benefit Plan)
1. Retiring employee must not be less than 50 years old.
2. Must have been in the service for at least 10 years of the same employer.
3. Exemption must be availed only once.
4. The private benefit plan must be approved by the BIR. (Reasonable private pension plan.)

Retirement benefits under RA 7641 (In the Absence of Retirement Plan)

1. The retiring employee is 60 years old. (The compulsory retirement age of an employee under
the Mandatory Retirement is 65 years old.)
2. He must have served the company for at least 5 years in said establishment.
Any amount received by an official or Any amount received by an official or employee of by his heirs from the employer as a consequence

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 1 of 14

employee as a consequence of separation of separation of such official or employee from the service of the employer because of death,
sickness, or physical disability or for any cause beyond the control of the said official or employee
is not included in the gross income
Social security benefits, retirement The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement
gratuities, pensions and other similar gratuities, pensions and other similar benefits received from foreign government agencies and other
benefits received from foreign institutions, private or public resident or non-resident citizen of the Philippines or aliens who come to
government agencies and other reside permanently in the Philippines are not included in the gross income
institutions, private or public
Social Security System (SSS) Benefits Benefits received from or enjoyed under the Social Security System are not included in the gross
income
Government Service Insurance System Benefits received from the GSIS including retirement gratuity received by government officials and
(GSIS) Benefits employees are not included in the gross income
United States Veterans Administration Payment of benefits due or to become due under United States Veterans Administration are not
Benefits included in the gross income

Exercise: Mr. Mario Matiyaga, 50 year old, rendered service as a security guard of Anscor Corporation. He had a monthly salary of P5,000 before
retirement in October 31, 200x. During the same taxable year he received P500,000 retirement benefits in accordance with reasonable private
benefit plan maintained by Anscor Co.

Required: Compute for the amount to be included in the gross income of Mr. Matiyaga for 200x based on the following independent
assumptions:
1. He received the retirement benefit for the first time after serving for 10 years
2. He received the retirement benefit for the second time
3. He has served the company for 10 non continuous years.

7. Miscellaneous Items

a. Passive income derived from investments in the Philippines in loans, stocks, bonds, or other domestic securities, or from interest on deposits in
banks in the Philippines by:
• Foreign governments
• Financing institutions owned, controlled, or enjoying refinancing from foreign governments
• International or regional financial institutions established by foreign government

b. Income derived from any public utility or from the exercise of any essential governmental function by the Philippine Government or political
subdivision thereof

c. Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only
if:
• The recipient was selected without any action on his part to enter the contest or proceeding; and
• The recipient is not required to render substantial future services as a condition to receiving the prize or award.

d. 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.

e. 13th Month Pay and other benefits of public and private entities – BUT total exclusion under this item not to exceed P90,000.

f. GSIS, SSS, Medicare, PAG-IBIG contributions, and union dues of individuals

(RMC 27-2011)
Contributions to SSS,
GSIS, PHIC and HDMF in
excess of mandatory
contributions are not
exempt from withholding
tax on compensation.
1. Only the mandatory or compulsory contributions of employees to SSS, GSIS, PHIC and HDMF are exempt
from income tax and consequently, from the withholding tax on compensation.
2. The voluntary contributions in excess of what the law requires as mandatory contributions are taxable gross
income of the employee, hence, subject to income tax and withholding tax on compensation.
The exemption from withholding tax on compensation referred to in Section 2.78.1(B)(12) of Revenue Regulations
(RR) No. 2-98 shall apply only to mandatory/compulsory GSIS, SSS, Medicare and Pag-ibig contributions. It does
not include voluntary contributions.

g. Gains from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5)
years.

h. Gains realized by the investor upon redemption of shares of stock in a mutual fund company as defined in Section 22 (BB)

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 2 of 14

 PROBLEMS

Problem 1 : Precious Lara received cash amounting to P1,000,000 plus a house and lot amounting to P3,000,000 for winning as Miss International.
How much is tax exempt from the awards of Miss Lara?

Problem 2 : Onyok Velasco, a national athlete, received the following during the year:

Ramon Magsaysay award P50,000

Athlete of the year award 100,000
Prize – Jolibee raffle 5,000
Prize for winning the silver Olympic medal 500,000
Cash award from Mr. Alfred Lim 250,000
Car from Nissan as a Gift 1,000,000
Winnings – Philippine sweepstake 100,000
Gambling winning 500,000

How much is the the total winnings/awards and prizes not subject to income tax?

Problem 3 : The following earnings were realized from investment in 5 year government bonds:

Interest Income P60,000

Gain from sale of bonds classified as capital asset 140,000

How much is the total taxable income?

Problem4: Mr. Jose Velasco received the following items for the taxable year 200x
Winning from charity horse race sweepstakes from PCSO P500,000
Winnings from gambling, net of P700,000 loss from gambling 800,000
Interest on government debt securities 100,000
Damages awarded by the court for breach of contract
(of which 40% is damages for unrealized profits) 1,000,000
Gains from redemption of shares in mutual fund 300,000
Gain from sale of bonds with maturity of more than five years 60,000
Gifts from friends 200,000

Required compute the total amount of exclusion from gross income

Problem 5: Mr. Allan Cruz received the following:

Return of his life insurance premium paid for 25 years
With annual premium of P15,000 P2,000,000
Proceeds his mother’s life insurance, paid premium for
30 years with annual premium of P5,000 P1,000,000
Cash gift from his missionary friend 50,000
House and lot inherited from his mother 3,000,000
Rent income from house and lot inherited 100,000

Required: Compute for the following

1. Amount to be excluded from gross income.
2. Amount to be included as gross income

Problem 6: The following relates to the compensation income of Ms. Cruz in 20X4:
Compensation P1,900,000
Contribution to SSS, Philhealth, and HDMF
Mandatory contributions 125,000
Voluntary contributions 150,000
Creditable withholding taxes 190,000
Labor union dues 10,000
Advances from company 450,000 (925,000)
Net Compensation P 975,000

What is the total exclusion in gross income?

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 3 of 14

B. INCLUSIONS FROM GROSS INCOME

Meaning of income
• Income means all wealth, which flows into the taxpayer’s hands other than as a mere return of capital
• Income is the gain derived from labor, or from capital, or from both labor and capital, including the gain derived from the sale or exchange of
capital asset

Requisites of a taxable income

a. There must be a gain
b. The gain must be realized or received
c. The gain must not be excluded by law from taxation

Income distinguished from other terms

From capital From receipts
Capital is the fund or property Receipts have reference to all
existing at one distinct time, wealth that flows into the taxpayer,
while income denotes a flow of which includes return of capital.
wealth during a definite period Receipts are broader in scope than
income
From revenue
1. Revenue, as applied to taxation, refers to all the funds or income
derived by the government, whether from tax or any other source while
income, for tax purpose, is employed in its “natural and obvious sense” to
mean money or gain received, coming to a person (natural or juridical)
during a given period of time

2. Revenue is to the government while income is to a person (natural or

juridical)

SEC. 32. Gross Income.

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 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.

Items of gross income explained

(1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items

a. Compensation for personal services

1) Gross compensation income, defined
2) Director’s fee
3) Compensation income in the absence of
employer employee relationship
4) Examples of compensation for services
rendered
Gross compensation income means all remuneration for services performed by an employee by his
employer whether paid in cash or in kind, unless specifically excluded under the Tax Code (e.g.
salaries, wages, emoluments, honoraria, bonuses, allowances, director’s fee)
Director’s fee is part of the gross compensation income if the director is at the same time an
employee of the employer/corporation. If the director is not an employee, the director’s fee is
subject to 8% creditable withholding tax
In the absence of employer-employee relationship, compensation for personal services shall be
considered as gross professional fee (e.g. audit fee received by CPA from his client, lawyer’s
fee)
All kinds of compensation for services rendered constitute gross income. They include:
a. Salaries, wages and fees
b. Commission paid to salesman
c. Compensation for services on the basis of a percentage of profits
d. Commission on insurance premiums
e. Tips
f. Pensions or retiring allowances paid by private pensions or by the government (except pension
exempt from tax) and
g. Marriage fees, baptismal offering sum paid for saying masses for the dead, and other
contributions received by a clergyman, evangelist, or religious worker for services rendered

5) Forms of compensation Forms of compensation Taxable amount

a) Payment made in cash The full amount received
If the services are paid in a medium other b)Service paid for with something other The fair market value (FMV) of the
21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 4 of 14
than money, the FMV of the thing
consideration received is the amount of
compensation.
If compensation is paid in kind such as
stocks of employer, the FMV at the time the
services were rendered is the measure of
compensation.
than money
c) Services rendered at a stipulated price
consideration received
In the absence of evidence to the
contrary, the stipulated price shall be
presumed to be the fair market value
(FMV)

6) Examples of payments in kind Payment in kind Taxable amount

a) Compensation paid to an employee of
a corporation in its stock
b) Promissory note and other evidence
of indebtedness in payment of services,
and not merely as security for such
payment
Fair market value of the stock at the
time the services were rendered by the
employee
a. Promissory note is not interest
bearing
Year received – Fair discounted value
Year collected - Face value less fair
discounted valued

b. Promissory note is interest bearing

Year received – face value
Year collected – Maturity value less
face value
.
Tips and Gratuities Tips or gratuities paid directly to an employee by a customer of the employer that are not accounted
for by the employee to the employer are considered as taxable income subject to basic tax.
However, the same shall not be subject to withholding for the reason that tips are not accounted for
by the employee to the employer (RR 2-98)
Stock Option (SOP) Stock-based compensation has been acknowledged as an effective means of rewarding and
motivating employees, attracting and retaining the best talent, and enhancing employee commitment
and performance.

There are three important events in SOP -
- the grant date, the vesting period and the
exercise date
Stock plans could take various forms. In an SOP, the employee is given the option to purchase a
specific number of shares on specified dates at a specified price which is lower than the market value
of the stocks.
The grant date is the date on which the employee is given a stock option by the employer.
The vesting period is the time that an employee must wait in order to be able to exercise employee
stock options.

Tax Treatment (RMC NO. 79-2014)
Reportorial Requirements:
The issuing corporation shall submit to the
Revenue District Office where it is registered
a statement under oath within 30 days
from the grant of the option indicating the
following:
1. Terms and condition of the stock option
2. Names, TINs, positions of the grantees
3 Book value, fair market value, par value of
the shares subject of the option at the
grant date
4. Exercise price, exercise date and/or
period
5. Taxes paid on the grant, if any
6. Amount paid for the grant, if any
During the exercise period, the issuing
corporation shall file a report on or
before the 10th day of the month
following the month of exercise stating
therein the following:
1. Exercise date
2. Names, TINs, positions of those who
exercised the option
3. Book value, fair market value, par value
of the shares subject of the option at the
exercise date/s
4. Mode of settlement (i.e. cash, equity)
5. Taxes withheld on the exercise, if any
6. Fringe Benefits Tax paid, if any
21. GROSS INCOME INCLUSIONS AND EXCLUSIONS
The exercise date is when the employee/option holder notifies the company that he or she would like
to buy the stock at the strike price/option price indicated in the SOP.
Grant of Option
If the option was granted by the The grantor/employer cannot claim a deduction
employer to its employees and no on grant date. The actual benefit of the employees
payment was received for the grant of cannot be determined yet until the employee
the said option exercises the option. Therefore, no actual expense is
incurred yet by the employer upon grant of the
option.
If the option was granted for a price The full price of the option shall be considered
capital gains, and shall be taxed.
Upon issuance of the Option, the same Stock with par value
amounting to P0.75 on each
is subject to a Documentary Stamp P200, or fractional part thereof, of the par value of
Tax: the stock subject of the option.
Stock without par value
the amount equivalent to
25% of the Documentary Stamp Tax paid upon the
original issue of the stock subject of the option, as
provided for in the Section 175 of the NIRC of 1997,
as amended.
Sale or Transfer of Option
If the option is transferred by the The RMC 79-14 clarified that the sale,
grantee/subsequent owner without barter or exchange of the stock option
any consideration: is subject to capital gains tax.
1. Capital gains tax
2. Donor’s tax If the option was granted without any
consideration, the cost base of the
option for purposes of computing the
capital gains shall be zero.
Page 5 of 14

Exercise of Option
Equity – Settlement Option:
Upon exercise of the option
The benefits (i.e., the difference between
the book value or fair market value,
whichever is higher, at the time of the
exercise of the option and the option
price)
Cash –Settlement Option:
The same rules apply in case of cash-
settlement option. In a cash-settlement
option, the actual delivery of the stock is
not required.
In the event that the option was granted
to a supplier of goods or services.
In the event the option was granted to a
person, natural or juridical, who is not
an employee, or a supplier of goods or
services to the grantor.
.
Exercise: Atty. Anita Lucenario is employed as a corporate-lawyer of FLP, International. In 200B, he received the following from his employment.
Salary
One thousand corporate shares of stock for special service
rendered in October 200A:
Fair market value per share – 200A
Fair market value per share – 200B
Cancellation of debt in lieu of service rendered
Insurance (the company is the beneficiary)
Profit sharing
Required: Compute for the gross taxable compensation income of Mr. Thomas for year 200B.
(2) Gross income derived from the conduct of trade or business or the exercise of a profession
Gross Sales/receipts xxx
Less: sales returns and allowances/sales discount (xxx)
Net Sales/receipts xxx
Less: Cost of sales/services (xxx)
Gross income from operation xxx
Add: Other income:
Other Incidental income xxx
Gross Income xxx
(3) Gains derived from dealings in property
• Sale of Capital Assets Other than Real Property and Shares of Stock that are subject to a special CGT rate.
• The net capital gain realized from the sale of assets classified as capital assets shall be subject to ordinary income tax.
21. GROSS INCOME INCLUSIONS AND EXCLUSIONS
The same shall be treated as a donation
subject to 30% donor’s tax. The basis
shall be the fair value of the option at
the time of the donation.
If provided to rank-and-file employees
shall be subject to withholding tax on
compensation
If such benefit is granted to supervisory
and managerial employees, it will be
subject to FBT.
The difference between the market
value of the stocks at the exercise date
and the option price is paid by the
grantor to the holder of the option.
The difference between the book value
and fair market value -- whichever is
higher at the time of the exercise and the
price fixed on grant date -- shall be
recognized as additional consideration
for the purchases. Hence, the same is
subject to the relevant withholding tax at
source and other taxes applicable.
The difference between the book
value/fair market value of the shares,
whichever is higher, at the time of the
exercise of the stock option and the price
fixed on the grant date, shall be
considered a donation, and shall be
subject to donor’s tax.
P300,000
100
125
50,000
20,000
40,000
Page 6 of 14
GENERAL RULE IN DETERMINING GAIN OR LOSS FROM SALES OR EXCHANGES OF PROPERTY

Computation of gain or loss.

Amount Realized = Sum of money received + FMV of property (other than money received)
Less basis or Adjusted Basis
Gain or loss.

Basis – General Rules

1. The cost thereof in the case of property acquired on or after March 1, 1913, if such property was acquired by purchase; or
2. The fair market price or values as of the date of acquisition, if the same was acquired by inheritance; or
3. If the property was acquired by gift, the basis shall be the same as it would have been in the hands of the donor or the last preceding owner by
whom it was not acquired by gift, except that if such basis is greater than the fair market value of the property at the time of the gift then, for the
purpose of determining loss, the basis shall be such fair market value; or
4. If the property was acquired for less than an adequate consideration in money or money’s worth, the basis of such property is the amount paid by
the transferee for the property; or
5. The basis as defined in paragraph (C) (5) of this Section, if the property was acquired in a transaction where gain or loss is not recognized under
paragraph. (c) (2) of this Section.

(4) Interests

1) Included in interest income
2) Subject to final tax
3) Exempt from income tax
4) Interest income or yield
Interest includes such interest arising from indebtedness, whether business or non-business. Unless
exempted by law, interest received by taxpayer, whether or not usurious, are taxable.
Interest income subject to regular income tax, not to final tax:
a. Lending activities, whether or not in the course of business
b. Investment in bonds
c. Promissory notes
d. Foreign sources, whether bank or non-bank
e. Penalty for legal delay or default
Interest income from Philippine sources subject to final tax (not included in the taxable net income
subject to tax rates in general)
a. Interest from any currency bank deposit
b. Yield or any other monetary benefit from deposit substitute
c. Yield or any other monetary benefit from trust funds and similar arrangements
d. Interest income received from a depository bank under expanded foreign currency deposit system
e. Interest income from long-term deposit or investment evidenced by certificates prescribed by
Bangko Sentral ng Pilipinas if pre-terminated before fifth year.
Interest income from Philippine sources exempt from tax:
a. Interest income received from a depository bank under expanded foreign currency deposit system
by non-resident (individual or corporation)
b. Interest income from long-term deposit or investments evidenced by certificates prescribed by
Bangko Sentral ng Pilipinas received by individual (RC, NRC, RA, NRA-ETB)
Recipient
Individuals DC/RFC
Source of interest income Individuals Corporations
Short-term deposit Pre-terminated: 30% (Regular tax)
4 yrs to < 5 yrs
5%
3 yrs to < 4 yrs
12%
< 3 yrs
20%
Long-term deposits/investment certificates Exempt* 30% (Regular tax)
Note* exemption does not include NRA-NETB (25%)
NRFC – 30% Final tax

Short term deposits – are those made for a period of less than five years.

Long term deposits or investment certificates – refer to certificate of time deposit or investment in
the form of savings, common or individual trust funds, deposit substitutes, investment management
accounts and other investments with a maturity of not less than five years the form of which shall be
prescribed by the BSP and issued by banks only (not by non-bank financial intermediaries or finance
companies) to individuals in denomination of P10,000 and other denominations as may be prescribed
by the BSP. (RMC 18-2011)
5) Foreign currency deposit with foreign Taxpayer Individuals Corporations
currency depository banks Residents 15% 15%
Non-residents Exempt Exempt
.
Joint Accounts on Forex Deposits – if the bank account is jointly in the name of the non-resident and a
resident taxpayer, 50% of the interest shall be exempt while the other 50% shall be subject to the 15%
final tax (RR 10-98)
6) Income derived under expanded DC RFC NRFC
foreign currency deposit system by From foreign currency transactions with nonresident, OBUs in the Exempt Exempt Exempt
depository bank Philippines, local commercial bank including branches of foreign
banks
From foreign currency loans granted to resident other than OBUs 10% 10% Exempt
21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 7 of 14
 in the Philippines and other depository bank

(5) Rents

1. Income of lessor under lease agreement

Payment Made Lessor Lessee
Rent Income Expense
Obligation of lessor to third person paid by Income Expense
lessee to third person
Advance rent Income in full in the year received regardless Expense to be prorated over the period
of accounting method used covered regardless of accounting method
Leasehold improvement Income reported under lump sum or annual Expense (depreciation) over the term of the
method lease or estimated life whichever is shorter

2. Advance payment not representing rent

Loan Advance payment representing loan to the lessor is not taxable unless applied to unpaid rent.
Security Deposit Advance payment representing deposit is not taxable unless violation in the lease contract
arises.

3. Leasehold Improvement
Additional income to the lessor
Recognition of income from
improvement
a. Lump sum or outright method
b. Annual or spread out method
1. Computation of annual income
Leasehold improvement is a source of additional income to the lessor if it shall become his upon
the expiration of the lease contract
leasehold
Lessor may report as income, at the time when such buildings or improvements are completed,
the fair market value (FMV) of such buildings or improvements subject to lease.
(Depreciated value at the end of the lease term)
Cost of leasehold improvement xx
Less: Acc. Dep (remaining term of lease) (xx)
Book value, end of lease xx

Annual income:
Book value, end of lease xx
Remaining term of lease

2. Computation of income resulting from FMV of improvement when lessor took possession xx
premature termination of lease Less: Amount already reported as income (xx)
Income, year of termination xx
3. Computation of loss due to destruction Amount already reported as income xx
of leasehold improvement before the Less: Insurance recovery*** xx
term of the lease expires Salvage value xx (xx)
Loss (xx)

***To the extent that such loss was not compensated for by insurance.

Exercise A: Ria leased a facility from Cathy Company. Part of the lease agreement is for Ria to improve facility. Details of the
improvement were as follows:
Cost of construction (Improvements) P10,000,000
Estimated useful life of improvements 20 years
Remaining terms of the lease 10 years
What amount, if any, should Cathy Company report as income from leasehold improvements under the following independent
assumptions?
a. The income from the improvements is to be reported in one lump sum amount_____
b. The income from the improvements is to be reported annually_____

Exercise B: In connection from Problem A: Assume the income from the improvements is to be reported annually. However, at the
beginning of the 6th year, both parties agreed to terminate the lease agreement. Consequently, Cathy took possession of the improvements.
The fair value of the improvements at that time was P3,500,000. What amount should Cathy report as income from improvements on the
6th year of the lease agreement?

(6) Royalties
21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 8 of 14
1. Subject to final tax Royalties from Philippine sources
2. Subject to tax rates in general Royalties from foreign sources
Recipient
Royalties Source of passive Individuals Corporations
royalties
Notes: Books, literary works and 10% final tax 20% final tax
1. If the royalties are received in active pursuit musical compositions
of business, it is subject to 30% RCIT. Other sources 20% final tax*** 20% final tax ***
Notes:
2. If royalties are considered as passive income, 1. *** Under the regulations, the 10% preferential royalty final tax on books and literary
these are subject to 20% final withholding works pertain to printed literatures. Royalties on books sold on e-copies or CDs such as e-
tax. books are subject to the 20% final tax.
2. Royalties on cinematographic films and similar works paid to NRA-ETBs, NRA-NETBs or
NRFCs is subject to a final tax of 25%.

(7) Dividends

1) Difference between direct and indirect Direct dividend – is one where the paying corporation acknowledges that the distribution is a
dividend dividend payment

Indirect dividend – is a distribution of profits disguised as payment of services, properties, etc

2) Dividend/shares in net income subject to a) Cash and / or property dividends actually or constructively received by individual from
final tax domestic corporation or from a joint stock company, insurance or mutual fund company
Recipient of dividends and regional operating headquarters of multinationals.
Source of Individuals Corporations b) Inter-corporate dividends received from domestic corporation by non-resident foreign
dividen corporation.
ds c) Share of an individual in the distributable net income after tax of a partnership (other than a
Domestic 10% final Exempt** general professional partnership) of which he is a partner.
Corpora tax* d) Share of an individual in the net income after tax of an association, a joint account, or a
tion joint venture or consortium taxable as a corporation of which he is a member or co-
Foreign Regular Regular rate venturer.
Corpora rate
tion
*A NRA-ETB is subject to a 20% final tax on
dividend, not to the usual 10%; but an NRA-
NETB is subject to a 25% final tax.
** A NRFC is not exempt but is subject to the
30% general final tax rate. However, the
imposable dividend tax shall be 15% when the
tax sparing rule applies.
3) Dividends/shares in net income subject to a) Dividends from foreign corporation
tax rates in general b) Share in the net income of a general professional partnership
4) Dividends that are exempt from tax Inter-corporate dividends received from domestic corporation by other domestic corporation
and resident foreign corporation.

(8) Annuities

1) Annuities An annuity is a specified income payable at stated intervals for a fixed or a contingent period, often
for the recipient’s life, in consideration of a stipulated premium paid either in prior installment
payments or in a single payment
2) Non-taxable annuity Annuity representing return of premium
3) Taxable annuity Excess of the amount returned as premium

(9) Prizes and winnings

1) Subject to tax rates in general a) Prizes and winnings from foreign sources received by individuals and corporations
b) Prizes and winnings from Philippine sources received by corporations
c) Prizes from Philippine sources received by individuals amounting to P10,000 or less.
2) Subject to final tax Subject to 20% final tax
Recipient a) Prizes received by individual from Philippine sources (except prizes amounting to P10,000 or
Amount Individuals Corporations less which shall be subject to tax under Sec. 24 (a))
taxable b) Other winnings of individual from Philippine sources (except Philippine Charity sweepstakes
prize and Lotto winnings).
Prize 20% final Regular tax
exceeding tax Subject to 25% final tax
21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 9 of 14
 P10,000 Prizes and other winnings ( including PCSO and Lotto Winnings***) received by NRA-NETB
Prize not Regular Regular rate
exceeding rate *** Section 25 (B) of the tax code provides there shall be levied, collected and paid for each
P10,000 taxable year upon the entire income received from all sources within the Philippines by
every NRA-NETB within the Philippines as interest, dividends, rents, salaries, wages,
Recipient premiums, annuities, compensation, remuneration, emoluments, or other fixed/determinable
Type of Individuals Corporations annual or periodic or casual gains, profits, and income, and capital gains, a tax equal to
winnings twenty five percent (25%) of such income.
(winnings to Exempt Exempt
P10,000 or Note: Prizes and other winnings of corporations are not subject to final tax but included as part
less of their gross income.
Philippine
Charity
Sweepstakes NRA- NRA-
RES/CIT DOM RFC NRFC
and Lotto ETB NETB
winnings) Other winnings and
Regular Regular
Other 20% final Regular rate PCSO & Lotto – 20% 20% 25% 30%
rate rate
winnings, tax taxable above P10,000
in general
3) Exempt/excluded from gross income a) Philippine Charity Sweepstakes and Lotto Winnings if P10,000 or less

b) Prizes and awards made primarily in recognition of achievements in the followings fields:
1. Religion
2. Charitable
3. Scientific
4. Educational
5. Artistic
6. Literary
7. Civic
Conditions for the exemption of prizes and awards:
a. The recipient was selected without any action on his part to enter the contest or
proceedings
b. The recipient is not required to render substantial future services as a condition to receiving
the prize or award

c) All prizes and awards granted to athletes to local and international sports competitions and
tournaments whether held in the Philippines or Abroad and sanctioned by their national
sports association

(10) Pensions

A. Exclusion from gross income:
Retirement Benefits – Requisites:
• Retirement benefits pursuant to RA 4917 (Private Retirement Benefit Plan)
1. Retiring employee must not be less than 50 years old.
2. Must have been in the service for at least 10 years of the same employer.
3. Exemption must be availed only once.
4. The private benefit plan must be approved by the BIR. (Reasonable private pension plan.)

• Retirement benefits under RA 7641 (In the Absence of Retirement Plan)

B. Exclusion from gross income:
Separation Pay – Separation of employee
from service must be due to:
1. The retiring employee is 60 years old. (The compulsory retirement age of an employee under the
Mandatory Retirement is 65 years old.)
2. He must have served the company for at least 5 years in said establishment.
1. Death, Sickness, Physical Disability.
2. Any cause beyond the control of the employee. (Examples: dismissal due to installation of labor
saving device, retrenchment, bankruptcy and redundancy.)

DOCUMENTARY REQUIREMENTS (RMO NO. 66-2016)

In order to facilitate the processing of requests for tax exemption of separation benefits received by officials/employees or his/her heirs as a result of
their separation from employment due to death, sickness or other physical disability or for any cause beyond the control of said officials or
employees, regardless of age and length of service, the following documents are required to be submitted to the Revenue District Office (RDO)
or appropriate Large Taxpayers (LT) Office where the employer is originally registered, to support such request:

1. Letter request from the Official/Employee (or by his heirs) or the Employer for the exemption of separation benefits from income tax and
withholding tax;
2. Death Certified true copy of Death Certificate;
3. Sickness/Physical a. Sworn Affidavits to be executed by the employer's physician or the employee's attending physician and the Head
Disability of Office/Entity or his representative, attesting to the fact that the retiring/separated official or employee is
suffering from a serious illness or physical disability that affects the performance of his duties and endangers his
life, if he continues working;

b. Clinical Record of the official/employee concerned indicating the history of illness/physical disability and initial
diagnosis; and

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 10 of 14

 c. Laboratory examination confirming the illness suffered by such official/employee or medical certificate
confirming the physical disability of the official/employee.
4. Installation of a. Written notice to the employee and the appropriate Regional Office of the Department of
Labor-saving Devices Labor and Employment (DOLE) at least thirty (30) days before the effectivity of termination, specifying the ground for
termination.

b. Board Resolution, in case of a juridical entity, or sworn affidavit to be executed by the owner, in case of
a sole proprietor, stating the following:
• That there has been an introduction of machinery, equipment or other devices, with brief description of the use of
said machinery, equipment or device;
• That the introduction of the machinery, equipment or other device has been done in good faith and for valid
reason;
• That there is no other option available to the employer than the introduction of machinery, equipment or other
device; and
• That the selection of employees to be terminated has been made in accordance with a fair and reasonable criteria.
5. Redundancy a. Written notice to the employee and the appropriate Regional Office of the Department of Labor and
Employment (DOLE) at least thirty (30) days before the effectivity of termination, specifying the ground for
termination.

b. Board Resolution, in case of a juridical entity, or sworn affidavit to be executed by the owner, in case of a sole
proprietor, stating the following:
• That there has been superfluous positions or services of employees;
• That the positions or services are in excess of what is reasonably demanded by the actual requirements of the
enterprise to operate in an economical and efficient manner;
• That the redundant positions have been abolished in good faith; and
• That the selection of employees to be terminated has been made in accordance with a fair and reasonable criteria.

c. Adequate proof of redundancy such as but not limited to the new staffing pattern, feasibility studies/proposal, on
the viability of the newly created positions, job description and the approval by the management of the
restructuring.
6. Retrenchment a. Written notice to the employee and the appropriate Regional Office of the Department of Labor and
Employment (DOLE) at least thirty (30) days before the effectivity of termination, specifying the ground for
termination.
b. Board Resolution, in case of a juridical entity, or sworn affidavit to be executed by the owner, in case of a sole
proprietor, stating the following:
• That the retrenchment is reasonably necessary and likely to prevent business losses;
• That the losses, if already incurred, are not merely de minimis, but substantial, serious, actual and real, or if only
expected, are reasonably imminent, with appropriate supporting evidence of said losses;
• That the retrenchment is made in good faith for the advancement of its interest and not to defeat or circumvent the
employees’ right to security of tenure; and
• That the selection of employees to be terminated has been made in accordance with a fair and reasonable criteria.
7. Closure or a. Written notice to the employee and the appropriate Regional Office of the Department of Labor and
Cessation of Employment (DOLE) at least thirty (30) days before the effectivity of termination, specifying the ground for
Operation termination.
b. Board Resolution, in case of a juridical entity, or sworn affidavit to be executed by the owner, in case of a sole
proprietor, stating the following:
• That the management has decided to close or cease operation of the company;
• That the closure or cessation of operation has been made in good faith; and
• That there is no other option available to the employer except to close or cease operation.
C. Terminal leave pay of Government “Commutation of leave credits” is applied for by an officer or employee who retires, resigns or is
Employees: separated from the service through no fault of his own.

Not being part of the gross salary or income of a government official or employee but a retirement
benefit, terminal leave pay is not subject to income tax.

Terminal Leave Benefits (SL/VL)

1. EO 291 provides that terminal leave benefits of government employees are exempt from tax
2. For private employees, if terminal leave benefits are paid upon retirement, such benefits are
exempt from income tax.
(11) Partner's distributive share from the net income of the general professional partnership.

Share from the net income of the General
Partnership
Share from the net income of the General
Professional Partnership
Under Sec. 73 of the NIRC, the net income of these entities is deemed constructively received
by the partners, members or venturers, respectively, in the same year the net income is
reported. Hence, the 10% final tax applies at the point of determination of the income-
not at the point of actual distribution.
Partner’s distributive share from the net income of the general professional partnership
(Subject to Section 24 (a))

Income from whatever source

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 11 of 14

1) Example of income from whatever
source
2) Damage recovery
3) Forgiveness of debt
Not Subject to income tax nor donor tax:
(Debt restructuring) The gain resulting
from condonation of a company’s debts to
its various creditors pursuant to a court-
approved debt restructuring is not subject
to income tax. Likewise, the creditors will
not be subject to donor’s tax since the
condonation was not implemented with a
donative intent but only for business
consideration. The restructuring was not a
result of the mutual agreement of the
debtors and creditors. It was through
court action that the debt rehabilitation
plan was approved and implemented. (BIR
Ruling No, DA28-2005)
4) Bad debt recovery
5) Tax Refunds
1. Gains arising from expropriations of property
2. Gambling gains
3. Income from illegal business or from embezzlement
4. Damage recovery (compensation from damages)
5. Forgiveness of debt
6. Bad debt recovery
7. Tax refunds
8. Prizes and awards
1. Recovery of lost profit is taxable
2. Recovery of lost capital is not taxable
Condonation of Debt
1. Debtor rendered services to the creditor – income to the debtor (subject to income tax)
2. No services rendered – taxable gift to the creditors as gift given to the debtor (taxable indirect gift)
(subject to donor’s tax)
3. Creditor is a corporation while the debtor is a stockholder – it has the effect of a payment of
dividend (subject to final tax)
Citizen 10%
Resident alien 10%
NRA – ETB 20%
NRA – NETB 25%
4. Creditor is the stockholder while the debtor is the corporation – amount condoned is considered as
an additional investment
Recovery of Bad Debt previously deducted (application of the tax benefit rule)
a. Taxable – if deduction of bad debt has reduced the tax liability of taxpayer (Tax Benefit Rule)
b. Not Taxable – if there is no reduction in the tax liability of the taxpayer
1. If the refunded tax is a deductible tax, the tax refund is taxable
2. If the refunded tax is not deductible tax, the tax refund is not taxable

Non-deductible taxes:
1. Philippine income tax (except fringe benefit tax)
2. Transfer taxes –Estate tax and Donors tax
3. Special assessment
4. Foreign income tax if claimed as tax credit
5. Value added tax
6. Stock transaction tax
a. 6/10 of 1%
b. % tax on public offerings

Gross income from farming:

Cash method of accounting Accrual method of accounting
Revenue:
Livestock and farm product raised xxx Xxx
Livestock and farm product purchased xxx Xxx
Miscellaneous income xxx Xxx
Farm equipment sold Xxx
Less: Book value of equipment sold Xxx xxx Xxx
Cost:
Cost of lives stock purchased (xxx) (xxx)
Add: increase by inventory Xxx
Gross income Xxx Xxx
Less: Livestock and farm product expenses (xxx) (xxx)
Taxable income xxx Xxx
 Gross income is the selling price less book value on:
o Sale of draft, breeding or dairy animals
o Sale of farm machinery and equipment
 Proceeds of insurance on growing crop destroyed is included in gross income.

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 12 of 14

Exercise: X Corporation received the following refunds during the taxable year:
Licensing fee P 30,000
Registration fees of delivery trucks 4,000
Donor’s tax 50,000
Real estate tax 5,000
Community tax 3,000
Special assessment 10,000
Corporate income tax 150,000
Foreign income tax previously claimed as tax credit 60,000
Foreign income tax previously claimed as deduction 80,000
Value-added tax 120,000

How much is the tax benefits on the tax refunds?

PROBLEMS

Problem 1: Determining the Taxability of an Item

Indicate whether the item is taxable or nontaxable with income tax

1. Novel prize received for achievement civic achievements.
2. Prizes and awards in sports competition, not sanctioned by their respective national association accredited by POSC.
3. World Bank’s income earned in the Philippines.
4. Cost of Living Allowance.
5. Union due Contribution.
6. Proceeds of from life insurance policy, revocable designation of beneficiary.
7. Pensions, in general.
8. Income of PAGCOR.
9. Proceeds from the sale of land (capital asset) P100.000: costs P120,000
10. Income of government from holders of public utility franchise.
11. Interest income.
12. Board of director’s fee.
13. Mandatory retirement pay
14. Professional athlete’s salary.
15. Winnings from Philippine Sweepstakes or Lotto.
16. Income derived from smuggling.
17. Interest received from life insurance’s annuity.
18. Annual clothing allowance of P4,000.00
19. Hazard pay received by MWE.
20. Gains from redemption of shares in mutual fund.
21. Magsaysay awards.
22. GSIS Retirement benefits.
23. Cash surrender value received from insurance in excess of premium paid.
24. Proceeds from life insurance of a deceased employee received by the employer.
25. Dividend income derived in the Philippines by the Taiwan Government.
26. Gains from the sale of bond with a maturity of four years.
27. Gains from the sale of certificate of indebtedness with a maturity of six years.
28. Cancellation of debt in lieu to services rendered.
29. Shares of stock received due to professional service rendered.
30. Accumulated vacation and sick leave credits for government employees converted into cash at the end of employment contract.

Problem 2: Mrs. Rowena Gorospe reports the following items of income and expenses as of December 31,200B:
Cash salary, net of withholding tax, P25,000 and SSS, P3,000 P302,000
Dividend from San Magnolia Corporation 30,000
Cancellation of her debt from San Magnolia Corporation 50,000
Living quarters and meals allowances, within the employer’s premises 40,000
Income tax paid by the employer 5,000
One year note receivable from the employer, net of discount
P1,000 (maturity June 30, 200B) 19,000
Gross income from business 400,000
Allowable expenses 250,000
Prepaid rent income 50,000
Interest from bank deposit, net of withholding tax 18,000
Bad debt recovery (60% previously written-off) 38,000
Gambling winnings 20,000
Gambling losses 30,000
Income tax refund 8,000
Household expenses 200,000
Donation from relatives 150,000
Winnings 10,000
Stock dividends from Asia Brewery at fair market value 4,000

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 13 of 14

Required: Compute the taxable income subject to normal tabular tax.

Problem 3: The following are the revenue items in the income statement of Domestic Corporation for the year 20X1:
Sales P1,000,000
Cost of sales 500,000
Interest income from bank deposit, Philippines 40,000
Yield from deposit substitute, Philippines 80,000
Interest income received from depository bank under EFCDS, Philippines 60,000
Interest income from bank deposit, USA 400,000
Interest on notes receivable- trade, Philippines 30,000
Royalties, Philippines 70,000
Royalties, USA 300,000
Cash dividend received from domestic corporation 150,000
Prize and winnings, Philippines 400,000
Refund of Philippine value added tax 100,000
Bad debt recovery (tax benefit rule) 50,000
Required:
1. How much was total exempted/excluded from gross income?
2. How much was the total gross income subject to 30% corporate income tax?

END

21. GROSS INCOME INCLUSIONS AND EXCLUSIONS Page 14 of 14