WEEK 8

INCLUSIONS AND
EXCLUSIONS FROM THE
GROSS INCOME
Gross Income (INCLUSIONS)
Under Section 32 (A), Except when otherwise provided in this
Title, gross income means all income derived from WHATEVER
SOURCE, including, but not limited to the following items:

(1) Compensation for services in whatever form paid, including,

but not limited to fees, salaries, wages, commissions, and similar
items;
(2) Gross income derived from the conduct of trade or business or
the exercise of a profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
Thus, the pertinent items of gross
income when earned by an RC (within
and without), NRC (within), RA (within),
NRAETB (within) shall be reported and
shall form part of their income.
6) Royalties; a sum of money paid to a patentee for the
use of a patent or to an author or composer for each
copy of a book sold or for each public performance of a
work.
(7) Dividends;
(8) Annuities; a fixed sum of money paid to someone
each year, typically for the rest of their life.
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner's distributive share from the net income of
the general professional partnership.
Please take note that Tax Code did not
distinguish the source of the income. The
definition did simply provide for WHATEVER
SOURCE. So this means that the income even
proceeding from illegal sources like illegal
gambling, bribes, kickbacks is still taxable and
needs to be reported in the Income Tax Return.
Compensation Income
Income arising out of employer-employee
relationship. It encompassed all remuneration
for services performed by an employee for his
employer whether paid in cash or in kind.
Compensation income includes
● Salaries and wages
● Emoluments
● Honoraria
● Taxable bonuses
● Allowances (such as entertainment, and the
like)
● Fringe benefits fees
● Taxable pensions and retirement pay
● Commission
● Compensation for services on the basis of a
percentage of profits
● Commissions on insurance premiums
● Tips
● Marriage fees
● Baptismal offerings
● Sum paid for saying masses for the dead
● And other contributions received by a
clergyman,evangelist or religious worker
Forms/Measurement of Compensation

It can be paid in money or in some medium other

than money such as stocks, bonds or other forms of
property.
Employee an individual performing
services under an
employer-employee relationship.
Employer-Employee Relationship

What is the Four-Fold Test? This is the test to ascertain the existence
of an employer-employee relationship jurisprudence has invariably
adhered to the four-fold test, to wit:

(1) the selection and engagement of the employee;

(2) the payment of wages;

(3) the power of dismissal; and

(4) the power to control the employee's conduct, or the so-called

"control test."
Classification of Compensation Income

1. Regular compensation - includes basic salary,

fixed allowances for representation,
transportation and others paid to an employee
per payroll period.
2. Supplemental compensation - includes payments to an
employee in addition to the regular compensation such as but
not limited to the following
● Fringe benefits
● Hazard pay
● Taxable 13th month payment
● Overtime pay
● Fees
● Commissions
● Profit sharing
● Monetized vacation and sicky and other benefits
Compensation Income received After termination of
Employee-employer relationship

Remuneration for services constitutes

compensation income even if the relationship of
employer and employee does not exist any longer at
the time when payment is made between the person in
whose employ the services had been performed and the
individual who performed it.
Illustration

On June 2,2020, Chris resigned from employer

“A” due to a better career opportunities offered by
employer “B” on July 15,2020. On July 31,2020,
Chris received his salary from employer “A”
applicable for June 16 to June 30 payroll period as
well as his separation pay.
Question:
Should the amounts received by Chris on
July 31 from his former employer be
treated as compensation income despite
of the termination of the employer
employee relationship?
Answer:

YES, the amount paid by employer “A” to

Chris pertains to services performed by
Chris when employer-employee relationship
was not yet terminated
FRINGE BENEFITS AND 13TH MONTH PAY
(Discussed in Chapter 3 )
Fixed or Variable Allowances
This allowances are compensations subject to
income tax and creditable withholding tax on
compensation income.
Examples :
● Transportation allowance
● Representation allowance
● Communication allowance
● Living away from home allowance
Advances and Reimbursements for Traveling and
Entertainment Expenses
Generally it is not a part of compensation if the
following conditions are satisfied.
1. It is for ordinary and necessary travelling and
representation or entertainment expenses paid or
incurred by the employee in the pursuit of the
trade, business or profession.
2. The employee is required to
account/liquidate for the foregoing
expenses in accordance with the
specific requirements of substantiation
for each category of expenses.
Premiums on Life Insurance

Premiums on life insurance covering the life

of an employee paid by the employer is taxable
income to the employee, where the insured
employee directly or indirectly is the
beneficiary under the policy.
Deductible Expense of the Employer
Any amount given by the employer as
benefits to its employees, whether classified as
de minimis benefits or fringe benefits shall
constitute as deductible expense upon such
employer.
Tips and Gratuities

Paid directly to an employee by a customer of the

employer that are not accounted for by the employee
to the employer are considered as taxable income
subject to basic tax. But it shall not be subject to
withholding for the reason that tips are not
accounted for by the employee to the employer.
Vacation and Sick Leave Allowances

They are amounts of “vacation allowances or

sick leave credits” which are paid to an employee
treated as compensation income. But the
monetized value of unutilized vacation leave
credits of ten (10) days or less which were paid to
the employee during the year are not subject to
income tax and to withholding tax.
Representation and Transportation Allowances
(RATA)
They are considered reimbursements for the
expenses incurred in the performance one’s duties
rather than as additional compensation. But if
there is an excess of RATA, if not returned to the
employer, constitutes taxable compensation
income of the employee.
Stipends of Resident Physicians

Stipends are subject to creditable withholding

tax (CWT) , shall include not only fees, but alo
per diems,allowances, and any other form of
income payments not subject to withholding
tax on compensation.
Cost of Living Allowance (COLA)

COLA of minimum wage earners is exempt from

income tax.
Income or Gain from the Exercise of Stock
Options Plans
The BIR ruled that any income or gain derived
by an employee from the exercise of stock option is
considered as additional compensation subject to
income tax and consequently, to withholding tax
on compensation.
End of PART 1
Week 9
Part 2 Inclusions and Exclusions of
Gross Income
Business Income
They may arise from the sale of products or
services.

Examples. -
● Fees received by a person in the real estate
business
● Rents
Bad debt Recovery

Recovery of bad debt previously written off

in the books is a TAXABLE INCOME provided
that the write-off of the account resulted to a
lower taxable income at the time of write off.
- Also known as. TAX BENEFIT RULE
TAX BENEFIT RULE
The rule states that the taxpayer is
obliged to declare as taxable income its
subsequent recovery of bad debts in the year
they were collected to the extent of the tax
benefit enjoyed by the taxpayer when the bad
debts were written-off and claimed as a
deduction from the income.
Illustration: Case A
B Company has a business connected receivables
amounting to P100,000 from H who was declared bankrupt
by a competent court . Despite earnest efforts to collect the
same. H was not able to pay, prompting B Company to
write-off the entire liability. During the year of write-off,
the entire amount was claimed as a deduction for income
tax purposes reducing the taxable net income of B
Company to only P1,000,000. Three years later, H
voluntarily paid his obligation previously written-off by B
Company. Should the recovery of bad debt previously
written-off be considered part of B Company’s gross
income?
Answer- YES

Applying the “Tax Benefit Rule” B Company

should include the amount recovered in the
computation of its taxable income in the year of
recovery considering that it was able to get full tax
benefits three years later.
Case B
The following data pertain to recovery of bad debt
previously written off by a taxpayer. Determine the
taxable recovery of bad debts previously written off
assuming the amount of write-off for the previous
year(s) was P50,000.

a. P50,000 recovery from accounts written off in a

year which had a net income of P300,000 before
write off.
Answer - P50,000.
b.P30,000 recovery from accounts written off in a
year which had a net loss before write-off of
P5,000.

Answer - P0
c. P20,000 recovery from accounts written off
in a year which had a net income of P15,000.

Answer : P15,000
Applying the tax benefit rule, only P15,000
should be considered taxable income
Tax Refund
The “Tax Benefit Rule”also applies with respect
to refund or credit for taxes. Thus, tax refunds are
taxable if the tax, when paid, was deducted from
gross income (i.e.,local taxes and fringe benefit
tax). Taxes which were not previously allowed as
deductions from the gross income should not form
part of taxable income when refunded.
The following tax refund are not taxable.
1. Income tax (except fringe benefit)
2. Estate tax
3. Donor’s tax
4. Special assessment
5. Stock transaction tax
6. Income tax paid to a foreign country if the
taxpayer claimed a credit for such tax in the
year it was paid.
● Tax refunds shall be reported as income in
the year it was received.
● If the accounting method employed by the
taxpayer is the cash method
● If the accounting method used is the accrual
basis, the tax refund must be reported in the
year the refund was ordered.
Cancellation or Condonation of Debts
● Subject to basic income tax
- If services were rendered by the debtor, in
consideration of which the indebtedness was
cancelled by the creditor
● Subject to 10% final tax
- If the debtor is a shareholder of a corporation
that cancels the indebtedness, such
cancellation constitutes indirect dividend.
● Subject to Donor’s Tax
- If the creditor , without receiving any
consideration from the debtor, and purely as an
act of liberality, cancels the indebtedness.
Illustration-Case A- Subject to Basic Income Tax
Alex, creditor of Atty. Manalo , is facing tax
evasion charges filed against him by the BIR. The
latter provided legal services to Alex and was able
to obtain favorable judgement for the Court of
Appeals. In return, Alex condoned(accept and allow)
the indebtedness of Atty. Manalo. Should the
amount of indebtedness condoned form part of
Atty. Manalo’s taxable income?
Answer : YES
The debt was condoned in consideration for
services rendered. Hence, the debtor realized a
taxable income
Case B-Subject to Donor’s Tax
At the testimonial dinner for new CPAs, Ivan
was requested to sing the original sound track of a
teleserye “Ang Probinsiyano”. Abi was invited in
the event by a close friend and was so delighted
that she feels she is falling in love with Ivan so she
decided to cancel Ivan indebtedness. Should the
amount of indebtedness condoned form part of the
Ivan’s taxable income?
Answer : NO
Ivan received a gift from Abi which is subject
to donor’s tax, not income tax.
Case C- Not Subject to Income Tax nor Donor’s Tax

A parent company extended a loan to its

subsidiary. Due to continuing business losses,
however, the parent suspended, waived or condoned
interest due from, but not accrued by, the
subsidiary. Notwithstanding the condonation,
however, the subsidiary remained insolvent in that
its liabilities still exceeded its assets. Should the
amount of interest condoned forms part of the
debtor’s taxable income?
Answer : NO

- Before the condonation or forgiveness of

indebtedness will give rise to taxable
income,there must be an increase in the assets
of the debtor thereby enriching the latter.
Case D-Not subject to Income tax nor Donor’s tax
Court Approved Debt Restructuring
The Gain resulting from condonation of a
company’s debts to its various creditors pursuant to
a court-approved debt restructuring is not subject
to income tax. Likewise, the creditors will not be
subject to donor’s tax since the condonation was not
implemented with a donative intent but only for
business consideration.
The restructuring was not a result of the mutual
agreement of the debtors and creditors. It was
through court action that the debt
rehabilitation plan was approved and
implemented.
GAINS DERIVED FROM DEALINGS IN PROPERTY

- Includes all income derived from disposition of

property which results in gain or loss.
- The gain from the transaction shall be taxable gain
and the loss shall be deductible if incurred in
trade, profession or business.
Summary of applicable taxes on income or gains
from dealings or sale of property

● Ordinary Asset
-Ordinary gain
-Basic tax (graduated rate for individuals and
RCIT rate for corporate taxpayers.
● Shares of stock of a Capital gain domestic
corporation not listed in the local stock exchange
- Capital gain
- Capital gains tax
● Real property in the Philippines
- Capital Gain
- Capital Gains tax
● Other types of capital assets
- Capital gain
- Basic tax
*Gains arising from expropriation of properties
or other dispositions of properties to the
government of real properties are taxable
Interest Income

Generally interest are taxable income, unless

exempted by law, whether or not usurious.
Interest Income Applicable Tax
Arising from indebtedness Basic tax

Arising from bank deposit

● Bank deposit, trust fund,
mutual fund, deposit substitute 20%, 25% FWT
● Deposit under FCDU 15%
● Long term bank deposit
Or investment Exempt
Rental Income
Rent paid by the lessee for the use or lease of
property is taxable income to the lessor.
Rent income may be in the FORM of:
1. Cash, at stipulated price
2. Obligations of the lessor to third persons paid
assumed by the lessee in consideration of the
contract of lease such as real property taxes
assumed by the lessee on the property being leased.
3. Advance Payment
Non-taxable rent
Advance rentals representing option money for
the property as well as security deposits to insure
faithful performance of certain obligations of the
lessee are not considered as income on the part of
the lessor
LEASEHOLD IMPROVEMENT

An improvement made to a leased asset. Buildings

erected or improvements made by the lessee on the
leased premises are taxable only if the same were
made pursuant to an agreement with the lessor and
the buildings erected or improvements made are not
subject to removal by the lessee.
PRE-TERMINATION OF LEASE

If for any reason other than bona fide purchase

from the lessee by the lessor, the lease is terminated,
the lessor realized additional income for the year to
the extent that the value of such improvement
exceeds the amount already reported as income on
account of such improvement.
Case A
On December 1,2020, HP Company leased office space
for 5 years to JC Corporation at a monthly rental of
P60,000. On the same date, the HP received the following
amounts from JC:
1. First month’s rent P60,000.00
2. Second month’s rent P60,000.00
3. Last month’s rent P60,000.00
4. Security deposit (refundable upon expiration of the
lease) P80,000. JC also improved the office space
for a total cost of P360,000.
Question : What amount should HP report
as rental income in December 2020?
*Answer : P180,000

The total amount received applicable to rental

including prepaid rent for the second month and for
the last month of the lease term shall be reported as
income in the year it was received, regardless of the
accounting method used.
Case B
In 2020 Roxanne leased a facility from Samantha
Company. Part of the lease agreement is for Roxanne
to improve the facility. Details of the improvements
were as follows:
Cost of construction(improvements) P10,000,000
Estimated useful life of improvements 20 years
Remaining lease term 10 years
Question 1:
What amount should Samantha report in
2020 as income from leasehold improvement
using the lump-sum method?
Answer : P10,000,000
Question No. 2 :
What amount should Samantha report in
2020 as income from lease improvement
using the spread out method?
Answer : P500,000.

Depreciated value after lease

term (10Mx10/20) P5,000,000
Remaining term of the lease 10 years
Annual Income from leasehold
Improvement P500,000
Question no. 3:
Assume the income from the improvement is to be
reported annually. However at the beginning of the
6th year, both parties agreed to terminate the lease
agreement.Consequently, Samantha took possession
of the improvements. The fair value of the
improvements at the time was P3,500,000. What
amount should Samantha report as income from
improvement on the 6th year of the lease agreement?
Answer : 1,000,000 computed as follows:

Fair value of the improvements P3,500,000

Income recognized for the first five
Years (P500,000x5) (2,500,000)

Income to be recognized on
the 6th year P1,000,000
ROYALTY INCOME

Royalties are subject to final withholding tax.

However, if the royalty was generated in the
active pursuit and performance of the
corporation’s primary purpose, the same is not
passive income but considered ordinary
business income subject to basic tax
Dividend Income

Payments made by the corporation to its

shareholder members. It is the portion of
corporate profits paid out to stockholders,
direct or indirect. Both are subject to tax.
 Types of Dividends
1. Cash dividends
2. Property dividends
3. Liquidating dividends
4. Stock dividends
ANNUITY INCOME
Specified income payable at stated intervals
for a fixed or a contingent period, often for the
recipient’s life, in consideration of a stipulated
premium paid either in prior installment
payments or in a single payment.
Annuity payments received by a taxpayer represent a
part of which is taxable and not taxable.

● The amount received representing return of

premium is considered return of capital.
● The annuity received representing interest or
amounts over the premiums paid are
considered gains and should form part of the
recipient’s taxable income.
Case A:
Juan purchased a life insurance contract ten (10)
years ago requiring him to pay an annual
insurance premium of P6,000 for a period of 6
years. The contract provides that should Juan die
or outlived his policy within 15 year period, his
beneficiaries will receive 300,000. On January
1,2020 Juan outlived the policy. Consequently, he
received the P300,000 as stipulated in the
contract.
Question 1 : How much is the taxable income of
Pedro on January 1,2020?
Answer : P210,000
Taxable income =P300,000-(6,000x15)= P210,000
Non-taxable portion=P6,000x 15 =P90,000
(return of premium)
Question No. 2 :Assume Juan died within the
15-year period, how much should be reported by
his beneficiaries as taxable income from the
insurance contract?
Answer : P 0
Proceed of life insurance paid to the
beneficiaries upon death of the insured are not
taxable.
Question 3:
Assume Juan died in 2020 (within the 15 -year
period) His beneficiaries agreed to received
P30,000 a year plus P2,000 annual interest for the
next ten (10) years, how much should be reported
by his beneficiaries as taxable income in 2020?
Answer : P2,000 representing interest income
PRIZES AND OTHER WINNINGS
- Prize is an award to be given to a person or a
group of people to recognize and reward actions
or achievements.
- It is also given to publicize noteworthy or
exemplary behavior, and to provide incentives for
improved outcomes and competitive efforts.
Winnings for tax purposes, should refer should
refer to rewards/income by virtue of chance or
bets.

● As a rule prizes and winnings are taxable

unless exempt.
Case A
A taxpayer received the following prizes and
winnings:
Cash prize - “The Voice” Philippines P2,000,000
House and Lot won as “The Voice”
Philippine grand champion P3,000,000
Philippine winnings 10,000,000
Question : How much is the correct amount of
winnings and prizes subject to tax?
Answer : P15,000,000
- All the prizes and winnings provided in the
problem are subject to tax.
- Prizes received from X Factor Philippines are
considered prizes constituting gains from labor.
- Philippine lotto winnings exceeding P10,000 are
subject to 20% FWT under the Tax Code as
amended by TRAIN Law and CREATE Act
Case B
JC a young artist and designer received a prize
of P100,000 for winning in the “on the spot
poster contest”. Is the prize taxable?
Answer : Yes the prize is taxable,subject to a
final tax of 20% the amount thereof in excess of
P10,000. The prize was given primarily in
recognition of JC’s artistics achievement which
he won due to an action on his part to enter
the contest.
Case C
Hidilyn Diaz, a weightlifter, won a silver medal in
2016 Rio Olympics. She received the following
prizes and awards: P10,000,000 cash prize from
the Philippine Government; P10,000,000 worth of
house and lot donated by Matatag Corporation;
P4,000,000, talent fee as a product endorser of
Smart Ako Communications. How much of the
foregoing amounts received by Hydilyn is exempt
from income tax.
Answer : P20,000,000
● The P10,000,000 from the government is
exempt from income tax.
● The house and lot received worth
P10,000,000 is also exempt from income tax.
However, Matatag Corporation shall be
subject to Donor’s Tax.
● The P4,000,000 talent fee is subject to income
tax.
PENSIONS

Pensions, in general, are subject to income

tax, except pensions and retirement benefits
exempt under the law.
Retirement

Section 32 (B) (6) (a) of the Tax Code, as

amended, provides that retirement benefits are
exclusions from gross income and exempt from
tax. Exempt retirement benefits are (1) benefits
received under Republic Act No. 7641 (Labor
Code) and (2) benefits received in accordance
with a reasonable private benefit plan
maintained by the employers.
Retirement Republic Act No. 7641 December 9, 1992
"In the absence of a retirement plan or agreement
providing for retirement benefits of employees in the
establishment, an employee upon reaching the age of
sixty (60) years or more, but not beyond sixty-five (65)
years which is hereby declared the compulsory
retirement age, who has served at least five (5) years in
the said establishment, may retire and shall be entitled
to retirement pay equivalent to at least one-half (1/2)
month salary for every year of service, a fraction of at
least six (6) months being considered as one whole
year.
"
Retirement

“Unless the parties provide for broader

inclusions, the term one-half (1/2) month salary
shall mean fifteen (15) days plus one-twelfth
(1/12) of the 13th month pay and the cash
equivalent of not more than five (5) days of
service incentive leaves.”
Retirement

For retirement benefits received under a

reasonable private benefit plan, the tax
exemption can be availed of if 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, and that the benefits granted may be
availed of by an official or employee only once.
Separation pay Exempt from income tax under
Section 32 (B) (6) (a) and (b) of the Tax Code of 1997.

any cause beyond the control of the employee is

exempt from taxes regardless of age or length of
service. Ex. separated due to retrenchment

(1) the employee is separated from the service due to a

cause beyond his control; and (2) the employer pays
benefits as a consequence of such separation.
REPUBLIC ACT NO. 11494, September 11, 2020 Section 5.
Exemption from Tax of Retirement Benefits;. — Retirement
benefits received by officials and employees of private firms;'
whether individual or corporate, from June 5, 2020 until
December 31, 2020 shall be excluded from gross income and
shall be exempt from taxation: Provided, That any
re-employment of such official or employee in the same firm,
within the succeeding twelve (12)-month period, shall be
considered as proof of non-retirement and shall subject the
benefits received to appropriate taxes. In addition to the payment
of appropriate taxes, any person who willfully evades or defeats
any imposable tax under this section shall be criminally liable
and penalized under Section 255 of Republic Act No. 8424, as
amended.
Partner’s share in the net income of a General
Professional Partnership (GPP)
- Not subject to income tax. However partners shall
be liable for income tax on their separate and
individual capacities. Each partner shall report as
gross income, his or her distributive share in the
net income of the GPP.