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Chapter 4
GROSS INCOME
GROSS INCOME - Means the pertinent items of
income referred to in Sec 32 of the tax code
- It includes all income from whatever source
(unless exempt from tax by law)
including but not limited to, the following items:
1. Compensation for services in whatever form
paid including fees, salaries, and
wages,commissions, and similar items
2. Gross Income derived from the conduct of
trade or business or the exercise of a profession
3. Gains from dealings in property
4. Interests
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions
11. Partners’ distributive share from the net
income of general professional partnership
Gross income includes a catch-all clause
(that is “from whatever source”) to supplement
enumeration by including any non-enumerative
items which can properly be defined as “income”.
Gross Compensation Income – means any
remuneration for rendering personal services. It
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 compensation. Thus, it
may be paid on the basis of piecework, or
percentage of profits and may be paid hourly,
daily, weekly, monthly or annually.
There is no determination of compensation until
the service is rendered
Exception: the compensation income including
overtime pay, holiday pay, night shift differential
pay, and hazard pay, earned by Minimum Wage
Earners (MWE) who has no other returnable
income are non-taxable and not subject to
withholding tax on wages
When does an employer-employee relationship
exist?
Generally, an employer-employee relationship
exists when the person for whom services are
rendered has the right to control and direct the
individual who performs the services, not only as
to the result in accomplishing the work but also
as to the details and means by which that result
is accomplished
Remuneration for services constitutes
compensation 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
them.
Compensation income subject to tax is based on
gross income less applicable exemptions.
No business and personal expenses are allowed
as deductions from gross compensation income
The rule on compensation income applies only to
resident citizens, resident aliens and non resident
citizens and non-resident aliens engaged in
business in the Philippines. It does not apply to
non-resident aliens not engaged in business.
Neither does it apply to corporations, estate and
trusts because compensation presupposes
personal service.
Classification of Gross Compensation Income
1. Basic Salary or Wage Salary
Salary - refers to earnings received periodically
for a regular work other than manual labor, such
as a monthly salary of an employee
Wages - are earnings received usually according
to specified intervals of work, as by the hour, day
or week. (E.g. carpenter’s daily wage)
Backwages are subject to income tax and the
withholding tax on wages
2. Honoraria are payments given in recognition
for services performed for which established
practice discourages charging a fixed fee. The
honorarium of a guest lecturer is an example.

3. Fixed or variable allowances
In general, fixed or variable transportation,
representation, COLA and other allowances that
are received by a public officer or employee or
officer or employee of a private entity in
addition to the regular compensation fixed for
his position or office, are compensation subject
to withholding tax
Any amount paid specifically, either as advances
or reimbursements for travelling, representation
and other bona fide ordinary and necessary
expenses incurred or reasonably expected to be
incurred by the employee in the performance of
his duties are not compensation subject to
withholding tax,
if the following conditions are satisfied:
a. It is for ordinary and necessary travelling and
representation or entertainment expenses paid
or incurred by the employee in the pursuit of the
employee in the pursuit of the employer’s trade
business or profession
b. The employee is required to account/liquidate
for the foregoing expenses pursuant to
substantiation requirements of Sec. 34 of the tax
code
The excess of actual expenses over advance
made shall constitute taxable income if such
amount is not returned to the employer
Latest Rulings on Allowances:
a. Transportation and cell phone allowances
given to call center employees are not taxable
compensation
b. Transportation and Night Shift Allowances
granted to night shift employees and Meal
and/or Out-of-Town Allowances granted to
employees assigned to conduct field work are
not subject to FBT, income tax and withholding
tax.
c. Taxi/transportation allowance of P100 per
day given by BPO company servicing global
businesses 24 hours a day to employees who
work overtime beyond 10PM or whose work
shift starts at 10 PM onwards is exempt from tax
d. Where taxi/transportation allowance is
precomputed on a daily basis and is paid to
employees while they are on assignment or duty,
it is not subject to substantiation requirement or
to income and withholding tax
4. Commission is usually a percentage of total
sales or on certain quota of sales volume
attained as part of incentive such as sales
commission
5. Fees are received by an employee for the
services rendered to the employer including a
director’s fee of the company, fees paid to the
public officials, such as clerks of court or sheriffs
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for service rendered in the performance of their
official duty over and above their regular salaries.
Legal fees paid by a union on behalf of its
president constitute compensation
Marriage fees, baptismal offerings, sums paid
for conducting masses for the dead and other
contributions received by a clergyman,evangelist,
or religious worker for services rendered are
considered compensation
6. Tips and gratuities – paid directly to an
employee (by a customer of the employer) which
are not accounted for by the employee to the
employer are considered taxable income, but
not subject to withholding tax
7. Hazard or Emergency pay – an additional
payment received due to workers’ exposure to
danger or harm while working. This is normally
night differential pay to arrive at gross salary.
Hazard, overtime, night shift differential and
holiday pay of a minimum wage earner is non-
taxable as long as the MWE has no other
reportable income
8. Retirement pay – it refers to a lump sum
payment received by an employee who has
served a company for a considerable period of
time and has decided to withdraw from work
into privacy.

in general, retirement pay is taxable except in the
following instances:
I. SSS or GSIS retirement pays
II. Retirement pay due to old age provided that
the following requisites are met:
a) The retirement program is approved by
the BIR Commissioner
b) b. It must be a reasonable benefit plan. Its
implementation must be fair and equitable
for the benefit of all employees (from
president to labour)
c) The retiree should have been employed for
10 years in the said company
d) The retiree should have been 50 years old
at the time of retirement
e) It should have been availed of for the first
time
9. Separation pay – taxable if voluntarily availed
of. It shall not be taxable if involuntary.
Examples of involuntary separation are:
a. Death
b. Sickness
c. Disability
d. Reorganization/merger of company
e. Company at the brink of bankruptcy
When a company is at the brink of bankruptcy,
the sequence of satisfying the company’s
indebtedness should be in this order
a. BIR
b. Employee
c. Creditors
As a rule, any amount received by an official or
employee or by his heirs from the employer due
to death, sickness or other physical disability or
for any cause beyond the control of the said
official or employee(such as retrenchment,
redundancy, or cessation of business) are
exempted from tax
The phrase for any cause beyond the control of
the said official or employee connotes
involuntariness on the part of the official or
employee. The separation from the service of
the official or employee must not be asked for or
initiated by him.
Amounts received by reason of involuntary
separation remain exempt from income tax even
if the official or the employee, at the time of
separation, had rendered less than 10 years of
service and/or is below 50 years of age.
Any payment made by an employer to an
employee on account of dismissal constitutes
compensation regardless of whether the
employer is legally bound by contract, statute or
otherwise, to make such payment
10. Pension is a stated allowance paid regularly
to a person on his retirement or to his
dependents on his death, in consideration of past
services, meritorious work, age, loss or injury.
Pension pay is TAXABLE unless the law states
otherwise, or unless the BIR approves the
pension plan of a private company.
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11. Vacation and Sick Leave
Taxable or Not:
a. If paid or availed of as salary of an employee
who is on vacation or on sick leave
notwithstanding his absence from work, it
constitutes taxable compensation income
b. Monetized value of unutilized vacation leave
credits of 10 days or less which were paid to
private employees during the year are not subject
to tax and to the withholding tax
c. Monetized value of vacation and sick leave
credits paid to government officials and
employees are not subject to income tax and to
the withholding tax
12. Thirteenth month pay and other benefits
As a general rule, thirteenth month pay and
other benefits are not taxable if the total amount
received is P82000or less. Any amount exceeding
P82000 is taxable.
13. Fringe benefits and de Minimis
FRINGE BENEFITS - as any good, service, or other
benefit furnished or granted by an employer, in
cash or in kind, in addition to basic salaries of an
individual employee
De Minimis benefits - privileges of relatively
small value as given by the employer to his
employees. They are not considered as
compensation subject to income tax and
consequently to withholding tax.
14. Overtime Pay – refers to premium payment
received for working beyond regular hours of

work which is included in the computation of
gross salary of employee. Back pay and overtime
pay constitute compensation.
15. Profit sharing – proportionate share in the
profits of the business received by the employee
in addition to his wages
16.Awards for Special Services – the amount
received as an award for special services of
employee, or suggestions to employer resulting in
the prevention of theft or robbery. Awards for
past services and the like are also compensations
17.Beneficial payments – such as where an
employer pays the income tax owned by an
employee are additional compensation income
18.Other forms of Compensation – received due
to service rendered are compensation paid in kind.
It is to be noted that compensation can be paid in
kind but taxes are generally paid in money.
For example, an insurance premium paid by
employer for insurance coverage where the heirs
of employee are the beneficiaries is the
employee’s income
Shares of Stock Received as Compensation
Compensation paid to an employee of a
corporation in its stock is to be treated as if the
corporation sold the stock at its market value and
paid the employee in cash
Hence, if compensation is received in the form of
shares of stock, the fair market value of the
shares of stock at the time the service is rendered
is the basis of tax.
Employee stock option A stock option is a
privilege granted to some key employees of a
corporation to avail of the said corporation’s
share of stock in the future for a certain price.
Equity-settlement option is a stock option
granted by a person, natural or juridical, to a
person or entity
Cash -settlement option entitles the holder to
receive cash, equivalent to the difference
between the actual fair market value (FMV)
The following rules shall be observed when a
company issues a stock option to its employees:
1. Compensation income – if the market price is
greater than the option price, the difference is a
compensation income at the date of grant.
2. Capital gain – when the stocks are sold, the
excess of the market price at the date of sale over
the market price at the date of grant is a capital
gain
Cancellation of Debt The cancellation and
forgiveness of indebtedness may amount to a
payment of income, gift, or capital transaction,
depending upon the circumstances.
Insurance Premiums as Compensation These are
premiums paid by the employer on life insurance
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coverage of the employee wherein the
beneficiary is the employee’s family. These
constitute taxable income on the basis of the
amount of premium paid.
Income Tax Paid as Compensation For income
tax paid by the employer in favour of the
employee, the basis of tax is the amount of tax
paid.
Convenience of the Employer’s Rule This tax rule
provides that allowances in kind furnished to the
employee for and as a necessary incident to the
performance of his duties are not taxable.
Examples are food and lodging benefit by a
household maid, driver, etc.
Living Quarters
The following rules govern the living quarters and
meals:
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
Unless provided for the exclusive benefit of the
employer, the rental value of living quarters is
compensation income to the employee to the
extent of his reasonable needs, and the excess
shall be considered as expenses of the
corporation.

Meals Subsidized by Employer
The value of any board and lodging furnished by
an employer is ordinarily taxable to the employee
The exclusion for meals is allowed only when
meals are furnished or subsidized to an employee
for the convenience of the employee and
incidental to the requirement of his work or
position
Remuneration for Casual Labor
1. Remuneration for casual labor not in the
course of an employer’s trade or business is not
considered compensation
The term casual labor includes labor which is
occasional, incidental or regular.
The expression not in the course of the
employer’s trade or business includes labor that
does not promote or advance the trade or
business of the employer
2. Any remuneration paid for casual labor( that
is, labor which is occasional, accidental or
irregular, but which is rendered in the course of
the employer’s trade or business) is considered
compensation
3. Any remuneration paid for casual labor
performed for a corporation is considered as
compensation
Gross Income from Business and Profession
Business – means any commercial activity
engaged in as a means of livelihood or profit of an
individual or group of individuals.
Examples are trading, merchandising,
manufacturing and other similar benefits
Profession – primarily any endeavour or work
requiring specialized training in the field of
learning, art, or science engaged in as a means of
livelihood or profit of an individual or group of
individuals
. In general, a practice or profession is a service
business.
Gross income from Business classified into
groups:
1. Manufacturing
2. Merchandising
3. Servicing
4. Farming
5. Long-term contract
In case of manufacturing, merchandising or
mining business, Gross income shall mean gross
sales less sales returns, discounts and allowances,
and cost of goods sold, plus any income from
investment and other incidental or outside
operations or sources
In determining gross income, subtractions
should not be made for depreciation, depletion,
selling expenses or losses or for items not
ordinarily used in computing the cost of goods
sold In the case of taxpayers engaged in the sale
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of service, gross income is based on gross
receipts less returns
The Cost of Sales
Cost of Goods Sold shall include all business
expenses directly incurred to produce the
merchandise to bring them to their present
location and use.
The cost of sale is deducted from the net sales to
calculate gross income from business.
Cost of Sales of a business may be classified as
follows:
1. Cost of Goods Manufactured and Sold – it
shall include all costs of finished goods that are
sold such as raw materials used, direct labor and
manufacturing overhead, freight cost, insurance
premiums and other costs incurred to bring the
raw materials to the factory or warehouse
2. Cost of goods sold of trading or
merchandising concern – refers to the invoice
cost of goods sold, plus import duties and freight
incurred in transporting the goods to the place
where they are actually sold, including insurance
while the goods are in transit
3. Cost of Service of Servicing Concern – for
minimum corporate income tax purposes, gross
income from service business is gross receipts
less returns, allowances, discounts and cost of
services.

The Cost of Services shall include the direct costs
and expenses necessarily incurred to provide the
services required by the customers and clients
which include the following items:
a. Salaries
b. Benefits of personnel, consultants and
specialists directly rendering the service
c. Cost of facilities directly utilized in providing
the service such as depreciation or rental of
equipment used and cost of supplies
d. In the case of banks, costs of services shall
include interest expense.
Telegraph and Cable Services of a foreign
corporation – shall include income from services
within the Philippines only.
Specifically, the income may be derived from the
following:
1. Gross revenues derived from messages
originating in the Philippines
2. Amount received by the company collected
abroad on collect messages originating in the
Philippines and deducting from such amounts
paid or accrued for transmission of messages
beyond the company’s own circuit
Amounts received by the foreign company in the
Philippines with respect to collect messages
originating outside the Philippines.
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
Rental income is generally determined by the
gross receipts for the year, (earned and unearned
under accrual basis) because the nature of
business involved is service.
1. Prepaid rental – if the advance payment is a
prepaid rental received without restriction as to
its use the entire amount is taxable in the year it
is received whether the lessor uses cash or
accrual method of accounting
2. Security Deposit with Restriction – if the
advanced payment is a security deposit which
restricts the lessor as to its use, then such
amount should be excluded in the determination
of rental income
3. Security Deposit with an Acceleration Clause
– if the advanced payment is a loan deposit, or
option money for the property or security
deposit for the faithful compliance of the lessee
of the lease contract, such advance payment is
not an income to the lessor.
The income to the lessor inures when the lessee
violates the terms of the contract. Income from
Leasehold Improvement – 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
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reported as income of the lessor using either
outright method or spread out method.
A. Outright method – the income from
leasehold improvement shall be recognized
when the improvement is completed at its fair
market value
b. Spread-out 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 part thereof
Termination of the Contract of Lease Where
there is an immovable improvement made by the
lessee on the lease property and the termination
of the contract of lease is made before the
expiration of the lease term,
the following rules should regulate the
circumstances:
1. If the improvement is destroyed BEFORE the
expiration of the lease, the lessor is entitled to
deduct as a loss for the year, when such
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
2. If for any reason other than a bona fide
purchase from the lessee by the lessor, the lease
is terminated so that the lessor comes into
possession of the property prior to the final fixed
period of the lease contract, the lessor receives
additional income for the year if the value of

improvement exceeds the amount of income
already reported No appreciation in value due to
causes other than the premature termination of
lease shall be included.
Gains from Dealings in Property
This refers to the income derived from the sale,
and/or exchange of assets, which results in gain
because of the excess of the amount or value
received by the taxpayer over the determined
value of the property he has disposed of.
The general rule is that the entire amount of the
gain or loss arising there from is a taxable gain or
deductible loss.
Passive Income A final tax is imposed upon gross
passive income of citizen and resident aliens
An income is considered passive if the taxpayer
merely waits for it to be realized.
Examples of passive income are:
1. Yield from deposit substitutes and trust fund
Deposit substitute – is a debt instrument issued
by the bank to borrow money from the public
other than from the client’s deposit
Trust fund – is any estate, especially stock,
securities, or money which is held in trust by a
person in behalf of another person
Both deposit substitute and trust fund yield
earnings that are to be treated as interest
income
2. Interest income – an earning derived from
depositing or lending of money, goods, or credits.
Unless exempted by law, interest income
received by the taxpayer, whether or not
usurious, is subject to income tax
For individuals, except non-resident aliens not
engaged in trade or business in the Philippines,
interest income from long-term deposit or
investment shall be exempt from income tax,
provided that the following conditions must be
met:
a. The deposit or investment must be evidenced
by certificates conforming to the Bangko Sentral
ng Pilipinas prescribed form
b. The same must have a maturity period of not
less than five years and in denominations of
P10,000 or other denominations as may be
approved by BSP issued by banks(not by non-
bank financial intermediaries or finance
companies)
However, should the holder of the certificate
pre-terminate the deposit or investment before
the fifth year, a tax shall be imposed on the entire
income and shall be deducted and withheld by
the depository bank from the proceeds of the
long term deposit or investment certificate based
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on the remaining maturity thereof, as follows:
Final tax of 5% ------------------- 4 years to less than 5 years
Final tax of 12% ------------------3 years to less than 4 years
Final tax 20% ---------------------less than 3 years
Classifications of Interest Income
Interest income may be classified into three
categories;
a. Exempt from Income tax – if received from:
1. By members from a duly-registered
cooperative
2. BSP prescribed form of investments maturing
more than 5 years
3. Expanded foreign currency deposit system by
non-resident citizens/aliens
4. A tenant who paid to a landowner on the price
of land under a tenantpurchaser agreement as
part of CARP
b. Subject Final Withholding tax Interest income
on deposits made in banking institutions is a
passive income which is usually subjected to final
withholding tax of 20%
c. Subject to Normal Tax (lending is the Main
Course of Business) These are earnings derived
from lending money, goods or credits from one
person to another without any withholding tax
made.
Since these interest earnings are received in its
total amount, they should be subject to normal
tax of the taxpayer Since the interest income is
earned in the normal conduct of business, this

shall be included as part of income to be
reported in the Annual Income Tax Return
Royalty income – is a payment or portion of
proceeds paid to the owner of a right, such as an
oil right or a patent for the use of it, or a portion
of the proceeds from the work of an author or
composer.
a. In general, royalty income includes those which
are derived from natural resources or products
such as coal, gas, oil, copper, silver, gold, and
other similar products. These kinds of royalty
income are subject to 20% final tax
b. Royalties on books, literary works and musical
composition are royalty income subject to 10%
final tax
5. Dividend income – is a form of earnings
derived from the distribution made by a
corporation out of its earnings or profits and
payable to its stockholders, whether in money or
in other property
Such earnings may be exempt from income tax,
or subject to either final tax or on the normal
year-end tax of individuals or corporations
Tax Rules on Dividend Income
1. If received by a domestic or resident
corporation from a domestic corporation subject
to tax, such dividend is tax exempt (non-taxable
inter-corporate principle)
2. Pure stock dividends, dividends received from
cooperative, and pure liquidating dividends are
tax-exempt
3. Cash or property dividend is subject to final tax
if received by an individual or non-resident
corporation from a domestic corporation subject
to income tax a. If received by a resident citizen,
nonresident citizen and resident alien, the final
tax applicable is 10%
A. If received by a non-resident alien engaged in
business in the Philippines, the final tax is 20%
B. If received by a non-resident alien not doing
business within, the final tax is 25%
C. If received by a non-resident foreign
corporation from a domestic corporation, the
final withholding tax is 15%
4. Other dividends excluded from rules 1,2, and 3
are included in the computation of the taxable
income and income tax at the end of the year
Tax sparing rule - inter-corporate dividend
received by a non resident foreign corporation.
Forms and Valuations of Dividend Income
For income tax purposes, the form of dividend
income shall determine its applicable treatment.
Dividends that are usually received by a
stockholder are as follows:
1. Cash dividend – the most common form of
dividend. It is valued and taxable to the extent of
amount of money received by the stockholder
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2. Property dividend – a dividend payable in
property of an issuing corporation is a property
dividend. The property dividend is usually valued
and taxable to the extent of the fair market value
of the property received at the time of
declaration
a. Merchandise inventory, supplies, etc.
b. Shares of stock of another corporation
c. Treasury stock of issuing corporation if
acquired at cost different from its par value
3. Stock Dividend – pure stock dividends are not
subject to tax because they simply involve a
transfer of the retained earnings to the paid-in
capital account, except when the following
circumstances exists:
a. There is an option that some stockholders
could take cash or property dividends instead of
stock dividends
b. Some stockholders exercised the option to take
cash or property dividends
c. The exercise of option resulted in a change of
the stockholder’s proportionate share in the
outstanding shares of the corporation
Redemption of Stock Dividend
If the corporation cancels or redeems stock
issued as a 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.
Stock Dividends Different from Shares
Previously Acquired
When stock dividends received are of a different
class from shares previously acquired, the stock
dividends are not income, and therefore, not
taxable. The original cost of the investment is
allocated between the original shares and the
stock dividends on the basis of their respective
market value at the date of receipt
4. Scrip Dividend – is issued in the form of
promissory note and is taxable to the extent of
its fair market value. It is taxable in the year
when the warrant was issued.
5. Indirect Dividends – are those other dividends
representing payments or rights received by the
taxpayer, which are really dividends
6. Liquidating Dividend – are return of
stockholders investment. It arises from the
distribution of assets by a corporation to its
stockholders upon corporate dissolution
As a rule, the excess amount of liquidating
dividends over cost of shares surrendered is
taxable. Such excess is a gain realized which is
taxable.
Distribution of liquidating dividends is to be
treated as a sale of stock. The difference
between the cost or other basis of the stock and
the amount received in liquidation of the stock is
a capital gain or a capital loss.
The gain realized or loss sustained by the
stockholder is a taxable income or deductible loss,
as the case may be.
Consequently, the capital gain on liquidating
dividend is not subject to final tax.
Indirect Dividends representing payments or
rights received by the taxepayer.
Prizes and winnings Prize –
Prize - is a reward for a contest or a competition.
It represents remuneration for an effort
reflecting one’s superiority, like prize money of a
boxing contest
Winnings – is a reward for an event that depends
on chance such as winnings from gambling,
lottery or raffle ticket In general, prizes are
subject to final tax of 20% except if the amount
of the prize is ten thousand (P10,000) or less
which shall be subjected to normal tax.
Winnings are subject to final tax final tax of 20%
regardless of amount
Prize and winnings are generally taxable except
when the law provides for their exemption
PARTNERS’ DISTRIBUTIVE PROFITS FROM
PROFESSIONAL PARTNERSHIP’S NET INCOME
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The partner’s share in the distributive profit of a
professional partnership represents his gross
income
Other Sources of Income – generally incidental
earnings or not common source earnings
1. Bad debt recovery
2. Tax refund or credit
2. Damages recovery
3. Annuities
4. Income from whatever source
Tax 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 (reduced his income tax) thereby, and in
a subsequent year recovers all or part of that
item, he will recognize gross income in the year
the deducted item is recovered
Bad Debt Recovery
The following are the requisites for deductibility
of bad debts:
1. There must be a valid and existing debt arising
from business or trade of the taxpayer
2. The debt must be actually ascertained to be
worthless and uncollectible during the taxable
year
3. The debt must be charged off during the
taxable year
For taxation purposes, bad debts are considered
the amounts of receivable being ascertained
worthless to be written off during the taxable
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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 was
written of
Tax Refund or Credit As a rule, refunds from
taxes paid are taxable except for the following:
a. Estate or Donor’s tax
b. Philippine income tax
c. Stock transaction tax
d. VAT, claimed as input tax
Tax refund is subject to the tax benefit rule
which states that the refund of tax would only be
subjected to tax if such tax was previously
deducted from gross income resulting in the
reduction of reported taxable income
As a rule, if the tax paid is deductible, refund is
taxable. If the tax paid is not deductible, refund
is not taxable.
TAX REFUND OR CREDIT shall be included as
part of gross income in the year of receipt to the
extent of the income tax benefit of the said
deduction
Damages Recovery – an amount received by an
injured person as payment for loss income or
payment to compensate damage to property,
injury to person, or loss of life. As a rule,
recoveries of damage representing
compensation for loss of profit or income are
TAXABLE Recoveries that are to compensate for
damages to property, injury to person, or loss of
life are not taxable
Annuities – are instalment payments received
for life insurance sold by insurance companies.
The annuity payments represent a part that is
taxable and not taxable.
If the part of annuity payment represents
interest, then it is TAXABLE income. If the
annuity is a return of premium, it is NOT
TAXABLE.
Under the contract of life annuity, the debtor
binds himself to pay an annual pension or
income during the life of one or more
determinate persons in consideration of a
capital consisting of money or other property,
whose ownership is transferred to him at once
with the burden of the income
Income from whatever sources – inclusion of all
income not expressly exempted within the class
of taxable income under the laws irrespective of
the voluntary or involuntary action of the tax
payer in producing the gains and whether
derived from legal or illegal sources
Examples of Income from legal source are:
a. Employee’s salary bonus
b. Commissions/rebate of a medical
representative
Examples of Income from illegal sources are:
a. Gambling
b. Kidnapping
c. Extortion
d. Smuggling
e. Embezzlement
Illegal Obtained Income As a rule, illegal income
is taxable. Income obtained through illegal
means is included in the wrongdoer’s gross
income even though he is obligated to return it
when discovered
The mere fact that a transaction is illegal does
not exempt it from income tax laws. Gains from
such transactions as gambling, extortion,
swindling and the like are all taxable Income that
is not realized is not taxable, even though its
absence is due to an illegal act.
Moral turpitude is not a touchstone of taxability
The courts have sustained the BIR
Commissioner’s determination of the illegal gains
from such records as bank deposits, or on the
basis of commissions paid out, and even from a
formula determination based upon the
nationwide experience.
The burden is on the taxpayer to offer
independent evidence to contradict such
determination
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Embezzled funds - are income without consent

(express or implied) with an obligation to repay.

If the embezzler reaps the fruit of his crime

without restriction as to disposition, he is in
receipt of income though it may be claimed he is
not entitled to the money and may be adjudged
liable to restore its equivalent. When reported as
income, actual repayment of embezzled fund will
give rise to deduction.

Income Received by Error When income is

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.