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    Taxation Chap3 7

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    marquescallie

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    Chapter 3 - Introduction to Income Tax CHAPTER 3 INTRODUCTION TO INCOME TAXATION Chapter Overview and Objectives This chapter discusses the concept of tax income, the situs of income, and the types of taxpayers. After this: chapter, readers are expected to comprehend and demonstrate knowledge on the following: 1, The concept of gross income 2. The types of income taxpayers 3. The general rules in income taxation 4. The income tax situs rules 4 MW taxable, hineti cacaite THE CONCEPT OF INCOME Cox Gyott cows Why is income subject to tax? Income is regarded as the best measure of.taxpayers’-ability-tospaystax. It is an excellent object of taxation in the allocation of government costs. What is income for taxation purposes? The tax concept of income is simply referred to as “gross income” under the NIRC. A taxable item of income is referred to as an “item of gross income” or “inclusion.in gross income’. Gl ieled eae a Gross income simply means taxable income_in layman’s term. Under the NIRC however, the term “taxable income” refers to certain items of gross-income.less deductions and_personal exemptions allowable by law. Technically, gross income is broader to pertain to any income that can be subjected to income tax. Gross. income, is broadly defined as any inflow of wealth to the taxpayer from_ whatever source, legal or illegal, that increases net worth. It includes income from employment, trade, business or exercise of profession, income from properties, and other sources such as dealings in properties and other regular or casual transactions. ELEMENTS OF GROSS INCOME 1. Itisareturn on capital that increases net worth. 2, Itis a realized benefit. 3. It is not exempted by law, contract, or treaty. 63 Cha r ‘epter 3 - Introduction to Income Tax @ eoiale ON CAPITAL means any wealtl Property.that incre property. Gross income is a return on. weal Wiusteasion ‘payer's net worth. falth ABC purchased ods for: ABT Purchased goods for P300 and sold them for 500: The P500.consideration cay, Selling pri : Cost (value ¢ a consideration received) P 500 Total return Mark- Care Tnvenmnty forgone) “300 Return of capital “UP (gross income) 2200 Return on capital | come subject to income Th - e.return on capital that increases net worth is in ta hence, it is not- taxable, & | Return of capital merely maintains net_worth; improvement in net worth indicates an ability to pay tax 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 return g capital Examples: 1. Life 2. Health 3. Human reputation Life | The value of life is immeasurable*by money. Under Sec. 32 of the NIRC, the proceeds of life insurance policies paid to the heirs or beneficiaries upon death of} the insured, whether ina single sum or otherwise, are exempt from income tax. The proceeds ofa 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 likewiseexempt- These proceeds are viewed as advanced recovery’ef . future loss. ital from insurance policies: paid by the insured upon d outlives the policy.) t or sale of his insurance However, the following are taxable return on cap Any excess amount received over premiums surrender or maturity of the policy (i.e. the insure' b. Gain realized by the insured from the assignmen| olicy interest income from the unpaid bi f the proceeds received over the acq| d, Any excess Ol payments by an assignee of a life insurance policy valance of the proceeds of the policy uisition costs and premil 64 eee Yevec kable— won tovor ble MIE NOCKA Ie — taxable Chapter 3 - Introduction to Income Tax Health Any compensation received in Consideration=for=the=loss~of “health such compensation for personal injuries or tortuous acte I. Human Reputation — Ale nol from income 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 Illustration 1 Mang Reyes insured his strawberry crop in a P200,000 crop insurance coverage against calamities. The crop was eventually destroyed by an unusual frost. Mang Reyes was paid the P200,000 insurance proceeds, The P200,000 proceeds which is a reimbursement for the lost value of the future harvest, lis an item of gross income. The value of the lost crops is, in effect, realized not through actual harvest but through the insurance contract. Illustration 2 Mr. Ramos purchased a franchise. The franchisor guaranteed an annual franchise income of P100,000 to Mr. Ramos. In the first year of operation, Mr. Ramos’outlet only earned P60,000. The franchisor paid the P40,000 difference to Mr. Ramos. 65 Tax Chapter 3 - Introduction to Income uity but a recovery of lost profit fo, a gral is not The P40,000 guarantee payment is m Mr. Ramos sh Ramos; hence, subject to income income. fn its fl after a compet; Illustration 3 decline in its income Pet Davao Crocodile Inc. experience Copied its patented invention. Dar infringement and was awarded an int The Crocodile due to the patent infringement. The si | | fr ‘all report P100,000 as Fra dan unusual | Crocodile sued the competitor for Pate lernnity of P3,000,000. income not realized by D, avy the fs n for item of grass income. 3,000,000 indemnity is a compensatio! ‘ame isan i ynded to compensate for the loss of is intel Y The recovery of lost income or profits is not inferi-t o¢ cross income. Capital. It is as good as realization of income; hence, REALIZED BENEFIT Wh The “benefit” concept \ The term “benefit” means any form of advantage derive ‘at is meant by realized benefit? .d by the taxpayer. There jg er. An increase in benefit when there is an increase in the net worth oon net worth occurs when one receives income, donation or in! The following are not benefits, hence, not taxable: a. b. c Receipt of a loan - properties increase but obligations also increase resulting in an offsetting effect in net worth. ad Discovery of lost properties - under the law, the finder has an obligation to return the same to the owner. 7 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. Mus de stration 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 theemployee is considered income since this. was'the extent hewas benefited. (RR2-98) 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 itis benefited, The P100,000 pertaining to salaries of security guards is recognized by the agency as a liability upon receipt. 66 Chapter 3- Introduction to Income Tax is adegree ofundertaking The “realized” concept ‘The term realized meansearned. It requires that there titled’oft! orsacrifice fromthe taxP: Requisites ofa realized benefit: 4, There must be an exchange transaction. The transaction involves another entity. rth of the recipient. 3. rincreases the net wo Transfers pa asso HP preces 1. Bilateral transfers or exchanges, such Sale ~ rw /SEUR b, Barter These are referred to as “onerous transactions”. Unilateral transfers, such as: a. Succession - transfer of prope! p. Donation - pmore's we ese are alsO referred to as “gratuitous unilateral transfers are simply referred to as “transfers” led “exchanges.” Benefits derived from onerous they are subject: to income’ tax. d from gratuitous transactions are not realized because of the ing process. Benefits derived from gratuitous transactions are not income tax. ty upon death — came THC Th transactions”. Under current usage, while bilateral transfers are cal transactions are “earned or realized”; hence, Benefits derive absence of an earn subject to transfer CaX, 3, Complex transactions are partly gratuitous and partly onerous. These are Complex transactions commonly referred to as “trans| andadequate consideration”. tion of the transaction is subject to transfer tax while the ‘The gratuitous Po! benefit from the onerous portion is subject to income tax, illustration ppayer sold his car which was previously purchased for 100,000 and with a A arr value of P180,000 for only P430,000. ‘the transaction will be analyzed as follows: Fair value P 180,000 poroe's Thee 50,000 *Subjectto.transfer,tax selling price 130,000 } , —100,000 —100,001 2_300,000 2300,000 B.400,000 'FABC Corporation : DonwPo Chapter 3 - Introduction to Income Tax arned Supposing that the ratio is 49%, the entire 400,000 will be deemed e | Gutside the Philippines. ¢, Merchandising income - earned where the property is sold Illustration sourceots t hased and sold within P 200,000 | | Goods pur¢l Goods purchased within and sold abroad 100,000 Goods purchased abroad and sold within 150,000 Goods purchased and sold abroad 350,000 ‘the income earned within and without shall be: witht ith purchased and sold within P 200,000 purchased within and sold abroad P 100,000 purchased abroad and sold within 150,000 purchased abroad and sold abroad 350,000 P_450,000 facturing income - earned where the goods are manufactured and sold ‘Total p. Manui Operations Remark Production | Distribution. Within Within Total income from production and distribution is earned within the Philippines Without Without | Total income from production and distribution is earned without the Philippines within Without Production income is earned within, Distribution income is earned without Without Within Distribution income is earned within, Production income is earned without Illustration 1 Island, Inc. manufactures goods and sells them through its branch. Island bills its ranch at established market prices. Island reported the following gross income: ¢ offi Branch Total Sales P 4,000,000 P 2,000,000 P 6,000,000 Cost of goods sold 2,400,000 __ 1,200,000 _ 3,600,000 Gross income P.1,600,000 Pp 800,000 P 2,400,000 81 Chapter 3 - Introduction to Income Tax i Island under ¢, | i ‘oss income of ACh The following shows the situs of the gr "y following scenario: - | Scenario _Home office __Branch _ SD ue 0 No. 1 Philippines Philippines 400, 0 | 2,400,000 No.2 Abroad Abroad 09,000 300,000 No.3 Philippines Abroad 1,6 ‘300 1,600,000 No.4 Abroad Philippines 800, Note: ble entity, Island, 2, Bath production and detibution are conducted by the same taxable ants imag 2. The branch is not a separate taxable entity, but an integ! Ce, income is taxable to Island Inc. Mlustration 2 ion and the distributiy | Assuming production is conducted by a parent corporation an Ution i) conducted by its subsidiary corporation: | rent Si Sales P 4,000,000 P 2,000,000 P 6,000,000 Cost of goods sold 2,400,000 1,200,000 _ 3,600,000 | Gross income P.1,600,000 P 800,000 P 2,400,000 The gross income recognized by each corporation is taxable to each Corporatio, because each Corporation is a separate taxpayer. The situs of taxation shall be the place of sale without Tegard to the seller or the supplier. The following are the situs of income for the Parent corporation: Scenario ___Parent Subsidiary __Within _ itho No. 2 Abroad Abroad - 1,600,000 No.3 Philippines Abroad 1,600,000 : No.4 Abroad Philippines - 1,600,000 | | —Without _ No.1 Philippines Philippines. P 1,600,000 P - | | | The following are the situs of income for the subsidiary corporation: | Scenario Parent Subsidiary Within Without No.1 Philippines Philippines P 800,000 P - No.2 Abroad Abroad = 800,000 No.3 Philippines Abroad = 800,000 No.4 Abroad Philippines 800,000 Note to readers: Readers are advised to master the situs rules as this havea signi ficant effect on your comprehension of advanced tax rules to be introduced in Succeeding chapters, Chapter 3 - Introduction to Income Tax CHAPTER 3: SELF-TEST EXERCISES Discussion Questions Enumerate the characteristics of gross income. 1, jat are capital i i ith infini 2. Whi : : pital Tene considered with infinite value? Enumerate. 3. When is income considered realized? 4, Distinguish exchange from transfer. 5, Whatis a complex transaction? How is it taxed? 6. What is a holding gain? Why is it exempt from taxation? 7. Compare actual receipt with constructive receipt. 8. Enumerate and explain the classifications of individual taxpayers. 9, What constitute a taxable estate and trust? 10. Enumerate and explain the classifications of corporate taxpayers. 11. Discuss the taxability of each class of taxpayers. 42. Explain situs. Differentiate situs from source of income. 43. What is the situs of the following income? Interest income Service income Royalty income Rental income Gain on sale of movable property Gain on sale of immovable property Dividend income from domestic corporation Dividend income from resident foreign corporation Merchandising income rem mop ao oP Exercise Drill No. 1: Return of capital and Return on capital Indicate the amount representing return of capital or return on capital: Return OF Return ON Consideration | _For the loss of Capital Capital 1. P.1,000,000 Health 2. P__500,000 P.400,000 car 2 P 300,000 | P350,000 building 4. P__ 600,000 Income 5. P 1,200,000 Life 83 i je Tax Chapter 3 - Introduction to Incomi -ansfer tax : mcome tax and tr g items is taxable: ise Drill No. sci teat box where each of the follo Income tax Transfer tax Transaction Barter of properties Sale of goods Rendering of services Donation of properties Transfer of properties from a decedent to the heirs upon death Transfer for less than full and adequate consideration a} [oo] fe 2 it le Exercise Drill No. 3: The tax concept of incom taxable: Cheek the appropriate box whether the following are exempt or ‘able | Exempt Item aes met | 1. | Winnings from gambling 2. Income from swindling 3.| Indemnity for moral damages 4. | Harvested fruits from an orchard 3. Compensation income 7. Interest income Amount received by the Insured in excess of [—p-Hinsurance premiums paid Proceeds of life insurance Teceived by the heirs |__| of the insured 9. | Gain si Sale of goods by the home office to is branch 10. | Gain on sale of goods and services between relatives . 11. | Gain on sale of goods by a parent corporation to J a subsidiary corporation 12. | Appreciation in the value of land [nob 13. | Birth of animal offspring | [oto | 14. | Income ofa registered Barangay Micro-Business cap] Enterprise 15. | Cancellation of debt Out of gratuity of the [o>] creditor 16. | Cancellation of debt by the creditor in exchange [| Of services rendered by the debtor 17. | Matured interest from coupon bonds Pe | 18. | Receipt of bank loan [$Y] eam meee 84 Chapter 3 - Introduction to Income Tax ‘aries of a minimum wage earner Sal u pcs0 or lotto winnings. Benefits from. GSIS, SSS, Pag-Ibig or PhilHealth of hidden treasure in No. 4: Income taxpayer classificatio : following taxpayers: propriate classification for each of the a .stic corporation RC- Resident citizen _ Ee » esident forelgn corporation. NRC- Non-resident citizen NRFC - Non-resident foreign corporation RA- Resident alien NRA-ETB - Non-resident alien engaged in trade or business _ NRA-NETB ~ Non-resident alien not engaged in trade or business NT -Nota taxpayer “Notamnpayer ________a ciation | [_____ Person or Entity ___— agsinication exercise Drill indicate the ap ‘A fat Mexican tourist ‘Ahardworking overseas Filipino worker Nec ‘An expatriate employee f=PRe a Filipino who is privately employed in the Philippines [ete comseest |-

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