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Module 3 - Income Tax Concepts
Module 3 - Income Tax Concepts
CONCEPTS
Module No. 3
BAINCTAX
Income Taxation
Pre-Activity
Try to answer the following questions.
1. When is a foreigner considered a resident of the Philippines?
2. Are compensations from vehicular accidents taxable?
3. Name a type of permanent difference as discussed in your BAFACR4X class?
4. Do you think a dead person is still liable to pay income tax?
5. When can you say you are a Filipino citizen?
CONCEPT OF INCOME
One popular definition of income is the amount of wealth accumulated plus savings and the
value of the personal consumption.
The term 'income' refers to all earnings derived from service rendered (labor), from capital
(business or investment), or both including gain derived from sale or exchange of personal or
real property classified as either ordinary or capital asset.
There is no single criterion for determining income for tax purposes, but it may be helpful to
remember that the "rule-of-thumb test” to determine income is the increase in net worth.
Why is income subject to tax?
Income is regarded as the best measure of taxpayers' ability to pay tax. It is an excellent object of
taxation in the allocation of government costs.
Illustration 3.1.
Miss Dina B. Nalican invested P10,000 in the stocks of a mining company. On December 29,
2020, she received P2,500 dividends from the company. Twenty percent of the dividend
received was considered liquidating dividends.
Only P500 of the receipt is taxable as this is the return on capital. Since the P2,000 received was
liquidating dividend, this clearly suggest a return of capital.
Life
The value of life is immeasurable by money. Under Sec. 32 of the NIRC, the proceeds of life
insurance policies paid to the heirs or beneficiaries upon death of the insured, whether in a
single sum or otherwise, are exempt from income tax.
The proceeds of a life insurance contract collected by an employer as a beneficiary from the life
insurance of an officer or any person directly interested with his trade are likewise exempt.
These proceeds are viewed as advanced recovery of future loss.
However, the following are taxable return on capital from insurance policies:
a. Any excess amount received over premiums paid by the insured upon surrender or
maturity of the policy (i.e. the insured outlives the policy.)
b. Gain realized by the insured from the assignment or sale of his insurance policy
c. Interest income from the unpaid balance of the proceeds of the policy
d. Any excess of the proceeds received over the acquisition costs and premium payments
by an assignee of a life insurance policy
Health
Any compensation received in consideration for the loss of health such as compensation for
personal injuries or tortuous acts is deemed a return of capital.
Human Reputation
The value of one's reputation cannot be measured financially. Any indemnity received as
compensation for its impairment is deemed a return of capital exempt from income tax.
Illustration 3.2.
Mang Tomas insured his strawberry crop in a P200,000 crop insurance coverage against
calamities. The crop was eventually destroyed by an unusual frost. Mang Tomas was paid the
P200,000 insurance proceeds.
The P200,000 proceeds which is a reimbursement for the lost value of the future harvest is an item of
gross income. The value of the lost crops is, in effect, realized not through actual harvest but through
the insurance contract.
Realized Benefit
The following must be met for the income to have a realized benefit.
Realized
The term realized means earned. It requires that there be a degree of undertaking or sacrifice
from the taxpayer to be entitled of the benefit. For a benefit to be realized, there must be an
exchange transaction and the transaction involves another entity.
Exchange Transaction
Bilateral transfers such as sale and barter are onerous transactions and gains from these
transactions are more likely taxable as income. For unilateral transfers such as donations and
succession, these gratuitous transfers do not involve an earning process. Complex transactions
like transfers for less than full and adequate consideration are taxable under income tax and
transfer tax.
Illustration 3.3.
A seller sold a piece of jewelry for P140,000 when its fair market value was P200,000. The cost
of the jewelry was P90,000.
The difference of the sale price and cost of P50,000 is subject to income tax while the excess of the fair
market value and the sale price of P60,000 is deemed a donation subject to donor’s tax.
Gains or income derived between relatives, corporations, and between a partner and the
partnership are taxable since it is made between separate entities. Likewise, the income between
affiliated companies such as between a holding or parent company and its subsidiaries and
between sister companies are taxable because each corporation is a separate entity. This applies
regardless of the underlying economic relationship.
However, the sales of a home office to its branch office are not taxable because they pertain to
one and the same taxable entity. Furthermore. the income between businesses of a proprietor
should not be taxed since proprietorship businesses are taxable upon the same owner. Note that
a proprietorship business is not a juridical entity.
Benefit
The term "benefit" means any form of advantage derived by the taxpayer. There is benefit when
there is an increase in the net worth of the taxpayer. An increase in net worth occurs when one
receives income, donation or inheritance.
Illustration 3.4.
An employee was granted P20,000 transportation advance. He liquidated P18,000
transportation expenses and was allowed by his employer to keep the P2,000.
Only the P2,000 retained by the employee is considered income since this was the extent he was
benefited.
These are referred to as unrealized gains or holding gains because they have not yet
materialized in an exchange transaction. Examples of unrealized gains or holding gains:
a. Increase in value of investments in equity or debt securities
b. Increase in value of real properties held (revaluation increment)
c. Increase in value of foreign currencies held or receivable
d. Decrease in value of foreign currency denominated debt by virtue of favorable
fluctuation in exchange rates
e. Birth of animal offspring, accruals of fruits in an orchard or growth of farm vegetables
f. Increase in value of land due to the discovery of mineral reserves
Rendering of Services
The rendering of services for a consideration is an exchange but does not cause a loss of capital.
Hence, the entire consideration received from rendering of services such as compensation
income or service fees is an item of gross income.
Illustration 3.5.
Mr. Nash E. Mulan wants you to evaluate whether he is liable to tax on the following:
Income from employment P 250,000
Prizes from jueteng 5,000
Fair Value increase of trading investments 25,000
Cancelled debt for services he rendered 50,000
Cancelled debt out of affection 10,000
Receipt of cash, in trust for his nephew 40,000
There is no realization of benefits for the fair value increase of the trading investments. The cancelled
debt out of affection constitutes gratuity and is not subject to income tax. The cash receipt which was
in trust does not increase his net worth.
The following items of income are exempted by law from taxation; hence, they are not
considered items of gross income:
CLASSIFICATIONS OF TAXPAYERS
One of the determinants in the imposition and assessment of taxes is the classification of the
taxpayer, thus, one should consider the nationality and residence of individual taxpayers in
computing for their taxes.
Individual Taxpayers
Resident Citizen (RC)
A Filipino citizen residing in the Philippines
a. A citizen of the Philippines who establishes to the satisfaction of the BIR Commissioner
the fact of his physical presence abroad with a definite intention to reside therein
b. A citizen of the Philippines who leaves the country during the taxable year to reside
abroad, either as an immigrant or for an employment on a permanent basis
c. A citizen of the Philippines who works and derives income from abroad and whose
employment thereat requires him to be physically present abroad most of the time
during the taxable year;
d. A citizen who has been previously considered as non-resident citizen and who arrives in
the Philippines at any time during the taxable year to reside permanently in the
Philippines shall likewise be treated as non-resident citizen for the taxable year in which
he arrives in the Philippines with respect to his income derived from sources abroad
until the date of his arrival in the Philippines
e. In the absence of information on taxpayer’s intent, citizens staying abroad for a period of
at least 183 days are considered non-resident citizens.
Filipinos working in Philippine embassies or Philippine Consulate Offices are not considered
non-resident citizens.
a. An alien who lives in the Philippines without definite intention as to his stay
b. One who comes to the Philippines for a definite purpose which in its nature would
require an extended stay and to that end makes his home temporarily in the Philippines,
although it may be his intention at all times to return to his domicile abroad
c. In the absence of information on intention, aliens who stayed in the Philippines for more
than 1 year as of the end of the taxable year are considered resident aliens.
An alien who has acquired residence in the Philippines retains his status as such until he
abandons the same or actually departs from the Philippines.
In the absence of information as to taxpayer’s intent, aliens who stayed in the Philippines for
an aggregate period of more than 180 days during the year are presumed to be engaged in
trade or business.
Estate
This refers to the properties, rights and obligations of a deceased person not extinguished by
death. Estates under judicial settlement are treated as individual taxpayers. Estates under
extrajudicial settlement are exempt entities. The income of properties of the estate under
extrajudicial settlement is taxable to the heirs.
Trust
A trust is an arrangement whereby one person called the grantor or trustor transfers property to
another person called the beneficiary, which will be held under the management of a third
party called the trustee or fiduciary.
Corporate Taxpayers
Domestic Corporation (DC)
A corporation formed and authorized to conduct trade and business under the Philippine law.
Partnership
A partnership is a business organization owned by two or more persons who contribute their
industry or resources to a common fund for the purpose of dividing the profits from the
venture.
Joint Venture
A joint venture is a business undertaking for a particular purpose. It may be organized as a
partnership or corporation.
Co-Ownership
It is a joint-ownership of a property formed for the purpose of preserving the same and/or
dividing its income.
Taxability
The income earned by a taxpayer may be taxed depending on the situs or place where it was
earned. Following is a table summarizing taxability of a taxpayer’s income based on its situs.
Income Income
Classification earned earned Rate of Tax
Within Without
RC ✓ ✓
NRC ✓ X
Generally, progressive tax on the net income
RA ✓ X
NRA-ETB ✓ X
NRA-NETB ✓ X Generally, 25% final tax on the gross income
DC ✓ ✓
Generally, 30% ad valorem tax on net income
RFC ✓ X
NRFC ✓ X Generally, 30% final tax on the gross income
Depends on the
Estates and Trusts Generally, progressive tax on the net income
decedent or trustor
Illustration 3.6.
Mrs. Dina A. Moon, a tax practitioner, derives the following income during the taxable year
(all in Philippine pesos).
Nature Within Without
Income from Employment 180,000 -
Consultancy Fees 270,000 140,000
Rental Income 40,000 70,000
Interest Income 50,000 10,000
Determine the amount subject to income tax if she is:
1. Resident Citizen
She will be taxable on her worldwide income totaling P760,000.
2. Resident Alien
She will only be taxable on her income within totaling P540,000.
SITUS OF INCOME
The situs of income is the place of taxation. It is the jurisdiction that has the authority to impose
tax upon the income. It is to be noted that it is different from source of income as the latter
pertains to the activity or property that produces the same. The following are the specific
income situs rules:
Illustration 3.7.
Jack E. Shang obtained the following income during the taxable year.
Collected interest income of P15,000 from a resident Indonesian when they were in
vacation in Macau
Earned P60,000 from rentals of commercial spaces in Tokyo, Japan
Earned P280,000 compensation expense from a domestic employer
Received P25,000 royalties from musical compositions copyrighted in the Philippines
Earned P145,000 from professional services rendered in the Philippines to non-
resident clients
Earned a gain of P80,000 on merchandise purchased abroad but sold locally
Transferred goods manufactured at a cost of P80,000 to a foreign branch for P100,000
and was subsequently sold by the branch at P150,000
The interest income is earned within as the debtor resides in the Philippines. The rentals are earned
abroad as the property is located outside the country. The compensation expense is earned within as the
service is performed and the employer is located domestically. The royalties are earned within as this
was registered in the country. Though the recipient of the professional services are non-residents, the
services are rendered within making the income earned within. The gain on merchandising is earned
within as the place of sale is the Philippines. The excess of P20,000 on the transfer of goods to the
foreign branch is a manufacturing income earned within, whereas, the gain of P50,000 is a gain earned
abroad.
Illustration 3.8.
Paul E. Goss obtained the following income:
Gain on sale of foreign stocks sold in Makati– P200,000
Gain on sale of domestic bonds sold in Phuket– P50,000
Gain on sale of agricultural lot in Ilocos – P180,000
Gain on sale of jewelries in Calamba – P75,000
All are earned within except for the gain on sale of stocks.
From Domestic
Presumed earned within the Philippines
Corporation
Predominance Test:
Compare the Philippine Gross Income with the
World Gross Income in the preceding three-year
period
Dividend From Resident
~ If at least 50%, the portion of the dividend
Income Foreign Corporation
corresponding to the Philippine gross income is
earned within
~ Less than 50%, the entire dividends received is
earned abroad
From Non-Resident
Presumed earned abroad
Foreign Corporation
Illustration 3.9.
Rosa Noble received P120,000 dividends from Tulips Corporation which had the following
gross income in the following years.
Determine where the dividend is earned under the following independent scenarios:
a. Tulips is a domestic corporation
The total amount of P120,000 dividend received is earned within.
b. Tulips is a non-resident foreign corporation
The total amount of P120,000 dividend received is earned abroad.
c. Tulips is a resident foreign corporation and the dividend is received in 2020
The gross income ratio for 2017-2019 is 60%. Prorated to the dividend received, only P72,000
is earned within and the P48,000 is earned abroad.
d. Tulips is a resident foreign corporation and the dividend is received in 2019
The gross income ratio is 47%, therefore, the whole P120,000 is earned without.
Self-Check
Basing on your readings, answer the following questions.
1. When is an item of receipt considered an item of gross income?
2. Who are the different income taxpayers? How do they differentiate in being taxable
on their income?
3. When is a benefit considered realized?
4. What are the situs rules discussed in this module?
___________10. Moira dela Sobre, a Filipino citizen, has been residing abroad for 90 days as
an Overseas Filipino Worker
___________11. Jason Nonoa, an American citizen, left for South Korea on March 17 for a 50-
day vacation. After his vacation, he immediately boarded to the Philippines.
He stayed in the Philippines for 2 weeks for the finalization of some business
deals
___________12. Stephen Agila, a Filipino Pharmacist, went to a 183-day backpacker
adventure with his friends in Iraq.
___________13. Lina Vaughn, a German, works as a Secretary for the German Ambassador to
the Philippines in the British Embassy
___________14. Dina Natuto, a Filipino CPA, went abroad for a vacation on September 5. She
fell in love with the country she visited so she decided to stay there for good.
___________15. Lone Lee, a Singaporean tourist, finding the beauty of the Philippines, stayed
therein for 180 days.
___________16. Lee Gon Na, a Korean Superstar, visited the Philippines for one week to
promote a major clothing line.
Compute that total income earned from sources within and outside the Philippines.
Compute the manufacturing income respectively earned within and earned without the Philippines.
Pia got frustrated when she learns that the amount is still taxable in the Philippines saying
that it violates the territoriality limitation of taxation. She then adds that the service was
rendered abroad and the company which hired her is a non-resident foreign corporation.