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    Chapter 9

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    Fely Maata

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    Chapter 9 - Reguter Income Tax inclusion in Gross Income CHAPTER 9 REGULAR INCOME TAX: INCLUSION IN. GROSS INCOME. Chapter Overview and Objectives me subjectto the regular income ay “This chapter discusses inclusion in grO55 ‘After this chapter, readers are expected to demonstrate: se Mastery of the NIRC list of tems of gross income Subject to regular tax ang their measurement rules 2, Knawledge of the boundary between income subject to final tax or capi gains tax and those subjectto regular income tx 3, Rnowledge ofthe link between items of exernpt income and income subject ty regular income tax Conprehension of the effect of accounting methods and situs rules on the reportable amount of gross income 5. Knowledge of the treatment of creditable withholding tax & Understanding the treatment of income from pass-through entities 7. Mastery of the rules on recoveries of past deductions 8. Appreciation of the essence and purposes of transfer pricing regulation ITEMS OF GROSS INCOME ‘The term items of gross income or inclusions in gross income is a broad category pertaining to all items of mcome subject to taxation, namely: 1, Gross income subject to final tax 2. Gross income subject to capital gains tax 3. Grossancome subject to regular tax items of gross income subject +o final tax and items of gross income subject to capital gains tax are respecuvely discussed in Chapter 5 and Chapter 6. This chapter focuses on the items of gross income subject to regular tax. ITEMS OF GROSS INCOME SUBJECT TO REGULAR TAX GGross income includes, but isnot imited to, the following items: ‘Compensation for servicesin whatever form paid {Gross income from the conduct of trace, business, or exercise of a profession Gains derivee from dealings in properties Interest Rents Royalties 276 chapter 9- Regular Income Tax: Inclusion in Gross Income eet hapa iter sm ize the complexity of this section, compen: bie coe . compensation income is separately Gros: 1e from the conduct of trade, business or exercise of a profession ‘This includes income from any trade or business, egal oF illegal, and whether registered or unregistered, Gross income from business or profession is determined as follows: sales/Revenues/Recerpts/Fees Less: Cost of sales or services Gross income from operations PB xxxe as Poa ‘The following business income shall not be included in gross income subject to income exempt from income tax such as: 3¥ Micro: Rusiess Enterprise (BME) under RA 9178 ‘enjoying tx holiday incentves under EO 226 come tax holiday ineentives 10 special tax regime such 2 ‘Zone Authority (PEZA) registered enterprises subject ro 5% terprse Zone Authority (TIEZA} registered come tax iiviuals (SE/P) who opted to be taxed under the 8¥o income tax 3. Business income subject to final tax when not subjected to final tax by the payor sof petroleum serece contractors subject 9.8% final tax “currency deposit units (FCDUs) and offshore banking residents subject to 10% fal tax ‘of business income shall report thelr gross income subject to heparin the computation of tox per regime nthe Annas a Taxpayers wath multiple type regular tax under the column chapter 9 - Regular income T8x: Inclusion in Gross Income seen ont fe me eat ven cot eon nes pce wen sn Ne ea Tem — ins: lings in properties Cain rom aig pr nny ase Fe SUBEL 0 eRe igang Th Bs es cr tan dete ck od el propertes ae Sate ayy subject to regular income ta Ordinary losses are nom other capa tem of gross income. gross income. me Ordinary gains are included as items of gross deductions against gross income. The after deducting 1s also ‘capital loss isnot an To avoid complicating this section, the tax rules on measurement and recogn Tere com desing in popertis ae discussed in detall in Chapter 12," iy refers to interest income other than passive interest income tax A taxable interest income must have been actually paid out gt an agreement to pay interest. It cannot be imputed. (IR vs. Flinvest Development Corporation, QR 163653 and 167659) Examples oferestincome subject to regular income tax 1 Taerest income from lending activities to individual and corporations by ba finance companies and other lenders by tain, 2. Interet income from bonds and promissory notes 41 Interest income from bank depos abroad Exempt interest income ‘The following are exempt from regular income taxation: 1. Interest income earned by landowners in disposing their lands to their ts pursuant to the Comprehensive Agrarian Reform Law terest income (the opportunity cost of money) does not constitute an actual income; hence itis exempt from income tax. ‘The power of the Commissioner to include the power to impute “theoretic ‘Mlustration Sapphire Hank ashe following income in 2014 Interest income from loans etoomginan income and deduction does not terest. (Ibid) > Ineretncnefomdpststhatertnks —* 900609 Interest income from notes rediscour i Inereincme om enum "Segoe 78 chaper 9- Regu Income Tax Inclusion in Gross income ‘nly the interest income from loans and notes rediscounting are items of gross income sie regula income tn, The terest on depos ond easy note are wens of gross x Rents ent income arises from leasing properties of any kind. Its a passive income but {snot subject to final tax under the NIRC; hence, i is subject to regular income tax. special considerations on rent {L_ Obligations of the lessor that are assumed by the lessee are additional rental income to the lessor. 2, Advance rentals are ‘a, Item of gross income upon receipt if Unrestricted or si Restricted to be applied in future years or upon the termination of the lease b._ Notan item of gross income if: ii, It 1s a security deposit to guarantee payment or rent subject to ‘contingency which may or may not happen Leasehold improvements made by the lessee on the leased property are recognized by the lessor as income using the spread-out method or outright method discussed in Chapter 4 Mustration Under the tba Leasing Corporation’s standard lease contract, leases shall run for 3 able 12-month period for a monthly’ rental of P25,000. The lessee shall rental im advance plus one month security deposit. The reat fo e lease shall be taken from the advance while the security dey ere are no damages sustained by the property during the I is an item of income subject to regular tax The P25,000 security deposit is not an income. Royalties Royalties earned from sources within the Phulippines are genera Income tax except when they are active by nature. Active royalties earned from sources outside the Philippines are subject to regular icome tax. 279 ‘Chapter 9- Regular income Te} Mtustration 1 PorressoRtware is a distributor of a compu licensed users. Computer programs are sPec! ‘continuing maintenance services are provides total of PSO0.000 royalty payments. “The entire 500000 1s subject to regular income tx since te royalty (5 aM active In to Forressoftware rogram and ears Foy: red to cach 3 year. ‘Mlustration 2 ‘Mang Damian has the following roys P 550,000 200.000 300,000 400,000 from books from franchise exercised abroad ing properties and from books in the Phipines are subject "fom sources abroad aggregating P700,000 ave ters of gross lar income tax Remember that the final withholding tox does not Dividends ‘These pertain to dividends declared by foreign corporations. It should be recalled that dividends declared by domestic corporations are gener: lect to 10% he recipient is an individual taxpayer and exem fea ‘or a resident foreign corporation. Cash, property, idends ign corporations are items of gross income subject tax snd declaration or when stocks dividends are subsequently redeemed such amounts to payment of cash dividend, the fair market value of the stock dividends received is taxable. Liquidating dividends tration bao Company, a domestic corporation, received cash dividends from the following: Domes corporations m4 Resident rag corporations 400000 Nomen rg oportns 5o.000 280 chapter 9 - Regular tneome Tax Inclusion in Gross income ne Pt) merce tn tty tne too ge Le an ne “phe P500,000 total dividends from the resident and non-resident foreign corporations he items of regular income subject to regular income tax and shall be reported a5 follows: scenario 1: Assuming Cubao is a domestic corporation, the PS00,000 total dividends from foreign corporations shall be included in gross income because domestic forporations are taxable on world income, ‘scenario 2: Assuming Cubao 1s a resident foreign corporation, anly a portion of the 200,000 dividends from the resident foreign corporation determined as earned vaitin by yminance test discussed in Chapter 3 shall be included in gross fncome. The situs of dividends from the non-resident foreign corporation is abroad. Annuities ‘The excess of annuity payments received by the recipient aver premium pad is taxable income inthe year of receipt. mMustration “Andrew purchased an annuity contract for P100,000 which shall pay him P10,000 ‘annually until he dies. The receipt of the fist 10 annua? annuity payments isa return of capital Any further receipt from year 11 onwards isan item of gross income subject to regular income tax. Prizes and Prizes and income subject to regu t are exempted from final tax are not items of gross income tax. Exempt prizes and winnings 1. Prizes received without effort to joi a contest 2. Prizes in athletic competitions sanctioned by their respective national sports association 3. Winnings from PCSO or loto, not exceeding P20,000 in amount Summary rales of prizes and winnings for mdividual taxpayers: TYonin Abroad — Regular tax. Regular tax Finabtax Regular tax 0, exceeding P20.000 Finaltax N/A PCSO and lotto, nocexcecding P20.000 Exempt N/A ‘Winnings from other sources Regular tax 281 CChepter 9 - Regular Income Tax inclusion in Gross Income inal taxation of | izesrand winnings for corporations Metta orn ae Plated is Ube, Rlustration . The City of Baguio held its Panagbenga flower festival. During the festivities, y, Erorita, the proprietor of Mr. Sexy Body Gym, won the PS00.000 second prize in flower foat competion. John Hay Corporation won the P600,000 frst prize tte onthe wining of Mr Brora The The if ag tl wil 206 fr 20 0 Tao eg al at be suiectd to 20% nl tax but to creda withholding tax john Hay shall include the prize in its gross income subject to rug rae Pensions ‘These pertain to pensions and retirement benefits that fail to meet the excusoy criteria and hence subject to regular tax. Partner's distributable share from the net income of the genera professional partnership It should be recalled that general professional parmerships are not subject Income tax (Le, final tax, capital gans tax or regular income tax) because they ar merely viewed as pass-through entities. The partners are the ones subject regular tax on their share in the net income of the general professiond partnership. For this purpose, the net income of the general professional partnership shal include items of income which are exempted from final tax or capital gains tax to {the general professional partnership, Mlustration ‘et and Siegiried practice their profession in a general professtonal partnership ané share profits 60:40. Their firm reported the following: Gross receipts P 2,000,000 Less: Professional expenses 200.000 [Net income trom operations. P a00,000 Interest from bank deposits ——20.000 Distributive net income Eaz0.000 ‘The share ofthe parmers in the net income of the partnership shall be computed 2: ‘Total distribution to Zef (60% x P620,000) P 492,000 ibution to Siegfried (40% xP820,000) _ 326,000 tive net income ECazo009 Di 282 chapter 9- Regular Income Tax Inctusion in Gross income ‘The partners shall include their respective shares i heir gross income regular income tax. ‘708s income subject to Note that this rule applies to other pass-through entities such as: 1, Exempt joint ventures 2. Exempt co-ownership venture or co-ownership come tax. The distributive share of a ‘income of these entities, if organized. tnholding tax ted abroad, the share from ‘income tax for taxpayers taxable on global income. the final income taxation is territorial and does not apply to foreign income, GENERAL CRITERIA FOR ITEMS OF GROSS INCOME Items of gross income subject to regular income tax are not limited to the provision for 1. not subject to final tax, capital gains tax, and special tax regime, and 2, notexcluded or exempted by law, treaty, or contract from taxation. :ROSS INCOME SUBJECT TO REGULAR INCOME TAX 8 from taxable estates or trusts income of other pass-through entities: b. Exempt co-ownership 3. Farming income 4. Recovery of past deductions. 5. Reimbursement of expenses 6. Cancellation of indebtedness for a consideration Income Distribution from taxable estates or trusts ‘Any income distribution received by an heir or beneficiary from a taxable estate or trust shall be ject to regular tax, provided that sch income must not have been subjected to final tax or capital gains tax. IMlustration: Estates Roman is one of several heirs Judicial settlement. The admi support of Roman: estate of his father which is under ed the following income for the ‘chapter 9- Reguar income Tax Inctusion Gross Income P 22,500 Domestic dividends mano Business income a hs gros tacome subject to regular INCOME COX the py clude m is gress nor Tote shal present the same amoung Roman disoibucion from business income deduction against its gross income. The Roman since tis was already subjected 0 dividend shalt not be neue atsource. Mlastration: Trusts Havana received the following income distributions in his capacity as beneficiary yyy Irrevocable trust designated by his grandmother: Net capital gains on saleofdomesticstocks P9,500 Rental income 12,000 Horace shall report nly the P12,000 rental income in his grass income subject to regu income tox. The net gain on the sole of stocks is subject o capital gains tax to the ruse, Share from the net income of exe! ‘The same tax treatment on recog professional partnership applies ventures and co-ownerships. int ventures and co-ownerships of share in the net income of a gener share from the acti Farming income Farming operations can be classified as: 1. Raise and sell operation ‘The proceeds on the sales of livestock or farm products is included in gross ‘income subject to regular income tax. Animal raising expenses are presented as items of dedi ss income. 2 Purchase ai operation The gross profit rom the sale (sles less cos of purchase is included in poss income. Taxpayers livestock or used for reco, yy follow accrual or cash basis in accounting for inventories of m products. The crop year basis discussed in Chapter 4 may be igincome for long-term crops, It should be recalled that the proceeds of ceeds of cop oF vestock tmable tem of ross income because they are ecoery olen prof ‘RECOVERIES OF PAST DEDUCTIONS When past year deductions from (en pst yar deductions rom gross income ae subsequently recovered by it expense Aeducted are subsequently paid a am amount ess than the deducuon Ca ot they resedntaxbenefit tothe taxpayers Nl De analyte whether 284 ‘chapter 9 - Regula Income Tax. Inclusion in Grass income xamples of recoveries of past deductions: Fapecovery of previously claimed bad debt expense J. Refund of local tax expense & Getund of foreign tax previously caimed as deduction + Recommissioning of banwoned petroteum service contracts or mining tenements £ Release of reserve funds of insurance companies 5 Inerest expense which were subsequently condoned bythe lender past deductions that created tat benefit to the taxpayer must be reverted back to Foss income in the year of recovery so thatthe government wall recover the tax fost from the deduction. ‘Fax benefit ‘There are two ways a taxpayer may benefit from a deduction: ‘through reduction of taxable income in the year deduction 1s made ‘through redilction of future taxable income through carry-over of Mote der outta laws the exces of deduoans over gos ncn i teal year i came ov ade ehucon apunst the vet income of the next three years of operation This called net 23 dings carne NOLCD Because of th, amet al prior year deductions have tax Demet ence, thelr recovery i dhesend in Chapter fis partly dscused hee Because oft elvan 10 Itustration 1: With Net income in the year of deduction ‘Rtaxpayer incurred P60,000 bad debt expense in 2018 out of which P35,000 was recovered in 2020: 2g 202 2020 Ft00.000 F 80,000 P 120,000 (_s0.20) =. 35,000 19.000 E gogo £22 The entire P60,000 deduction in 2018 sa tax benefit othe taxpayer tence, the P35.000 Trvery from this deduction 6 0 fax Benefit which must be reverted hock to grass Income in 2020. The taxable net income in 2020 shal be P155,000. Net income before bad debt expense (Bad debt expense)/Recoveries Net income after bad debt expense tgstraton 2: With operating loss & NOLCO carry-over before recovery aaa er 0 bad deb expense in 2038 out of which PE0.000 was recovered in 2020. —2og_ 2012 _ 2020 P 70.000 100000 P 120.000 Pion om eee zat Neoncome EAD Less: NOLCO application 285, ‘chapter 9 - Regular Income Tax Inclusion in Grass Income tthe entre P90,000 deduction fsa tax Benefit The taxpayer benefited by the p Fa ei cable income piste P20.000 cory-over of NOLCO. The pogo rere fm the deduction in 2020 sa tox benef SUbfect 0 £0x. The repoeay ‘income in 2020 shall be P180,000. % user expired NOLCO before recovery Suypuce'a taxpayer ducted 2 P5O0 interest expense in 2016 but flled top | dificult. The lender condoned the interest in 2020, 2016. 2017 _2018_ 2019 2020 _ Income beforeinterest P 100 (P 130) P80 (P 160) (P70) Less Interest expense (_S00) pie = __ 500 Netincome (NOLCO) (400) (L130) P80 (P16 Paw NOLCO application ———> (20) pow. aay ‘The interest expense saved the 2016 P100 pre-tax income and the 2018 P8O net income {from taxation, Note that NOLCO can be deducted only against net income in the net tree ers The P30 emaning NOLCO ened n 2019 without tox Benefit The aa interest deduction only benefited the taxpayer P180. Hence, only P180 of the Mnepntiiadinnsaesctysckoc bees one re mney bela aueyone ty ayer incurved a ‘bad debt expense in 2019 out a pens tt of which P45,000 was —tm2_ _2020 [Net income/(loss) before bad debts/recovery P 70,000 (P 15,000) (Bad debt expense} /Recovery (30,000) __45,900 [Net income after bad debt expense (20.000) & 2 ‘An increases NOLCO which hasnt expired before h te beginning of the taxable year in whch che recovery takes plc sl be treated es tex Bena The the cnt S000 a tar beneficcothe Hence, mbes aay: ence P4000 recovered cut of sax bereft whith The 2020 net income shall be computed as follows: ‘Net ioss before reco ha: Recovery” (15000) iNet income saa Less: NOLCO application ~ 2020 P3600 Taxable net mcome 20.000 caper 9- Regu Income Tax Incusionn Goss income -Tuetax benefit ofthe P90,000 bad debt expense tothe corporation in this case shall be ‘otermined using the As-If Approach. e-compute the the subsequent dedi jously reported to det ‘Assuring the future recovery is known, Net income before bad debt expense Less: Bad debt expense if recovery is known (P 90,000 - P60,000) __30.000 Eagoon ‘income that escaped taxation in 2019 computed as: known (recovery is unknown) P 40,000 ——2 e4o009 140,000 out of the 260,000 recovery in 2021 constitutes tax benefits which must be included in the 2021 gross income. The 2021 net income shall be P160,000. Illustration 6: Taxpayer fs exempt in the year of deduction Kalinga Corporation is an exempt BMBE taxpayer in 2019 but became a taxable oone taxpayer in 2020. it deducted P120,000 bad debt expense in 2019. In recovered P40,000 out of the bad debts 2019 2020 F 70.000 F 100,000 (10.000) _40.000 (sog00) Bm [Net income before bad debt expense Jeb expense)/Recovery comme after bad debt expense Deductions have no tax benefit toa taxpayer who is exempt from fox. Future recoveries rom dedurtions mode m the yeurof exemption are nan-taxable, The PAO.000 recovery is ‘ot income. The 2020 net income shal be P100,000. 287 ‘Chapter 9 - Regular Income Tax. nciusion in Gross Income Refund of non-deductible expenses Expenses of payments which aren ‘computation of taxable net income w' ‘such, their recovery should not be sdeacible ais £055 income ng eet ided in gross income Hence, the refund of the following non-deductible items is not taxable: 1. Philippine income tax 2. Estate or donor's tax 3. income tax paid or incurred to a foreign country if the taxpayer claimed g credit for such tax n the year it was paid oF incurred. 4. Stock transaction tax in disposing stocks through the Philippine stocy Exchange 5. Special assessment [REIMBURSEMENTS OF EXPENSES Expenses of the taxpayer that are reimbursed or paid by the customer or cient constitute additional income to the taxpayer. Examples: 1. When the lessee pays the ownership costs of the lessor such as real property tax and insurance on the property. the payment constitutes income to the lessor 2. When 2 chent reimburses the out-of-pocket expenses of a professional practitioner, the reimbursements are income to the practitioner. CANCELLATION OF INDEBTEDNESS ‘The cancellation of indebtedness may amount to gratuity or payment of income. ‘service or goods - treated as income yratuny - treated as gift; not as income transaction such as forfeiting the right to receive dividends m exchange of the debt ~ treated as dividend income ‘SPECIAL CONSIDERATIONS IN REPORTING OF GROSS INCOME |. Accounting methods Situs rules Erfect of value added tax L Creditable withholding tax Power of the CIR to redistribute Income and expenses Paden 288 chapter 9 - Regular Income Tax Inclusion in Gross income: ACCOUNTING METHOD ‘The accounting, met teportable amount of er sdopted by the taxpayer has a direct effect on the income subject to regular mcome tax Enllected and uncollected income as gross income, Ir must be recalled also that regardiess ofthe accounting methods ofthe taxpayer, Juvaneed income must be included in gross mcome in the period received. SITUS RULES ‘on global income. pine income, only their items of gross income For taxpayers taxable only on Phi ‘wnthin the Philipp included in gross subject to regular tax from sour imcome. For taxpayers taxable on \come, their items of gross income subject to regular tax from sources within and without the Philippines are included in gross income Integrative illustration 1 Nomisma,a finance corporation, ends to various chents: Interest income from loans to Imerest nome fom bank ep Required: Requlreds al amount of goss income subject final tax and the reportable oe te rogulrncme ta asoming the tanpayer raygcorporston srcorporeton 3. Domestic corporation Solution: ‘An analysis ofthe situs ofthe above income is shown below. wishin Without Loan interest income P 490,000 P 500.000 Bank interest income 2000p 10.000 Total Paragon bsx0000 289 Chapter 9 - Regular income Tax Inclusion in Goss Income sme fatowing ae the amounts subject to final tx andthe #OUnES 0 be repo, gross income subject to regular sncome ———Subectto_ TBualtax. Regular tax reigneorporaon §—«P420.000 Ps 1. Non-resident foreign corporat 20D 400,000 S Bomerecoerason 2.000 910.000 ~~ final income tax on gross “on esd oe copraons ese en Ton ee gt shal wild 30% fia aon tei ETO come : 2. The mere nce om bake the Pippin ian tem of Bess Income seg y ee eer Ine 2 ot Troe 2a acoso thove eared om sours thin. * fren, ee evan oe ke ran hens mega ea tom oc wihin a ee 3, Incame from sources abrox Integrative Mlustration 2 ‘A certain taxpayer had the following details of income during the year: jents P 400,000 Service fees from for s 500,000 Gain on sale of dome directly to abuyer 150,000 Dividends from domestic corporations 5,000 Interest income on bank deposits abroad 30,000 2. Non-resident alien not engaged in trade or business (NRA-NETB) ‘engaged in trade or business (NRA-ETS), a resident aie ‘tizen (NRC} (RA) oranon-resi Resident citrzen (RC) 2 acorpors 2 Non-resident foreign corporation b._ Resident foreign corporation © Domestic corporation chapter 9 - Regular Income Tax Inclusion in Gross Income sotoion: ‘erbnlyis ofthe sks ofthe foregoing income sas falows: jer iatons pitta, wathout ain on sale of domestic stocks £00000 500,000 Domestic didends 008 Peter ooiirtoiont Toul snow ‘The folowing are the amounts ob ineaded in gras ncome subject ina incom tae (FT, capa gain a (COP, and rept ncone sa gr neo mane ae Toor individeals i 1. NRA-NETB P 405,000 P 150000 P 2. NRA-ETB, RA or NRC S000 150000 400.000 3 RC 5000 150,000 930,000 Corporations 4. REC P 405000 P 1s0000 P s. RFC ~ 150000 400000 6 pe 10600 930.000, note: 1. NRFCs and NRA-NETB are subjectto final tax on Philippine income. 2. The 5%-10% capital gains tax is the most universal rule im fenton that applies to all taxpayers regardless of elasifcaton. 3. Inver-corporate dindends are exempt from fina tax, except when the recipient resident foreign corporation EFFECTS OF VALUE ADDED TAX ON REPORTABLE GROSS INCOME Remember that business taxpayers are required to either register as: a. VAT taxpayers ~ if their sales or receipts exceeds 3,000,000 in the last consecutive 12-month period b. Non-VAT taxpayers - if their sales or gross receipts is below the VAT threshold cor are specifically designated by the law to pay percentage taxes Every VAT taxpayer is mandatorily required to charge 12% output tax on their sales or receipt. The regulations presume that the amount charged to customers is ‘nelusive of the 12% VAT, The output VAT will be raid to the government net of the VAT paid by the taxpayer (input VAT) on his purchases. As such, the amount of reportable gross income shall not include the output VAT. 291 chapter - Regular Income Tax Inctusionm Gross Income imlustration 1: VAT taxpayers RAT togstered taxpayer charged P78.00 toa client OF renal. “The VAT taxpayer shall spt the billing 2s follows 70,000 Bo Pa aDHA00 ‘ny the renal incomes subject 0 income tax. The output VAT shall be recorded agg Tabity, The collection ofthe rental is recorded in accounting as follows: cosh 778.400 Rentincome 70000 ‘urout VAT 3400 Rental income (P78,400/112%) Plus: Output VAT (P78,400 x 12/122) Invoice price Wustration 2: Non-VAT taxpayers. ‘Aron VAT taxpayer charged P78,400 to a client for rental Non-VAT caxpayers re not subject to VAT. The entire amount they charge for thee sly of goods or service i gros income subject to income tax WITHHOLDING TAK holding taxes (CWT) dedueted by income payors against the gross sare not exclusions in gross income. These should be added reportable amount of gross income. CWTs are tax credits that are deductible against the annual income tax due of the taxpayer. Mlustration Denzo Inc. anon-VAT domestic corporation, reported the following P 475,000 360,000 40,000 10,000 500,000 the to le gross incom wie irene aa ‘gross income and the income tax due and still due ‘The total reportable gross come shall be: 475K /95% oF (PATEK + P2SK)) HOK/O0% oF (PB6OK+PaOx) — gosgog --40u.009 Bawuuog 292 chapter 9- Regu Income Tax Inclusion in Gross income sox fo trimer dn Se cen cele seers et em i tT ee ‘The income tax dve and still due shal be determined as: come P 900,000 ole deductions (business expenses) _s00.009 income P 400, Jy: Corporate tax rate 1. Fiza ‘withholding tax angen P 25,000 ional fees —-40.000 __65.090 Income tax still due 2. Thesinal axes shoul Creditable withholding tax and VAT VAT taxpayers shall revert back to grass income amounts of withholding tax but texcludes therefrom the amount of VAT charged to customers o Mustration 1 1,000 smpute his rent income subject to regular tax as follows: Wve of 12% but net ofS% CWT] — P8560 107% Bop0.000 Rent income (Gross income} 293 Chapt 9- Regular Income Tax etuson 1° Gross fncome “The VAT and withholding tax are as follows: Rent inco P 90,000 income 3600 ‘lus Output VAT (PB0,000 x 12%) iatholding tx (PB0,000 « 5%) 4000 Less: 8 Lbs600 ‘Cash payments to th lessor POWER OF THE CIR TO | REDISTRIBUTE INCOME. AND DEDUCTIONS POWER OF THE On Tare oganzauons wades OF DUSIESSS (Whether o qReorporated. and whether or not organized in the Philippines) owned Incorporated a erty by the same Interests, the Commision cond eyo rely patrons income or des authored tee ongamatin, trade oF business, ihe determined tng betwee Calon pporsenment or alcaton is neceSS2y in order to preva, aoe eee ipery to reflec the income of any such Organtzabon, trade, Brsiness (Se 50,NIRC) ‘The Problem of Unfair Pricing between Associated Enterprises ‘There is a risk that the pricing of the transfer of goods and services between, associated enterprises will be con 9 such a way to further the interests of the associated enterprises as a whole in disregard of their social responsibility on taxes. Examples: 1. Adomestc corporation which is subject to 30% corporate tax in the Phil has a subsidiry that operates in a tax haven count transfer pricing ba recognized in the Phi abroad where no taxis imposed. A foreign corporation subject to 10% corporate tax in its home country has & cost to his exempt business thereby shifting the profits to the exempt business to save from income tx ‘The transfer pricing guideline Those enumerat about rw of the problems in taxation brought these Unfair praties and to propery Ccnapter @ - Regular Income Tax: Inclusion in Gross Income reflect the income of associated enterprises, the BIR and the Department of sehance promulgated Revenue Regulations No.2 series of 2013 (RR2-2013) 0° transfer PreiOg, whot are associated enterprises? Under RR2-2013, two or more enterprises are associated if one participates igrectly or indirectly in the management, control, or capital of the other; or ifthe Gomme persons participate directly or indirectly m the management, control, oF SShital ofthe enterprises. Associated enterprises are also called "related parties” Examples of associated 1 parent corporation and its subsidiary corporation 1. Sister companies oF businesses owned by the same parent corporation 3. Allcorporations controlled under the same holding company 4 Businesses owned by the same person. prises: ‘The arm's length principle Tier RR2-2013, ransfer pricing between assoaated enterprises shall be made Under comparable conditions and circumstances as those entered into between unfependent parties where market forees drive the terms and conditions of the ‘Maneaction rather than being controlled solely by reason of special relaonship between the associated enterprises. ther words, an uncontrolled pricing method determined by free market forces, also called arm's length pricing is preferred. The failure to comply may expose the taxpayer to a transfer pi justment where the BIR re-computes the proper income of the associated enterprises. ‘The arm’s length principle shall be applied to: 1. Cross-border transactions between associated enterprises 2. Domestic transactions between associated enterprises When operations are conducted cross-border, the taxpayer may enter into an “lavanced pricing agreement” with the BIR where a pricing rates pre-agreed to apply fora period of time. [Although this is not a mandatory requirement, this may serve as 2 safety net for the taxpayer to avoid the risk of transfer pricing examination and adjustment and the inconvenience it may possibly cause. ‘Transfer pricing methods Whe 1e pricing methods between associated enterprises do not reflect arm's Jength pricing, the DIR will adjust the controlled transactions to ther arm's length 295 chapter 9- Reguiar Income Tax Inclusion in Gross Income valves using the most appropate of the following method considenng y tarcumstance of the taxpayer: a ‘uncontrolied price (CUP) method - The transaction 1s va 2 cm et ne et comparable circumstances ie oa ries en et does not apply ¢@ products containing patented products or those containing trade secrets. ~The transaction is valued based on the fu 2. Resale price method (RPM) - The transaction is val setae pertormed by the reseling party to the product. This is used when produg, purchased froma related party are resold to an independent party 3. Cost plus method (CPM) - The transaction is measured by valuing the functng performed by the supplier of the property or services. pit based ow the dmsion of profits Would have ‘expected to realize from Res:dual profit: ‘The residual profit after based on an analysis of independent parties. anctions performed by each of thea rolled transactions 5S. Transactional net margin method (TNMM) - the resale price methods in the sense that sm appr reference tothe operating profit earned in comparable uncontrolled transactions ‘When no comparatives can be derived within the industry of the subject taxpayer, the Bik may the transfer pricing methods using comparatives derived from rr segmen b. Use a combination ofthe transter pricing methods or other methods 296 chapter 9 - Regular Income Tax: Incluaon in Gross income {ts forengn branch at cost; ) ith che BIR which Crosby compiled the following costs and sales during the year Philippines. Branch — Sales through the branch (tatra-company sles) P 7.000.000. 12,000,000 —Zan0.009 7.000.000 b___o 2 scango0 ‘Sales to unassoctated domestic enterprises: P 3,000,000 [Applying the APA, the gross income earned from within and outside the Philippines shall be computed as: Sales through the bronc! Sales ‘Less: cost of sales Gross income Sales to unassociated domestic enterprises: 3.000.000 P © P 3,000,000 297 chapter 9 - Regular Income Tax Inclusion in Gross Income eee omegen a ey NIE sty shal rep cing rae only important the measurement aoe a a yaaa soucesfor purposes ofthe computation ofthe foreign income | pp sources Prope Raxcrei Scenario 2: Crest sa domestic corporaion, andthe foelgn operation ny, branch but a foreign subsidtary incorporated abroa come The income ofthe Foreign subside ‘a non-resident foreign corporation. Note’® in measuring the fair and proper amout the Philippines 2 the transfer pr weorable srofits on the sales of Crosby to the rable gross income rom with. The pro : Mates could hove escaped ataton without this rl ie foreig, ‘The same procedures in this scenario wil be applied if Crosby 5 a resident fore corporation. IMlustration 2: Without an advanced pricing agreement Hot Corpo foreign corporation, sells cosmetics products in the Philippine, theough i ‘The Philippine branch fled an income tax return reflecting te following gross income: Sales P 4,000,000 Less: Cost of goods sold 3.500.009 Gross income B_S00.900 ‘Scenario 1: The BIR determined that Hot Corporation is billing its branch at 200% of cost. Meanwhile, other competitors of Hot Corporation which offer simitor Product lines are billing their Philippine independent distributors at an average 0f 150% of cost. ‘The gross income ofthe Hot Corporation for purposes of Philippine income tax shall be restated by e-measuring the cost of goods sold as follows, les t 200% billing rate (ie. 200% x Cost) P 3,500,000 selling party (P3,500,000/200%) 11,750,000 length price (150% x P1,750,000) 2,625,000 ‘Thus, the gross income of Hot Corporation shall be restated as follows: Sales ‘Les: Cost of goods so (orm engeh con) P 4,000,000 2.625.000 BLg7s.009 Note: Hot Corporation wall be given an assessment Dales tht ay be Gu rome ear etment by he BIR forthe incremental tax lt 298 chapter 9- Regular Income Tax, inclusion in Gross income Scenario 2: Hot Corporation bills ts branch at established market prices since te taste pics of Hot Corporation recs arm's length pricing no transfer ‘aujustment shall be made pricing selection of Transfer Pricing Method To minimize the risks of transfer pricing adjustments, taxpayers may also consider using the transfer pricing methods used by the BIR in pricing their transactions with associated enterprises. The taxpayer must support the propriety ofthe method adopted through proper documentation, PERIOD IN WHICH ITEMS OF GROSS INCOME ARE INCLUDED ‘The amount sms of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted, any such amounts are to be property accounted for as of a different penod. ‘chapter 9 - Regular Income Tax. Incision in Gross Income curren, seueresrenenases Discussion Questions the NIRC ist of tems of gross income, 2, What are the broad categories of grass income? 3 Discnas in detail the taxation of interest tncome. Which is subject to final tay Which is subject to regular income tx? 2 Discuss the treatment of gains from de properties. Which gaing Which gains are subject to regular income tay?“ Discuss he taxation o i" Compare actual distnbution andthe share in the net income of the parte 1e gross income of the partner? Partnershy, 9, Diseuss the taabiityof recoveries of past deductions. 10, Enumerate examples of pass-through entities. Are they taxable to final tay, apt fins tax oF regular anceme tx? 11, Brumerate and discuss the transfer pricing methods. come subjet to regular income tax and capital gans tax ae government. assvencorre buts no subject to ial a The tere income rombonds sed by bak s subject to alae ser ange nepal tt ace ee bec the Pepa coe 5. The gous income from operations enjoying stax hollay are included in income subject to regular ax, uta presented ae deductions in he income tat earn he share ina busines partnership subject t0 final tax, bu the share 8 rehab 300 cpacter 9 - Regular Income Tax Inclusion n Gross income property ta and Insurance on the propery if assumed by the lessee ‘winnings are exclusions in gross income; hence, they are exempt from income tax idends are never subject to mcome tax 's are inclusions in gross income subject to regular due toany cause within his control ‘Trucor False 2 ributat ta by the heir or beneficiary. past deduction must be rverted back to gross income of ye accrual basis, rad debts need aot be reverted back to grass income of taxpayers he debtor. subsequent ny tax benelit. taxes shall not be reverted back £0 BrO35. ‘The lets of the partnership can be claimed by the partners as deduction in their 15, The accounting period of the taxpayer has a direct impact upon the amount of {ross income to be reported. 301 ‘chapter 9 - Regular Income Tax Inclusion in Gross Income eesetmebemer ane eo Oe Fine bee a pact on the ee of Ne FEPOMAbL oN ny 2 ot nnoling tensa ade back tothe AMUN of epoca income 19, The ockput VAT must be included as part of grassincome of VAT taxpayers, re tert bac to gros come fe aunt Of wie tag Payee of NRA-NETB and NRFCS from the Philippines me subject to final tax. ™ no an advanced pricing agreement the Bry gt associate enterprises. vaatenoeen ansocited enterprises mst be made at ars length, Fe celanons apply only to cross-border transtes of goad ng {envces between assornte enterprises 25. eeidone ander the dicet aed indirect contol of the same contoiy fediidual or corporation are sesoclated enterprises. 26, Uns he accrual Sat of accounting, hems Of gos Income are reported in he period they are received “anster prem, adjustment is needed when the income reported te Palippte train sunersated ‘Multiple Choice - Theory: Part 1 4. Gain from sale of shares in mutual funds by the investor b. Prizes in recognition of civic, religious, and artistic achievements € PCSO and loito winnings, not exceeding P20.000 . Allofthese Which isan item of gross income subject to regular tax? a. Gain on sale of lot by a realty dealer Interest income from bank deposits © Passiveroyalty income 4. Capita gain on the sale of domestic stocks 3. Which is tan item of gross income subject to final tax? 1s from a domestic corporation B. Prizesin excess of PI Peni yan © Shareinte income ofa general profesional d. Winnings ® — 4. Which oftesemployeebenefis sujet fal at 3 rings nets tori nde employees Regular pay ot supervisory and managerial employees 302 chapter 9 - Regular Income Tax Inclusion in Gross Income ‘e_Pringe benefits to supervisory and managertal employees ._ Regular pay of rank and file employees " 5, Allof these are items of gross income subject to regular tax except one. Select the exception. ‘2 Compensation income ’b._ Interest income from long-term bank deposits Ordinary gain on sale of properties 4, Interest on notes receivables 6. Which isan income exempt from income tax? ‘a. Income of a general professional partnership, B. Forcign divdends Taxes collected by the government 4. Income of government-owned and controlled corporations, 7, Allofthese are subject to regular income tax, except a. Professional fees bb. Wages and commissions ¢, Businessincome 4. Capital gain from the sale of real property located inthe Philippines |. Which is exempt from regular tax? a. Income from construction bb. income of qualified pension plans ‘e._ Income from merchandising or trading 4. Income from financing or leasing, item of gross income is nor subject to regular tax? ycome from foreign bank depo==> in on the sale of bonds with more than S years maturity 1 sale of damestic stocks by a security dealer gain on sale of patent pases 10. Which is not part of compensation income subjectto regular tax? 2 or'sfees Bonuses and fixed allowances ‘c. Portion of salary contributed to $SS Portion of salary used to pay salary loans 11, Which is included in the gross income subject to regular tax of a resident alien? Gross income from the sale of goods abroad 'b._ Interest income from promissory notes of resident clients Interest income from relatives abroad ‘&._ Galn from the sale of domestic stocks directly toa buyer 303, Chapter 9- Reguar Income Tax Inclusion i Gross Income chapter 9 - Regular Income Tax Inclusion in Gross income Me 20, The proceeds of life insurance received by the wife ofthe insured ts a. exempt from income tax, © part of taxable income. ee Wihhodingtax au * subject to inal tax 4. pertly exempt and pardy taxable cre te tn lng spats thane cae bara 2 tncecenn co regalar tax inudes vidends - ¢. Both aandb dens aiNethernorb come of a foreign partnership foreign sources n from a taxable estate 15, Stotement 1: All prizes earned Statement 2: Ali prizes inthe generally correct? «Both statements 1 and 2 are subject to regular tax, 2. Which isnot a reportable type of gross income? ines are subject to final tax. wwe royalties 's trom a foreign corporation ie Sate iahlies amtemece bee, Capital gains from the sale of domestic stocks through the PSE 16, Which isan item of ross income subject to regular tax? 3 Lottery winnings from abroad b, Imputed interest income Advanced rent representing security deposit for contingency which may o may not happen 4. Leasehold improvements with useful life not extending beyond the lease term 117. Which ofthe following is not subject to regular tax of a domestic corporation or resident citizen? ‘2 Deposit interest income from abroad Prize not exceeding P10,000 fromthe Philippines s. Income from abroad exempt under treaty Royalties from abroad 4. all taxpayers. income earned abroad are subject to regular tax to poration only. resident citizens and domestic corporations. b 4 alltaxpayers. 28, Which is subject to regular tax to a non-resident foreign corporation or nos resident alien not engaged in trade or business? 6. Which individual taxpayer is not subject to progressive tax? 'b, Capital gain from the sale of stocks directly to a buyer in the Philippines a NRAETB « Resident ‘Dividends from domestic corporations = nm b. Special aliens @-Reskdent cirzen 4 Noe ot these 2. Which corporat taxpayer snot able requla a? reqs teres tgncoportent wit comere ener eae ed 'b. Resident corporation d. Non-resident foreign corporatior real property capital assets in the Philippines je damiessc carpoe sxpayers shall report their income on 4. Gain from dealings in propernes abro: & aa ae ‘elther a fiscal or calendar year. d.acrop year. 305, 304 ‘Chapter @ - Regu Income Tax: Inclusion i Gross Income chapter 9 - Regular income Tax inclusion in Gross incom jons are allowed to report eon 9. Coren: a ether a fiscal year oF calendar year 150000 fever: d acropye 3 stocks through the PSE 400,000 lincome to bereported by Mr. Lelng in ross nome. ¢P1026,000 * a Pazeato b Git e.Amounts received by the insured in excess of premiums paid Compensation for perso P40 11, wie ofthese sujet ther benefits 2000 and Pag-Ibig contributions 20,000 payments 50.000 Deductions for withholding tax 60,000 ompu smpensation it in the annual income 12. If not covered by the substituted fling system, employed individual taxpayers & 7 ste the compensation income to be reported in the annual tax stare og ome we p40,000 .P380900 Abceon SEE snd ernest, ». ¥330,000 4.P390,000 resigned in 2015 after 12 years of service. S 3 falowing income 13, Corporations and individuals engaged in business or in the exercise of, * — Yeas cfserve. Ste athe profession are required to repo ye year: net of P80,000 withholding tax, P20,000 SSS, 000 Philhealth and P40,000 13 month pay P 40,000 Separation pay 1,000,000 Compute the gross income to progressive (regular) tax. a. P1.480,000 560,000, by the need to save from total income tax b P1'560,000 «480,000 ‘may be restated by the BIR 4. niga Corporation is engaged in the sales of goods. it reported the following. summarized financial statements during the eat: an associated enterprise to the controling individual of a holding ‘sien 3,500,000 @ Anassociate of iary in the, Less: cost of sales 2.000.000 & Teparentconpany EP Pisoo 000 200.000 i 20,000 we aroup 10.000 Fr7e0000 ed the following income in 2015: lesa sien Pzaocoa 4000 P 800,000 200,000 Gain from redemption ofsharesin amutual fund 10¢ 000 306 jor income Tax Incusion in Gross Income crater 9 Rep ol gossncome saeco regula Compa eO ee Phe0O & byro000 been 9 sa dmenicoperaton eared the olomng nomen 214 / service ees PE oS meres “I 40,000 1 te ne 80,000 30,000 Royalties ~ franchise ‘compute the total gross Income subject to regular Income tax 2 7970,000 .P800,000, 7860.00 44,700,000 st recy Ine isa resident foreign corporation, compute the gross income subjety regular tax a. 520,000 «.P400,000 . P480,000 4.440.000 “Andres leases a building toa cient. During the year. he received the folowing remittance from the lessee lewithholding tax P 1,900,000 Rental, net ofS ‘building $0,000 ed 200,000 P 30,000 70,000 Reimbursements for client expenses 40,000 Reimbursement for out-of-pocket expenses 10,000 How much wil be incuded in Crokts gots Income for regular inom tt a P150,000

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