II.

INCOME TAXATION (RA 8242 Tax Reform Act of 1997)

A. INDIVIDUALS

Classification of taxpayers
1. Resident Citizen (RC)
a. Citizen of the Philippines residing therein
b. Citizen residing outside the Philippines without the intention of residing thereat
permanently
c. Citizen who did not manifest to the total satisfaction of the Commissioner the fact
of his physical presence abroad with a definite intention to reside therein perm.
2. Non-Resident Citizen (NRC)
a. Citizen who established to the satisfaction of the Commissioner the fact of his
physical presence abroad with a definite intention to reside therein.
b. Citizen who leaves the Philippines during the taxable year to reside abroad as
immigrants.
3. Overseas Contract Worker (OCW)
a. Covers only those individuals with a working contract abroad
b. TNTs are not considered OCWs but are usually classified as RCs
4. Resident Alien (RA)
a. An individual residing in the Philippines who is not a citizen thereof
b. Intention to reside in the Philippines is not necessary
5. Non-resident Alien Engaged in Trade or Business in the Philippines (NRA ETB)
a. Engaged in retail trade or business
b. Engaged in the exercise of profession therein
c. Staying for an aggregate period of more than 180 days for the calendar year
6. Non-resident Alien Not Engaged in Trade of Business in the Phils. (NRA NETB)
a. NRAs not engaged in business but deriving income in the country
7. Aliens Employed in MNCs, OBUs, & Petroleum Service Contractors

B. CORPORATIONS

Definition: NIRC defines a corporation as including partnerships, no matter how created or

organized, joint stock companies, joint accounts, associations, insurance companies but does
not include general professional partnerships and JV formed for the purpose of undertaking
construction projects or engaging in petroleum, coal, geothermal and other energy operations
pursuant to an agreement under a service contract with the government.

Classification of Corporations

1. Domestic Corporations
2. Resident Foreign Corporations ETB
3. Non-Resident Foreign Corporations NETB

III. KINDS OF INCOME TAXES

Net Income Tax; Gross Income Tax; Final Income Tax; MCIT, IAET; Optional Corporate Income
Tax
A. NET INCOME TAX

Taxable Income: Gross Income

Less: Deductions (Personal & Additional)
Net Income
Multiplied by: Tax Rate
Net Income Tax Payable
Less: Tax Credits
Net Income Tax Due

Note: This kind of income tax allows deduction, personal as well as additional exemptions
& tax credits.
The determination of actual gain or loss is material since the tax shall be based on NET

The rate of this tax is 32% for individual & 35% for corporate taxpayers.

B. GROSS INCOME TAX

Unlike the net income tax, the gross income tax does not allow deductions, hence he formula is:

Gross Income X Tax Rate = Tax Due

Notes: The application of this tax BARS the application of the income tax.
The gross income tax is always subject to the Final WHT.

C. FINAL INCOME TAX

This is the only income tax applicable to all types of taxpayers without distinctions. The formula
is:

Gross Income X Tax Rate = Tax Due

Notes: Under final income tax, the rate is multiplied to each income individually as each income
may have a different rate.
This tax does not allow deductions.
The determination of gain or loss is immaterial since the basis of taxation is the GROSS,
Hence actual gain or loss does not matter.
An income which is subject to final income tax is no longer subject to net income tax!
Withholding agent is responsible in filing the income tax returns.
Applicable only to passive income and income from sources within the Phils.
If the taxpayer fails to pay, the withholding agent shall be liable!!!

D. MINIMUM CORPORATE INCOME TAX – 2% on Gross Income

The 2% MCIT on gross income is imposed on corporations beginning the 4th year of the
corporation. The formula is:

Gross Income X 2% = MCIT

Pay the MCIT or the Net Income Tax, whichever is higher!

Rationale: To prevent corporations from claiming too many deductions.
E. IMPROPERLY ACCUMULATED EARNINGS TAX – 10% of Taxable Income

This tax is imposed on the improperly accumulated earnings by corporations.

Purpose: To discourage the practice of corporations of accumulating earnings

& profits in avoidance of the payment of taxes.

To avoid this: Distribute earnings among the shareholders.

F. OPTIONAL CORPORATE INCOME TAX – 15% on Gross Income

Corporations may opt to be taxed at 15% of their gross income in lieu of the Net Income Tax or
the MCIT. This may be imposed by the President upon the recommendation of the DOF.

IV. SOURCES OF INCOME

What is the relevance in determining the sources?

Its relevance relates to the income tax liability of the taxpayers. RC and domestic corporations
are the only taxpayers liable for income derived from sources within and without the Philippines.

A. GROSS INCOME FROM SOURCES WITHIN THE PHILIPPINES. (Section 42[a])

1. Interest from sources within the Philippines

o Interests derived from sources within the Philippines
 Interest earned from domestic bank deposits
o Interests on bonds, notes or other interest-bearing obligations of residents,
corporate or otherwise.
 The determining factor is the residence of the obligor, whether individual
or corporation.

2. Dividends
o Any distribution made by a corporation to its shareholders out of its earnings or
profits and payable to its shareholders, whether in money or property.
o Dividends issued by foreign corporations are considered income from sources
within provided the 2 requisites are present:
 At Least 50% of its gross income is from sources within the Phils.
 Such gross income must be for the 3-year period ending with the close of
the taxable year.

3. Services
o This is the compensation for labor or personal services performed in the Phils.
o The determining factor is the place of performance. The place of payments is
IRRELEVANT!

4. Rentals and Royalties from property located in the Phils.

 o Use of copyright, patent, design or model, plan, secret formula or process,
goodwill, trademark, trade brand or other like property or right in the Phils.
o Use of industrial, commercial or scientific equipment in the Phils.
o The supply of scientific, technical, industrial or commercial info.
o The supply of services by a non-resident person or his employee in connection
with the use of property or rights belonging to, or the installation or operation of
any brand, machinery or other apparatus purchased from such non-resident
person.
o Technical advise, assistance or services rendered in connection with technical
management or administration of any scientific, industrial or commercial
undertaking.
o The use or right to use motion picture films, films or video tapes for use or in
connection with TV, & tapes use in connection with radio broadcasting.

5. Sale of Real Property

o Gains, profits and income from sale of real property located in the Phils.
o Location of the property is the controlling factor to determine the source of the
income.

6. Sale of Personal Property

B. GROSS INCOME FROM SOURCES WITHOUT THE PHILS.

Any income not falling under any of the 6 above is an income derived from sources outside the
Philippines.

C. INCOME FROM SOURCES PARTLY WITHIN & PARTLY WITHOUT THE PHILIPPINES

The taxable income is computed by first deducting the expenses, losses or other deductions
apportioned or allocated thereto and ratable part of any expense, loss or other deduction which
cannot definitely be allocated to some items or classes of gross income; and the portion of such
taxable income attributable to sources within the Phils.

Basic Formula: Gross Income Within

Gross Income World

= Rate X Expenses World

= Expenses to be allowed

To illustrate: Suppose the Gross Income Within is P10k; the Gross Income World is P100K; and
the Expenses-World is P50k, thus:

P10k_ = 10% X P50K = P5K.

P100k

In this illustration, only P5k should be allowed as deduction against the gross income derived in
the Phils.
D. SALE OF PERSONAL PROPERTY

Guidelines:
1. For those produced, in whole or in part, by the taxpayer within and sold without the
Philippines, or produced in whole or in part, by the taxpayer without and sold within the
Philippines – the income shall be treated as partly within and partly without from sources
within the Philippines and partly from sources without the Phils.
2. For those purchased within and sold without the Philippines, or for purchase of personal
property without and sold without – the gains, profits or income shall be treated as
derived entirely from sources within the country where the property is sold; EXCEPT –
gains from the sale of shares of stock in a domestic corporation shall be treated as
derived entirely from sources within the Phils., regardless of the place where the shares
were sold.

V. CAPITAL GAINS AND LOSSES

What is a capital asset?

Capital assets are property held by the taxpayer, but does not include:
1. Stock in trade of the taxpayer / inventory on hand at the close of the taxable year
2. Property held primarily for sale to customers in the ordinary course of his business
3. Property used in the business, of a character which is subject to the allowance for
depreciation.
4. Real property used in business of the taxpayer.

What is the relevance for the determination?

1. Holding period – percentage taken into account
2. Loss Limitation Rule – limitation on Capital Losses
3. Net Capital Loss Carry Over Rule

A. PERCENTAGE TAKEN INTO ACCOUNT

Holding period (percentage taken into account) is defined as the length of time or duration by
which an individual held the capital asset.

In sale of exchange of a capital asset, there are 2 percentages which should be taken into
account in recognizing the gain or loss from such sale or exchange:
1. 100% if the capital asset has been held for not more than 12 months (ST)
2. 50%, if held for more than 12 months (LT)
3. Capital Assets held by Corporation – not included

Sales not subject to the rule:

1. Sale or exchange of shares of stocks which is a capital asset.
2. Sale or exchange of real property held as a capital asset.

Notes: Capital gain is included in the gross income subject to net income tax.
A capital gain or loss is included in the gross income

B. LIMITATIONS ON CAPITAL LOSSES

Loss Limitation Rule provides that “losses from sales of exchanges of capital assets shall be
allowed only to the extent of the capital gains from such sale or exchange.”

A capital loss can only be deducted from capital gains but never from an ordinary gain, while an
ordinary loss may de deducted from both capital and ordinary gain. Applicable to individual and
corporations.

Rationale:
1. Ordinarily, a capital gain is included in the gross income. The items included in the gross
income are ordinary gains and losses – those related to the ordinary business.
2. With respect to capital losses, these are not related to the ordinary business of the
taxpayer.

C. NET CAPITAL LOSS CARRY-OVER

A capital loss may only be deducted from a capital gain, if there is any. What then is the remedy
of the taxpayer where is capital loss but there is no capital gain?

Apply the NOLCO Rule.

NOLCO Rule:
 Any capital loss sustained by the taxpayer during a taxable year shall be treated in the
succeeding taxable year as a loss from sale or exchange of capital asset held for not
more than 12 months.
 Requisites
o Amount of loss should not exceed net income for the taxable year when the loss
was incurred.
o There should be capital gain from which the carried over loss can be deducted
o Can only be availed by individuals!

D. GAINS AND LOSSES FROM SHORT SALES

Short Sale is defined as a sale where the seller is selling a property without distinction of what
kind of property he is selling, whether a share of stock or not. The seller is selling property which
he is not in his possession.

Any gains or losses are considered as capital gains or losses.

E. CAPITAL TO ORDINARY ASSET, VICE VERSA

Calasanz V CIR
 A conversion from capital to ordinary asset is allowed provided that it is:
o In furtherance of the taxpayer’s business
o Substantially improved or very actively sold or both.

RR 7-2003
 Properties classified as ordinary assets are automatically converted into capital assets
upon showing of proof that the same have not been used in business for more than 2
years prior to the consummation of the taxable transactions involving said properties.