THE CONCEPT OF INCOME Why is income subject to tax? Income is regarded as the best measure of taxpayers’ ability to pay tax. It is an excellent object of taxation in the allocation of government costs. What is income for taxation purposes? The tax concept of income is simply referred to as. "gross income" under the NIRC. A taxable item of income is'referred to as an ‘item of grossincome’ or “inclusion * in gross income’, . Gross income simply means taxable income in layman's term. Under the NIRC however, the term "taxable income" refers to certain items of gross income less deductions and personal exemptions allowable by. law. Technically, gross income. is broader to pertain to any income that can be subjected to income tax. Gross income, is broadly defined as any inflow of wealth tothe taxpayer from whatever.soutce, legal or illegal, that.increases net worth. It includes income from. employment, trade, business or exercise of profession, income from. properties, and other sources ‘such as dealings i in properties and other regular or casual transactions. ELEMENTS OF GROSS INCOME 1. Itis a return on capital that increases net worth. = Capital means any wealth or property. ~ = Gross income is a property that increases the taxpayer's net worth. The return on capital that increases net worth is income subject to income tax. Return of capital merely maintains net worth; hence, it is not-taxable taxable. An Capital items deemed with infinite value There are capital items that have infinite value and are‘incapable of pecunian” valuation. Anything received as compensation for their. loss is deemed a returng capital, Examples: Life Health Human reputationLife” The value of life isimmeasurable by money. Under Sec. 32 of the NIRC, the proceeds. of life insurance policies paid to the heirs or beneficiaries upon death of. the insured, whether ina single sum or otherwise, are exempt from income tax. The proceeds’of a'life insurance contract collected by an employer as a beneficiary from the life insurance of an officer or.any person directly interested . with his trade are likewise exempt These proceeds are viewed as advanced recovery of future loss. However, the following.are taxable return.on capital from insurance policies: . a. Any excess amount received over premiums paid by the insured upon surrender or maturity of the policy (ie the insured outlives the policy.) b. Gain realized by the insured from the assignment or’sale’of his insurance policy c. Interest income from the.unpaid balance of the proceeds of the policy d. Any excess of the proceds received over the acquisition costs and premium payments by an assignee of a life insurance policy : : Health Any compensation FECEIERI in consideration for the 1658 of health such as pene sLOn for Personal injuries or tortuous acts is deemed a return of capital. Human Reputation The value of one's reputation cannot be measured financially, any indemnity received as compensation for its eimpalrment| is deemed areturn a capital exempt fromincome tax. * Examples include moral damages received from: a. Oral defamation or slander b. Alienation of affection c. Breach of promise to marry Recovery of lost capital vs. Recovery of lost profits The loss of capital results in decrease in net worth while the loss of profits does not decrease net worth. The recovery of lost capital merely maintains net worth while the recovery of lost profits increases net worth. Therefore, the .recovery.of lost profits is a return on capital.Taxable recovery of lost profits The recovery of lost profits through insurance, indemnity contracts, or legal suits * constitutes a taxable return. on capital. The following are taxable recoveries of lost profits: a. Proceeds of crop or livestock insurance b. Guarantee payments c Indemnity received from patent infringement suit 2. Itis a realized benefit. What is meant by realized benefit? The "benefit" concept : The term benefit means any form ofadvantage derived by the taxpayer. There is ~ benefit when there is an increase in the net worth of the taxpayer. Anincrease in . net worth occurs when one receives income, donation or inheritance. The following are not benefits, hence, not taxable: a. Receipt of a loan - properties increase but obligations also increase resulting an offsetting effect in net worth. b. Discovery of lost properties - under the law, the finder has an obligation to return the same to the owner. c. Receipt of money or property to be held in trust for, or to be remitted to, another person. If the taxpayer is entitled to keep for! his account portion of a receipt only that portion is a benefit. Illustration 1.An employee was granted P20,000 transportation advance, He liquidated P18,000 transportation expenses and was allowed by his employer to keep the P2,000. Only the P2,000 retained by the eraplaysan is considered income since BEETS was entra extent he was benefited. (RR2-98) 2. A security agency receives P120,000 from clients, P100,000 of which is for the * salaries of security guards. Under RMC 39-2007, only the P20,000 attributable to the agency is considered income of the agency since it is the extent it is ate eae ee Sige uae ceca ed lig anil The P100,000 pertaining to’salaries of security guards ‘is 6 recognized "e’Dy by me the agency as aliability upon receipt. .The “realized”. concept. The term realized means earned. It requires that therei isa degree of undertaking : or sacrifice from the taxpayer to be entitled of the benefit. Requisites of a realized benefit: . 1. There must be an exchange transaction. 2. The transaction involves another entity. 3. It increases the net worth of the recipient ~ Types of Transfers 1. Bilateral transfers or “exchanges, such 2 as: @° eo : a. Sale - >i b. Barter . 5 Sees These are referred to as "onerous transactions” 2. Unilateral transfers, such’as: : a. Succession transfer of property upon death. 1 EAN, w b. Donation (donor tax) These are also referred to as “gratuitous transactions’ : Under current usage, unilateral transfers are simply referred to as “transfers” while bilateral transfers are called exchanges,’ Benefits derived from onerous transactions are "earned or realized"; hence, they are subject to income tax. Benefits derived from gratuitous transactions. are not realized because of the. absence of an earning process. Benefits derived from gratuitous transactions: are subject to transfer tax not income tax. 3. Complex transactions Complex transactions are partly aratuitous and partly 0 onerous. These are commonly referred to as "transfers for less than full and adequate consideration’. The gratuitous portion of the transaction is subject to transfer tax while the benefit from the onerous portion is subject to.incame tax, Illustration A taxpayer sold his car'which was previously purchased for P100,000 and with a current fair value of P180,000 far only P130,000. The transaction will be analyzed as follows:fair value 180,000 selling price - * Pied cost. 100,000 goers co NAME HH m0 The excess of fair value over selling price is a gratuity or gift whereas the selling price over the cost is an of item Gross.income . What is meant by another entity? Every person. natural or juridical. is an entity. Natural persons are living persons while juridical.persons are those created by law such as partnerships and corporations. An entity may be a taxable entity Or an exempt entity. A taxable item of gross income arises from transactions which involve another natural or juridical entity. Gains or income derived between relatives, corporations, and between a partner and the partnership are taxable since it is made between separate entities, Likewise, the income between affiliated companies such as between a holding or’ parent company and its subsidiaries.and.between.sister companies are taxable because each corporation is a separate entity. This applies regardless of underlying economic relationship. = oo Benefits in the absence of transfers . : The increase in wealth of the taxpayer in the form of appreciation or increase in the value of his properties or decrease in the value of his obligations i inthe ~ absence of a sale or barter transaction is not taxable. ~ : These are referred to as unrealized gains or holding gains because they have not yet materialized in an exchange ‘transaction. Examples of unrealized gains or. holding gains: . a. Increase in value of investments in equity or debt coun b. Increase in value of real properties held (revaluation increment) c. Increase in value of foreign currencies held or receivable d. Decrease in value of.foreign currency denominated debt by virtue of favorable fluctuation in exchange rates e. Birth of animal offspring, accruals of fruits in an orchard or growth of farm’ vegetables f. Increase in value ofland due to the.discovery of mineral r reserves.Rendering of services ~ The rendering. of services for a consideration is an exchange but does not cause a loss of capital. Hence, the entire consideration received from rendering of services such as compensation income or service fees is an item of gross income. Basis of Exemption of Unrealized Income Normally, taxpayers will have the ability to pay tax when their i income materializes in inan exchange transaction since tax is generally payable in money. This does not.mean, however, that only income realized in cash.is subject to tax. . Income realized in non-cash properties are, in effect, received in cash but the taxpayer used the same to acquire the non-cash property. Income received in non- cash'considerations is taxable at the fair value of the property received. Moreover, exempting income realized in non-cash considerations would open a wide avenue. for tax evasion since taxpayers can easily divert their it income in the form of non- cash consideration. : Mode of or renee Benefits Taxable items of income may be realized by the taxpayer in two ways: 1. Actual receipt Actual receipt involves:actual physical taking of the income in the form of cash 2. Constructive receipt Constructive receipt involves no actual physical taking, of the income but the taxpayer is effectively benefited: Inflow of wealth without increase in net worth a The inflow of wealth to a person that does not increase his net worth is not income due to the total absence of benefit. Examples: a. Receipt of property in trust b. Borrowing of money'under an obligation to‘return In law, the proceds of embezzlement or swindling where money is taken without an original intention to return are considered as income because ofthe increase in net worth of the swindler.3. Itis not exempted by law, contract, or treaty. NOT EXEMPTED BY LAW, CONTRACT, OR TREATY. An item of gross income is not exempted by the Constitution, law, contracts or treaties from taxation. The following ‘following items of income are exempted by law from taxation; * hence, they are not considered items of gross income:. 1. Income of qualified employee trust fund 2. Revenues of non+ profit, non-stock educational institutions 3. SSS, GSIS, Pag-IBIG, or PhilHealth benefits ° 4. Salaries and wages of minimum wage.earners and qualified senior citizen . 5. Regular income of Barangay Micro- business Enterprises (BMBES) 6. Income of foreign governments and foreign See -owned and controlled corporations Z 7. Income of international missions and organizations with.income tax immunity . Items of gross income that are exempted from taxation are discussed extensively under Exclusions in Gross Income in Chapter 8. TYPES OF INCOME TAXPAYER 1. Citizen a. Resident citizen. b. Non-resident citizen 2. Alien a. Resident alien b. Non-resident alien a engaged in trade or business — b. not engaged in trade or business 3. Taxable estates and trusts B. Corporations Domestic corporation Foreign corporation a. Resident foreign corporation — b. Non-resident foreign corporationINDIVIDUAL INCOME TAXPAYERS Citizens Under the Constitution, citizens are: a. Those who are citizens of the Philippines at the time of adoption of the Constitution on February 2, 1987 b. those whose fathers or mothers are citizens of the Philippines c. Those born.before January 17, 1973 of Filipino mothers who elected Filipino citizenship upon reaching the age of majority d. Those who are naturalized in accordance with the law Classification. of citizens: A. Resident citizen - A Filipino citizen residing | inthe Philippines. B. Non-resident citizen includes: 1. A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact. of his physical presence abroad with a definite intention to reside therein; 2. A citizen of the Philippines who leaves the Philippines during the taxable year to reside ‘abroad, either as an immigrant or for an employment permanent basis; 3. A citizen of the Philippines who works and derives income from abroad and whose employment thereat | requires him to be physically present abroad most of the time during the taxable year; A citizen who has been previously considered as non-resident citizen and who arrives in the Philippines at anytime during the taxable year to reside permanently in the Philippines shall likewise be treated as a non-resident citizen for the'taxable year in which he arrives in the Philippines with respect to his.income derived from sources abroad until the date of his arrival in the Philippines Filipinos working in Philippine embassies or Philippine’consulate considered non-resident citizens. Alien A. Resident alien an individual who is residing in the Philippines but is not citizen thereof, such as: 1. An alien who lives in the Philippines without a definite intention as to his stay; or 2. One who comes to the Philippines for a definite.purpose which in. nature would require an extended stay and(to that end makes his hometemporarily in the F Philippines, althoudt) iit may be ie intention at all times to return to his domicile abroad; An alien who has acquired residence in the Philippines retains his status such until he abandons the same or actually departs from the Philippines. B. Non-resident alien an individual who is not residing the Philippines and who is not a citizen thereof 1. Non-resident aliens engaged in business (NRA-ETB)- aliens who stayed in the Philippines for an aggregate period of more than 180 days during the year . 2s Non-resident aliens not engaged i in business (NRA-I NETB) - include: a. Aliens who come to the Philippines for a definite PUIOSE which in its nature may be promptly accomplished; b. Aliens who shall come to the Philippines and stay therein for an aggregate period of not more than 180 days during the year THE GENERAL CLASSIFICATION RULE FOR INDIVIDUALS ° 1. Intention The intention of the taxpayer regarding the nature of his stay within or outside the Philippines shall determine his appropriate residency classification: The taxpayer shall submit to the CIR of the BIR documentary proofs such as visas, work contracts and other documents.indicating such intention. Documents purporting‘short term stay such as tourist visa shall not result in * the reclassification of the taxpayer's.normal residency. Documents purporting a long-term stay such as immigration visa or working visa for an extended period would result in the automatic reclassification of the taxpayer's residency. 2. Length of stay In default of such Gteremientetyy pre ie length of stay of tae taxpayer is considered: a. Citizens staying.abroad for a periad of.at least 183 days are considered non-resident. b. Aliens who ‘stayed in the Philippines for more than 1 year as of the end of | the taxable year are considered resident.’ c. Aliens who are staying in.the Philippines for not.more than 1 year but more than 180 days are deemed non-resident aliens engaged in business.d. Aliens who stayed in the Philippines for not more than 180 days are considered non-resident aliens not engaged in trade or business. Taxable Estates and Trusts 1, Estate Estate refers to the properties, rights, and obligations of a deceased person not extinguished by his death. Estate under extrajudicial settlement treated as individual taxpayers. The Estates taxable on the income of properties of the estate under‘extrajudicial * settlement is taxable to the.heirs. Zur rustea A trust is ‘an arrangement whereby one person (grantor or trustor) transfers (ie. donates) property to another person (beneficiary), which will be held under the management of a third party (trustee or fiduciary). A trust that is irrevocably designated by the grantor is treated in taxation‘as if it is an individual taxpayer. The income of the.property held.iin trust.taxable . is to the trust. Trusts that a are designated as revocable by the grantor are not taxable entities and are not considered as i individual taxpayers. The income of properties held under revocable trusts is taxable to the grantor not to the trust. When the trust agreement is silent as to ietierestaliy) ai the trust, the trust is presumed to be revocable. CORPORATE INCOME TAXPAYERS The term “corporation “shall include one person corporations (OPCs), partnerships, no matter how created or organized, joint-stock companies, joint accounts, association, insurance companies, except general professional partnerships and a joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal, and other energy operations pursuant to an operating consortium agreement under a * service contract with the government. Hence, the term corporation includes profit-oriented and non-profit institutions institutions, cooperatives, government agencies and such as charitable instrumentalities, associations, leagues, civic.or religious and other organizations.Domestic Corporation A domestic corporation is a corporation that is organized in accordance with Philippine laws. It includes one-person corporations (OPC) owned and registered by resident citizens in the Philippines. Foreign Corporation A foreign.corporation is one organized under a foreign law . Types of foreign corporations: : 1. Resident foreign corporation (RFC) -a foreign corporation which operates and ° conducts. business in the Philippines through a permanent establishment (ie.. al branch). foreign corporation which does 2. Non resident) foreign corporation (NRFC) © notc operate or conduct business in the Philippines Note: 1. A corporation that incorporates in the Philippines is a domestic corporation under the Incorporation Test even if the same is controlled by foreigners: 2. A foreign corporation that transacts business with residents through a resident. branch is if it taxable on such transaction as a resident foreign corporation through its a branch. 3. An individual that establishes'a one-person corporation (OPC) shall be taxable corporate taxpayer for the business transactions of the OPC but he shall.be . subject to tax as an individual for his personal transactions. Special Corporations ~ Special corporations are domestic or foreign corporations which are subject to special tax rules or preferential tax rates. OTHER CORPORATE TAXPAYERS 1. One- -person corporation. A one-person corporation is a enneniens with a single mmeiienhiens mins may be a natural person, trust or an estate. Banks and quasi-banks, preneed, trust, insurance, public and publicly-listed companies, and non- chartered GOCCs may not incorporate as One-person corporations. Anatural person who is licensed to exercise a profession may : not organize as a One Person Corporation forthe purpose of exercising such profession except as otherwise provided under special laws.i, Partnership A partnership is a business‘organization owned by two or morepersons who* contribute their industry or resources to a common fund for the.purpose of dividing the profits from the venture. Types of partnership a. General professional partnership (oP) . A GPP is a partnership formed by persons for the sole exercising a common profession, no part of the income cof which purpose is derived from engaging jin any trade‘or business. *