1

OSIAS COLLEGES INC .

F. Tañedo St. cor. Mc Arthur Highway, San Nicolas

2300 Tarlac, Philippines

WRITTEN REPORT IN
INCOME TAXATION
MODULE 4:
GROSS INCOME
SUBMITTED BY:

Mark Kevin Sicat Jessie Castillo

Junelle Vrian Gonzales Melody Valdez
Donnabel Estabillo Dhy Jay Longga
Alyssa Kate Ayson
BSBA-MM/FM 2ND YEAR
SUBMITTED TO:

Mrs. Melinda Abejuela

Professor
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OSIAS COLLEGES INC .

F. Tañedo St. cor. Mc Arthur Highway, San Nicolas

2300 Tarlac, Philippines

SUBJECT : BA COURSES – 3 (INCOME TAXATION)

TOPIC : GROSS INCOME
MODULE : 4
OBJECTIVES
After reading the lesson and doing the activity sheets, the students are expected to:
a. Define gross income, gross compensation income.
b. Enumerate and describe the classifications of gross compensation income.
c. State the rules when a retirement pay would not be subjected to income tax.
d. Explain tax exemption under the principles of convinience of employers rule.
e. Enumerate and explain the classification of gross compensation income from business.

LESSON PROPER:
I. READ
(See the uploaded mpodule)

II. REFLECT
Gross income includes gross profit from ordinary business and other income not
subjected to passive income tax or final withholding tax. Whereas gross compensation income
means any remuneration for rendering personal services and is obtained from an employer –
employee relationship between payor and recipient.

III. RESPOND
Accomplish the activity sheets provided for this lesson.
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OSIAS COLLEGES INC .

F. Tañedo St. cor. Mc Arthur Highway, San Nicolas

2300 Tarlac, Philippines

MODULE 4
ACTIVITY SHEET – 1

1. Define gross income, gross compensation income.

2. Enumerate and describe the classifications of gross compensation income.

3. State the rules when a retirement pay would not be subjected to income tax.

4. Explain tax exemption under the principles of convinience of employers rule.

5. Enumerate and explain the classification of gross compensation income from business.
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OSIAS COLLEGES INC .

F. Tañedo St. cor. Mc Arthur Highway, San Nicolas

2300 Tarlac, Philippines

MODULE 4
ACTIVITY SHEET – 2

1. Distinguish prizes from winnings.

2. What is a passive income?

3. When is bad debt recovery taxable?

4. Explain the principles of tax benefit rule in determining tax refunds or bad debts recovery
as taxable income.
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MODULE 4: GROSS INCOME

Gross Income means the pertinent items referred to in Section 32(A) of the Tax Code of the
Philippines, and It includes all income from whatever source, unless exempt from tax by law
including, but not limited to the following items…
• Compensation for services in whatever form paid including fees, salaries, and wages,
commissions, and similar items.
• Gross income derived from the conduct of trade or businesses or the exercise of a
profession.
• Interests, Rents, Royalties, Dividends, Annuities, prizes and winnings, and Pensions.
• Gains from dealings in property.
• Partners’ distributive share from the net income of general professional partnership.
For households and individuals, gross income is the sum of all wages, salaries, profits, interest
payments, rents, and other forms of earnings, before any deductions or taxes. It is opposed to net
income, defined as the gross income minus taxes and other deductions.

Gross income — also known as gross profit, pre-tax income or before-tax income —
measures total income and revenue from all sources. For companies, gross income is total
revenue minus the cost of goods sold. For individuals, it means total income before tax deductions
and tax charges.
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GROSS COMPENSATION INCOME

Gross compensation income means remuneration for rendering personal services. Generally,
compensation income is obtained from an employer-employee relationship between payor and
recipient. It may be paid on the basis of piecework or a percentage of profits and may be paid
hourly, daily, weekly, monthly, or annually.
Take Note: In general, every form of compensation income is taxable. Regardless of how it is
earned, by whom it is paid, the label by which it is designated, the basis upon which it is
determined, what the form in which it is received.
Exception: The compensation income including overtime pay, holiday pay, night shift differential
pay, and hazard pay earned by minimum wage earners (MWE) who has no other returnable income
are nontaxable and not subject to withholding tax on wages.
When Does An Employer-Employee Relationship Exists?

Generally, an employer employee relationship exists when the person for whom services are
rendered has the right control and direct the individual who performs the services, not only as to
the result in accomplishing the work but also as to the details and means by which that result is
accomplished. A contract of service, or employer-employee relationship, generally exists when
a worker agrees to work for an employer, on a full-time or part-time basis, for a specified or
indeterminate period of time, in return for wages or a salary. The employer has the right to decide
where, when and how the work is to be done.
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CLASSIFICATION OF GROSS COMPENSATION INCOME

1. Basic Salary or Wage
Salary - Refers to the earnings received periodically for a
regular work other than manual labor, such as a monthly salary
of an employee.
Wage - On the other hand, wages are earnings received
usually according to specified intervals of work , as by the
hour, day or week. An example is a Carpenter’s daily wage.

2. Honoraria
Honoraria – Are payments given in recognition for services
performed for which established practice discourages charging a
fixed fee. The honorarium of a guest lecturer is an example.

3. Fixed or Variable Allowances

In general, fixed or variable transportation, representation,
COLA or “cost of living allowance” and other allowances that
are received by a public officer or employee, or officer and
employee of a private entity, in addition to the regular
compensation fixed for his position or office, are compensation
subject to withholding tax.

The Bureau of Internal Revenue is an agency of Department of

Finance. BIR collects more than half of the total revenues of the
government.
Latest BIR Ruling on Allowances
A. Transportation and cellphone allowances given to call center employees are not taxable
compensation.
1. Fixed monthly allowance of P1,500 for rank and file employees pre computed on a daily basis.
2. Mobile phone allowance of P1,200 for supervisors, managers, and directors who are expected
to be on call 24 hours a day.
B. Transportation and Night shift allowances granted to night shift employees and Meal and/or
out of town allowances granted to employees assigned to conduct field work are not subject to
FBT (Fringe Benefit Tax), income tax, and withholding tax.
C. Taxi/transportation allowance of P100 per day given by BPO Company servicing global
businesses 24 hours a day to employees who work overtime beyond 10 p.m or whose work shifts
starts at 10 p.m onwards is exempt from tax.
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4. Commission
Is usually a percentage of total sales or on certain quota of sales
volume as part of incentives such a sales commission.

5.Fees
Is received by an employee for the services rendered to the
employer including a director’s fee of the company, fees paid to the
public officials, such as clerks of court or sheriffs for the services
rendered in the performance of their official duty over and above
their regular salaries.
6.Tips and Gratuities
Tips or gratuities paid directly to an employee by a customer of
the employer which are not accounted by the employee to the
employer are considered taxable income but not subject the
withholding tax.
7.Hazard or Emergency Pay
This is an additional payment received due to workers exposure
the danger or harm while working. this is normally added to the
basic salary together with overtime pay and night differential pay
to arrive at gross salary.
8.Retirement Pay
It refers to a lump sum payment received by an employee who
has served a company for a considerable period of time and has
decided to withdraw from work into privacy.

In general, retirement pay is taxable except in the following instances…

1. SSS and GSIS Retirement Pay
2. Retirement pay due to old age provided that the following requisites are met…
a. do you retirement program is approved by the BIR commissioner.
b. it must be a reasonable benefit plan.
c. retiree should have been employed for 10 years in the said company.
d. retiree should have been 50 years old at the time of retirement.
e. it should have been availed of for the first time.
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9. Separation Pay
Separation pay is taxable if voluntarily availed of. It shall not be
taxable if voluntarily. Examples of voluntarily separation are. a.
Death, b. Sickness, c. Disability, d. Reorganization/merger of
company; and e. Company at the brink of bankruptcy.

10. Pension
This is a stated allowance paid regularly to a person on his
retirement or to his dependents on his death, in consideration of past
services, meritorious work, age, loss, or injury. Pension pay is
taxable unless the law states otherwise, or unless the BIR approves
the pension plan of a private company.
11. Vacation and Sick Leave
The following rules shall be observed in determining whether
money received for vacation and sick leave is taxable or not;
a. If paid or availed of as salary of an employee who is on
vacation or in sick leave not withstanding his absence from work,
it constitutes taxable compensation income.
b. Monetized value of unutilized vacation leave credit of 10 days or less which are paid to
private employees during the year or not subject to tax and to the withholding tax.
c. Monetized value of vacation and sick leave credits paid to government officials and
employee are not subject to income tax and withholding tax.
12. 13th Month Pay and Other Benefits
13th month pay and other benefits are not taxable if the amount is
P82,000 or less any amount exceeding P82,000 is taxable
The new law (R.A 10653) increase the 13’th month pay and other
benefits from P30,000 to P82,000.
13. Fringe Benefits and De Minimis
The tax code defines fringe benefits as any good services or other
benefit furnish or granted by an employer in cash or in kind in
addition to basic salaries or an individual employee.
“DE MINIMIS” benefits are privileges of relatively small Value as
given by the employer to his employees, under revenue regulations
NO. 5-2011 as amended, they are not considered as compensation
subject to the income tax and consequently to withholding tax.
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14. Overtime Pay

Which refers to premium payment received for working beyond
regular hours of work which is included in the computation of gross
salary of employee, Back Bay and overtime pay constitute
compensation.

15. Profit Sharing

It is the proportionate share in the profits of the business received

by the employee in addition to his wages.

16. Awards for Special Service

The amount received as an award for special services of employee,
or suggestions to employer resulting in the prevention of theft or
robbery. awards for bus services and the like are also
compensations.

17. Beneficial Payments

Beneficial payments such as where an employer pays the income

tax owed by an employee are additional compensation income.

18. Other Forms of Compensation

Other forms received due to service rendered are compensation
paid in kind. it is to be noted that compensation can be paid in kind
but taxes are generally paid in money. for example, an insurance
premium paid by employer for insurance coverage where the heirs
of employee are the beneficiaries is the employee’s income.
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STOCK OPTION
A stock option is a privilege granted to some key employees of a corporation or other
entities to avail of the said corporation's share of stock in the future for a certain price.
Under RMC No. 79-2014, stock options can either be (a) equity-settlement option, or (b) cash-
settlement option.
EQUITY-SETTLEMENT OPTION is a stock option granted by a person, natural or juridical,
to a person or entity entitling said person or entity to purchase shares of stocks of a corporation,
which may or may not be the shares of stock of the grantor corporation.
CASH-SETTLEMENT OPTION entitles the holder to receive cash, equivalent to the difference
between the actual fair market value (FMV) of the share and the fixed nominal value of the shares
of stock set in the grant of the option, at a specific date or period.

The following are the salient provisions of RMC No. 79-2014:

1. GRANT OF OPTIONS:
a. If the stock option was granted due to employer-employee relationship and no payment was
received for such as grant, the grantor-employer cannot claim deductions for the grant of the
option.
b. If the option was granted for a price, the full consideration shall be subject to capital gains tax.
ILLUSTRATION
SN Corporation granted 1,000 stocks options to its employees at par value per share of
P100. At the time of the granting of the option, the fair market value per share was P180. What are
the tax treatments if the stock options were granted;
(1) Without payment received by SN Corporation?
(2) For a price at P120?
SOLUTION:
(1) If the stocks options were granted without payment, the option is not subject to income tax,
and at the same time the stock option can no longer be deducted as a salary expense of the employer
corporation.
(2) If the stock options were granted for an option price of P120 per share, the capital gains tax
would be
Full consideration (P120 x 1,000) P120,00
Capital gains tax:
First P100,000 x 5% P5,000
Excess P20,000 x 10% 2,000 P7,000
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2. SALE OR TRANSFER OF OPTIONS:

a. The sale, barter, or exchange of stock option by the grantee is treated as sale, barter, or exchange
of shares of stock not listed on the stock exchange, thus subject to capital gains tax if transferred
of an consideration.
b. If the option is sold or transferred without any consideration, it shall be treated as a donation
subject to donor's tax, basing on the FMV of the option at the time of donation.
ILLUSTRATION
Assume further that Edil Pat, one of the employees of SN Corporation, received stock
options of 100 shares with FMV of P180 per share. How much is the appropriate tax imposed if
the options were;
(1) sold for P200 per share?
(2) transferred to his friend without any consideration?
SOLUTION:
(1) If the stock options were sold for P200 per share, the capital gains tax would be P1,000
Capital gains tax [(P200 x 100) x 5%] P1,000
(2) If the stock options were transferred to his friend without any consideration, the donor's tax
would be
Donor’s tax [(P200 x 100) x 30%] P6,000
3. EXERCISE OF OPTIONS:
The difference between a book value/FMV of the shares, whichever is higher, at the time of
the exercise of the stock option and the price fix on the grant date shall be taxed depending on the
grantee, as follows:
• Rank-and-file employee: subject to income and withholding tax in compensation;
• Supervisory or managerial position: subject to fringe benefit tax;
• Supplier of goods or services: subject to the relevant withholding tax at source and other
taxes applicable;
• Person, natural or juridical, who is not an employee or supplier: subject to donor's tax.

ILLUSTRATION
Assume that 1,000 stock options were granted to Miss Malou Wang, the President of SN
Corporation, for a stock options price P100 per share. At the time when the stock options were
exercised, the fair market value per share was P134.

The applicable tax on the exercise of stock options will be:

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Excess of FMV over stock option price

[(P134 – P100) x 1,000] P34,000
Divided by grossed-up monetary factor 68%
Grossed-up monetary value P50,000
Multiplied by fringe benefit tax rate 32%
Fringe benefit tax on the exercise of stock option P16,000

CANCELLATION OF DEBT
The cancellation of forgiveness in indebtedness may amount to a payment of income, gift,
capital transaction, depending upon circumstances the following rules shall then be observed:
1. If a creditor Merily desires to benefit a debtor and without any consideration cancels the debt,
the amount of the canceled debt is a gift, not an income of debtor.
2. If a corporation to which a stock holder is indebted forgives the debt, the transaction has the
effect of the payment of a dividend income to debtor.
3. If however, the debtor performs services for a creditor who is consideration thereof cancels the
debt, debtor realizes income for his services to extent of the amount of cancelled.
ILLUSTRATION
Miss Marie Utang a computer encoder, borrowed P10,000 payable within two months from
Mr. Ulysses Chan Her employer, Miss Utang was not able to settle her debts on the stipulated time
of payment. However, Mr. Chan cancel her indebtedness in lieu of her two months services.
The cancelled indebtedness of P10,000 shall be considered compensation income of Miss Marie
Utang.
INSURANCE PREMIUMS AS COMPENSATION
These are periods paid by the employer on life insurance coverage of the employee wherein
the beneficiary is the employee's family. This constitute taxable income on the basis of the amount
of premium paid.
ILLUSTRATION
Baguio water supply (BSW) paid the life insurance premium of Mr. Vincent August
amounting to P5,000 per year. The beneficiary of the proceeds of insurance is Mrs. August.
Mr. August earned P5,000 compensation in relation to life insurance premium paid in the
behalf a deductible expense of BWS because the beneficiary is other than the employer.
However, if the beneficiary of the life insurance is the employer such payment of the
insurance premium shall neither be part of the employee's compensation income nor shall it
become the employer's deductible expense.
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Taxability and Deductibility of Life Insurance Premium Paid by The Employer

Beneficiary
Employee Employer
Taxable compensation of the employee? Yes No
Deductible operating expense of the employer? Yes No

INCOME TAX PAID AS COMPENSATION

For income tax paid by the employer in favor of the employee, the basis of tax is the amount
of tax paid.
ILLUSTRATION
Magnolia corporation pays the income tax of miss Cristine Leung being the vice president
for the operation assuming that the amount of miss Leung's salary is P300,000 and income tax paid
is P50,000, the gross income of miss Leung is P350,000.
CONVENIENCE OF THE EMPLOYER’S RULE
This tax rules provides that allowances in kind furnished to the employee for and as a
necessary incident to the performance of his duties are not taxable Examples are food and lodging
benefits by a household, maid, driver, etc.
LIVING QUARTERS
The following rules govern the living quarters and meals:
1. When living quarters are furnished in addition to cash salary, the rental value of such quarters
should be reported as income.
2. However if living quarters or meals are furnished to an employee for the convenience of the
employer, the value thereof need not be included as part of compensation income.
MEALS SUBSIDIZED BY EMPLOYER
The value of any board and lodging furnished by an employer is ordinarily taxable to the
employee.
The exclusion for meals is allowed only when meals are furnished or subsidized to an employee
for the convenience of the employer, and incidental to the requirements of his work or position.
REMUNERATION FOR CASUAL LABOR
The follow rules shall be observed regarding remuneration for casual labor:
1. Remuneration for Casual Labor not in the course of an employer trade or business is not
considered compensation.
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2. Any remuneration paid for casual labor (that is labor which is occasional accidental or Irregular,
but which is rendered in the course of the Employer's trade or business) is considered
compensation; and
3. Any remuneration paid for casual labor performed for a corporation is considered as
compensation.
ILLUSTRATION
Miss Adalyn owns the Choco Company, a chocolate manufacturing business in Baguio
City. She employs the following persons during a taxable year for a short period of time and pays
their related remuneration.

Workers Services rendered Status Amount

A Repair service – home of Adalyn 5 day work P1,500
B Repair service – Choco Company 10 day work 4,000
C Accounting clerk Casual (3 months) 18,000
D Store helper Casual (2 months) 9,600

How much is the total remuneration considered as compensation from casual service received?
The total remuneration considered as compensation for the year is P31,600, computed as follows:
B Repair service – Choco Company 10 day work P 4,000
C Accounting clerk Casual (3 months) 18,000
D Store helper Casual (2 months) 9,600
P31,600
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Gross Income from Business and profession

Business Defined
Business means any commercial activity engage in as a means of livelihood or profits of an
individual or a group of individuals.
Profession Defined
Is primarily any endeavour or work requiring training in the field of learning, art, or individual or
groups of individuals.
Gross income from business
The gross income from business is classified into several groups, namely.
1. Manufacturing
2. Merchandising or trading
3. Servicing
4. Farming: and
5. Long-term contract
Gross income
Means gross sales less sales return, discount and allowances and cost of goods sold plus other time
of income not subjected ti final tax, and other incidental or outside operations or sources.
Illustration
Cabreros store has just gone through its initial operation and provided the following data to
determine the gross income for the current year.
Sales 240,000
Merchandising inventory, end 20,000
Sales return and allowances 10,000
Purchases 150,000
Sales discounts 30,000
Gains form sale of scrap materials 5,000

The gross income of Cabreros store would be

Sales, net of discounts, 30,000; return/allowances, 10,000 200,000
Less:Costs of goods sold (150,000-20,000) 130,000
Gross profit from sales 70,000
Add: Gains of sales from scrap materials 75,000
The cost of sales
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Costs of goods sold shall include all business expenses directly incurred the merchandise to bring
them to their present location. The cost of sales deducted from the net sales to calculate gross
income from business may be classified as follows;
1. Cost of goods manufacturing and sold of manufacturing concern
2. Cost of goods sold of trading or merchandising concern; and
3. Cost of service of servicing concern.
Cost of goods manufacturing and sold
All costs of finished goods that are sold such as raw materials used, direct labor and manufacturing
overhead, freight cost, insurance premiums and other course incurred to bring the raw materials to
the factory or warehouse.
Illustration
Assume that the following data of golden fry manufacturing
Sales 6,100,000 Purchases dis. 40,000
Sales returns and allowances 100,000 Raw materials insurance 50,000
Raw materials beginning 200,000 Freight- in 80,000
Raw materials purchases 3,600,000 Direct labor 500,000
Raw materials, ending 300,000 Manufacturing overhead 210,000

Golden fry gross income is computed as follows

Sales
Less: sales returns and allowances
Net sales
Less: goods sold and manufactured sold
Raw materials used
Raw materials beginning
Raw material purchases
Raw materials insurance
Freight in
Purchases discount
Raw materials ending
Direct labor
Manufactured overhead
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Gross income

Cost of goods sold and trading or a merchandising concern

A merchandising firm is a business that purchases finished products and resells them. To Sales
revenue minus cost of goods sold equals gross profit.
Illustration
Assume the following data of the diamond grocery
Sales
Sales return and allowances
Sales discount
Inventory, beginning
Purchases

Purchase return
Purchase discount
Freight in
Inventory ending
Insurance from good transit

Diamond grocery gross income is computed as follows.

Sales
Less: sales return and allowances
Sales discounts
Net sales
Less: cost of good sold
Inventory beginning
Purchases
Freight in
Insurance for good in transit
Purchase return
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Purchase discount
Inventory ending
Gross income

Cost of services (MCIT)

For services-based businesses, the Cost Of Service will consist of mostly labor costs that contribute
to the revenues generated.
a. Salaries
b. Benefits of personel, consultants and specialist directing rendering the services
c. Cost of facilities directly utilized in providing the service such as depreciation or rental of
equipment used and cost of supplies
d. In the case of banks, costs of services shall included interest expense.

Illustration
Assume the following data of recky reyes beauty parlor
Service revenue
Service discount
Salaries of beautician
Depreciation of beauty equipment
Consultants fee
Beauty supplies used
Salaries of accountant
Interest expense

Recky reyes beauty parlos gross income is computed as to follow,

Service revenue
Less: service discount
Net revenue
Less: cost of services
Salaries of beauticians
Beauty supplies used
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Consultants fee
Depreciation of beauty equipment
Gross income

Notes:
1. The salary of the accountant is not a direct cost of a beauty parlor. Likewise interest
expense is not a direct cost because the business is not a banks.

Telegraph and Cable Services

The gross income of telegraph and cable services of a foreign corporation shall include income
form services within the Philippines only. Specifically, the income may be derived from the
following.
1. Gross revenues derived from messages originating in the Philippines, And
2. Amount received by the company collected abroad on collect messages originating in the
Philippines and deducting from such amounts paid or accrued for transmission of messages
beyond the company`s own circuit. (sec. 164, Rev. Reg. No. 2)
Amounts received by the foreign company in the Philippines with respect to collect messages
originating outside the Philippines shall not be included in the taxable gross income.
Illustration
Excel communications a resident foreign corporation, engages in telegraph and cable services. Its
revenues during the year were as follows.

Revenue Within Without

Telegraph service 5,000,000 60% 40%
Cable service 10,000,000 90% 10%
Total service 15,000,000

Excel`s total income subject to tax in the Philippines would be 12,000,000 computes as follows:
Telegraph within (5,000,000 x 60%) 3,000,000
Cable service ( 10,000,000 x 90%) 9,000,000
Total income subject to Philippines income tax 12,000,000
Note: only revenues earned within are subject to Philippines income tax
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Rental income
Rental income refers to earnings derived from leasing real estate as well as personal property.
Aside from the regular amount of payment for using the property, rental income also includes all
other obligation assumed to be paid by the lessee to the third party in behalf of the lessor (example
are interest, taxes, loans, insurance premiums and others.)
Rental income is generally determined by the gross receipts for the year, (earned and unearned
under accrual basis) because the nature of business involved is service.

Illustration
Tiongsan Bazaar leases a portion of its commercial space to Mr. Henry Lao with the agreement
that Mr. Lao should be responsible to pay the following:
a) Advanced rental of 100,000
b) Monthly rental of 25,000
c) Annual insurance premium of 5,000
d) Annual interest expense of 3,000 and
e) Real estate tax 2,000
The computation of income from the lease agreement between Tiogsan and Mr. Lao should be
governed
by the following rules:
1. Prepaid Rental. If the advanced payment is a prepaid rental received without restriction
as to its use, the entire amount is taxable in the year it is received whether lessor uses cash
or accrual method of accounting.
The determination of the rental income of Tiogsan would be

Advanced rental received 100,000

Rental income (25,000 x 12) 300,000
Annual insurance premium 5,000
Annual interest expense 3,000
Real estate tax 2,000
Annual rent income 410,000

Notes:
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1. The lessor will report the computed amount as part of rental income. On the other hand,
the lessee will report it as part of his rental expense.
2. The rule is that advanced payment received by the lessor is presumed income unless the
amount represent a security deposit as discuss in 2 to 3 below.
3. Payment is taxable income in full to the lessor in the year when we received even though
the lessor is on the actual method or the cash method of accounting.

2. Security deposit with restriction

A security deposit is money that is given to a landlord, lender, or seller of a home or
apartment as proof of intent to move-in and care for the domicile. Security deposits can be
either be refundable or nonrefundable, depending on the terms of the transaction.

The annual rental income of tiongsan would be:

Rent income ( 25,000x 12)

Annual insurance premium
Annual interest expense
Real estate tax
Annual rent income

3. Security deposit with an acceleration clause

An acceleration clause allows the lender to require payment before the standard terms of
the loan expired. Some acceleration clauses may invoke immediate payoff after one
payment is missed while others may allow for two or three missed payments before
demanding that the loan be paid in full.

Income from leasehold improvement

Leasehold improvements are defined as the enhancements paid for by a tenant to leased space.
Outright method
The income from leasehold method improvement shall be recognized when the improvement
is completed and at its fair market value.
Illustration
Baguio improvement lease its lot to mrs rose fernandez for a term 3 years with an annual rental of
50,000 as of january a year 1, mrs fernandez completed the construction of an improvement on
the lot with a value of 1,500,000 with an estimated life of 5 years.
The leasehold contract stimulate the improvement will belong to the Baguio improvements after
the term of a lease.
Value of building
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Add: annual rental per arrangement

Total lease income to be reported
Spread out method
to open, arrange, or place ( something) over a large area He spread out the map on the table. He
spread the cards out on the table.

INCOME FROM LEASEHOLD IMPROVEMENTS

When the lessee erected or built permanent improvements on the leased property
which will become the property of the lesson upon the expiration of the lease, the value of the
improvements should be reported as income of the lessen using either outright method or spread
out method.
OUTRIGHT METHOD
Under this method, the income from leasehold improvement shall be recognized
when the improvement is completed at its fair market value.
➢ ILLUSTRATION
Baguio Improvements leases its lot to Mrs. Rose Fernandez for a term of 3 years
with an annual rental of ₱ 50.000. As of January of year 1, Mrs. Fernandez completed the
construction of an improvement on the lot with a value of ₱ 1,500,000 with an estimated life of 5
years.
The leasehold contract stipulates that the improvements will belong to Baguio
Improvements after the term of the lease.
By using outright method, Baguio Improvements should report its income from rent
in the year WHEN the improvement was completed as follows:
Value of building ₱ 1,500,000
Add: Annual rental per agreement 50,000
Total lease income to be reported ₱ 1,550,000

SPREAD- OUT METHOD

Under this method, the estimated book value of the leasehold improvement at the
end of the lease is spread over the term of the lease and is reported as income for each year of the
lease an aliquot part thereof.

ESTIMATED BOOK VALUE OF THE LEASEHOLD IMPROVEMENT AT THE END OF

THE LEASE CONTRACT
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REMAINING TERM OF THE LEASE IN YEARS

Using the same illustration above, the computation of the annual rent income of
Baguio Improvements would be:
Cost of the building ₱ 1,500,000
Less Accumulated depreciation at the end of the lease
(₱1,500,000/5 years) 3 years 900,000
Book value of improvement at the end of the lease ₱ 600,000
Divide by the term of the lease (in years) 3
Annual income on leasehold improvement ₱ 200,000
Add: Annual rental 50,000
Total lease income to be reported ₱ 250,000
COMPARISON OF OUTRIGHT METHOD VS. SPREAD-OUT METHOD
OUTRIGHT METHOD YEAR 1 YEAR 2 YEAR 3 TOTAL
Improvement Income 1,500,000 -0- -0- 1,500,000
Depreciation expense ( 300,00 ) ( 300,00 ) ( 300,00 ) ( 900,00 )
Net income from 1,200,000 ( 300,00 ) ( 300,00 ) 600,000
Improvement
SPREAD-OUT METHOD
Net income from 200,000 200,000 200,000 600,000
Improvement
TERMINATION OF THE CONTRACT OF LEASE
Where there is an immovable improvement made by the lessee on the lease property
and the termination of the contract of lease is made before the expiration of the term, the following
rules should regulate the circumstances:
1. If the improvement is destroyed before the expiration of the lease, the lessor is entitled to
deduct as a loss for the year, when such destruction takes place, the amount previously
reported as income less any salvage value, to the extent that such loss was not compensated
for by insurance.

➢ ILLUSTRATION
➢
Highland Co. leases its lot to Mr. So for 15 years with an annual
rental of ₱ 50,000. Mr. So erected a building with fair value of ₱ 1,200,000 with an
 25

estimated life of 20 years. The building will belong to Highland Co. after the term
of the lease. Assume that Mr. So’s building was destroyed by fire on the 10th year
if the lease and it’s salvage value is ₱ 40,000.
Using the spread out method, the loss of Highland Co. will be
computed as follows:
A. WITH INSURANCE
Assume that the building is covered with insurance amounting to
₱100,000.

Book value at the end of lease

(₱ 1,200,000) – (₱ 1,200,000/20) x 15 years ₱ 300,000
Divided by term of lease 15
Annual income from leasehold Improvement ₱ 20,000
Multiplied by years until the fire 10
Total reported income from Improvement ₱ 200,000
Less: Salvage value ₱ 40,000
Insurance collected 100,000 140,000
Loss on leasehold improvement due to fire ₱ 60,000
B. WITHOUT INSURANCE
If the building was not covered by insurance the computation of loss
would be:
Total reported income from improvement ₱ 200,000
Less: Salvage value 40,000
Loss on leasehold improvement due to fire ₱ 160,000

2. If for any reason other than a bona fide purchase from the lessee by the lesser, the lease is
terminated so that the lessor comes into possession of the property prior to the final fixed
period of the lease contract, the lessor receives additional income for the year if the value
of improvement exceeds the amount of income already reported.

➢ ILLUSTRATION
In the preceding illustration, assume that the lease was terminated
on the 10 year for failure of Mr. So to pay the annual rental of ₱ 50,000 for that
th

year. The computation of additional income would be:

Value of the building ₱ 1,200,000

Less: Accumulated depreciation at termination
Of lease (₱ 1,200,000/20) x 10 years) 600,000
Book value of the building on the 10th year ₱ 600,000
Less: Reported income – leasehold improvement
(₱ 20,000 x 10) 200,000
Additional income for the year ₱ 400,000
GAINS FROM DEALINGS IN PROPERTY
 26

This refers to the income derived from the sale, and/or exchange of assets, which
results in gain because of the excess of the amount or value received by the taxpayer over the
determined value of the property he has disposed of.
PASSIVE INCOME
Under Section 24(B) of the Tax Code, a final tax is imposed upon gross passive
income of citizen and resident aliens.
An income is considered passive if the taxpayer merely waits for it to be realized.
Examples of passive income are:
1. Yield from deposit substitutes and trust fund
2. Interest Income
3. Royalty Income
4. Dividend Income
5. Prizes and Winnings
➢ YIELD FROM DEPOSIT SUBSTITUTES AND TRUST FUND
A deposit substitutes is a debt instrumental issued by the bank to borrow money
from the public other that from the client’s deposit.
➢ INTEREST INCOME

Is an earning derived from depositing or lending of money, goods or credits. Unless

exempted by law, interest income received by the taxpayer, whether or not usurious, is subject
to income tax.
For individuals, except nonresident aliens not engaged in the trade or business in
the Philippines, interest income from lone-term deposit or investment (example: savings,
common or individual trust funds, deposit substitutes, investment management accounts and
other invesments) shall be exempt from income tax, provided that the following conditions
must be met:

1. The deposit or investment must be evidenced by certificates conforming to the Banko

Sentral ng Pilipinas (BSP) prescribed form.
2. The same must have a maturity period of not less than five years and in denominations
of ₱10,000 or other denominations as may be approved by BSP issued by banks (not
by non-bank financial intermediaries or finance companies).
However, should the holder of the certificate pre-terminate the deposit or
investment before the fifth year, a tax shall be imposed on the entire income and shall be deducted
and withheld by the depository bank from the proceeds of the long term deposit or investment
certificate based on the remaining maturity thereof, as follows;
• Final tax of 5% ………………………………………………………………………. Four
years to less than five years
• Final tax of 12%
……………………………………………………………………….Three years to less
than four years
 27

• Final tax of 20% ……………………………………………………………………… Less

than three years

➢ ILLUSTRATION

Mr. Wais invested ₱ 1,000,000 in a 12% long-term deposit certificate (BSP

prescribed form) with five years maturity. Is the interest income from investment subject to
income tax?

• ANSWER:
It depends. The interest income from such investment is subject to income tax (final
tax) if preterminated before the five-year maturity. However, the interest income therefrom shall
be exempted from tax if withdrawn upon maturity.
CLASSIFICATIONS OF INTEREST INCOME
Interest income may be classified into three categories, namely:
1. Exempt from income tax
2. Subject to final withholding tax
3. Subject to normal tax
TAX EXEMPT INTEREST INCOME
Interest earned is exempted from income tax if received from:
1.
By members from a duty-registered cooperative
2.
BSP prescribed form of investments maturing more than five years
3.
Expanded foreign currency deposit system by nonresident citizens/aliens
4.
A tenant who paid to a landowner on the price of land under a tenant-purchaser
agreement as part of CARP.
➢ ILLUSTRATION
Mr. Matipid put his retirement pay in the following investments;

Investments: Interest per Year Amounts

BSP deposit substitutes (more than 5 years) 12% ₱ 200,000
Baguio – Benguet Cooperative 24%
200,000
Time deposit – China Bank (not BSP prescribed form) 7%
100,000
Total Investments ₱ 500,000
 28

The interest income not subject to income tax during the year would be;
Interest income – BSP deposit substitutes (₱200,000 x 12%) ₱
24,000
Interest income – Baguio – Benguet Cooperative (₱ 200,000 x 24%)
48,000
Total interest income not subject to tax ₱
72,000
Accordingly, the only interest income subject to income tax (final tax of 20%) is
the income earned from time deposit. The net interest earning of Mr. Matipid would be;
Total interest income not subject to tax ₱
72,000
Add: Interest income – China Bank (₱ 100,000 x 7%) ₱ 7,000
Less: Final tax on interest (₱ 7,000 x 20%) 1,400
5,600
Total net interest earnings.

Interest Income OFW with Co-depositor

Interest on expanded foreign currency deposit (EFCD) whereby the OFW is a co-depositor in the
Philippines is subject to 50% of the 7.5% final tax.
Illustration
Eddie Paylang is an OFW working in Dubai. He has an expanded foreign currency joint account
deposit with his wife, Nabati Paylang.
Assume that the EFCD earned $1,000 as interest income, the final withholding tax on interest
income would be:
Final withholding tax on interest income – EFCD (₱1,000 × 7.5% × 50%) $37.50
Interest Income Subject to Final Withholding Tax
Interest income on deposits made in banking institutions is a passive income which is usually
subjected to final withholding tax of 20%.
Illustration
On April 30, 200×, Mr. Gabino Garoy placed his retirement pay amounting to ₱1,000,000 in
PNB as time deposit. The interest per annum is 18 %
The determination of Mr. Garoy’s 200× interest income woulb be
Gross Interest Income (₱1,000,000 × 18% × 8/12) ₱120,000
Less: Withholding tax interest income (20%) 24,000
 29

Interest Income, net of final withholding tax ₱ 96,000

Interest Income Subject to Normal Tax
These are earnings derived from lending money, goods or credits from one person to another
without any withholding tax made, Since these interest earnings are received in its total amount
they should be subject to normal tax of the taxpayer.
Illustration
Baguio Lending Corporation lends ₱1,000,000 during the year. The average interest per year is
18%.
The Interest income of Baguio Lending Corporation would be:
Interest income (₱1,000,000 × 18%) ₱ 180,000
Assuming that the operational expenses of Baguio Lending were ₱80,000, its income tax would
be ₱32,000, computed as follows:
Interest income ₱ 180,000
Less: Operating Expenses 80,000
Net taxable business income ₱ 100,000
Multiplied by corporate normal tax 30%
Income Tax ₱ 30,000
Royalty Income
A royalty income is a payment or portion of proceeds paid to the owner of a right, such as an oil
right or a patent for the use of it or a portion of the proceeds from the work of an author or
composer.
Royalty income may be classified as follows:
1. In general, royalty income include those which are derived from natural resources or
products such as coal, gas, oil, copper, silver gold, and other similar products. These
kinds of royalty income are subject to 20% final tax.
2. Royalties on books, literary works and musical composition are royalty income subject to
10% final tax.
Illustration
Mr. Good Godin received the following royalties.
On sale of Goods Hamburger (franchise) ₱200,000
On sale of books authored by Godin (Copyright 300,000
Total ₱500,000
The total tax due on royalties would be
 30

Royalty tax – sale of goods hamburger (₱200,000×20%) ₱40,000

Sale of books authored by Godin (₱300,000×10%) 30,000
Total royalty tax due ₱70,000
Divided Income
Dividend income is a form of earnings derived from the distribution made by a corporation out
of its earnings or profits and payable to its stockholders, whether in money or in other property.
Such earnings may be exempt from income tax, or subject to either final tax or on the normal
year-end tax of individual or corporations.
Tax Rules on Divided Income
1. If received by a domestic or resident corporation from a domestic corporation subject to
tax, such dividend is tax-exempt (nontaxable inter-corporate principle)
2. Pure stock dividends, dividends received from cooperative, and pure liquidating
dividends are tax-exempt.
3. Cash or properly dividend is subject to final tax if received by an individual or
nonresident corporation from a domestic corporation subject to income tax.
a. If received by a resident citizen, nonresident citizen and resident alien, the final tax
applicable is 10%.
b. If received by a nonresident alien engaged in business in the Philippines, the final tax
is 20%
c. If Received by a nonresident alien not doing business within, the final tax is 25%
d. If received by a nonresident foreign corporation from a domestic corporation, the
final withholding tax is 15%
4. Other dividends excluded from rules 1, 2, and 3 are included in the computation of the
taxable income and income tax at the end of the year.
Tax Sparing Rule
Tax Sparing Rule is an inter-corporate dividend received by a non-resident foreign corporation
from domestic corporation from a domestic corporation is subject to 15% Final Withholding Tax
provided that foreign law allows taxpayer clause; otherwise, it will be subject to the normal
domestic rate of 30%. (R.A. 9337)
The tax rate of 15% shall be applicable if the foreign country does not impose any income tax on
dividends received by the non-resident foreign corporation from a domestic corporation. The
15% tax rate shall be effective starting January 1, 2009.
Forms and Valuations of Dividend Income
For income tax purposes, the form of dividend income shall determine its applicable treatment.
Dividends that are usually received by a stockholder are as follows:
1. Cash dividend
2. Property dividend
3. Stock dividend
 31

4. Scrip dividend
5. Indirect dividend; and
6. Liquidating dividend

Cash Dividend
A cash dividend is the most common form of dividend. It is valued and taxable to the extent
amount of money received by the stockholder.
Illustration
Mr. Solibao received P60000 cash dividend from Manna Corporation, A domestic corporation
The P60000 received by Mr. Solibao is subject to a 10% final tax.
Property Dividend
A dividend payable in property of an issuing corporation is a property dividend. The property
dividend is usually valued and taxable to the extent of the fair market value of the property
received at the time of declaration.

Examples of property dividends are:

a. Merchandise inventory, supplies, etc.,
b. Shares of stock of another corporation, or
c. Treasury stock issuing corporation if acquired at cost different from its par value.

Illustration
Mr. Gallardo invested in the common stock of Anscor Co. for 1,000 shares at a cost amounting
to P50000. After a year of investments, he received from Anscor 100 shares of stock of Cebu
Pacific common shares with a unit cost of P10 per share.
The fair market value of Cebu Pacific at the time of declaration was P8 per share and the faird
market value of Anscor’s share at the time of distribution is P55 per share. How much is the
property dividend income received income of Mr. Gallardo?
The property dividend income of Mr. Gallardo would be?
Fair market value of Cebu Pacific per share P 8
Number of Cebu Pacific shares received 100
Dividend income Of Mr. Gallardo 800
Stock dividend
 32

As a general rule, pure stock dividends are not subject to tax because they simple involve a
transfer of the retained earnings to the paid-in capital account, except when the following
circumstances exist:
a. There is an option that some stockholders could take cash or property dividends instead
of stock dividends;
b. Some stockholders exercised the option to take cash or property dividends; and
c. The exercise of option resulted in a change of the stockholders’ proportionate share in the
outstanding shares of the corporation.

Taxable Stock Dividend – with change in the proportionate share of the stockholders
Assume that Aurora Co. with common stock outstanding declared a 20% stock dividend to its
stockholders with an option to choose property dividend instead of stock.
Stockholder X opted to choose property dividend with a fair market value of P15000 and other
stockholders choose the common stock dividend. The fair market value of the common stock
upon distribution was P500 per share.

Stock Before Dividend Stock Number After Dividend

Holders Shares Percent Dividends Shares Percent
X 200 20% 200 17.24%
Others 800 80% 160 960 82.76%
100% 100%
The stock dividends mentioned above shall be subject to tax since it resulted in the change in the
proportionate share of the stockholders. The determination of the dividend income of
stockholders X and other stockholders would be:
Dividend income of stockholders X is P15000, the fair market value of the property received.
Dividend income of other stockholders:
Fair market value of common stock per share P 500
Multiply by number of stock dividends (800 x 20%) 160
Dividend income P80000
Not Taxable Stock Dividend – No change in the proportionate share of the stockholders
Based on the preceding illustration, if all of the stockholders opted to receive stock dividends
then it will not result in a change in the proportionate interest of the shareholders in the net assets
of the corporation, as shown below:
 33

Stock Before Dividend Stock Number After Dividend

Holders Shares Percent Dividends Shares Percentage
X 200 20% 40 240 20%
Others 800 80% 160 960 80%
1000 100% 1200 100%
The dividend exercise is purely stock, and therefore, not taxable.
Redemption of Stock Dividend
If the corporation cancels or redeems stock issued as a dividend at such time and in such
manners as to make the distribution and cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable dividend, the amount so distributed in
redemption or cancellation of the stock is considered taxable income to the extent that it
represents a distribution of earnings or profits.
Illustration
In 200A, Kantata Corporation issued 10000 redeemable preferred shares at a par value per share
of P100. During 200B, Kantata declared and issued a 10% preferred stock dividend.
In 200C, Kantata redeemed all the preferred shares at P100 per share. How much dividend is
taxable in 200B and 200C?
There is no taxable dividend in 200B because at that time the dividend is presumed as pure stock
dividend. However, the stock dividend became taxable because it was redeemed at P100 per
share in 200C.
The taxable dividend income in 200C would be:
Redemption price of preferred stock/ share P 100
Multiplied by number of stock dividends (10000 x 10%) 1000
Taxable dividend P 100000
The appropriate simple journal entries would be:
200A Cash 1,000,000
Preferred stock 1,000,000
200B Retained earnings 100,000
Preferred stock 100,000
200C Preferred Stock 1,100,000
Cash 1,100,000
 34

The above journal entries can be compounded as follows:

Retained earnings 100,000
Cash 100,000
The compounded journal entry is in effect equal to the nature of cash dividend.

Stock Dividends Different from Shares Previously Acquired

When stock dividends received are of a different class from shares previously acquired, the stock
dividends are not income, and therefore, not taxable. The original cost of the investments is
allocated between the original shares and stock dividends on the basis of their respective market
value at the date of receipt.
Illustration
Virgil Bitukon acquired 1,000 common shares of CBA Corporation for P 100,000. Subsequently,
he received 20% stock dividends in the form of preferred stock. The market values of the stocks
are P60 for common stock and P100 for preferred stock.
The new cost of common stock and the preferred stock dividends are determined as follows:
Market value Fraction Allocated cost
Common stock (P60 x 1,000 shares) P60,000 6/8 P75,000
Preferred stock (P100 x 200 shares) 20,000 2/8 25,000
Total P80,000 P100,000
The stock dividend does not constitute income because the old certificates plus the new
certificates represent the same proportionate interest in the net assets of the corporation as it was
prior to the declaration of stock dividend.
However, if a stockholder maintains more than one class of shares of stock in a particular
corporation, and he subsequently receives one class of shares as stock dividend, such dividend is
taxable.

Scrip Dividend
A scrip dividend is issued in the form of promissory note and is taxable to the extent of its fair
market value. It is taxable in the year when the warrant was issued.
Illustration
 35

On April 1, 200B, Mrs. Elvira Sacayan received scrip dividend from Philex Mines amounting
toP20,000 with an annual interest of 12% payable within one year from date of the note.
The taxable dividend income received by Mrs. Sacayanan is P20,000 which is to be declared in
200B. the P2,400 interest (P20,000 x 12%) shall not be a part of dividend income declared but a
part of interest income earned in 200C.
Indirect Dividends
Indirect dividends are those dividends representing payments or rights received by the taxpayer,
which are really dividends.
Illustration
Alvino Tanicala, a stockholder of Jollibee Corporation, is indebted to Jollibee amounting to P
30,000. At the end of the taxable year, he received a notice that the corporation has cancelled his
indebtedness. According to the law, the transaction has an effect of the payment of dividend.
Liquidating Dividend
Liquidating dividends are return of stockholders investment. It arises from the distribution of
assets by a corporation to its stockholders upon corporate dissolution.
As a rule, the excess amount of liquidating dividends over cost of shares surrendered is taxable.
Such excess is a gain realized which is taxable.
If the stockholder sustains a loss, such loss is deductible.
Illustration
E&N Company acquired 10,000 common shares from Philex Corporation at P10 per share.
Philex decided to liquidate so it issued a liquidating dividend of P12 per share.
The taxable gain would be
Amount received as liquidating dividend (P12 x 10,000 shares) P120,000
Less: Cost of common shares surrendered (P10 x 10,000 shares) 100,000
Capital gain realized upon liquidation P 20,000
Distribution of liquidating dividends is to be treated as a sale of stock. The difference between
the cost or other basis of the stock and the amount received in liquidation of the stock is a capital
gain or a capital loss. The gain realized or loss sustained by the stockholder is a taxable income
or deductible loss, as the case may be. Consequently, the capital gain on liquidating dividend is
not subject to final tax.
Prizes and winnings
A prize is a reward for a contest or a competition. In other words, a prize represents
remuneration for an effort reflecting one’s superiority, like prize money of a boxing contest.
 36

On the other hand, a winning is a reward for an event that depends on a chance such as winnings
from gambling, lottery or raffle ticket.
In general, prizes are subject to final tax of 20% except if the amount of the prize is ten thousand
(P10000) or less which shall be subjected to normal tax. Winnings are subject to final tax of 20%
regardless of amount.
Prizes and winnings are generally taxable except when the law provides for their exemption.
Illustration
Regine Vellasquez won the following pries/ winning during the year:
First prize – singing contest P 10,000
First prize – Philippine charity sweepstakes winning 1,000,000
Third prize – raffle ticket winnings 20% 5,000
Which of the prizes is subject to normal tax, final tax and tax exempt?
The prize from the singing contest being earned in a contest and within the threshold amount of
P10000 and below is subject to normal tax. The winning on a raffle ticket being earned by a
chance is subject to final tax of 20% even if the amount is less than P10000; and the winning
from Philippine charity sweepstakes is tax exempt.
PARTNER’ DISTRIBUTIVE PROFITS FROM PROFESSIONAL PARTNERSHIP’S NET
INCOME
The partner’s share in the distributive profit of a professional Partnership represents his gross
income.
OTHER SOURCE OF INCOME
This earnings are categorized as other “source of income” because they are generally incidental
earnings or not common source earnings. Usually those incomes are , but not limited to the
following :
1. Bad debt recovery
2. Tax refund or credit
3. Damages recovery
4. Annuities; and
5. Income from whatever source .
TAX BENEFITS RULE
Tax benefit rule is general principle in taxation which states that if a taxpayer deducted an item on
his income tax return and enjoyed a tax benefit (Reduces his income tax) thereby, and in a
subsequent year recovers all or part of that item, He will recognize gross income in the year the
deducted items is recovered.
 37

The rule has both an inclusionary and an exclusionary component, The recovery is included in the
taxpayer’s gross income to the extent that the taxpayer obtained the tax benefits from the prior
year’s deduction, and the recovery is excluded to the extent that the prior year’s deduction did not
provide a tax benefit.
BAD DEPT RECOVERIES
The following are the requisites for deductibility of bad debts:
1. There must be a valid end existing debt arising from business or trade of the taxpayer
2. The debt must be actually ascertained to the worthless and uncollectible during the taxable
year.
3. The debt must be charged off during the taxable year.
TAX REFUND OR CREDIT
As a general rule, refunds from taxes are taxable except for the following:
• Estate of donor’s tax
• Philippine income tax
• Stock transaction tax
• VAT , claimed as input tax.
That refund is subject to the tax benefit rule which states that the refund of tax would only be
subjected to tax if such tax was previously deducted from gross income resulting in the reduction
of reported taxable income.
as a rule, if the tax paid is deductible, refund is taxable. if the tax paid is not deductible, refund is
not taxable.
Tax refund or credit shall be included as part of gross income in the year of receipt to extent off
the income tax benefit of the said deduction.

Even if the two deficiency taxes were refunded n 200C,Only community tax is taxable because it
was allowed as deduction from gross income in 200A.The refund on income it’s not taxable in
200C because it was not deductible jn 200B.
DAMAGE RECOVERY
Damages recovery is an amount received by an injured person as payment for lost income or
payment to compensate damage to property, injury to person, or loss of life.
As a rule, recoveries of damage representing compensation for loss of profit or income are taxable.
Recoveries that are compensate for damage to property, injury to person, or loss of life are not
taxable.

Annuities
 38

Annuities are installment payments receive for life insurance sold by insurance companies. The
annuity represents a part that is taxable and not taxable. If the part of annuity payment represents
interest, then it is a taxable income. If the annuity is a return of premium, it is not taxable.
Under the contact of life annuity, the debtor binds himself to pay as annual pension or income
during the life of one or more determinate persons in considering of a capital consisting of money
or other property, whose ownership is transferred to him at once with the burden of the income
The income is the interest. Hence, the P909 return of premium is nontaxable, while the P91 interest
is taxable.
Income from Whatever Sources Defined
Income from whatever sources derived means inclusion of all income not expressly exempted
within the class of taxable income under the laws irrespective of the voluntary or involuntary action
of the taxpayer in producing the gains, and whatever derived from legal of illegal sources. Example
of income from legal source are:
a. Employee's salary, bonus; and
b. Commissions/ rebates of a medical representative.

Examples of Income from illegal sources are:

a. Gambling;
b. Kidnapping;
c. Extortion;
d. Smuggling; and
e. Embezzlement.

Illegally Obtained Income

As a rule, illegal income is taxable. Income obtained through illegal means is included in the
wrongdoer's gross income even though he is obligated to return it when discovered.

The mere fact that a transaction is illegal does not exempt it from income tax laws. Gains from
such transactions as gambling, extortion, swindling and the like are all taxable

Income that is not realized is not taxable, even though its absence is due to an illegal act. " Moral
turpitude is not a touchstone of taxability."
 39

The Courts have sustained the BIR's determination of the illegal gains from such records as bank
deposits, or on the basis of commissions paid out, and even from a formula determination based
upon the nationwide experience. The burden is on the taxpayer to offer independent evidence to
contradict such determination.

Embezzled funds
Embezzled funds are income without consent (express or implied) with an obligation to repay.
If the embezzler reaps the fruit of his crime without restrictions as to disposition, he is in receipt
of income though it may be claimed he is not entitled to the money and may be adjudged liable to
restore its equivalent. When reported as income, actual repayment of embezzled fund will give
rise to deduction.

Income Receive by Error

When income received under a mistake of fact or law, the income is included in the gross taxable
income of the recipient not with standing tge fact that the recipient may be required to return the
income item to the payor when the error is discovered.