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Tests to determine realization of income

Severance test

As capital or investment is not income subject to tax, the gain or profit derived
from the exchange or transaction of said capital by the taxpayer for his separate use, benefit and
disposal is income subject to tax.
Substantial alteration of interest test

Income is earned when there is a substantial alteration of the interest of a

taxpayer, i.e. increase in proportionate share of a stockholder in a corporation.

Income to be returnable for taxation must be fully and completely realized. Where
there is no separation of gain or profit, or separation of increase in value from capital, there is no
income subject to tax.

Thus, stock dividends are not income subject to tax on the part of the shareholder
for he had the same proportionate interest in the assets of the corporation as he had before, and
the stockholder was no richer and the corporation no poorer after the declaration of the dividend.
However, if the pre-existing proportionate interest of the stockholder is substantially altered, the
income is considered derived to the extent of the benefit received.

Moreover, if as a result of an exchange of stocks, the person received something of

value which are essentially and fundamentally different from what he had before the exchange,
income is realized within the meaning of the revenue law.
Flow of wealth test

The essential difference between capital and income is that capital is a fund
whereas income is the flow of wealth coming from such fund; capital is the tree, income is the
fruit. Income is the flow of wealth other than as a mere return of capital.

According to the principle, revenues are recognized when they are realized or realizable, and are earned
(usually when goods are transferred or services rendered), no matter when cash is received. In cash
accounting in contrast revenues are recognized when cash is received no matter when goods or
services are sold.

To determine the amount of income tax owed, certain deductions are taken from an
individual's gross income to arrive at an adjusted gross income, from which additional
deductions are taken to arrive at the taxable income. Once the amount of taxable income
has been determined, tax rate charts determine the exact amount of tax owed. If the
amount of tax owed is less than the amount already paid through tax prepayment or the
withholding of taxes from paychecks, the taxpayer is entitled to a refund from the IRS. If
the amount of tax owed is more than what has already been paid, the taxpayer must pay
the difference to the IRS.
Gross receipts are the total amounts the organization received from all sources during its annual accounting
period, without subtracting any costs or expenses.


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Tax on Income Derived under the Expanded Foreign Currency Deposit System. - Income derived
by a depository bank under the expanded foreign currency deposit system from foreign currency
transactions with nonresidents, offshore banking units in the Philippines, local commercial banks
including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas
(BSP) to transact business with foreign currency deposit system shall be exempt from all taxes,
except net income from such transactions as may be specified by the Secretary of Finance, upon
recommendation by the Monetary Board to be subject to the regular income tax payable by
banks: Provided, however, That interest income from foreign currency loans granted by such
depository banks under said expanded system to residents other than offshore banking units in
the Philippines or other depository banks under the expanded system shall be subject to a final
tax at the rate of ten percent (10%)

After all is said and done, companies that have made a profit can do one of two things with the
excess cash. They can (1) take the money and reinvest it to earn even more money, or (2) take
the excess funds and divide them among the company's owners, the shareholders, in the form of
a dividend.
If the company decides to pay out dividends, the earnings are taxed twice by the government
because of the transfer of the money from the company to the shareholders. The first taxation
occurs at the company's year-end when it must pay taxes on its earnings. The second taxation
occurs when the shareholders receive the dividends, which come from the company's after-tax
earnings. The shareholders pay taxes first as owners of a company that brings in earnings and
then again as individuals, who must pay income taxes on their own personal dividend earnings.
This may not seem like a big deal to some people who don't really earn substantial amounts of
dividend income, but it does bother those whose dividend earnings are larger. Consider this: you
work all week and get a paycheck from which tax is deducted. After arriving home, you give your
children their weekly allowances, and then an IRSrepresentative shows up at your front door to
take a portion of the money you give to your kids. You would complain since you already paid
taxes on the money you earned, but in the context of dividend payouts double taxation of earnings
is legal.


Income-Under Philippines rules, resident citizens and domestic corporation are

taxable on all income derived from sources within or without the Philippines. A
non-resident citizen, an alien whether or not a resident of the Philippines and a
foreign corporation, whether engaged or not in trade or business in the
Philippines, are taxable only from sources within the Philippines.
Resident and nonresident aliens are allowed exclusions from gross income if they meet certain conditions. An exclusion
from gross income is generally income you receive that is not included in your U.S. income and is not subject to U.S. tax

5) What are some of the exclusions from gross income?


Life insurance

Amount received by insured as return of premium

Gifts, bequests and devises

Compensation for injuries or sickness

Income exempt under treaty

Retirement benefits, pensions, gratuities, etc.

Miscellaneous items

o income derived by foreign government

o income derived by the government or its political subdivision
o prizes and awards in sport competition
o prizes and awards which met the conditions set in the Tax Code
o 13th month pay and other benefits
o GSIS, SSS, Medicare and other contributions
o gain from the sale of bonds, debentures or other certificate of
o gain from redemption of shares in mutual fund

individuals who are either earning compensation income, engaged in business or deriving income
from the practice of profession are entitled to personal and additional exemptions as follows:
Personal Exemptions:
For single individual or married individual judicially decreed as legally separated with no qualified
dependentsP 50,000.00
For head of familyP 50,000.00
For each married individual *P 50,000.00
Note: In case of married individuals where only one of the spouses is deriving gross income, only
such spouse will be allowed to claim the personal exemption.
Additional Exemptions:

For each qualified dependent, an P25,000 additional exemption can be

claimed but only up to 4 qualified dependents

The additional exemption can be claimed by the following:

The husband who is deemed the head of the family unless he explicitly
waives his right in favor of his wife

The spouse who has custody of the child or children in case of legally
separated spouses. Provided, that the total amount of additional exemptions
that may be claimed by both shall not exceed the maximum additional
exemptions allowed by the Tax Code.

The individuals considered as Head of the Family supporting a qualified


The maximum amount of P 2,400 premium payments on health and/or hospitalization insurance can
be claimed if:

Family gross income yearly should not be more than P 250,000

For married individuals, the spouse claiming the additional exemptions for
the qualified dependents shall be entitled to this deduction

7) Who are required to file the Income Tax returns?


Resident citizens receiving income from sources within or outside the


o employees deriving purely compensation income from 2 or more

employers, concurrently or successively at anytime during the taxable
o employees deriving purely compensation income regardless of the
amount, whether from a single or several employers during the calendar
year, the income tax of which has not been withheld correctly (i.e. tax
due is not equal to the tax withheld) resulting to collectible or refundable
o self-employed individuals receiving income from the conduct of trade or
business and/or practice of profession
o individuals deriving mixed income, i.e., compensation income and
income from the conduct of trade or business and/or practice of
o individuals deriving other non-business, non-professional related income
in addition to compensation income not otherwise subject to a final tax
o individuals receiving purely compensation income from a single
employer, although the income of which has been correctly withheld, but
whose spouse is not entitled to substituted filing
o marginal income earners

Non-resident citizens receiving income from sources within the Philippines

Aliens, whether resident or not, receiving income from sources within the

Corporations no matter how created or organized including partnerships

o domestic corporations receiving income from sources within and outside

the Philippines

o foreign corporations receiving income from sources within the Philippines

o taxable partnerships

Estates and trusts engaged in trade or business