Course Code AE26

Description Income Taxation

Pre-Requisites
Department: College of Business and Accountancy Week 6

Gross Income: Part 1 Module No. 5

LEARNING OUTCOMES

At the end of this module, the student will be able to:

1. Identify the items included in Gross Income.
2. Describe the nature of and tax treatment on compensation income, fringe benefit,
profession income, income from business, income from dealings in property, and passive
income.

INTRODUCTION

Section 32 of National Internal Revenue Code (NIRC) provides:

Gross Income. – (A) General Definition. – Except when otherwise provided in this Title, gross
income means all income derived from whatever source, including (but not limited to) the
following items:

(1) Compensation for services in whatever form paid, including, but not limited to fees, salaries,
wages, commissions, and similar items;

(2) Gross income derived from the conduct of trade or business or the exercise of a profession;

(3) Gains derived from dealings in property;

(4) Interests;

(5) Rents;

(6) Royalties;

(7) Dividends;

(8) Annuities;

(9) Prizes and winnings;

(10) Pensions; and

(11) Partner’s distributive share from the net income of the general professional partnership.

COURSE CONTENT

“Income from whatever source” includes all income not expressly excluded or exempted from the
class of taxable income, irrespective of the voluntary or involuntary action of the taxpayer in
producing the income (Gutierrez v. CIR, CTA Case No. 65, August 31, 1955).

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The following are income subject to tax:
1. Compensation income - includes all remuneration for services rendered by an employee
for his employer unless specifically excluded under the NIRC (R.R. 2- 98, Sec. 2.78.1).
2. Fringe benefit - refers to any good, service or other benefit furnished or granted by an
employer, in cash or in kind, in addition to basic salaries, to an individual employee, except
a rank and file employee, such as but not limited to:
• Housing
• Expense account
• Vehicle of any kind
• Household personnel such as maid, driver and others
• Interest on loans at less than market rate to the extent of the difference between
the market rate and the actual rate granted
• Membership fees, dues and other expenses athletic clubs or other similar
organizations
• Expenses for foreign travel 8. Holiday and vacation expenses
• Educational assistance to the employee or his dependents
• Life or health insurance and other non-life insurance premiums or similar amounts
in excess of what the law allows (NIRC, Sec. 33 [B]; R.R. 3-98, Sec. 2.33 [B])
3. Professional income - refers to the fees received by a professional from the practice of his
profession, provided that there is no employer-employee relationship between him and
his clients. The existence or nonexistence of employer-employee relationship is material to
determine whether the income is a compensation income or professional income. If the
employer-employee relationship is present, then it is considered compensation income.
Otherwise, it is a professional income.
4. Income from business - refers to income derived from merchandising, mining,
manufacturing, and farming operations.

The term “gross income” derived from business shall be equivalent to gross sales less sales
returns, discounts and allowances and cost of goods sold. In the case of taxpayers engaged
in the sale of service, “gross income” means gross receipts less sales returns, allowances
and discounts (NIRC, Sec. 27 [A]).
5. Income from dealings in property
Types of properties from which income may be derived
• Ordinary assets - refer to properties held by the taxpayer used in connection with
his trade or business which includes the following:
a. 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;
b. Property held by the taxpayer primarily for sale to customers in the ordinary
course of trade or business;
c. Property used in the trade or business of a character which is subject to the
allowance for depreciation provided in the NIRC; and
d. Real property used in trade or business of the taxpayer.
Examples of ordinary assets
a. The condominium building owned by a realty company, the units of which are for rent or
for sale.
b. Machinery and equipment of a manufacturing concern subject to depreciation
c. The motor vehicles of a person engaged in transportation business
• Capital assets - include property held by the taxpayer (whether or not connected
with his trade or business) other than the enumerated under ordinary assets.
Examples of capital assets
a. Jewelry not used for trade or business
b. Residential houses and lands owned and used as such
c. Automobiles not used in trade or business
d. Stock and securities held by taxpayers other than dealers of securities

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Significance of determining whether the capital asset is ordinary asset or capital asset
They are subject to different rules. There are special rules that apply only to capital asset
transactions, to wit:
1. Holding period rule
2. Capital loss limitation
3. Net capital loss carry-over (NELCO)

ORDINARY INCOME ORDINARY LOSS

It includes the gain derived from the sale or The loss that may be sustained from the sale
exchange of ordinary asset. or exchange of ordinary asset.

CAPITAL GAIN CAPITAL LOSS

It includes the gain derived from the sale or The loss that may be sustained from the sale
exchange of an asset not connected with the or exchange of an asset not connected with
trade or business. the trade or business. Capital loss may not
exceed capital gains when used as a deduction
to income.

Difference between treatment of capital gains and losses between individuals and corporations

BASIS INDIVIDUAL CORPORATION

Availability of holding period Holding period available No holding period
Extent of Recognition The percentages of gain or Capital gains and losses are
(Taxability) loss to be taken into account recognized to the extent of
shall be the ff.: 100%
• 100% - if the capital
assets have been held
for 12 months or less;
and
• 50% - if the capital
asset has been held
for more than 12
months

Deductibility of capital losses Non-deductibility of Net Non-deductibility of Net

Capital losses Capital losses

Capital losses are allowed Exception: If any domestic

only up to the extent of the
capital gains; hence, the net
capital loss is not deductible.
Availability of Net Capital Loss Allowed
Carry-Over
bank or trust company, a
substantial part of whose
business is the receipt of
deposits, sells any bond,
debenture, note or certificate
or other evidence of
indebtedness issued by any
corporation (including one
issued by a government or
political subdivision)
Not allowed

Tax treatment of capital gains and losses

1. From Sale of Stocks of Corporations
a. Stocks Traded in the Stock Exchange - subject to stock transaction tax of ½ of 1% on its

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 gross selling price
b. Stocks Not Traded in the Stock Exchange - subject to capital gains tax.
2. From Sale of Real Properties/Land and/or Buildings in the Philippines - capital gain derived
is subject to capital gains tax but no loss is recognized because gain is presumed.

Gains from sale to the government of real property classified as capital asset The taxpayer
has the option to either:
a. Include as part of gross income subject allowable deductions and personal
exemptions, then subject to the schedular tax; or
b. Subject to final tax of 6% on capital gains (Sec. 24 [D], NIRC).

3. From Sale of Other Capital Asset - the rules on capital gains and losses apply in the
determination of the amount to be included in gross income subject to the graduated
rates of 5- 32% for individuals and the normal corporate income tax of 30% for
corporations, and not subject to capital gains tax.

Capital gains realized from the sale of real property/ land and/or buildings
Treatment of sale or disposition of real property located in the Philippines treated as capital asset.
A final tax of 6% shall be imposed based on the higher amount between:
1. The gross selling price; or
2. Whichever is higher between the current fair market value as determined by:
a. Zonal Value - prescribed zonal value of real properties as determined by the CIR; or
b. Assessed Value - the fair market value as shown in the schedule of values of the
Provincial and City assessors (NIRC, Sec. 24 D [1]).

Actual gain or loss is immaterial since there is a conclusive presumption of gain. As regards
transactions affected by the 6% capital gain tax, the NIRC speaks of real property with respect to
individual taxpayers, estate and trust but also speaks of land and/or building with respect to
domestic corporations.

Transactions covered by the “presumed” capital gains tax on real property

It covers:
1. Sale; Exc
2. Exhange; or
3. Other disposition, including pacto de retro and other forms of conditional sales (NIRC, Sec. 24
D [1]).

Sale of Principal Residence

Principal residence - refers to the dwelling house, including the land on which it is situated, where
the individual and members of his family reside, and whenever absent, the said individual intends
to return. Actual occupancy is not considered interrupted or abandoned by reason of temporary
absence due to travel or studies or work abroad or such other similar circumstances (RR No. 14-00)

A sale of principal residence by an individual is exempt from capital gains tax provided the
following requisites are present:
1. Sale or disposition of the old actual principal residence;
2. By a citizen or resident alien;
3. Proceeds from which is fully utilized in acquiring or constructing a new principal residence
within 18 calendar months from the date of sale or disposition;
4. Notify the CIR within 30 days from the date of sale or disposition through a prescribed
return of his intention to avail the tax exemption;
5. Can be availed of once every 10 years;
6. The historical cost or adjusted basis of his old principal residence shall be carried over to
the cost basis of his new principal residence;
7. If there is no full utilization, the portion of the gains presumed to have been realized shall

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 be subject to capital gains tax; and
8. The 6% capital gains tax due shall be deposited with an authorized agent bank subject to
release upon certification by the RDO that the proceeds of the sale have been utilized (R.R.
No. 14-00)

6. Passive investment income - refers to income derived from any activity in which the
taxpayer has no active participation or involvement.

Summary rules on the tax treatment of certain passive income as applied to individuals

RC NRC RA NRA- NRA-

ETB NETB
Within Within Within Within Within
Sources of Income and
without
Nature of Income Tax Rate
Interest
On interest on currency bank deposits, yield or other
monetary benefits from deposit substitutes, trust funds and 20% 20% 20% 20% 25%
similar arrangements

Exception: If the depositor has an employee trust fund or

accredited retirement plan, such interest income, yield or
other monetary benefit is exempt from final withholding tax.
Interest income under the Expanded Foreign Currency Deposit 15% Exempt 15% Exempt Exempt
System

NOTE: If the loan is granted by a foreign government, or an

international or regional financing institution established by
government, the interest income of the lender shall not be
subject to the final withholding tax.
Interest Income from long-term deposit or investment in the Held for:
form of savings, common or individual trust funds, deposit 5 years or more - exempt
substitutes, investment management accounts and other 4 years to less than 5 years - 5% Exempt
investments evidenced by certificates in such form prescribed 3 years to less than 4 years - 12%
by the BSP (RR. 14-2012) Less than 3 years - 20%
Dividend
Dividend from a DC or from a joint stock company, insurance 10% 10% 10% 20% 10%
or mutual fund company and regional operating headquarters
of a multinational company; or on the share of an individual in
the distributable net income after tax of partnership (except
that of a GPP) of which he is a partner, or on the share of an
individual in the net income after tax of an association, a joint
account or joint venture or consortium taxable as a
corporation of which he is a member of co-venturer.
Royalty Income
Royalties on books, literary works and musical composition 10% 10% 10% 10% 10%
Other royalties (e.g. patents and franchises) 20% 20% 20% 20% 25%
Prizes and Winnings
Prizes exceeding P10,000 20% 20% 20% 20% 25%
Winnings 20% 20% 20% 20% 25%
Winnings from Philippines Charity sweepstakes and lotto Exempt Exempt Exempt Exempt Exempt
winnings which are less than P10,000

Otherwise, follow 20%

Summary rules on the tax treatment of certain passive income as applied to corporations (NIRC, Sec.
27 [D])

Nature of Income DC RFC NRFC

Interests from any currency bank deposits, yield, or any other monetary benefits 20% 20% Shall be
from deposit substitutes and from trust fund and similar arrangement and considered
Royalties derived from sources within the Philippines as part of gross
income subject to
NOTE: Interest income or yield earned by DC from sources outside the Philippines 35% NCIT.
shall not be subject to final tax of 20% but included in the gross income and
subject to NCIT.
Interest Income derived under expanded foreign currency 15% 15% Exempt
deposit system
Interest derived by depositary bank under the expanded foreign currency deposit 10% 10% Exempt
system from foreign currency loans granted to residents other than offshore

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 banking units (OBUs)

NOTE: If granted to nonresidents, OBUs, local commercial banks or branches

foreign banks authorized by BSP to transact business - EXEMPT
Interest received by NRFC on foreign loans(NIRC, Sec. 28 [5a]) - - 20%
Dividends received from Domestic Corporation (Inter-corporate Dividend) Exempt Exempt 15% (subject to
tax credit sparing
rule)

Tax sparing rule

Under this rule, the dividends received shall be subject to 15% FWT, provided, thatthe country in
which the corporation is domiciled either (i) allows a tax credit of 15% against the taxes due from
the foreign corporation for taxes deemedpaidor (ii) does not impose income tax on such
dividends(CIR v. Wander Philippines Inc., G.R. No. L-68375, April 15, 1988); otherwise, the dividend shall be subject
to 30%.

Summary of Rules on Dividends

SOURCE OF DIVIDENDS
RECIPIENT DC RFC NRFC
RC 10% final tax Regular income tax (0-32%) Regular income tax (0-32%)
RA 10% final tax Less than 50% of income of RFC/NRFC is from PH: Nontaxable Income from sources
NRC 10% final tax outside PH are not taxable for RA, NRC, NRAETB, and NRANETB).
NRAETB 20% final tax
NRANETB 25% final tax If 50%-85% of income of RFC/NRFC is from PH, a proportion of the income is
considered as income within the Philippines, subject to regular income tax (or 25%
final tax for NRANETB).

If more than 85% of income of RFC/NRFC is from PH, entire dividend income is
considered as income within the Philippines, subject to regular income tax (or 25%
final tax for NRANETB).
DC Exempt (intercorporate Same rule for RFCs and NRFCs (see Regular corporate income tax (30%)
dividends) below)
RFC Exempt (Intercorporate Less than 50% of income of RFC/NRFC is from PH: Nontaxable Income from sources
dividends) outside PH are not taxable for RFC and NRFC).
NRFC 30% subject preferential
treaty tax rate If 50%-85% of income of RFC/NRFC is from PH, a proportion of the income is
considered as income within the Philippines, subject to regular income tax (or 30%
final tax on gross income for NRFC).

If more than 85% of income of RFC/NRFC is from PH, entire dividend income is
considered as income within the Philippines, subject to regular income tax (or 30%
final tax on gross income for NRFC).

FOCUS QUESTIONS

1. What is gross income?

2. What are the different types of gross income?
3. What are the tax treatment on each type of gross income?

LEARNING ACTIVITIES

A. Individual Oral Recitation.

B. Discussion of relevant examples and cases.

ASSESSMENT

Short Quiz
Direction: Answer Questions 1 to 5 found in the LMS Quiz No. 5 Week No. 6
You will be guided with the instructions provided.

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ASSIGNMENT

Assignment No. 5
Answer the following questions:
1. State with reason the tax treatment of the following in the preparation of annual income
tax returns: Income realized from sale of:
a. Capital assets; and
b. Ordinary assets.
2. If the taxpayer constructed a new residence and then sold his old house, is the transaction
subject to capital gains tax?

RELATED READINGS / REFERENCES

READINGS/REFERENCES:
• Banggawan, Rex. Income Taxation, Laws, Principles, and Applications. Quezon City,
Rex Bookstore, 2019.
• National Internal Revenue Code of 1997 as amended by RA 10963.

Prepared by: Approved by: Noted by:

Noel Velasco, CPA Roman S. Asiño Rito A. Camigla Jr., EdD.

Faculty Program Chair, College of Business and VP for Academic & Student Affairs
Accountancy

PLAGIARISM DECLARATION

I hereby certify that the module AE26 – INCOME TAXATION submitted to Trimex
Colleges is entirely my original work, except where otherwise indicated. I am aware of
the College's rules on plagiarism, including those on disciplinary action that may result

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from plagiarism. Any use, in any form whatsoever, of the works of any other author shall
be properly recognized and cited at their point of use.

Signature :

Author’s Name : NOEL VELASCO,CPA

Faculty

Date of submission : July 20, 2020

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