Chapter 3: Introduction to Income Taxation

THE CONCEPT OF INCOME

Income is regarded as the best measure of taxpayer’s ability to pay tax. The tax concept
of income is referred to as gross income or inclusion in gross income
Gross income is broadly defined as any inflow of wealth to the taxpayer from whatever
source, legal or illegal, that increases net worth.

ELEMENTS OF GROSS INCOME

1. It is a return on capital that increases net worth
2. It is a realized benefit
3. It is not exempted by law, contract, or treaty.

Capital items deemed with infinite value

1. Life – The value of life is immeasurable by money. ‘
2. Health – in consideration for the loss of health such as compensation for personal
injuries or tortuous acts is deemed a return of capital.
3. Human Reputation – the value of one’s reputation cannot be measured financially.

Note: The loss of capital results in decrease in net worth while the loss of profit does not decrease net worth. The recovery of lost
capital merely maintains net worth while the recovery of lost profits increases net worth.

REALIZED BENEFIT

The benefit concept

The term benefit means any form of advantage derived by the tax payer. An increase in
net worth occurs when one receives income, donation or inheritance.

The following are not benefit, hence not taxable:

a. Receipt of loan – properties increase but obligation also increases.
b. Discovery of lost properties – the finder has an obligation to return the same to the
owner.
c. Receipt of money or property to be held or trust for, or to be remitted to another person.

The realized concept

The term realized means earned. It requires that there is a degree of undertaking or
sacrifice from the taxpayer to be entitled of the benefit.

Requisites of a realized benefit

1. There must be an exchange transaction
2. The transaction involves another entity
3. It increases the net worth of the recipient

Types of transfers
1. Bilateral transfers or exchange, such as:
 Sale
 Barter
These referred to as onerous transaction
2. Unilateral transfers, such as:
 Succession – transfer of property upon death
 Donation
These referred to as gratuitous transactions
3. Complex transfer – are partly gratuitous and partly onerous

Note: The gratuitous portion of the transaction is subject to transfer tax while the benefit from the onerous is subject
to income tax.
NOT EXEMPETD BY LAW, CONTRACT, OR TREATY
An item of gross income is not exempted by the constitution, law, contract or treaties
from taxation.
The following items of income are exempted by law from taxation; hence they are not
considered items of gross income:
1. Income of qualified employee trust fund
2. Revenue of non-profit non-stock educational institutions
3. SSS, GSIS, Pag-ibig, or PhilHealth benefits
4. Salaries and wages of minimum wage earners and qualified senior citizens
5. Regular income of BMBE’s
6. Income of foreign government and foreign government-owned controlled
corporations
7. Income of international missions and organization with income tax immunity

TYPES OF INCOME TAYPAYERS

A. Individuals
1. Citizen
Under the constitution, citizens are:
a. Those who are citizens of the Philippines at the time of adoption of the constitution of
February 2,1987
b. Those whose fathers or mothers are citizen of the Philippines
c. Those whose born before January 17,1973 of Filipino mothers who elected Filipino
citizenship upon reaching the age of majority
d. Those who are naturalized in accordance with the law

a. Resident citizen – Filipino citizen residing in the Philippines

b. Non-resident citizen

2. Alien
a. Resident alien – an individual who is residing in the Philippines but is not a
citizen thereof, such as:
1. Alien who lives in the Philippines without definite intention as to his stay; or
one who comes to the PH for a definite purpose which in its nature

b. Non-resident alien - an individual who is not residing in the Philippines and who
is not citizen thereof
a. Engaged in trade or business (NRA-ETB) – aliens who stayed in the
Philippines for a period more than 180 days during the year
b. Not engaged in trade or business (NRA-NETB) - aliens who shall come in
the Philippines for a period not more than 180 days during the year

3. Taxable estates and trusts

1. Estate – refers to the properties, rights, and obligations of a deceased person
not extinguished by his death.
2. Trust – a trust is an arrangement whereby one person transfer property to
another person which will be held under the management of a third party.
 B. Corporations – includes profit-oriented and non-profit institutions such as charitable
institutions, cooperatives, government agencies etc.
1. Domestic corporation – a corporation that is organized I accordance with Philippine
Laws
2. Foreign corporation – a corporation is one organized under foreign law
a. Resident foreign corporation (RFC) – a foreign corporation which operates and
conducts business in the Philippines through a permanent establishment
b. Non-resident foreign corporation (NRFC) - a foreign corporation which does
not operate or conduct business in the Philippines
Special Corporation – are domestic or foreign corporations which are subject to special
tax rules or preferential tax rates

OTHER CORPORATE TAXPAYERS

1. Partnership – a business organization owned by two or more persons who can
contribute their industry or resources to a common fund for the purpose of dividing
the profits from the venture.

Types of partnership
a. General professional partnership – a partnership formed for the exercise of a
common profession. All partners must belong to the same profession
b. Business partnership - a business partnership is one formed for profit. It is taxable
as a corporation.

2. Joint venture – a business undertaking for a particular purpose. It may be organized

as a partnership or a corporation

Types of joint ventures

a. Exempt joint ventures – are those formed for the purpose of undertaking
construction projects
b. Taxable joint ventures – all other joint ventures are taxable as corporation

3. Co-ownership – is a joint ownership of a property formed for the purpose of

preserving the same and/or dividing its income

Situs of income vs. Source of income

INCOME SITUS RULES

Types of income Place of taxation
1. Interest income Debtor’s residence
2. Royalties where employed
3. Rent income Location of property
4. Service income Service is rendered

OTHER INCOME SITUS RULES

 A. Gains on sale of property
1. Personal Property
 Domestic securities – presumed earned within the Philippines
 Other personal properties – earned where the property is sold
2. Real property – earned where the property is located

B. Dividend income from:

1. Domestic corporation – presumed earned within
2. Foreign corporation
a. Resident foreign corporation – depends on the pre-dominance test
The pre-dominance test
 At least 50%, the portion of the dividend corresponding to the Philippines gross income ratio is earned within
 Less than 50%, the entire dividends received is earned abroad
b. Non-resident foreign corporation – earned abroad

C. Merchandising income – earned where the property is sold

D. Manufacturing income – earned where the goods are manufactured and sold