Course Code and Title : BACR 5 - Income Taxation

Lesson Number : 1
Topic : Fundamental Principles of Taxation
Instructor : Prof. Rosario A. Calamba, CPA, MBM, PhD
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LEARNING OBJECTIVES

At the end of this lesson, the student should be able to:

1. Identify and differentiate the three inherent powers of the state;

2. Explain the definition of taxation and its necessity for every government;

3. Discuss the different fundamental theories and doctrines in taxation;

4. Define the scope of taxation and classify the sources of its limitations;

5. Explain the stages on the exercise of the power of taxation;

6. Identify the situs of taxable events;

7. Explain the characteristics of double taxation;

8. Identify the different methods of escaping from taxation and explain the effects

on government revenue collections; and

9. Differentiate tax amnesty from tax condonation.

 PRE-ASSESSMENT
Identify the words which are described by the following statements by filling out the boxes on the left.
1. This is the power of the State enforce proportional contribution from
its subjects to sustain itself.
2. Taxes are the main form of government .
3. This is the place of taxation.
4. This is the process of transferring the tax burden to other taxpayers.

LESSON PRESENTATION

INHERENT POWERS OF THE STATE

A government has its basic needs and rights which co-exist with its creation. It has rights
to sustenance, protection and properties. The government sustains itself by the power
of taxation, secures itself and the well-being of its people by police power and secures
its own properties to carry out its public services by the power of eminent domain.

These rights dubbed as “powers” are natural, inseparable and inherent to every
government. No government can sustain or effectively operate without these
powers. Therefore, the exercise of these powers by the government is presumed
understood and acknowledged by the people from the very moment they establish
their government.

Taxation
This is the power of the State to enforce proportional contribution from its subjects
to sustain itself.

Police Power
This is the inherent power of a sovereign state to legislate for the protection of the
health, general welfare, safety and morals of the public. It involves the power to
regulate both liberty and property for the promotion of the public good.

The police power of the State may be exercised through taxation because taxes may
be levied for the promotion of the welfare of the public.
Eminent Domain
This is the power of the State to take private property for public use after paying
just compensation. This is synonymous to expropriation.

S imilarities of the Inherent Powers

The three inherent powers of the State are similar in the following senses.

1. They are all necessary attributes of the sovereignty.

2. They are all inherent to the State.
3. They all presuppose an equivalent form of compensation received by
the persons affected by the exercise of the power.

C omparison of the Inherent Powers

Point of
Taxation Police Power Eminent Domain
Difference
Exercising Government and
Government Government
Authority private utilities
For the support of the To protect the general
Purpose For public use
government welfare of the people
Persons Community or class of Community or class of
Owner of the property
Affected individuals individuals
Amount of Limited to cover cost of
Unlimited No amount imposed
Imposition regulation
Importance Most Important Most Superior Important
All persons, property,
All persons, property, Only upon specific
Scope rights, privileges and
rights and privileges property
liberties
No transfer, but only
Transfer of
Taxes collected become restraint on the Transfer is effected in
Property
part of public funds exercise of property favor of the State
Rights
rights
No special or direct A direct benefit results
No direct benefit but a
Benefits benefit but the general in the form of just
healthy economic
Received benefit of general compensation to the
standard of society
welfare property owner
TAXATION DEFINED:
Taxation is the i nherent power of the state1, e xercised through the legislature2,
to i mpose b urdens3 upon s ubjects and objects4 within its jurisdiction5 for the
purpose of raising revenues6 to c arry out the functions7 of government.

NATURE / CHARACTERISTICS OF TAXATION:

1. Inherent Power of the State
Taxation is one of the three inherent powers of the state, with police power
and eminent domain. Inherence means that even with the absence of an
express grant of the Constitution, the State can still exercise the power to levy
and collect taxes.

2. Exercised through the Legislature

Only the legislative branch of the government can levy taxes, meaning, tax
laws can only originate, specifically, from the House of Representatives. The
Senate, however, may propose tax laws to the House of Representatives.
The executive branch is tasked in the enforcement of said tax laws through the
assessment and collection of taxes, whilst, the judiciary branch is concerned
with any tax-related cases that may emanate from the administration of taxes.

3. Impose Burdens
The imposition of taxes to individuals, objects or privileges normally
would cause a financial burden to the taxpayer.

4. Subjects and Objects

Different subjects may be considered in the levying of taxes. Common are
those taxes on individuals, properties and privileges. Taxation serves as a
mode by which the state allocate its costs to its subjects who are benefited by
its spending.

5. Within its Jurisdiction

The state can only tax a subject that is within its territoriality. This is true since
it is one of the inherent limitations of taxation. Taxing outside its jurisdiction
would constitute impossibility of collection and immorality of taxing subjects
which do not receive benefit from the government’s services.

6. Purpose of Raising Revenues

Taxes are the main source of funds which the state needs to conduct its
public services. Though the government also receives inflows from other
sources, taxes generate the most to fund said services.
 7. Carry Out the Functions
The government is the one responsible for the various public services like
education and health. In the conduct of said services, the government needs
taxation to defray the costs associated to said services.

Purposes of Taxation
The exercise of the power of taxation may be classified as to its purpose.
R evenue or Fiscal
The primary purpose of taxation on the part of the government is to provide funds or
property with which to promote the general welfare and the protection of its citizens
and to enable it to finance its multifarious activities.

N on-Revenue or Regulatory
Taxation may also be employed for purposes of regulation or control, e.g., imposition
of tariffs on imported goods to protect local industries, the adoption of progressively
higher tax rates to reduce inequalities in wealth and income and the increase or
decrease of taxes to prevent inflation or ward off depression.

FUNDAMENTAL THEORIES AND DOCTRINES

Theory of Taxation
A system of government is indispensable to every society. Without it, the people will not relish
the benefits of a civilized and orderly society. The power of taxation proceeds upon the theory
that the government has the necessity for funding; that it cannot continue without means to pay
its expenses; and that for these means, it has a right to compel all its citizens and properties
within its limits to contribute.

Basis of Taxation
The basis of taxation is found in the reciprocal duties of protection and support between the
State and its inhabitants. In return for his contribution, the taxpayer receives benefits and
protection from the government. In short, both the government and the people receive
mutuality of benefits.
 Benefit Received Theory
This theory bases the power of the State to demand and receive taxes on the reciprocal
duties of support and protection. The citizen supports the State by paying the portion
from his property that is demanded in order that he may, by means thereof, be secured
in the enjoyment of the benefits of an organized society. Thus, the taxpayer cannot
question the validity of the tax law on the ground that payment of such tax will render
him impoverished, or lessen his financial or social standing, because the obligation to
pay taxes is involuntary and compulsory, in exchange for the protection and benefits
one receives from the government.

In return for his contribution, the taxpayer receives the general advantages and
protection which the government affords the taxpayer and his property. One is
compensation or consideration for the other; protection for support and support for
protection.

However, it does not mean that only those who are able to and do pay taxes can enjoy
the privileges and protection given to a citizen by the government.

In fact, from the contribution received, the government renders no special or

commensurate benefit to any particular property or person. The only benefit to which
the taxpayer is entitled is that derived from the enjoyment of the privilege of living in
an organized society established and safeguarded by the devotion of taxes to public
purpose. The government promises nothing to the person taxed beyond what may be
anticipated from an administration of the laws for the general good.

R eceipt of benefits conclusively presumed

Every citizen and resident of the state directly or indirectly benefits from the public services
rendered by the government. These benefits can be in form of daily free usage of public
infrastructures, access to public health or educational services, the protection and security of
person and property, or simply the comfort of living in a civilized and peaceful society which
is maintained by the government.
While most public services are received indirectly, their realization by every citizen and
resident is undeniable. In taxation, the receipt of these benefits by the people is conclusively
presumed, thus, taxpayers cannot avoid payment of taxes under the defense of absence of
benefit received. The direct receipt or actual availment of government services is not a
precondition to taxation.
Ability to Pay Theory:
The ability to pay theory presupposes that taxation should also consider the taxpayer’s
ability to pay. Taxpayers should be required to contribute based on their relative capacity
to sacrifice for the support of the government. In short, those who have more should be
taxed more even if they benefit less from the government. Those who have less shall
contribute less even if they received more of the benefits from the government.

Lifeblood Doctrine:
Taxes are the lifeblood of the government and should be collected without necessary
hindrance. They are what we pay for a civilized society. Without taxes, the government
would be paralyzed for lack of motive power to activate and operate it. The
government, for its part, is expected to respond in the form of tangible and intangible
benefits intended to improve the lives of the people and enhance their moral and
material values. Taxes are the lifeblood of the government and their prompt and certain
availability is an imperious need. Put simply, taxes are needed by the government to
carry out its functions.

Other Fundamental Doctrines

M arshall Doctrine
“The power to tax is the power to destroy.” Taxation power can be used as an
instrument of police power. It can be used to discourage or prohibit undesirable
activities or occupation.

H olme’s Doctrine
“Taxation power is not the power to destroy while the court sits.” Taxation power may
be used to build or encourage beneficial activities or industries by the grant of tax
incentives.

P rospectivity of Tax Laws

Tax laws are generally prospective in operation. However, tax laws may operate
retrospectively if so intended by Congress under certain justifiable conditions.

N on-Compensation or Set-Off
Taxes are not subject to automatic set-off or compensation. The taxpayer cannot delay payment
of tax to wait for the resolution of a lawsuit involving the pending claim against the
government. Tax is not a debt; hence, it is not subject to set-off.
 Exceptions:
a. Where the taxpayer’s claim has already become due and demandable such
as when the government already recognized the same and an appropriation
for refund was made
b. Cases of obvious overpayment of taxes
c. Local taxes

N on-Assignment of Taxes
Tax obligations cannot be transferred to another entity by contract. Contracts executed by
the taxpayer to such effect shall not hinder the government to collect taxes.
I mprescriptibility in Taxation
The government’s right to collect taxes does not prescribe unless the law itself provides.

In the Philippines, tax prescribes if not collected within 5 years from the date of its
a ssessment. In the absence of an assessment, tax prescribes if not collected within 3
years from the date the return is required to be filed. However, taxes due from
taxpayers who did not file a return or those who filed a fraudulent returns do not
prescribe.

D octrine of Estoppel
The error of any government employee does not bind the government. It is held that the
neglect or omission of government officials entrusted with the collection of taxes should
not be allowed to bring harm or detriment to the interest of the people.

J udicial Non-Interference
Generally, courts are not allowed to issue injunction against the government’s pursuit
to collect tax as this would unnecessarily defer tax collection.

SCOPE OF TAXATION
The power of taxation is the most absolute of all powers of the government. It has
the broadest scope of all the powers of government because in the absence of limitations,
it is considered as comprehensive, unlimited, plenary and supreme.

However, the power of taxation should be exercised with caution to minimize injury to
the proprietary rights of the taxpayer. It must be exercised fairly, equally, and
uniformly, lest the tax collector kill “the hen that lays the golden egg”.
LIMITATIONS OF TAXATION
Despite the un-seemingly unlimited nature of taxation, it is not absolutely unlimited. Taxation
has its own inherent limitations and limitations imposed by the Constitution.

Inherent Limitations
T erritoriality
Public services are normally provided within the boundaries of the State, thus, tax can
be imposed only within its territories. It cannot tax outside because foreigners do not
derive benefits from our government. The Philippines would not tax objects from
foreign States as this would amount to encroachment of foreign sovereignty.
I nternational Comity
This pertains to mutual courtesy or reciprocity between states. When a state enters into
treaties with other states, it is bound to honor the agreements as a matter of mutual
courtesy and in case such treaties are in conflict with local laws, the treaties are given
primacy.

P ublic Purpose
Proceeds from the collection of tax is intended for the common good, thus, tax must be
exercised absolutely for public purpose and cannot be exercised to further any private
interest.

E xemption of the Government

Taxation, being broad, the government can exercise the power to tax including upon
itself. However, taxing itself would not raise additional funds rather will only
impute additional costs.

N on-Delegation of the Taxing Power

The legislative taxing power is vested exclusively in Congress and is non-delegable
pursuant to the doctrine of separation of the branches of the government.

Constitutional Limitations
As the power of taxation is inherent to every state, there is no need for an express stipulation of
law for the State to exercise it. In fact, the Constitution only tackles the power of taxation by
imposing limitations on its exercise.

D ue Process of Law
No one should be deprived of his life, liberty or property without due process of law. Tax
laws should neither be harsh nor oppressive.
 Aspects of Due Process:
Substantive Due Process – Tax must be imposed only for public purpose, collected only
under authority of v alid law and only by the taxing power having jurisdiction. An
assessment without legal basis violates the requirement of due process.
Procedural Due Process – There should be n o arbitrariness in assessment and collection
of taxes and the government shall observe the taxpayer’s right to notice and hearing.

E qual Protection of the Law

No person shall be denied the equal protection of the law. Taxpayers should be treated
equally both in terms of rights conferred and obligations imposed. This rule applies
where taxpayers are under the same circumstances and conditions.

A common example of this would be the Congress cannot exempt sellers of “balot”
while subjecting sellers of “penoy” to tax since they are essentially the same goods.

Uniformity Rule
Taxpayers under dissimilar circumstances should not be taxed the same. Taxpayers
should be classified according to commonality in attributes. Each class is taxed
differently but taxpayers falling under the same class are taxed the same.

P rogressive System
In a progressive system, tax rates increase as the tax base increases. This is consistent
with the ability to pay theory. Moreover, the progressive system aids in an equitable
distribution of wealth to society by taxing the rich more than the poor.

N on-Imprisonment for Non-Payment of Debt or Poll Tax

As a policy, no one shall be imprisoned because of his poverty and no one shall be
imprisoned for mere inability to pay debt. It should be noted, however, that only the
non-payment of Basic
Poll Tax (cedula) is within the scope of this limitation. Non-payment of other taxes may
result to imprisonment.

N on-Impairment of Obligation and Contract

The state should not set aside its obligations from contracts by the exercise of its taxation
power. Tax exemptions granted under contract should be honored and should not be
cancelled.
F ree Worship Rule
The Philippine government adopts free exercise of religion and does not subject its
exercise of taxation. The properties and revenues (not commercial in nature) of
religious institutions are not subject to tax.

E xemption of religious, charitable or educational entities, nonprofit cemeteries, churches

and m osques, lands, building, and improvements from property taxes
The constitutional exemption from property tax applies for properties actually,
directly and e xclusively used for charitable, religious and educational purposes.

N on-appropriation of public funds or property for the benefit of any church, sect, or
system o f religion
This constitutional limitation is intended to highlight the separation of the church and
the state. To support freedom of religion, the government should not favor any
particular system of religion by appropriating public funds or property in support
thereof.

E xemption from taxes of the revenues and assets of non-profit, non-stock,

educational i nstitutions
The Constitution recognizes the necessity of education in state building by granting
tax exemption on revenues and assets of non-profit educational institutions. This
exemption, however, applies only on assets and revenues actually, directly and
exclusively devoted for educational purposes.
C oncurrence of a majority of all members of Congress for the passage of a law granting
tax e xemption
The Constitution requires the vote of majority of all members of Congress in the grant
of tax exemptions. A q uorum majority, however, is only required for the withdrawal of
tax exemption.

N on-diversification of tax collections

Tax collections should be used only for public purposes. It should never be diversified
or used in private purpose.

N on-delegation of Taxing Power

The impact of taxation cannot be delegated. The incidence, however, may be delegated
on matters involving expedient and effective administration.

N on-impairment of the jurisdiction of the Supreme Court to review tax cases

All cases involving taxes can be raised to and be finally decided by the Supreme Court of
the Philippines.
Appropriations, revenue and tariff bills shall originate exclusively from the
House of Representatives
Tax Laws should emanate from the House of Representatives, however, the
Senate may propose tax laws and may concur amendment.

E ach LGU shall exercise the power to create its own sources of revenue and shall
have a just s hare in the national taxes
This is a constitutional recognition of the local autonomy of LGUs and an express
delegation of taxing power.

STAGES OF EXERCISE OF TAXATION POWER

Levy or Imposition
This process involves the enactment of a tax law by Congress. It is also referred
to as the legislative act in taxation.

Assessment and Collection

The tax law is implemented by the administrative branch of the government.
Implementation includes the assessment or determination of the tax liabilities of taxpayers
and subsequent collection. This stage is referred to as the administrative act of taxation.

SITUS OF TAXATION
Situs is the place of taxation. It is the tax jurisdiction that has the power to levy taxes
upon the tax object. Situs rules serves as frames of reference in gauging whether the tax
object is within or outside the tax jurisdiction of the taxing authority.

Tax Imposed Situs Rule

Business Tax
Income Tax on Services
Income Tax on Sale of Goods
Property Tax
Personal Tax
Income Tax on Interests
It is subject to tax in the place where the business is conducted
Service fees are subject to tax where they are rendered
The gain on sale is subject to tax on the place of sale
Properties are taxable in their location
Persons are taxable in their place of residence
It is subject to tax on the debtor’s place of residence.

Other situs rules may be followed depending on the kind of tax being imposed.
 Nash E. Mulan, a Chinese national, resides in Sampaloc, Manila. He has the following
endeavors:
• He has a car dealership business in Macau and a restaurant operation in Quezon City.
• He renders consultancy services in the main office of a domestic company.
• He casually sells jewelry stored in Pasay City. During his trip to Palawan, he agreed to
Kim Bong-Un to sell a piece of necklace. They stipulated that it will be delivered in
Pyongyang a week later.
• Mr. Mulan owns a hectare parcel of land in Chonburi, Thailand.

The Philippine government can only impose business taxes upon Mr. Mulan relating to his restaurant
operation since it is within the territory of the country. Income tax on his consultancy services may
also be collected since it is rendered within the Philippines considering it is a domestic company.
Regarding the sale of necklace to Kim Bong-Un, the Philippine government can tax the gain from said
sale since the sale was perfected in Palawan. The stipulation of delivery in North Korea is not
considered in this case. No local government unit in the Philippines can impose a real property tax on
the parcel of land owned by Nash since it is found in Thailand. Mr. Mulan, being a resident of the
country, shall be subject to personal tax, notwithstanding his Chinese nationality.

DOUBLE TAXATION
Double Taxation can be either direct or indirect. For a double taxation to be considered direct,
all of the following characteristics should concur:

a. Taxing the same object twice;

b. By the same taxing authority;
c. Within the same jurisdiction;
d. For the same purpose;
e. In the same period.

An example of a direct double taxation is as follows:

The state taxes the income of self-employed individuals at 10% of its monthly gross receipts. In
addition, it also imposes a 2% annual income tax on the annual gross receipts.

In this case, self-employed individuals are burdened by paying the monthly and annual
income tax based on their gross receipts (the annual totaling all monthly gross receipts). It
was imposed by the same taxing authority within the same jurisdiction, with the same
purpose of taxing the income for the same period.

The absence of one or more of the given circumstances does not constitute direct
double taxation, thus, classifying it as an indirect double taxation.
 Constitutionality of Double Taxation:

The Philippine Constitution does not prohibit double taxation. However, while it is
not forbidden, it is something not favored. Such taxation should, whenever possible,
be avoided and prevented. In addition , where there is direct double taxation, there
may be a violation of the constitutional precepts of equal protection and uniformity in
taxation.

ESCAPES FROM TAXATION

Escapes from taxation are the means available to the taxpayer to limit or completely avoid
the impact of taxation.

With Loss of Government Revenue

The following are the escapes from taxation that would result to loss of government
revenue.
T ax Evasion
Also known as tax dodging, it refers to any act or trick that tends to illegally reduce or avoid
the payment of tax.

Tax Avoidance
Also known as tax minimization, refers to any act or trick that reduces or totally escapes
taxes by any l egally permissible means.

To further illustrate the difference between tax evasion and tax avoidance, refer to the
table below.

BASIS TAX AVOIDANCE TAX EVASION

What is it? Hedging of tax Concealment of tax

Immoral in nature, which Illegal and objectionable, both in

Attributes involves bending the law script and moral.
without breaking it.

Taking unfair advantage of the Deliberate manipulations in

Concept
shortcomings in the tax laws. accounts resulting in fraud.

Use of Justified means Use of such means that are

Legal implication
forbidden by law

Before the occurrence of tax After tax liability arises.

Happened when
liability.
 Type of act Legal Criminal

Consequences Deferment of tax liability Penalty or imprisonment

To reduce tax liability by To reduce tax liability by

Objective
applying the script of law. exercising unfair means.

T ax Exemption
Also known as tax holiday, refers to immunity, privilege or freedom from being subject to a
tax which, others are subject to.

Without Loss of Government Revenue

Escaping from taxation, however, may not result into loss of government revenue.
Common examples of which are as follows.

S hifting
This is the process of transferring the tax burden to other taxpayers.

C apitalization
This pertains to the adjustment of the value of an asset caused by changes in tax rates.

T ransformation
This pertains to the elimination of wastes and losses by the taxpayer to form savings to
compensate for the tax imposition or increase in taxes.

Tax Amnesty vs. Tax Condonation

Tax amnesty is a general pardon given by the government to erring taxpayers. It
generally operates retrospectively by forgiving past violations. It is conditional upon
the taxpayer paying a portion of the tax. On the other hand, tax condonation or tax
remission prospectively applies to forgiving any unpaid balance of tax. The portion
already paid is not refunded and no further payment is necessary.

GENERALIZATION:
This module discusses the general principles in Taxation that comprises its
definition, the inherent power of the State, the purposes of taxation, its theory and
basis. It includes essential elements of tax, the different theory of taxation, situs of
taxation, its nature and characteristics as well as its limitations.
APPLICATION:

1. Illustrate the three (3) inherent powers of the State by way of an

example.
a. Taxation power
b. Police power
c. Power of Eminent Domain

2. Situational:
The Congress, after much public hearing and consultations with
various sectors of society, came to the conclusion that it will be good for
the country to have only one system of taxation by centralizing the
imposition and collection of all taxes in the national government.
Accordingly, it is thinking of passing a law that would abolish the taxing
power of all local government units. Would such law be valid under the
present Constitution?

3. Explain the difference between Tax Avoidance and Tax Evasion by

citing an illustration.

4. What is Double Taxation?

- Does it exist in the Philippine Tax System?
- In your answer provide a proof of its existence.
ACTIVITY/EVALUATION

TRUE OR FALSE
Determine whether the following statements are true or false. Write your answers on the
space provided for.
1. Though the Senate is part of the Philippine Congress, tax bills
cannot originate from it.
2. The primary purpose of taxation is to raise revenues of the
government in order to defray its expenses on its performance of
public goods.
3. The basis of taxation is the government’s necessity for funding.
4. Tax laws are generally retrospective in application, meaning,
application of which starts when the statute is enacted.
5. The Marshall Doctrine states that the power to tax is not the power to
destroy while the court sits.
6. The administrative act of taxation is primarily the duty of the
Bureau of Internal Revenue.
7. The police power of the State may be exercised through taxation
because taxes may be levied for the promotion of the welfare of the
public
8. A person cannot be imprisoned for non-payment of tax.

IDENTIFICATION
Identify the terminologies best described by the following statements.
1. The enforced proportional contributions from persons and property
levied by the lawmaking body of the State
2. The power of the State to take private property for public use after
paying just compensation
3. This refers to any act or trick that tends to illegally reduce or
avoid the payment of tax
4. This pertains to the elimination of wastes and losses by the taxpayer to
Form savings to compensate for the tax imposition or increase in taxes
MULTIPLE CHOICE
Choose the best answer from the choices provided.
1. A tax must be imposed for public purposes. Which of the following is not
a public purpose?
a. Procurement of army weapons
b. Construction of rehabilitation centers for drug addicts
c. Construction of a satellite for a telco company
d. Expenses on the President’s state visits to other countries

2. Persons or things belonging to the same class shall be taxed at the same rate
a. Simplicity in taxation
b. Equality in taxation
c. Reciprocity in taxation
d. Uniformity in taxation

3. For double taxation to be considered direct, it should meet the following

criteria, except
a. Taxing the same object twice
b. Same period
c. Same amount of tax
d. Same jurisdiction

4. This is an inherent limitation on the power of taxation

a. Rule on uniformity and equity in taxation
b. Due process of law and equal protection of tine laws
c. Non-impairment of the jurisdiction of the Supreme Court in tax cases
d. Exemption of the government

5. Taxation as distinguished from police power and power of eminent domain

a. Property is taken to promote the general welfare
b. May be exercised only by the government
c. Operates upon the whole citizenry
d. There is generally no limit as to the amount that may be imposed
REINFORCEMENT:

Case Study THE SWEET TAX

1.1
To provide means for the rehabilitation and stabilization of the sugar industry so as
to prepare it for the eventuality of the loss of the quota allocated to the Philippines
resulting from the lifting of U.S. sanctions against African countries, Congress
passes a law increasing the existing tax on the manufacture of sugar on a graduated
basis. All collections made under the law are to accrue to a special fund to be spent
only for the purposes enumerated herein, among which are to place the sugar
industry a living wage and to improve their working conditions.

Sweet, a sugar planter, files a suit questioning the constitutionality of the law
alleging that the tax is not for a public purpose as the same is being levied
exclusively for the aid and support of the sugar industry.

Is the contention of Sweet tenable?

Case Study WHO IS TO BLAME?

1.2
Many consider that it was untimely that the internal revenue office of Wakanda
issued a memorandum circular during the pandemic reminding guidelines on the
registration of online businesses for tax filing. As enacted under Wakanda’s
revenue code, online businesses are liable to income tax on the gains from their
sales.

One of Wakanda’s officials, Senator Jack A. Moon, questioned the internal revenue
office on its issuance indicating that it was not moral for it to run after online
businesses and impose taxes on their income, more so that they are normally
conducting such endeavors for mere subsistence.
Is the senator’s contention tenable?

Case Study IS IT EXEMPT?

1.3
A congregation owns a parcel of land. Most of it is directly used for its religious and
educational endeavors. A small commercial space was built beside the school it operates to
rent out to businesses which would cater the needs of its students. The proceeds from
rentals are being used for charitable purposes.

Should the rental income and property be subjected to tax?

SITUS RULES APPLICATION:
Dina B. Nalican, Spanish by citizenship, obtained the income from the following
during the year.
• Having posted in Shoppy, a customer browsing the online shopping
application in General Santos City asked if she could inspect the car
personally. It was after the inspection in Zamboanga City that the
customer agreed to buy the car. It is to be delivered to and paid by the
customer in Davao City.
• Dina has a hardware store located in Mactan, Cebu. She decided to close
the main branch in Leyte five years ago.
• She also lends thru the 5-6 system of lending in her residence in Quiapo. A
debtor residing in Quezon City owes her P60,000, inclusive of interests.
They are to meet in Sampaloc for the payment of said debt.
• Dina owns a condo unit in Laoag City. A student from Cagayan rents said
property and pays to Dina’s son (residing in Vigan City) the rent when they
meet up in Batac City.

Determine the situs of:

1. Tax on the gain on sale of her car
2. Tax on her hardware store
3. Tax on interest income earned
4. Tax on rental income earned
5. Personal Tax

LIMITATIONS
Identify the source of the limitation on the power of taxation. Write C if it is constitutional, I
if it is inherent, B if it is both constitutional and inherent and N if it is not a limitation.
1. Taxes collected must be used for public purposes
2. Taxes can only be imposed within the territory of the State
3. Taxes cannot be assigned
4. Tax treaties entered into with other contracting States must be honored
5. Imprisonment for non-payment of income tax
6. Non-delegation of the taxing power
7. Exemption from taxes of the revenues and assets of religious,
charitable or educational entities, nonprofit cemeteries, churches
and mosques
8. No arbitrariness in assessment and collection of taxes
REFERENCES:

❖ Income Taxation with Special Topics and Properly Filled BIR

Forms, 2020 Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson
R. Garcia, CPA, MBA

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition-

Asser S. Tamayo, CPA, MBA

❖ Income Taxation-Laws, Principles and Applications- Rex B.

Banggawan, CPA, MBA

❖ National Internal Revenue Code of 1997

❖ Bureau of Internal Revenue Regulations

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Decisions on Tax Cases

Course Code and Title: BACR 5 – INCOME TAXATION

Lesson Number : 2

Topics : Tax, Laws, Systems and Administration

Prof. Rosario A. Calamba, CPA, MBM, PhD

__________________________________________________________________

LEARNING OBJECTIVES

At the end of this lesson, the student should be able to:

1. Identify the type of taxation laws;

2. Classify taxes as to different criterion and differentiate them as to other government

revenues;

3. Define tax laws and its types, sources and nature;

4. Explain the rules on the interpretation of vague tax laws;

5. Differentiate the relevant issuances related to the administration of tax laws;

6. Describe the characteristics of a sound tax system;

7. Differentiate the various tax collection systems;

8. Enumerate the powers of the BIR & CIR

PRE-ASSESSMENT
Match Column A with Column B.
Column A Column B
Toll - 1 A – most likely similar with proportional tax
CIR - 2 B – sources of funds must be sufficient to cover costs
Fiscal Adequacy - 3 C – the highest official of the Bureau of Internal Revenue
Progressive – 4 D – a charge for the use of others’ property
Ad valorem - 5 E – an agency tasked for collection of tariffs
BOC- 6 F – tax rates increase as the tax base increase
Revenue Issuances - 7 G – a source of tax law from the BIR

LESSON PRESENTATION

TAXES
Taxes are the enforced proportional contributions from persons and property levied by
the law- making body of the State by virtue of its sovereignty for the support of the
government and all public needs.

Essential Elements
The following are the essential elements of taxes.

1. It is an enforced contribution.
2. It is generally payable in money.
3. It is proportionate in character.
4. It is levied on persons, property, or the exercise of a right or privilege.
5. It is levied by the State which has jurisdiction over the subject or object of taxation.
6. It must be uniform and equitablIt must not violate constitutional and inherent
limitations.
7. It is levied by the law-making body of the State.
8. It is levied for public purpose or purposes.

Classifications of Taxes
Taxes may be classified as to different categories.

Fiscal or Revenue A tax imposed on general purpose

A tax imposed to regulate business, conduct, acts or
Regulatory
As to Purpose Transactions
A tax levied to achieve some social or economic
Sumptuary
Objectives
 Personal or Poll or A tax on persons who are residents of a particular
Capitation Territory
As to Subject Property Tax A tax on properties whether real or personal
Matter A tax imposed upon the performance of an act,
Excise or Privilege
enjoyment of a privilege or engagement in an
Tax
occupation

A tax where the statutory and economic taxpayer are

Direct Tax
As to the same person
Incidence A tax where the statutory and economic taxpayers are
Indirect Tax
not the same person

S tatutory vs. Economic Taxpayer

The statutory taxpayer is the one named by the law to pay the tax levied. On the other hand, the
economic taxpayer is the one who actually pays and carries the burden of the tax. These two
taxpayers may not necessarily be the same person. This depends on the kind of tax being paid.

A tax of a fixed amount imposed on a per unit basis

Specific Tax
As to such as per kilo, liter, meter, etc.
Amount A tax of a fixed proportion upon the value of the tax
Ad Valorem
Object

Proportional Tax This is a flat or fixed rate tax

Progressive or This is a tax which imposes increasing rates as the tax
graduated tax base increases
As to Rate This is a tax which imposes decreasing rates as the tax
Regressive Tax
base increases
This is manifest tax rates which is a combination of any
Mixed Tax
of the above types of tax

As to National Tax Tax imposed by the national government

Authority Local Tax Tax imposed by local government units
Other Government Collection Terms
T ax vs. Revenue
Tax refers to the amount imposed by the government for public purposes. Revenue refers
to all income collections of the government which include taxes, tariff, licenses, toll,
penalties and others. The amount imposed is tax but the amount collected is revenue. All
taxes are revenue but not all revenues are taxes.

T ax vs. License Fee

Tax has a broader subject than license. Tax emanates from taxation power and is imposed
upon any subject to raise revenue. License fees emanate from police power and is
imposed to regulate exercise of such privilege such as the commencement of a business
or profession. Taxes are imposed after the commencement of a business or profession
whereas license fee is imposed before engagement in those activities. In other words, tax
is a post-activity imposition whereas license is pre-activity imposition.

T ax vs. Toll
Tax is a levy of government; hence, it is a demand of sovereignty. Toll is a charge for the
use of other’s property; hence, it is a demand of ownership. The amount of tax depends
upon the needs of the government, but the amount of toll is dependent upon the value
of the property leased. Both the government and private entities impose toll, but private
entities cannot impose taxes.

T ax vs. Debt
Tax arises from law while debt arises from private contracts. Non-payment of tax leads
to imprisonment, but non-payment of debt does not lead to imprisonment. Debt can be
subject to set-off but tax is not. Debt can be paid in kind but tax is generally payable in
money.

T ax vs. Special Assessment

Tax is an amount imposed upon persons, properties or privileges. Special assessment is
levied by the government on lands adjacent to a public improvement. It is imposed on
land only and is intended to compensate the government for a part of the cost of the
improvement. The basis of special assessment is the benefit in terms of the appreciation
in land value caused by the public improvement.

T ax vs. Tariff
Tax is broader than tariff. Tax is an amount imposed upon persons, properties and
privileges. Tariff is the amount imposed on imported or exported commodities.
T ax vs. Penalty
Tax is an amount imposed for the support of the government. Penalty is an amount
imposed to discourage an act. Penalty may be imposed by both the government and
private individuals. It may arise both from law or contract whereas tax arises from law.

TAX LAWS
Taxation law refers to any law that arises from the exercise of the taxation power of the State.

Types
Tax laws can be classified into two categories depending on their effect on both the
government and the taxpayer.

T ax Laws
These are laws that provide for the assessment and collection of taxes.

Examples:
1. The National Internal Revenue Code (NIRC)
2. The Tariff and Customs Code
3. The Local Tax Code
4. The Real Property Tax Code

T ax Exemption Laws
These are laws that grant immunity from taxation.

Examples:
1. The Minimum Wage Law
2. The Omnibus Investment Code of 1987 (E.O. 226)
3. Barangay Micro-Business Enterprise (BMBE) Law
4. Cooperative Development Act

Nature
The Philippine Internal Revenue laws are generally civil in nature; they are neither
political nor penal in nature.

Although tax laws deal with the fundamental symbiotic relationship of people with the
government, basically they are not political in nature. They remain effective even if
foreign invaders occupy our country. They are deemed to be the laws of the occupied
territory and not of the occupying enemy. Hence, it is valid and legal that income tax
returns shall be filed and
paid by the inhabitants even if foreign invaders occupy our country. Even if there are
some penalties provided for violation of tax laws, they are not penal in nature because
they do not define crimes and provide for their punishment. The internal revenue law
provides for some penalties for tax delinquencies only to effect timely payments of taxes
or punishes tax evasion for neglect of duty by those subjects of taxation.

Revenue laws are n ot remedial laws. They do not include procedures to protect rights;
and prevent or rectify wrong doings.

The Tax Code are special laws which prevail over general laws such as Civil Code or
Rules of Court. Accordingly, the provisions of the NIRC on prescription arc given priority
over the provisions of Civil Code on prescriptions.

Sources
With the exercise of the power of taxation, tax laws provide guidance on its scope. The
following are the common sources of tax statutes.

C onstitution of the Philippines

The term Constitution refers to that body of rules and maxims in accordance with which
the powers of sovereignty are habitually exercised. It is often referred to as the Supreme
or Fundamental Law of the land because all other laws must conform to it. It is the basis
in determining the legality of all-governmental actions and decisions. A constitutional
provision regarding taxation is primarily intended to limit and regulate the exercise of
taxation power. The State can exercise the power to tax even if the Constitution is
completely silent about taxation.

S tatutes
Statutes are laws enacted and established by the will of the legislative department of the
government. The present tax statutes of the Philippines are embodied in the Republic Act
No. 8424, which is now the prevailing NIRC effective January 1, 1998, which was
amended by various republic acts and revenue regulations.

J udicial Decisions
These refer to the decisions for application made concerning tax issues by the proper
courts exercising judicial authority of competent jurisdiction. These courts may be the
Supreme Court and the Court of Tax Appeals. Their decisions on tax laws comprise the
greater portion of tax jurisprudence. They form part of the legal system of the Philippines.
By the nature of its jurisdiction, the decisions of the Court of Tax Appeals are still
appealable to the Supreme Court. The decision of the Supreme Court on any matter is
final and executory.
E xecutive Orders
Executive orders are regulations issued by the President or some administrative
authority under his direction for the purpose of interpreting, implementing, or giving
administrative effect to a provision of the Constitution or of some law or treaty.

T ax Treaties and Conventions

These refer to the treaties or international agreements with foreign countries regarding tax
enforcement and exemptions. They have the force and effect of law.

L ocal Tax Ordinances

These are tax ordinances issued by the Province, City, Municipality and Barrio subject to such
limitations as provided by the Local Government Code and the Real Property Tax Code.

Steps in the Legislative Process

Under the 1987 Philippine Constitution, all revenue and tariff bills shall originate from
the House of Representatives. A revenue bill is one that levies taxes and raises funds for
the government while a tariff bill specifies the rates or duties to be imposed on imported
article.

Often, major tax proposals are initiated by the Executive Department thru the President
upon the recommendation of the Department of Finance based on the latter's study or
proposal, and then introduced into Congress by the allies of the President.

The steps in the legislative process are as follows:

1. A tax bill is introduced in the House of Representatives and is referred to the House
Committee on Ways and Means. This is known as the first reading. The first reading
involves only a reading of the number and title of the measure. All appropriation
revenue or tariff bills, bills authorizing increase of the public debt, bills of local
application, and private bills shall originate exclusively in the House of
Representatives but the Senate may propose or concur with amendments.
2. The proposal is considered by the Committee on Ways and Means. Committee
hearings as well as public hearings are held If there are several bills of the same
nature or purpose, they shall all be consolidated in the conduct of the hearings.
Moreover, the committee may introduce amendments or propose substitute bill.
3. The tax bill is voted on by the Committee and if approved, is reported out
to the House of Representatives for a vote. Deliberations, interpellations
and even amendment by the members of the House are held. This is
known as the second reading in the House.
4. If passed by the House, the bill is transmitted to the Senate for consideration by the
Senate Committee on Ways and Means and public hearings are held. This is known
 as the second reading in the senate. The bill undergoes the same legislative
process in the Senate.
5. Upon approval by the Senate, both the Senate and the House versions are sent
to the Bicameral Conference Committee consisting of representatives of the
House and of the Senate.
6. The two versions are generally dissimilar. Thus, the conflict is reconciled
in the Bicameral Conference Committee. This process of ironing out the
differences generally involves substantial compromise.
7. A final bill as approved by the Bicameral Conference Committee, is then
resubmitted to the House and Senate for approval. This is known as the third
reading. Generally, it shall only be the reading of title. No deliberations will be
allowed.
8. If the Bicameral Conference Committee bill is approved by the House and
Senate, it is sent to the President for approval or veto. This is known as the
"enrolled bill."
9. If the President approves the bill, he shall sign it and the bill becomes a law.
When the President vetoes it, both Houses may override the veto by two-
thirds vote of all the members of each house. If the required measure is met,
the bill is converted into law over the President's objections. Moreover, the
bill may become a law when the President does not act upon the measure
within thirty days after it shall have been presented to him.

Interpretation of Tax Laws

Though the power of taxation may be broad, tax laws and tax exemptions may be vague that the
application of which may be difficult to determine. If such is the case, proper interpretation of
said laws should be done with consideration of the original intent of the lawmakers at the time
such law is drafted and approved.

The maxim, strictissimi juris, indicates that he, who a tax statute is construed against, bears the
burden of proving relation to said statute. Taxation is the rule, exemption is the exception.

Vague Tax Laws

Ambiguous Tax Laws are c onstrued against the government and in favor of the taxpayer. This
is so because the state is the one imposing a burden to its subjects, thus, it is the taxpayer who
has the right to question the applicability of said tax law to himself. Moreover, a vague tax law
means no tax law. Obligation arising from law is not presumed. This is also in conjunction with
the uniformity and equal protection clause granted by the Constitution. Considering also that it
is the State that drafts tax laws, it should be drafted properly that the approved law should be
clear and concise.
Vague Tax Exemptions
In the construction of tax statutes, exemptions are construed against the taxpayer and in favor
of the government. The fundamental theory is that all taxable property should bear its share in
the cost and expense of the government. A vague exemption law means no exemption law. The
claim for exemption is construed against the taxpayer in accordance with the lifeblood doctrine.
It is, therefore, the responsibility of the taxpayer that he/she is within the context of said tax
exemption.

Administrative Issuances
To facilitate the administrative act of taxation, the Bureau of Internal Revenue as a body under
the Department of Finance, releases revenue issuances. The following would be the differences
of the issuances.

Revenue Regulations (RRs)

These are issuances signed by the Secretary of Finance, upon recommendation of the
Commissioner of Internal Revenue, that specify, prescribe or define rules and regulations for
the effective enforcement of the provisions of the National Internal Revenue Code (NIRC) and
related statutes.

Revenue Memorandum Orders (RMOs)

These are issuances that provide directives or instructions; prescribe guidelines; and outline
processes, operations, activities, workflows, methods and procedures necessary in the
implementation of stated policies, goals, objectives, plans and programs of the Bureau in all
areas of operations, except auditing.

Revenue Memorandum Rulings (RMRs)

These are ruling, opinions and interpretations of the CIR with respect to the provisions of the
Tax Code and other tax laws as applied to specific sets of facts, with or without established
precedents, and which the CIR may issue from time to time for the purpose of providing
taxpayers guidance on the consequences in specific situations.

Revenue Memorandum Circulars (RMCs)

These are issuances that publish pertinent and applicable portions, as well as amplifications, of
laws, rules, regulations and precedents issued by the BIR and other agencies/offices.

Revenue Administrative Orders (RAOs)

These are issuances that cover subject matters dealing strictly with the permanent
administrative set-up of the Bureau, more specifically, the organizational structure, statements
of functions and/or responsibilities of BIR offices, definitions and delegations of authority,
staffing and personnel requirements and standards of performance.
Revenue Delegation of Authority Orders (RDAOs)
These refer to functions delegated by the Commissioner to revenue officials in accordance with
law.

Revenue Bulletins (RB)

These refer to the period issuance, notices and official announcement of the CIR that
consolidate the BIR’s position on certain specific issues of law or administration on
relation to the provisions of the tax code, relevant tax laws, and other issuances for the
guidance of the public.

BIR Rulings
These are official positions of the BIR to queries raised by taxpayers and other stakeholders
relative to clarification and interpretation of tax laws.

TAX SYSTEM
The tax system refers to the methods or schemes of imposing, assessing, and collecting
taxes. It includes all the tax laws and regulations, the means of their enforcement, and the
government offices, bureaus and withholding agents which are part of the machineries
of the government in tax collection. The Philippine tax system is divided into two: the
national tax system and the local tax system.

Types According to Imposition

P rogressive
This is employed in the taxation of income of individuals, and transfers of properties by
individuals.

P roportional

This is employed in taxation of corporate income and business.

R egressive

This is not employed in the Philippines.

Types According to Impact

Progressive System
A progressive tax system is one that emphasizes direct taxes. A direct tax cannot be shifted.
Hence, it encourages economic efficiency as it leaves no other resort to taxpayers than to be
efficient. This type of tax system impacts more upon the rich.

R egressive System
A regressive tax system is one that emphasizes indirect taxes. Indirect taxes are shifted by
businesses to consumers; hence, the impact of taxation rests upon the bottom end of the society.
In effect, a regressive tax system is anti-poor. It is widely believed that despite the
Constitutional guarantee of a progressive taxation, the Philippines has a dominantly regressive
tax system due to the prevalence of business taxes.

Tax Collection Systems

Withholding System on Income Tax
The government requires taxpayers to withhold (i.e. deduct) taxes on their income payments
(i.e. expenses). These withheld taxes are called "withholding tax." These are not tax to the
taxpayer but to the recipient of the income payments. The taxpayer must deduct the
withholding tax on his income payments, file a withholding tax return, and remit the withheld
tax to the government.

Non-compliance to the withholding tax rules shall expose the taxpayer to penalties and fines
aside from the disallowance of the expense as deductions against income.

Creditable Withholding Tax

These are taxes withheld on certain passive and active income where can be credited against
income tax due.

Withholding tax on The tax is withheld by the employer from payments of

compensation compensation income to employees
A withholding tax prescribed on certain income payments and is
Expanded
creditable against the income tax due of the payee for the taxable
withholding tax
quarter or year in which the particular income was earned

Final Withholding Tax

A kind of withholding tax which is prescribed on certain income
Final withholding tax payments and is not creditable against any income tax due of the
payee for the taxable year
Withholding System on Business Tax
This is the tax withheld by the national government agencies and instrumentalities including
government-owned and controlled corporations on their payments to taxpayers, suppliers, or
payees.

Voluntary Compliance System

Under this collection system, the taxpayer himself determines his income, reports the same
through income tax returns and pays the tax to the government. This system is also referred to
as the "Self-assessment method." In preparing their tax return, taxpayers declare their income
and expenses, and personally determine the tax due thereon. The government relies on the
good faith of taxpayers in the preparation of their tax returns but employs detective techniques
to ascertain non-compliance or under-compliance. These returns will be further discussed in
succeeding modules. A portion of the tax due payable herein may have been withheld under
the withholding system, such as:

a. Withholding tax on compensation by compensation earners

b. Expanded withholding tax by taxpayer engaged in business or exercise of profession

The taxes withheld are treated as tax credit (deduction) against the tax due of the taxpayer in
the income tax return. The taxpayer shall pay any balance still due after such credit or claim
refund or tax credit for excess tax withheld.

Assessment or Enforcement System

Under this collection system, the government identifies non-compliant taxpayers, assesses their
tax dues and penalties, and enforces collections by coercive means such as summary proceeding
or judicial proceedings when necessary.

Principles of Sound Tax System

According to Adam Smith, governments should adhere to certain principles or canons to evolve
a sound tax system:

F iscal Adequacy
The sources (proceeds) of tax revenue should coincide with and approximate needs of
government expenditures. The sources of revenue should be sufficient and elastic to meet the
demands of public expenditures. The government must not incur a deficit. A budget deficit
paralyzes the government's ability to deliver the essential public services to the people. Hence,
taxes should increase in response to increase in government spending.

Theoretical Justice
The tax system should be fair to the average taxpayer and based upon his ability to pay. It also
suggests that the exercise of taxation should not be oppressive, unjust, or confiscatory.

Administrative Feasibility
The tax system should be capable of being properly and efficiently administered by the
government and enforced with the least inconvenience to the taxpayer.

The following are applications of the principle of administrative feasibility:

1. E-filing and e-payment of taxes
2. Substituted filing system for employees
3. Final withholding tax on non-resident aliens or corporations
4. Accreditation of authorized agent banks in the filing and payment of taxes
TAX ADMINISTRATION
Tax administration refers to the management of the tax system. Tax administration of the
national tax system in the Philippines is entrusted to the Bureau of Internal Revenue which is
under the supervision and administration of the Department of Finance.

BIR Officials
Commissioner of Internal Revenue (CIR)
This is the head of the whole bureau. The duties and powers of this office will be further
discussed in the succeeding pages.

D eputy Commissioners
Four Deputy Commissioners are assigned to the following: (1) Operations Group, (2) Legal
Enforcement Group, (3) Information Systems Group and (4) Resource Management Group.

Assistant Commissioners
Thirteen assistant commissioners are designated to each of the service divisions.

H ead Revenue Executive Assistants

Thirteen head revenue executive assistants are designated to each of the service divisions.

Regional Directors
They are the heads of each revenue region which administers and enforces internal revenue
laws including the assessment and collection of all internal revenue taxes, charges and fees from
taxpayers within the region's jurisdiction, as well as ensures proper and effective
implementation of National Office's policies and programs within the Regional Office.

Revenue District Officers

They are the heads of the 123 revenue district offices which mainly provide frontline assistance
and service to taxpayers.

Powers of the BIR

The following are the powers of the Bureau of Internal Revenue as vested by law.

1. Assessment and collection of taxes

2. Enforcement of all forfeitures, penalties and fines and judgments in all cases decided in
its favor by the courts
3. Giving effect to, and administering the supervisory and police powers conferred to it by
the NIRC and other laws
4. Assignment of internal revenue officers and other employees to other duties
5. Provision and distribution of forms, receipts, certificates, stamps, etc. to proper officials
6. Issuance of receipts and clearances
 7. Submission of annual report, pertinent information to Congress and reports to the
Congressional Oversight Committee in matters of taxation

Powers of the CIR

The Commissioner of Internal Revenue is given the following powers to fulfill the duties and
responsibilities of its office.

1. To interpret the provisions of the NIRC, subject to review by the Secretary of Finance
2. 2. To decide tax cases, subject to the exclusive appellate jurisdiction of the Court of Tax
Appeals
3. To obtain information and to summon, examine, and take testimony of persons to effect
tax collection
4. To make assessment and prescribe additional requirement for tax administration and
enforcement
5. To examine tax returns and determine tax due thereon
6. To conduct inventory taking or surveillance
7. To prescribe presumptive gross sales and receipts for a taxpayer when:
a. The taxpayer failed to issue receipts; or
b. The CIR believes that the books or other records of the taxpayer do not correctly
reflect the declaration in the return.
8. To terminate tax period when the taxpayer is:
a. Retiring from business
b. Intending to leave the Philippines
c. Intending to remove, hide, or conceal his property
d. Intending to perform any act tending to obstruct the proceedings for the
collection of the tax or render the same ineffective
9. To prescribe real property values
10. To compromise tax liabilities of taxpayers
11. To inquire into bank deposits, only under the following instances:
a. Determination of the gross estate of a decedent
b. To substantiate the taxpayer's claim of financial incapacity to pay tax in an
application for tax compromise
12. To accredit and register tax agents
13. To refund or credit internal revenue taxes
14. To abate or cancel tax liabilities in certain cases
15. To prescribe additional procedures or documentary requirements
16. To delegate his powers to any subordinate officer with a rank equivalent to a division
chief of an office
Non-delegated Power of the CIR
The following powers of the Commissioner shall not be delegated:

1. The power to recommend the promulgation of rules and regulations to the Secretary of
Finance.
2. The power to issue rulings of first impression or to reverse, revoke or modify any
existing rulings of the Bureau.
3. The power to compromise or abate any tax liability
4. The power to assign and reassign internal revenue officers to establishments where
articles subject to excise tax are produced or kept.

Rules in assignments of revenue officers to other duties

1. Revenue officers assigned to an establishment where excisable articles are kept shall in
no case stay there for more than 2 years.
2. Revenue officers assigned to perform assessment and collection function shall not
remain in the same assignment for more than 3 years.
3. Assignment of internal revenue officers and employees of the Bureau to special duties
shall not exceed 1 year.

Agents and Deputies for Collection of National Internal Revenue Taxes

The following are constituted agents for the collection of internal revenue taxes:

1. The Commissioner of Customs and his subordinates with respect to collection of

national internal revenue taxes on imported goods.
2. The head of appropriate government offices and his subordinates with respect to the
collection of energy tax.
3. Banks duly accredited by the Commissioner with respect to receipts of payments of
internal revenue taxes authorized to be made thru banks. These are referred to as
authorized government depositary banks (AGDB).

Other Revenue-Related Government Bodies

Bureau of Customs (BOC)
Aside from its regulatory functions, the Bureau of Customs is tasked to administer collection of
tariffs on imported articles and collection of the Value Added Tax on importation. Together
with the BIR, the BOC is under the supervision of the Department of Finance.

The Bureau of Customs is headed by the Customs Commissioner and is assisted by five Deputy
Commissioners and 14 District Collectors.
Board of Investments (BOI)
The BOI is tasked to lead the promotion of investments in the Philippines by assisting Filipinos
and foreign investors to venture and prosper in desirable areas of economic activities. It
supervises the grant of tax incentives under the Omnibus Investment Code. The BOI is an
attached agency of the Department of Trade and Industry (DTI).

The BOI is composed of five full-time governors, excluding the DTI secretary as its chairman.
The President of the Philippines shall appoint a vice chairman of the board who shall act as the
BOI's managing head.

Philippine Economic Zone Authority (PEZA)

The PEZA is created to promote investments in export-oriented manufacturing industries in the
Philippines and, among other myriads of functions, supervise the grant of both fiscal and non-
fiscal incentives.

PEZA-registered enterprises enjoy tax holidays for certain years, exemption from import and
export taxes including local taxes. The PEZA is also an attached agency of the DTI.

The PEZA is headed by a director general and is assisted by three deputy directors.

Local Government Tax Collecting Units

Provinces, municipalities, cities and barangays also imposed and collect various taxes to
rationalize their fiscal autonomy.

Taxpayer Classification
For purposes of effective and efficient tax administration, taxpayers are classified into large and
non-large. Large taxpayers are under the supervision of the Large Taxpayer Service (LTS) of the
BIR. Non-large taxpayers are under the supervision of the respective Revenue District Offices
(RDOs) where the business, trade or profession of the taxpayer is situated. The following are the
criteria for determining large taxpayers:

Value Added Tax At least P200,000 per quarter for the preceding year
Excise Tax At least P1,000,000 tax paid for the preceding year
At least P1,000,000 annual income tax paid for the
Income Tax
preceding year
As to At least P1,000,000 annual withholding tax payments or
Withholding Tax
payment remittances from all types of withholding taxes
At least P200,000 percentage tax paid or payable per
Percentage tax
quarter for the preceding year
Documentary
At least P1,000,000 aggregate amount per year
stamp tax
 Gross receipts or
As to P1,000,000,000 total annual gross sales or receipts
Sales
financial
P300,000,000 total net worth at the close of each
conditions Net worth
calendar or fiscal year
and results of
P800,000,000 total annual purchases for the preceding
operations Gross purchases
year

Top corporate taxpayer listed and published by the Securities and Exchange Commission shall
also be under LTS.

1. All branches of taxpayers under the Large Taxpayer's Service

2. Subsidiaries, affiliates, and entities of conglomerates or group of
companies of a large taxpayer
3. Surviving company in case of merger or consolidation of a large
Taxpayer
4. A corporation that absorbs the operation or business in case of spin-off
of any large taxpayer
5. Corporation with an authorized capitalization of at least P300,000,000
registered with the SEC
Automatic
6. Multinational enterprises with an authorized capitalization or assigned
classification
capital of at least P300,000,000
7. Publicly listed corporations
8. Universal, commercial, and foreign banks (the regular business unit and
foreign currency deposit unit shall be considered one taxpayer for
purposes of classifying them as large taxpayer)
9. Corporate taxpayers with at least P100,000,000 authorized capital in
banking, insurance, telecommunication, utilities, petroleum, tobacco,
and alcohol industries
10. Corporate taxpayers engaged in the production of metallic minerals
 GENERALIZATION:

This module discusses tax laws, taxes and their distinction from similar items and the
administration of the tax system

APPLICATION:

Case Study GOING LOCO ON LOCAL

2.1
The Municipality of Santo Cristo, claiming that it can impose taxes under the Local
Government Code, imposed a tax on common carriers in addition to the 3% common
carrier’s tax imposed in the National Internal Revenue Code. The common carriers in
the municipality objected on this ordinance stating that the power of taxation cannot
be delegated and that this constitutes double taxation.

Is their contention tenable?

Case Study IS THE COMPROMISE COMPROMISED?

2.2
Due to the government budget crunch due to the pandemic, the economic manager
of the country looked into tax compromises and abatements done during the year.
Upon evaluation, it discovered a tax liability of P400,000 which was compromised
by the Regional Evaluation Board. The economic manager stated that the tax
compromise is not valid since it is the CIR’s power for the tax compromise to take
effect. He also adds that this power cannot be delegated.

Is his contention tenable?

EVALUATION:
TRUE OR FALSE: Write True on the blank provided if the statement is
correct and False if the statement is incorrect:

1. Tax laws must originate exclusively from the House of Representatives.

2. The presence of penalties for late filing and payment of taxes suggests that
tax laws are penal in nature.
3. Tax exemption laws which are vague as to its provisions must be construed
against the government as this should have been deliberated well when it
was still in the legislative process.
4. One characteristic of a sound tax system is that taxes are generally paid
in cash since liquidity is important for the use government funds.
5. All of the powers of the Commissioner of Internal Revenue cannot
be delegated.
6. In case of discrepancies of GAAP and tax laws, the provisions of tax
laws should be followed in terms of tax reporting.
7. The presence of a graduated tax table for personal income tax in
the Philippines suggests the employment of a progressive tax
system.
8. Tax is a broader term as compared to revenue and tariff.
9. Sources of tax laws are only from the legislative and executive branch of
the government.
10. Even though the community/poll tax is a local tax, the certificate still bears
the BIR logo.
REINFORCEMENT:

MULTIPLE CHOICE
Choose the best answer from the choices provided.
1. When the economic burden of a tax already paid is transferred to another, the tax
is most likely a/n .
a. Direct Tax
b. Indirect Tax
c. Personal Tax
d. Specific Tax

2. Which is not a characteristic of tax?

a. It is an enforced contribution.
b. It is generally payable in money.
c. It is subject to assignment.
d. It is levied by the law-making body of the State.

3. Which issues revenue regulations?

a. Commissioner of Internal Revenue
b. Bureau of Internal Revenue
c. Department of Finance
d. Secretary of Finance
 4. Philippine Tax laws, by nature, are
a. penal
b. civil
c. remedial
d. political

5. Which of the following do not relate to tax?

a. does not render business illegal when not paid
b. arises from law rather than from contracts
c. intended to cover cost of regulations
d. intended for public purpose

TAX TYPES
Determine the tax type best described by each of the following statements.
1. The value-added tax was previously 10% when it was expanded to 12%
2. The TRAIN Law removed the use of a graduated tax table for estate tax
3. The excise tax on distilled spirits during 2017 was 20% of the net retail
price and P21.63 per proof liter
4. Legislative officials are pushing for taxes on junk foods to fund health
efforts against the pandemic
5. Excise taxes are mostly capitalized as cost of the merchandise
6. In efforts to reduce plastic consumption, an LGU imposed a plastic tax

LARGE TAXPAYERS
Determine whether the following taxpayers are to be supervised under the Large Taxpayer Service.
Write LTS if yes and RDO if not.
1. With an excise tax rate of 30% on selling price on its automobiles, Vroom
Company sold five units at P1,500,000 each on the preceding year
2. Batty Company paid a total of P200,000 on value-added tax during the
preceding year
3. The 2019 Balance Sheet of Cappy Company showed assets of P900 million
and liabilities of P550 million
4. The 2019 Income Statement of Netty Company reported a taxable income
of P4,000,000
5. Fristy Company had its initial public offering on June 19, 2019
REFERENCES:

❖ Income Taxation with Special Topics and Properly Filled BIR Forms, 2020
Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S.

Tamayo, CPA, MBA

❖ Income Taxation-Laws, Principles and Applications- Rex B. Banggawan,

CPA, MBA

❖ National Internal Revenue Code of 1997

❖ Bureau of Internal Revenue Regulations

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Jurisprudence on Tax Cases

Course Code and Title : BACR 5 – INCOME TAXATION (BSBA)

Lesson Number : 3

Topic : Income Tax Concepts

Professor : Prof. Rosario A. Calamba, CPA, PhD

__________________________________________________________________

LEARNING OBJECTIVES

At the end of this lesson, the student should be able to:

1. Explain the concepts for gross income;

2. Identify and differentiate the different classifications of income taxpayers;

3. Differentiate the treatment of recovery of loss capital and loss profits;

4. Explain the general rules in income taxation;

5. Explain the concepts of realized benefit and identify the modes where income is
realized; and

6. Identify the situs of income taxes.

PRE-ASSESSMENT:

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?

LESSON PRESENTATION:
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.

What is income for taxation purposes?

The tax concept of income is simply referred to as "gross income" under the NIRC. A taxable
item of income is referred to as an "item of gross income" or "inclusion in gross income". Gross
income simply means taxable income in layman's term. Under the NIRC however, the term
"taxable income" refers to certain items of gross income less deductions and personal
exemptions allowable by law. Technically, gross income is broader to pertain to any income that
can be subjected to income tax. Gross income is broadly defined as any inflow of wealth to the
taxpayer from whatever source, legal or illegal, that increases net worth. It includes income
from employment, trade, business or exercise of profession, income from properties, and other
sources such as dealings in properties and other regular or casual transactions,

ELEMENTS OF GROSS INCOME

1. It is a return on capital that increases net worth.
2. It is a realized benefit.
3. It is not exempted by law, contract, or treaty.
Increase in Net Worth
The following must be considered if a transaction would result to an increase in net worth.

R eturn on Capital vs. Return of Capital

Capital means any wealth or property. Gross income is a return on wealth or property that
increases the taxpayer's net worth. The return on capital that increases net worth is income
subject to income tax. Return of capital merely maintains net worth; hence, it is not taxable. An
improvement in net worth indicates an ability to pay tax.

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.

C apital items deemed with infinite value

There are capital items that have infinite value and are incapable of pecuniary valuation.
Anything received as compensation for their loss is deemed 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.

R ecovery of lost capital vs. Recovery of lost profits

The loss of capital results in decrease in net worth while the loss of profits does not decrease net
worth. The recovery of lost capital merely maintains net worth while the recovery of lost profits
increases net worth. Therefore. the recovery of lost profits is a return on capital. The recovery of
lost profits through insurance, indemnity contracts, or legal suits constitutes a taxable return on
capital.

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.

R ealized
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.

Involvement of Another Entity

Every person, natural or juridical, is an entity. Natural persons are living person:, while
juridical persons are those created by law such as partnerships and corporations. An entity may
be a taxable entity or an exempt entity. A taxable item of gross income arises from transactions
which involve another natural or juridical entity.

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.

B enefit
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.

The following are not benefit, hence, not taxable:

a. Receipt of a loan - properties increase but obligations also increase resulting in an

offsetting effect in net worth
b. Discovery of lost properties - under the law, the finder has an obligation to return the
same to the owner
c. Receipt of money or property to be held in trust for, or to be remitted to, another person
If the taxpayer is entitled to keep for his account portion of a receipt, only that portion is
a benefit.
 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.

Tax Treatment of Increase in the Value of Property

The increase in wealth of the taxpayer in the form of appreciation or increase in the value of his
properties or decrease in the value of his obligations in the absence of a sale or barter
transaction is not taxable. A mere increase in the value of property is not income, but merely
and unrealized increase in capital.

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.
Not Exempted by Law, Contract, or Treaty
An item of gross income is not exempted by the Constitution, law, contracts or treaties from
taxation.

The following items of income are exempted by law from taxation; hence, they are not
considered items of gross income:

1. Income of qualified employee trust fund

2. Revenues of non-profit non-stock educational institutions
3. SSS, GSIS, Pag-Ibig, or PhilHealth benefits
4. Salaries and wages of minimum wage earners and qualified senior citizen
5. Regular income of Barangay Micro-business Enterprises (BMBEs)
6. Income of foreign governments and foreign government-owned and controlled
corporations
7. Income of international missions and organizations with income tax immunity

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.

General Classification Rule

In classifying individual taxpayers based on residency, one ought to consider the intention of an
individual’s stay within the Philippines or abroad. The taxpayer shall submit documentary
proofs such as visas, work contracts and other documents indicating such intention.

Individual Taxpayers
R esident Citizen (RC)
A Filipino citizen residing in the Philippines

Definition of a Citizen under the Constitution

Under the Constitution, citizens are:
a. Those who are citizens of the Philippines at the time of adoption of the Constitution
on February 2, 1987
b. Those whose father or mother are citizens of the Philippines
c. Those born before January 17, 1973 of Filipino mothers who elected Filipino
citizenship upon reaching the age of majority
d. Those who are naturalized in accordance with the law
N on-Resident Citizen (NRC)
The following are considered as non-resident citizens:

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.

R esident Alien (RA)

A resident alien is someone who is residing in the Philippines but is not a citizen.

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.

N on-Resident Alien Engaged in Trade or Business (NRA-ETB)

An individual who is not residing on the Philippines and is not a resident thereof, intends to
conduct trade, business or exercise of his profession.
 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.

N on-Resident Alien not Engaged in Trade or Business (NRA-NETB)

An individual who is not residing on the Philippines and is not a resident thereof, not intending
to conduct trade, business or exercise of his profession. Aliens who come to the Philippines for a
definite purpose which in its nature may be promptly accomplished shall not be considered to
be engaged in trade or business.

O ther Individual Taxpayers

The tax treatments for these taxpayers will be discussed in Module 7.

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
D omestic Corporation (DC)
A corporation formed and authorized to conduct trade and business under the Philippine law.

R esident Foreign Corporation (RFC)

A corporation organized, authorized, or existing under the laws of any foreign country but is
authorized to engage in trade or business in the Philippines through a permanent
establishment.

N on-Resident Foreign Corporation (NRFC)

A corporation organized, authorized, or existing under the laws of any foreign country and is
not authorized to engage in trade or business in the Philippines.

O ther Corporate Taxpayers

The tax treatments for these taxpayers will be discussed in Module 7.
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:

Interest Income Debtor’s Residence

Royalties Where the intangible is employed
Rent Income Location of the property
Service Income Place where the service is performed
Basic Rules
Merchandising
Earned where the property is sold
Income
Manufacturing Earned where the goods are manufactured and sold
Income ~ separated if the places of such are not the same
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.

Domestic Securities Presumed earned within the Philippines

Gains on sale Other Personal
Earned in the place where the property is sold
of property Properties
Real Properties Earned where the property is located

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.

Situs 2016 2017 2018 2019

Philippines 100,000 100,000 200,000 300,000
Abroad 150,000 200,000 100,000 100,000
Total 250,000 300,000 300,000 400,000

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.
 GENERALIZATION:
This module discusses the concept of gross income, the types of income taxpayers, the
general rules in income taxation and the income tax situs rules.

APPLICATION:
Problem 3.1 HENSON CASE
Henson sued an unscrupulous person for derogatory remarks which he considered
to have besmirched his reputation. The court awarded Henson an indemnity of
P1,000,000 inclusive of P200,000 reimbursement for Attorney's fees and P100,000
exemplary damages.

Compute Henson's total return on capital.

Problem 3.2 DENVER CASE

Denver is a supervisory employee of Atlantis Corporation. He had the following items of
gross income during the year:
• Denver was paid P800,000 salaries.
• Denver's P100,000 personal loan was paid by Atlantis Corporation as reward for
his excellent performance.
• Denver's P50,000 advances to the company was paid by Atlantis' chief
executive officer as a gift.
• Denver is entitled to excess representation and travel allowances. He
received P150,000 of which only P120,000 was actually disbursed.

Compute Denver’s total income subject to income tax.

Problem 3.3 TC COMPANY

TC Company manufactures wooden furniture for the local and export market. It has a
distribution outlet abroad which handles foreign sales. It bills all customers, including the
foreign outlet, 70% above manufacturing costs. The foreign outlet bills its customers 100%
above TC Company's billing price. TC Company reports P3,400,000 in total sales inclusive of
sales to the foreign outlet. The foreign outlet reports P2,720,000 total sales to customers.

Compute the manufacturing income respectively earned within and earned without
the Philippines.
 ACTIVITY / EVALUATION:

TRUE OR FALSE:

Determine whether the following statements are true or false. Write the answer on
the blank space provided for:

1. Dividends received from a foreign corporation may be earned within

the Philippines.
2. A citizen may be both a resident and non-resident in a taxable year.
3. There must be another party involved in an exchange transaction for a
benefit to be realized.
4. The situs of the gains on sale of domestic stocks is the place where the
sale occurred.
5. In classifying individual taxpayers, the intention is evaluated first before
applying rules on length of stays.

MULTIPLE CHOICE
Choose the best answer from the choices provided.
1. Which of the following is there a benefit realized?
a. Receipt of proceeds of an approved bank loan
b. Receipt of a car from a deed of donation
c. Discovery of lost properties
d. Discovery of hidden treasures in a lot owned
e. None of the above

2. Which of the following is taxable on their income earned abroad?

a. Resident Alien
b. Resident Citizen
c. Non-Resident Alien
d. Non-Resident Citizen

3. When are holding gains subject to income tax?

a. Never subject to income tax
 b. Once the value is determined
c. Once the asset is sold
d. Every yearend

4. Which of the following is subject to income tax?

I. Return on Capital
II. Return of Capital
III. Recovery of Lost Capital
IV. Recovery of Lost Profits
a. I and III
b. I and IV
c. II and III
d. II and IV

5. Dividends from this corporation is subject to the pre-dominance test.

a. Domestic Corporation
b. Resident Foreign Corporation
c. Non-Resident Foreign Corporation
d. Special Corporation
REINFORCEMENT:

TAXPAYER CLASSIFICATION
Determine the classification of each of the following taxpayers.
1. Liza Sober, a Filipino actress, visited Canada for 3 days to promote her
movie "Darna"
2. Melania, a Russian beauty queen, stayed for in the Philippines for 181 days
3. Valak Caudian, an Ilongga dancer, left the Philippines on March 15
for Tokyo, Japan to be an entertainer
4. Lala Pitan, a Cebuana, is employed in the Philippines in the
regional headquarters of McBonalds, a multinational company
5. Kim Chi, a Chinese, stayed in the Philippines for more than one year
6. Paul Lickett, an British citizen, has a business in the Philippines. He has
staying in the Philippines since April 17 of the previous year
7. Coolie Tan, a Filipino citizen, works as a chef in a Chinese restaurant
in Binondo
8. Sam Vanda, a Scottish, lives in the Philippines after being naturalized
9. Michael Angan, a Filipino, maintained his residence in Australia to live a
life with his wife

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.
 REFERENCES:

❖ Income Taxation with Special Topics and Properly Filled BIR Forms, 2020
Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S.

Tamayo, CPA, MBA

❖ Income Taxation-Laws, Principles and Applications- Rex B. Banggawan,

CPA, MBA

❖ National Internal Revenue Code of 1997

❖ Bureau of Internal Revenue Regulations

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Jurisprudence on Tax Cases

REFERENCES

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser

S. Tamayo, CPA, MBA
❖ Income Taxation-Laws, Principles and Applications- Rex B.
Banggawan, CPA, MBA
❖ Income Taxation with Special Topics in Taxation- Enrico D. Tabag,
CPA, MBA & Earl Jimson R. Garcia, CPA, MBA
❖ National Internal Revenue Code of 1997
❖ Bureau of Internal Revenue Regulations
Course Code and Title: BACR 5 – INCOME TAXATION

Lesson Number : 4

Topic : Income Tax Compliance

Instructor : Prof. Rosario A. Calamba, CPA, PhD

LEARNING OBJECTIVES

At the end of this lesson, the student should be able to:

1. Differentiate the three income tax schemes;

2. Determine what accounting periods to use for tax reporting;

3. Apply the different accounting methods in tax reporting; and

4. Define the types of returns for filing and payment of income taxes.
PRE-ASSESSMENT:
Try to answer the following questions.
1. Will a taxable income always be reported in an income tax return?
2. Is the monthly compensation income received passive or active income?
3. Do you think a business is allowed to file an annual income tax return which covers
less than a year of operations?
4. How do you think taxes are reported through filing?
5. How do you think taxes are paid?
6. Is it possible that late filing and payment of taxes may double or triple the amount
originally due?

LESSON PRESENTATION:

INCOME TAXATION SCHEMES

By virtue of the Ability to Pay Theory, the government should tax its subjects based on
their ability to pay, one basis of which is the income earned. Now that you have identified
what constitutes an item of gross income from the previous module, you are now to
determine how they are taxed in different schemes depending on the nature of said
income.

Based on the illustration above, income may be taxed under the three different schemes, namely,
Final Income Taxation, Capital Gains Taxation or Regular Income Taxation. This three income
tax schemes will be discussed thoroughly on the next modules.

Mutually Exclusive Coverage

The tax schemes are mutually exclusive. An item of gross income that is subject to tax in one
scheme will not be taxed by the other schemes. Similarly, items of gross income that are
exempted in one scheme are not taxable by the other schemes.
Final Income Taxation
Final Income Taxation is characterized by final taxes where taxes are withheld or
deducted at source. The taxpayer receives the income, net of tax. The payor of income
remits the tax to the government. Final taxation is applicable only on certain passive
income. Not all passive income is subject to final tax.

Passive Income vs. Active Income

Passive incomes are earned with very minimal or even without active involvement of the
taxpayer in the earning process and are generally irregular in timing and amount, whilst, active
income arises from transactions requiring a considerable degree of effort or undertaking from
the taxpayer.

Capital Gains Taxation

A capital gains tax is imposed on the capital gain on the sale, exchange and other
disposition of certain capital assets.

Capital Assets vs. Ordinary Assets

Ordinary assets are assets directly used in the business, trade or profession of the taxpayer such
as inventory, supply and items of property, plant and equipment. Capital assets include all
other assets other than ordinary assets.
Capital Gains vs. Ordinary Gains
Capital gains arise from the sale and other disposition of capital assets. Ordinary gains arise
from the sale and other disposition of ordinary assets.

Regular Income Taxation

The regular income taxation is the general scheme and is the catch basin for all other
incomes not subject to the other tax schemes. Items of gross income from these sources
are measured using an accounting method, accumulated over an accounting period,
and reported through an i ncome tax return.

ACCOUNTING PERIODS
Accounting period is the length of time over which income is measured and reported.

Regular Accounting Period

This composes of 12 months in length.
C alendar Year
The calendar accounting period starts from January 1 and ends on December 31. This
accounting period is available both to corporate and individual taxpayers.

Under the NIRC, the calendar year shall be used when the:

1. taxpayer's annual accounting period is other than a fiscal year

2. taxpayer has no annual accounting period
3. taxpayer does not keep books
4. taxpayer is an individual or cooperative

F iscal year
A fiscal accounting period is any 12-month period that ends on any day other December
31. The fiscal accounting period is available only to corporate taxpayers and is not
allowed for individual income taxpayers.

Short Accounting Period

This composes of less than 12 months.

N ewly commenced business

The accounting period covers the date start of the business until the designated year-end
of the business.

D issolution of business
The accounting period covers the start of the current year to the date of dissolution of the
business.

C hange of accounting period by corporate taxpayers

The accounting period covers the start of the previous accounting period up to the
designated year-end of the new accounting period. Note that BIR approval is required
in changing an accounting period. It is not automatic

D eath of the taxpayer

The accounting period covers the start of the calendar year until the death of the taxpayer.

T ermination of the accounting period of the taxpayer by the CIR

The accounting period covers the start of the current year until the date of the termination
of the accounting period.

ACCOUNTING METHODS
Accounting methods are accounting techniques used to measure income.
Accrual Basis
Under the accrual basis of accounting, income is recognized when earned regardless of
when received. Expense is recognized when incurred regardless of when paid. Income is
said to have accrued when the right to receive is established or when an enforceable right
to secure payment is created against the counterparty.

Cash Basis
Under the cash basis of accounting, income is recognized when received and
expense is recognized when paid.

R econciling the Difference

The financial accounting concept of accrual basis and cash basis are similar to their tax
counterparts, except only for the following tax rules:

Advanced income is taxable upon receipt.

Income received in advance is taxable upon receipt in pursuant to the Lifeblood Doctrine
and the Ability to Pay Theory. The subsequent taxation of advanced income in the period
earned will expose the government to risk of non-collection.

Prepaid expense is non-deductible.

Prepaid expenses are advanced payment for expenses of future taxable periods. These
are not deductible against gross income in the year paid. They are deducted against
income in the future period they expire or are used in the business, trade or profession
of the taxpayer.

Normally, the expensing of prepayments does not properly reflect the income of the
taxpayer. It also contradicts the Lifeblood Doctrine as it effectively defers the recognition
of income.

Special tax accounting requirement must be followed.

There are cases where the tax law itself provides for a specific accounting treatment of an income
or expense. The specified method must be observed even if it departs from the basis regularly
employed by the taxpayer in keeping his books.

Refer to the table below to distinguish the two general accounting methods for a service taxpayer.
Line Item Tax Accrual Basis Tax Cash Basis
Cash Income Add Add
Accrued Income Add Ignore
Advanced Income Add Add
Gross Income Xxx xxx
Cash Expenses Deduct Deduct
 Accrued Expenses Deduct Ignore
Amortization of Prepayments Deduct Deduct
Depreciation Deduct Deduct
Net Income Xxx xxx

Illustration 4.1.
A service-type business reports the following for the year 2019 and 2020: [Refer to the answer
on the right portion]
Actual Tax Accrual Basis Tax Cash Basis
Item
2019 2020 2019 2020 2019 2020
Collection for Services 50,000 80,000 50,000 80,000 50,000 80,000
Rendered
Accrued Income from 50,000 40,000 50,000 40,000 - -
Service Rendered
Collection of Accrued 30,000 45,000 - - 30,000 45,000
Income from Previous
Year
Collections for Service 30,000 20,000 30,000 20,000 20,000 20,000
not yet Rendered
Gross Income - - 130,000 140,000 100,000 145,000
Payment of Current 40,000 60,000 40,000 60,000 40,000 60,000
Year’s Expenses
Accrued Expenses 10,000 15,000 10,000 15,000 - -
Payment of Previous 5,000 10,000 - - 5,000 10,000
Year’s Expenses
Prepayment for Next 20,000 30,000 - 20,000 - 20,000
Year’s Expenses
Net Income - - 90,000 45,000 55,000 55,000

The same can be applied to sellers of goods. The computation of COGS will be the same
as what you have used in your Intermediate Accounting and Cost Accounting classes.

Instalment Method
Installment method is available to the following taxpayers:

1. Dealers of personal property on the sale of properties they regularly sell

 2. Dealers of real properties, only if their initial payment does not exceed 25% of the selling
price
3. Casual sale of non-dealers in property, real or personal, when their selling price exceeds
P1,000 and their initial payment does not exceed 25% of the selling price.

S teps for Instalment Method

Step 1: Evaluate the seller.
Check which item from the three above the sale is similar to. If it is similar to the first item,
proceed directly to Step 6.

Step 2: Compute for the Selling Price

The selling price is the entire amount for which the buyer is obligated to the seller.

Total Cash Consideration xx

FV of Non-Cash Consideration xx
Mortgage/Indebtedness assumed by the Buyer xx
Selling Price xx
If the item is the last one and the selling price is less than P1,000, you may not use the
instalment method.

Step 3: Check if the Mortgage/Indebtedness assumed exceeds the tax basis of the asset.
If there is no indebtedness assumed, skip this step. If the indebtedness exceeds the tax
basis of the asset, add the excess to Step 4.

Step 4: Compute for the Initial Payment

This includes all payments, be it in cash or property, made by the buyer at the year of
sale.

Downpayment xx
Instalment made on the same year xx
Excess mortgage/indebtedness (from Step 3) xx
Initial Payment xx
This is to reiterate that it should be at the same year of sale and not within a year after the sale.

Step 5: Compute for the IP/SP Ratio

This is to check whether the use of instalment method is allowed for the second and third

item. If the ratio exceeds 25%, the instalment method is not allowed.

Step 6: Compute for the Contract Price

The contract price is the amount receivable in cash or property from a buyer.

Selling Price xx
Mortgage/Indebtedness assumed by the buyer (xx)
 Excess mortgage/indebtedness (from Step 3) xx
Contract Price xx

Step 7: Compute for the Gross Profit

This involves computing for the total gross profit from the sale.

Selling Price xx
Tax Basis of the Asset (xx)
Gross Profit xx

Step 8: Compute for the Gross Income for each collection

To compute for the gross income for each collection, use the formula below.

Gross Profit xx
Multiply by: Collection xx
Divide by: Contract Price xx
Gross Income xx

Illustration 4.2.
On June 19, 2019, a dealer made a sale of real property with a tax basis of P1,300,000 for
P2,000,000. The property was subject to a P1,500,000 mortgage which was agreed to be
assumed by the buyer. The buyer paid a P100,000 downpayment with the balance due in two
instalments of P200,000 on December 31, 2019 and July 1, 2020.

Step 1: The sale is made by a dealer of real property

Step 2: The selling price is P2,000,000.
Step 3: The mortgage exceeds the tax basis by P200,000.
Step 4: The initial payment of P500,000 consists of the P200,000 excess mortgage, P100,000
downpayment and P200,000 first instalment.
Step 5: The IP/SP Ratio is exactly 25%, thus, the instalment method can be used.
Step 6: The contract price of P700,000 can be obtained by deducting the mortgage assumed of
P1,500,000 from and adding the excess mortgage of P200,000 to the selling price.
Step 7: The gross profit of P700,000 can be obtained by deducting the tax basis of P1,300,000 to the
selling price.
Step 8: Using the formula, the gross income will be recognized for tax purposes in this pattern.
At the date of sale (downpayment and excess mortgage) 300,000
December 31, 2019 200,000
July 1, 2020 200,000
Deferred Payment Method
This is a variant of the accrual basis and is used in reporting income when a non-interest-
bearing note is received as consideration in a sale.

This will not be thoroughly discussed in this module since it is similar to the accounting you
have learned in your Intermediate Accounting classes.

Percentage of Completion Method

This method is more likely to be used by construction companies or those whose earning
process takes more than a year. IN this method, the estimated gross income from construction is
reported based on the percentage of completion of the construction project. There are several
methods of estimating project completion in practice, but the output method based on
engineering survey is prescribed by NIRC.

Illustration 4.3.
On March 16, 2018, Takder Constructions accepted a P5,000,000 fixed-price construction
contract. It incurred construction expenses of P2,800,000 and P1,500,000 for 2018 and 2019,
respectively. The project was 65% completed by yearend 2018 and was fully completed by
2019.

The reportable gross income on construction will simply be

computed
Year as follows: 2018 2019
Contract Price 5,000,000 5,000,000
Percentage of Completion 65% 100%
Cumulative Construction Revenue 3,250,000 5,000,000
Construction Revenue from Prior Years - 3,250,000
Construction Revenue for Current Year 3,250,000 1,750,000
Construction Expenses for Current Year 2,800,000 1,500,000
Construction Gross Income 450,000 250,000

Income from Leasehold Improvement

Leasehold improvements are tangible improvements made by the lessee to the property
of the lessor. Improvements will benefit the lessor when their useful life extends beyond
the lease term. This benefit is referred to as income from leasehold improvement.

Under Revenue Regulations No, 2, the income from leasehold improvement can be
reported using either of the two following methods at the option of the taxpayer.
Outright Method
The lessor may report as income the fair market value of such buildings or improvements
subject to the lease at the time when such buildings or improvements are completed.

Spread-Out Method
The lessor may spread over the life of the lease the estimated depreciated value of such
buildings or improvements at the termination of the lease and report as income for each
year of the lease an aliquot part thereof. The depreciated value of the leasehold
improvement is computed as follows.

Cost of Improvement x
Multiply by: Remaining Useful Life after Lease x
Term Divide by: Useful Life of the Improvement xx
Depreciated Value xx
xx

It should be pointed out that this rule exists only in the regulation and is absent in the
NIRC. Some taxpayers are questioning its validity pointing out lack of legal basis.
However, it is fairly proper to consider the depreciated value of the improvement that
remains to the lessor upon termination of the lease as income because it is an actual
benefit to the lessor. These are, in effect, additional rental consideration in kind.

However, the treatment specified by the outright method is perceived as unjust and
abusive, and is an improper introduction of legislation. The depreciated value of the
improvement at the termination of the lease should be the proper value to be recognized
as gross income under the outright method. This view is supported by the fact that the
spread-out method could not have been an option if the outright method intended to tax
the entire fair value of the improvement considering the huge disproportion in the
reportable gross income in the two options. The outright method as mandated by the
regulation will best apply in cases where lessees pay the lessor rentals in the form of
leasehold improvements or when leasehold improvements made by lessees are treated
as reductions to cash rentals.
 Illustration 4.4.
On January 1, 2018, Anderson leased a vacant lot to Greg under a 20-year lease contract. Greg
immediately constructed a building on the lot at a total cost of P4,500,000 and was finished on
December 30, 2019. The building has useful life of 30 years.

Under the plain wordings of Section 49 of Revenue Regulations No. 2, Anderson shall recognize the
entire P4,500,000 fair value of the improvement as gross income upon completion of the improvement
in 2018. This is not income in its totality, but this is the amount referred to by the regulation.

The depreciated value of the property at the termination of the lease is the value of the years of usage of
the lessor. This can be computed by splitting the value of the improvement.
Cost of Improvement 4,500,000
Multiply by: Remaining Useful Life after Lease Term 12
Divide by: Useful Life of the Improvement 30
Depreciated Value 1,800,000
Divide by: Remaining Lease Term 18
Annual Income from Leasehold Improvement 100,000
The computed depreciated value of the improvement will be recognized as income by the lessor for the
remaining 18 years of the lease term.

Crop Year Basis

Farming income is commonly recognized using the cash basis or accrual basis. However, long-
term crops or those that take more than one year to harvest may be accounted for under the
crop year basis. Under the crop year basis, farming income is recognized as the difference
between the proceeds of harvest and expenses of the particular crop harvested. The expenses of
each crop are accumulated and deducted upon the harvest of the crop. No illustration will be
given for this as the matching principle is just followed in using this accounting method. The
cropping expenses are deducted to the related revenues derived from the same crop year,
regardless of when this expense is incurred, and the revenue earned.

INCOME TAX REPORTING

Type of Returns to the Government
I ncome Tax Returns
These provide details of the taxpayer’s income, expense, tax due, tax credit and tax still
due. This is more likely applicable for the self-assessment method.
Deadline of Income Tax Returns for Full Accounting Period
For income tax returns of income subject to regular income taxation, the following are the
deadlines for filing and payment.

Period of the
For Individuals in Business For Corporations
Taxable Year
May 15 of the taxable year using
First Quarter
1701Q
Sixty (60) days following the close
August 15 of the taxable year using
Second Quarter of each of the first three (3) quarters
1701Q
of the taxable year using 1702Q
November 15 of the taxable year
Third Quarter
using 1701Q
15th day of the 4th month following
April 15 of the succeeding year
Whole close of the taxpayer's taxable year
using 1701 or 1701A
normally using 1702RT

Deadline of Income Tax Returns for Short Accounting Period

Filing of ITRs with a short accounting period has the same deadline for annualized
returns for full accounting periods above.

Frequency of Reporting
Taxpayer Frequency
Individual – Pure Compensation
Annual
Income Earned
Individual – Purely Engaged in
Quarterly and Annually
Business or Profession
Individual – Mixed Income Earner Quarterly and Annually
Corporations Quarterly and Annually

Substituted Filing System for Employees

Pure compensation income earners may be relieved from the obligation to file their
annual income tax return if they have no taxable income from other sources other from
their lone employer. The employee may avail of the substituted filing system wherein
the employer shall withhold the income tax of the employee's compensation.

If the employer correctly withheld the tax due of the employee through the withholding
tax on compensation, the employee need not file his Form 1700 anymore since there would be no
residual tax due or tax refundable, The Form 1700 is required if the employee has other
taxable income or has more than one employer, either concurrent or successive, during the
year.

W ithholding Tax Returns

These provide reports of income payments subjected to withholding tax by the taxpayer-
withholding agent.

These returns will also be further discussed in Module 16.

I nformation Returns
Certain taxpayers are also required to file information returns to the government. These
information returns do not involve any payment or withholding of tax but are essential to the
government in its tax mapping efforts and in its evaluation of tax compliance. Non-filing of
required information returns are also subject to penalties, fines, and or imprisonment.

Modes of Filing Income Tax Returns

M anual Filing System
The traditional manual system of filing income tax return is by paper documents where
taxpayers fill up BIR forms to report income, expenses, or any declaration required to be filed
with the BIR. Under the NIRC, the income tax return shall be filed to the following, in descending
order of priority, within the revenue district office where the taxpayer is registered or required
to register:

1. An authorized agent bank (AAB)

2. Revenue Collection Officer
3. Duly authorized city or municipal treasurer

eBIR Forms
The BIR introduced the eBIR Forms with an offline or online version. Taxpayers fill up their
income tax returns in electronic spreadsheets without the need of writing on papers returns. The
system ensures completeness of data on the return and is capable of online submission. If there
are no penalties that require BIR assessments, taxpayers would have to print a hard copy of the
filled tax returns and proceed directly to the bank for payment.

E lectronic Filing and Payment System (eFPS)

The eFPS is a paperless tax filing system developed and maintained by the BIR. Taxpayers file
tax returns including attachments in electronic format and pay the tax through the Internet.

Taxpayers mandated to use the eFPS

1. Large taxpayers duly notified by the BIR

2. Top 20,000 private corporations duly notified by the BIR
 3. Top 5,000 individual taxpayers duly notified by the BIR
4. Taxpayers who wish to enter into contracts with government offices
5. Corporations with paid-up capital of P10,000,000
6. PEZA-registered entities and those located within Special Economic Zones
7. Government offices, in so far as remittance of withheld VAT and business
tax are concerned
8. Taxpayers included in the Taxpayer Account Management Program (TAMP)
9. Accredited importers, including prospective importers required to secure the
Importers Clearance Certificate (ICC) and Custom brokers Clearance Certificate
(BCC)

G rouping of Taxpayers under eFPS

Certain taxpayers are grouped together depending on their industry. Taxpayers in each group
who use the eFPS are given additional days to file their returns after the regular deadline for
manual filing.

Payment of Income Taxes

The general rule is "pay as you file". The capital gains tax and regular income tax are paid
as the taxpayer files his return. Installment payment of income tax is allowed on certain
conditions.
Taxpayers under the EFPS system shall e-pay their tax online through internet banking
service. The account of the taxpayer will be auto-debited for the amount of taxes to be paid.
Basic Comparison
Activity Manual eBIR eFPS
Data Entry Manual Electronic Electronic

Filing/Submission Manual Electronic Electronic

Tax Payment Manual Manual Electronic

Penalties for Late Filing or Payment of Tax

The late filing and payment of taxes is subject to the following additional charges.

S urcharge
The surcharge penalty to be paid is either of the following:

a. 25% of the basic tax for failure to file or pay deficiency tax on time
b. 50% for willful neglect to file and pay taxes

The non-filing is considered 'willful neglect' if the BIR discovered the non-filing first. This is the
case when the taxpayer received a notice from the BIR to file return. If the taxpayer filed a
return before the receipt of such notice, the same is considered simple neglect subject to the 25%
surcharge.

I nterest
The taxpayer must pay an additional 12% per annum interest on the basic tax due starting from
the date of the deadline of filing the return. The actual days will be considered in computing the
period factor.

It should be noted that the TRAIN Law states that the interest penalty shall be twice the legal
rate prescribed by the Bangko Sentral ng Pilipinas which is currently at 6%. The 12% interest
rate prescribed by the TRAIN Law has no retrospective effect on late filings of returns with
deadlines before 2018, thus, the 20% interest is still applicable by the time the interest accrues
up to December 31, 2017.

C ompromise
Compromise penalty is paid in lieu of criminal prosecution over a tax violation. For the full
information on the amounts of this penalty, click the link on the following text: Revised
Schedule of Compromise Penalty
 Illustration 4.5.
Due to the limited workforce and cash resources, E-Gull Company was not able to file and
pay its 2019 Income Tax Return by the last day of filing on June 15, 2020. The same problem
was only brought up by September 10, 2021 by which the company was only able to finally
pay on September 29, 2021. Their income tax due for 2019 is P250,000.

The following should be paid on September 29, 2021:

Basic tax Due 250,000
Surcharge (250,000 x 25%) 62,500
Interest (250,000 x 12% x 471/365) 38,712
Compromise Penalty (based on Annex A of RMO 7-2015) 20,000
Total Payment 371,212

Penalties for Non-Filing or Late Filing of Information Return

For each failure to file a separate information return, statement or list, or keep any record,
or supply any information required by the Code or by the Commissioner on the date
prescribe therefor, unless it is shown that such failure is due to reasonable cause not to
willful neglect, shall be subject to a penalty off P1,000 for each such failure. Provided that
the amount imposed for all such failure during a calendar year shall not exceed
P25,000.00.

GENERALIZATION:
This module discusses about the types of taxation schemes and their
scope; the concept of accounting period and its types; the concept of
accounting methods and their accounting procedures and the types of
income tax returns, their deadline and place of filing.
APPLICATION:
Determine whether the following needs to file for a regular or short accounting period. Write R if its
regular and S if it is short under the Period Column. Also determine the start and end of the period
to be used on the ITR and deadline for filing and payment. Indicate the code of the form to be used. If
the statement is silent, assume the events occur in 2020 and the reportable period is for a whole
accounting period, be it regular or short.
Taxpay Period Start End Form Deadlin
er e
1. The second quarter return of a
corporation whose fiscal year
ends on April 30

2. The third quarter return of item

number 1

3. The third quarter return of an

individual business owner

4. A corporation whose fiscal year

ends on September 30 switches
to use the calendar year

5. The annual ITR of a corporation

whose fiscal year ends June 30

6. The annual ITR of a self-employed

individual

7. A corporation registered with the

BIR on April 6 which it opted to
use a fiscal year ending October
31
8. A self-employed individual
registered with the BIR on
October 15

9. A taxpayer dies on July 10

10. A corporate taxpayer with a fiscal

year ending March 31 was
dissolved on November 1
ACTIVITY/EVALUATION:

TRUE OR FALSE
Determine whether the following statements are true or false. Write your answer on
the blank space provided for:
1. Only corporate taxpayers may use the fiscal accounting year.
2. The interest on unpaid taxes is computed based on the basic tax
due and surcharge penalty.
3. The crop year basis is an accounting period.
4. The accounting period of a deceased taxpayer shall be
terminated on December 31 of the year of his/her death.
5. The excess mortgage is considered as a payment on the date of
sale when using the instalment method.
6. The use of different methods for different businesses of the same
taxpayer is permitted by law.
7. When using the percentage of completion method, the gross
income to be reported for income tax purposes is the computed
amount of construction revenue earned during the year.
8. Payments made covering future expenses are deductible on the
year of outflow.
9. The 25% ratio rule must be satisfied in order for a dealer of personal
property to use the instalment method.
10. Withheld taxes on income payments are creditable against the income

tax due of the payee.

Identify the terminologies best described by the following statements.

1. The tax scheme for most passive income
2. The online filing and payment of taxes in the Philippines
3. This is the sum of all consideration receivable by the seller in an
instalment sale
 4. This is the sum of all considerations receivable by the seller on the year
of sale in an instalment sale
5. A full accounting period not ending with December 31

MULTIPLE CHOICE:
Choose the best answer from the choices provided.
1. Under which of the following will short accounting period not arise?
a. Change of accounting period by a corporate taxpayer
b. Change of accounting period by an individual taxpayer
c. Death of a taxpayer
d. Dissolution of a business
e. None of the above

2. Which is a capital asset?

a. Fixtures used to display merchandise
b. An undeveloped land owned held for capital appreciation
c. Jewelries owned by a pawnshop business
d. Building used for administrative operations

3. Which of the following is not required to be paid in case of late filing?

a. Basic Tax Due
b. Surcharge
c. Compromise
d. Interest
e. All are required

4. Which of the following sale can directly use the instalment method
without any other requisites to follow?
a. Sale of personal property by a dealer
b. Sale of real property by a dealer
c. Sale of personal property by a non-dealer
d. Sale of real property by a non-dealer
REINFORCEMENT:
Case Study TAX STALLING VIA INSTALMENT METHOD
4.1
Paz Encioso, a dealer of real properties, uses the instalment method in accounting
for its instalment sales using appropriate accounting standards. During the year,
the assigned revenue officer informed him that it cannot be used for one sale
transaction he entered into since the initial payments exceeded the 25% ratio
relative to its selling price.

Paz questions why the method is disallowed for this transaction as he has always
been using said method for tax purposes. He also assails that he cannot yet fully pay
the related income tax on the gross income since he is yet to receive most of the
instalments in the coming years.

Feeling fed up with the continuous rants of the mad Paz Encioso, the revenue officer
just answered that Paz should research the term “Lifeblood Doctrine” on Google.

Whose contention is tenable?

Case Study PICKING ON PENALTIES

4.2
The former accountant of Ragsak Company resigned on April 10 without informing
anyone that she did not file for the company’s income tax return for the previous year.
Dina Natuto, the chief financial officer just found out this problem by a notice given by BIR
and rushed to file and pay their income tax due despite months being past the deadline.
When she looked at the penalty portion of the ITR, she found out that they were charge a
50% surcharge instead of the 25% rate and high amounts of interest and compromise
penalty.

Due to the cash restrictions of the company, Dina argues that she did not know of the
unfiled ITR and she acted in good faith upon knowing such that she rushed immediately
to settle it, proving that there were no acts of willful neglect. She also argues that there
should be no compromise penalty since this for the criminal prosecution and that the
Constitution sets a non-imprisonment provision limiting the State’s power of taxation.
Lastly, she argues that there should be no interest to be paid on late filing for the same
reason that the government does not pay interest on excess taxes paid to them, also
considering that applications for refund takes longer to be approved in practice.

Will Dina be the hero of the company on this problem?

REFERENCES:

❖ Income Taxation with Special Topics and Properly Filled BIR Forms, 2020
Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S.

Tamayo, CPA, MBA

❖ Income Taxation-Laws, Principles and Applications- Rex B. Banggawan,

CPA, MBA

❖ National Internal Revenue Code of 1997

❖ Bureau of Internal Revenue Regulations

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Jurisprudence on Tax Cases

Course Code and Title: BACR 5 – INCOME TAXATION

Lesson Number : 5

Topics : Final Income Taxation

Instructor : Prof. Rosario A. Calamba, CPA, PhD

LEARNING OBJECTIVES

At the end of this lesson, the student should be able to:

1. Define the characteristics of final income taxation;

2. Differentiate passive and active income;

3. Explain the coverage of final taxes on income of non-residents;

4. Identify the final tax rates for different income types;

5. Properly journalize final taxes in the books of the payor and payee;
and

6. Identify the required forms to be filed and their deadlines.

PRE-ASSESSMENT

Try to answer the following questions.

1. When you open the bank statement of your deposit account, do you see an
item “Tax Withheld” showing up every quarter?
2. Assuming your bank account earns a 4% interest per annum, how much is its
effective interest rate considering the tax consequences?
3. Would you rather want your tax directly deducted from your income or still
get the whole of your income and then pay the corresponding tax later?
4. Assume your rich grandfather died recently and he was your favorite
grandchild. Since he says that you are a great accountant, you should be the
executor of his will, with the free portion directly going to you. Which
would you like the estate to be? One mostly consisting of cash in various
bank deposits or one mostly in the form of tangible assets? Why?
5. Why do you think most game shows of raffle promos limit most of their
regular prizes at P10,000? Why won’t they adjust it to reflect inflation?
6. If you won P250 million from the lotto today, by how much would you be
richer once you redeem your ticket?
7. Supposed you informed BIR on a tax fraud and it awarded you a reward for
that. Will BIR tax that reward back?
LESSON PRESENTATION

DEFINITION

Final Withholding Tax is a kind of withholding tax which is prescribed only for
certain payors and is not creditable against the income tax due of the payee for the
taxable year. Income Tax withheld constitutes the full and final payment of the
Income Tax due from the payee on the said income. Final Income Taxation is
characterized by final taxes where taxes are withheld or deducted at source. The
taxpayer receives the income, net of tax. The payor of income remits the tax to the
government. Final taxation is applicable only on certain passive income. Not all
passive income is subject to final tax.

Passive Income vs. Active Income

Passive incomes are earned with very minimal or even without active involvement of
the taxpayer in the earning process and are generally irregular in timing and amount,
whilst, active income arises from transactions requiring a considerable degree of effort
or undertaking from the taxpayer.

The final withholding tax is built upon the taxpayer and government convenience. It
relieves the taxpayer of the obligation to file an income tax return. This is very convenient
for taxpayers who are limited by distance, time and cost to comply. For the government, the
final withholding tax system is the most convenient and effective system in collecting taxes on
income where there is no risk of non-compliance or tax evasion.

FEATURES
The final tax scheme has the following features:

1. Full and final payment

2. Tax withholding at source
3. Territorial imposition
4. Imposed on certain passive income and persons not engaged in
business in the Philippines
5. No filing of income tax return by the payee
GENERAL COVERAGE

Unless otherwise indicated, the final tax rates shall apply to all taxpayers, except for non-
resident aliens not engaged in trade or business who are taxed at 25% and non-resident
foreign corporations which are taxed at 30%.

Individuals in this discussion would involve: Resident Citizens, Non-Resident Citizens,

Resident Aliens and Non-Resident Aliens engaged in trade or business, whereas,
corporation would include: Domestic Corporations and Resident Foreign Corporations.

INTEREST INCOME ON SHORT-TERM PESO DEPOSITS

There shall be a final tax at the rate of 20% imposed on the interest income or yield from
the following sources:
Illustration 5.1
Banco del Oro incurs the following interest in its deposit accounts from
depositors:
Non-resident Citizens 600,000
Resident Aliens 100,000
Non-resident Corporation 200,000

The total final tax withheld would

be: Non-resident 600,000 x 20% =120,000
Citizens Resident Aliens 100,000 x 20% = 20,000
Non-resident 200,000 x 30% = 60,000
Corporation
200,000
TOTAL
480,000
The depositors would only receive the following
amounts:
Resident Aliens 80,000
Non-resident Corporation 140,000
TOTAL 700,000

INTEREST INCOME ON LONG-TERM PESO DEPOSITS

There shall be a final tax at the rate of 20% imposed on the interest income or yield from
long- term deposits and deposit substitutes earned by corporations. Interest income
earned by individuals on the same financial products are exempt from this final tax.

What constitutes long-term?

In the context of this final tax, a deposit/deposit substitute is considered long-term if the
holding period is at least five years.

Since individual taxpayers are exempt if the deposit is long-term, most would just open a
long- term one and then pre-terminate such to avoid the final tax. As such, if the deposit or
investment placement of individual taxpayers is pre-terminated before five years, any
previously untaxed or exempted interest income will be subjected to the following final
taxes upon pre-termination depending on the length of the holding period.
 Illustration 5.2
On January 1, 2018, AMC invested P2,000,000 in a 5-year bank deposit with an interest of 5%
annually. AMC preterminated the deposit on July 1. 2021.
• If AMC is a corporation.
Interest Income (2,000,000 x 5% x 3.5) 350,000
Multiply: Final Tax Rate 20%
Final Tax 70,000
• If AMC is a resident citizen.
Untaxed Interest Income (2,000,000 x 5% x 3.5) 350,000
Multiply: Final Tax Rate 12%
Final Tax on Pre-termination 42,000

INTEREST INCOME FROM FOREIGN CURRENCY DEPOSITS AND

LOANS
Interest income derived from the following sources shall be imposed with the respective rates of
final tax:

Offshore Banking Unit" or "OBU" shall refer to a branch, subsidiary or affiliate of a foreign
banking corporation which is duly authorized by the Central Bank of the Philippines to
conduct of banking transactions in foreign currencies involving the receipt of from external
sources and utilization of such funds.
 "Foreign currency deposit unit" or "FCDU" shall refer to that unit of a local bank or of a
local branch of a foreign bank authorized by the Central Bank to engage in foreign
currency- denominated transactions.

AMOUNTS WITHDRAWN FROM DECEDENT'S DEPOSIT ACCOUNT

If a bank has knowledge of the death of a person, who maintained a bank deposit account alone,
or jointly with another, it shall allow the withdrawal from the said deposit account, subject to a
final withholding tax of six percent (6%) of the amount to be withdrawn, provided that the
withdrawal shall only be made within one year from the date of the decedent. Such withheld
tax shall not be creditable to the estate tax in relation to the death of the decedent.

Illustration 5.3
Going back to question number 4 in the pre-activity, suppose there is a P1,000,000 deposited
in the bank account of your grandfather and the rest of his estate consists of several parcels of
land readily divided for the legitime of the mandatory heirs, including the free portion that
you can get. The titles of the lands cannot be transferred if the Estate Tax of P940,000 cannot
be paid with the BIR.

You may withdraw the full amount of the bank deposit but it will be subject to 6% final tax amounting
to P60,000. The net proceeds of P940,000 can be used to pay the estate tax to BIR. Once paid, you can
already be issued the electronic Certificate of Authority to Register and transfer the titles to the heirs
and yours.

TAX-FREE COVENANT BONDS

Interest income or other payments of any individual taxpayer, including NRA-NETB, from
tax- free covenant bonds, mortgages, deeds of trust or other obligations of domestic and
resident foreign corporations shall be subject to final withholding tax of 30%.
 Illustration 5.4
Juana del Cruz, a resident entered into a tax-free covenant bond agreement with Salakot
Corporation, a domestic corporation. The bonds carried a 10% interest for the principal
amount of P7,000,000.

The interest received will be assumed as net of tax.

Principal 7,000,000
Multiply: Rate of interest 10%
Interest Income, net 700,000
Divide by to Gross-up 70%
Interest Income, gross (Tax Base) 1,000,000
Multiply: Final Tax Rate 30%
Final Tax Withheld 300,000

CASH AND PROPERTY DIVIDENDS

Dividends received by the following taxpayers, whether in cash or in kind, shall be
subject to the following final tax rates depending on the payor.

The tax sparing rule shall apply to an NRFC which is a resident or is domiciled in a
country which: (1) has no effective tax treaty with the Philippines; (2) has a worldwide
system of taxation; and (3) allows a tax credit against the tax due from the NRFC
dividend taxes deemed to have been paid in the Philippines equivalent to 15%.
 A real estate investment trust (REIT) is a corporation whose primary business is owning,
developing, and managing real estate properties, such as apartment buildings, office
buildings, hotels, warehouses, health care facilities, shopping malls or golf courses.

SHARE IN NET INCOME IN A TAXABLE PARTNERSHIP,

ASSOCIATION, JOINT ACCOUNT, JOINT VENTURE OR
CONSORTIUM
The share in the net income of the following taxpayers shall be subject to the respective final tax
rates as summarized below:

It is to be noted that this is only applicable to taxable partnerships. Notice that the rates are
similar to that of the final taxes with dividends. In essence, shares of partners in the net income
of a partnership are dividends available for withdrawal. Also notice that there are no rates for
corporations since partnerships can only be formed by natural persons.

Illustration 5.5
Paul, Lee and Kath formed a partnership engaged in a merchandising business in Batangas.
The three personally manages the business. Paul and Kath are Filipinos. Lee’s Chinese
citizenship adds effectiveness in managing the business. During the year, they reported net
income of P600,000 which they divide equally among themselves.

The three partners will have a share of P200,000 each. They are, however, subject to 10% final tax,
therefore, each will only receive P180,000.

PASSIVE ROYALTIES
Passive royalties received by a taxpayer shall be subject to the following final tax rates:
Illustration 5.6
Michael Angan is an author of an accounting book. He earned a 10% royalty for every P500
copy of his book sold. During the month, his book sold 900 copies.

Michael will receive the following amount:

Copies Sold 900
Multiply: Sales Price 500
Sales 450,000
Rate 10%
Royalties earned 45,000
Less: Final Tax (45,000 x 10%) 4,500
Amount Received 40,500

Illustration 4.6
Film-ipino Inc. received a check for P640,000 from FilmWorld Corp. as royalties for its
cinematographic works.

The final tax to be remitted to BIR is:

Net Amount 640,000
Divide by to Gross-up 80%
Royalties 800,000
Rate 20%
Final Tax 160,000
PRIZES AND WINNINGS OF INDIVIDUALS
Prizes and winnings of individuals obtained from local sources shall be taxed at the
following final rates:

It should be noted that the P10,000 threshold is not an exemption threshold rather it only
determines whether the income is included in final tax or regular income tax. As such,
prizes at most P10,000 is still taxable under regular taxation and those above P10,000 is
fully taxable under final taxation. Prizes and winnings of corporate taxpayers are subject
to regular income tax. Prizes and winnings not subjected to final tax are reportable under
regular income taxation.

E xempt Prizes
The following are exempt prizes:

1. Prizes received by a recipient without any effort on his part to join a contest.
Examples include prizes from awards like Nobel Prize, Most Outstanding
Citizen, etc.
2. Prizes from sports competitions that are sanctioned by their respective national
sport organizations

R equisite for Exemption

Exempt prizes mentioned above should meet the following requisites:

1. The recipient was selected without any action on his part to enter the contest.
2. The recipient is not required to render substantial future services as a
condition to receiving the price or award.

Prize vs. Winning

A prize is a reward for a contest or competition. In other words, a prize represents a
remuneration for an effort reflecting one’s superiority. A winning, in contrary, is a
reward for an event that depends on chance such as winnings from gambling, lottery or
raffle ticket.
 Illustration 5.7
Lucky Manzañas won in a raffle promo and took home P9,000 cash. Two days after, he
played in “Bawal Judgemental”, earning a prize of P35,000 since he got three wrong answers.
Compute the final taxes withheld from him.

The P9,000 cash winnings from the raffle promo was subjected to final tax regardless of the amount.
This amount is already the net receipts. The grossed-up amount of P11,250 is multiplied by 20% to get
the final tax of P2,250. As for the prize, the gross amount of P35,000 is multiplied by 20% since it
exceeds P10,000. The final tax on such is P7,000.

INFORMER’S CASH REWARD

A 10% final tax shall be imposed on rewards received from informing on violations of
NIRC and discovery and seizure of smuggled goods which were deemed legitimate and
collectible against the violator. It should be noted, however, that the amount of reward
is 10% of the collection from the information or P1,000,000, whichever is lower.

Illustration 5.8
Wiz L. Blue shared two pieces of information with the BIR that allegedly proves two tax
evading companies. Company A was then assessed and was forced to pay P500,000 of
deficiency taxes. Company B was also assessed and was liable to deficiency taxes of
P12,000,000.

Wiz will be earning 10% of P500,000 as reward related to Company A’s violation. The P50,000
reward will be subject to 10% final tax, reducing the cash receipt to P40,000.
For the information provided anent to Company B, the 10% of P12,000,000 exceeds the maximum
reward of P1,000,000, therefore, the basis of the 10% final tax is P1,000,000.
OTHER ITEMS OF INCOME SUBJECT TO FINAL TAX

The following are other items of passive income specifically subject to final tax.

ACCOUNTING FOR FINAL TAXES

To illustrate the journal entries for the recording of final taxes, let us journalize some of
the illustrations given.

Illustration 5.1
Books of Payor Books of Payee
Interest Expense 900,000 Cash in Bank 700,000
Final Tax Withholdings 200,000 Income Tax Expense 200,000
Payables Interest Income 900,000
Cash 700,000

Final Tax Withholdings 200,000

Payables
Cash 200,000
 Illustration 5.6
Books of Payor Books of Payee
Royalty Expense 800,000 Cash 640,000
Final Withholding Taxes 160,000 Income Tax Expense 160,000
Payable Royalty Income 800,000
Cash 640,000

Final Withholding Taxes 160,000

Payable
Cash 160,000

FILING AND PAYMENT OF FINAL TAXES

Every withholding agent (WA)/payor required to deduct and withhold taxes on
income payments subject to Final Withholding Taxes shall file the following
within the specified deadlines: [You may click the form codes to access the link to
the pdf file of said form.]

Deadline
Form Name Manual Filing eFPS Filing

Monthly Remittance Form of tenth (10th) day 11th-15th day

Final Income Taxes Withheld following the month following
in which withholding month
0619F
withholding was depending on the
made taxpayer’s line of
business
Quarterly Remittance Return of last day of the Not yet available
Final Taxes Withheld on month following the
Interest Paid on Deposits and close of the quarter
1602Q
Deposit during which
Substitutes/Trusts/Etc. withholding was
made
Quarterly Remittance Return of last day of the month following the close of
1601FQ Final Income Taxes Withheld the quarter during which withholding was
made
Certificate of Final Income Tax on or before January 31 of the year
2306 Withheld following the year in which income
payment was made
 Annual Information Return on
Final Income Taxes Withheld
1604F
(with Annual Alphabetical List
of Payees)
on or before January 31 of the year
following the calendar year in which the
income payments subject to final
withholding taxes were paid or accrued

ACTIVITY/EVALUATION

TRUE OR FALSE
Determine whether the following statements are true or false.
1. The maximum net cash receipts from rewards on informing BIR on tax
violations is P900,000. The payee of an income subject to final tax is also
called the withholding agent.
2. The first P10,000 of an prize is exempt from final taxes.
3. There is a separate quarterly remittance return for final taxes collected
on income payments of banks.
4. Dividends received by resident aliens from non-resident foreign
corporations are subject to 10% final tax.
5. The final tax withheld constitutes full payment.
6. Prizes and winnings received by corporate taxpayers are subject to
regular income tax.
7. The interest income received by corporate taxpayers from tax-free
covenant bonds are deemed net-of-tax.
8. Final tax is generally applicable to passive income since these are
more susceptible to non-reporting.
9. Income subjected to final tax are not reported in the income tax return.
10. Active royalties are mostly subject to 20% final tax.

MULTIPLE CHOICE
Choose the best answer from the choices provided.
1. Who is subject to final tax on royalties earned, whether active of passive?
a. Resident citizen
b. Resident Alien
c. Non-resident citizen
d. Non-resident alien not engaged in trade or business
 2. Which is the following recipients is exempt from final tax on dividends?
a. Resident Alien
b. Resident Citizen
c. Resident Corporation
d. Resident Foreigner

3. Which of the following is not subject to final tax?

a. Prizes exceeding P10,000
b. Prizes not exceeding P10,000
c. Winnings exceeding P10,000
d. Winnings not exceeding P10,000

4. Which is not subject to 10% final tax?

a. Royalties from a business trademark
b. Royalties from literary works
c. Dividends from a domestic corporation
d. Share in the net income of a business partnership

FINAL TAX RATES

Write the final tax rate applicable for each income. If it is exempt, write EX. If it is subject to other
income tax schemes, write NA.
1. Jackie received P10,000 from a raffle promo
2. Jonny, a resident Italian, received P60,000 dividends from an REIT
3. Jimmy, preterminated a seven-year peso deposit four years before its maturity
4. Jessy, received the interest from her investment on Philippine t-bills
5. Justme, an NRFC, earned interest from a loan extended
6. Jill, a non-resident alien engaged in trade, received a share in the net income of an
exempt partnership
7. June, received a reward on whistleblowing on a tax violation
8. A non-resident lessor of aircrafts earns rentals from domestic companies
9. A company engaged in arts primarily obtains income from royalties on its literary
works
10. An NRFC received dividends from a domestic corporation which was subject to tax
sparing rule
REINFORCEMENT/ASSIGNMENT

Problem 5.1 PASSIVE ROYALTIES

Dina Amon, a resident citizen, earned the following royalties from her intellectual
works: Cook Books 45,000
Musical Compositions 80,000
Other Passive Royalties 120,000
How much is the withheld final tax of Dina?

Problem 5.2 PASSIVE ROYALTIES

Jack Amon, a resident alien, received the following royalties during the taxable
year: Hairy Cutter Novel Books 450,000
Patents 120,000
Other Passive Royalties 224,000
How much is the final tax of Jack?

Problem 5.3 INTEREST INCOME

Hannah Caiat, a non-resident citizen, was credited with the following interest income from
her bank deposits:
Banco de Oro (net of tax) 1,600
Bank of the Philippine Islands (gross of tax) 5,000
Metro Bank (net of tax) 8,000
Citi Bank (gross of tax) 9,600
How much is the final tax on interest income on bank deposits of Hannah?

Problem 5.4 DIVIDENDS

Mary Ribook, received the following dividends in Philippine pesos, gross of
tax. San Miguel Corporation
25,0
00
Apple Corporation 50,000
Ayala Land Corporation 30,000
Google Corporation 10,000
How much is the final tax from the said dividends?

Problem 5.5 PRIZES AND WINNINGS

Nash E. Mulan wants to experience placing a bet in the PCSO Ultra Lotto and tries to bet on
the combination 06-19-23-39-41-50. Knowing the minimal chance of winning, he did not
watch the telecast of the draw. Getting the newspapers on the next day, it revealed the
following winning numbers 41-23-19-51-06-39. The prizes are as follows: 6 digits –
P55,000,000, 5 digits – P300,000, 4 digits – P4,000 and 3 digits – P20.
How much is the final tax of Nash?
Problem 5.6 PRIZES AND WINNINGS
Nash, from the previous problem, was not satisfied of winning once and places again the
same combination on the next draw of 6/58. Winning numbers were 06-56-47-41-50-23.
How much is the final tax of Nash?

Problem 5.7 PRIZES AND WINNINGS

Nash, again from the previous problem, having been obsessed with lottery adapts the same
combination as being his lucky numbers and places a bet on the Mexican Lottery. He won
the jackpot prize of P960,000,000 during the draw.
How much is the final tax of Nash?

Problem 5.7 PRIZES AND WINNINGS

Venti Lador, obtained the following winnings (gross of tax) during the taxable year.
January 21 60,000
March 16 14,000
September 18 86,000
How much is the total final tax from the winnings?

Problem 5.8 TAX INFORMER’S REWARD

Lala Pit, reported to the BIR, Tim Maray, as having evaded from the payment of tax worth
P9,000,000. Due to the information she provided, BIR was able to collect said amount.
How much is the final tax?

Problem 5.8 TAX INFORMER’S REWARD

Assuming from the previous problem, the tax reported was P20,000,000.
How much is the final tax?
REFERENCES:

❖ Income Taxation with Special Topics and Properly Filled BIR Forms, 2020 Edition -
Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S. Tamayo, CPA,

MBA

❖ Income Taxation-Laws, Principles and Applications- Rex B. Banggawan, CPA, MBA

❖ National Internal Revenue Code of 1997

❖ Bureau of Internal Revenue Regulations

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Jurisprudence on Tax Cases

Course Code and Title: BACR 5 – INCOME TAXATION

Lesson Number : 6

Topic : Capital Gains Taxation

Instructor : Prof. Rosario A. Calamba, CPA, PhD

________________________________________________________________

LEARNING OBJECTIVES

At the end of this module, you are expected to:

1. Explain the rules on classifying assets;

2. Compute for the capital gains tax on sale of real properties;

3. Apply the alternative taxation rule on sale of real properties;

4. Explain the exemption on sale of real properties considered as principal

residence;

5. Compute for the documentary stamp tax on sale of real properties;

6. Compute for the capital gains tax on sale of domestic shares directly to
buyer;

7. Explain the rules on wash sales; and

8. Identify the required forms to be filed and their deadlines.

PRE-ASSESSMENT

Try to answer the following questions.

1. Who do you think pays the tax on a sale of real property?
2. When is a property considered real or personal?
3. What differentiates a capital asset from the ordinary asset?
4. Where are stocks normally bought?
5. How are land parcels valued?

LESSON PRESENTATION

CAPITAL GAINS TAXATION

A capital gains tax is imposed on the capital gain on the sale, exchange and other disposition of
certain capital assets.

ASSET CLASSIFICATION RULES

Ordinary assets are assets directly used in the business, trade or profession of the taxpayer such
as inventory, supply and items of property, plant and equipment. Capital assets include all
other assets other than ordinary assets.
The following are special rules in classifying assets.

1. A property purchased for future use in business is an ordinary asset even though this
purpose is later thwarted by circumstances beyond the taxpayer's control.
2. Discontinuance of the active use of the property does not change its character previously
established as a business property.
3. Real properties used, being used, or have been previously used, in trade of the taxpayer
shall be considered ordinary assets.
4. Properties classified as ordinary assets for being used in business by a taxpayer not
engaged in the real estate business are automatically converted to 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 transaction involving such property.
5. A depreciable asset is an ordinary asset even if it is fully depreciated, or there is a failure
to take depreciation during the period of ownership.
6. Real properties used by an exempt corporation in its exempt operations are considered
capital assets. Exempt corporations are not business.
7. The classification of property transferred by sale, barter or exchange, inheritance,
donation, or declaration of property dividends shall depend on whether or not the
acquirer uses it in business.
8. For real properties subject of involuntary transfer such as expropriation and foreclosure
sale, the involuntariness of such sale shall have no effect on the classification of such real
property.
9. Change in business from real estate to non-real estate business shall not change the
classification of ordinary assets previously held.

Taxpayers engaged in real estate business includes real estate dealer, real estate developer,
real estate lessor and taxpayers habitually engaged in real estate business.
Taxpayers habitually engaged in real estate business include those registered with the
HLURB or HUDCC as dealer or developer or those with at least 6 taxable real estate sales
transactions in the preceding year

SCOPE OF CAPITAL GAINS TAXATION

However, not all capital gains are subject to capital gains tax, most of them are subject to regular
income tax. The following are the common capital gains transactions taxed under the capital
gains taxation scheme:

1. Capital gains on the sale of domestic stocks directly to buyer

2. Capital gains on the sale of real properties not used in business
ONEROUS TRANSFERS OF REAL PROPERTIES CLASSIFIED
AS CAPITAL ASSET
The sale, exchange, and other disposition of real property capital assets in the Philippines is
subject to a tax of 6% of the selling price or the fair value, whichever is higher.

Under the NIRC, the fair value of real property is whichever is higher of the:

a. Zonal value, which is the value prescribed by the Commissioner of Internal Revenue for
real properties for purposes of enforcement of internal revenue laws; and
b. Assessed value, which is the value prescribed by the City or Municipal Assessor's Office
for purposes of the real property tax

Note that independent appraisal valuation, the fair value commonly used in external financial
reporting, is not used in the computation of the capital gains tax.

Illustration 6.1
Jackie sold a residential house and lot for P6,000,000. She purchased the lot when it was
worth P1,200,000 and a constructed a house on it for P3,500,000. The lot has a zonal value of
P2,100,000. The assessor’s value of the house and lot are P4,000,000 and P2,000,000,
respectively.

The capital gains tax would be

Higher of zonal and assessor’s value of land 2,100,000
Assessor’s value of house 4,000,000
Total Fair Value 6,100,000
Selling Price 6,000,000
Higher of the Two 6,100,000
Tax Rate 6%
Capital Gains Tax 366,000
BIR Tax Clearance
No registration of any document transferring real property shall be effected by the Register of
Deeds unless the Commissioner or his duly authorized representative has certified that such
transfer has been reported, and the capital gains or creditable withholding tax, if any, has been
paid. The certificate for purposes of this legal requirement is referred to as the "Certificate
Authorizing Registration (CAR)".

Nature
Presumption of capital gains
The 6% capital gains tax applies even if the sale transaction resulted to loss. Gain is always
presumed to exist. The basis of taxation is the selling price or fair value whichever is higher, not
the actual gain.

Non-consideration to the involuntariness of the sale

The capital gains tax applies even if the sale is involuntary or is for, circumstances such as in the
case of expropriation sale, foreclosure sale, dispositions by judicial order, and other forms of
forced disposition. It applies to conditional sales and pacto de retro sales

Final tax
The capital gains tax shall be withheld by the seller and remit the same to the government.

Scope and Applicability

The 6% capital gains tax is applicable to all individual taxpayers and to domestic corporations
only. The NIRC did not impose final capital gains tax on foreign corporations. However, in
cases where foreign corporations realize gains from the sale of real property classified as capital
assets, the capital gain shall be subject to the regular income tax.

The sale of real property located abroad is not subject to capital gains tax since withholding of
the capital tax cannot be imposed abroad due to territorial consideration. Hence, the actual
gains realized on the sale, exchange, and other dispositions of properties abroad are subject to
the regular income, z if the taxpayer is taxable on global income such as resident citizens and
domestic corporations. For all other taxpayers, the capital gain realized abroad is exempt.

Alternative Taxation Rule

An individual seller of real property capital assets has the option to be taxed at either 6% capital
g ains tax or regular income tax. It should be noted that this is permissible only when the seller
is an individual taxpayer, and the buyer is the government, its instrumentalities or agencies
including government-owned and controlled corporations.

The alternative taxation is intended to ease the burden of government expropriation where
taxpayers may incur losses on the forced expropriation sale and are still required to pay tax.
 Illustration 6.2
An individual taxpayer bought a house and lot near a highway at a cost of P2,000,000. After
several years, the government invoked its power of eminent domain to buy the property for
the expansion of the highway.

Assuming the property has a fair value of P1,800,000 for purposes of the expropriation, the taxpayer
would be forced to incur P200,000 loss (P1.8M-P2.0M) and still pay the 6% capital gains tax. This
would be too oppressive to the taxpayer. With the alternative regular income tax option, the taxpayer
would be given the benefit of deduction of the P200,000 capital loss without being imposed the 6%
capital gains tax.

Exemption to the 6% Capital Gains Tax under the NIRC

The sale, exchange and other disposition of a principal residence for the re-acquisition of a new
principal residence by individual taxpayers is exempt from the 6% capital gains tax. Principal
residence means the house and lot which is the primary domicile of the taxpayer. If the taxpayer
has multiple residences, his principal residence is deemed that one shown in his latest tax
declaration.

Requisites of exemption:
1. The seller must be a citizen or resident alien.
2. The sale involves the principal residence of the seller-taxpayer.
3. The proceeds of the sale is utilized in acquiring a new principal residence.
4. The BIR is duly notified by the taxpayer of his intention to avail of the tax exemption
within 30 days of the sale through a prescribed return (BIR Form 1706) and "Sworn
Declaration of Intent".
5. The reacquisition of the new residence must be within 18 months from the date of sale.
6. The capital gain is held in escrow in favor of the government.
7. The exemption can only be availed of once in every 10 years.
8. The historical cost or adjusted basis of the principal residence sold shall be carried over
to the new principal residence built or acquired.

It must be emphasized that the sale of principal residence must acquisition of the new principal
residence to be exempt.
 Illustration 6.3
Helen sold her principal residence with a fair market value of P6,000,000 for P5,000,000.
Helen purchased the residence for P3,000,000 several years ago. The imposable capital gains
tax is 6% of P6,000,000 or P360,000.

Helen should indicate her intention to apply for exemption in the capital gains tax return to be filed
and submit a Sworn Declaration of Intent. She will be required to deposit the P360,000 capital gains
tax in an escrow account in favor of the government.

Full Utilization
Assuming Helen acquires a new principal residence for P5,200,000 within 18 months, the P360,000
capital gains tax in escrow will be released to her. If Helen does not acquire a new principal residence
within 18 months, the capital gains tax in escrow will be taken by the government. If the proceeds are
fully utilized, the tax basis of the new residence, which is now at P3,200,000, shall be the basis of the
old residence plus additional cost incurred by the taxpayer in acquiring the new residence. The
additional cost is the excess of the purchase price of the new rest over the selling price of the old
residence.

Partial Utilization
Assume Helen uses only P4,500,000 out of the P5,000,000 proceeds in acquiring her new residence.
The portion representing the unused proceeds shall be subject to tax, thus, only 90% is exempt. Of the
P360,000 deposited in escrow, P324,000 will be remitted to the government and the balance of P36,000
is released to the taxpayer. Any interest which might have accrued on the escrow fund shall be released
to the taxpayer. The government is entitled to the amount of the unpaid tax only. The similar
percentage is multiplied with the tax basis of the old residence to get the new tax basis of the new
residence, in this case, P2,700,000, which is 90% of P3,000,000.

Capital Gains Tax Exemption under Special Laws

Sale of land pursuant to the Comprehensive Agrarian Reform Program
Sale of land under the Comprehensive Agrarian Reform Program The sale of agricultural lands
by land owners pursuant to the Comprehensive Agrarian Reform Program of the government
shall be exempt from capital gains tax. Similarly, interest income on the selling price that may
have been agreed by the land owner and the tenant-buyer shall he exempt from income tax.

Sale of socialized housing units by the National Housing Authority

The sale of socialized housing units for the underprivileged and homeless citizens by the
National Housing Authority (NHA) pursuant to the Urban Development and Housing Act of
1992 is exempt from the capital gains tax. This exemption is limited to socialized housing units
only. The BIR ruled that the sale of the NHA of commercial lots which is not part of the
socialized housing project for the poor and homeless is subject to capital gains tax or regular tax
and documentary stamp tax. To qualify for exemption, the socialized housing units of the NHA
must comply price ceilings set by the NIRC and other special laws.

Documentary Stamp Tax on the Sale of Real Properties

The sale of real property capital assets is subject to a documentary stamp tax on the gross selling
price or fair market value whichever is higher. The documentary stamp tax is P15 for every
P1,000 and fractional parts of the tax basis thereof. However, if the government is a party to the
sale, the basis shall be the consideration paid.

Illustration 6.4
A taxpayer disposed a real property capital asset acquired for P2,000,000 10 years ago for
P4,000,000. The property has a zonal value of P5,000,000 and declared real property value per
real property tax declaration of P3,000,000.

The documentary stamp tax shall be computed from the fair value since it is higher than the selling
price. Hence, the documentary stamp tax shall be P75,000 computed as P15/P1,000 x P5,000,000.

ONEROUS TRANSFERS OF DOMESTIC STOCKS

Domestic stocks are evidences of ownership or rights to ownership in a domestic corporation
regardless of its features, such as:

1. Preferred stocks
2. Common stocks
3. Stock rights
4. Stock options
5. Stock warrants
6. Unit of participation in any association, recreation, or amusement club

The capital gains tax covers not only sales of domestic stocks for cash but also exchange of
domestic stocks in kind and other dispositions such as:

1. Foreclosure of property in settlement of debt

2. Pacto de retro sales - sale with buy back agreement
3. Conditional sales - sales which will be perfected upon completion of certain specified
conditions
4. Voluntary buy back of shares by the issuing corporation - redemption of shares which
may be re-issued and not intended for cancellation
The term other disposition does not include:

1. Issuance of stocks by a corporation

2. Exchange of stocks for services
3. Redemption of shares in a mutual fund
4. Worthlessness of stocks
5. Redemption of stocks for cancellation by the issuing corporation
6. Gratuitous transfer of stocks

Tax on Sale of Domestic Stocks through PSE

This sale is not subject to capital gains tax but to stock transaction tax of 60% of 1% of the selling
price. Since the basis is the selling price, the sale is taxable whether is results to a gain or loss.

Capital Gains Tax on Sale of Domestic Stocks Directly to Buyer

When the sale is made directly to the buyer, the net gain on the sale is subject to a 15% flat rate,
except if the seller is a non-resident foreign corporation which has a two-tiered rate of 5% on the
first P100,000 net gain and 10% on the gain in excess of P100,000.

Nature
Universal Tax
It applies to all taxpayers disposing stocks classified as capital assets regardless of the
classification of the taxpayer. BY situs, the gain on sale of domestic stocks is within. The tax still
applies even if the sale is executed outside the Philippines.

Annual Tax
It is imposed on the annual net gain on the sale of domestic stocks directly to buyer.

The Net Gain

The net gain from the sale is computed using the formula below.

Selling Price xx
Tax Basis of Stocks Disposed (xx)
Selling Expenses (xx)
DST on the Sale (xx)
Net Capital Gain xx
Not unlike the CGT on sale of real properties, the gain is not presumed here. There will only be
a tax liability if the sale results to a net gain.

Since documentary stamp taxes may be paid by either party to the contract, such tax incurred
on the sale is only deducted if it is paid by the seller.
Illustration 6.5
EGA Company, a non-dealer in stocks, holds 100,000 listed shares of AKR Company, a
domestic corporation. It was acquired at P20 each. On January 5, 2020, it sold 30,000 shares
for P540,000. On March 16, 2020, it sold 50,000 shares P1,150,000. It sold the remaining shares
for P500,000 on September 14, 2020.

Scenario 1: The sale is made through PSE

The sale shall be subject to the stock transaction tax. Consequently, the total tax liability would be:
Selling Price (540,000+1,150,000+500,000) 2,190,000
STT Rate X 0.006
Stock Transaction Tax 13,140

Scenario 2: EGA is a domestic corporation and the sale is made directly to the buyers.
Each sale shall be liable to the transactional CGT rate of 15% and will be annualized.
Selling Price on 1/5 540,000
Tax Basis of Shares 600,000
Net Capital Loss (60,000)
There shall be no capital gains tax liability on the sale on January 5.
Selling Price on 3/16 1,150,000
Tax Basis of Shares 1,000,000
Net Capital Gain 150,000
CGT Flat Rate 15%
Capital Gains Tax 22,500
Since the sale resulted to a gain, there is a tax liability of P22,500.
Selling Price on 9/14 500,000
Tax Basis of Shares 400,000
Net Capital Gain 100,000
CGT Flat Rate 15%
Capital Gains Tax 15,000
Since the sale resulted to a gain, there is a tax liability of P15,000.
All sales will be consolidated to determine the annual CGT.
Net Capital Loss on 1/5 (60,000)
Net Capital Gain on 3/16 150,000
Net Capital Gain on 9/14 100,000
Annual Net Capital Gain 190,000
CGT Flat Rate 15%
Annualized Capital Gains Tax Due 28,500
 Transactional Capital Gains Tax Paid (22,500+15,000) 37,500
Capital Gains Tax Due (Refundable) 9,000

Scenario 3: EGA is a non-resident foreign corporation and the sale is made directly to buyer.
The procedure is similar to Scenario 2. The only difference would be the use of the two-tiered rate.
1/5 3/16 9/14 Annualized
Net Capital Gain (Loss) (60,000) 150,000 100,000 190,000
First-Tier CGT - 5,000 5,000 5,000
Second-Tier CGT - 5,000 - 9,000
CGT Due 0 10,000 5,000 14,000
CGT Credits 15,000
CGT Still Due (Refundable) (1,000)

Documentary Stamp Tax on the Sale, Exchange, and Other Dispositions of

Domestic Stocks Directly to a Buyer
The sale of domestic stocks is subject to a documentary stamp tax of P1.50 for every P200 of the
par value of the stocks sold.

Illustration 6.6
A taxpayer sold domestic stocks with total par value of P800,000 for P1,200,000. The stocks
have a fair value of P1,250,000 and were acquired for P1,000,000.

The documentary stamp tax shall be P6,000 computed as P1.50/P200 x P800,000.

Wash Sales
Wash sale of securities is deemed to occur when within 30 days before and 30 days after the sale
(also referred to as the 61-day period), the taxpayer acquired or entered into a contract or option
to acquire substantially identical securities. Capital losses on wash sales by non-dealers in
securities are not deductible against capital gains. The wash sales rule is intended to prevent
taxpayers from feigning temporary losses which could enable them to manipulate their
reportable taxable net gain. Hence, the prohibition against the claim of wash sales is not an
absolute rule but is a form of deferral of loss. The wash sales rule is not applicable to dealers in
securities as it is normal business for them to buy and sell stocks and realize gains or incur
losses within short periods of time.
 Illustration 6.7
Acquisition of identical shares before and after a losing sale. In 2019, Mr. Iriga had the
following transactions in the shares of Naga Corporation, domestic corporation:
Date Transaction Shares Price/Share Value
January 4 Purchase 15,000 20.00 300,000
February 15 Purchase 5,000 21.00 105,000
February 28 Sale 12,000 18.00 216,000
March 4 Purchase 3,000 16.00 48,000
April 18 Sale 5,000 25.00 125,000
The shares sold on February 28 were the shares bought on January 4, 2019. The sale on April
18 were the shares bought on February 15.

The capital loss is P24,000 computed as (P18/share selling price - P20/share cost) x 12,000 shares sold.
Since the sale happened on February 28, it a wash sale of February 15 and March 4 purchases. The
portion of the capital loss allocable to the 8,000 replacement shares (5,000 from Feb 15 and 3,000 from
Mar 4) is deferred and capitalized and the balance recognized as a deductible loss.
Date Computation Deferred Loss Purchase Price New Tax Basis
February 15 5,000/12,000 x 24,000 10,000 105,000 115,000
March 4 3,000/12,000 x 24,000 6,000 48,000 54,000
The deductible capital loss of P8,000 is computed by 4,000/12,000 x 24,000.

The capital gain on April 18 is P10,000 which is the sale price of P125,000 less the new tax basis of Feb
15 shares at P115,000.

FILING AND PAYMENT

The following are the required forms in paying for the capital gains tax and the specified
deadlines for filing and payment. [You may click the form codes to access the link to the pdf file
of said form.]

Deadline
Form Name Manual Filing eFPS Filing

Capital Gains Tax Return for
Onerous Transfer of Real
1706
Property Classified as Capital
Asset
30 days following each sale, exchange or
disposition of real property (after receipt of
first payment, if instalment)
 Capital Gains Tax Return for
Onerous Transfer of Shares of
1707
Stock Not Traded Through the
Local Stock Exchange
Annual Capital Gains Tax
Return for Onerous Transfer of
1707A Shares of Stock Not Traded
Through the Local Stock
Exchange
30 days following each sale, exchange or
disposition of shares not thru PSE (after
receipt of first payment, if instalment)
On or before April 15 for individuals
On or before 15th day of the 4th month
following close of taxable year for
corporations

Instalment Payment
The same principles and calculation method from the Instalment Method illustrated in Module
4 is to be used except that instead of using the gross profit, we multiply the capital gains tax
due.
ACTIVITY/EVALUATION

TRUE OR FALSE
Determine whether the following statements are true or false.
1. The CGT on sale of real properties classified as capital assets assumes a gain
on the sale.
2. The capital loss on wash sales is fully capitalized as cost of the replacement
shares if the number of shares sold exceeds the replacement shares.
3. The CGT on sale of domestic stocks directly to buyer only results to a tax
liability if it results to a gain.
4. Upon signifying intention to avail exemption on CGT on sale of principal
residence, the amount of supposed CGT should be deposited in an escrow
account.
5. The option to be taxed at regular income taxation arises from the State’s
power of eminent domain.
6. Dealers of stocks are subject to capital gains tax.
7. There is a possibility of a CGT refundable in the annual return if a
transactional CGT resulted on a net capital loss.
8. The documentary stamp tax can be paid by either party to the contract.
9. The capital gains tax is a final tax.

MULTIPLE CHOICE
Choose the best answer from the choices provided.
1. Who is subject to the two-tiered CGT rate?
a. Resident Individual
b. Non-Resident Individual
c. Resident Corporation
d. Non-Resident Corporation
 2. Which of the following may not be the tax base of the 6% CGT?
a. Selling Price
b. Appraised Value
c. Zonal Value
d. Assessor’s Value

3. What is the base of the 15% CGT?

a. Par Value
b. Selling Price
c. Net Gain
d. Fair Market Value

4. What is the base of the documentary stamp tax?

a. Par Value
b. Selling Price
c. Net Gain
d. Fair Market Value

Exercise 6.3 CAPITAL GAINS TAX RATES

Write the capital gains tax rate applicable for each income. Write NA if it is not subject to CGT.
1. A non-resident foreign corporation sells a building located in Pasay City
2. A resident alien sells Ayala Stocks to an alien residing in France
3. A non-dealer domestic corporation buys 10,000 shares of a publicly traded stock
4. A resident citizen acquires Jollibee stocks directly from a non-resident citizen
5. A non-resident foreign corporation sells domestic shares directly to a buyer
6. A stock dealer directly sells domestic shares to a domestic corporation
7. A domestic corporation sells Apple stocks directly to a citizen buyer

REINFORCEMENT/ASSIGNMENT

Problem 6.1 SALE OF REAL PROPERTY

Colly owns a parcel of land which it acquired for P3,100,000. It sold the same on November 18,
2020 via a deed of sale for P5,000,000. The zonal value of the land is P4,800,000 while its
assessor’s value is P5,200,000.

Answer the following independent questions.

1. How much is the capital gains tax due?
2. If the return is only filed on June 19, 2021, how much is the total amount due exclusive of
compromise penalty?
3. Assume the payment is 20% downpayment and the balance in five equal annual instalments
every June 30, how much is the capital gains tax due for the year 2020?
 4. Assume it is considered a principal residence and only P4,000,000 of the proceeds are utilized
for the purchase of a new one, how much is the capital gains tax due to the government?
5. Assume Colly is a real estate business, how much is the capital gains tax due?

Problem 6.2 SALE OF PRINCIPAL RESIDENCE

Taraji owns a residential house and lot costing P2,500,000 which is her principal residence for
P4,000,000. The fair market value of the property is lower than the sale price. Eight months after
the sale, Taraji was able to purchase a new principal residence worth P3,200,000. Appropriate
amount was deposited in an escrow account earning 4% interest p.a.

Answer the following questions.

1. How much should be deposited to an escrow fund?
2. How much is the capital gains tax due to the government?
3. How much should be released to Taraji?
4. How much is the tax basis of the new principal residence?

Problem 6.3 SALE OF DOMESTIC STOCKS DIRECTLY TO BUYER

Henson Company, a non-dealer, owns 20,000 unlisted shares of a domestic corporation costing
P2,800,000. It sold 14,500 shares during June 2020 for P155 each and the balance on September 2020
at P138 each.

Answer the following questions.

1. Assume Henson is a domestic corporation, how much is the transactional CGT due on the June
2020 sale?
2. Assume Henson is a domestic corporation, how much is the transactional CGT due on the
September 2020 sale?
3. Assume Henson is a domestic corporation, how much is the CGT still due(refundable) on the
annual CGT return?
4. Assume Henson is a non-resident foreign corporation, how much is the transactional CGT due on
the June 2020 sale?
5. Assume Henson is a non-resident foreign corporation, how much is the transactional CGT due on
the September 2020 sale?
6. Assume Henson is a non-resident foreign corporation, how much is the CGT still due(refundable)
on the annual CGT return?

Problem 6.4 WASH SALES

On July 8, 2020, Machine Company, a non-dealer, purchased 10,000 domestic shares for P800,000.
These shares were sold on October 1, 2020 for P750,000. Other purchases of the same shares were
6,000 on September 15 for P492,000 and 2,000 on October 29 for P170,000. All of the shares acquired
on September 15 were sold on December 16 at P600,000.

Answer the following questions.

1. How much is the deductible capital loss from the October 1 sale?
2. How much is the tax basis of the October 29 shares as of December 31, 2020?
Problem 6.4 DOCUMENTARY STAMP TAX
During the year, Matilda sold two capital assets:
• 25,000 unlisted domestic stocks with a par value of P50 which was acquired for
P1,500,000 at a selling price P1,800,000
• An agricultural lot with an assessor’s value of P1,800,000, cost of P1,200,000, zonal value of
P1,500,000 for a selling price of P2,000,000

Answer the following questions.

1. How much is the documentary stamp tax on the sale of domestic stocks?
2. How much is the documentary stamp tax on the sale of agricultural lot?
3. How much is the capital gains tax on the sale of domestic stocks?
4. How much is the capital gains tax on the sale of agricultural lot?

REFERENCES:

❖ Income Taxation with Special Topics and Properly Filled BIR Forms, 2020
Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S.

Tamayo, CPA, MBA

❖ Income Taxation-Laws, Principles and Applications- Rex B. Banggawan,

CPA, MBA

❖ National Internal Revenue Code of 1997

❖ Bureau of Internal Revenue Regulations

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Jurisprudence on Tax Cases

Course Code and Title: BACR 5 – INCOME TAXATION

Lesson Number : 7

Topic : Introduction to Regular Income Tax

Instructor : Prof. Rosario A. Calamba, CPA, PhD

_________________________________________________________

LEARNING OBJECTIVES

At the end of this lesson, the student should be able to:

1. Describe the characteristics of regular income tax;

2. Illustrate the regular income tax model and its components;

3. Identify the relevant returns for regular income tax;

4. Differentiate computation of taxable income for special taxpayers;

5. Explain the effects of choosing the 8% income tax;

6. Compute the income tax due;

7. Explain the globalization rule for mixed income earners;

8. Apply the rules on rounding in accomplishing returns; and

9. Identify the required attachments for each return.

 PRE-ASSESSMENT
Try to answer the following questions.
1. What is usually needed for reference in a progressive tax?
2. Do you think income from illegal activities, in theory, should be taxed?
3. How do you think is the income tax due computed?
4. What are the differences of a traditional Income Statement to that of the Income Tax
Return?
5. Do you think the rules on rounding off from your basic Mathematics classes apply in
tax reporting?
6. Which would you prefer between ease in tax computations or lower income tax due?

LESSON PRESENTATION

REGULAR INCOME TAX

As discussed in the previous modules, the income tax scheme of regular income taxation is a
catch basin for all those items of income which are not specifically within the scopes of final
income taxation and capital gains taxation.

CHARACTERISTICS
The following are the characteristics of this income tax scheme.

General Coverage
The regular income tax applies to all items of income except those that are subject to final tax,
capital gains tax, and special tax regimes.

Net Income taxation

The regular tax is an imposition on residual profits or gains after deductions for expenses and
personal exemptions allowable by law.

Annual Income Tax

The regular income tax applies on yearly profits or gains. The gross income and expenses of the
taxpayer are measured using the accounting methods adopted by the taxpayer and are reported
to the government over the accounting period selected by the taxpayer.

Creditable Withholding Taxes

Most items of regular income are subject to creditable withholding tax (CWT). These creditable
withholding taxes are advanced taxes that must be deducted against regular tax due in
computing the tax still due to the government.
Progressive or Proportional Tax
The NIRC imposes a progressive tax on the taxable income of individuals while it imposes a flat
or proportional tax of 30% upon the taxable income of corporations. Note that the revision of
the corporate income tax in the second package of the TRAIN Law proposes a 25% corporate
income tax.

REGULAR INCOME TAX MODEL

The formula below illustrates the bird’s eye view of the regular income tax scheme.

Gross Income xx
Allowable Deductions (xx)
Taxable Income xx

Tax Due xx
Tax Credits (xx)
Tax Payable/(Overpayment) xx

It is to be noted that extensive discussions of each item in the model will be included in the
succeeding modules.

Gross Income
The gross income consists of all other items of income not taxed under the Final Taxation and
Capital Gains Taxation and other special tax regimes. Some items of income, however, are
excluded or exempted by law, treaty or contract from taxation. Normal items of gross income
are as follows:

1. Compensation Income
2. Business/Professional Income
3. Capital Gains

Excluded Income vs. Exempt Income vs. Deductions

Excluded income is also exempt income. Excluded income are those listed by the NIRC as
exempt from regular tax. The term exempt income includes all income exempt from income
tax whether final tax, capital gains tax or regular income tax. Exclusions from gross income
are listed in the NIRC. Both excluded and exempt income are not included in the amount of
reportable gross income in the income tax return. The amount of deductions is initially
included in the amount of gross income but is separately presented as deduction against
gross income.
Allowable Deductions
Allowable deductions, or simply “deductions,” are expenses in the conduct of business or
exercise of profession. It should be noted that only business expenses are allowed for
deductions, considering limits and caps given by law.

Taxable Income
This is the basis of the income tax due.

Tax Due
The progressive tax table below shall be used for individual taxpayers and the 30% income tax
rate for corporate taxpayers. In computing the tax due for individuals, the taxable income is
located on the applicable bracket of the income tax table to know the basic tax and the
additional tax rate.

Taxable Income
Basic Tax Additional Tax
Over But Not Over
0 250,000 - -
250,000 400,000 - 20% of excess over 250,000
400,000 800,000 30,000 25% of excess over 400,000
800,000 2,000,000 130,000 30% of excess over 800,000
2,000,000 8,000,000 490,000 32% of excess over 2,000,000
8,000,000 - 2,410,000 35% of excess over 8,000,000

Tax Credits
Tax credits are subtracted not from taxable income, but directly from a person’s tax liability;
they therefore reduce taxes peso for peso. As a result, credits have the same value for everyone
who can claim their full value. As one of the characteristics of regular taxation, it is subject to
creditable withholding taxes. As such, any withheld taxes from payors of income may be used
as tax credits to be deducted to the Tax Due. Tax credits usually arise from creditable
withholding taxes.

Tax Payable/(Overpayment)
This is the net amount of the tax liability to the BIR. If the tax credits exceed the tax due, the
overpayment may be refunded or used as tax credits in the succeeding periods.
 Illustration 7.1
Tim Maray has a total income of P1,240,000 during the taxable year. Of the said amount,
P110,000 were subject to final tax and P80,000 were subject to capital gains tax. Of the
remaining amount, P50,000 are considered exempt. He also incurred P520,000 worth of
expenses but P40,000 was not allowed for deduction. Several of the income were subjected to
creditable withholding taxes which reduced the receipts of income to P1,229,000.

Following the regular income tax model, the taxable income would be:
Gross Income (1,240,000 – 110,000 – 80,000 – 50,000) 1,000,000
Less: Allowable Deductions (520,000 – 40,000) 480,000
Taxable Income 520,000

Scenario 1: Tim Maray is an individual

The tax payable, basing on the third bracket of the progressive tax table, would be:
Basic Tax 30,000
Additional Tax (25% x 120,000) 30,000
Tax Due 60,000
Less: Tax Credits (1,240,000 – 1,229,000) 11,000
Tax Payable 49,000

Scenario 1: Tim Maray is a corporation

The tax payable would be:
Taxable Income 520,000
Tax Rate 30%
Tax Due 156,000
Less: Tax Credits 11,000
Tax Payable 145,000

REGULAR INCOME TAX RETURNS

The following are the required returns for taxpayers. [You may click the form codes for links on
the full pdf of the return.]

Form Code Type of Taxpayer

1700 Purely Employed Individuals
Individuals purely in Business, using Itemized Deduction, OSD or opting to
1701A
the 8% Optional Income Tax
1701 Mixed Income Earning Individuals, Estates and Trusts
 1702RT Corporations subject only to the 30% Regular Income Tax
1702MX Corporations subject to Special or a combination of tax rates
1702EX Corporations that are exempt with no tax due

It should be noted that exempt corporations are required to report their results of operations
through BIR Form 1702-EX even if they do not have taxable income. They are mandated to
itemize their deductions in their income tax return. The rule is apparently intended to assist the
BIR in monitoring compliance of exempt corporation with their withholding tax obligations and
to provide for a mechanism to identify income earned by third parties.

Exempt corporations with gross income subject to the regular corporate income tax or special
rate shall file BIR Form 1702-MX.

Individual ITR Line Items

Let us take a look at Form 1701 to further evaluate the regular income tax model for individuals.
You are encouraged to familiarize yourself with the structure of the income tax return to
facilitate understanding in the succeeding modules.

Taxable Compensation Income
Gross Income/(Loss) from
Operation
Allowable Deductions
Net Income/(Loss) from
Operations
Other Non-Operating Income
Taxable Business Income
Total Taxable Income
Tax Payable/(Overpayment)
The taxable compensation income only comprises of the
gross compensation income and the exempt portion. These
two are netted. Information on this portion normally comes
from the accomplished BIR Form 2316 by the employer
which will be further discussed in Module 10.
This portion follows that of the traditional format of the
Gross Profit computation in the Income Statement.
There are different types of deductions which the taxpayer
can avail.
This is the difference of the gross income from operations
and allowable deductions.
These are separated since some rules (e.g. OSD) are not
applicable to revenues from non-business endeavors.
This is the sum of all taxable non-compensation income.
This will now be the basis of the income tax due of the
individual taxpayer.
This is similar to the tax model. Tax credits will be
extensively discussed in Module 16.

Looking at the structure of the items in the form, it can be presented in the form below to
illustrate it in practical sense.

Taxable Compensation Income

Gross Compensation Income xx
Exempt/Non-Taxable Compensation Income (xx) xx
Taxable Business Income
Net Sales/Revenues/Receipts/Fees xx
Cost of Sales/Services (xx)
Gross Income/(Loss) from Operations xx
Allowable Deductions (xx)
Net Income/(Loss) from Operations xx
Other Non-Operating Income xx xx
Total Taxable Income xx
 Tax Due xx
Tax Credits (xx)
Tax Payable/(Overpayment) xx

For purely self-employed individuals, the portion for compensation income is ignored.
Same is true for purely employed individuals on the portion for business income.
Illustration 7.2
Chutimon, an individual taxpayer, reported the following for the taxable year.
• Gross compensation of P140,000, P20,000 of which was exempt.
• Winnings from PCSO Lotto, P60,000.
• Capital gain of jewelries sold, P50,000.
• Gross income from merchandising business, P470,000.
• Expenses of the merchandising business, P210,000, P25,000 of which are non-
deductible.
• Prior year’s excess credits, P10,000.

The tax payable would be computed as follows:

Taxable Compensation Income
Gross Compensation Income 140,000
Exempt/Non-Taxable Compensation Income 20,000 120,000
Taxable Business Income
Gross Income/(Loss) from Operations 470,000
Allowable Deductions 185.000
Net Income/(Loss) from Operations 285,000
Other Non-Operating Income 50,000 335,000
Total Taxable Income 455,000

Tax Due 43,750

Tax Credits 10,000
Tax Payable/(Overpayment) 33,750

Quarterly Return
Let us take a look at the 1701Q to differentiate it with the annual ITR.
The quarterly return is mostly similar to that of the annual return. The difference is that the
amounts for the computation of the net income/(loss) from operations only include those
arising from the period the return covers.

The quarterly return is cumulative in amount. This means that it computes the income tax due
based on the cumulative taxable income as of the close of the taxable quarter. This is why it
adds the reported taxable income from the previous quarterly returns filed during the year.

Also take note that only the business income is included in the quarterly returns. The taxable
compensation income is only reported in the annual income tax return.
 Illustration 7.3
Pat, a mixed income earner, reports the following for each quarter of 2020.
Item First Second Third Fourth
Taxable Compensation 90,000 90,000 90,000 90,000
Gross Income from Business 240,000 160,000 180,000 380,000
Allowable Deductions 90,000 80,000 80,000 120,000
Non-Operating Income 10,000 15,000 40,000 10,000
The only sources of tax credit are the timely tax payments made every quarter and the
income tax withheld from compensation amounting to P22,000.

The income tax returns to be filed would carry the following amounts:
Item Q1 Q2 Q3 Annual
Gross Income from Business 240,000 160,000 180,000 960,000
Allowable Deductions 90,000 80,000 80,000 370,000
Net Income from Operations 150,000 80,000 100,000 590,000
Taxable Income from Previous Quarter/s - 160,000 255,000 -
Non-Operating Income 10,000 15,000 40,000 75,000
Total Taxable Business Income to Date 160,000 255,000 395,000 665,000
Taxable Compensation Income - - - 360,000
Total Taxable Income 160,000 255,000 395,000 1,025,000
Tax Due - 1,000 29,000 197,500
Tax Credits - - 1,000 51,000
Tax Payable - 1,000 28,000 146,500

Corporate ITR Line Items

Let us also take a look on a portion of the 1702RT to illustrate the same for corporate taxpayers.
Gross Income from Operation
Other Taxable Income
Total Taxable Income
This is mostly similar with that of individuals.
Other taxable income not subjected to final tax is directly
added to the gross income from operations, not unlike for
individuals where it is only added after the allowable
deductions are deducted.
This is the total gross taxable income.
 Allowable Deductions Similar to that of individuals, it is to be further discussed in
Modules 13-15.
Net Taxable Income/(Loss) This is the basis of the income tax due.
Tax Payable/(Overpayment) This is similar to that of individuals.

Looking at the structure of the items in the form, it can be presented in the form below to
illustrate it in practical sense.

Net Sales/Receipts/Revenues/Fees xx
Cost of Sales/Services (xx)
Gross Income from Operation xx
Other Taxable Income Not Subjected to Final Tax xx
Total Taxable Income xx
Allowable Deductions (xx)
Net Taxable Income/(Loss) xx

Tax Due xx
Tax Credits (xx)
Tax Payable/(Overpayment) xx

Illustration 7.4
Assume Chutimon from Illustration 7.2 is a corporate taxpayer and ignore the figures related
to the compensation income.

The tax payable would be computed as follows:

Gross Income from Operation 470,000
Other Taxable Income Not Subjected to Final Tax 110,000
Total Taxable Income 580,000
Allowable Deductions 185,000
Net Taxable Income/(Loss) 395,000
Regular Corporate Tax Rate 30%
Tax Due 118,500
Tax Credits 10,000
Tax Payable/(Overpayment) 108,500
Quarterly Return
The difference of the quarterly and annual ITR for corporations is similar to that of individuals,
except that there is no compensation income.

8% OPTIONAL TAX
Individual taxpayers have the option of availing the 8% optional tax as provided by RA 10963.
It should be noted that the taxpayer should signify that it chooses this option on the first
quarterly income tax return and/or quarterly percentage tax return for every year. Such election
shall be irrevocable and no amendment of option shall be made for the said taxable year.

Purely Self-Employed Individuals

The taxpayer may opt to be taxed under the two schemes, provided that his gross sales/receipts
and other non-operating income do not exceed the P3,000,000 VAT threshold:

1. 8% of gross sales/receipts and other non-operating income in excess of P250,000 in lieu

of graduated rates and percentage tax; or
2. Graduated rates

Below is the portion of 1701A that should be filled out.

Mixed-Income Earners
If the individual taxpayer earns compensation income aside from its exercise of profession,
trade or business, he shall have no choice but to be taxed at the graduated rates on its
compensation income. Its business income, however, may be opt to be taxes at the following
schemes, provided that his gross sales/receipts and other non-operating income do not exceed
the P3,000,000 VAT threshold:

1. 8% of gross sales/receipts and other non-operating income in lieu of graduated rates

and percentage tax; or
2. Graduated rates

It should be noted that the P250,000 exemption is not deducted on the tax base for the 8%
preferential tax since it is already availed on the tax on compensation income using the
graduated rates.

Below is the portion of 1701 that should be filled out.

Illustration 7.5
Chanon, a non-VAT individual taxpayer, reported the following for the year.
• Gross sales of P1,800,000
• Cost of sales of P860,000
• Allowable deductions of P220,000

Scenario 1: Chanon chooses the 8% optional rate

Gross Sales 1,800,000
Exemption Threshold 250,000
Basis for 8% 1,550,000
Optional Rate 8%
Income Tax Due 124,000

Scenario 2: Chanon chooses the graduated rates

Gross Sales 1,800,000
Cost of Sales 860,000
Gross Income 940,000
Allowable Deduction 220,000
Taxable Income 720,000
Income Tax Due (based on Progressive Tax Table) 110,000
Percentage Tax Due (1,800,000 x 3%) 54,000
Total Tax Due 164,000

Scenario 3: Chanon has taxable compensation of P420,000 and chooses the 8% optional rate
Gross Sales 1,800,000
Optional Rate 8%
Income Tax Due on Business Income 144,000
Income Tax Due on Compensation Income (based on PTT) 35,000
Total Income Tax Due 179,000

Scenario 4: Chanon has taxable compensation of P420,000 and chooses the graduated rates
Taxable Business Income 720,000
Taxable Compensation Income 420,000
Total Taxable Income 1,140,000
Income Tax Due (based on PTT) 232,000
Percentage Tax Due (1,800,000 x 3%) 54,000
Total Tax Due 286,000
Breach of the VAT Threshold
Even if the flat 8% income tax rate option is initially selected, the taxpayer shall automatically
be subject to the graduated rates of tax when his gross sales/receipts and other non-operating
income exceeded the P3,000,000 during the taxable year. In such case, his income tax shall be
computed under the graduated income tax rates and shall be allowed a tax credit for the
previous quarter/s’ income tax payment/s under the 8% income tax rate option.

Illustration 7.6
The following are the income of Jackie, a self-employed individual, for the first two quarters
of the taxable year. It signified the use of 8% optional rate on the first quarter return.
Item First Quarter Second Quarter
Gross Sales 800,000 2,500,000
Cost of Sales 400,000 1,200,000
Allowable Deductions 250,000 750,000

The tax due and payable for the first quarter is P64,000 computed by P800,000 x 8%.
Jackie exceeded the VAT threshold in the second quarter, therefore, he is not eligible for the 8% optional
rate. His tax payable for the second quarter is:
Total Gross Sales 3,300,000
Total Cost of Sales 1,600,000
Total Gross Income 1,700,000
Total Allowable Deductions 1,000,000
Total Taxable Income as of end of Q2 700,000

Tax Due based on PTT 105,000

Tax Credits 64,000
Tax Payable 41,000
Other Corporate Taxpayers
Refer to the summary below as to the taxability of partnerships, co-ownership and joint
ventures.

Rules Partnership Joint Venture Co-Ownership

General Rule Taxable Taxable Exempt
Exception Exempt: Exempt: Taxable:
if it is a general if formed for the if income from the co-
professional partnership purpose of undertaking owned property is
construction projects or reinvested to other
engaging in petroleum, income-producing
coal, geothermal, and properties or ventures
other energy operations
pursuant to an
operating consortium
agreement under a
service contract with the
government

Once a partnership, joint venture or co-ownership is not exempt, it will be taxable in the same
manner as a corporation.

ROUNDING RULES
The requirement for entering centavos in the latest version of the income tax return
(June 2013 version) has been eliminated. If the amount of centavos is 49 or less, the
centavos are dropped down. If the amount is 50 centavos or more, it is rounded up to
the next peso.

Hence, an amount for P100.49 shall be entered in the income tax return as P100. An
amount of P100.50 shall be rounded to P101.
ACTIVITY/EVALUATION
TRUE OR FALSE
Determine whether the following statements are true or false.
1. Items of non-operating income earned by self-employed individuals are
added at the net income from operations.
2. The use of the progressive tax table indicates that there is no tax on the first
P250,000 of the taxable income, 20% on the next P150,000, 25% on the next
P400,000, 30% on the next P1,200,000, 32% on the next P6,000,000 and 35% on
succeeding amounts.
3. The progressive tax table is applied to all individuals including non-resident
aliens not engaged in trade or business.
4. The corporate income tax rate is an ad valorem tax.
5. A certificate of independent CPA is required as attachment if annual receipts
exceed P3,000,000.
6. Income tax returns are required to be filed by taxpayers who are engaged in
business.
7. Exempt corporations are still required to file income tax returns despite
absence of a tax liability.
8. All purely employed individuals are required to file BIR Form 1700.
9. When a mixed income earner chooses the 8% optional income tax, the taxable
compensation income is taxed using the progressive tax table.
10. When an individual taxpayer chooses the 8% optional income tax, the
P250,000 threshold is always deducted to the net sales/receipts to serve as the
basis for the income tax due.
11. There is no need to pay the percentage tax if the taxpayer opts to be taxed at
the 8% optional rate.
12. The choice of availing the 8% income tax should be signified on the first
quarter returns.
Problem 7.1 REGULAR INCOME TAX MODEL
Lina Vaughn has a merchandising business. The Gross Income, net of creditable withholding
taxes of P20,000, of the business totaled P860,000. Total expenses incurred by the business
totaled P420,000 (P100,000 cannot be allowed for deduction). She also received a prize from a
competition in the amount of P50,000.

Fill out the table below.

Items Lina is an Individual Lina is a Corporation
Gross Income
Allowable Deductions
Taxable Income
Tax Due
Tax Credits
Tax Payable

Problem 7.2 REGULAR INCOME TAX FOR INDIVIDUALS

John Camuna, a mixed income earner, obtained the following for the quarters of 2020.

Items Q1 Q2 Q3 Q4
Taxable Compensation 110,000 110,000 110,000 140,000
Net Sales 410,000 470,000 510,000 750,000
Cost of Sales 240,000 280,000 310,000 400,000
Allowable Deductions 110,000 140,000 150,000 180,000
Passive Royalties 20,000 20,000 25,000 16,000
Winnings 50,000 - - -
Capital Gains under RIT - 15,000 45,000 -
Tax payments are made within deadlines and tax withheld on compensation totaled P47,500
during the year.

Fill out the table below to support amounts on income tax returns filed.
Items Q1 Q2 Q3 Annual
Gross Income from Business
Allowable Deductions
Net Income from Operations
Taxable Income from Previous Quarters
Non-Operating Income
Total Taxable Business Income to Date
Taxable Compensation Income
Total Taxable Income
Tax Due
Tax Credits
Tax Payable
Problem 7.3 REGULAR INCOME TAX FOR CORPORATIONS
Assume the same facts from Problem 7.2, except that John Camuna is a corporation and that
there were no compensation income and the related tax withheld.

Fill out the table below to support amounts on income tax returns filed.
Items Q1 Q2 Q3 Annual
Gross Income from Operation
Non-Operating Income
Total Gross Income
Allowable Deductions
Taxable Income for this Quarter
Taxable Income from Previous Quarter/s
Total Taxable Income
Tax Due
Tax Credits
Tax Payable

Problem 7.4 8% OPTIONAL RATE

Teeradon, a mixed income earner, reported a taxable compensation income of P400,000. His
taxable business income is P800,000. The cost of services and allowable deductions from the
business are P1,000,000 and P500,000, respectively.

Answer the following independent questions.

1. How much is the tax due if Teeradon chooses to be taxed at 8%?
2. How much is the total tax due if Teeradon chooses to be taxed at graduated rates?
3. Ignore the compensation income. How much is the tax due if Teeradon chooses to be taxed at
8%?
4. Ignore the compensation income. How much is the total tax due if Teeradon chooses to be taxed
at graduated rates?
REFERENCES:

❖ Income Taxation with Special Topics and Properly Filled BIR Forms, 2020
Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA

❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S.

Tamayo, CPA, MBA

❖ Income Taxation-Laws, Principles and Applications- Rex B. Banggawan,

CPA, MBA

❖ National Internal Revenue Code of 1997

❖ Bureau of Internal Revenue Regulations

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Jurisprudence on Tax Cases