UNIT 2: GROSS INCOME ‘The term “income” refers to all earnings derived from service rendered Gabor), from capital (business or investments), or both including gain derived from sale or exchange of personal or real property classified as either ordinary or capital asset. (Section 56, Revenue Regulation No. 2) The elements of a taxable income are: 1, there must be a gain or profit; 2. the gain must be realized or received: 31a lew or treaty must not exclude euch gain or profit from taxation’. ELEMENTS OF TAXABLE INCOME ‘THERE MUST BE A GAIN OR PROFIT Gain or profit must be distinguished from “receipts” and “capital”. Capital denotes the original investments or fund used in order to generate earnings which is called income. Capital is wealth, while income is the service of wealth. Labor or Capital is the tree, incone is the fruit. (Madrigal eaterno v. Refferty & Conception) Receipts are not income. xeccipts may include capital as well as its earnings, hile incone refers to the amount after excluding capital, invested, cost of goods sold, and other deductions allowed by law A sale does not necessarily mean income. To be considered income, the Sale must exceed its related costs. Thus, an income cannot be determined by just receiving cash as a result of sales or collection of receivables (Section 36, Revenue Regulation No. 2). It is not merely a growth or increment of value of an investment, but a gain, a profit in excess of capital as a result of exchange transactions. (fisner v. Macomber) ‘THE GAIN MUST BE REALIZED OR RECEIVED The gain must be an actual, real and present return that has accrued to the taxpayer The realization of gain may take the form of actual receipt of cash or may occur as a constructive receipt of income. Actual receipt of income need not be further elaborated An income is considered constructively received when it is credited to the account of, or segregated in favor of a person. Examples constructive receipt of income are: 1. Interest credited on a savings bank deposit; 2. Matured interest coupons not yet collected by the taxpayers3. Dividends applied by the corporation against the indebtedness of a stockholder. (Section 50, Revenue Regulation No. 2) 4, Share in the profit of a partner in a general professional partnership, although not yet distributed; 5. Intended payment consigned in court. Moreover, income fron investments in the form of share dividends are generally nct considered taxable income. A stock dividend, evincing merely a transfer of an accumulated surplus to the capital account of the corporations, takes nothing from the property of the corporation and adds nothing to that of the shareholder; a tax on such dividends is @ tax on capital increase, and not income. 7A mare inrease in the value of property fs not income bat merely an unealzed areas in wveted capital (Femandez Hos, nc v. Cormier). Hence, ams tat are recognized under the ecru bei such as revaaton surplus and urreakzed gan from investnents are not teated as tare come. The Supreme Court has applied three tests in determining whether an income is already realized, to wit: REALIZATION or SEVERANCE TEST ‘There is no taxable income until there is a separation from capital of something of exchangeable value, thereby supplying the realization or transmutation which would result’ in the receipt of income. ECONOMIC BENEFIT TEST Any economic benefit to the employee that increases his net worth, whatever may have been the mode by which it takes effect is taxable. CLAIM OF RIGHT TEST A taxable gain is conditioned upon the presence of a claim of right to the alleged gain and the absence of a definite unconditional obligaticn to return or repay that which would otherwise constitute a gain CLASSIFICATIONS OF INCOME income may be classified as follows: Compensation is the income derived from an employer-employee relationship, this is commonly referred to as wages, salaries, or commissions. The Labor Code of the Philippines, however, provides that all compensation arising from enployer-enployes relationship are to be considered as “wages” of the same kind however it may be designated. Professional or Busin Income This is the value derived from the exercise of a profession, utilization of capital, or doing of business,An entity is considered engaged in trade or business when ite operations are regular and continuous. Casual or irregular transactions does not amount to doing of business in the Philippines. While it is true that a single act does not constitute “doing business” within the meaning of law. A “single act,” however may bring the corporation under the puzview of “doing business” if such act is not merely incidental or casual, but it is of such character as distinctly to indicate a purpose on the part of the corporation to do business in the state, and to make the state 2 basis of operations for the conduct of @ part of the corporation's business. Passive Income A type of income that does not require active motion for accrual. The taxpayer merely waits for the amount of income to be ripe and ready for harvest. Examples are royalty, interests, prizes. Generally, passive incone is subject to final tax. Capital Gain An income derived from sale of assets classified as capital assets. TAX SYSTEMS IN THE PHILIPPINES Global Incone Tax system A globe system of income taxation imposes a single tax on all income of whatever nature Schedular Income Tax System A schedular system of taxation is one in which separate taxes are imposed on different categories of income The Philippines adopts the semi-global tax system and taxes all income subject to final withholding taxes under the schedular income tax system, and all other income under the global income tax system.‘Types of Taxpayers? CLASSIFICATIONS OF INDIVIDUAL TAXPAYERS Resident citizen ‘Non-resident citizen : Resident alien ‘Non-resident alien engaged in trade or business in the Philippines + Non-resident alien not engaged in trade or business in the Philippines CLASSIFICATIONS OF CORPORATE TAXPAYERS 1, Domestic corporation 2. Resident Foreign Corporation 31 Non-reeident Foreign Corporation 4, Business partnerships The term “income” under the context of income tax laws does not bear its usual meaning as used in layman’s language. The law provided for requisites before an income may be considered taxable, these are: there must be a gain or profit; the gain must be realized or received; and a law or treaty must not exclude such gain or Profit from taxation. Another important concept is the classification of income as its proper classification bears direct relation to ite proper taxation - whether they are to be taxed under the gicbal income tax system or under the schedular income tax system - as the Philippines adopts both in the exercise of its power of taxation.EXCLUSIONS FROM GROSS INCOME vexclusion,” in the context of income taxation, refers to items not included in the determination of the taxable income because a law or treaty expressly or impliedly exempts them from income tax ‘he following items shall not be included in gross income, and shall be exempt from income taxation: Life insurance; Amount received by insured as return of premium; Gifts, bequests, and devises; Compensation for injuries or sickness; Income exempt under treat: Retirement benefits, pensions, gratuities, ete.; Miscellaneous items. (Section 32 (B), NERC) care insonasez &) The proceeds of life insurance policies paid to the heirs or beneficiaries upon the death of the insured, whether in a single sum or otherwise, shall be excluded from gross income, but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income. Blenente: 1. The insured dies: 2. The proceeds of a life insurance policy is paid to the heirs or beneficiaries. It is true that the Income Tax Law, in excepting individual beneficiaries, speaks of proceedings of life insurance policies as income, but this is a very slight indication of legislative intention In reality, what the plaintiff received was in the nature of an indemnity for the loss which is actually because of the death of the insured. (£1 Oriente Fabrica De Tabacos, Inc. v. Fosadas) qlustration Joseph Risal, fearing some danger to his person, entered into a 20,000,000 insurance contract with Osangbife. The contract providing that upon his death, his wife, ae irrevocable beneficiary, shall receive the said amount. Joseph will be paying a monthly premium of 20,000 for 30 years After paying for three months, Joseph was taken by the Lord. Thus, his wife received 20,000,000. The Commissioner of Internal Revenue immediately assessed her for income tax. How much is the income tax Liability of Joseph's wife? NONE. The proceeds of Iife insurance policies paid to the heirs or beneficiaries upon the death of the ineuzed ie exempt £xom income tax.AMOUNT RECEIVED BY INSURED AS RETURN OF PREMIUM The amount received by the insured, as a turn of premiums paid by him under life insurance, endowment, annuity contracts, either during the term or at the annuity of the term mentioned in the contract or upon surrender of the contract shall be excluded from gross income. Here, unlike in the previous case, no death has ‘transpired, and the insured outlived the 1ife insurance policy. Joseph Risal, fearing some danger to his person, entered into a 20,000,000 insurance contract with Osanglife. The contract providing that upon his death, his wife, as irrevocable beneficiary, shall receive the said amount. Joseph will be paying a monthly premium of 20,000 for 30 years Joseph miraculously outlived the policy and personally received the policy's cach surrender value. How much of the proceeds is exempt fron incone tax? out of the total proceeds of 20,000,000, only 7,200,000 is exempted from income tax. This represents the total premium payments made by Joseph during the entire duration of the insurance contract (230,000 x 12 months x 30 years). ne remaining amount - P12,800,000, shall be subject to income Te reept of premisns pad a mere reture of capil ence, not dasalied ae income, and Us, exempted Fram Illustration Emily Aguinaldo entered into an insurance contract insuring her own lige, She paia monthly premium of P2,000 for a policy wnich allows the beneficiary to recover P 2,000,000 in case of her untimely demise, the insurance policy is good for 60 months. After 7 months of paying the premiums, Emily needed immediate funds for the replacement of her ganing rig’s graphics card, thus, she transferred the policy to Andrea Boni for a total value of P 10,000. The latter, immediately agreed, named herself as the new beneficiary of the policy and continued paying fe S premium. After a month, Andrea died. What is the tax consequence of andrea’s death? The heire of Andrea will not be liable to pay any income tax with respect to the proceeds of the life insurance acquired by Andrea from Baily.Andvea outlived the policy without missing a single premium payment and surrender value of P 1,000,000. What is the tax consequence of this event? received the ca Out of the total proceeds, only P 116,000 is exempted from income taxation, This is composed of the remaining premium payments that Andrea made (53, since Emily paid for the first 7) and the amount of consideration she paid Emily at the time the policy was transferred to the former (P10,000) GIFTS, BEQUESTS, DEVISES, DESCENTS The value of property acquired by gift, bequest, devise, or descent, shall be excluded from gross income: Provided, however, that income from such property, as well as gift, bequest devise or descent of income from any property, in cases of transfers of divided interest, shall be included in gross income. on Janvary 1, 2020, Jot received, as a gift, an apartment unit from his grandfather, Don Alberto, The value of such property is P10,000,000, and earns annual income of 600,000 from Chinese tenants low much ie the taxable income of Jot? be quired 600,000. The value of the property excluded from inCOMPENSATION FOR INJURIES AND SICKNESS Amounts received, through Accident or Health Insurance or under Workmen’s Compensation Acts, as compensation for personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on account of such injuries or sickness. Illustzation Dax, @ senior Vice-President of Monterey, was accidentally hit by a auetving SUV driven by James. The accident reeulted in the former! s deformity and severe physical injuries requiring intense medic: bax, represented by his counsel, Albin, filed a case against Janes. As expected, the case was decided in favor of Dax, The presiding magistrate, Judge Alic, awarded the prevailing party the following monetary relief: eval damages r 7,000,000.00) ‘Aetualdarages t 500,000.00 Damages for permanent loss of right ib loading to loss of ening eapecity * __10,000.000.00 ‘Compensation for unealzedsalares durng the hospitalization perod ° 750,000.00 How mach is Dax’s taxable income? only 750,000 is considered taxable. The rest of the damages received by Dax is exempted from income tax being conpensation for the injuries he suffered. 750,000 is taxable as this does not represent compensation for injuries ‘or sickness but is rather a compensation for lost profits suffered by Dax. {et be emphasized that “damages” i pot synonymous with “damage.” The farmer refers to the compensation (ranted to's person who was wronged by another person, while the later refers to the actu! wrong or ijn, suffered by the victim INCOME EXEMPT UNDER TREATY Income of any Kind, to the extent required by any treaty obligation binding upon the Government of the Philippines shall be excluded from gross incone. SEPARATION BENEFITS Retirement benefits Retirement benefits received under the Labor Code of the Philippines and those received by officials and enployees of private firme, whether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer shall be excluded from gross incone: Provided, that the retiring official or employee has been in the service of the same employer for at least 10 years and is not less than 50 years of age at the time of his retirement: Provided, further,that the benefits granted under this subparagraph shall be availed of by an official or employee only once Elements: 1, Retirement benefits received by employees of private firms; 2. In accordance with a reasonable private benefit pian’ maintained by the employer; 3. The retiring employee must have been in the service of the sane employer for at least 10 years and is not less than 50 years old at the time of his/her retirement; The benefits shall be availed of by the employee for the first time. In cases where there is no reasonable private benefit plan maintained by the employer the following requisites shali be followed: 1. An employee retired upon reaching the age of 60 years or more, but not more than 65 years old; 2. The same employee has served at least 5 yeare under the same employer Disability Benefits Any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death, sickness, or other physical disability or for any cause beyond the control of the said official or employee shall be excluded from gross income Tt can be observed that when the separation is beyond the control of the employee, e.g., death, sickness, or other physical disability, any benefits received by reason of such shall be excluded from gross income. On the other hand, benefits as a result of an employee’s own volition such as voluntary resignation shall be subject to income tax. Social Security Benefits ‘he provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other similar benefits received by resident or nonresident citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions, private or public, shall be excluded from gross income. (Section 32 3.6, NIRVeteran's Benefite Payments of benefits due or to become due to any person residing in the Philippines under the laws of the United States adniniatered by the United States Veterans Administration. on 32, B.6.D, NIRC) S88 Benefite Renefits received from or enjoyed under the Social Security system in accordance with the provisions of Republic Act No. 8282. (Section 32, 8.6.2, NIRC) GsIS Benefits Benefits received from the GSIS under Republic Act No. 8291, including retirement gratuity received by government officials and employees (Section 32, 8.6.F, NI MISCELLANEOUS ITEMS Government income Income derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof. Income of foreign governments Income derived from its investments in the Philippines in loans, atocke, bonds, or other domestic securities, or from interest on deposits in banks in the Philippines by: 1. Foreign governments; 2. Financing institutions owned, controlled, or enjoying refinancing from foreign governments; and 3. International or regional financial institutions established by foreign governments. China reported the following earnings derived from its several investments and activities in the Philippines: Interest income from bonds r 5,000,000.00 ‘iin income received from SME shares r 2,000,000.00) Gain on toe of domeste secures r 10,000,000.00 The entize income earned within the country by the Chinese government shall be exempted from income tax in the Philippines.*Prizes and awards Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievenent shall be excluded from gross income, but only if: 1. The recipient was selected without any action on his part to enter ‘the contest or proceeding; and 2. The recipient is not required to render substantial future services as a condition to receiving the prize or award. Prizes and Awards in Sports Competitions ALL prizes and awards granted to athletes in local and international sports competition and tournaments whether held in the Philippines or abroad sanctioned by their national sports associations. Pies won spats touraments not sanctioned by thar watioal sports esogatons sal be subject to come tn ‘Also, prize out of PROFESSIONAL toumaments shal be treted ae professional income and are properly subject 0 income to. Contributions G18, SSS, Medicare and Pag-Ibig contributions, and union dues‘ of individuals ahall be excluded from gross income. Gains from Sale of Bonds Gains? realized from the sale or exchange or retirement of bonds, debentures, or other certificates of indebtedness with a maturity of more than five years The interest income earned from bonds is not synonynous with the “gains*”, which exempts gains derived from trading, redemption, or retirement of long-term securities from ordinary income tax. on January 1, 2021, Franklin invested in @ 10-year, 128 bond for P1,000,000. At the beginning of October of the same year, Franklin sold the bond for Pl,100,000 resulting to the gain on sale of P100,000. In addition, total interest income accrued amounted to P90,000. How much is to be excluded from gross income? Only the P100,000 gain from #ale shall be excluded from gross Jncome. The P90,000 interest income is not covered by this provis. Union ues refer to those regular contributions of laborers to the labor unions to which they belong, “The exertion applies onl to the gains derived from sale does not extand to the intaveat neon dei he aforementioned certificates of indebtedness, {The term “gain” does not inch interest, which represents forbearance forthe use of money. Guns from sale or ‘exchange or retirement bonds or ether certicate of indebtedness. Bance de Oro v. Republic ofthe Philippines Page 11 ofMutual Funds Gains realized by the investor upon redemption of shares of stock ina mutual fund company shall be excluded from gross income: Sale of Gold income derived from the following transactions pureuant to People’s Small-scale Mining Act of 1991: 1. The sale of gold to the Bangko Sentral ng Pilipinas by registered small-scale miners, and accredited traders; and The sale of gold by registered amall-scale miners to accredited traders for eventual sale to the Bangko Sentral ng Pilipinas (Section 32, 8.7.1, NIRC) Inventors, To promote, encourage, develop and accelerate conmercialization of technologies developed by local researchers or adapted locally from foreign sources including inventions, any income derived from the: technologies shall be exempted from all kinds of taxes. During the fizet ten (10) years from the date of the first sale, subject to the rules and regulations of the Department of Finance: Provided, that this tax exemption privilege pertaining to invention shall be extended to the legal heir or assignee upon the death of the inventor. the technologies, their manufacture or sale, shall also be exempt from payment of license, permit fees, customs duties and charges on imports. (Section 6, R.A. 7459) ‘The income tax exemption, however, does not apply to the prizes awarded to the individual inventor which ie still subject to a final tax of 20%. (BIR Ruling 069-2000) Barangay Micro Business Enterprise BUBEs are enenpt from income taxa minimum wage law. (R.A. 9178) a and exenp’ om the coverage of “Barangay Micro Business Enterprise refers to any business entity or entexprise engaged in the production, processing, or manufacturing of products or commodities, including agro-processing, trading and services, whose total assets including those arising from loans bu exclusive of the land on which the particular business entity’s office, plant and equipment are situated, shall not be more than Three Million Pesos (P3,000, 000)TAXES ON PASSIVE INCOME THE FINAL WITHHOLDING TAX SYSTEM? A tax compliance method utilized by the taxing authority which requires a tax agent to withhold a portion of a payment for services or good to a supplier and remit tha’ portion to the government. © ensures that taxes are remitted properly by a business and on a timely basis A final tax is the term used to describe the tax on earnings that have been subjected to complete withholding tax payment at source. These earnings are no longer included in the determination of taxable income subject to regular tax Final taxes withheld by the withholding agent constitute full and final settlement of the income tax due from the payee on the said income. The jability of payment of the tax rests primarily on the payor as @ withholding agent. thus, in case of nis failure to withhold that tax oF se of under-withholding, the deficiency tax shall be collected from the payor/withholding agent. The payee is not required to file an income tax return for the particular income.To illustrate, interest income arising from bank deposit is subjected to 20% final withholding tax. Thus, say, P20,000 has accrued in favor of the taxpayer as interest income for the current year, the bank will credit only P16,000 to the taxpayer’s account and will directly remit the 4,000 constituting the tax on interest to the BIR. As a result of this, the taxpayer need not go to the BIR to file and pay the tax on interest as the bank, as withholding agent, has already done it for him, SPECIFIC TYPES OF PASSIVE INCOME AND THEIR TAX TREATMENT INTEREST INCOME A final tax at the rate of 208 is hereby imposed upon the amount of interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements. (Section (24) (B)1, Section 25 (A) (2), Section 27 (D) (1), Section 28 (A) (7) (a), NIRC) ‘The fina withhalaing to system must nat be confussl ith he editable withhaleing tax eyetemn, which cows lement of tax habit not constitute a inal set This concept willbe futher discussed in the subsequent chapters Appl to Cizene, Ressans, Nonrescent Aliens Engaged in Trade or Business within the Philippines Domestic Corporations, and Resident Fore'gn Corporations.The interest income must be sourced from a BANK DEPOSIT, DEPOSIT SUBSTITUTES!2, TRUST FUNDS!, OR SIMILAR ARRANGEMENTS, for the rules herein to be applicable. Interest income from other sources, such as interest from receivables arising from contracts with customers, shall be outside the coverage of this section and shall be ¢: differently. dilustration Davie placed her retirement pay, which she painstakingly earned during her entire lifetime as an employee in an auditing firm, amounting to Pi,500,000 in DBO, a banking institution in the Philippines. The said bank offers 14 interest rate per annum, How much interest income should Davie receive in a year? Davie receives an annual net interest income of P12, 000. “The total interest income eared is P15.000 per sum, P3,000, constituting 20% of such income i arecly remitted by BDO to the BI 35 tak setement Tilustration on the other hand, Galo, Davie’s workmate, lent her retirement pay to Aloy, an alleged businesswoman. Out of this transaction Malo, earned 20,000 interest. How much is the final tax on interest? “he intrest core is vot sourced fom a bark depos, deposit edbttute, tnt find oF any other sar ‘rangement. Such income is subjected to normal tax are not fin tx 19-LENDER RULE in order for an instrument to qualify as a ‘deposit aubstitute.” the borrowing mist be made from 20 or more individual or corporate lenders at any one time. Corollary, the mere flotation of a debt instrument is not considered to be a “public"borrowing and is not deemed a “deposit substitute” if there are only 19 or less individual or corporate lenders at any one time: A person holding any interest, whether legal or beneficial, on a debt instrument or holding thereof either by assignment or participation with or without recourse, shall be considered as lender, and thus, be counted in applying the 19-lender rule. "= Deposit substitutes are alternative forms of obtaining funds fom the public other than deposits, through the iseuance, endorsement, o sezeptance of debt instruments forthe borrower’ © n account, forthe purpore ofr lending or purchasing of rceivables and other abligaions, or fnancng thet agent or dealer awed or the nowds of thei "© Atwst fund is any estate, stock, security or any property held in tus by @ person called the trustee in favor of snather person calles the Baneficiay ‘The phrase “at any onetime" for purposes of determining the "20 or moe lenders” would mean every raneacion exaeuted inthe primary or secondary market in connacton with the purchase orale of scutes, (00 v. Republic)cooperatives are not required to withhold taxes on interest from savings and time deposits of their members. (Dumaguete Cathedral Credit Cooperative v. CIR) INTEREST INCOME FROM LONG-TERM DEPOSIT OR INVESTMENT CERTIFICATE Interest income from certificate of time deposit or investment in the form of savings, common or individual trust fund, deposit substitutes, investment management accounts and other investments with a maturity period of not less than 5 years, the form of which shall be prescribed by the Banko Sentral ng Pilipinas and issued by banks only (not by nonbank financial intermediaries and finance companies) to individuals in denominations of P10,000 and other denominations as may be Prescribed by the BSP shall be exempted from final tax of 208. (Section 24 (B) (1), Section 25(A) (2), NIRC)” Blenente: 1, Interest income from a time deposit or investment in the form of common or individual, trust fund, deposit substitutes, investment management accounts and other investments: . Maturity period of not less than 5 years; Form prescribed by the BSP and issued by BANKS only: i In denominations of P10,000 or other as may be prescribed by the BSP. ‘PRE-TERMINATION Should the holder of the certificate pre-terminate the deposit or investment before the Sth year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depositary bank from the proceeds of the long-term deposit or investment certificate paged on the remaining maturity thereo Four to less than five years oe Tree to les than four years 9 ess than tee yes 20% dilustration 9 Rost invested 1,500,000 in a time-deposit with DBO Bank with a maturity period of five years. The investment earns P10,000 per year of investment. How mich is Rost’s tax 1sapility? None. erest income from long-term deposit or investment certificates is exempt from tax ' Apples to Citizens, Residents, Nonasient Aliens Engaged in Trade or Business within the Philip Page 15 of 1Assume: At the beginning of the fourth year of investment, Rost was in desperate need of money and thus withdrew his deposit in D380 bank. What is the tax implication of the transaction? Rost’s final tax liability on interest is P1,500. Since he pre-terninated the investment at the beginning of the fourth year, he is liable to pay a tax of 5% on the ENTIRE interest incone earned (refer to the table above). Total interest income earned amounted to 730,000. rilustration Terisa, Rost’s dear friend, did the same thing and deposited her Lifetime's savings in a time-deposit with a bank. The investment has a maturity period of 4 years, and earns P10,000 interest annually. How much is Teriea’s annual tax liability? veriea’s final tax liability is 22,000 per year. The transaction does not fall under the exception 2s the original maturity is less than § years Tis problem and the immediately preceding one shoud not be confused with each other The formar mwalves an investment that had an origin! maturity peed of lees than five years, whe the later had sn orignal matty period of five years but was later on pre-termnated for personal reasons. Illustration (RMC Wo. 7-2015) Tresa, a nonresident alien engaged in trade in the Philippines, transferred an instrument with a maturity period of years to ‘Theresa. The former held it for three years, while the latter held it for two years before subsequently transferring the same to Terry Crews, who, in turn, pre-terminated it after four years. Determine the applicable tax rates for all the mentioned taxpayers Tes (Heid the instrament for 3 years) 72K Theresa (Held the iatrment for 2 yeas) 20% Terry Crews (Hed the instrument for 4 years) om EXPANDED FOREIGN CURRENCY DEPOSIT SYSTEM Interest income received by an resident individual taxpayer or a domestic/ resident corporation fvon a depositary bank under the expanded foreign currency deposit system shall be subject to @ final income tax at the rate of 15% of such interest income. (Section 24, (B) (1), Section (0) (1), Section 28 (6) (a), NIRC) Simply stated, interest income from a foreign currency deposit by residents of the Philippines is subject to 15¢ final withholding tax. This is a result of che recent amendment brought about by TRAIN Law. The previous rate was 7.5%.hile the interest earned from the same transaction earned by NON- RESIDENTS is exempted from tax In a case of interest on expanded foreign currency deposit account jointly in the name of an overseas contract worker or a Filipino Seaman, and an individual (spouse or dependent) who is living in the Philippines, only 50% of euch intezest is subject to the 15% tax and the other half shall be exerpted. (Section 3.4, Revenue Regulation No. 21-2011) INTEREST INCOME EARNED UNDER THE NORMAL COURSE OF BUSINESS Interest income earned under the normal course of trade or business by entities such as banks or other financial intermediaries, shall not be considered ae passive income and shall be subject to REGULAR INCOME TAX and not to final withholding tax. ROYALTY INCOME A final tax at the rate of 206 is hereby imposed upon the amount of royalties, except on books as well as other literary works and musical compositions, which shall be imposed a final tax of 10%. (Section 24(B) (1), Section 25(a) (2), Section 27 (D) (1), Section 28 (AJ (7) NTR)? This proven may be dssected and dided into two parts being, royales from books, as well as ote eran) works and muses! compostions wich shal be subject to TOS fin tax and al other royalties considered 88 passive Tecome which subject to 20% Fira ax. Meanwhile, royalties arising from the regular course of trade or business, which is considered as active income rather than passive, shall be subject to REGULAR INCOME TAX and not to final withholding tax. ‘The Bureau of Internal Revenue has clarified in various rulings that royalty income is considered as active income if the same arises from the active pursuit of business, using as basis the primary purpose indicated in the Articles of Incorporation. In a case (Iconic Beverage, Inc. v. Commissioner of Internal Revenue) brought to the Supreme Court, a taxpayer was assessed by the BIR for deficiency income tax on its royalty income earned during taxable year 2010. The taxpayer is a domestic corporation engaged in manufacturing, buying, selling, and dealing alcoholic and non-alcoholic beverages, as stated in its amended AOI. The taxpayer entered into a license agreement with another company (Company A) for the latter's use of certain domestic intellectual property (IP) rights and received royalty fees. The taxpayer contended that the royalty fees are merely passive income arising from mere ownership of an asset. The generation of such income does not require any active action or material participation ron the taxpayer. The taxpayer further reasoned that the act of "Applies only ta individual, and not to cxporatetexpayers Applies to Citzons, Residents, Nonesident Aliens Engaged in Tade or Business within the Philippi Domestic Corporations, and Resident corporations,Licensing out certain 1? rights is merely incidental to its primary purpose. It also claimed that it did not actively pursue Company A to enter into the said license agreement. The BIR, however, argued that the taxpayer's amended AOT revealed that part of the taxpayer’s primary purpose is “to own, purchase, license and/or acquize such trademarks and other intellectual property rights necessary for the furtherance of its business.” Hence, the BIR believed that there is factual basis to conclude that the taxpayer generated its royalty incone in active purewit and performance of its primary purpose. In addition, an analysis of the taxpayer's financial Statements disclosed that it had no other source of income other than the royalty income and a minimal amount of interest income. The SC, on the other hand, pointed out that the amount of cash inflows from the taxpayer's operating activities consists only of income from its royalty and interest income, as presented in the Statement of cash Flows for both taxable years 2010 and 2009. Similarly, the SC observed that the taxpayer's income tax return did not reflect any cost of sales or services for 2010. Having no amount reflected as cost of sales or services gave the SC sufficient reason to doubt whether the taxpayer's main Line of business actually involves manufacturing, buying, selling, and dealing alcoholic and non-alcoholic beverages, as they claim, The SC deduced that the taxpayer’s royalty income from licensing its IP rights is income generated in the active pursuit and performance of its primary purpose; thue, it ie not considered passive income subject to final withholding tax. (https://wew.grantthornton.com.ph/insights/ articles-and-updatesi/lets-talk-tax/royalties-active-or-passive- incone/} DIVIDEND INCOME INDIVIDUALS A final tax at the rate of 108 shall be imposed upon the cash and/or property dividends actually or constructively received by an individual from a domestic corporation. (Section 24, (8) (2), Section 25(A) (2), MIRC) eceived by a non-resident alien engaged in business in the ippines, the final tax is 20.1 while the receipt by @ non-resident alien not doing business in the Philippines is subject to a final tax of 25419 This provision refs aly to CASH OR PROPERTY dividand dalarations made by DOMESTIC CORPORATIONS ard recente by RESIDENT CITIZENS, NON-RESIDENT CITIZENS, AND RESIDENT ALIENS.DOMESTIC CORPORATIONS Dividends received by o domestic cozporation shall not be subject to tax: Provided, That for foreign-sourced dividends to be exempt, the funds from such dividends actually received or remitted into the Philippines are reinvested in the business operations of the domestic corporation in the Philippines within the next taxable year from the time the foreign-sourced dividends were received and shall be limited to funding the working capital requirements, capital expenditures, dividend payments, investment in domestic subsidiaries, and infrastructure project: Provided, further, That the domestic corporation holds directly at least twenty percent (208) of the outstanding shares of the foreign cozporation and hae held the shareholdings for a minimum of two years at the time of the dividends distribution. (Section 27(D) (4), NIRC) Elements: 1, Dividends received by a domestic corporation is absolutely exempt from income tax; 2. Dividends yeceived by a domestic corporation from a foreign corporation may be exempted from income tax only if all of the Following conditions are satisfied: vidends actually received or remitted into the Philip wested in the bi erations of the domestic cozpor: the Philippines within the next taxable year from the time the foreign-sourced dividends were received and shall be limited to funding the working capital requirements, capital expenditures, dividend payments, investment in domestic subsidiaries, and ucture project; and 4. The domestic cozporation holds directly (20%) of the outstanding shares of the fore! held the shareholdings for a minimum of two years at the tine of the Gividends distribution, poration from another domestic RESIDENT FOREIGN CORPORATIONS Dividends received by a resident foreign corporation from a domestic corporation shall not be subject to tax. (Section 28 (A) (7) (a), NIRC) NON-RESIDENT FOREIGN CORPORATIONS A final withholding tax at the rate of fifteen (15%) is hereby imposed on the amount of cash and/or property dividends received from a domestic corporation, subject to the condition that the country in which the nonresident foreign corporation is domiciled, shall allow a credit against the tax due from the nonresident foreign corporation taxes deomed to have been paid in the Philippines equivalent to fifteen percent (15%), which represents the difference between the regular income tax and the fifteen percent (15%) tax on dividends as provided in this subparagraph: Provided, That effective July 1, 2020, the credit against the tax due shall be equivalent to the difference between the regular income tax rate of twenty five percent (25%) and the fifteen percent (15%) tax on dividends. (Section 28(8) (5) (b), NRC)In um, a non-resident corporation is subject to 25% final tax unless the tax sparing rule applies, in which case it shall only be taxed at 158. SHARE DIVIDENDS A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. (Section 73, B, NIFC) This is an application of the realization or severance test previously discussed. However, pure stock dividends may be subject to dividends tax when all of the following circumstances exist: 1. there is an option to take cash or property dividends instead stock dividends: 2. some stockholders exercised the option to take cash or property dividends; 3. the exercise of option resulted in a change of the stockholders’ proporticnate share in the outstanding shares of the corporation. Illustration BOA Co. with common outstanding declared a 208 stock dividend to its stockholders with an option to choose property dividend instead of stock. Baki, a shareholder of BQA Co., opted for the property dividend with a fair market value of P15,000 while the other stockholders chose the stock dividend. The fair market value of the common stock upon distribution was P500 per share ‘SHAREHOLDERS BEFORE OIVENDS {STOCK IVDENDS ‘AFTER DVIDENDS Tio of shares | Percentage | 20% outstanding | No.of shares | Percentage hares ake 200 70% 200 V20% Others 300 1% 16 960 e278 Toul 1000 100% 1160 100% Notice that Baki’e number of shares held did aot change because he opted for the property dividend. By reason of this, the proportion of shareholdings was affected and thus, the stock dividend declaration shall be subject to tax. Baki shall pay P1,500 ae settlement of his tax liability. This is 10% of 15,000, which is the fair market value of the property he received. The other shareholders, on the other hand, shall be collectively Liable for P8,000, representing 108 of the fair market value of the share dividends received. (160 shares % P500 market value per share) assume:Suppose that all stockholders opted for the share dividends ‘SHAREHOLDERS TEFORE DVIDENDS STOCK DAIDENDS "AFTER DVIDENOS To of ares | Percentage | 20 outstanding | No of shares | Percentage shores ake 200 20% 0 20 2098 ‘Othe 300 ry 760 300 208 Tota 7000 700% 7200 100% Such scenario did not change the proportionate interest of the shareholders of BQA Co., thus the pure stock dividend is EXEMPT f taxation. REDEMPTION OF STOCK DIVIDEND I€ the corporation cancels or redeems stock issued as dividend at such ‘time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock is considered taxable income to the extent that it represents a distribution of earnings or profits (Section 73, B, NIRC) SCRIP DIVIDEND A scrip dividend is issued in the form of a promissory note and is taxable to the extent of its fair market value. It is taxable in the year the warrant was issued. (Section 251, Revenue Regulation Wo. 2) Hlustration on April 1, 2020, Karl received scrip dividend from GTA, Inc. amounting to P20, 000 with an annual interest of 12% payable within one year from the date of the note. How much is Kar: taxable dividend income? The taxable dividend income received by Karl is P20,000 which was dectared in 2020. The 72,400 interest (220,000 x 12%) shall not be part of the dividend income but instead part of interest income earned in 2021 LIgurparING DIvZDENDS Liguidating dividends represent return of capital and not return on capital. It arises from the distribution of assets by @ corporation to its stockholders upon corporate dissolution As a rule, the excess amount of liquidating dividends over the cost of the shares surrendered is taxable not as dividend income but as a capital gain. If the result is otherwise, then the result is treated as @ capital loss.1A prize a reward fora contest or @ compattion Diferentiy warded, pas represents remuneration for an efert, of one's super in sil ad effort, Ike prize money of a boxng or video game tourament. On the other hand, 3 ong is renaed for an event that substantaly depends on chance such az gambing, lottery, or raffle thet. The foomarrequres the exertion of effort, whl the latter doesnot aque as much, PRIZES AND WINNINGS A final tax at the rate of 20% is hereby imposed upon the amount of prizes (except prizes amounting to P10,000 or less which shall be subject to the graduated tax rates; and other winnings (except winnings amounting to P10,000 or less from Philippine Charity Sweepstakes Office (2CS0) games which shall be exempt), derived from sources within the Philippines. (Section 24, (B) (1), Section 25(A) (2), NIRC, as amended) * The provision may be simplified in the following manner: 1. prizes amounting to P10,000 or less shall not be subject to = final tax on winnings of 20% but is subject to the ordinary graduated tax 2. winninge from the PCSO or lotto amounting co F10,000 or less shall be exempt from any tax, while the excess are taxable at the rate of 208; 3. all other prizes and prizes and winnings shall be subject to a fina tax on prizes and winnings of 208 Illustzation Few won the following prizes and winnings during the year 2020 ‘Woncvin Televised random gve-anay r 170,000.00 15 Fie, Sah Nelee Tournament r 50,000.00 PSO Wiens r 35,000.00 ‘6h ner vp, Bird Open r 5,000.00 Determine the tax treatment for each item. Wowonin Televised random gve-_[P _ 10,000.00] Winnings, subject 200 Fal tax 15 Pie, Smash Melee Touramant [P $0,000.00 Prize, subject t 206 final x PCSO Winnings 35,000.00] Loto wiangs, subject to 20% fal tx ass excaeds 10,000, ‘th unmer up, Bri Open P 5000.00] Piz, subject to normal tat as It dove not exceed| 10,000PARTNERS’ SHARE IN THE DISTRIBUTIVE PROFITS OF A PARTNERSHIP OTHER THAN ‘A GENERAL PROFESSIONAL PARTNERSHIP A partner’s share in the income of a business partnership is subject to the same rules on dividends as discussed above A business partnership is a partnership engaged in trade or business as contrasted against a General professional Partnership which solely derives its income from the exercise of a conmon profession. The tax treatment for General Professional rartn Giscusced in the eubeaquent chaptess 2 shall be INEORMER’S REWARD TO PERSONS INSTRUMENTAL IN THE DISCOVERY OF VIOLATIONS OF THE NIRC AND IN THE DISCOVERY AND SEIZURE OF SMUGGLED oops: A, For Violations of the National Internal Revenue Code. - Any person, except an internal revenue official or employee, of other public official or employee, or his relative within the sixth degree of consanguinity, wac voluntayily gives definite and sworn information, not yet in the possession of the Bureau of Internal Revenue, leading to the discovery of frauds upon the internal revenue laws oF violations of any of the provisions thereof, thereby resulting in the recovery of revenues, eurcharges and fees and/or the conviction of the guilty party and/or the imposition of any of the fine or penalty, shall be rewarded in a sum equivalent to ten percent (102) of the revenues, surcharges or fees recovered and/or fine or penalty imposed and collected or One million pesos (P1,000,000) per case, whichever is lower. The same amount of reward shall also be given to an informer where the offender has offered to compromise the violation of law committed by him and his offer has been accepted by the Commissioner and collected from the offender: Provided, That should no revenue, surcharges or fees be actually recovered orimposed and collected or One million pesos (P1,000,000) per case, whichever is lower, The same amount of reward shall also be given to an informer where the offender has offered to compromise the violation of law committed by him and his offer has been accepted by the Commissioner and collected from the offender: Provided, That should no revenue, surcharges or fees be actually recovered or collected, such person shall not be entitled to a reward: Provided, further, That the information mentioned herein shall not refer to a case already pending or previously investigated or examined by the Commissioner or any of his deputies, agente or examiners, or che Secretary of Finance or any of his deputies or agents: Provided, finally, That the reward provided herein shal be paid under rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner 5. For Discovery and Seizure of smuggled Goods. - To encourage che public to extend full cooperation in eradicating smuggling, a cash reward equivalent to ten percent (10%) of the fair market value of the smuggled and confiscated goods cr One million pesos (P1,000, 000) per case, whichever is lower, shall be given to persons instrumental in the discovery and seizure of such smuggled goods. The cash rewards of informers shall be subject to income tax, collected as a final withholding tax, at the rate of ten percent (108). The provisions of the foregoing Subsections notwithstanding, all public officials, whether incumbent or retired, who acquired the information in the course of the performance of their duties during their incumbency, are prohibited from claiming informer's reward. Elements: 1. The discovery of any violations of the NIRC that resulted to recovery of revenues, surcharges, and fees and/or conviction of the guilty party and/or the imposition of any fine or penalty, or to the discovery and seizure of smuggled goods; Excludes those discovered by an internal revenue official or employee, or other public official or employee, or his relative within the sixth degree of consanguinity; 3. The reward is limited to 108 of the revenues, surcharges, fees, fine or penalty imposed, or fair value of the emuggled and confiscated goods, whichever is applicable, or P 1,000,000, whichever is lower; 4. The appropriate value in number 3 above, shall be subject to a final withholding tax of 10%.GROSS INCOME SUBJECT TO NORMAL TAX Gzoss Incone. - General Definition. - Except when otherwise provided in this Title, gross income means all income derived from whatever source, including (bat act limited to) the following items: 1. Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items; 2. Gross income derived from the conduct of trade or business or the © of a profession; 3, Gaine derived from dealings in property; 4. Interests; 5. Rents; 6. Royalties: 7. Dividends; 8 ° u L + Annuities; Prizes and winnings 0.Pensions; and Lipartner’s distributive share from the net income of the general professional partnership. (Section 32, A, NIRC) “The opanng paragraph, apecfcaly the cause “al one danved from whatever source including but nat Imad a2" shows Be inn scope of tation a & reaches oll fypes oF icone and such scope ts mot merely Contd in the enumeration provided, The items to be included in the gross income are generally those that laze properly to be included in the Income Tax Return and is subject to the ordinary graduated tax rates Note that other items such as “interests,” “dividends,” and “prizes and winnings,” have already been mentioned in the previous topice on exclusion from gross income and final taxes. The items to be mentioned herein are those that are outside the scope of the items previously discussed. GROSS COMPENSATION INCOME Gross compensation income means any remuneration for rendering personal services. Generally, compensation incone is obtained from an employer- employee relationship between payor and recipient ‘The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes compensations. It may be paid on the basis of plecework, or @ percentage of profits and may be paid hourly, daily, weekly, month, annually. (Revenue Regelation No. 2-98) EXISTENCE OF EMPLOYER-EMPLOYEE RELATIONSHIP ‘There is employer-enployee relationship when the following elements of the four-fold test are present: 1. Power of the employer in the selected and engagement: of employees: 2. Payment of wages; 3. The employer's power of dismissal; and4. The power to control the employee's conduct in terms of both the end to be achieved and the means and method used to achieve that end, (Belicilda v. vy) CLASSIFICATIONS OF GROSS COMPENSATION INCOME Basic salary or wage Salary refers to earnings received periodically for regular work other than manual labor, such as a monthly salary of an employee. Wages, on the other hand, are earnings received usually according to specified intervals of work, as by the hour, day, or week. An exanple would be a crafteman’s daily wage. Cancellation of debt The cancellation and forgiveness of indebtedness may amount to a Payment of income, gift, or capital transaction, depending upon the Circumstances (Section 50, Revenue Regulation No. 2). The following gules shall then be observed: 1, If a creditor merely desires to benefit a debtor and without any consideration cancels the debt, the amount of the cancelled debt i a gift, not an income of debtor; 2. If 2 coxporation to which a etockhelder ie indebted forgives the debt, the transaction has the effect of the payment of a dividend income to debtor; 3. If, however, a debtor performs services for a creditor, who in consideration thereof cancels the debt, the debtor realizes income for his services to the extent of the amount of debt cancelled. Honoraria Honoraria are payments given in recognition for services performed for which established practice discourages charging a fixed fee such as the honorarium of a guest lecturer. Allowances In general, fixed or variable transportation, representation, cost of Living allowance and other allowances that are received by an officer er employee, in addition to the regular compensation fixed for his position or office, are compensation subject to withholding tax (Revenue Regulation No. 2-98) CONVENIENCE OF EMPLOYER RULE Allowances furnished to the employee for and as a necessary incident to the performance of hie duties are not congidered as compensation and are not taxable. Examples would be gasoline allowance for automobile sales agents, car benefits for medical representatives, or focd and lodging benefit granted te a household helper or family driver, among others.‘Ueimatey, the ea afeence bes not on te Kn of th beneft but on te purpose why Kwa given by the ‘employer. fit priariy fer the employee's gain, then the benafit is facity (eal; # ts prowsen ie may for the employes advantage, then itis a supplement (not taxable). Again, this is to ensure that employees are protected in ercumstances where the employer desgates a beneit as deducbbi Wom the wages even thaugh i ‘leary woris to the employer's gremter comvenanes or advantage. (Ow Haut Reaty Devalopment Corporation Pain) Living Quarters ‘The following rules govern the living quarters furnished by the employer to the employee: 1. When living quarters are furnished in addition to cash salary, the rental value of such quarters should be reported as income. 2. However, if living quarters or meals are furnished to an employee for the convenience of the employer the value thereof need not be included as part of compensation income. (Revenue Regulation No. 2-98) STATUTORY MINIMUM WAGE EARNER A minimum wage earner ic a worker in the private sector paid the statutory minimum wage’! or is an employee of the public sector with compensation income of not more than the statutory minimum wage in the non-agricultural sector where he/she is assigned. (Section 22, HH, NRC) The RTWPR of each region shall determine the wage rates in their respective iuriedictions based on established criteria euch as, the cost of living, demand for services, the industry demographics, the ability of the employers to pay the employees, and the demands of the employees, among others. ‘Minimum wage earners shall be exempt from the payment of income tax on their taxable income. Holiday pay, overtime pay, night-shift differential pay, and hazard pay received by such minimum wage earners shall likewise be exempt from Ancome tax, (Section 24, a.1.8, NIRC) Other income, however, earned by the said MES shall be subjected to tax accordingly, without affecting their status as minimum vage earners. Thus, # MiP may engage in other income generating activities and still enjoy the exemption granted to MWEs for their compensation income as above-mentioned. Marginal Income Earner ~ shall refer to those individual whose business does not realize gross sales or receipte exceeding P100,000 in any 12- month period. (Section 3, Revenue Regulation No. 7 -2012) 2 Statutory minimum wage shal refer to (eTWPe) ot rate fixed bythe Regional Tripartite Wage and Productivity Board Page 27 of 41The individual referred to in that section is an individual not deriving compensation as an employee under an employer-employer relationship but who is self- employed and deriving gross sales or receipts not exceeding P100/000 in any 12-month period. Moreover, the activities of such MIE should principally or be for subsistence or Livelihood. The MIE, as herein defined shall include but not limited to agricultural growers/producers (farmers/fishermen) selling directly to ultimate consumers, small sari- sari stores, small carinderias or "turo-turos", drivers/operators of a single unit tricycle, and such, but shall not include licensed professionals, consultants, artists, sales agents, brokers and other similarly situated, ineluding all others whose incone have been subjected to withholding tax. (Revenue Memorandum Cixcular No. 7-2014) 13th MONTH PAY AND OTHER BENEFITS Gross benefits received by officials and employees of public and private entities shall be excluded from gross income: Provided, however, that the total exclusion shall not exceed P90,000 which shall 1. Cheistmae bonus to national and local government officials and employees. 2. 13th month pays 3. Benefits not covered by the mandatory 13th month pay 4, Other benefits such as productivity incentives. (Section 32, 8.7.5, MIRC, as amended) ‘The previous celng was FB2,000 but the same was increased to P30.000 by the TRAN lw Llustza Melicdas, a minimun-wage earner working in Palo as a security officer reported the following items for the taxable year 2020: Basic pay t 76,800.00 Hazard pay ? 30,00000 Nite ferential pay ? 30,000.00 (Overtine pay ? 170,000.00) 13th month pay ? 25,000.00 How much is Meliodas’ taxable compensation income? NONE. Neliodas, being @ minimum wage earner Is exempt from income tax for his basic compensation income, hazard pay, night-shift differential pay, and overtime pay, regardless of amount. On the other hand, his 13th month pay did not exceed the statutory ceiling of 790,000, thus also excluded from income tax.DE MINIMIS BENEFITS De minimis benefite are benefite of relatively emall value provided by the employers to their employees on top of the basic compensation intended for the general welfare of the employees. Being of relatively small values, the same is not being considered as 2 taxable compensation and as such, not subject to income tax and withholding tax on compensation. The amount of de minimis provided is a deductible salaries expense, while for the employee, it would constitute as an additional salary that is not deducted withholding tax on compensation The following are considered de minimie benefits (Revenue Regulation No. 11-2018): 1. Monetized unused vacation leave credits of private employees not exceeding ten (10) days during the yeary 2. Monetized value of vacation and sick leave credits paid to government official and employees; 3. Medical cash allowance to dependents of employees, not exceeding P1,500 per employee per semester or F250 per month: 4, Rice subsidy of P2,000 or one (1) sack of rice 50-kilogram rice per month amounting to not more than P2, 000; Uniform and clothing allowance not exceeding P6,000 per annum; 6. Actual medical assistance, e.g. medical allowance to cover medical and healthcare needs, annual medical/executive check-up, matern: assistance, and routine consultations, not exceeding 10,000 per 7, Laundry allowance not exceeding 2300 per month? 8. Employees achievement awards, €.g. for length of service or safety achievement, which must be in the form of tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding P10,000 received by the employee under an established written plan which does not discriminate in favor of highly paid employees; 9. Gifts made during Christmas and major anniversary celebrations not exceeding P5,000 pez employee per anauns 10.paily meal allowance for overtime work and night/graveyard shift not ‘exceeding twenty-five percent (258) of the basic minimum wage on a per region basis. 1l.Benefits received by an employee by virtue of @ collective bargaining agreement (CBA) and productivity incentive schemes provided that the total monetary value received from both CBA and productivity incentive schemes combined do not exceed P10,000.00 per employee per taxable year. ‘The it is exclusive, and all othr Benefits given by emplayers which are not inched inthe ove enumeration shal not be cansiered de minimis bereits, and hence, shal be subject to income tax as wel as withing tax Compensation core. (Reverue Regulation No. 15-2011) ‘BENEFITS ARISING FROM A COLLECTIVE BARGANING AGREEMENT AND PRODUCTIVITY NOENTIVE SCHEMES: ‘Any CBA or productivity incentives scheme benefits shal nly be exempt a8 “de minis” Benes the total ‘mount thereof does not exceed PY0,000 per taxable yer. Cthervee, the TOTALTY of such benefit wil cease to be ade minimis benef. For example ifthe benefit amounts to P17,000, the ene P17,000, and not the mare excess of 1,000, call be considered as other Benefits subject to the P3O,000 vertex. (RR. 293-201) Ths rung spois nly to this ype of de mis benef, the decussions onthe other bereits stil stand, (GR Rung 283-2015)Hlustration John Paul George, the most leg-breaking, hardworking DJ in Los Santos Radio, Inc. received the following benefits during the year: In addition, JPG was named as the DJ of the Year, and was consequently awarded with gift certificates redeemable in Bello Clinics for up to 20,000. How much is the amount of the total benefits exempted from income tax? 71,100 Supporting calculations Manetzed unised vacation leave crite (PISOO/C=y) * 20,000.00] Medical cash alowance to dependents ? 2,000.00 Rice subsidy r 30,000.00 tial mete sstance r 3,000.00 Lundy atowance ? ¥2,000.00| Crictnas of ? 70,000.09 [Unter allowance * 72,000.00] Productivity noentve scheme as provided in the GIA r 7,500.00 Notice thatthe entre P20,000 recsved forthe employee acieverent award was wcuded nthe taxable arount ‘because the lw provides thet the avard must be inthe Form of tangle persona propertes other than cach or git Cerofeates. Another, the exemationcellngs were converted ito ther annual values since the data given s For 3 ‘hole taxable yer Additional query: What happens to the benefits at exceeded the statutory exemption ceiling? Are they to be immediately reported as part of gross compensation income? The answer is in the negative. The excess of ‘de minimis’ benefits, ?50,400 in this case, may be absorbed by the P90,000 ceiling discussed above under Section 32 of the dlational Internal Revenue Code. Since such amount did not excead the 790,000 ceiling, then considered exempt from income \ch excess 18 a. In sum, ‘de minimis’ benefits enjoy a two-tiered exemption system. First, such benefits are to be absorbed by the limits provided under Revenue Regulation No. 11-2018, and the excess, if there is any, is to be taken in by the P90,0000 ceiling under Section 32 of the National Internal Revenue Code, on 13th-month pay and other benefit:‘TAX-EMEPT CONTRIBUTIONS Mandatory GSIS, SSS, PhilHealth, and HDMF (Pag-IBIG) contributions and union dues of individuals are considered as tax exempt- contributions. (Section 32, B, NIRC) Tllustration Neo, @ newly hired auditor in a big auditing firm in Makati, was so excited to check his pay slip fox his very firet compensation income: To his mind, it is the beginning of his road to riches. To his dismay, the said document showed the following values: Pay Sip forthe month of une OSB and Go, Assurance Neo. Waray — Jair Autor Base Pay r 73,000.09 Deductions Wwihioting tax r 00.00 SSS prem r 300500 Peg BIG premiom + 500.00) ‘Union iss 500500 Take-home pay ? 70,900.00 How much is Neos taxable compensation income? P11,700, Neo’s SSS, Pag-IBIG, and union contributions are exempt from income tax. The withholding tax is added back to the taxable compensation income as such type of withholding does not represent a final settlement of 3 tax liability, it is but a meze advance payment of a tax liability to be determined at the end of the taxable year. Berett ‘amomt | Genpton | Taube | Nortaable eceved | Colina Excess Monetzed unused VLC ® 2000000|F 15,00000|? 5,000.00] 15,000.00) Mescal cash allowance 200000]F so0000]r 0.00} 2.00000 Ree waked ¥ 3000000] 2400000] 6,000.00] F 24,000.00 Medical asitance e00000]F 1000000]r 0.00] —@,000.00 Laundry alowance 7 1200000/F 360000]? 8400.00] F 3,600.00 ‘Chistmas gf ¥ 7000000]F 500000]? —s,000.00] F s,000.0 Uniform aflowance ¥ 1200000/F 600000|r 6000.00]F 6,000.00) Procuctty eentive r 750000/r 1000000/r _o.00|r 7,500.00 ‘achievement award % zoo0000|F 1000000] 20,0000] 000 Tota ¥ 12150000] F #660000]? s0.«00.00] F 71,100.00CREDITABLE WITHHOLDING TAX SYSTEM The creditable withholding tax system provides for an advance collection ef taxes. The income from wnich it ie withheld ie still required to be included in the taxpayer's gross income when he filed his incone tax return. However, any excess creditable withholding taxes can be carried forward and be consumed in the successive taxable pericds, or, at the option of the taxpayer, it may be refunded. The taxes withheld are in the nature of advance tax payments by a taxpayer in order to extinguish ite possible tax obligation. They are installments on the annual tax which may be due at the end of the taxable year. (Chamber of Real Estate and Builders’ Associations, Inc v. Romulo) This systen is another countermeasure to ensure the collection of taxes. And those agents that would perform acts of under-withholding or non-withholding would suffer the disallowance of expenses in which the withholding was due, as deductions from their gross income. The Secretary of Finance may, upon the recommendation of the Commissioner, require the withholding of a tax on the items of income payable to natural or juridical persons, residing in the PH, by payor- corporation/persons as provided for by law, at the rate of not less than 1% but not more than 15% thereof, which shall be credited against the income tax liability of the taxpayer for the taxable year. (Section 57, (B), NERC) Any income payment which is otherwise deductible under the Code shall be allowed as a deduction from the payor’s gross income only if it is shown that the income tax required to be withheld has been paid to the BIR. (RR. 6-2018) The withholding tax system was devised for three primary reasons: 1. To provide the taxpayer @ convenient manner to meet hie probable income tax Liability; 2. To ensure the collection of income tax vhich can otherwise be lost or substantially reduced through failure to file the corresponding returns; and 3. To improve the government's cash flow. ‘The withholding agent is the payor, 4 separate entity acting no more than an agent of the government for the collection of the tax in order to ensure its payments; the payer is the taxpayer - he is the person subject to tax imposed by laws and the payee is the taxing authority. (RBC v. CIR) Tlustration General Grievous, 2 lessor of commercial areas, leased one unit to Kenobi. The contract provides for a monthly lease of P100,000. Kenobi pays at the beginning of every month. Wnat are the tax implications in relation to creditable withholding taxes?LESSEE (Kenobi) Kenobi shall remit to General Grievous an amount of P95,000 only, as the transaction is subject to a 5% creditable withholding tax. Kenobi then can validly deduct 100,000 from his gross income as one of his allowable deductions. In case, Kenobi fails, or deliberately omits the withholding, by paying to General Grievous the full amount of P100,000, the RENT =xPENSE shall be disallowed for purposes of computing Kenobi’s taxable income. LESSOR (General Grievous) General Grievous shall receive the P95,000 rental, net of creditable withholding taxes. However, when he files his income tax return, he Shall still be required to declare P100,000 as part of his gross Income, but after computing his tax liability, he shall be allowed to deduct the P5,000 creditable tax as a tax credit Notice the snesome contro ths tax measure has put in place, curbing the chances of caluson between the payor ‘and the payee as the payor suffers the injury of nen-deducton in case he succumbs tothe evi wil (on wvthholdg) of the payee. FINAL WITHHOLDING TAX v. CREDITABLE WITHHOLDING TAX Gross compensation income are those remuneration or earnings paid to any employee, however designated, capable of being expressed in terms ef money, whether fixed or ascertained on a time, task, piece, or commission basis, or other method of calculating the same, which is payable by an employer to an employee under a written or unwritten contract of employment for work done or to be done, or for services rendered or to be rendered and includes the fair and reasonable value, as determined by the Secretary of Labor and Employment, of board, lodging, or other facilities customarily furnished by the employer to the employee. “Fair and reasonable value” shall not include any profit to the employer, or to any person affiliated with the employer. De minimis benefits, 13th month pay, and other benefits are special Atens of compensation income which aze subject to special vules and Limitations as provided by law PARTICULARS FNAL WT ‘CREDITABLE WT Income tox witiheld Fal ‘Aliquot portion Coverage Specified passive income Specified passive and active income Wo remit the tar Treome paver Income payor (tne withholding ond remittance) and payee (tme of fling and payment) Necessity fora return Negative PositiveBUSINESS AND PROFESSIONAL GROSS INCOME GROSS INCOME FOR MANUFACTURERS OR MERCHANDISERS Gross income shall mean gross sales less sales returns, discounts, and allowances, and cost of goods sold, plus other items of income not subjected to Final tax, and other incidental or outside operations or sources. (Section 43, Revenue Regulation No.2) GROSS INCOME FOR SERVICE-CONCERNED ENTITIES Gross income shall mean gross receipts less sales returns, discounts, and allowances and cost of services, plus subjected to final tax, and other incidental cher items of income not cuteide or so For both types of ene, subtractions shoud not be made for deprecation, depletion sling expenses or Ieee OF or items not eran used in computing the cst ef goods sl RENTAL INCOME, Rental income refers to earnings derived from leasing real estate as well as personal property. Aside from the regular amount of payment for using the property, rental income also includes all other obligations assumed to be paid by the lessee to the third party in behalf of the lessor such as, interest, taxes, loans, insurance premiums, and others: (Revenue Regulation 19-86) Illustration chito entered into a lease transact son with vinci. The lease ‘angement provided that the forner shall lease a portion of his studio in favor of the latter subject to the following conditions: iy ent r 75,0000 Two months advance rent * 30,000.00, Trsrance premio r 3000.00 Rea estate te r 200000 How much is Chito’s taxable rental is Situation 1: Jf the advance payment is a prepaid rental received without restriction as to its use, the entire amount is taxable in the year it 4s received whether the lessor uses cash or accrual method of ‘accounting. Monty rental ° 15,000.00 “Two months advanced payrent ° 30,000.00Irewance premium ? 3,000.00 Real ecate or ? 2,000.00 Tota tarable income ? 50,000.00 ion 2: If the advance payment is a security deposit which restricts the Jessor as to its use, then such amount should be excluded in the determination of rental incom Monty ental ¥ 7570.00 Tes pemre ¥ 3900.00 eal erate tx ? 2000.00 Total tse income * 2000.00 Situation 3: If the advance payment is 2 loan deposit, or option money for the property, or a security deposit for the faithful compliance of the lessee of the lease contract, such advanced payment is not an income of the lessor unless the lessee violates the terms and conditions of the Jease contract. Assume that the lease contract contains an acceleration clause stipulating that the lease contract will be terminated for nonpayment of rental income in any month during the year and the security depocit shall be forfeited in favor of the lessor If vinei violates the terme and conditions of the contract. the reportable rental income would be: Monty rental ? 75,000.00) Two months advance reals r 30,000.00) Insurance premio t 3,000.00 eal eatate tae ? 2,000.00 Tota ale more ? 30,000.00 If Vinei faithfully complies with the contract, then the taxable income would be the same with situation 2INCOME FROM LEASEHOLD IMPROVEMENTS When the lessee erected or built permanent improvements on the leased property which will become the property of the lessor upon the expiration of the lease, the value of the improvements should be reported as income of the lessor using either outright or spread out method. (Section 49, Revenue Regulation No. 2) outright method Under this method, the income from leasehold improvement shall be recognized when the improvement is completed at ite fair market valve Spread-out method Under this method, the estimated book value of the leasehold improvement at the end of the lease is spread over the term of the lease and is reported as income for each year of the lease an aliquot portion thereof Illustration Arlease, Inc. is the leading corporation in the leasing industry. In January 1, 2020, it leased one of its lots to Captain Abanilla for a term of 10 years. The lease contract includes the following provisions: Annual rental Pi00,000; in case of improvements introduced to the leased land, the ownership over such improverent shall automatically transfer to the lessor at the end of the lease contract After a year, Captain Abanilla erected a small office with a value of P5,000,000. The said building is expected to last for 15 years How much is Arlease’s taxable income for 2020? 2021? Outright method: Under the outright method, the taxable rental income is to be computed as follows: 2020 r 100,000.00 ‘val rental ® 100,000.00 Fair market valve of the improvernent r 5,000,000.00] Tota tarable rental income r 100,000.00 Spzead-Out method:Under the spread-out method, the taxable rental income is to be computed as follow: 2020 ‘mwa ental ° 700,000.00 2021 ‘aml ental ? 100,000.00, ‘anual nome from late old provements ? 222,222.00 “Total table rental income ° 322,222.00, The aliquot portion of P222,222 is derived in the following manner: ‘ot of th bulking ° 5/900,000.00 ‘Accurate deprecation atthe end of the lease (see schedule) ° 3/000,000.00 Book vale of the improvement atthe end of the late period ? 5,000,000.00 Remaining term of the lease ab of the conglelon af improvement 9 years ‘nal come from leasehold inrovements ° 222,222.00 Schedule 1: ‘Coat ofthe bulking P 000,000.00 Estimated wall Me ofthe improvement 1S year ‘eal deprecation r 333,388.00 "Year dpsed from completion of the improvement unt the termination of the lease 9 years contact (2021 2028) ‘Arnal come from latchold improvements F 3,000,000.00 PRE-TERMINATION XE the improvement is destroyed before the expiration of the lease, the lessor is entitled to deduct as a loss for the year, when auch destruction takes place, the amount previously reported as income less any salvage value, to the extent that such loss was not compensated for by insurance. Consider the facts of the immediately preceding problem and assume the following additional information on January 4, 2025, the small office was struck by lightning and was subsequently devoured by the fire that occurred thereafter. The ingurance company that covered the building paid Arlease P500,000 as indemnity for the damage that the latter suffered,Determine Arlease’s reportable loss at the date of fixe outright method Tneome fom improvement previous reported ? (000,000.00 Tederty Wom aware: ? (600,000.00) Lows on leasehold improvement de to the fre r 4,500,000.00 Spread-Out method “anual meome from latched inprovernents ? 222,222.00 Years unt the fe ° 00 Total reported income fom erproverent unt! the fe ? 1885 888.00 Tnderity from surance ? (500,000.00) Loss on leasehold improvement be to the fre r 388,888.00 DIVIDEND INCOME Grose income shall include the amount received as dividends: a. From a domestic corporation? and b. From a foreign corporation, unless less than fifty percent (508) of the gross income of such foreign corporation for the three- year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the Philippines as determined under the provisions of this Section; but only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period Gevived from sources within the Philippines bears co ite gross income from ali sources. [Section 42(2), IRC] Illustration KRKAROT Corporation operates both domestic and international franchise business. The company started its operation in 2018, since then the sd accumulated earnings of P5,000,000 and P3, 000,000 from ‘and international franchise revenues, respectively. In 2020, KAKAKOT declared cash dividends worth 2,000,000. How should the dividends be classified for taxation purpose? case 1 KAKAROT is a domestic corporation. P 2,000,000.00 shall be classified as dividend income fully earned within the Philippines.case 2: KAKAROT is a foreign corporation. The P 2,000,000.00 dividend income shall be classified as follows: P 1,250,000.00 ~ dividend income earned within the Philippines P 750,000.00 - dividend income earned outeide the Philippines Supporting calculations: Since KAKAKOT is a foreign corporation which earns at least 50% of its incone within the Philippines, the dividends it declares shall be pro- rated in proportion to the income earned within with respect to its global income to determine the dividend income earned within the Philippines. The rest shall be classified as dividend incore earned without the Philippines Tota dividend income F 000,000.00 Years antl Oe fre * Tato of PH ncome to Gaba Income ofthe foregn corparation swan Divdend income eared within the PH ? 120,000.00 Loss on leasehold improvement due to the fre ? 1,250,000.00 Tota dividend income P 000,000.00 Diddend income eared within the PH 7 ci280,00000) Divdend income eared without the PH ? 750,000.00 diuetration KAKAROT Corporation operates both domestic and international franchise business. The company started ite operation in 2018, since then the company reported accumulated earnings of P3,000,000 and P5,000,000 from both domestic and international franchise revenues, respectively. In 2020, KAKAROT declared cash dividends worth 2,000,000. How should the dividends be classified for taxation purpose? case 1 KAKARO? ig a domestic corporation. P 2,000,000.00 shail be classified as dividend incone fully earned within the Philippines. case 2 EAWAROD $2 a foxeiga coxporation P 2,000,000.00 shaiI be classified as dividend income fully earned without the Philippines.Since KAKAROT is a foreign corporation which earns less than 50% of ite income within the Philippines, the dividends it declares shall be treated as fully earned without the Philippines. There is no need to pro-rate. SPECIAL ITEMS TAK BENEFIT RULE A general principle in taxation which states that if a taxpayer deducted an item on his income tax return and enjoyed a tax benefit thereby, and in a subsequent year recovers all or part of that item, he will recognize gross in the year the deducted item is recovered. The rule has both an inclusionary and an exclusionary component, i.e., the recovery is included in the taxpayer's gross income to the extent that the taxpayer obtained a tax benefit from the prior year's deduction, and the recovery is excluded to the extent that the prior year’s deduction did not provide a tax benefit. RECOVERY OF DOUBTFUL ACCOUNTS WRITTEN OFF The following are the requis: s for deductibility of bad debts 1. There must be a valid and existing debt arising from business or trade of the taxpayers 2. The debt must be actually ascertained to be worthless and uncoLlectible during the taxable year; and 3. The debt must be charged off during the year. For taxation purposes, bad debts are considered the amounts receivable being ascertained worthless to be written off during the taxable year. When a written off receivable has been recovered in the succeeding year, the recovered amount must be included in the gross income during the taxable year of recovery. However, under the doctrine of equitable benefit, the amount recovered is only taxable to the extent of the tax benefit in the year the account wae written off, (Section 34, E.1, NERC) qlustration Marzia, upon finding out that Pwe, one of her customers, has already absconded, wrote off worthless accounts amounting to P200,000 from her books in 2020. However, on February 12, 2021, Pwe returned and paid all of his Liabilities with Marzia. How much ie to be included in Marzia’e gross income for the year 2021? 720,000. Since Marzia benefited in the form of deductions from the written-off accounts in 2020, the recovery of the same accounts in the subsequent year should be included in Marzia’s gross income. Supposing, Marzia did not write-off the account receivable in 2020, then there is no taxable recovery in 2021.REFUND OR CREDIT OF TAXES PAID ‘Taxes allowed as deductions, when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction. (Section 24, C.1, NIRC) ‘Tax refund is subject to the tax benefit rule which states that the refund of tax would only be subjected to tax if such was was previously allowed as a deduction from gross income, ultimately resulting to the reduction of tax liabilities As a rule, if the tax paid is an allowable deduction, the refund of the same is taxable, If otherwise, the refund is not taxable. INCOME FROM WHATEVER SOURCE “tncome from whatever source derived,” refers to the inclusion of all types of income not expressly excluded or exempted from taxation, irrespective of the voluntary of involuntary action of the taxpayer in producing such income. This only means that the list provided at the beginning of this material is not exclusive and is deemed to include income from any source, whether legal or illegal, despite it not being specifically mentioned in such provision. Thus, reportable gross income may be derived from gambling, kidnapping, extortion, smuggling, or embezzlement, among others, and the person earning these types of income shall pay the corresponding income tax. The mere fact that a transaction is illegal does not exempt it from income tax laws. Gains from such transactions are all taxable (Michie, P. 282). Moral turpitude is not a touchstone of taxability. (P. Hsbough Milk, Co., 26 7.C. 707) If the embezzler reaps the fruit of his crime without restriction as to disposition, he is in receipt of income though it may be clained he is not entitled to the money and may be adjudged liable to restore its equivalent, (James v. U.S) The long arms of taxation even extend to income received under a mistake of fact or law; the income is included in the gross taxable income of the recipient notwithstanding the fact that the recipient may be required to return the income item to the payor when the error is discovered.