INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 25

SUGGESTED ANSWERS
Chapter 4: Gross Income

CHAPTER 4
GROSS INCOME

Problem 4 – 1 TRUE OR FALSE

1. False – Only 13 th month pay and other benefits are covered by the P82,000. The 14 th
month pay is taxable.
2. False – this is an equity settlement option.
3. False – the capital gains tax is based on the full consideration received.
4. True
5. False – the excess of book value or FMV over the option price is subject to fringe benefit
tax.
6. True
7. True
8. True
9. False – COLA is taxable even its amount is very minimal. COLA is now included in the
basic wage.
10. True
11. False – Religious officer’s income is subject to income tax.
12. True
13. False – at the exercise of option. There is no compensation at the grant of the option,
unless the stock option is exercised by the employee.
14. False – the basis of tax is the cancelled obligation.
15. False – transportation allowance pre-computed on a daily basis is not subject to tax.

Problem 4 – 2 TRUE OR FALSE

1. False – only 50% of 7.5% is the final tax imposed.
2. True
3. False – tips are taxable. There is no law exempting tips from income tax.
4. False – there is no income because the actual expenses is greater than the advances.
5. True
6. False, the rule on MCIT is being described.
7. True
8. True
9. True
10. False – Not income but a liability in compliance with the trading business rule.
11. False – Under service business, advances from clients are to be reported as income.
Include as income because the advanced rental is without restriction.
12. True

Problem 4 – 3 (A) TRUE OR FALSE

1. True
2. True
3. False – Income from profession
4. True
5. True
6. False – because estimated bad debts is not allowed to be deducted from gross business
income.
7. True
8. False – Not an option to report, but required to report.
9. False – the return of premium from insurance company is not taxable.
10. True
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 26
SUGGESTED ANSWERS
Chapter 4: Gross Income

11. False – income should be realized to be taxable.

12. True
13. False – As a rule, income obtained illegally is taxable.
14. False – As a rule, income received by error is reportable income.

Problem 4 – 3 (B) TRUE OR FALSE

1. True
2. True
3. False – The rule of P10,000 and below applies to prizes not winnings.
4. False – Only damages resulting from injuries is nontaxable.
5. True
6. False – this rule applies to winnings. Prizes amounting to P10,000 and below is subject
to normal tax.
7. True
8. False – This tax-exemption is granted only to public employees and applicable to
accumulated monetized vacation and sick leave credits.
9. False – Only 14 th month pay is taxable.
10. True
11. False – proceeds of life insurance due to death is nontaxable regardless of who is the
beneficiary.
12. False – as a rule board and loading furnished by an employer is taxable, except when it
applies to employer’s benefit rule.
13. True
14. False – not taxable income because the dividend received is still stock though different
in class.
15. True

Problem 4 – 4 TRUE OR FALSE

1. True
2. False – Only those employees who can meet the requisites are exempt from income tax
even if the retirement plan is BIR approved.
3. True
4. False – Not taxable.
5. False – Overtime pay of MWE is nontaxable.
6. True
7. True
8. False – Interest expense of a bank is treated as part of cost of service.
9. False – Advance collection of rent income is taxable.
10. False – All earnings of a resident Filipino citizen from all sources are taxable in the
Philippines.
11. False – Subject to a normal tax of 30% because such interest income is a normal
operating income of the bank.

Problem 4 – 5 Problem 4 – 6 Problem 4 – 7

1. B 1. A 1. C
2. D 2. C 2. C*
3. A 3. D 3. D
4. D 4. B 4. C
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 27
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Chapter 4: Gross Income

5. C 5. D 5. B
6. A 6. C 6. C
7. D 7. A 7. A
8. D 8. B 8. B
9. A 9. C 9. D
10. B 10. A 10. B
11. A 11. C 11. B
12. C 12. D
Correction:
* 2. The tax rate on inter-corporate dividend income received by a nonresident foreign
corporation from a domestic corporation is

Problem 4 – 8 A
Net take home pay P180,000
Add: Withholding income tax 30,000
Total P210,000
Less: 13 th month pay 10,000
Gross reportable compensation P200,000

Unused 10-day vacation leave is nontaxable if it is converted into cash (Rev. Regs. No. 10-2008;
BIR Ruling No. 93-34). In the above problem, the 10-day vacation leave was actually availed;
hence, taxable.

Problem 4 – 9 D
Salary (P370,000 + P50,000) P420,000
Per diem as a board of director 200,000
Taxable thirteenth month pay (P35,000 – P5,000) 5,000
Gross taxable compensation income P625,000

Problem 4 – 10 C
Salary P1,500,000
Taxable 13 th month pay and other bonuses (P150,000 – P82,000) 68,000
Total compensation income P1,568,000

Problem 4 – 11 B
Salary P120,000
Tips 360,000
14th month pay 10,000
Cost of living allowance 5,000
Total taxable compensation income P495,000

Note: Since the 13 th month pay is only P10,000, the P20,000 achievement awards being part of
de-minimis can be used as other benefits, to be added to the new P82,000 nontaxable threshold
of 13th month pay and other benefits.

Problem 4 – 12 C
Salary (P120,000 + P24,000) P144,000
Overtime pay 36,000
Payment of services (P4,000 + P30,000) 34,000
Present value of non-interest bearing notes (P30,000 x 0.909) 27,270
Reportable taxable income per ITR P241,270
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 28
SUGGESTED ANSWERS
Chapter 4: Gross Income

In general, interest income is subject to final tax; hence not to be reported in the ITR.
Non-interest bearing note is to be reported at its discounted value when received. (Sec.
2.78.1, Rev. Reg. No. 2-98)

Problem 4 – 13 D
(First employment for 30 years received at the age of 50) P500,000

Aside from the requirement that the plan should be reasonable, the Tax Code requires that the
retiring employee should have been in the service of the same employer for at least ten years
and is not less than fifty years of age at the time of his retirement. The taxpayer should not also
have previously availed of the privilege under a retirement benefit plan for the same or another
employer.)

Problem 4 – 14 B
First employment – resigned P300,000

Problem 4 – 15 C
Gross compensation income (1,000 x P10) P10,000

Problem 4 – 16 D
P – 0 -. Since the total amount of donation to his brother is only P50,000 or (P100 x 500 shares),
the donation is tax-exempt.

Problem 4 – 17
1. Letter B
Capital gains tax (P23 x 1,000) x 5% P1,150

2. Letter D
Gross-up monetary value (P30 x 1,000)/68% P44,118
Multiplied by Fringe benefit tax 32%
Fringe benefit tax P14,118

Problem 4 – 18 C
Regular compensation per month P 50,000
Cancellation of indebtedness (P300,000 – P275,000) 25,000
Total compensation income – December 200B P75,000

Problem 4 – 19 B
Insurance premium – beneficiary Sico P5,000

Problem 4 – 20 A
Basic compensation (P30,000 x 12) P360,000
Shares of stock (P100 x 100) 10,000
Stock option (P120 – P80) x 100 4,000
Annual insurance premium (P4,000 x 50%) 2,000
Gross compensation P376,000

Problem 4 – 21 B
Commission income P30,000
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Chapter 4: Gross Income

Indirect dividend 20,000

Two-month salary 40,000
Gross income P90,000

The P10,000 debt cancellation made by his brother in favor of Mr. Swerte is not an income but a
gift.

Problem 4 – 22 B
Cleaning of business equipment P 1,000
Repair service of store 3,000
Total casual service income P 4,000

Problem 4 – 23 C
Total purchases P500,000
Transportation cost on purchases 5,000
Unsold goods ( 40,000)
Cost of goods sold P465,000

Problem 4 – 24 C
Inventory, beginning P 20,000
Purchases 1,200,000
Purchase discounts ( 10,000)
Purchase returns ( 40,000)
Transportation in 5,000
Inventory end ( 50,000)
Cost of sale P1,125,000

Problem 4 – 25 C
Year 1 Year 2
Inventory, beginning P 50,000
Inventory, ending (P50,000) ( 30,000)
Purchases 850,000 900,000
Freight – in 10,000 15,000
Purchase discount ( 20,000) ( 25,000)
Cost of sales P790,000 P910,000

Problem 4 – 26 B
Sales P1,275,000
Sales returns ( 25,000)
Net sales P1,250,000
Less: Cost of goods manufactured and sold
Purchases – raw materials P 540,000
Freight-in 20,000
Raw materials, ending inventory ( 10,000)
Raw materials used P 550,000
Direct labor 400,000
Factory overhead 200,000
Total manufacturing cost P1,150,000
Work-in-process, ending inventory ( 100,000)
Finished goods, ending inventory ( 50,000) 1,000,000
Gross business income P 250,000

Problem 4 – 27 B
Advance payment P 2,000
Additional collection 8,000
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 30
SUGGESTED ANSWERS
Chapter 4: Gross Income

Office machine 3,000

Gross service income P13,000

Problem 4 – 28 B
Professional fee, accounting services P500,000
Less: Direct costs of services:
Salaries of accounting staff P150,000
Accounting supplies 10,000 160,000
Gross business income for MCIT purposes* P340,000

Correction: The requirement should qualify that the gross business income is for MCIT
purposes.

Problem 4 – 29 B
Interest income from clients P50,000,000
Trading gain 10,000,000
Less: Cost of services:
Lending and investments funds salaries P3,000,000
Interest expenses paid to depositors 2,000,000 5,000,000
Gross income for MCIT purposes P55,000,000

Problem 4 – 30 D
Interest income from clients P10,000,000
Gain on sale of capital assets 5,000,000
Rent income 2,000,000
Total P17,000,000
Less: Cost of services:
Salaries of bank employees assigned in
lending and investments of funds P3,700,000
Depreciation of computers and
teller machines used 600,000
Direct supplies used 200,000
Interest expense paid to depositors 1,500,000 6,000,000
Gross income for MCIT purposes P11,000,000

Problem 4 – 31 B
Service charges:
Originating from the Philippines P 150,000
Collection abroad of collect messages originating in the Philippines 60,000
Gross income for Philippine Income Tax computation P 210,000

Problem 4 – 32 B
Rent for year:
200A P 80,000
200B 480,000
200C 40,000
200B Reportable income P 600,000

Problem 4 – 33
1 Letter C
.
Advanced deposit P 40,000
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 31
SUGGESTED ANSWERS
Chapter 4: Gross Income

Monthly rental (P20,000 x 10 months) 200,000

Annual insurance premium to be paid by the lessee
(P6,000 x 10/12) 5,000
Portion of real estate tax to be paid by the lessee
(P3,000 x 10/12) 2,500
Rent income P247,500

As a general rule, pre-collection of rental is taxable in full to the lessor when

received regardless of accounting method used.

2 Letter B
.
Monthly rental (P20,000 x 10 months) P200,000
Annual insurance premium to be paid by the lessee
(P6,000 x 10/12) 5,000
Portion of real estate tax to be paid by the lessee
(P3,000 x 10/12) 2,500
Rent income P207,500
Commission income (P2,000,000 x 5%) 100,000
Reportable taxable income P307,500

Problem 4 – 34 D
Outright Spread-out
Year 1 Outright method P240,500
Year 1 Spread-out method
Value of investment P240,500.00
Less: Accum. depreciation [(P240,500 - P560)/8 yrs] x 4.75 yrs 142,464.37
Book value, end of lease P 98,035.63
Divided by remaining years of contract 4.7
5
Annual income from improvement P 20,639
Multiplied by months in a year 9/12
Year 1 spread-out – rent income on improvement P 15,479

Problem 4 – 35 C
Outright Spread-out
Outright P180,000
Spread-out P - 0 -

For spread out method, there is no reportable income from leasehold improvement for year 200B
because the said improvement was completed at the end of the year.

Problem 4 – 36 C
Cost of improvement P300,000
Less: Accumulated depreciation at the end of the lease (P300,000/6) x 4 years and 7 months 229,167
Book value at the end of the lease P 70,833
Divided by number of years until the termination of lease contract = 4 years and 7 months 4.58
Annual additional income P 15,454
Multiplied by number of years expired (from March 31, 200B to December 31, 200D) 2.75
Reported additional income from improvement (P42,500)
Book value of improvement at the time of pre-termination
Cost P300,000
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 32
SUGGESTED ANSWERS
Chapter 4: Gross Income

Less: Accum. depreciation at pre-termination (P300,000/6) x 2.75 years 137,500 162,500

Additional income in 200D from the pre-termination of contract P120,000

Problem 4 – 37 A
Interest income from an investment in a 10-year bond P 40,000
Interest income from 5-year time deposit in Philippine bank 50,000
Interest income from expanded foreign currency deposit 60,000
Total taxable interest income P150,000

Note: Technically speaking, the interest from 5-year time deposit in Philippine bank is taxable
because the period involved is not more than 5 years and the deposit is not BSP prescribed
form.

Problem 4 – 38 D
Year 3 interest income of P4,461.20.

Problem 4 – 39
1. Letter B
Interest income – lending business P500,000
Less: OSD (P500,000 x 40%) 200,000
Net income before personal exemption P300,000
Less: Personal exemption – basic 50,000
Net taxable income P250,000
Normal tax of P250,000 P50,000
Final taxes:
Interest income – EFCD (P200,000 x 7.5%) 15,000
Interest income – Peso time deposit (P100,000 x 20%) 20,000
Total income taxes P85,000

2. Letter A
Interest income – lending business P500,000
Less: OSD (P500,000 x 40%) 200,000
Net income before personal exemption P300,000
Less: Personal exemption – basic 50,000
Net taxable income P250,000

Normal tax of P250,000 P50,000

Final tax:
Interest income – Peso time deposit (P100,000 x 20%) 20,000
Total income taxes P70,000

Problem 4 – 40 D
Royalty income as author (P100,000 x 10%) P 10,000
Royalty income from franchising (P200,000 x 20%) 40,000
Royalty income from gold mine (P500,000 x 20%) 100,000
Total final tax P150,000

Problem 4 – 41 D
Copyright Patent
Gross royalties: P 35,000
Copyright (P31,500/90%)
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 33
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Chapter 4: Gross Income

Patent (P20,000/80%) P 25,000

Income tax – final
Copyright (P35,000 x 10%) ( 3,500)
Patent (P25,000 x 20%) . ( 5,000)
Income after tax P 31,500 P 20,000

Problem 4 – 42
1 Letter B
.
Royalties within derived from:
Pain reliever invention (P100,000 x 20%) P20,000
Musical compositions (P200,000 x 10%) 20,000
Books (P500,000 x 10%) 50,000
Final tax on royalty income P90,000

2 Letter D
.
Royalties outside derived from:
Pain reliever invention P200,000
Musical compositions 100,000
Books 300,000
Royalty income subject to normal tax P600,000

In general, royalties derived from sources within the Philippines are subject to a final
tax of 20%, except royalties on books, other literary works and musical compositions
which shall be subject to a final tax of 10%. Royalties received by resident citizens
from sources outside the Philippines shall be subject to normal tax under Section 24
(A) of the NIRC and by the domestic corporation under Section 27 (A) of the NIRC.

Problem 4 – 43 A
P500,000 - Dividends earned by a domestic corporation from a foreign corporation are taxable.

Problem 4 – 44 A
The dividend received by a domestic corporation from another domestic corporation is
nontaxable.

Problem 4 – 45 C
First prize in Talentadong Pinoy P10,000
2nd place in bicycle race 6,000
3rd place in chess tournament 15,000
Amount subject to normal tax P31,000

In general, prizes (reward for a contest) are subject to final tax of 20% except if the amount of
the prize is P10,000 or less which will be subject to normal tax. Winnings (reward that depends
on chance) are subject to 20% final tax regardless of amount. [Sec. 24 (B)(1), NIRC]

Problem 4 – 46 D
First prize – raffle draw (P50,000 – P1,000) P 49,000
Gambling winnings 300,000
Beauty contest winnings 100,000
Taxable prizes and winnings P449,000

Problem 4 – 47 C
Year 1 Year 2 Year 3
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 34
SUGGESTED ANSWERS
Chapter 4: Gross Income

Income (loss) P100,000 (P 20,000) P 50,000

Less: NOLCO (P25,000 – P20,000 – P10,000) 5,000
Bad debts written off 25,000 10,000 5,000
Income (loss) before bad debts recovery P 75,000 (P 30,000) P 40,000
Bad debts recovery of previous year with tax benefit . 25,000 8,000
Taxable income P 75,000 (P 5,000) P 48,000

Note: The tax benefit allowed in year 2 for the bad debts written off is only P5,000; hence, the
reportable bad debts recovery in year 3 should also be P5,000.

Problem 4 – 48 D
Year 1: No bad debt recovery None
Year 2: Bad debt recovery P 600

Problem 4 – 49 D
P5,000 local tax recovery.

Problem 4 – 50 D
Licensing fee P 30,000
Registration fees of delivery trucks 4,000
Real estate tax 5,000
Community tax 3,000
Foreign income tax previously claimed as deduction 80,000
Reportable gross income on tax refunds P122,000

Problem 4 – 51 C
Real property tax P 10,000
Local taxes 500
Reportable income from tax refund P 10,500

Problem 4 – 52 B
Unfair competition P400,000
Loss earnings 100,000
Moral damages for breach of contract 150,000
Exemplary damages for breach of contract 50,000
Interest on damages 10,000
Gross income from damage recoveries subject to tax P710,000

Actual damages are considered taxable income to the extent that such damages constitute a loss
of anticipated profits, and are non-taxable to the extent they represent a return of capital or
investment. However, moral and exemplary damages awarded as a result of a breach of contract
are subject to income tax, and, consequently, withholding tax. (BIR Ruling No. DA-489-2005
dated December 6, 2005)

Take note that the moral damages and exemplary damages awarded were not on account of
injuries or sickness.

Problem 4 – 53 D
Actual damages for anticipated profits P800,000
Moral damages for breach of contract 100,000
Exemplary damages for breach of contract 50,000
Interest on damages 10,000
Amount included as taxable gross income P960,000
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 35
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Chapter 4: Gross Income

Problem 4 – 54 C
Annuity received P 20,000
Present value (P20,000 x 0.9091) 18,182
Interest income - Taxable annuity P 1,818

Note: The present value factor of P1 for an effective interest rate of 10% is 0.9091.

Problem 4 – 55 D
Annuity received P 5,880
Present value (P5,880 x 0.8928) 5,250
Interest income - Taxable annuity P 630

Problem 4 – 56 B
Excess of withdrawable amount ($10,000 - $1,000) $ 9,000
Multiplied by exchange rate per 1 dollar P 50
Reportable income received by error P450,000

Problem 4 – 57 C
Net increase in net asset P108,000
Less: Salary in a year (P5,000 x 12) 60,000
Illegally obtained income - taxable P 48,000

Note: Income derived from illegal source is taxable even if the taxpayer is a MWE.

Problem 4 – 58
Gross income P 425,000

In case of taxpayers engaged in the sale of service, “gross income” means gross receipts less
sales returns, allowances and discounts. [Sec. 27 (A) NIRC]

Problem 4 – 59
Salary P300,000
Corporate shares received (1,000 shares x P100) 100,000
Cancellation of debt in lieu of service rendered 50,000
Profit sharing 40,000
Gross taxable compensation income P490,000

Problem 4 – 60
Taxable stock dividend (P50 x 400 shares) P20,000
Property dividend (P60 x 600 shares) 36,000
Total dividend income P56,000
Multiplied by tax rate 10%
Final withholding tax on dividend P 5,600

All of the dividends (both the stock and property dividends) become taxable because the
stockholders do not retain the percentage of their interest as a result of the option exercise by
some of the stockholders. The changes in the interest ownership were as follows:

Stockholders A B C D E Total
Shares owned 1,000 1,000 1,000 1,000 1,000 5,000
Add: Stock dividend 200 200 0 0 0 400
Total shares owned 1,200 1,200 1,000 1,000 1,000 5,400
Percentage of ownership interest:
INCOME TAXATION 7TH Edition (BY: VALENCIA & ROXAS) 36
SUGGESTED ANSWERS
Chapter 4: Gross Income

Stockholders A B C D E Total
Previous interest 20% 20% 20% 20% 20% 100%

Current interest 22.22 22.22% 18.5% 18.5% 18.5% 100%

%

Since the final tax on dividend is to be withheld by the payor company, the fair market value of
the property dividend at the time of declaration will be used for tax purposes.

Problem 4 – 61
1. Gross income – trading business (P500,000 – P200,000) P300,000
Gross income – warehouse (P200,000 – P150,000) 50,000
Net capital gains (loss) on personal properties
Computer – more than 1 year
(P10,000 – P20,000) x 50% (P5,000)
Car – more than 1 year (P100,000 – P50,000) x 50% 25,000 20,000
Gross income subject to regular tax P370,000

2. Unutilized portion of sale of residential house

(P1,000,000 – P800,000) x 6% P12,000

Problem 4 – 62
Salary (P25,000 + P302,000) P327,000
Income tax paid by the employer 5,000
Note receivable 20,000
Total compensation P352,000
Business gross income P 400,000
Allowable expenses ( 250,000) 150,000
Prepaid rent income 50,000
Bad debts recovered previously written- off (P38,000 x 60%) 22,800
Taxable income subject to tabular tax P574,800