CPA Review & Training Center TAX-0105

Urdaneta City, Pangasinan Concept of Income (Part 1)

CONCEPT OF INCOME.

Income - All wealth that flows into the hand of the taxpayer, except a mere return of capital.

GENERAL RULE: increase in taxpayer’s net worth other than return of capital is income.
Under the Tax Code, the BIR Commissioner could best assess the amount of income using the
net worth method if the taxpayer does not have reliable accounting records.

FORMS AND VALUATION OF INCOME

o Cash, the amount of income is the nominal value of cash.
o Non-cash, the amount of income is the fair value of non-cash in year earned.
o Promissory note, if interest bearing, the face value of promissory note received.
o If non-interest bearing, the cash value of the amount stated on the face of the note at
prevailing interest rate.
o Stock option
 Compensation income if the fair value at date of grant is higher than the
option price
 Capital gain, if at date of exercise the selling price at date of exercise is
higher than the fair value at date of grant

CLASSIFICATIONS OF INCOME AS TO TAX LIABILITY

1. Taxable
2. Non- taxable

CLASSIFICATIONS OF TAXABLE INCOME AS TO MANNER OF REPORTING

1. Reportable in the annual tax return
2. Non-reportable, subject to final tax at source base on gross amount

CLASSIFICATIONS OF INCOME AS TO SOURCE

1. income earned within
2. income earned outside the Philippines
3. income earned partly within and partly outside

TYPES OF INCOME
1. Ordinary Income
a. Compensation for personal services
b. Business income or profit
2. Passive income
a. Dividends
b. Interests
c. Winnings/prizes
d. Royalties
3. capital gains
a. sale of investment property and other capital assets

SITUS OF INCOME
1. Interest – debtor’s residence
2. Dividends
a. By a domestic corporation – within the Philippines
b. By a foreign corporation – apply the dominance test
3. Service – place of performance of the service
4. Rent – location of the property
5. Royalties – place where the intangible is used
6. Gain on sale
a. Real property – location of the property
b. Domestic shares of stock – within the Philippines
c. Personal property – place of sale
7. Mining – location of mine
8. Farming - location of farm
9. Merchandising – place of sale
10. Manufacturing – place of manufacturing and place of sale

Requisites of taxable income

1. there must be a gain

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CPA Review & Training Center TAX-0105
Urdaneta City, Pangasinan Concept of Income (Part 1)

2. the gain must be realized or received

3. the gain must not be excluded from taxation

ACCOUNTING METHODS
1. Cash Basis Method – income is recorded in the year it is actually or constructively
received; expenses are generally reported in the year it is paid
2. Accrual Method – income is reported in the year it is earned; expenses are deducted in
the year incurred
3. Hybrid method – a method of income recognition which combines both cash basis and
accrual basis method
4. Percentage of completion – this is applicable only to long-term construction contracts
covering a period in excess of one year

5. Installment method – applicable in the following three cases only:

a. sale of personal property by a dealer
b. casual sale of personal property where:
 selling price is over P1,000.00
 initial payment do not exceed 25% of the selling price
 property is of a kind which would be included in the taxpayer’s inventory if on hand
at the close of the taxable year
c. sale of real property where the initial payment do not exceed 25% of the selling price
6. Crop year basis – applicable only to farmers engaged in the production of crops which
takes more than a year from the time of planting to the process of gathering and disposal.
Expenses paid or incurred are deductible in the year the gross income from the sale of
the crops is realized

ACCOUNTING PERIOD – the length of time over which income is measured

1. Calendar year – 12 months period ending December 31
- this is applicable to:
a. individuals
b. taxpayers who do not keep books
c. taxpayers with no annual accounting period
d. taxpayers whose annual accounting period is other than a fiscal year

2. Fiscal period – any 12 months period ending the last day of any month other than
December 31st
- this is applicable to corporations and partnerships

Cases when short accounting arises:

1. death of a taxpayer
2. newly organized business
3. dissolution of a business
changes in accounting period (voluntary and involuntary, but applicable only to corporation)

BASIC TAX RETURN FORMAT FOR REPORTABLE INCOME

 Gross income-----------------Pxx
 Less: deductions ------------ xx
 Net taxable -------------------Pxx
 x tax rate %
 Tax due ----------------------Pxx
 Less: tax credits xx
 Net tax payable -------- Pxx

DEFINITION OF TAXABLE INCOME

The term taxable income means the pertinent items of gross income specified in this Code, less
the deductions and/or personal and additional exemptions, if any, authorized for such types of
income by this Code or other special laws. (Sec 31)

Compensation income
Compensation income is income arising from employee-employer relationship.
o Reportable = those collected with creditable withholding tax
o Non-Returnable = those collected with final tax ( Fringe benefit of Managerial
employee, compensation employed by offshore banking unit, exploration service
contractor)

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CPA Review & Training Center TAX-0105
Urdaneta City, Pangasinan Concept of Income (Part 1)

Non-Taxable compensation Income

o 13th month pay and similar benefits not exceeding P90,000 (before P82,000/year
(rev reg 3-2015)
o Benefits received for convenience of the employer
o Contribution to SSS/GSIS/Philhealth/Pag-ibig/Union dues
o Benefits received from SSS/GSIS, under Workmen’s compensation Act
o Terminal pay ( received by heir upon death of employee)
o Retirement pay:
 Has been in service of same employer for at least 10 years
 Retiring at not less than 50 years of age
o Separation pay due to involuntary causes
o Proceeds of life insurance policy
o Casual labor, if the employment is not related in the conduct of business of the
employer.
o Minimum wage earners (RA 9504, Rev.Reg. 10-2008)
o compensation income of qualified senior citizens which are not exceeding the
poverty level of P60,000/year
o De minimis benefits:
1. P10,000 de minimis benefit granted by RR 1-2015 (productivity incentive
schemes combined with other benefits received by the employee arising
from a collective bargaining agreement (CBA))
2. 10 days and below monetized unused vacation leave
3. medical cash allowance to dependents, P250/employee/month (Before,
P125/employee/month)
4. actual yearly medical benefits not exceeding P10,000
5. rice subsidy of P2,000/month (Before, P1,500/month)
6. uniform/clothing allowance, P6,000/year (Before, 5,000/year Rev Reg 8-
2012)
7. laundry allowance of P300/month
8. daily meal allowance for over time work not exceeding 25% of basic
minimum wage
9. tokens/gifts for marriage, birth , illness
o Income excluded under treaty

Minimum wage earners, exempt from income tax, if not earning other type of reportable
income.
Minimum wage earner also receives/earns additional compensation such as holiday pay, overtime
pay, night shift differential and hazard pay are Also exempt from income tax. (Rev. rev 10-2008)

Taxable minimum wage earner

1. If receiving commissions, honoraria, fringe benefits, benefits in excess of statutory
amount of P90,000 (Before P82,000), and other taxable income (other than income
subject to final tax).
2. If receiving other type of reportable income.

Compensation income that are subject to final tax at source

1. Fringe benefits of managerial or supervisory employees, 35% (Before 32%):
a. Housing, car, household personnel, personal expense, travel, holiday,
membership, educational and health
b. Final tax of 35% (Before 32%) on the grossed up monetary value.
c. The final tax should be based on the grossed up monetary value of fringe benefits
granted/paid.
TAX LIABILITY
o Income tax of employee
o Liability of the employer to withhold

2. Compensation of alien employed by:

o offshore banking unit
o petroleum exploration service contractor
o regional area headquarter of multinational
Final tax rate is 15%

3. 25% of fringe benefits granted to non-resident alien not doing business in the Philippines.

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FRINGE BENEFITS
Forms of fringe benefits (cash or in kind)
1. housing allowance
2. reimbursement of personal expenses
3. holiday and vacation expenses
4. foreign travels

Foreign travel expenses of managers

 When the purpose of the travel is for business purposes, not taxable.
 Except
 When inland travel expenses such as local transportation and food expenses
exceeds $300/day and when the plane ticket is first class, in such case 30% of
the cost of 1st class plane ticket is subject to fringe benefit tax.

Business income
Income earned from conduct of business, which could be trading, manufacturing, servicing,
leasing, construction or farming.

Non-taxable business Income:

Earned by the cooperative is SURPLUS, to be returned to members in form of dividend and capital
build-up.

Gross income from business

 'gross income' derived from business sales shall be equivalent to gross sales less sales
returns, discounts and allowances and cost of goods sold.
 sale of service, 'gross income' means gross receipts less sales returns, allowances and
discounts.

Reporting of business income

 Business Income (reportable every quarter)
 Subject to (creditable) expanded withholding tax :
 Sales – Cost of sales (reportable, point of sale)
 Gross receipts (reportable, point of collection)
 Gross receipts – cost of services for long term contract, (reportable @ % of
completion)

Long term contracts

 Sec. 48 ,Persons whose gross income is derived in whole or in part from long term
contracts shall report such income upon the basis of percentage of completion.
 The percentage completion should be certified by architects or engineers.

Passive income
 Income earned not through employment nor from doing business.
 Passive income earned within the Philippines are taxed at source at their gross amount.
 Only passive income earned within are subject to the following Philippine final withholding
tax
 Passive Income within ( final tax):
 Interest income:
 peso deposit, 20% except:
 0 , five years or more maturity
 5%, 4 years to less than 5 years maturity
 12%, 3 years to less than 4 years maturity
 15% (Before 7.5%) on income from Expanded foreign currency deposit, earned by
resident
 10% on income from expanded foreign currency deposit earned by OBU’s

Dividend income:
From domestic corporation to:
a. citizen or resident, 10%
b. non-resident alien, doing business in the Phil., 20%
c. non-resident, not doing business in the Phil., 25%
d. domestic or resident foreign corporation, exempt
e. non-resident foreign corporation, w/o reciprocity, 30%

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Urdaneta City, Pangasinan Concept of Income (Part 1)

f. non-resident foreign corporation, with reciprocity, 20%

Other cash and property dividend other than enumerated above are reportable, if
taxable.

 Royalties, final tax of 20%, except royalty for copy rights, 10%
 Prizes, final tax of 20%, except prizes P10,000 and below which are reportable.
 Winnings, final tax of 20%. (Lotto and PCSO winnings above P10,000 is now
taxable)

Non-taxable passive income

1. passive income derived by foreign government
2. prizes and awards made primarily in recognition of achievements in the following fields:
 religious * charitable
 scientific * educational
 scientific * artistic
 literary * civic

3. prizes and awards granted to athletes to local and international sports competitions and
tournaments whether held in the Philippines or outside and sanctioned by respective
sports association.

Reportable passive income

 passive income earned outside are reportable by resident citizen and domestic
corporation.
 prizes P10,000 and below earned within are reportable along with business income. These
are not subject to final tax collected at source (Sec. 24 B).

Winnings considered within

 general rule, winnings within are subject to 20% final tax,
 except Philippine Charity Sweepstakes and Lotto winnings ( Under TRAIN, PCSO and
Lotto winnings above P10,000 is now taxable)

Capital gains
a. Capital Gains , arising from capital asset transactions
Capital assets= not inventory, not PPE, not receivable arising from sale of
inventory.
b. The determining factor is the purpose that the property was in use at the time of sale or
exchange.

Cost basis to determine the amount of capital gain or loss

1. acquisition cost, if purchased
2. fair market value at date of inheritance, if inherited
3. the lower of cost to the donor of fair market value at date of donation , whichever is lower
if received as gift.

Rules is determining gain or loss in exchange

1. The property received in exchange is substantially different(in nature and substance) from
the property given away.
2. The property received in exchange should have market value.
3. Gain of loss = fair value of property received – cost of property given
Or
= cash received + fair value of property received – cost of property given.

What is the treatment of the cost /expenses of disposition of capital assets?

 These are treated as reduction from selling price to determine capital gain or loss.

CAPITAL GAINS EXEMPT FROM INCOME TAX

 gains realized from the sale, exchange or retirement of bonds with maturity of more than
5 years.
 gains realized upon redemption of investment in mutual fund company.
 Gains in a corporate reorganization (merger/consolidation) where exchange is purely in
kind (shares of stock).

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 Sale of family home where the proceeds is fully utilized in acquiring new family residence
w/in 18 months from date of sale.

Taxable gain in a business combination, when cash or property other than share of stocks are
received. The taxable gain should not exceed the fair market value of the cash and property
received.

Are taxable gains in a business combination reportable or subject to final tax?

Yes, if pertaining to land, final tax.

CAPITAL GAINS SUBJECT TO FINAL TAX

The following capital assets transactions are Subject to Final Tax:
o Sale of Real Property (located within), 6% of selling price or zonal value whichever
is higher.
o Sale of securities outside stock exchange, 15%. (Before, 5% on the first P100,000
gain and 10% on gains in excess of P100,000 on per transaction basis)

Are all taxable sale of real property considered as capital assets, subject to final tax of 6%
of selling price or zonal value?
 No, if the real property sold by the citizen or domestic corporation is located outside the
Philippines, the gain is subject to normal tax on reportable income. (Sec. 24D of NIRC)

Rules on capital asset transactions

a. Capital losses are deductible only to the extent of capital gain
b. Net capital gains are added to reportable ordinary income
c. Net operating loss is deductible from net capital gain
d. Net capital loss is not deductible from reportable ordinary income

Rule on holding period governing capital asset transactions of individual taxpayer

Holding period and carry-over for individuals
 If capital asset is held for more than 12 months, only 50% of gain or loss is considered
 Net capital loss is allowed as carry over only for the next year.

Installment basis reporting of capital assets transaction

Installment payment of capital gain tax on sale of real property is allowed, when
o Initial payment is not exceeding 25% of the selling price
o Initial payment is the amount of cash paid in the year of sale + the excess of assumed
mortgage over the cost of property.
o Contact price is the selling price less the lower of the mortgage assumed or the cost of the
property
o Installment payment = Capital gain tax x (collections/contract price)

Exemption of sale of real property from capital gain tax:

If the sale is pertaining to the official residence of the taxpayer
o The Commissioner is notified within 30 days from date of sale
o The exemption is just once every 10 years
o the proceeds is fully utilized in the acquisition of his new residence within 18
months from sale

Cost basis of new residence (exempt sale of original residence):

o If proceed is fully utilized, new cost basis = cost of property disposed of
o If partially utilized, new cost basis = cost of property disposed of x (proceeds
utilized/selling price of old residence)
o If acquisition cost of new residence exceeds the proceeds of sale, new cost basis
= excess + cost of property disposed of.

Are all ownerships of shares of stocks of other entity considered as capital assets
No, if the shares are holdings of dealers in securities, these are its inventories.

TREATMENT OF SHARES OF STOCKS HELD AS CAPITAL ASSETS

Shares of stock (as capital asset):
 If sold outside stock exchange, tax is 15%.

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The computation is on per transaction basis.

To arrive at the amount of gain, costing could be FIFO or Moving Average

 If sold inside the stock exchange;

 Exempt from final tax of 15% if sold inside stock exchange but subject to stock
transaction tax of 0.60 of 1% (before, 0.50 of 1% transaction tax).

Original issuance of own shares

Original issuance of shares stock will not result to taxable capital gain nor deductible loss

Wash sales of shares of stocks

sales of stocks or securities where substantially identical securities are acquired or purchased
within a 61-day period, beginning 30 days before sale and ending 30 days after sale.
 gain is reportable,
 loss is not deductible

Treasury stocks
o Treasury stock acquired in exchange of non-cash property may give rise to taxable gain
or deductible loss
o Re-issuance of treasury stock may result to taxable gain

Rule on determination of the cost of shares sold

o The cost should be determined using direct identification,
o if not possible, FIFO,
o if perpetual record is maintained, moving average method of costing.

When will stock dividend be taxable?

Issuance of stock dividend followed by its redemption may give rise to taxable dividend

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