UNIVERSITY OF SAN CARLOS

School of Law and Governance

Cebu City

Activity 1

INCOME TAXATION
General Overview 
(revised pursuant to the Tax Reform for Acceleration and Inclusion, R.A. No. 10963)

I. Definition of Income Tax

 A tax on all yearly profits arising from property, professions, trades
or offices, or
 A tax on a person’s income, emoluments, profits & the like.
 It may be succinctly defined as a tax on income, whether gross or
net, realized in one taxable year. 

II. Nature of Income Tax – national, excise, direct, and general tax.
 Income Tax is source [1] blind            .

III. Purposes of Income Taxataion

1. Revenue
Purpose of taxation is to raise revenue in order to defray the
expenses of the government.
2. Redistribution
People who earn more, pay more taxes, so their wealth is used
for the benefit of everyone, including the less wealthy
individuals. 
3. Re-pricing 
Higher taxes are imposed on articles which are considered
dangerous to the health of the people to address externalities
and prevent citizens from using such dangerous products,
higher taxes may be imposed to curtail such practice. The end
goal is to change the behaviour of the citizens or to promote a
certain policy.
4. Representation
Our representatives are the ones imposing the tax, but since
the people are the ones putting them in power, the people can
demand something from them — efficient and effective
government service. There is the sense of accountability. “No
taxation without representation”

IV. Brief Historical Background of Philippine Income Taxation

 V. Sources of Income Tax Law
1) Constitution 
2) Legislation from Congress – National Internal Revenue Code, as
amended, by TRAIN law and other special laws like the exemption
granted to economic zones (very common example are PEZA entities -
these are subject to income tax on activities not exempted from their
grant since they can have the 5% rate in lieu of other taxes) 
3) Judicial decisions – As per the principle of stare decisis, SC decisions
form part of the law of the land. 
4) Administrative rules and regulations – Those issued by BIR, and other
administrative agencies to interpret tax laws. 
• Revenue regulations – issued by Sec of Finance with
recommendation of the Commissioner of Internal Revenue 
• Revenue memorandum orders, memorandum rulings, and
memorandum circulars – issued by BIR
VI. Definition of Terms
 
 Income (broad sense)- all wealth w/c flows into the taxpayer
other than as a mere return of capital; includes the forms of
income specifically described as gains & profits, including
gains derived from the sale or other disposition of capital assets.
Income means - 
 accession to wealth
 gain
 flow of wealth
 [2] ____________Capital_____ – a fund or property existing
at one point of time (while income denotes a flow of wealth during
a definite period of time). Capital is wealth, income is the flow of
wealth.
 Gain - transaction resulting in increases of wealth capable of
pecuniary estimation
 Gross Income - income (in its broad sense) less income w/c is
by statutory provision or otherwise excluded from the tax imposed
by law. This includes but not limited to the enumerations under
Section 32a.
 [3] _______Gross Income Taxation_______- a system of
taxation where the income is taxed at gross. The taxpayers under
this system are not entitled to any deductions.
 [4] ___Net Income Taxation___- system of taxation where the
income is taxed at net. The taxpayer may claim allowable
deductions.
 Passive Income - refers to those items of gross income earned by
the taxpayer w/o his active/direct participation in the earning
process.
 Taxable Income (previously, Net Income)- pertinent items of
income as specified in the Tax Code less the deductions and/or
personal and additional exemptions, if any, authorized for such
types of income by the Code or other special laws. It is the amount
of income that is taxed [Pertinent items of GI – Allowed
Deductions]  
VII. General principles of Income Taxation in the Philippines
1. A [5] ____Resident Citizen____ is taxable on all income derived
from sources within and without (outside) the Philippines.
2. A NON-RESIDENT CITIZEN is taxable only on incomes derived from
sources within the Philippines.
3. An [6] __Overseas Contract Worker____ is taxable only on income
from sources within the Philippines. A seafarer who is a citizen of the
Philippines and who receives compensation for services rendered
abroad as a member of the complement of a vessel engaged
exclusively in the international trade shall be treated as an overseas
contract worker.
4. An [7] ____Alien Individual_____ whether a resident or not of the
Philippines, is taxable only on income derived from sources within the
Philippines.
5. A DOMESTIC corporation is taxable on all income derived from sources
within and without (outside) the Philippines.
6. A [8] _____Foreign __________ Corporation whether engaged or not
in trade or business in the Philippines, is taxable only on income
derived from sources within the Philippines.

VIII. Systems of Income Taxation [Philippines: partly schedular  and partly

global system of income taxation]

1. Schedular Income Tax System

2. Global Income Tax System

IX. Kinds of Income Tax Methods

1. Gross Income Taxation

2. Net Income Taxation

X. Features of Our Present Income Taxation (RA No. 8424, RA No.

9504, RA No. 9337) – Comprehensive Tax Situs

1. Basic Features of Individual Income Taxation

1. [9] ____Schedular___ System of Taxation.
2. Tax rates are progressive in character.
3. [10]    Modified Gross Income Taxation    as regards
pure compensation earner.
4. Net income taxation as regards those individual taxpayers
that derive business, trade or professional income.
Allowable deductions under Section 34 may be claimed by
individual taxpayers who derive business, trade and/or
professional income.
5. “Pay-as-you-File” System.
6. Under certain cases, [11] ___”Pay-As-You-Earn”___
system, as applicable to income subject to withholding tax.
 
2. Basic Features of Corporate Income Taxation
a. Global Concept of Taxation
 b. Corporate taxpayers’ exception- resident foreign
corporations are entitled to deductions. Net Income taxation
is applicable to domestic corporations and resident foreign
corporations.
c. “Pay-as-you-File” system (except in cases of electronic filing
system application)

3. Criteria Used – comprehensive system of imposing income tax

a. Residency (Domiciliary Rule) 
b. Nationality or citizenship (Nationality Rule)
c. Place/Source of Income (Source Rule)

XI. Sources of Income

[12] ____Capital__________
[13] ____Labor__________
[14] ____Both Labor and Capital__
[15] ____Sale of Property______

XII. Criteria to Determine if Income is Taxable

1. There is gain or profit (derived from a close and completed
transaction)
NB: In determining the profit for sale of property, the formula
is
 Amount Received/Realized LESS Cost of Property =
Profit
2. The gain or profit is [16] __realized____ or [17] _____received______
(either actually or constructively)
a. Example of income constructively received:
i. Matured interest coupons
ii. Interest on savings bank deposit
iii. Dividends applied to indebtedness of a shareholder
iv. Share in the profits of a partner in a GPP

3. Such gain or profit is not exempt under any law or treaty ergo, if there is a
provision of law recognizing or taxing the income

Hence, for income to be taxable it must be realized and

recognized.

TESTS:
1. [18] _____Flow of Wealth Test_____ - The
determining factor for the imposition of income tax is
whether any gain was derived from the transaction. (CIR
vs. Administratrix of the Estate of Echerri)

ii. Realization Test – also known as “Macomber Test”

-unless the income is deemed "realized," there is no
taxable income. Revenue is generally recognized when
both of the ff. conditions are met:
a. The earning process is complete or virtually complete, and

b. An exchange has taken place.

Stock Dividends as a rule are not subject to income tax.

iii. Economic-Benefit Principle - flow of wealth realized is

taxable only to the extent that the taxpayer is
economically benefited. Example: stock options – FMV in
shares upon exercise of the option vs. option price is
additional compensation income.

iii. [19] __Net Effect Test____ - The substance of the

whole transaction, not the form, usually controls the tax
consequences.

iii. Claim of right doctrine – doctrine of ownership,

command or control (embezzled funds-there is no
consensual agreement to return, hence taxable as an
income)

iii. [20] __All Events Test___- 1.) right to collect the

income or an obligation on the other party to pay the
same 2.) the amount if liquidated/certain

XIII. Kinds of Taxable Income or Gain

1. Capital Gains
-gains or income from the sale or exchange of capital assets,
including:
a. income from dealings in shares of stocks or domestic corporation whether or
not through the stock exchange;

What is a capital asset? (Section 39, NIRC)

Capital Assets. - the term 'capital assets' means property
held by the taxpayer (whether or not connected with his
trade or business), but does not include: 
[21] _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 _____
[22] __property held by taxpayer primarily for sale to
customers in the ordinary course of his trade or
business__
[23]    property used in the trade or business of a
character which is subject to the allowance for
depreciation___
[24] __real property used in trade or business of the
taxpayer_____

b. income from dealings in real property located in the

Philippines;
b. income from dealings in other capital assets other than (a) and (b).

2. Ordinary gains
- gains or income from the sale or exchange or property which are
not capital assets.
 1. Business income
2. Compensation income
3. Passive income
4. Other income derived from whatever source.

XIV. Gross Income

1. Inclusions – Section 32A [CG IR DAP ]

2 2 3

I. Compensation for services in whatever form paid, including, but not

limited to fees, salaries, wages, commissions, and similar items; 
     .__includes the cash value of all remuneration paid in any medium other
than cash.
 types of taxable compensation income: salaries, wages, bonus,
remuneration, honorarium, benefits and allowances, longevity pay,
subsistence allowance, hazard pay, annuities, pensions. 
 13 month pay and “other benefits” shall be excluded from
th

compensation income provided that the total amount does not exceed
[25] 90,000[effective January 1, 2018].
 backwages, allowances and benefits awarded in labor disputes –
subject to withholding tax on wages.

STOCK OPTIONS
Any income derived by the employees from their exercise of stock
options is considered as compensation income subject to withholding tax.
Subject to the following rules:
1. If granted to managerial or supervisory
employees – subject to [26] Fringe Benefit Tax (FBT)
2. Additional compensation of the taxable fringe
benefit is the difference between the BV/FMV of the shares whichever
is higher at the time of the exercise of the option;
3. Subject to DST if considered as original issuance
i.e. taken from unissued shares;

PRIMARY METHOD OF COLLECTING TAX FROM COMPENSATION

General Rule: Withholding by the employer

Exception: Those employed by foreign embassies and diplomatic missions,
aid agencies of foreign governments, United Nations and its specialized
agencies who are exempted from withholding tax on their compensation
income. 

II. Gross income derived from the conduct of trade or business or the
exercise of a profession; 

Manufacturing, merchandising, mining business:

GI = Total Sales – COGS + other income from other investments/from
incidental sources

Service enterprises:
GI = Total receipts – direct costs and expenses 
(refer to RMC 4-2003 as amended by RMC 30-2008)
 Professional Income: fees received by a professional from the
practice of his profession, provided that there is no employer-
employee relationship.

III. Gains/Income derived from dealings in property (Ordinary Asset);

III. Interests; 
III. Rents; 
III. Royalties; 
III. Dividends; 
III. Annuities; 
III. Prizes and winnings; 
III. Pensions; and
III. Partner's distributive share from the net income of the general professional
partnership. 

The enumeration is not exclusive.

Special Items Treatment:
 Self-Help Income
 Forgiveness/Condonation of Debt;
 Recovery of amounts previously written off

2. Exclusions – Section 32B

XV. Situs of Income (Section 42)

Sources Tax Situs

1. Compensation Income  [27]    Place where the service/s is/are rendered
2. Business Income Merchandising, Farming, Mining
-Place where the business is undertaken.

Manufacturing
a. Goods manufactured and sold within the
Philippines- income derived [28] _purely
within_________.
b. Goods manufactured & sold outside the
Philippines- income derived purely outside.
c. Goods manufactured within the Philippines and
sold outside the Philippines- [29] ____Income party
within and partly without____
d. Goods manufactured outside the Philippines and
sold within the Philippines- income partly within and
partly without.
3. Income from Sale 1. If it involves personal property- the place of
or Exchange of sale.
Property 2. In the case of sale of transport documents- the
place where the transport document is [30]
___Sold______.
3. If it involves real property- the place or location
of real property
 Interest Income Residence of the debtor/borrower.
5. Rent Income Place where the property subject of the contract is
located.
6. Royalties Place where the intangible property is used.
7. Dividend 1. Received from domestic corporation- income
purely within.
2. Received from foreign corporation outside the
income of the foreign corporation in the Philippines
during the last preceding 3 taxable years, following
rules shall apply, to wit—
1.  The income is purely within if the income
derived from the Philippines is more than 85%;
2.  It is purely without if the proportion of
its Philippine income to the total income is 50%
or less;
3.  There should be an allocation if it is
more than 50% but not exceeding 85%. 
8. Annuities Place where the contract was made.
9. Prizes and Winnings If on account of services rendered- place where the
services were rendered.
If not on account of service rendered – place where the
same is given. 
10. Pension Place where this may be given on account of services
rendered.
11. Professional income Place where the exercise of profession is undertaken.
of professional
partners

XVI. Exclusions from Gross Income

Exclusion from Gross Income Deductions from Gross

Income
Flow of wealth to the taxpayer which are not Amounts allowed by the law to
treated as part of gross income for purposes of be deducted from the gross
computing taxable income due to: income to arrive at net income.
1. Exemption under fundamental law;
2. Exemption by the statute;
3. Does not come under the definition of an
income.
Pertains to computation of gross income Pertains to computation of net
income.
Earned or received by the taxpayer but does Something spent or paid in
form part of the gross income. earning gross income.
Example: 13 month pay not exceeding the
th
Example: Business rent expense,
P90,000 exclusionary threshold salaries to employees, etc.

1. Proceeds of Life Insurance Policy

Subject to tax if:
1. Insurer and insured agreed that the amount of the proceeds
shall be withheld by the insurer with the obligation to pay
interest in the same, the interest will be subject to tax;
2. There is transfer of the insurance policy.

2. Amount Received as Return of Premium

 Reason for exclusion: it represents a mere return of capital.

3. Gifts, Bequests, Devises

Exceptions to the rule: the income or fruit of such money given by
donation, bequests or devise.
Bequests – personal property
Devise – real property

4. Compensation for injuries or sickness

Reason for exclusion: this is just an indemnification for the injuries
or damages suffered (compensatory in nature). The sources are:
a. The compensation may be paid by virtue of a suit; or 
b. It may be paid by virtue of health insurance, accident insurance or Workmen’s
Compensation Act.

5. Income exempt under treaty

Reason for the exclusion: Treaty has the obligatory force of a
contract.
Exception: as may be provided in the treaty.

6. Retirement benefits, Pensions, Gratuities

a. Retirement benefits under R.A. No. 7641 or a reasonable private benefit plan
b. Separation pay- amount received by an official or an employee or by his heirs
from the employer due to separation from service because of death, sickness,
or other physical disability or for any cause beyond the control of the official
or employee.
c. Social security benefits, retirement gratuities, pensions and other similar
benefits received by resident or non-resident citizens or resident aliens from
foreign institutions, whether public or private.
d. US veterans benefit
e. SSS
f. GSIS

Recipient: Private employees or official of private firm.

Requisites:
1. The private employee or official must be at least 50 years of
age at the time of his retirement;
2. He must have rendered at least 10 years of service to the
employer at the time of retirement;
3. There must be reasonable private benefit plan;
4. Reasonable private benefit plan may be in the nature of
pension plan, profit sharing plan, stock bonus plan, or gratuity;
5. The reasonable private benefit plan must be approved by the
BIR;
6. The employer must give contribution and no amount shall inure
to the benefit of a particular employee or official. This must be
established for the common benefit of the employees or
officials;
7. This can be availed of once. The subsequent retirement benefits
received from another private employer is no longer exempt
but subject to tax. (If the second employer is a government
entity or institution – exempt)
  
7. Miscellaneous Items
a. Prizes and awards given in recognition of Religious, Charitable, Scientific,
Educational, Artistic, Literary, or Civic achievements.

Conditions:
i. The recipient was selected without any action on his part to enter the contest
or proceeding, and
ii. The recipient is not required to render substantial future services as a
condition to receiving the prize or award.

b. Prizes and awards in sports competitions

Requisites:
i. Competition and tournament must be sanctioned or approved by the National
Sports Association; and
ii. The competition and tournament must also be approved by the Philippine
Olympic Committee, whether local or international, whether held in the
Philippines or outside.

c. Income derived by the Government or its political subdivisions

from the exercise of any essential governmental function or
from any public utility.

d. Income derived from investments in the Philippines by Foreign

Government or Financing Institutions
Requisites:
i. Recipient must be a:
a. Foreign government;
b. Financing institution owned, financed or controlled by foreign
government;
c. Regional financing institution, international financing institution
established by foreign government.
ii. It must be an income received from investment in the Philippines.

e. Gains derived from redemption of shares of stock issued by a

Mutual Fund Company

f. Contributions to GSIS, SSS, PAG-IBIG, and Union Dues

g. Benefits in the form of 13 month pay and other benefits

th

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

XVII. Allowable Deductions

1. Deduction vs. Exemption

2. Deduction vs. Exclusion

3. Basic principles governing deductions

1. The taxpayer seeking deduction must
point to some specific provisions of the
statute authorizing the deduction, and
 2. He must be able to prove that he is
entitled to the deduction authorized or
allowed.

4. Kinds of allowable deductions

i. Itemized deductions (Section 34A-K and 34M)
ii. Optional Standard Deduction of forty percent (40%) of the Gross Income.

Note: Under the TRAIN Law (R.A. No. 10963), the provisions on Basic
and Additional Personal exemption, as well as, deductions for
Premiums on Health and/or Hospitalization has been repealed.

XVIII. Non-deductible Items, (Section 36A and 36B)

1. Personal living or family expenses;
2. Amount paid for new buildings or permanent
improvements, or betterment to increase the value of any
property or estate;
3. Any amount expended in restoring property or in
making good the exhaustion thereof for which an allowance is or
has been made; or
4. Premium 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.
5. Losses from sales or exchanges of property
directly or indirectly-
1. Between members of a family (brother,
sister of half or full blood, spouse,
ascendants, lineal descendants).
2. Except in case of distributions in
liquidation between an individual and a
corporation- more than 50% in value of
the outstanding stock of which is owned
directly, by or for such an individual.
3. Except in case of distributions in
liquidation, between two corporations—
more than 50% in value of the
outstanding stock of each of which is
owned, directly or indirectly, by or for
same individual, if either one of such
corporation is a personal holding company
or a foreign personal holding company; or
4. Between the grantor and a fiduciary of
any trust, or
5. Between fiduciary of a trust and the
fiduciary of another trust, if the same
person is a grantor with respect to each
trust; or
6. Between a fiduciary of a trust and a
beneficiary of such trust.
 -END-

"A person doesn't know how much he has to be thankful for until he has to
pay taxes on it."
-Anonymous