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FINALS REVIEWER Coverage: Passive income (p.

18 of course outline) onwards


TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

Interest income
Passive income Rules on Interest income
Source Residence of debtor, source within the Phils.
General rule Included in gross income
 Passive income is income derived not from direct or active practice of trade, industry or Exceptions 1. If exempt from tax
profession. It is “passive” because it is income that originates from an existing asset or
investment (or an offshoot of an asset) and it is earned without active participation on 2. Subject to final tax at preferential rate
the part of the taxpayer.
Interest income subject to final tax
 Rather than being subject to the graduated income tax (in case of individuals) or the
Type Individual (24.B.1) Corporation
regular corporate income tax (RCIT, in case of corporations), certain passive income are NRA-ETB NRA-NETB DC RFC NRFC
RC NRC RA
subject to final tax. (Refer to 24.B for individuals and 27.D for corporations) (27.D.1) (28.A.7)
Interest on any Part of Part of
currency bank 20% 20% 20% 20% gross 20% 20% gross
What are considered as passive income? deposit income income
1. Interest income (see page 1)
Yield or any other
2. Dividend income (see page 2) monetary benefit Part of Part of
3. Royalty income from deposit
20% 20% 20% 20% gross 20% 20% gross
4. Rental income substitutes, trust
income income
funds, and similar
5. Annuities/proceeds from life insurance/other types of insurance arrangements
6. Prizes and awards Interest income
7. Pensions/retirement benefits received from a
depositary bank 7½% Exempt 7½% Exempt Exempt 7½% 7½% Exempt
8. Income from whatever source
under the FCD
system
Interest income from Holding period Final tax Not subject to final tax.
long-term deposits or > 5 years Exempt Exempt Included as part of gross
investment 25% income.
4 to < 5 years 5%
3 to < 4 years 12% 25%
< 3 years 20% 25%
Interest on foreign
20%
loans

Interest income subject to final tax of certain corporations


Creditor (interest income derived by) Debtor
Residents Non-resident
Depository banks under the
10% Exempt
expanded FCD system (28.A.7.b)
Offshore banking units (28.A.4) 10% Exempt

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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

Dividend income Royalty income


Rules on Dividend income Mamalateo: Royalty is valuable property than can be developed and sold on a regular basis
Source Residence of corporation paying dividends for a consideration.
General rule Included in gross income
Rules on Royalty income
Exceptions 1. If exempt from tax
Source Location of the property or interest in the property
2. Subject to final tax at preferential rate General rule Included in gross income (active business income)
Exceptions Subject to final tax at preferential rate (royalty received from
Cash dividend Total amount received subject to income tax
another for the use of taxpayer’s intellectual property—passive
Property dividend FMV of property received subject to income tax income)
Stock dividend General rule: not taxable
Exception: gain resulting from a change in interest subject to Royalty income subject to final tax
income tax The following table applies if the royalties are received from sources within the Philippines.
Liquidating dividend Not taxable (return of capital)
Disguised dividend Any distribution made by a corporation to its shareholders, Type of Royalty Individual (24.B.1) Corporation
RC NRC RA NRA-ETB NRA-NETB DC RFC NRFC
whether in money or other property, out of its earnings or Recipient>> (25.A.2) (27.D.1) (28.A.7.d) (28.B.5.b)*
profits is subject to income tax. (CIR v Manning 66 SCRA 14) Royalties, in general 20% 20% 20% 20% 20% 20%
Dividend income subject to final tax Royalties on books 10% 10% 10% 10% 20% 20%
Royalties on literary Part of Part of
Payor Individual (24.B.2) Corporation 10% 10% 10% 10% 20% 20%
NRA-ETB NRA-NETB DC (27.D.4) RFC NRFC works gross gross
Recipient>> RC NRC RA
(25.A.2) (28.A.7.d) (28.B.5.b)* Royalties on musical income income
Domestic 15% if compositions 10% 10% 10% 10% 20% 20%
10% 10% 10% 20% Exempt Exempt
corporation there is
Joint stock company 10% 10% 10% 20% Exempt Exempt tax
Insurance or mutual
10% 10% 10% 20% Part of Exempt Exempt sparing If, however, a resident citizen or a domestic corporation receives royalties from sources
fund company without the Philippines (foreign corporations), they are taxable using the graduated income
gross credit, or
Regional operating st
income simply tax table (in case of individuals) or RCIT (in case of corporations). Source: Mamalateo 1
headquarters of edition, p. 135.
10% 10% 10% 20% Exempt Exempt part of
multinational
company gross
Business partnership 10% 10% 10% 20% Exempt Exempt income

Taxable intercorporate dividends – dividends received by NRFC


These dividends are subject to final tax of 15% if:
1. Paying corporation is a domestic corporation
2. Receiving corporation is an NRFC
3. Country in which NRFC is domiciled allows credit against the tax due from the NRFC tax
deemed paid equivalent to 15% (Difference between RCIT of 30% and final tax of 15%)

*If dividends received by NRFC do not qualify as enumerated above, included as part of gross
income, taxable at a fixed rate of 35%.

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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

Rental income Prizes & Awards


Rules on Rental income Rules on Prizes and awards
Source Location of the property or interest in the property General rule Included in gross income
General rule Included in gross income Exceptions If subject to final tax

Special issues on Rental income Prizes and awards subject to final tax
Tax treatment of leasehold improvements by lessee – taxable income if the ownership of Type of Prize/award Individual (24.B.1) Corporation
RC NRC RA NRA-ETB NRA-NETB DC RFC NRFC
such improvements will transfer to the lessor at the end of the lease term. Taxable based on Recipient>> (25.A.2) (27.D.1) (28.A.7.d) (28.B.5.b)*
the fair market value of such improvements either as a one-time charge or on a staggered Prizes in general 20% 20% 20% 20% 20% 20%
basis. Prizes amounting to
Part of gross income 20% 20%
Tax treatment of advance rental/long-term lease – if prepaid, considered as taxable income P10k or less Part of Part of
when received. Winnings in general 20% 20% 20% 20% gross 20% 20% gross
Winnings from PCSO income income
20% 20%
Annuities/Proceeds from life insurance
Rules on Annuities/proceeds from insurance
General rule The proceeds of life insurance policies paid to heirs or
beneficiaries upon the death of the insured should be treated
as indemnity and not as gain or income. (32.B.1 and 32.B.2)
Exceptions 1. If such amounts are held by the insurer under an
agreement to pay interest thereon, such interest
payments shall be included in gross income.
2. Subject to estate tax if proceeds are from a life insurance
and:

a. Decedent is the policy owner and the beneficiary is


the estate

b. Decedent is the policy owner and the beneficiary is


any other person, but such designation is revocable
Summary table
Excluded from gross income All proceeds from life insurance
Excluded from gross estate 1. Decedent is not the policy holder
2. Designation of beneficiary is irrevocable
Included in gross estate (taxable – 1. Decedent is policy holder and beneficiary is the
estate tax) estate, whether or not irrevocable
2. Decedent is the policy holder and beneficiary is
anybody, but such designation is revocable

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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

from sources within the Philippines so long as the services were


performed in the Philippines, regardless of:

Situs/Sources of Income 1.
2.
3.
Residence of the payor
Place where the contract was executed
Place of payment

Other rules pertaining to income from services:


Situs vs. Source 1. Rendered partly in the Philippines and partly outside, formula as
Source of income – not a place but an activity or property from which income is derived; That follows:
activity which produced the income; conveys one essential idea, that of origin (Commissioner
vs. BOAC 149 SCRA 395)
Situs of income – location of taxing authority or place where the source of income should be
taxed
Classification of income as to source (Sec. 42)
1. Income from sources within the Philippines 2. International shipping line – Gross Philippine billings or all revenues
originating from the Philippines up to final destination, regardless of
2. Income from sources outside the Philippines
the place of sale or payment of tickets
3. Income partly from sources within and partly outside the Philippines 3. International air carrier – Gross Philippine billings or all revenues
General rule originating from the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or payment of the ticket
The place of the contract is not a sole criterion that exclusively determines situs. Place of
a. Flight originating from the Philippines, but transshipment takes
activity, not place of business, is controlling. place at any port outside involving another carrier – Only
Rules on Sources of Income income from such leg flown from the Philippines to such other
Type of income Within the Philippines (Sec 42.A) port shall be considered derived from the Philippines
b. Ticket sold by foreign carrier through an agent in the Philippines
Interest Interest on bonds, notes, or other interest-bearing obligations of
– The sale of tickets in the Philippines is the activity that
residents, corporate or otherwise (42.A.1)
produces income. Hence, such sales, although pertaining to
travel between countries other than the Philippines, is
Hence, interest income is to be considered to be derived from Philippine
considered income derived from sources within the Philippines
sources if the debtor, whether an individual or a juridical person and
(Commissioner vs. BOAC)
whatever debt instrument, is a resident of the Philippines
4. Turnkey contracts – income from such services are to be considered
Dividends Amount received as dividends from a:
within the Philippines if the services for design, fabrication,
1. Domestic corporation
engineering, and manufacture, not merely assembly and
2. Foreign corporation, if at least 50% of the gross income of such
installation, were rendered in the Philippines. (Commissioner vs.
corporation for the 3-year period ending with the close of the
Marubeni)
taxable year preceding the declaration of such dividends was
Rentals and royalties Rentals and royalties from property located in the Philippines. (42.A.4)
derived from sources within the Philippines; dividend from source
within the Philippines shall be computed only in the same Sale of property
proportion with the gross income derived from sources within the Real Gains, profits, and income from the sale of real property located in the
Philippines. (42.A.2) Philippines. (42.A.5)
Personal General rule
Computation as follows: Income derived from country where such personal property was sold.
Place of sale is determine by when or where the title passes from the
buyer to the seller.
Exceptions
1. Sale of shares of stock of a domestic corporation – income derived
from such sale shall always be considered as from sources within
the Philippines, regardless where such shares were actually sold.
Services Compensation for labor or personal services performed in the Philippines 2. Produced in whole or in part by the taxpayer within the Philippines
(42.A.3) and sold outside
3. Produced in whole or in part by the taxpayer outside the Philippines
Hence, income from services shall be considered to have been derived and sold within

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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

Computation of taxable income from sources within the Philippines


Deductions
General rule, as to Items of deductions to be allowable must be effectively
Exclusions from Gross Income
deductions connected with the business or trade conducted exclusively
within the Philippines and fully substantiated by all the
information necessary for its calculation. (42.B.1)
What is gross income (32.A)
Exceptions Interest expense will only be deductible if the funds obtained All income derived from whatever source, including (but not limited to) the following items:
from the loan to which such interest is related to were for use 1. Compensation for services in whatever form paid, including, but not limited to, fees,
in connection with the conduct or operation of trade or salaries, wages, commissions, and similar items;
business in the Philippines. 2. Gross income derived from the conduct of trade or business or the exercise of a
profession
Formula 3. Gains derived from the dealings in property
4. Interests
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions
11. Partner’s distributive share from the net income of a general professional partnership

*If deductions can be directly attributed to gross income derived from sources either within Exclusions
the Philippines or outside, the portion to be deducted as pertaining to Philippine sources is to An item may not be taxable for any of the following reasons:
be computed as follows: 1. The item of receipt does not fall within the meaning of income for income tax purposes
(e.g. return of capital)
2. A provision of law exempts it from income tax
a. Under the Constitution
b. Under the Tax Code
c. Under special laws
Exclusions under the Constitution
All assets and revenues of a non-stock, non-profit private educational institution used
directly, actually, and exclusively for private educational purposes shall be exempt from
taxation.
Exclusions under the Tax Code (32.B)
Item of income excluded Remarks
Proceeds from life insurance Proceeds are excluded from the gross
income of the beneficiary, but may be
subject to estate tax if:
1. Decedent is policy holder and
beneficiary is the estate, whether or not
irrevocable
2. Decedent is the policy holder and
beneficiary is anybody, but such

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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

designation is revocable gratuities, pensions, and other similar


benefits
Interest paid by the insurer in connection Payments of benefits in relation to US
with the proceeds are included in gross Veterans administration
income. (32.B.1) SSS benefits
Amount received by insured as return of These are considered returns of capital or GSIS benefits
premium the premiums paid. If the aggregate amounts Miscellaneous items
received exceed the premiums paid, the Income derived by foreign government Income of:
excess shall be included in gross income. 1. Foreign governments
(32.B.2) 2. Financing institutions owned and
Gifts, bequests, and devises These are not subject to income tax, but to controlled or enjoying refinancing from
estate or donor’s tax. Income derived from foreign governments
such property shall, however, be subject to 3. International or regional financial
income tax. institutions established by foreign
Compensation for injuries or sickness Any amount received as an indemnity governments, received from their
(proceeds of insurance, damages recovered, investments in the Philippines
etc.) is excluded from gross income. Income derived by the Government or The government cannot logically tax itself.
Income exempt under treaty its political subdivision
Retirement benefits, pensions, gratuities, Prizes and awards – religious, Requisites
etc. charitable, scientific, artistic, literary a. Recipient was selected without any
Retirement benefits under RA 7641 Reasonable private benefit plan action on his part to enter the contest
Pension, gratuity, stock, bonus, or profit- or proceeding
sharing plan maintained by an employer for b. The recipient was not required to
the benefit of some or all of his officials or render substantial future services as a
employees, where in contributions are made condition to receiving the prize
by such employer or the employees or both
for the purpose of distributing such earnings Prizes from PCSO and lotto winnings shall be
and principal thus accumulated to the exempt from tax (24.B.1)
employees. Prizes and awards in Sports Commission All prizes and awards granted to athletes in
local and international sports competitions
Requisites
and tournaments whether held in the
a. Employee has been in the continuous
Philippines or abroad and sanctioned by the
service of the same employer for at
Philippine Olympic Committee.
least 10 years th
13 month pay and other benefits Only up to the extent of P30,000.
b. Employee is not less than 50 years of
age GSIS, SSS, Medicare, and other
c. Benefits shall be availed of only once contributions
Amount received by an employee or his Requisites Gains from the sale of bonds,
heirs as a consequence of separation a. Employee is separated from the service debentures, or other certificates of
from employment of the employer due to death, sickness, indebtedness
or other physical disability or for cause Gains from redemption of shares in
beyond his control mutual fund.
b. The employer pays benefits to the
official or employee or his heirs as a
consequence of his separation
Social security benefits, retirement
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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

Exclusions under special laws


1. PAGCOR (PD 1869)
2. Gain arising from the transfer of agricultural land (CARP)
Costs, Deduction, & Personal
3. Interest on bonds paid by the NPC to its foreign bondholders (RA 6975)
4. BSP (RA 7459) Exemptions
5. PEZA-registered enterprises (PEZA law)
6. Special-purpose vehicles (RA 9182)
7. BOI-registered entities (Omnibus investments act) Deductible costs
1. Cost of goods sold
Exempt Corporations 2. Cost of services
See discussion under tax on corporations.
Deductions, in general
General rules
1. Strictly construed against taxpayers claiming it
2. Must be paid or incurred in connection with the taxpayer’s trade, business, or
profession
3. Must be supported by adequate receipts or invoices (except for OSD)
Deductions from gross income per taxpayer
Individuals Corporations
1. Citizens 1. Domestic corporations
2. Resident aliens 2. Resident foreign
3. Nonresident aliens corporations
engaged in trade or 3. Taxable partnerships
business 4. Estates and trusts
With gross compensation With gross income from
income only business or practice of a
profession
1. Optional Standard 1. OSD
Deduction (OSD)
2. Itemized deductions 2. Itemized deductions
1. Premium payments on 3. Premium payments on
health and/or health and/or
hospitalization hospitalization
insurance insurance
2. Personal exemptions 3. Personal exemptions

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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

the principal indebtedness is paid


Itemized Deductions 2. Reduction of interest expense – formula
Deduction Remarks
Business Requisites for deductibility
expenses 1. Must be ordinary and necessary
2. Paid or incurred within the taxable year
3. Incurred in carrying on, or directly attributable to, the
development, management, operation and/or conduct of the trade 3. Interest expense incurred to acquire property for use in
or business, or the exercise of a profession trade/business/profession – may be, at the option of the taxpayer,
4. Substantiated by official receipts and other adequate records be included in the cost of such asset or property
Taxes Requisites for deductibility
Examples of business expenses
1. Taxes are imposed by law upon the taxpayer
1. Salaries, wages, and other forms of compensation for personal
2. Paid or accrued within the taxable year in connection
services, including grossed up monetary value of fringe benefits,
3. In connection with the taxpayer’s trade, business, or profession
the FBT for which has been duly paid.
4. Not expressly prohibited by law to be deductible
2. Traveling/transportation expenses – incurred while away from
home
Deductible Taxes Non-deductible Taxes
3. Cost of materials
1. Import duties 1. Income tax, whether
4. Rent
2. Business taxes Philippine or foreign
5. Repairs and maintenance – incurred to keep the property used in
3. License taxes 2. Estate and donor’s taxes
the trade or business in an ordinarily efficient operating condition.
4. Privilege taxes 3. Special assessments or
6. Expenses under lease agreements
5. Documentary stamps tax levies on real property
7. Professional fees
4. Final tax
8. Entertainment expenses
Ceiling Losses Requisites for deductibility
a. Merchandising/manufacturing entity – 0.5% of net sales 1. Must be actually sustained and charged off within the taxable year
b. Service entity – 1% of net revenues 2. Incurred in trade, business, or profession
9. Political campaign expenses 3. Must be evidenced by a closed or completed transaction
10. Training expenses 4. Must not be compensated for by insurance or other form of
indemnity
Interest Requisites for deductibility
1. There must be an indebtedness Types of losses
2. Indebtedness must be that of the taxpayer 1. Ordinary losses
3. Interest must be legally due and stipulated in writing 2. Capital losses
4. Interest expense must be paid or incurred within the taxable year 3. Special kinds of losses
5. Indebtedness must be connected with the taxpayer’s trade,
business, or exercise of profession Net operating loss carry over (NOLCO)
The net operating loss, which had not been previously offset as
Non-deductible interest expense deduction from gross income, shall be carried oever as a deduction
1. Interest incurred abroad by non-resident parent lending institution from gross income for the next 3 consecutive taxable years immediately
2. Interest on preferred stocks following the year of such loss.
3. Interest on loans between related parties
4. Interest paid on earned but unpaid salary
5. Interest on indebtedness incurred to finance petroleum operations What is Net Operating Loss?
6. Interest on indebtedness for purely personal reasons Excess of allowable deductions over gross income of the business or
Other issues regarding interest expense enterprise for any taxable year
1. Interest paid in advance – interest shall be deductible in the year When net operating loss not deductible
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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

1. Any net loss incurred in a taxable year during which the taxpayer 3. Must not be between related parties
was exempt from income tax shall not be allowed as a deduction 4. Must be actually charged-off the books of accounts of the taxpayer
(Net operating loss during income tax holiday) as of the end of the taxable year
2. There is substantial change in the ownership of the enterprise. 5. Must be worthless and uncollectible (write-off)
When there is substantial change – If, as a result of a business
Recovery of accounts previously written-off – Tax Benefit Rule
combination, the stockholders of the transferor or the transferor,
Subsequent recovery of previously written-off accounts are to be
gains control of the enterprise claiming the NOLCO as a deduction
included in the gross income of the taxable year in which these were
such that they acquire:
received only to the extent the taxpayer was benefited when it claimed
a. Less than 75% of the outstanding shares or paid-in capital of
the write-off as a deduction.
the transferee enterprise
Depreciation Requisites for deductibility
b. Less than 75% interest in the business of the transferee
1. Must be reasonable
Sample application of NOLCO 2. Must be for property arising out of its use or employment in the
business or trade
3. Must be charged-off during the taxable year
Depletion
Pension trust Payments to employees’ pension trust (reasonable pension plan)
Charitable and Requisites for deductibility
other 1. Must actually paid or made to the Philippine government or any
contributions political subdivision thereof exclusively for public purposes
2. Must be made within the taxable year
3. Must not exceed 10% (individual) or 5% (corporation) of the
taxpayer’s taxable income before charitable contributions
Research and
development

Entitlement to NOLCO
Entitled Not entitled
1. Any individual engaged in 1. OBUs
trade or business or in the 2. FCDUs
practice of a profession 3. BOI-registered entity
2. Domestic corporations 4. PEZA, SBMA, CSEZ-
(including private registered enterprises
educational institutions) 5. Entity already enjoying
3. Resident foreign income tax holiday (ITH)
corporations (including
regional operating
headquarters
Bad debts Requisites of deductibility
1. There must be an existing indebtedness which must be valid and
legally demandable
2. Must be connected with the taxpayer’s trade, business or
profession
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FINALS REVIEWER Coverage: Passive income (p. 18 of course outline) onwards
TAXATION 1 – Prof. Othelo Carag Prepared by C. Gomez

Optional Standard Deduction (OSD) Personal and Additional Exemptions


Basic personal exemptions P50,000 for each taxpayer, whether single,
What is OSD?
married, or head of the family
It is the standard deduction availed of, equal to 40% of gross income (gross profit), in lieu of
Additional exemptions P25,000 for each dependent, not exceeding
itemized deductions.
4 dependents
Who may avail of OSD?
Individuals Corporations A person is a dependent if:
1. Resident citizen 1. Domestic corporations 1. He is not more than 21 years of age,
2. Non-resident citizen 2. Resident foreign corporations unless incapacitated or incapable of
3. Resident alien self-support
4. Estate and trusts 2. Unmarried
3. Not gainfully employed
Unless the taxpayer signifies his intention to elect the OSD, he shall be considered as having 4. Living with the taxpayer
availed himself of the itemized deductions. Such election when made in the return shall be 5. Chiefly dependent on the support
irrevocable for the taxable year for which the return was made. provided by the taxpayer
Who may avail of Personal exemptions
Individual Basic Additional
RC Yes Yes
NRC Yes Yes
RA Yes Yes
NRA-ETB Yes, subject to reciprocity, whichever No
is LOWER between P50,000 and
amount allowed by foreign country
NRA-NETB No No

Status at the end of the year rule


In case a taxpayer changes his status during the year, his status shall remain the same as
prior to the change until the end of the taxable year.

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