Speaker:

Dr. Jason R. Radam, CPA, MICB

I. Basic Principles of Income Taxation
A. What is income?
1. Income Defined
2. Concept of Realization of Income
3. Gross Income
4. Exclusions from Gross Income
5. Taxable Income
B. Who gets taxed on what?
1. General Principles
2. Source of Income Rules
C. Income Tax Accounting Methods
1. Tax Accounting vs Financial Accounting; Purpose
2. Tax Accounting Methods
(a) Cash Method
(b) Accrual Method
(c) Other Methods Permitted by the Tax Code
 D. Dealings in Property
1. Capital Asset vs Ordinary Asset
2. General Rule; Determining Gain or Loss
3. Exceptions to General Rule:
(a) 40(c)(2) - Exchanges solely in kind
(b) 40(c)(3) – Exchanges not solely in kind
(c) Assumption of Liabilities

II. Income Tax Rates

A. Individuals
B. Estates and Trusts
C. Corporations

III. Deductions
A. What is income?

1. Income Defined
2. Concept ofA.Realization of Income
What is income?
3. Gross Income
4. Exclusions from Gross Income
5. Taxable Income
▪ It is a flow of service rendered by capital by the payment of
money from it or any benefit rendered by a fund of capital in
relation to such fund through a period of time.

Supreme Court in Madrigal vs Rafferty, 38 Phil 414:

“Income as contrasted with capital or property is to be the test.

The essential difference between capital and income is that
capital is a fund; income is a flow. A fund of property existing at
an instant of time is called capital. A flow of services rendered
by that capital by the payment of money from it or any other
benefit rendered by a fund of capital in relation to such fund
through a period of time is called income. Capital is wealth,
while income is the service of wealth.”
▪ The Supreme Court of Georgia expresses the thought in the
following figurative language:

"The fact is that property is a tree, income is the fruit; labor is a

tree, income the fruit; capital is a tree, income the fruit." xxx A
tax on income is not a tax on property. xxx”
▪ Except when otherwise provided in this Title, all income from
whatever source derived including but not limited to the
following:
1) Compensation;
2) Annuities;
3) Rents;
4) Gross income from profession, trade or business;
5) Dividends;
6) Royalties;
7) Interests;
8) Annuities;
9) Prizes and winnings;
10) Gains from dealings in property;
11) Pensions; and
12) Partner’s distributive share in the net income of the general
professional partnership
▪ Inherently necessitated by the definition of income:
▪ Something of exchangeable value must be separated
from capital.
▪ This supplied the realization or transmutation which
results in the receipt of income ➔ the “Severance test”
▪ Driven by the principle that a mere increase in the value
of property is not income, but only an unrealized
increase in capital.
▪ There is no realization through mere bookkeeping.
▪ Practical considerations for the requirement of realization:
(1) A tax on an unrealized increment in value would be
awkward from the administrative point of view.
(2) It would be a hardship ordinarily for the taxpayer who
would not have a source from which the tax could be
paid; and
(3) It might result in deductions for losses as yet unrealized.
▪ “Except when otherwise provided in this Title”

▪The term “exclusions” refers 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.
(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 are included in gross income.

(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) is included in the gross income.

(3) Gift, bequest or devise – value of the property received is

excluded BUT the income from such property is included in gross
income.
(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.

(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 as a result of involuntary separation –
death, sickness or other physical disability or for any
cause 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
(6) Retirement benefits, pension, gratuities, etc. Contd
▪ Those received by employees of private employers in
accordance with a reasonable private benefit plan;
▪ Requisites:
▪ In the service of the same employer for at least 10
years;
▪ At least 50 years old;
▪ Must be availed of only once; and
▪ Plan approved by the BIR
(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 governments
(7) Miscellaneous Items
(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
P30,000
(f) GSIS, SSS, Medicare, Pag-Ibig contributions, and union dues of
individuals
(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) of
the Tax Code
▪ The term “taxable income” means the pertinent items of
gross income specified in the Tax Code, less the
deductions and/or personal and additional exemptions, if
any, authorized for such types of income by the Tax Code
or other special laws.
B. Who gets taxed on what?

1. General Principles
2. Source of Income Rules
▪ Individuals:
 Resident citizen – taxed on worldwide income
 Nonresident citizen – taxed only on Philippine-source
income
 Overseas contract worker – taxed only on Philippine-
source income
 Alien, whether resident or nonresident – taxed only on
Philippine-source income

▪ Corporations:
 Domestic corporation – taxed on worldwide income
 Resident and Nonresident foreign corporation – taxed only
on Philippine-source income
▪ Income from sources within the Philippines
▪ Income from sources without the Philippines
▪ Income from sources partly within and partly without the
Philippines
▪ Interest derived from sources within the Philippines, and interest on
bonds, notes or other interest-bearing obligations of residents,
corporate or otherwise
▪ Dividends received ---
 From a domestic corporation; and
 From a foreign corporation.
BUT if less than 50% of the gross income of such foreign
corporation for the 3-year period preceding the declaration of
such dividends was derived from sources within the Philippines,
then only so much of such dividends which bears the same ratio
as the gross income of the corporation for such period derived
from sources within the Philippines bears to its gross income
from all sources [(Phil GI/World GI) x Dividends].

▪ Services — Compensation for labor or personal services performed

in the Philippines
▪ Rentals and royalties from property located in the
Philippines or from any interest in such property,
including rentals or royalties for —
(i) The use of, or the right xxx to use in the Philippines,
any copyright, patent, or other like property or right;
(ii) The use of, or the right to use in the Philippines, any
industrial, commercial or scientific equipment;
(iii) The supply of scientific, technical, industrial or
commercial knowledge or information;
(iv) The supply of any assistance that is ancillary xxx and
is furnished as a means of enabling the application or
enjoyment of, any property or right mentioned in (i), (ii) or
(iii);
(v) The supply of services by a nonresident person or his
employee in connection with the use of property or rights
belonging to, or the installation or operation of any brand,
machinery or other apparatus purchased from such nonresident
person;
(vi) Technical advice, assistance or services rendered in
connection with technical management or administration of any
scientific, industrial or commercial undertaking, venture, project or
scheme;
(vii) The use of or the right to use:
 Motion picture films
 Films or video tapes for use in connection with television
 Tapes for use in connection with radio broadcasting.
▪ Sale of Real Property. — Gains, profits and income from
the sale of real property located in the Philippines

▪ Sale of Personal Property. — Gains, profits and income

from the sale of personal property, as determined in
Section 42(E) on Income from Sources Partly Within and
Partly Without the Philippines.

▪ BUT gains from sale of shares of stock of Philippine

corporations – always considered Philippine source
income, regardless of where sold
▪ Income OTHER THAN Philippine source ---
 Interest
 Dividends
 Service income
 Rentals and Royalties
 Gains from sale of real property
▪ Gains, profits, income derived from the sale of personal property* ---
▪ PRODUCED WITHIN and SOLD WITHOUT the Phils, or
▪ PRODUCED WITHOUT and SOLD WITHIN the Phils

➔ treated as derived partly from sources within and partly from

sources without the Philippines.

▪ Gains, profits, income derived from the sale of personal property* ----
▪ PURCHASE WITHIN and SOLD WITHOUT the Phils, or
▪ PURCHASE WITHOUT and SOLD WITHIN the Phils

➔ treated as derived entirely from sources within the country in

which sold.

* Other than shares of a domestic corporation

1. Labor, agricultural or horticultural organization not organized
principally for profit;
2. Mutual savings bank not having a capital stock represented by
shares, and cooperative bank without capital stock organized
and operated for mutual purposes and without profit;
3. A beneficiary society, order or association, operating for the
exclusive benefit of the members such as a fraternal
organization operating under the lodge system, or a mutual aid
association or a nonstock corporation organized by employees
providing for the payment of life, sickness, accident, or other
benefits exclusively to the members of such society, order, or
association, or nonstock corporation or their dependents;
4. Cemetery company owned and operated exclusively for the
benefit of its members;
5. Non-stock corporation or association organized and
operated exclusively for religious, charitable, scientific,
athletic, or cultural purposes, or for the rehabilitation of
veterans, no part of its net income or asset shall belong to or
inure to the benefit of any member, organizer, officer or any
specific person;
6. Business league, chamber of commerce, or board of trade,
not organized for profit and no part of the net income of
which inures to benefit of any private stockholder or
individual;
7. Civic league or organization not organized for profit but
operated exclusively for the promotion of social welfare;
8. A non-stock and non-profit educational institution;
9. Government educational institution;
10. Farmers’ or other mutual typhoon or fire insurance company,
mutual ditch or irrigation company, mutual or cooperative
telephone company, or like organization of a purely local
character, the income of which consists solely of assessments,
dues, and fees collected from members for the sole purpose of
meeting its expenses; and
11. Farmers’, fruit growers’, or like association organized and
operated as a sales agent for the purpose of marketing the
products of its members and turning back to them the
proceeds of sales, less the necessary selling expenses on the
basis of the quantity of produce finished by them;
I. Basic Principles on Income Taxation contd

C. Income Tax Accounting Methods

1. Tax Accounting vs. Financial Accounting;
Purpose
2. Tax Accounting Methods
a. Cash Method
b. Accrual Method
c. Others Permitted by Tax Code
▪ Different purposes, different rules, serve different purposes:
 Financial accounting – to provide useful information to
management, shareholders, creditors and other
interested parties as to financial position of a company
or a business
 Tax accounting – to determine when items of income
and expenses should be recognized
▪ Therefore: they vary on some significant issues, on
methods in determining whether and when income or
expenses should be recognized or reported
▪ BUT are nevertheless interrelated and interdependent.
▪ Clear Reflection of Income [Section 43]
➔ A taxpayer’s accounting method must clearly reflect income.

No one single method prescribed for all taxpayers. Generally (but not
always) methods that show the consistent use of GAAP are considered
to clearly reflect income. A method of accounting which reflects the
consistent application of GAAP in a particular trade or business in
accordance with accepted conditions or practices in that trade or
business is usually regarded as clearly reflecting income, provided all
items of gross income and expenses are treated consistently from year
to year.
➔ Controlled Taxpayers [Section 50] – Commissioner has the
power to re-allocate income and expenses between and among
controlled taxpayers, if he determines that such re-allocation is
necessary to prevent evasion of taxes or to clearly reflect the
income of any of such controlled taxpayers
▪ Cash Method
▪ Accrual Method
▪ Any other method permitted by the Code
▪ All items that constitute gross income are included in the taxable
year in which they have been ACTUALLY OR CONSTRUCTIVELY
RECEIVED.

▪ Expenses are deductible in the taxable year in which they are

PAID.

▪ BUT Cannot be used if inventory is a significant factor in the

business

▪ ACTUAL RECEIPT - Receipt constitutes a transfer of property

from one party to another at the taxpayer’s direction, or for the
benefit of the taxpayer; need not be in the form of cash, can be in
the form of property or cash equivalent. If the cash equivalent has
a realizable value and is transferable, it must be recognized as
payment for income tax purposes.
▪ CONSTRUCTIVE RECEIPT – Amounts are constructively
received when (i) credited to the taxpayer’s account, (ii) set apart
for the taxpayer, or (iii) otherwise made available so that the
taxpayer may draw upon it at any time, or draw upon it when
notice of intention to withdraw has been given.

▪ Income which is subject to the taxpayer’s unfettered command

and which he is free to enjoy at his option is taxed to him as
income, whether he sees fit to enjoy it or not.

▪ Constructively received income is taxable when the amount is

ascertained and available to the taxpayer without restriction or
subject to his control. Conversely, where the amount to which the
taxpayer is entitled is indefinite, or there is a definite contingency
as to the receipt of that amount, there is no constructive receipt.
▪ Generally, all items of income are included in gross income when
EARNED, even though payment may be received in another year.
A taxpayer may deduct an expense when INCURRED, even
though payment may be made in another year.

▪ Income and deductions are not included for a taxable year unless
the requirements of the “ALL-EVENTS TEST” are met.

▪ Under the “ALL-EVENTS TEST”, income and deductions accrue

when---
(a) all the events have occurred which fix the right to receive the
income or fix the liability; and
(b) the amount of income or liability is determinable with
reasonable certainty.
▪ The “all-events test” does not demand that the amount of
income or liability be known absolutely, only that the taxpayer
have at his disposal the information necessary to compute the
amount with reasonable accuracy.

▪ If there is a contingency as to the taxpayer’s right to the income,

as distinguished from an uncertainty as to the time of its
receipt, it is taxable in the year when the contingency is
removed. When the taxpayer’s right to the income has not been
established, no accrual if income is required.
▪ Accounting for Long-term Contracts [Section 48]
▪ Installment Basis
▪ Deferred Payment Sales Not On The Installment Basis
▪ Accounting for Long-term Contracts – percentage of
completion method [Section 48]

▪ Long-term contract – building, installation or construction

contracts covering a period more than one year
▪ Accounting method – Percentage of completion
▪ Proof – Certificate of architects or engineers showing
percentage of completion during the taxable year
▪ Installment Basis [Section 49 of Tax Code/Section 174 of Income Tax
Regs]
▪ Income is reported based on collection (even if accrual method taxpayer)
▪ Income is that proportion of the installment payments actually received in
that year which the gross profit realized or to be realized when payment is
completed bears to the total contract price
▪ When and by whom used?
 Sales of dealers in personal property
 (i) Casual sale or other disposition of personal property (other than
property of a kind which would properly be included in the
inventory of the taxpayer if on hand at the close of the taxable year),
for a price exceeding P1,000, or (ii) sale or other disposition of real
property --- if the initial payments do not exceed 25% of the
selling price.
The term 'initial payments' means the payments received in cash or
property other than evidences of indebtedness of the purchaser
during the taxable period in which the sale or other disposition is
made.
▪ Deferred Payment Sales not on the Installment Basis (Section
175 Income Tax Regs)

▪ Sales of real property in which the payments received in cash

or property, other than evidences of indebtedness of the
purchaser, in the year of sale exceed 25% of the selling price
➔ income is reported like cash sale
➔ seller recognizes the full gain, and deducts the full cost of
the property sold --- even if he has not yet been paid in full
D. Dealings in Property

1. Capital Asset vs. Ordinary Asset

2. General Rule – Determining Gain or Loss
3. Exceptions to General Rule
a. 40(c)(2) – Exchanges Solely in Kind
b. 40(c)(3) – Exchanges NOT Solely in Kind
c. Assumption of Liabilities
▪ Capital asset - property held by the taxpayer (whether or not
connected with his trade or business) OTHER THAN ordinary
assets
▪ Ordinary asset –
(i) stock in trade of the taxpayer or other property of a kind
which would properly be included in the inventory of the
taxpayer if on hand at the close of the taxable year, or
(ii) property held by the taxpayer primarily for sale to
customers in the ordinary course of his trade or business, or
(iii) property used in the trade or business, of a character
which is subject to the allowance for depreciation; or
(iv) real property used in trade or business of the taxpayer.
 Ordinary Asset
Ordinary gains includible in gross income on ITR
subject to normal income tax
Ordinary losses normally deductible from gross
income
Gain or loss taxable or deductible in full regardless
of holding period
Ordinary loss may form part of NOLCO available
for carryover
Capital Asset
Capital gains normally subject to a final tax ---
i.e.,taxpayer need not include gain in gross
income in ITR
Capital losses deductible only against capital
gains
For individual taxpayers, gain or loss taxable or
deductible only up to ---
50% if asset held for more than 12 months
100% if asset held for not more than 12 months
Does not apply to gain (loss) from sale of shares
of stock of domestic corporations not listed and
traded on the PSE (see RR 2-82)
For individual taxpayers, net capital loss carryover
to immediately succeeding year
Does not apply to gain (loss) from sale of shares
of stock of domestic corporations not listed and
traded on the PSE (see RR 2-82)
▪ Section 40 (C)(1):

▪ “Except as herein provided, upon the sale or exchange of

property, the entire amount of the gain or loss, as the case
may be, shall be recognized.”
▪ A sale generally occurs when there is a disposition of
property for cash, its equivalent, or the recipient’s promise to
pay.

▪ An exchange ordinarily implies a reciprocal transfer of assets

for other than cash, its equivalent, or the recipient’s promise to
pay. An exchange is both a disposition of property
transferred by a taxpayer and an acquisition of property
received in return.
▪ To constitute a sale or exchange, a transaction must be a bona
fide transaction and not a mere sham. A transaction will be
considered a sham if it lacks economic substance.
▪ The mere fact that the sale is motivated by tax considerations
is not sufficient to disregard it as long as the transaction has
real substance and is not a sham.
▪ Whether or not a sale took place is to be determined from a
consideration of the SUBSTANCE of the transaction and not
merely its FORM. Book entries, while of some evidentiary
value, are not controlling.
▪ It is immaterial whether the sale or exchange is voluntary or
involuntary
▪ Remember General Rule in 40(c)(1)? …
“Except as herein provided, upon the sale or exchange of
property, the entire amount of the gain or loss, as the case
may be, shall be recognized.”
▪ Section 40(A) is the rule in determining amount of gain or
loss:
▪ In a sale or other disposition of property ---
▪ Gain = the excess of the amount realized over the basis
or adjusted basis for determining gain.
▪ Loss = the excess of the basis or adjusted basis for
determining loss over the amount realized.
…Where:
▪ The amount realized = the sum of money received plus the
fair market value of the property (other than money)
received.
▪ Basis is ---
 if property was purchased = cost
 If property was inherited = FMV at time inherited
 If property was donated = the same basis as the donor or
the last person who acquired the property not by gift.
BUT if such basis is greater than the FMV of the property
at the time of the gift, then for purposes of determining
loss, basis is such FMV.
 If property acquired in 40(c)(2) exchanges = transferor’s
original or historical cost
▪ Remember General Rule in 40(c)(1)? …
▪ “Except as herein provided, upon the sale or exchange of
property, the entire amount of the gain or loss, as the case
may be, shall be recognized.”
▪ Sections 40(c)(2) & (c)(3) give the exceptions to this General
Rule.
 Exchanges solely in kind [Section 40(c)(2)]
 Exchanges not solely in kind [Section 40(c)(3)]
▪ They are exceptions because either ---
 the entire gain or loss is not recognized, or
 the gain but not the loss is recognized
▪ Exchanges SOLELY in kind – gain or loss is NOT recognized:

(1) Merger or consolidation

(2) Transfer to a controlled corporation
(1) Merger or consolidation:

“No gain or loss shall be recognized if in pursuance of a plan of merger

or consolidation:

(a) A corporation, which is a party to a merger or consolidation,

exchanges property solely for stock in a corporation, which is a party to
the merger or consolidation; or

(b) A shareholder exchanges stock in a corporation, which is a party to

the merger or consolidation, solely for the stock of another corporation
also a party to the merger or consolidation; or

(c) A security holder of a corporation, which is a party to the merger or

consolidation, exchanges his securities in such corporation, solely for
stock or securities in another corporation, a party to the merger or
consolidation.”
(1) Merger or consolidation contd:

▪ "Merger" or "consolidation" when used in this Section means:

▪ (a) the ordinary merger or consolidation – statutory merger, or
▪ (b) the acquisition by one corporation of all or substantially all the properties of another
corporation solely for stock – “de facto” merger

▪ Requirements:
➢ Undertaken for a bona fide business purpose
➢ Not solely for the purpose of escaping the burden of taxation

▪ Bona fide purpose

In determining whether a bona fide business purpose exists, each and every step of the
transaction shall be considered and the whole transaction or series of transaction shall be
treated as a single unit.

▪ All or substantially all …

▪ Generally, 80% of total assets
▪ In determining whether the property transferred constitutes a substantial portion of the
property of the transferor, the term 'property' shall be taken to include the cash assets of
the transferor.
(2) Transfer to a controlled corporation:

"No gain or loss shall also be recognized if property is

transferred to a corporation by a person in exchange for
stock or unit of participation in such a corporation of which
as a result of such exchange said person, alone or together
with others, not exceeding four (4) persons, gains control of
said corporation: Provided, That stocks issued for services
shall not be considered as issued in return for prop erty.”

▪ “Control” - ownership of stocks in a corporation amounting

to at least 51% of the total voting power of all classes of
stocks entitled to vote.
▪ Exchange NOT solely in kind

If in a 40(c)(2) exchange, an individual, a shareholder, a

security holder or a corporation receives not only stock or
securities, but also money and/or other property ----

The gain, if any, is recognized to the extent of the money or

FMV of the property received. The loss, if any, is not
recognized.

The money or property not permitted to be received without

recognition of gain ➔ “BOOT”
Example 1:

▪ Ms X transfers property to XCo, which she controls. FMV of

property is P500,000; cost basis is P100,000. She receives
from XCo the following:
(1) XCo shares worth P300,000;
(2) cash of P100,000; and
(3) other property with FMV of P100,000.

▪ Her gain is P400,000, but only P200,000 is recognized.

▪ Why:
Example 1 contd:

1. Amount realized:
(a) XCo shares P300,000
(b) Cash 100,000
(c) Other property 100,000
(d) Total P500,000

2. Less: Basis of property 100,000

3. Gain realized P400,000

4. Gain recognized P200,000 (which is 1b + 1c, or 3,

whichever is less)
▪ General Rule:

Liabilities assumed are not to be treated as “money and/or other property”

in determining the amount of realized gain to be recognized, if the
transaction would, but for the receipt of “boot”, qualify as tax-free.

In other words, if the only type of consideration received by the transferor, in

addition to the stocks or securities permitted to be received without
recognition of gain, consists of assumption of liabilities, the transaction if
otherwise qualified will still be deemed to be tax-free.

▪ Exception:

If the liabilities assumed (+ the amount of liabilities to which the property is

subject) exceed the total of the adjusted basis of the property transferred
pursuant to the exchange ➔ excess considered as gain.
II. Income Tax Rates

A. Individuals
 Citizen; Resident Alien Nonresident Alien Nonresident Alien
Engaged NOT Engaged
1.General Rule Graduated 5%-32% rates Same 25%

2. Passive Income:

Interest income --- 20% Same 25%

From any currency bank deposit and yield or any
other monetary benefit from deposit substitutes
and from trust funds and similar arrangements
“Deposit substitutes" shall mean an alternative
from of obtaining funds from the public (the term
'public' means borrowing from twenty (20) or
more individual or corporate lenders at any one
time) other than deposits, through the issuance,
endorsement, or acceptance of debt instruments
for the borrowers own account, for the purpose of
relending or purchasing of receivables and other
obligations, or financing their own needs or the
needs of their agent or dealer.
Interest income --- 7-1/2% Same N/A
From a depository bank under the expanded
foreign currency deposit system
Interest income --- Exempt – if held for 5 years or more Same N/A
From Long-term deposit or investment in the form 5% - if held for 4 years to less than 5
of savings, common or individual trust funds, years
deposit substitutes, investment management 12% - if held for 3 years to less than
accounts and other investments evidenced by 4 years
certificates in such form prescribed by the BSP 20% - of held for less than 3 years
 Citizen; Resident Alien Nonresident Alien Nonresident Alien NOT
Engaged Engaged
Royalties – 10% Same 25%
From books, literary works and musical
compositions
Royalties ---Others 20% Same 25%

Prizes ----Exceeding P10,000 20% Same 25%

Prizes ----From PCSO and lotto Exempt Same 25%

Cash and/or property dividends from a 10% BUT exempt if declared 20% 25%
domestic corporation or other entity taxed as from retained earnings
a corporation existing as of December 31,
1997
Capital gains from sale of shares of domestic 5% on first P100,000 of net Same Same
corporation not listed and traded on the PSE gain, and 10% on the excess
over P100,000
Capital gains from sale of real property
classified as capital asset --- 6% on gross SP or current Same Same
General rule FMV, whichever is higher
Exceptions:
(1) Sale to government or political subdivision Either 6% or graduated rates
or GOCC at option of taxpayer
(2) Sale of principal residence Exempt but there are
conditions; see Sec 24(D)(2)
 Citizen; Resident Alien Nonresident Alien Nonresident Alien NOT
Engaged Engaged
3. Special Rates

Compensation received by alien or Filipino 15% 15% N/A

executives of RAHQs or ROHQs of MNCs
Compensation received by alien or Filipino 15% 15% N/A
executives of OBUs
Compensation received by alien or Filipino 15% 15% N/A
executives of a foreign service contractor or a
foreign service subcontractor engaged in
petroleum operations in the Philippines
B. Estates and Trusts
▪ Estate –
 the mass of properties left by a deceased person

 Subject to income tax in the same manner as individuals

 The distribution to the heirs during the taxable year of

estate income is deductible from the taxable income of
the estate. BUT such distributed income shall form part of
the respective heirs’ taxable income.
 Where no such distribution to the heirs is made during
the taxable year when the income is earned, and such
income is subjected to income tax payment by the estate,
the subsequent distribution thereof is no longer taxable
on the part of the recipient
▪Trust –
 A right to the property, whether real or personal, held by one
person for the benefit of another.
 Subject to tax like individuals
▪ Irrevocable Trusts (irrevocable both as to corpus and as to income)
 Trust itself, through the trustee or fiduciary, is liable for the
payment of income tax.
 Taxed in the same way as estates under judicial settlement and its
status as an individual is that of the trustor.
 It is entitled to the minimum personal exemption (P20,000) and
distribution of trust income during the taxable year to the
beneficiaries is deductible from the trust’s taxable income.
▪ Revocable Trusts – the trustor, not the trust itself, is subject to the payment of
income tax on the trust income
▪ BUT Employees’ Trust is exempt, provided:
 must be part of a pension, stock bonus or profit sharing plan of
the employer for the benefit of some or all of his employees;
 contributions are made to the trust by such employer, or such
employees, or both;
 such contributions are made for the purpose of distributing to
such employees both the earnings and principal of the fund
accumulated by the trust; and
 the trust instrument makes it impossible for any part of the trust
corpus or income to be used for, or diverted to, purposes other than
the exclusive benefit of such employees. (Section 60B)

► Income of employees trust also exempt; otherwise, taxation of those

earnings would result in a diminution of accumulated income and
reduce whatever the trust beneficiaries would receive out of the trust
fund.
C. Corporations
▪ Term “Corporation” Includes:
 Corporation
 Partnerships, no matter how created or organized;
 Joint-stock companies;
 Joint accounts (cuentas en participacion)
 Associations; or
 Insurance companies

▪ Term “Corporation” Excludes:

 General professional partnerships;
 Joint venture or consortium formed for the purpose of undertaking
construction projects; and
 Joint venture or consortium for engaging in petroleum, coal, geothermal
and other energy operations pursuant to an operating or consortium
agreement under a service contract with the Philippine Government.
▪ Either:
 Domestic
 Foreign
❖ resident foreign corporation
❖ non-resident foreign corporation
▪ General Rule: 30% of taxable income
▪ Except:
 PEZA/SBMA/CSEZ/other Economic Zones registered entities -
5% Preferential tax rate on GIE
 Proprietary educational institutions & non-profit hospitals –
10%, provided gross income from unrelated business does not
exceed 50% of total gross income from all sources
 Depositary Bank under Expanded FCDU System:
❖ 10% on interest income earned from FX loans granted to
residents other than OBUs, or other depositary banks
under expanded FCDU system
❖ Exempt on foreign currency transactions with non-
residents
 Exempt corporations under Section 30 BUT only on income
derived as such
 Exempt GOCCs: GSIS, SSS, Philhealth, PCSO
 Passive income subject to final tax
 Where MCIT is greater than RCIT
➢ Passive income subject to final tax:
 Interest on currency bank deposit and yield or any
other monetary benefit from deposit substitutes and
from trust funds and similar arrangements – 20%
 Interest income from FCDU – 7 ½%
 Royalties – 20%
 Dividends from another domestic corporation – 0%
(exempt)
 Gain from sale of shares of stock of domestic
corporations not listed and traded on PSE – 5% on first
PhP100,000 of net gain, and 10% on the excess over
PhP100,000
 Gain from sale, exchange or other disposition of land or
building classified as capital asset – 6% on gross SP or
FMV, whichever is higher
▪ General Rule: 30% of taxable income
▪ Except:
 5% Preferential tax rate on GIE
 On-line international carriers – 2 ½% GPB,
BUT 1 ½% under most tax treaties
 Offshore Banking Units (OBUs):
❖ 10% on interest income earned from FX loans granted to
residents other than OBUs, or local commercial banks or
branches of foreign banks authorized to transact with
OBUs
❖ Exempt on income with nonresidents
 RAHQ – Exempt
 ROHQ – 10% of taxable income from qualifying services
 Passive income subject to final tax
 Where MCIT is greater than RCIT
➢ Passive income subject to final tax:
 Same as domestic corporation save only for 6% final
tax on gain from sale, exchange or other disposition
of land or building classified as capital asset
▪ General Rule: 30% of taxable income
▪ Except:
 Tax Treaty Provisions
 Non-resident cinematographic film owner or lessor or
distributor – 25% of gross income
 Non-resident owner or lessor of vessels – 4.5% of gross
rentals, lease or charter fees from leases or charters to
Filipinos duly approved by the Maritime Industry
Authority
 Non-resident owner or lessor of aircraft, machinery and
other equipment – 7.5% of gross rentals or fees
 Passive income subject to final tax
➢ Passive income subject to final tax BUT subject to tax
treaty rules:
 Interest on foreign loans – 20%
 Dividends from a domestic corporation – 15%
subject to deemed paid tax credit requirement –
20% now; 15% beginning January 1, 2009
 Gain from sale of shares of stock of domestic
corporations not listed and traded on PSE – 5% on
first PhP100,000 of net gain, and 10% on the excess
over PhP100,000
▪ 30% Regular Corporate Income Tax (RCIT)
▪ 5% Preferential Tax Rate based on GIE
▪ 2% Minimum Corporate Income Tax (MCIT)
▪ 10% Improperly Accumulated Earnings Tax (IAET)
▪ 15% Branch Profits Remittance Tax (BPRT)
▪ MCIT imposed ---
 Shall apply only to domestic and resident foreign corporations subject
to the normal corporate income tax
 Whenever such corporation has zero or negative taxable income; or
 Whenever the amount of MCIT is greater than the RCIT
 Beginning on the 4th year immediately following the year of start of
commercial operations (i.e., year of registration with the BIR)
 In case of a domestic corporation whose operations or activities are
partly covered by the regular income tax system and partly covered
under a special income tax system, the MCIT shall apply on operations
covered by the regular corporate income tax system.
 In computing the MCIT due from a resident foreign corporation, only
the gross income from sources within the Philippines shall be
considered for such purpose
▪ Tax Rate : 2%
▪ Tax Base: Gross income subject to RCIT less only cost of goods sold or
direct costs and expenses
 2000 2001 2002 2003 2004

Date of 1st 2nd 3rd 4th

registration taxable taxable taxable taxable
with BIR year year year year
(any date
within the
year)

Subject to MCIT starting

taxable year 2004
▪ Carry Forward of Excess MCIT:
 Any excess of MCIT over RCIT carried forward on an annual and
quarterly basis.
 For the next 3 immediately succeeding taxable years; excess
beyond 3 years – forfeited
 Credited only against RCIT payable
▪ MCIT NOW APPLIES TO QUARTERLY ITRs [RR 12-2007]
 The computation and the payment of MCIT shall likewise apply
at the time of filing the quarterly corporate income tax.
 The final comparison between the RCIT payable by the
corporation and the MCIT shall be made at the end of the
taxable year, and the payable or excess payment in the Annual
Income Tax Return shall be computed taking into consideration
corporate income tax payment made at the time of filing of
quarterly corporate ITRs whether this be MCIT or RCIT.
▪ Imposed in addition to income tax
▪ It is a surtax
▪ Tax rate: 10%
▪ Imposed on the improperly accumulated taxable income of every
corporation formed or availed for the purpose of avoiding the
income tax with respect to its shareholders, or the shareholders of
any other corporation, by permitting earnings and profits to
accumulate instead of being divided or distributed.
▪ Exceptions:
(a) Publicly-held corporations;
(b) Banks and other nonbank financial intermediaries; and
(c) Insurance companies.
▪ Exceptions:
(d) Taxable partnerships;
(e) General professional partnerships;
(f) Non- taxable joint ventures; and
(g) Enterprises duly registered with the Philippine
Economic Zone Authority under R.A. 7916, and
enterprises registered pursuant to the Bases
Conversion and Development Act of 1992 under R.A.
7227, as well as other enterprises duly registered
under special economic zones declared by law
which enjoy payment of special tax rate on their
registered operations or activities in lieu of other
taxes, national or local.
▪ Evidence of Purpose to Avoid Income Tax
 (1) Prima Facie Evidence. — The fact that any corporation is a
mere holding company or investment company shall be
prima facie evidence of a purpose to avoid the tax on its
shareholders or members.
 (2) Evidence Determinative of Purpose. — The fact that the
earnings or profits of a corporation are permitted to
accumulate beyond the reasonable needs of the business
shall be determinative of the purpose to avoid the tax upon
its shareholders or members unless the corporation, by the
clear preponderance of evidence, shall prove to the contrary.

▪ Reasonable Needs of the Business — the term 'reasonable needs

of the business' includes the reasonably anticipated needs of the
business.
▪ IAET Base: Improperly accumulated taxable income =

Taxable income per ITR

Add back:
(1) Income exempt from tax;
(2) Income excluded from gross income;
(3) Income subject to final tax; and
(4) The amount of net operating loss carry-over deducted;
Less:
(1) Dividends actually or constructively paid; and
(2) Income tax paid for the taxable year.
RMC No. 35-2011 (Illustration)

Particular Amount
Taxable income for the year (e.g., 2010) PhP xxx xxx xxx
Add: Income subjected to final tax xxx xxx xxx
NOLCO xxx xxx xxx
Income exempt from tax xxx xxx xxx
Income excluded from gross income xxx xxx xxx
Less: Income tax paid (xxx xxx xxx)
Dividends declared or paid (xxx xxx xxx)
Total* PhP xxx xxx xxx
RMC No. 35-2011 (Illustration)

Particular Amount
Total* PhP xxx xxx xxx
Add: Retained earnings from prior years xxx xxx xxx
Accumulated earnings as of December 31, PhP xxx xxx xxx
2010
Less: Amount the may be retained (100% of (xxx xxx xxx)
Paid-up capital as of December 31, 2010)
Improperly Accumulated Earnings PhP xxx xxx xxx
Multiplied by 10%
IAET PhP xxx xxx xxx
▪ 15% BPRT on any profit remitted by the Philippine branch of a
foreign corporation to its head office abroad based on the total
profits applied or earmarked for remittance, without any
deduction for the tax component thereof

▪ EXCEPT those registered with the PEZA

▪ To be subject to the BPRT – must be effectively connected with

the conduct of the branch’s trade or business in the Philippines.

▪ See Tax Treaties – some bring it down to 10%

Deductions
▪ The taxpayer seeking a deduction must point to some specific
provisions of the statute authorizing the deduction.

▪ He must be able to prove that he is entitled to the deduction

authorized or allowed.

▪ Any amount paid or payable which is otherwise deductible from, or

taken into account in computing gross income or for which
depreciation or amortization may be allowed, shall be allowed as
deduction only if it is shown that the tax required to be deducted
and withheld therefrom has been paid to the BIR.

▪ Deductions for income tax purposes partake of the nature of tax

exemptions; hence, if tax exemptions are to be strictly construed,
then it follows that deductions must also be strictly construed.
▪ ITEMIZED DEDUCTIONS
 Ordinary and necessary expenses;
 Interest;
 Taxes;
 Losses; see also NOLCO;
 Bad debts;
 Depreciation of property;
 Depletion of oil and gas wells and mines;
 Charitable and other contributions;
 Research and development;
 Pension trust contributions of employees; and
 Premium payments on health and/or hospitalization insurance.
(This is the only deduction which a compensation income earner
may claim as a deduction.)
► Necessary Expense – appropriate and helpful in the
development of taxpayer's business and are intended to
minimize losses or to increase profits

► Ordinary Expense – normal or usual in relation to the

taxpayer’s business and the surrounding circumstance.

► Examples:
 Salaries
 EAR
 Rent
▪ Payment for the use or forbearance or detention of money, regardless of the name
it is called or denominated. It includes the amount paid for the borrower's use of
money during the term of the loan as well as for his detention of money after the
due date for its repayment. (RR 13-2000)
▪ Requisites For Deductibility (RR No. 13-2000)
 there must be an indebtedness;
 of the taxpayer;
 legally due
 stipulated in writing;
 paid or incurred during the taxable year;
 connected with the taxpayer's trade, business or exercise of profession;
 not between related taxpayers as provided under Sec. 36 (B) of the NIRC;
 not expressly disallowed by law (e.g,, incurred to finance petroleum
operations)
 does not exceed the limit set forth in the law (reduced by 33% of the interest
income subject to final tax)
 In case of interest incurred to acquire property used in trade, business or
exercise of profession, the same was not treated as capital expenditure.
▪ Requisites for Deductibility
 Taxes paid or incurred within the taxable year in connection
with the taxpayer's profession, trade or business EXCEPT:
 (a) The income tax provided for under this Title;
 (b) Income taxes imposed by authority of any foreign
country; but this deduction shall be allowed in the case of a
taxpayer who does not signify in his return his desire to
have to any extent the benefits of the foreign tax credit
 (c) Estate and donor's taxes; and
 (d) Taxes assessed against local benefits of a kind tending
to increase the value of the property assessed.
▪ Losses which are not compensated by insurance and do not
come under the category of bad debts, inventory losses,
depreciation, etc., and which arise in taxpayer's profession,
trade or business; includes casualty loss.

▪ NOLCO – can be carried over as a deduction from gross

income for the next 3 consecutive taxable years immediately
following the year of such loss. Beyond 3 years – forfeited.

▪ Requisites for Deductibility:

▪ The loss must be that of the taxpayer
▪ Actually sustained and charged off during the taxable year
▪ Not compensated for by insurance or otherwise
▪ Debts resulting from the worthlessness or uncollectibility, in whole or
in part, of amounts due the taxpayer by others, arising from money lent
or from uncollectible amounts of income from goods sold or services
rendered.
▪ Requisites For Deductibility (R.R. No. 5-99 as amended by R.R. No. 25-
2002)
 Existing indebtedness due to the taxpayer which must be valid and
legally demandable;
 Connected with the taxpayer's trade, business or practice of
profession;
 Must not be sustained in a transaction entered into between
related parties enumerated under Section 36(B) of Tax Code;
 Actually ascertained to be worthless and uncollectible as of the
end of the taxable year ; and
 Actually charged off in the books of accounts of the taxpayer as of
the end of the taxable year.
▪ Equitable Doctrine Of Tax Benefit

A recovery of bad debts previously deducted from gross

income constitutes taxable income if in the year the
account was written off, the deduction resulted in a tax
benefit.
▪ The gradual diminution in the service or useful value of tangible
property due from exhaustion, wear and tear and normal
obsolescence. The term also applies to amortization of intangible
assets, the use of which in trade or business is of limited duration.

▪ Requisites for Deductibility:

 The allowance for depreciation must be reasonable.
 It must be for property arising out of its use in the trade or
business, or out of its not being used temporarily during the
year.
 The allowance must be charged off within the taxable year.
 Schedule on the allowance must be attached to the return.
▪ Exhaustion of natural resources as in mines, oil, and gas wells. The
natural resources are called “wasting assets”. As the physical units
representing such resources are extracted and sold, such assets move
towards exhaustion.
▪ Known as cost of depletion allowance for mines, oil gas wells and other
natural deposits starting calendar year 1976 and fiscal year beginning
July, 1975.
▪ To Whom Allowed:
 Only mining entities owning economic interest in mineral deposits.
 Economic interest means interest in minerals in the place of
investment therein or secured by operating or contract agreement
for which income is derived, and return of capital expected, from
the extraction of mineral.
 Mere economic or pecuniary advantage to be derived by
production by one who has no capital investment in the mineral
deposit does not amount to economic interest.
▪ Contributions and donations of a taxpayer may be deductible in
full, or deductible, but subject to limitations.
▪ See rules on accreditation with PCNC (EO 671)
▪ Requisites For Deductibility:
 The contribution or gift must be actually paid or made to the
Philippine government or any political subdivision thereof
exclusively for public purposes, or any of the accredited domestic
corporation or association specified in the Tax Code;
 It must be made within the taxable year
 Unless allowed full deductibility, it must not exceed 10%
(individual) or 5% (corporation) of the taxpayer’s taxable income
before charitable contributions.
 It must be evidenced by adequate receipts or records (i.e.,
Certificate of Donation/official receipt of donee).
▪ R&D costs are for improvements of processes and formulas
as well as the development of improved or new products.
Research and development costs may be expenditures ---
 For acquisition or improvements of property subject to
depreciation or depletion used in research and
development;
 Other research and development costs.
▪ Treatment either as:
(1) Revenue Expenditures
 Paid or incurred during the taxable year;
 Ordinary and necessary expenses in connection with
trade business or profession; and
 Not chargeable to capital account.
(2) Deferred Expenses
 Paid or incurred in connection with trade, business,
or profession;
 Not treated as expense; and
 Chargeable to capital account but not chargeable to
property subject to depreciation or depletion
 Amortized over a period of not less than 60 months.
▪ A deduction applicable only to the employer on account of its
contribution to a private pension plan for the benefit of its
employee.
▪ Requisites For Deductibility:
 The employer must have established and funded a pension or
retirement plan to provide for the payment of reasonable
pensions to his employees;
 The pension plan is reasonable and actuarially sound;
 The amount contributed must not be subject to the control and
disposition of the employer;
 The payment has not yet been allowed as a deduction; and
 Contribution for present or normal service cost – 100%
deductible in year paid or contributed; for past service cost -
deduction is apportioned in equal parts over a period of 10
consecutive years beginning with the year in which the transfer
or payment is made.
▪ Kinds Of Private Retirement Benefit Plans
 Trusteed plan
 Non-trusteed plan/insured plan
▪ Reasonable private benefit plan [RA 4917 and Section
32(B)(6)(a)]
 A pension, gratuity, stock bonus or profit-sharing plan maintained
by an employer for the benefit of some or all of his officials or
employees, wherein contributions are made by such employer for
officials or employees or both for the purpose of distributing to
such officials and employees the earnings and principal of the fund
thus accumulated, and wherein it is provided in said plan that at no
time shall any part of the corpus or income of the fund be used for,
or be diverted to, any purpose other than for the exclusive benefit
of the said officials and employees.
 Before availing of the privilege, a certificate of tax exemption for
reasonable private benefit plan must be obtained.
▪ Personal, living or family expenses – because these are personal
expenses;
▪ Amount paid out for new buildings or for permanent improvements, or
betterment made to increase the value of any property or estate -
because these are capital expenditures Except that intangible drilling
and development cost incurred in petroleum operations are
deductible;
▪ Amount expended in restoring property or in making good the
exhaustion thereof for which an allowance has been made – because
these are capital expenditures;
▪ Premiums paid on any life insurance policy covering the life of any
officer or employee, or of any person financially interested in any trade
or business carried on by the taxpayer, individual or corporate, when
the taxpayer is directly or indirectly a beneficiary under such policy –
because these are items not normally subject to income tax and
therefore not deductible.
▪ Interest and Losses from sales or exchanges of property between
related parties
• Implements Section 34 of RA No. 8424, as amended by Section 3 of
RA No. 9504
• Comparison of OSD rates

RA No. 8424 RA No. 9504

Domestic and OSD is not allowed 40% of gross income
Resident Foreign
Corporation
▪ OSD for Corporations
➢ Forty percent (40%) of gross income
➢ Can be claimed by:
-Domestic Corporation
-Resident Foreign Corporation
▪ OSD for Corporations
• “Gross Income” shall mean the gross sales less returns,
discounts and allowances and cost of goods sold. “Gross
sales” shall include only sales contributory to income
taxable under Section 27(A) of the Code. “Cost of Goods
Sold” shall include the purchase price or cost to produce
the merchandise and all expenses directly incurred in
bringing them to their present location and use.

• For trading or merchandising concern, “cost of goods

sold” means the invoice cost of goods sold, plus import
duties, freight in transporting the goods to the place
where the goods are actually sold, including insurance
while the goods are in transit.
▪ OSD for Corporations
• For manufacturing concern, “cost of goods sold” means all costs
incurred in the production of finished goods such as raw materials
used, direct labor and manufacturing overhead, freight cost,
insurance premiums and other costs incurred to bring the raw
materials to the factory or warehouse. The term may be used
interchangeably with “cost of goods manufactured and sold”.
• In the case of sellers of services, the term “gross income” means
the “gross receipts” less sales returns, allowances, discounts and
cost of services. “Cost of service” means all direct costs and
expenses necessarily incurred to provide the services required by
the customers and clients including (a) salaries and employee
benefits of personnel, consultants and specialists directly
rendering the service, and (b) cost of facilities directly utilized in
providing the service such as depreciation or rental of equipment
used and cost of supplies: Provided, however, that “cost of services”
shall not include interest expense except in the case of banks and
other financial institutions.
▪ OSD for Corporations

• The term “gross receipts” as used herein means amounts

actually or constructively received during the taxable year.
However, for taxpayers engaged as sellers of services but
employing the accrual basis of accounting for their income,
the term “gross receipts” shall mean amounts earned as
gross revenue during the taxable year.

• The items of gross income under Section 32 (A) of the Tax

Code which are required to be declared in the income tax
return of the taxpayer for the taxable year are part of the
gross income against which OSD may be deducted in
arriving at the taxable income.
▪ OSD for Corporations

• Passive income which have been subjected to a final tax

at source shall not form part of the gross income for
purposes of computing the 40% OSD.

• For other taxpayers allowed by law to report their income

and deductions under a different method of accounting
(e.g. percentage of completion basis, etc.) other than
cash and accrual method of accounting, the “gross
income” shall be determined in accordance with said
acceptable method of accounting.
▪ Illustrative Examples in Determining the basis of the 40% OSD for
Corporations

▪ Suppose a retailer of goods, whose accounting method is under the

accrual basis has a gross sales of P1,000,000 with a cost of sales
amounting to P800,000. The computation of the OSD for
corporations shall be determined as follows:

▪ Gross sales P1, 000,000

▪ Less: Cost of Goods Sold 800,000
▪ Basis of the OSD P 200,000
▪ x OSD Rate (maximum) .40
▪ OSD Amount P 80,000