Fundamentals of Accountancy,

Business and Management 2

Lesson 11 – Income and Business Taxation
 Introduction
Taxation is the power to tax inhabitants in a sovereign state to raise money for public use. In
other words, the Government collects money from its people (the taxpayer). Tax is the money
that will be used to pay Government expenses such as the salary of a public teacher,
government infrastructures like bridges, road improvements, free medicines, and the like. Our
Philippine Bureau of Internal Revenue (BIR) administers the collection of tax. This lesson will
focus on the two types of taxation, income and business taxation.

The main Philippine tax law is the National Internal Revenue Code of 1997. Some provisions of
this law were amended through Republic Act No. 10963 also known as Tax Reform for
Acceleration and Inclusion (Train Law) in 2018.
Learning Objectives
• At the end of this lesson, the learners should be able to :
Explain the principles and purpose of taxation;
Prepare a list of gross income from compensation and gross
income from a business, and the corresponding personal and
business deductions;
Compute the gross taxable income and tax due; and
Fill out BIR forms
Inherent Powers of the State
1. POLICE POWER is the power of promoting public welfare by restraining and regulating
the use of both liberty and property of all the people. It is considered to be the most all-
encompassing of the three powers. It may be exercised only by the government. The
property taken in the exercise of this power is destroyed because it is noxious or intended
for a noxious purpose.
It lies primarily at the discretion of the legislature. Hence, the President, and administrative
boards as well as the lawmaking bodies on all municipal levels, including the barangay may not
exercise it without a valid delegation of legislative power. Municipal governments exercise this
power by virtue of the general welfare clause of the Local Government Code of 1991. Even the
courts cannot compel the exercise of this power through mandamus or any judicial process
2. POWER OF EMINENT DOMAIN affects only property RIGHTS. It may be exercised by
some private entities. The property forcibly taken under this power, upon payment of just
compensation, is needed for conversion to public use or purpose.
The property that may be subject to appropriation shall not be limited to private property.
Public property may be expropriated provided there is a SPECIFIC grant of authority to the
delegate. Money and a choice in action are the only things exempt from expropriation.
Although it is also lodged primarily in the national legislature, the courts have the power to
inquire about the legality of the right of eminent domain and to determine whether or not
there is a genuine necessity, therefore.
3. POWER OF TAXATION affects only property rights and may be exercised only by the
government. The property taken under this power shall likewise be intended for public use or
purpose. It is used solely for the purpose of raising revenues, protecting the people, and
extending their benefits in the form of public projects and services (I hope so). Hence, it
cannot be allowed to be confiscatory, except if it is intended for destruction as an instrument
of police power.
It must conform to the requirements of due process. Therefore, taxpayers are entitled to be
notified of the assessment proceedings and to be heard therein on the correct valuation to be
given the property. It is also subject to the general requirements of the equal protection clause
that the rule of taxation shall be uniform and equitable
Taxation
Taxation is the inherent power of the state to demand contributions for public purpose or
purposes. Taxes are enforced proportional contributions from persons and property levied
by the law-making body of the state by virtue of its sovereignty for the support of the
government and all public needs.

Taxes are either

a) national or
b) local. National internal revenue taxes are imposed by the National Government and are
embodied in the National Internal Revenue Code (NIRC) and Tariff and Customs Code.
Local taxes are imposed by the local governments like those embodied by the Local
Government Code.
Essential Characteristics of Taxes
1. It is an enforced contribution
2. It is generally payable in money.
3. It is proportional in character.
4. It is levied on persons or property.
5. It is levied by the state which has jurisdiction over the person or property.
6. It is levied by the law-making body of the state.
7. It is levied for public purposes or purposes.
8. It is commonly required to be paid at regular periods or intervals.
License and Permit Fees
Taxes are different from license or permit fee. License or permit fee like the
mayor’s permit:
1. Is legal compensation or reward of an officer for specific services.
2. Is imposed for regulation
3. Involves police power
4. Is limited to the necessary expenses of inspection and regulation
5. Is imposed on the right to exercise a privilege
National Internal Revenue Taxes
The following are national internal revenue taxes that individuals and non-
individual taxpayers have to pay:
1. Income Tax
2. Value-Added Tax (VAT)
3. Percentage Taxes
4. Such other taxes that may be imposed by law and collected by the Bureau of
Internal Revenue (BIR)
Other National Internal Revenue Taxes
a. Estate Tax – the estate pays the estate tax and the estate is a separate and
distinct taxpayer. The term person means individual, trust, estate or
corporation.
b. Donor’s Tax – the donor pays the tax and it arises only if the taxpayer makes a
donation.
c. Excise Tax – paid by the taxpayer if the transaction involves excisable articles.
d. Documentary Stamp Tax – payable only on certain transactions or documents.
Principles of Taxation
Governing tax law in the Philippines is the National Internal Revenue Code of 1997. The Bureau
of Internal Revenue (BIR) is the primary implementing agency of this law.
• Taxation is the process by which the government collects revenue in order to pay for its
expenses.
• Income tax is defined as the tax on the net income or the entire income realized in one
taxable year. Both corporations and individuals are required to pay their income tax. For
corporations, taxes should be paid on the 15 th day of the fourth month following the close of
the taxpayer’s taxable year. This is the reason corporations following the December 31 calendar
year-end are required to settle their tax obligation by April 15 of the succeeding year. On the
other hand, requirements on individuals are based on their source of income. Employees who
derive their income solely from compensation essentially pay their income tax dues periodically
through payroll deductions. Their employees are withholding agents. This means their
employers deduct income tax from their salaries and remit those to the government monthly.
Who are required to pay income tax in the Philippines? (Section 23 of the National
Internal Revenue Code [NIRC] of 1997)

- A citizen of the Philippines, living in the Philippines, is taxable on all income earned inside
and outside the Philippines;
- A non-resident citizen is taxable only on income earned in the Philippines;
- An OFW is taxable only on income earned in the Philippines. Provided, that the OFW, who is
a citizen of the Philippines and who receives compensation for services rendered abroad as a
member of the complement of a vessel engaged exclusively in international trade shall be
treated as an OFW;
- A foreigner living in the Philippines is taxable only on income earned in the Philippines.
-A domestic corporation is taxable on all income derived from sources inside and outside the
Philippines; and
- A foreign corporation is taxable only on the income derived inside the Philippines.
The principles of income taxation in the Philippines require Filipino citizens residing in the Philippines
and domestic corporations to pay taxes on their income wherever it may come from, whether from
inside or outside the Philippines. Payment of taxes for income derived abroad does not automatically
exempt this income from Philippine taxation. The country that levied taxes on your income should have
a tax treaty with the Philippines and should have documentary proof of the tax payment to the foreign
country. On the other hand, foreign citizens and corporations are only liable to pay taxes for income
derived within the Philippines.

Philippine individual income tax is progressive. The tax rate increases with the tax base. It is based on
the principle that taxpayers with more capacity to pay should pay more taxes.
A. Compensation Income
• Employed individuals that earn compensation income pay their income taxes monthly. Employers
withhold the income tax of their employees from their monthly gross income and remit these sums to the
BIR.
* The withholding scheme is implemented because employees might not have sufficient cash to pay their
income tax dues of aggregated to a one-time annual payment. The withholding tax deduction is computed
based on the employee’s gross compensation (net of mandatory contribution to SSS or GSIS, Philhealth,
and Pag-IBIG Fund), the timing of compensation payments, and using the published BIR withholding tax
table.

• All individual taxpayers are granted a personal exemption of P 50,000. Additional exemptions of ₱
25,000 are given for each qualified dependent but only up to four dependents. For husbands and wives
with children, only one spouse can claim the additional exemption. The husband is deemed head of the
family and will claim the deduction unless he explicitly waves his right in favor of his wife.
• Even with periodic withholding income tax is computed at the end of the year
based on compensation income derived during the year. Taxable income is
computed after deducting statutory contributions (i.e., SSS, GSIS, Philhealth, and
HDMF). The applicable tax rate is then applied to the taxable income to get the tax
due. The objective of the periodic withholding is that the tax due computed at the
end of the year will be equal to the total amount withheld. However, this is not
always the case. At the end of the year, the employee could have remaining tax
liabilities or have a tax refund receivable. The difference between total tax due and
total income tax withheld may be due to changes in salaries during the year which
could result in pay increase, promotion, or change in employer. It is also quite
possible that there were errors in the periodic computations made during the year.
• Taxable Income and Tax Due

Compensation Income:
Gross compensation (salary and other bonuses)
Less: Statutory contributions (SSS or GSIS, PhilHealth, and Pag-ibig Fund)
Gross compensation, net of statutory payments
Less: 13th-month pay and other bonuses that are exempted from income tax
= Gross taxable compensation income
Less: Personal (P 50,000 per taxpayer) and additional deductions (P 25,000 per qualified dependent, max of
4)
= Net taxable compensation income
• List of sources of Gross Income: (NIRC 1997 Chapter 6 Section
32 A)
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 a trade or business or the exercise of a profession;
3. Gains derived from dealings in property; (Note: subject to 6% capital gains tax for individuals and for the
corporation if land and building is not used in business)
4. Interests; (Note: generally subject to 20% final withholding tax) Rents;
5. Royalties; (Note: generally subject to 20% final withholding tax,10% if from books and literary works)
6. Dividends; (Note: generally subject to 10% final withholding tax for individuals, tax-exempt for corporation)
7. Annuities;
8. Prizes and winnings; (Note: generally subject to 20% final withholding tax, except those that are tax exempt based
on specific criteria in the law)
9. Pensions; and
10. Partner's distributive share from the net income of the general professional partnership.
• Withholding income tax for employees:
- Employers are required by law to withhold income tax dues from their employees’ salaries.
- It is implemented because employees might not have sufficient cash to pay for their income tax dues if aggregated to a
one-time annual payment.
-The withholding tax deduction is computed based on the employee’s gross compensation (net of mandatory
contributions to SSS or GSIS, Philhealth, and Pag-ibig Fund), tax status, the timing of compensation payments, and using
the published BIR withholding tax table.
• Income tax is computed at the end of the year based on all compensation income derived during the year.
- Taxable income is computed after deducting personal and additional exemptions.
- Applicable tax rate is applied on the taxable income to get the tax due.
-The total income tax withheld by the employer is deducted from the tax due to get the remaining tax liability by the
employee.
• Taxpayers who derive their income solely from compensation are required to file BIR Form 1700 as their income tax
returns. However, to give relief to these taxpayers, the employee may present BIR Form 2316 as their income tax return.
BIR Form 2316 is a statement issued by the employer and signed by the employee but not filed with the BIR. This is
referred to as substituted filing.
• 
Graduated Income Tax Rates for Individuals
Taxable Income Computation of Tax Due
Over But Not Over Rate
10,000 5%
10,000 30,000 P500+10% of excess over P10,000
30,000 70,000 P2,500+15% of excess over P30,000
70,000 140,000 P8,500+20% of excess over P70,000
140,000 250,000 P22,500+25% of excess over P140,000
250,000 500,000 P50,000+30% of excess over P250,000
500,000 P125,00+32% of excess over P500,000
• Example:
Juan Dela Cruz generated annual compensation income of P615,000. Statutory payments are as follows:
SSS – P 6,975.60; Philhealth - P 5,250; Pag-ibig Contribution – P 1,200. Total: P 13,425.60 Tax exempt
13th month pay and other bonuses – P 60,000. (Note: Maximum tax-exempt 13th month and other
bonuses is P 82,000 per Revenue Regulation 3-2015)

Gross compensation (salary and other bonuses) P 615,000.00

Less; Statutory contributions (SSS/GSIS, Philhealth and Pag-ibig Fund) 13,425.60
Less: Tax exempt 13th month bonus 60,000.00
Gross taxable compensation income P541,574.40
• Scenario 1: Juan Dela Cruz is single with no qualified dependent
Gross compensation income P541,574.40
Less: Personal deduction 50,000.00
Net taxable compensation income P491,574.40
From tax table, tax due for P491,574.40 is computed as follows: P50,000 + 30% of the excess over P
250,000 P 50,000 + 30% (P491,574.40 - P250,000) = P122,472.32
(Note: This is not the tax payable by the individual. Compare this with the amount that the
employer withheld. Any difference is the tax liability payable on April 15. Generally, if the employer
correctly withheld during the year and there are no changes in the tax status and tax base during
the year, the amount withheld will be equal to the tax due. However, there will be a difference if
there are changes in the taxability of the tax payer (single to married, changes in number of
qualified dependents) and change in tax base (i.e. increase in salary)
•Scenario 2: Juan Dela Cruz is married with 3 qualified dependents
Gross taxable compensation income P541,574.40
Less: Personal deduction 50,000
Less: Additional deduction (P 25,000 x 3) 75,000.00
Net taxable compensation income P416,574.40
From tax table, tax due for P416,574.40 is computed as follows:
P 50,000 + 30% of the excess over P 250,000
P 50,000 + 30% (P416,574.40 - P 250,000) = P99,972.32

What if the employer withheld a total of P95,000? Then on April 15 on the subsequent year, the employee will
pay an additional P4,972.32. But this does not happen often. Normally, the employers compute for the annual
tax due based on the actual gross compensation income at the end of the year. Any additional tax payment may
be deducted from the December compensation.
B. Income Derived from Business or Practice of a Profession

 The tax payments of a business organized as a sole proprietorship are made in

the name of its owner. The owner is considered an individual taxpayer who
derived income from the business. He is required to file BIR Form 1701.
 Businesses may settle their income tax liabilities and submit their income tax
returns (tax form) to the government three months and fifteen days from the
close of the year. For a business that follows a calendar year, the date of
settlement is April 15.
- Some businesses pay income tax on a quarterly basis based on their quarter-
end income. Quarterly payments are due sixty days following the close of the
first three quarters of the year.
 
- When the tax due is in excess of ₱ 2,000, the individual taxpayer may elect to pay
the tax in two equal installments. The first installment shall be paid at the time
the return is filed and the second installment is paid on or before July 15
following the close of the calendar year.

- Two approaches for the computation of income tax for the business:
 Itemized deduction. Use the itemized expenses in the income statement. The
business should have a complete set of accounting books and supporting receipts
for the deductions that were itemized on the tax form.
 Optional standard deduction scheme. Deductions are up to a maximum of 40% of
“gross receipts”. “Gross receipts” is equal to net sales plus other taxable income.
This means that the business’s taxable income is equivalent to 60% of gross
receipts.
 
•Taxable Income and Tax Due

•Total revenues (Sales, Professional Fee, etc)

•Less: Total expenses (Cost of Goods Sold, Operating Expenses)
•Taxable income from business
•Less: Personal (P 50,000 per tax payer) and additional deductions (P
25,000 per qualified dependent, max of 4)
•=Net taxable income
•Example:

•Juan Dela Cruz is the owner-manager of JDC Trading Company. Total Sales generated during
the year amounted to P 1,230,000. Cost of goods sold is P 492,000 and total operating
expenses is P 184,500. The company opted for itemized deduction.
Sales P1,230,000
Less; Cost of goods sold 492,000
Gross profit 738,000
Less: Operating expenses 184,500
Taxable income from business or profession P553,500
Scenario 1: Juan Dela Cruz is single with no qualified dependent
Gross taxable compensation income P0
Less; Personal deduction 50,000
Net taxable compensation income (50,000)
Taxable income from business or profession P553,500
Total taxable income P503,500

From tax table, tax due for P503,500 is computed as follows:

•P 125,000 + 32% of the excess over P 500,000
•P 125,000 + 32% (P 503,500 - P500,000) = P 126,120

 Is this the amount payable to the BIR on April 15? Not exactly. If during the year, some of JDC’s
issued creditable income tax withheld (meaning the clients remitted the withheld amount to
the BIR), then the amount withheld maybe deducted from P 126,120. Creditable income tax
withheld is basically prepaid income tax.
 The remaining liability (after deducting creditable tax withheld), if greater than P
2,000, may be paid in installment – half on April 15 and the other half on July 15.
•Scenario 2: Juan Dela Cruz is single with 1 qualified dependent; JDC received creditable
income tax withheld from its customers at P 27,655.
Gross taxable compensation income P0
Less; Personal deduction 50,000
Less: Additional deduction 25,000
Net taxable compensation income (75,000)
Taxable income from business or profession P553,500
Total taxable income P478,500

•From tax table, tax due for P 478,500 is computed as follows:

•P 50,000 + 30% of the excess over P 250,000
•P 50,000 + 30% (P478,500 - P 250,000) = P118,550
•P 118,550 - P27,655 = P90,895
•(Note: Liability to the BIR. If paid in installment, Juan Dela Cruz will pay P 45,447.50 each on April 15 and
July 15).
C. Mixed Income Earner

“Mixed Income Earner” is a compensation earner who at the same time is

engaged in business or practice of the profession. A taxpayer deriving mixed
income will also use BIR Form 1701.
- taxpayer earns both compensation and business income.
- An example of a mixed-income earner is an executive of a multinational
company who also lectures part-time for a university during the weekends. The
corporation will withhold income taxes based on compensation income while the
university will withhold 10% to 15% of the lecturer’s honorarium.
BIR Forms
BIR Form 1700
BIR Form 1701
BIR Form 1701A
BIR Form 1701Q
BIR Form 2316
BIR Form 2307
Lesson Summary
1. Taxation is the process by which government collects revenue to pay for its expenses.
2. The Bureau of Internal Revenue is the primary implementing agency in charge of tax
collections.
3. The income tax is a tax on the net income or the entire income realized in one taxable year.
4. The principles of Income taxation in the Philippines require Filipino citizens residing in the
Philippines and domestic corporations to pay taxes on their income whether earned within
or outside the Philippines. The exception to this rule is when the country where the income
is derived from has collected taxes on the income and has an outstanding tax treaty with
the Philippines.
5. Philippine individual income tax is progressive- the tax rate increases as the tax base
increases.
6. Compensation income refers to the income derived by an employee from services rendered
to the employer.
7. The monthly withholding tax deduction is computed based on the employer’s gross compensation,
the timing of compensation payments, and the published BIR withholding tax table.
8. The tax payments of a business organized as a sole proprietorship are made in the name of the owner.
The owner is considered an individual taxpayer who derived from the BIR form 1701.
9. A taxpayer that derived income solely from business is required to the BIR Form 1701.
10. Business income may be computed based on itemized deductions or option standard deductions.
11. The optional standard deduction scheme allows the proprietor to claim deductions up to a maximum
of 40% of gross income.
12. A self-employed individual or professional has the option to use the 8% income tax rate on gross
sales/receipts.
13. A mixed-income earner is a compensation-earner who is also engaged in business or practice of the
profession.
14. A taxpayer deriving mixed income will also use BIR Form 1701.
Determination of Gross Income (National Internal Revenue Code of 1997)
Section 32 Gross Income
A. General Definition- Except when otherwise provided in this Title gross income means all income derived from
whatever source, including (but not limited to) the following steps.
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 a trade or business or the exercise of a profession;
3. Grains derived from dealings in property;
4. Interests;
5. Rents;
6. Royalties;
7. Dividends;
8. Annuities;
9. Prizes and winning;
10. Pensions; and
11. Partner’s distributive share from the net income of the general professional partnership.