COLLEGE OF ACCOUNTANCY & BUSINESS ADMINISTRATION
TAXATION I
MODULE 4
GROSS INCOME
Gross Income means all income from whatever source
derived including but not limited to the following
items: [CG2IR2DAP3]
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 (NIRC,
Sec. 32 [A])
“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).
NOTE: The above enumeration of gross income under
NIRC is NOT exclusive.
I. Compensation Income
All remuneration for services performed by an
employee for his employer under the employer –
employee relationship, unless expressly excluded by
the Tax Code (R.R 2-98, Sec. 2.78.1.
** Employee – refers to an individual performing
service under an employer – employee relationship.
** Employer – means any person for whom an
individual performs or performed service of whatever
nature under an employer-employee relationship.
Composition of gross compensation income
1. Salary, wages or fee
Salary is an earning paid on regular intervals; wage is
paid on an hourly or daily basis; and fee implies
payment to an individual who is of authority, such as
director’s fee, legal fee, accountant’s fee.
2. Commission
Payment made based on a certain percentage of
output, like salesman’s commission or underwriter’s
commission.
3. Honoraria
Honoraria are earnings derived from services usually
undertaken by individuals considered experts in a
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particular field. Example - Honoraria given to special
lecturers.
4. Allowances
An allowance may either fixed or variable. It is
considered fixed when it is attached to the position or
office and variable when it changes accordingly as
influenced by certain factors like number of visits,
distance of travel, frequencies of seminars.
Generally, fixed or variable allowance received by a
public officer or employee of a private entity, in
addition to the regular compensation fixed for his
position or office, is compensation subject to
withholding tax.
Any amount paid specifically, either as advance or
reimbursement for traveling, representation and other
bonafide ordinary and necessary expenses incurred or
reasonably expected to be incurred by the employee
in the performance of his duties is not compensation
subject to withholding tax, if the following conditions
are satisfied:
a. It is ordinary and necessary traveling and
representation or entertainment expense paid or
incurred by the employee on the pursuit of trade or
business or profession.
b. The employee is required to account for/to
liquidate the foregoing expenses in accordance with
specific requirements of substantiation for each
category of expenses pursuant to Sec. 34 of the Tax
Code. The excess of actual expenses over advances
made shall constitute taxable income if such amount
is not returned to the employer. Reasonable
amounts of reimbursements/advances for traveling
and entertainment expenses which are pre-
computed on a daily basis and are paid to an
employee while he is on an assignment or duty need
not be subject to the requirement of substantiation
and to withholding tax.
5. Thirteenth month pay and other benefits
Thirteenth month pay is equivalent of the mandatory
one-month basic salary of officials and employees of
the government, national or local, including
government-owned or controlled corporations, and or
private offices received after the 12th month pay.
The 13th month pay is computed by dividing the total
basic salary during the year by 12 months.
6. Holiday pay, Overtime pay, night shift
differential and hazard/emergency pay
Holiday pay, Overtime pay, night shift differential and
hazard/emergency pay are generally taxable.
However, Holiday pay, Overtime pay, night shift
differential and hazard/emergency pay earned by a
minimum wage earner paid on statutory minimum
wage shall be exempt from income tax.
7. Separation Pay
Separation pay may be taxable or not taxable. It is
taxable if the separation is voluntary on the part of the
employee.
Separation pay is not taxable on account of:
a. Sickness of the employee
b. Disability of the employee
c. Death of the employee
d. Reorganization of the company
e. Bankruptcy of the company
8. Retirement Pay
General rule: Retirement pay is taxable
The exceptions are the following:
a. Retirement pay from SSS or GSIS
b. Retirement pay from employer provided the
following requirements are met:
1. The retirement plan of the company has been
approved by the BIR Commissioner;
2. The retiree should have been connected with
the company for at least 10 years;
3. The retiree should be at least 50 years old;
4. The retiree availed of the company’s retirement
plan for the first time; and
5. The retirement plan is fair and equitable to all
employees regardless of position.
9. Sick leave pay and vacation leave pay
The salary of an employee on vacation or sick leave,
which is paid to him notwithstanding his absence from
work, constitutes taxable compensation income.
However, the cash value of unused vacation leave
credits of 10 days or less, which was paid to the
employee during the year, is not subject to tax.
10. Fringe benefits
Fringe benefits means any goods, services or other
benefit granted in cash or in kind by an employer to
an employee in addition to basic salary, such as but
not limited to the following: [HEV-HIM-HEEL]
1. Housing; 2. Expense account; 3. Vehicle of any
kind; 4. Household personnel such as maid, driver and
others; 5. Interest on loans at less than market rate
to the extent of the difference between the market
rate and the actual rate granted; 6. Membership fees,
dues and other expenses athletic clubs or other similar
organizations; 7. Expenses for foreign travel; and 8.
Holiday and vacation expenses.
Fringe benefits may be classified as compensation
income (part of gross income) or a passive income
subject to fringe benefit tax.
II. Gross income derived from the conduct of
trade or business or the exercise of a profession
1. Professional income
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.
For purposes of taxation, there is no deduction allowed
against compensation income, whereas allowable
deductions may be made from professional income.
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NOTE: Professional income shall be subject to
creditable withholding tax rates prescribed (R.R. No.
2-98).
2. Income from business
Business income refers to income derived from
merchandising, mining, manufacturing, and farming
operations.
NOTE: Business is any activity that entails time and
effort of an individual or group of individuals for
purposes of livelihood or profit.
Gross income derived from business
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]).
Cost of goods sold
It includes all business expenses directly incurred to
produce the merchandise, to bring them to their
present location and use such as invoice cost of the
goods sold, for a trading concern, or cost of production
for a manufacturing concern.
Cost of services All direct costs and expenses
necessarily incurred to provide the service required by
the customers and clients including: 1. Salaries and
employee benefits of personnel, consultants, and
specialists directly rendering the service; and 2. Cost
of facilities directly utilized in providing the service
(NIRC, Sec. 27 E [4]).
III. Gains derived from dealings in property
Types of properties from which income may be derived
1. Ordinary assets – refer to properties held by the
taxpayer used in connection with his trade or business
which includes the following: [SOUR]
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.
2. Capital assets – include property held by the
taxpayer (whether or not connected with his trade or
business) other than SOUR above.
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
IV. Interest income
Interest income is the amount of compensation paid
for the use of money or forbearance from such use.
The interest that are included in the gross income are
those from other debt instruments not within the
coverage of deposit substitutes or other than those
interest incomes which are subject to final tax or
exempt tax.
V. Rental income
Rental income is a fixed sum, either in cash or in
property equivalent, to be paid at a definite period for
the use or enjoyment of a thing or right. All rentals
derived from lease of real estate or personal property,
of copyrights, trademarks, patents and natural
resources under lease.
Prepaid rent Prepaid or advance rental is taxable
income to the lessor in the year received, if received
under a claim of right and without restriction as to its
use, regardless of method of accounting employed.
NOTE: Security deposit applied to the rental of
terminal month or period of contract must be
recognized as income at the time it is applied. The
purpose of security deposit is to ensure contract
compliance. It is not income to the lessor until the
lessee violates any provision of the contract.
VI. Royalty Income
Royalty income is compensation for the use of
property, usually copyrighted material or natural
resources, expressed as a percentage receipt from
using the property or as account per unit produced. It
is also a payment for the use or supply of scientific,
technical, industrial, commercial knowledge or
information. Royalties may be classified as business
income (part of gross income) or a passive income.
VII. Dividend Income
Dividend is any distribution made by a corporation to
its shareholders out of its earnings or profits and
payable to its shareholders, whether in money or in
other property.
Kinds of dividends
1. Cash dividend – paid in given sum of money
2. Property dividend – one paid in corporate
property such as bonds, securities or stock
investments held by the corporation, not its own stock.
They are taxable to the extent of the fair market value
of the property received at the time of distribution.
3. Stock dividend – one paid by a coporation with its
own stock. Stock dividends, strictly speaking,
represent capital and do not constitute income to its
recipient. So that the mere issuance thereof is not
subject to income tax as they are nothing but
enrichment through increase in value of capital
investment.
In a loose sense, stock dividends issued by the
corporation, are considered unrealized gain, and
cannot be subjected to income tax until that gain has
been realized. Before the realization, stock dividends
are nothing but a representation of an interest in the
corporate properties (Commissioner v. ANSCOR, G.R.
No. 108576, January 20, 1999). XPNs: a. Change in
the stockholder’s equity, right/interest in the net
assets of the corporation; b. Recipient is other than
the shareholder; c. Cancellation or redemption of
shares of stock; d. Distribution treasury shares; e.
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Dividends declared in the guise of treasury stock
dividend to avoid the effects of income taxation; and
f. Different classes of stock were issued.
NOTE: A stock dividend does not constitute taxable
income if the new shares did not confer new rights nor
interests than those previously existing, and that the
recipient owns the same proportionate interest in the
net assets of the corporation (RR No. 2, Sec. 252).
4. Scrip dividend – one that is paid in the form or
promissory notes
5. Indirect dividend – one made through the
exercise of right or other means of payment, e.g.
Cancellation or condonation of indebtedness
6. Liquidating dividend – one resulting from the
distribution by a corporation of all its property or
assets in compete liquidation or dissolution. It is
generally a return of capital, and hence, it is not
income. However, it is taxable income with respect to
the excess of amount received over cost of the shares
surrendered (Dimaampao, 2015).
VIII. Annuities
It refers to the periodic installment payments of
income or pension by insurance companies during the
life of a person or for a guaranteed fixed period of
time, whichever is longer, in consideration of capital
paid by him.
The portion representing return of premium is not
taxable while that portion that represents interest is
taxable.
IX. Prizes and winnings
Prizes are results of efforts while winnings are product
of chances and luck. A game of chance is that which
defends more on chance or hazard than on skill or
ability. In case of doubt a game is deemed to be one
of chance.
X. Pensions
Pension is a retirement benefit paid regularly
(normally, monthly), with the amount of such based
generally on length of employment and amount of
wages or salary of pensioner. It is regarded as a
deferred compensation for services rendered.
XI. Partner’s distributive share from the net
income of the general professional partnership
Partnership are, under the NIRC, either “taxable
partnerships” or “exempt partnerships”.
Ordinarily, partnerships, no matter how created or
organized, are subject to income tax which are by law
assimilated to be within the context of, and so legally
contemplated as, corporations.
Exempt partnership, on the other hand, are not
similarly identified as corporations nor even
considered as independent taxable entities for income
tax purposes. A general professional partnership is
such an example. Here, the partners themselves, not
the partnership are liable for the payment of income
tax in their individual capacity computed on their
respective and distributive share of profits. In fine,
under the NIRC, the general professional partnership
is deemed to be no more than a mere mechanism or
a flow-through entity in the generation of income by,
and the ultimate distribution of such income to,
respectively, each of the individual partners.
XII. Income from Other Sources
All income not expressly exempted from the class of
taxable income under our laws form part of the taxable
income, irrespective of the voluntary or involuntary
action of the taxpayer in producing the income. The
source of the income may be legal or illegal.
Examples of “income from other sources derived”
which form part of the taxable income of the taxpayer:
1.Gains arising from expropriation of property which
would be considered as income from dealings in
property;
2.Gains from gambling;
3.Gains from embezzlement or stealing money;
4.Gains, money or otherwise derived from extortion,
illegal gambling, bribery, graft and corruption,
kidnapping, racketeering, etc
Rationale: These are taxable because title is merely
voidable.
5.In stock options, the difference between the fair
market value of the shares at the time the option is
exercised and the option price constitutes additional
compensation income to the employee
(Commissioner v. Smith, 324 U.S. 177)
6.Money received under solutio indebiti
Rationale:Under the claim of right doctrine, the
recipient, even if he has the obligation to return the
same, has a voidable title to the money received
through mistake
7.Condonation of indebtedness for a consideration.
Rationale: This is because when a creditor cancels a
debt as part of a business transaction, the debtor
is enriched or receives financial advantages
thereby increasing his net assets, and thus
realizes taxable income.
8.Condonation of indebtedness
Tax treatment for condonation of indebtedness
1. When cancellation of debt is income. If an
individual performs services for a creditor, who in
consideration thereof, cancels the debt, it is
income to the extent of the amount realized by the
debtor as compensation for his services.
2. When cancellation of debt is a gift. If a creditor
merely desires to benefit a debtor and without any
consideration therefore cancels the amount of the
debt, it is a gift from the creditor to the debtor and
need not be included in the latter’s income. The
creditor is subject to donor’s tax.
3. When cancellation of debt is a capital transaction.
If a corporation to which a stockholder is indebted
forgives the debt, the transaction has the effect of
payment of a dividend (R.R. No. 2, Sec. 50).
4. An insolvent debtor does not realize taxable
income from the cancellation or forgiveness (CIR
v. Gin Co. 43 F.2d 327).
5. The insolvent debtor realizes income resulting
from the cancellation or forgiveness of
indebtedness when he becomes solvent (Lakeland
Grocery Co. v. CIR, 36 BTA 289).
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“The expenses of government, having for their object the
interest of all, should be borne by everyone, and the more
man enjoys the advantages of society, the more he ought to
hold himself honored in contributing to those expenses. -
Anne Robert Jacques Turgot (1727-1781)”
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Practical Exercises
“Write TRUE if the statement is correct. If you
believe otherwise, write FALSE”
1. Income represents inflow of money from whatever
sources other than those representing return on
capital.
Answer _____________
2. Professional income is an earning from services
rendered by an employee under an employer-employee
relationship.
Answer _____________
3. Fixed and variable allowances received by a
government officials and employees are not taxable.
Answer _____________
4. Hazard pays provided to Minimum Wager Earners
employees, either in private sector or government
agencies, who are regularly exposed to dangerous or
hazardous chemicals, are not taxable.
Answer _____________
5. Retirement pay from SSS or GSIS are taxable.
Answer _____________
6. Fringe benefits received by an employee whether
rank and file and holder of supervisory/managerial
position are subject to fringe benefits tax.
Answer _____________
7. Passive income refers to income earned without
effort or labor exerted.
Answer _____________
8. An income that has been subjected to final tax is still
included in the computation of gross taxable income
subject to the basic tax.
Answer _____________
9. Income derived from Gift, bequests, and devices are
subject to final tax
Answer _____________
10. The 13th month pay and other benefits of private
employees is taxable in excess of 82,000 threshold
Answer _____________
11. Compensation income includes salary, honoraria,
allowance, separation pay and retirement pay.
Answer _____________
12. As a general rule, proceeds of life insurance policy
received by heirs or beneficiary is not taxable.
Answer _____________
13. Taxable income refers to the earnings of a taxpayer
subject to tax
Answer _____________
14. Fringe benefits received by an employee may either
be subject to final tax or basic tax.
Answer _____________
15. Minimum wage earners who received additional
compensation, such as commissions and honoraria,
shall be subject to tax on their entire income
Answer _____________
16. Stock dividend is not taxable, because the company
simply capitalized part of its retained earnings.
Answer _____________
17. As a general rule, premium returned on life
insurance policy is not taxable
Answer _____________
18. Separation pay may be taxable or tax-exempt
income.
Answer _____________
19. Cancelation of debt in consideration of services is
tantamount to realization of income.
Answer _____________
20. Interest earned from the proceeds of life insurance
being withheld by the insurer is subject to final tax.
Answer _____________
Multiple Choices: Select the correct answer for
each of the following questions.
1. Which of the following is not a requisite for earnings
to be taxable?
a. There must be gain or profit
b. The gain or profit must be realized or recognized
c. The gain or profit must excluded by law from
income taxation
d. None of the above
6. The following items are considered taxable
compensation income, except:
a. Honoraria
b. Allowances
c. Royalties
d. Fringe benefits to rank and file employees
7. The following are exclusions from gross income
except:
a. proceeds of life insurance policies
b. retirement benefits plan duly approve by BIR
c. gifts, bequests and devises
d. prizes and winnings
8. The law excludes some items of income from
taxation because
a. the transformation of these incomes into economic
gain are not essentially the result of labor or efforts of
taxpayer
b. the law or treaty provides that they are not taxable
c. some of these items are just return of capital
d. all of the above
9. Which of the following income earned/received in the
Philippines by a citizen is subject to income tax?
a. Winnings in Philippines Charity Sweepstake lottery
b. SSS or GSIS benefits
c. Gains from sale of 3 year bond
d. Value of property received as gift
10. Which of the following nay be excluded from the
gross income of a taxpayer?
a. Income derived from bequests and devices
b. Income from illegal gambling
c. Laundry service income of a minimum wage earner
d. Hazard pay of MWE senior citizen

2. Separation pay brought about by the following

circumstances is non taxable, except:
a. Sickness
b. Reorganization of the company due to
consolidation
c. Bankruptcy of the company
d. None of the above

3. Which of the following is not a compensation income?

a. Separation pay
b. Passive income
c. Commission
d. Salary

4. Which of the following is not taxable

a. 2,500 pesos for 10 days sick leaves actually taken
b. P 1,250 for 10 days unused vacation leave
converted into cash
c. P 1,000 for unused vacation leave received as part
of separation pay due to voluntary resignation
d. P 500 availed vacation leave

5. The following are the requirements so that the

retirement pay received by an employee from his/her
employer is non-taxable, exempt.
a. The retiree should be at least 40 years old
b. The retiree should have been connected with the
company for at least 5 years
c. The retirement plan of the company has been duly
approved by the DFA Commissioner
d. All of the above