Income Taxation

REX B. BANGGAWAN, CPA, MBA

CHAPTER III: INTRODUCTION TO
INCOME TAXATION
LEARNING OBJECTIVES:
A F T E R T H I S C H A P T E R , S T U D E N T S A R E E X P E C T E D TO C O M P R E H E N D A N D
U N D E R S TA N D T H E K N O W L E D G E O N T H E F O L LO W I N G :

1 . T H E CON CEPT OF GROSS I N COME

2 . T H E T YPES OF I N COME TA XPAYERS
3. T H E G EN ERA L RULES I N I N COME TA XAT I ON
4 . T H E I N COME TA X SI T US RULES
The Concept of Gross Income
What is Gross Income?
Gross Income is broadly defined as any inflow of wealth to the taxpayer from whatever source, legal or illegal, that increases net
worth.

What is Income?
Income is regarded as the best measure of taxpayers ability to pay tax. It is an excellent object of taxation in the
allocation of government costs.
The tax concept of income is simply referred to as “Gross Income” under the NICR. A taxable items of income is referred to
as an items of gross income.

• Elements of Gross Income

• It is a returns on capital that increases net worth
• It is a realized benefit
• It is not exempted by law, contract, or treaty
• Return on Capital
Capital means any wealth or property. Gross income is a return on wealth property that increases the taxpayer’s
net worth.

Illustration of Return on Capital

XYZ purchased goods for P300,000 and sold them for P500,000. The P500,000 consideration analyzed as follows:

Selling price - P 500,000 Total Return

Cost price - 300,000 Return of Capital
Gross Income - P 200,000 Return on Capital

Capital items deemed with infinite value

There are capital items that have infinite value and incapable of pecuniary valuation. Anything received as
compensation for their loss is deemed a return capital.

Examples:
 Life – the value of life is immeasurable by money. Under Sec. 32 of the NIRC, the proceeds of life insurance
policies paid to the heirs on beneficiaries upon death of the insured are exempt from income tax.
 Health – any consideration received in consideration for the loss of health such as compensation for personal
injuries is deemed a return of capital.
 Human Reputation - the value of one’s reputation cannot be measured financially. Any indemnity received as
compensation for its impairment is deemed a return of capital, exempt from income tax.
Examples: Oral defamation or slander, Alienation of affection, Breach of promise to marry
The Types of Income Taxpayer
The following are types of income taxpayers:

Individuals
1. Citizens
a. Resident Citizen
b. Non-resident

2. Aliens
a. Resident Alien
b. Non-resident alien
a. Engaged in trade or business
b. Not engaged in trade or business

Corporation
1. Domestic corporation
2. Foreign corporation
a. Resident foreign corporation
b. Non-resident foreign corporation
• Classification of Citizens
• Resident Citizen – A Filipino citizen is residing in the Philippines.
• Non-resident citizen includes:
• Classification of Alien
• Resident Alien – An individual who is residing in the Philippines but is not a citizen
thereof.
• Non-resident alien – an individual who is not residing in the Philippines and who is not a
citizen thereof.
• Non-resident alien engaged in business (NRA-ETB) - aliens stayed in the Philippines for an
aggregate period of more than 180 days during the year.
• Non-resident aliens not engaged in business (NRA-NETB)
• Corporate Income Taxpayers
The term ‘corporation’ shall include partnerships, no matter how created or organized, joint-stockcompanies, joint
accounts, association, or insurance companies.

• Domestic Corporation
A domestic corporation is a corporation that is organized in accordance with Philippine laws.
• Foreign Corporation
A foreign corporation is one organized under a foreign law.

• Types of Foreign Corporation

• Other Corporate Taxpayers
• Partnership
A partnership is a business organization owned by two or more persons who contribute their industry or resources
to a common fund for the purpose of dividing the profits from the venture.
Types of Partnership
• General professional partnership (GPP)
A GPP is a partnership formed for the exercise of a common profession. All partners must belong to the
same profession.
A GPP is not treated as a corporation and is not a taxable entity. It is exempt from income tax, but the
partners are taxable in their individual capacity with respect to their share in the income of the partnership.

• Business partnership
A business partnership is one found for profit. It is taxable as a corporation.
General Rules in Income Taxation

• Individual Taxpayers & Corporate Taxpayers

• The Residency and Citizenship Rule

• Basis of the Extraterritorial Taxation

• The Issue of International Double Taxation
Situs of Income
A situs of income is the place of taxation of income. It is the jurisdiction that has the authority to impose tax upon the
income.

Situs is important in determining whether or not an income is taxable in the Philippines. Situs is particularly important
to taxpayers taxable only on income within. However, it is also important to taxpayers taxable on global income for
purposes of the computation of the foreign tax credit.

INCOM SITUS RULES

Types of income Place of taxation (situs)
1. Interest income Debtor’s residence
2. Royalties Where the intangible is employed
3. Rent income Location of the property
4. Service income Place where the service is rendered
Illustration No. 1.
A taxpayer had the following income:
Interest income from deposits in a foreign bank P3,000,000
Interest from domestic bonds 500,000
Royalties from books published in the Philippines 1,000,000
Rent income from properties abroad 1,500,000
Professional fees for services rendered in the Philippines to non-resident clients4,000,000
Suggested solution:
Within Without WorldTotal
Interest on foreign deposits P - P3,000,000 P3,000,000
Interest from domestic bonds 500,000 - 500,000
Royalties from books in the Philippines 1,000,000 - 1,000,000
Rent income on foreign properties 1,500,000 1,500,000
Professional fees 4,000,000 4,000,000
------------ ------------ -------------
Total P5,500,000 P4,500,000 P10,000,000
============================
Resident citizen or domestic corporation taxpayers would be tax on the world income while other taxpayers
would be taxable only on the income from within the Philippines.
OTHER INCOME SITUS RULES
A. Gain on sale of properties:
1. Personal property:
 Domestic securities- presumed earned within the Philippines.
 Other personal properties –earned in the place where the property is sold.
2. Real property – earned where the property located.

Illustration No. 2.
A taxpayer had the following income:
Gain on sale of domestic stocks P2,000,000
Gain on sale of foreign bonds 1,000,000
Gain on sale of commercial lot in Pangasinan 5,000,000
Gain on sale of car in Canada 2,000,000
Gain on sale of machineries in Dagupan City 2,500,000
Interest income on foreign bonds 500,000
Dividends on domestic stock 1,500,000
SUGGESTED SOLUTION.

Within Without

Gain on sale of domestic stocks P2,000,000

Gain on sale of foreign bonds P1,000,000
Gain on sale of commercial lot 5,000,000
Gain of sale on car 2,000,000
Gain on sale of machineries 2,500,000
Interest on foreign bonds 500,000
Dividends on domestic stocks 1,500,000
B. Dividend Income From :
1. Domestic corporation- presumed earned within.
2. Foreign Corporation:
a) Resident Foreign Corporation- depends on the pre-dominance test.
The pre-dominate test
If the ratio of the Philippine gross income over the world gross income of the resident foreign corporation in the
three-year period preceding the year of dividend declaration is:
 At least 50%, the portion of the dividend corresponding to the Philippine gross income ratio is 1,000,000
 Less than 50%, the entire dividends received is earned abroad.
b) Non- resident foreign corporation – earned abroad.

Illustration No. 3.
In 2019, Herman received a P4,000,000 dividend income from XYZ Corporation. XYZ had the following gross income from 2016 through 2018:
2016 2017 2018 Total
Philippines P1,000,000 P2,000,000 P3,000,000 P6,000,000
Abroad 2,000,000 1,000,000 1,000,000 4,000,000
Total P3,000,000 P3,000,000 P4,000,000 P10,000,000
========= ========= ========= ===========

IF XYZ CORPORATION is a :
a. Domestic Corporation- the entireP4,000,000 is earned within.
b. Non- Resident Foreign Corporation- The entire P4,000,000 is earned abroad.
c. Resident Foreign Corporation – theP4,000,000 dividend shall be split.
Gross Income Ratio = P6,000,000/P10,000,000 = 60%
Earned with the Philippines( 60% Xp4,000,000 ) p2,400,000
Earned without the Philippines ( 40% x P4,000,000 ) 1,600,000
Total dividends P4,000,000
==========
END