Income Taxation Quick Notes
Function of income tax system
Income taxation – branch of taxation which provides for
statutory and administrative system of imposing and
collecting tax on the yearly profits arising from property,
professions, trades and offices.
Nature of income taxation
 Excise transaction system since it is a taxation on the
exercise of a privilege to earn yearly profits from various
sources.
Basis in imposing income tax
1. Partnership theory – theory based on the right
of a government to tax income emanates from
its partnership in the production of income, by
providing the protection, resources, incentive,
and proper climate for such production. (CIR vs.
Lednicky)
2. Protection theory - The site of the source of
payments is the Philippines. The flow of wealth
proceeded from, and occurred within,
Philippine territory, enjoying the protection
accorded by the Philippine government. In
consideration of such protection, the flow of
wealth should share the burden of supporting
the government.
3. Favorable Business Climate Theory - Domestic
corporations owe their corporate existence and
their privilege to do business to the
government. They also benefit from the efforts
of the government to improve the financial
market and to ensure a favorable business
climate. It is therefore fair for the government
to require them to make a reasonable
contribution to the public expenses.
- These theories are the reason behind the law
requirement payment of income taxes.
Income tax systems:
1. As to manner of imposition:
a. Global tax system
b. Schedular tax system
c. Semi global/schedular
2. As to applicable tax law
a. NIRC
b. Special laws
3. As to tax rate
a. Progressive
b. Regressive
c. Proportionate
Madrigal vs. Rafferty Case
 The Income Tax Law of the United States, extended
to the Philippine Islands, is the result of an effect on the
part of the legislators to put into statutory form this
canon of taxation and of social reform. The aim has
been to mitigate the evils arising from inequalities of
wealth by a progressive scheme of taxation, which
places the burden on those best able to pay. To carry
out this idea, public considerations have demanded an
exemption roughly equivalent to the minimum of
subsistence. With these exceptions, the income tax is
supposed to reach the earnings of the entire non-
governmental property of the country. Such is the
background of the Income Tax Law.
Criteria in imposing Income Tax
1. Citizenship or Nationality Theory – the country
where the income earner is a citizen because he
is given protection by his country no matter
where he earns his income. He is therefore
obliged to give support to his country.
2. Residence or Domiciliary Theory – the country
where the income earner resides for the reason
that he is given protection in his place of
residence.
3. Source – the country where the source of
income is where the activity that produced the
income took place. Not where the money
originated. So you should look into where the
activity took place that produced the income.
Features of Philippine Income Tax
Doctrine of Moral Neutrality of the Taxing Authority 
The Establishment Clause principally prohibits the State
from sponsoring any religion, or favoring any religion as
against other religions. It mandates a strict neutrality in
affairs among religious groups. No tax in any amount,
large or small, can be levied to support any religious
activities or institutions, whatever they may be called,
or whatever form they may adopt to teach or practice
religion.
This doctrine believes that the "wall of separation" does
not require the state to be their adversary. Rather, the
state must be neutral in its relations with groups of
religious believers and nonbelievers." State power is no
more to be used so as to handicap religious than it is to
favor them. The Strict Neutrality approach is not hostile
to religion, but it is strict in holding that religion may not
be used as a basis for classification for purposes of
governmental action, whether the action confers right
or privileges or imposes duties or obligations. Only
secular criteria may be the basis of government action.
It does not permit, much less require, accommodation
of secular programs to religious belief.
Types of Philippine Income Tax
1. Gross income tax – occurs when the tax base is
the total gross income of an individual or
corporation during the taxable year without
deductions whatsoever.
2. Net income tax – occurs when the tax base is
the total gross income of an individual that has
claimed and was granted a deduction.
3. Presumptive income tax – allowed in the
context of capital gains tax. It is a concept of
taxation according to which income tax is based
on "average" income instead of actual income.
4. Composite tax – tax consisting of quasi-personal
taxes, assessed on the particular source of
income with a superimposed personal tax on
the income as a whole.
5. Unitary tax
INCOME – means all wealth which flows into the
taxpayer other than as a mere return of capital. It
includes the form of income specifically described as
gains derives from sale or other disposition of capital
 It is the amount of money coming to a person or
corporation within a specified time, whether as
payment for services, interest, or profits from
investment.
Other terms:
Capital – is the funds or property existing at one distinct
point of time. It is the wealth.
Receipts – has reference to all wealth that flows into the
taxpayer which includes return of capital. It is broader in
scope than income. It does not necessarily mean
income, this is what is received and includes the income
in its definition (literally yots, receipt “kung unsay
nadawat”)
Revenue – as applied to taxation, refers to all the funds
of income derived by the government, whether from
tax or any other source.
Dividends – payment made by the company to
shareholders or owners of stocks, way to distribute back
to investors the revenue, ways that an investor earns.
Also termed as cash dividend which is taxable.
Stock Dividends – is the dividend payment made in the
form of additional shares rather than a cash payout. The
company may decide to give this to the shareholders
instead of liquid cash, they are not taxable until they are
sold.
Sources of income:
1. Services rendered or labor
2. Capital which is not limited to money or
property
3. Gains from exchange of properties or gains
from profit.
Related concepts
a. Return of Capital  Return of capital (ROC) is a
payment, or return, received from an
investment that is not considered a taxable
event and is not taxed as income. Capital is
returned, for example, on retirement accounts
and permanent life insurance policies; regular
investment accounts return gains first. is the
return of the principal only, and it is not any
gain or any loss as a result of the investment 
NOT TAXABLE, reason: Because it is money
being returned and not earned, it’s not
considered taxable income. Once returns exceed
the original initial investment, it counts as a
capital gain and is therefore taxable.
b. Return on capital  (ROC) is a ratio that
measures how well a company turns capital
(e.g. debt, equity) into profits. In other words,
ROC is an indication of whether a company is
using its investments effectively to maintain and
protect their long-term profits and market share
against competitors. Return on capital is also
known as return on invested capital (ROIC). It is
an accounting measure. Return of capital refers
to a company returning original investment
funds back to the investor or by liquidating
assets. Return on capital refers to a company’s
profitability.
c. Revenue  Revenue is the income generated
from normal business operations and includes
discounts and deductions for returned
 merchandise. It is the top line or gross income
figure from which costs are subtracted to
determine net income.
 As applied to taxation, it refers to all funds or
income derived by the government, whether
from tax or any other source. Revenue is to the
government, income is to person or
corporation.
d. Receipts  Has reference to all wealth that
flows into the taxpayer which includes return of
capital. It refers to amounts one has earned as
the result of business activities such as selling
merchandise or performing services. Broader in
scope than income.
e. Accounting income  Accounting income is the
profit a company retains after paying off all
relevant expenses from sales revenue earned. It
is synonymous with net income, which is most
often found at the end of the income
statement. The metric differs from gross income
in that the latter accounts for only direct
expenses, whereas accounting income also
takes into consideration all indirect expenses.
Test of Taxable income
1. Flow of Wealth test  This test is based on the
definition of gross income under sec. 29, sec. 3
particularly the term and income derived from
any source whatever.
 The site of the source of payments is the Philippines.
The flow of wealth proceeded from, and occurred
within, Philippine territory, enjoying the protection
accorded by the Philippine government. In
consideration of such protection, the flow of wealth
should share the burden of supporting the government.
2. Realization Test  Under the realization
principle, revenue is generally recognized when
both of the following conditions are met: (1) the
earning process is complete or virtually
complete; and, (2) an exchange has taken place.
This principle requires that revenue must be
earned before it is recorded.
3. All – event test  The all-events test requires
the right to income or liability be fixed, and the
amount of such income or liability be
determined with reasonable accuracy.1âwphi1
However, the test does not demand that the
amount of income or liability be known
absolutely, only that a taxpayer has at his
disposal the information necessary to compute
the amount with reasonable accuracy. The all-
events test is satisfied where computation
remains uncertain, if its basis is unchangeable;
the test is satisfied where a computation may
be unknown, but is not as much as unknowable,
within the taxable year. The amount of liability
does not have to be determined exactly; it must
be determined with "reasonable accuracy.
"Accordingly, the term "reasonable accuracy"
implies something less than anex act or
completely accurate amount.
 The accrual of income and expense is permitted
when the all-events test has been met. This test
requires: (1) fixing of a right to income or liability to pay;
and (2) the availability of the reasonable accurate
determination of such income or liability.
4. Economic Benefit Principle  – Any economic
benefit to the employee that increases his net
worth, whatever may have been the mode by
which it is effect, is taxable.
5. Severance test  – There is no taxable income
until there is a separation from capital of
something of exchangeable value, thereby
supplying the realization or transmutation
which would result in the receipt of income.
6. Substantial alteration test  – There is no
taxable income until there is a separation from
capital of something of exchangeable value,
thereby supplying the realization or
transmutation which would result in the receipt
of income.
7. Control test  Power to dispose; Assignment of
income doctrine