AE-26 INCOME TAXATION

PRELIM EXAMINATION

I. General Principles. Write the letter of the correct answer. Explain briefly the main concept why it
is your chosen answer.

1. Which of the following statements is not correct?

a) Taxes may be imposed to raise revenues or to provide disincentives to certain activities
within the state;
b) The state can have the power of taxation even if the Constitution does not expressly give it
the power to tax;
c) For the exercise of the power of taxation, the state can tax anything at any time;
d) The provisions of taxation in the Philippine Constitution are grants of power and not
limitations on taxing powers.

Answer:
Why: ________________________________________________________

2. A religious order, a lessee of a piece of land, constructed a seminary and church on a portion
of the land. On the part of the land not used as seminary and church, it constructed a one-
story building that it sub-leased to private individuals selling religious materials, food and
refreshments. The rent income is used to finance teaching at the seminary.
Statement 1. The rent income of the religious order is subject to income tax;
Statement 2. The exemption from taxation provided in the Philippine Constitution
prohibits the imposition of any tax on the religious order.

a) True, true;
b) False, false;
c) True, false;
d) False, true.

Answer:
Why: ________________________________________________________

3. A non-profit, non-stock educational corporation earned interest on its bank deposits, on

which: Its information return filed with the Bureau of Internal Revenue carried the item, there
is a certification from the depositary bank of the amount of the interest on which there was no
withholding income tax; and there is a certification from the corporation on the utilization of
the income, or the use to which it is intended.
 Statement 1. If is a compliance with the documentation for the exemption, hence, there is
no income tax on the interest income;
 Statement 2. Even without the documentation, the income is still exempt from income tax
pursuant to the provision of the Philippine Constitution, if it can be shown that the
income was used actually, directly and exclusively for the purpose for which the
corporation was organized.
a) True, true;
b) False, false;
c) True, false;
d) False, true.
Answer:
Why: ________________________________________________________
4. In case of conflict between tax laws and generally accepted accounting principles (GAAP):
a) Both tax laws and GAAP shall be enforced;
b) GAAP shall prevail over tax laws;
c) Tax laws shall prevail over GAAP-
d) The issue shall be resolved by the courts

Answer:
Why: ________________________________________________________

5. The following are similarities of the inherent power of taxation, eminent domain, and police
power, except one:
a) Are necessary attributes of sovereignty;
b) Interfere with private rights and property;
c) Affect all persons or the public;
d) Are legislative in implementation.

Answer:
Why: ________________________________________________________

6. Which statement refers to police power as distinguished from taxation?

a) It can only be imposed on specific property or properties;
b) The amount imposed depends on whether the activity is useful or not;
c) It involves the taking of property by the government;
d) The amount imposed has no limit.

Answer:
Why: ________________________________________________________

7. Which of the following is not an example of excise tax:

a) Transfer tax;
b) Sales tax;
c) Real property tax;
d) Income tax.

Answer:
Why: ________________________________________________________

8. Value-added tax is an example of:

a) Graduated tax;
b) Progressive tax;
c) Regressive tax;
d) Proportional tax.

Answer:
Why: ________________________________________________________

9. Statement 1. The power of taxation is inherent in sovereignty being essential to the

existence of every government. Hence even if not mentioned in the Constitution the state
can still exercise the power.
Statement 2. It is essentially a legislative function. Even in the absence of any
constitutional provision, taxation power falls to Congress as part of the general power of law-
making
a. True, true;
b. False, false;
c. True, false;
d. False, true.

10. Which of the following is not a scheme of shifting the incidence of taxation?
 a. The manufacturer transfers the tax to the consumer by adding the tax to the selling price
of the goods sold;
b. The purchaser asks for a discount or refuses to buy at regular prices unless it is reduced
by the amount equal to the tax he will pay;
c. Changing the terms of the sale like FOB shipping point in the Philippines to FOB
destination abroad, so that the title passes abroad instead of in the Philippines;
d. The manufacturer transfers the sales tax to the distributor, then in turn to the wholesaler,
in turn to the retailer and finally to the consumer.

11. Which of the following statements is not correct?

a. An inherent limitation of taxation may be disregarded by the application of a
constitutional limitation;
b. The property of an educational institution operated by a religious order is exempt from
property tax, but its income is subject to income tax;
c. The prohibition of delegation by the state of the power of taxation will still allow the
Bureau of Internal Revenue to modify the rules on time for filing of returns and payment
of taxes;
d. The power of taxation is shared by the legislative and executive departments of
government.

Answer:
Why: ________________________________________________________

12. Quarantina enterprises are exempt from certain taxes for a certain period of time, that are
otherwise applicable to other enterprises. Which of the following statements is wrong?
a. This violates the constitutional requirement of rule of uniformity in taxation;
b. This is a sound tax incentive for development of the national economy;
c. This will provide employment opportunities;
d. This will not involve unconstitutional delegation of the power of taxation even as certain
government agencies, other than the Congress of the Philippines, will determine who
qualify as pioneer enterprises.
Answer:
Why: ________________________________________________________

13. The widow of your best friend has just been paid P1,000,000 on account of the life insurance
policy of the deceased husband: She asks you whether she must declare the amount for
income tax purposes or for estate tax purposes.
 1st advice: The proceeds of life insurance paid to the death of the insured are exempt
from income tax and need not be declared for income tax purposes;
 2nd advice: The proceeds of life insurance would have to be declared for estate tax
purposes if the designation of the beneficiary was irrevocable, otherwise it need
not be declared.

a. Both advices are correct;

b. 1st advice correct; 2nd advice wrong;
c. Both advises are wrong;
d. 1st advice wrong, 2nd advice correct.

Answer:
Why: ________________________________________________________

14. Mr. Cruz was retired by his employer corporation in 2018 and paid P1,000,000 as a
retirement gratuity without any deduction for withholding tax. The corporation became
bankrupt in 2019, Can the BIR subjecthe P1,000,000 retirement gratuity to income tax?

 1st answer: Yes, if the retirement gratuity was paid based on a reasonable pension plan
where Mr. Cruz was 50 years old and has served the corporation;
 2nd answer: No, if Mr. Cruz was forced by the corporation to retire.

a. Both answers are wrong;

b. Both answers are correct;
c. 1st answer is correct, 2nd answer is wrong;
 d. 1st answer is wrong, 2nd answer is correct.
Answer:
Why: ________________________________________________________

15. Mr. Z is the chief accountant of a very successful marketing corporation, At the age of forty-
five years, and having served the company for fifteen years, he retired from the corporation
and received a retirement pay of P1,500,000 from a funded plan registered with the Bureau of
Internal Revenue. For making a very significant contribution to the success of the
corporation, he received a gratuity of P1,000,000 from the general fund of the corporation.
o Statement 1. The retirement pay received is taxable income because he had not yet
reached the age of sixty at the time of retirement;
o Statement 2. The gratuity of P1,000,000 is not taxable income because it is a gift.

a) True, true;
b) False, false;
c) True, false;
d) False, true.

Answer:
Why: ________________________________________________________

16. If an individual performs services for a creditor who, in consideration there of.cancels the
debt, the cancellation of indebtedness may amount:
a. To a gift;
b. To a capital contribution;
c. To a donation inter vivos;
d. To a payment of income.

17. Mr. Covid, an executive of a company, owed his employer P10, 000. For a job well done, his
employer condoned his indebted ticket for travel abroad worth P10,000, and travel expenses
of P20, 000. Which statement is wrong?

a. The condonation of indebtedness did not result in income to Mr. Covid because it is a
gift;
b. The cost of the round trip ticket is fringe benefit to Mr. Covid, and not taxable income of
him because he is a managerial employee so that the employer must have paid a fringe
benefit tax on it,
c. The travel expenses is fringe benefit to Mr. Covid, and not taxable income to him
because the employer must have paid a fringe benefit tax on it;
d. All the amounts given to Mr. Covid are taxable income to him.

Answer:
Why: ________________________________________________________

18. ABC Corporation took two key men insurance on the life of its President, Mr. X. In one
policy, the beneficiary is the corporation to compensate it for its expected loss in case of
death of its president. The other policy designates Mr. X's wife as its irrevocable beneficiary.
Question 1 - Are the insurance premiums paid by X corporation in both policies deductible?
Question 2 - Will the insurance proceeds be treated as income subject to tax by the
corporation and by the wife?

a) Yes to 1st and No to 2nd questions;

b) Yes to both questions;
c) No to 1st question and Yes to 2nd question;
d) No to both questions.
Answer:
Why: ________________________________________________________

19. Statement 1. There can be a deduction from gross income for premium payments on
hospitalization and health insurance for the year, even as it is a non- business expense, against
gross compensation income or against income from business.
 Statement 2. There can be no deduction for premium payments on hospitalization and
health insurance.
a. The first statement is correct while the second statement is wrong:
b. The second statement is correct while the firs statement is wrong;
c. Both statements are correct;
d. Both statements are wrong

Answer:
Why: ________________________________________________________

20. Y Co. issued preferred shares with the following features: Non-voting, entitled to dividend
regardless of income or loss for the year, to be paid ahead of common shares in the event of a
dissolution, and Y Co. had the option to redeem the shares.
 Statement 1. The payment of dividend is interest payment by Y Co., deductible from its
gross income;
 Statement 2. The payment of dividend is income distribution and is not deductible from
gross income.
a) True, true;
b) False, false;
c) True, false;
d) False, true.

II. Problems. Show your solutions.

No. 1
Mr. Covid had the following data in a calendar year.
Gross sales from self-employment P2,000,000
Interest on Philippine currency bank deposit 10,000
Capital gain on sale of land in the Philippines
(selling price of P5,000, 000) 1,000,000
Capital gain on sale of shares of stock of a domestic
Corporation not listed and traded in a local stock exchange 110,000
Deductible expenses and losses from income from self-employment 1,100,000
His income tax expenses would have been:

Compute for Taxable Income and Income Tax

Case A: Resident Citizen
Case B: Non Resident Citizen
Case C: Resident Alien
Case D: Non-Resident Alien

No. 2:
Mr. Covid is a Filipino US OFW,he returned to the Philippines on June 5, 2019 to reside permanently in
the Philippines. He then managed a business in the Philippines starting August 2019. Mrs. Covid is in the
practice of profession, and Mr. Covidnd Mrs. Covid had gross rent income and expenses related to it.
From the data:
Foreign Salary(January to June 29) 3,000,000
Income from sale of US resources (July 1 to August 300,000
31)
Gross sales of Mr. Covid from business 4,000.000
Gross receipts of Mrs. Covid from practice of 300,000
profession
Gross rent income (gross receipts) 1,000,000
Cost and expenses, business of Mr. Covid 2,100,000
Cost and expenses, profession of Mrs. Covid 120,000
Expenses on the rental property 750,000
Income tax withheld, Mrs. Covid 5,000

Compute for the Taxable Income and Tax Due of Mr.A and Mrs A.
No. 3:

A motor vehicle accident involved ABZ Bus Co. and a private car of Mr. Covid resulting in the
death of Mrs. Covid, physical injuries to Mr. Covid, loss of earnings of Mr. Covid for a month,
and total loss of the car of Mr. Covid. From a court litigation, Mr. Covid received damages, as
follows: P500,000 for the death of the wife, P80,000 for his physical injuries, P50,000 for lost
eamings during the period under treatment, and P500,000 for the loss of the car that he bought for
P360,00 and had a value of P500,000 at the time of loss.

How much is taxable?

No. 4:

Mr. Covid bought a 2,000 square meter land at a cost of P500, 000. He leased the land to Mr.
Quarantine at an annual rental of P40, 000. The term of the contract of lease is 15 years. The
contract of lease provides that Mr. Quarantine will construct a building on the land and the
building will belong to the lessor at the end of the term of the lease or at the termination of the
lease. The building was constructed at a total cost of P400,000 and has an estimated useful life of
20 years which is the basis of a straight-line method of depreciation.

a) Assuming that Mr. Covid. Covid will spread his income over the term of the contract of
lease, how much is the annual income of Mr. Covid. Covid?

b) Assuming the contract of lease was terminated after the tenth (10th) year or at the beginning
of the eleventh (11th) year due to the fault of the lessee, how much is the annual income of
Mr. Covid. Covid in the eleventh (11th) year?

No. 5:

Ms. Quarantine, lessee made the payments to a lessor in 2019:

 Advance rental, applicable to two years P 480,000
 Security deposit 400,000
and made leasehold improvements on January 2, 2019 that will belong to the lessor when the
lease
expires, with the following data:

 Cost of leasehold improvement 2,000,000

 25 years Estimated useful life
 Remaining term of the lease 10 years
a. How does a lessor recognize income from a prepaid rent of the lessee?
b. How does a lessor recognize income from a security deposit of the lessee?
c. How does a lessor recognize income from leasehold improvements made by the lessee?
d. From the problem, how much was the income of the lessor in 2019?

No. 6:
The following were receive by A resident citizen:
Cash dividend from a domestic corporation P 100,000
Property dividend from a resident corporation,
fair market value of property received 50,000

Common stock dividend from a resident corporation with

authorized capital stock of common and preferred, out-
standing is common only, fair market value of dividend 150,000

Preferred stock dividend from a resident corporation with

authorized capital stock of common and preferred, out-
standing is common and preferred, fair market value of
dividend 50,000
 Liquidating dividend (cost of shares was P200,000), fair
market value 300,000

What is the measure of income in a:

a) Taxable cash dividend?
b) Taxable property dividend?
c) Taxable stock dividend?
d) From the problem, how much is the total taxable dividend at the end of the year?

No. 7:
Mr. Covid, an individual had:

Refund of graduated income tax P500,000

Refund of fringe benefit tax 300,000
Refund of special assessment 50,000
Refund of donor's tax 10,000
Refund of income tax paid to a foreign country 100,000
(previously claimed as deduction)
Refund of value-added tax 60,000
Refund of city business taxes 15,000
Damages recovered for physical injuries 40,000
Damages recovered for patent infringement 300,000
Prize won in an essay contest 10,000
Bad debt recoveries:
(1) Write off in a year with a net income 10,000
of P100,000 before write off
(2) Write off in a year with a net loss of 12,000
P60,000 before write off
(3) Write off in a year with a net income 20,000
of P5,000 before write off
Cancellation of indebtedness to a friend to whom taxpayer 50,000
rendered service

How much is the income?

No. 8:

Mr. Covid, an individual had:

Interest income on trade notes receivable P30,000
Interest income from government bonds 50,000
Interest income from money market 20,000
placements
Interest income on Banko Sentral bonds 100,000
Interest income from Bank Savings Deposit 60,000

(1) How much is the interest income subject to final and how much is the final tax?
(2) How much is the interest income in the taxable income at the end of the year?

No. 9:
An enterprise had the following results of operations in five years:
Year 1 Net operating loss (P50, 000)
Year 2 Net operating income 20,000
Year 3 Net operating loss ( 10, 000)
Year 4 Net operating income 15,000
Year 5 Net operating income 30,000

How much is the taxable income:

a) Year 1
b) Year 2
c) Year 3
 d) Year 4
e) Year 5

No. 10:
From the data: A loss by fire of a warehouse where the insurance company carted away the scrap:
Cost P2,000,000
Accumulated depreciation 800,000
Insurance recovery 700,000
Loss on an embezzlement of bonded cashier, where
there is a P50,000 loss coverage by a bonding company,
and where a case is filed in court for the entire amount
of embezzlement of 150,000

On a loss by accident of a delivery equipment, with the following data:

Cost of the delivery equipment 1,500,000
Accumulated depreciation 500,000
Cost to restore to normal operating condition 250,000
Insurance recovery 180,000

How much is the deduction for total loss?

How much is the deduction for partial loss?

“Nothing is impossible. The word itself says “I’m POSSIBLE.”

Prepared by:

ARLEA O. ASENCI, CPA

Faculty

Reviewed by:

HAZELLINE F. DOMINGO, CPA

Faculty

Approved by:

NIÑO ROMYR H. SAAVEDRA, PhD

Dean