MODULE 2

UNIT 2
SPECIAL INCOME TAXATION

What are the different kinds of income taxation schemes?

The following are the different kinds of income taxation schemes:
1. Final Income Taxation
2. Capital Gains Taxation
3. Regular Income Taxation

I. Final Income Taxation

What is final income taxation?

This is the imposition of tax on certain passive income wherein full taxes are withheld by the
income payor who is required by law to remit them to the government. The taxpayer
receives the income net of tax and there would be no need for him to file an income tax
return to report the same.

The final withholding system is inherently territorial. It applies only to certain passive income
earned from sources within the Philippines. Hence, all items of income earned from sources
abroad, passive or active, are subject to tax under the general scope of the regular
income tax.

What is the rationale of Final Income Taxation?

It is convenient for both the taxpayer and the government. It relieves the taxpayer of
having to file an income tax return. It is also convenient for the government because the
payor has the obligation to withhold and remit it on its behalf.

Final tax is tax on certain passive income. What is passive income?

Passive income is earned with very minimal involvement from the taxpayer in the earning
process. It is generally irregular in timing and amount.

Are all passive income subject to final tax?

Not all passive income is subject to final tax. Only the following are subject to final tax. The
rest are subject to regular income tax:
1. Interest or yield from bank deposits or deposit substitutes.
2. Domestic dividends, in general
3. Dividend income from a Real Estate Investment Trust
4. Share in the net income of a business partnership, taxable associations, joint
ventures, joint accounts, or co-ownership
5. Royalties, in general
6. Prizes exceeding P10,000
7. Winnings
8. Informer’s tax reward
9. Interest income on tax-free corporate covenant bonds.
What is the tax rate on interest income from bank deposits or deposit substitutes?
Interest income from local currency bank deposits are subject to final tax as follows:

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 Recipient
Source of interest income Individuals Corporations
Short term deposit
(deposited for less than 5 20% 20%
years)
Long term deposit
(deposited for 5 years and Exempt 20%
above)

If the deposit of an individual taxpayer is pre-terminated before 5 years, any previously

untaxed or exempted interest income will be subjected to the following final taxes upon
pre-termination:
Holding period Final tax
Less than 3 years 20%
3 years to less than 4 years 12%
4 years to less than 5 years 5%
5 years or more 0%

Interest income from foreign currency deposit with foreign currency depositary banks are
subject to the following final tax:
Taxpayer Individuals Corporations
Residents 15% 15%
Non-residents Exempt Exempt
• For joint accounts on forex deposits, if the bank account is jointly in the name of a non-
resident and a resident taxpayer, 50% of the interest shall be exempt while the other
50% shall be subject to the 15% final tax.

What are dividends?

Dividends are distributions made by a corporation to its shareholders out of its earnings or
profits and payable to its shareholders, whether in money or in other property. As a rule,
dividends are taxable however, in the case of stock dividends, it is exempt until it is sold
and the income is realized.

What are the tax rates for dividend income?

The following table shows the tax rates for dividend income:
Recipient of dividends
Source of dividends Individual Corporation
Domestic corporation 10% final tax Exempt
Foreign corporation Regular tax Regular tax

Are all dividends subject to final tax?

No, not all dividends are subject to final tax. The following are exempt:
1. Inter-corporate dividends – These are dividends declared by a corporation to
another corporation owned by it which in turn distributes the same to its
shareholders. The reason for the exemption is to avoid double taxation.
2. Dividends from cooperatives – These are exempt by express provision of the law.

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 What is the rate of final tax on shares in the net income of REIT, business partnerships,
taxable associations, joint ventures, and co-ownership?
The rate of final tax of these corporate taxpayers is 10%

What is royalty income?

This is payment received for the use of property, patent, copyrighted work or trademark.
There are two kinds of royalty income, passive and active.

What is passive royalty as distinguished from active royalty?

When royalties accrues from an undertaking where the taxpayer has active involvement, it
is an active income. Otherwise, it is a passive royalty income. Passive royalty income is
subject to final tax. Active income is subject to regular income tax.

What are the rates of final tax for passive royalty income?
The following are the final tax rates for passive royalty income:
Recipient
Source of passive royalties Individuals Corporations
Books, literary works and 10% final tax 20% final tax
musical compositions
Other sources 20% final tax 20% final tax

What are the tax rates for prizes won at contests?

Prizes may be exempt from tax or subject to either final or regular income tax. The
following are exempt from tax:
1. Prizes received by a recipient without any effort on his part to join a contest.
2. Prizes from sports competitions that are sanctioned by their respective national sport
organization.
• To be exempted, the recipient must have been selected without any action on his part
to enter the contest and the recipient is not required to render substantial future
services as a condition to receiving the price or reward.

Taxable prizes may either be subject to final or regular income tax depending on the
amount:
Recipient
Amount of taxable prize Individual Corporations
Prizes exceeding P10,000 20% final tax Regular tax
Prizes not exceeding P10,000 Regular tax Regular tax

What are the tax rates for winnings?

The following are the tax rates for winnings:
Recipient
Types of winnings Individuals Corporations
PCSO/lotto winnings not Exempt Exempt
exceeding P10,000
PCSO/lotto winnings 20% final tax 20% final tax
exceeding P10,000
Other winnings, in general 20% final tax Regular tax

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 What is a tax informer’s reward?
It is a cash reward given to any person instrumental in the discovery of violations of the
NIRC or discovery and seizure of smuggled goods. The tax informer’s reward is subject to
10% final tax.

What are the requisites to be entitled to a tax informer’s reward?

The following are the requisites:
1. Definite sworn information which is not yet in the possession of the BIR
2. The information furnished lead to the discovery of fraud upon internal revenue laws or
provisions thereof.
3. Enforcement results in recovery of revenues, surcharges, and fees and/or conviction of
the guilty party or imposition of any fine or penalty.
4. The informer must not be a BIR official or employee, other public official or employee or
a relative within the 6th degree of consanguinity of those BIR or public officials or
employee.

How much is the tax informer’s reward?

The reward is whichever is lower of the following:
1. 10% of revenues, surcharges, or fees recovered and or fine or penalty imposed and
collected or
2. P1,000,000.

What is the tax rate for tax-free corporate covenant bonds?

Interest income of non-resident aliens, citizens or residents of the Philippines on bonds,
mortgages, deeds of trust or other similar obligations of domestic or resident foreign
corporations with tax-free or tax reduction provision where the obligor shoulders in whole or
in part any tax on the interest shall be subject to final withholding tax of 30%

For Non-resident persons not engaged in trade or business who receives income, whether
passive or active, are subject to the following final tax:
NRA-NETB NRFC
General final tax rate 25% 30%
Exceptions:
1. Capital gain on sale 15% capital gains tax 15% capital gains tax
of domestic stocks
directly to buyer
2. Rentals on 25% of rentals 25% of rentals
cinematographic
films and similar works
3. Rentals of vessels 25% of rentals 4.5% of rentals
4. Rentals of aircrafts, 25% of rentals 7.5% of rentals
machineries, and
other equipment
5. Interest income under Exempt Exempt
the foreign currency
deposit system
6. Interest on foreign N/A 20%
loans

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 7. Dividend income 25% 15% if tax sparing rule is
applicable
8. Tax on corporate 30% 30%
bonds

Are there entities exempt from final income tax?

The following are exempt from final income tax:
1. Foreign governments and foreign government owned and controlled corporations
2. International missions or organization with tax immunity
3. General professional partnership
4. Qualified employee trust fund

II. Capital Gains Taxation

What is Capital Gains Taxation (CGT)?

CGT is the imposition of tax on gains on sale of certain capital assets.

What is a capital asset?

Capital asset is any asset which is not used in the taxpayer’s business. It is distinguished
from ordinary asset which is used in the trade or business of the taxpayer such as
inventories and real properties sold by the taxpayer in the ordinary course of his business
except financial and intangible assets (patent, copyrights, franchise rights) which are
considered capital assets.

How do we determine whether an asset is a capital or ordinary asset?

The classification of assets as ordinary or capital asset does not depend upon the nature of
the property but upon the nature of the taxpayer’s business and its usage by the business.
The following are the rules on asset classification:
1. A property purchased for future use in business is an ordinary asset even though this
purpose is later thwarted beyond the taxpayer’s control.
2. Discontinuance of the active use of the property does not change its character
previously established as a business property.
3. Real properties used, being used, or have been previously used in trade of the
taxpayer shall be considered ordinary assets.
4. Properties classified as ordinary assets for being used in business by a taxpayer not
engaged in the real estate business are automatically converted to capital assets
upon showing of proof that the same have not been used in business for more than
2 years prior to the consummation of the taxable transaction involving such
property.
5. A depreciable asset is an ordinary asset even if it is fully depreciated or there is a
failure to take depreciation during the period of ownership.
6. Real properties used by an exempt corporation in its exempt operations are
considered capital assets. Exempt corporations are not business.
7. The classification of property transferred by sale, barter or exchange, inheritance,
donation, or declaration of property dividends shall depend on whether or not the
acquirer uses it in business.
8. For real properties subject of involuntary transfer such as expropriation and
foreclosure sale, the involuntariness of such sale shall have no effect on the
classification of such real property.

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 9. Change in business from real estate to non-real estate business shall not change the
classification of ordinary assets previously held.

Are all gains from sale, exchange and other disposition of capital assets subject to CGT?
Not all gains on sale, exchange and other disposition of capital assets are subject to CGT.
As a rule, they are subject to regular income tax. There are only two types of capital gains
subject to CGT:
1. Capital gains on the sale of domestic stocks sold directly to buyer (15%) (For foreign
corporation, 5% for net gain up to P100,000 and 10% for gain above P100,000.
2. Capital gains on the sale of real properties not used in business (6%)

What other dispositions of capital assets are subject to CGT?

The following dispositions are subject to CGT:
1. Foreclosure of property in settlement of debt
2. Pacto de retro sales
3. Conditional sales
4. Voluntary buy back of shares by the issuing corporation.
But the following disposition is not subject to CGT:
1. Issuance of stocks by a corporation – because it is considered a financing
transaction rather than a sale transaction.
2. Exchange of stocks for services – because there is no gain or loss can be imputed as
it involves payment of expense in kind.
3. Redemption of shares in a mutual fund – because it is exempted by the NIRC.
4. Worthlessness of stocks – because it is considered a capital loss subject to the rules
on regular income taxation.
5. Redemption of stocks for cancellation by the issuing corporation – because any
gain from the redemption is subject to regular income tax.
6. Gratuitous transfer of stocks – because it is subject to transfer tax.

What is the tax rate for the disposition of domestic stocks?

The tax rate depends on how the stocks were disposed of:
1. If the stocks which are classified as capital assets were sold through the Philippine
Stocks Exchange (PSE), it will be subject to a stock transaction tax of 60% of 1% of
the SELLING PRICE.
2. If the stocks are classified as ordinary assets, the gain/loss will be subject to the rules
of regular income tax.
3. If the stocks are classified as capital assets and were sold directly to the buyer, the
tax is 15% on the NET GAIN. If the taxpayer is a foreign corporation, the net gain up
to P100,000 is subject to 5% CGT and the excess above P100,000 is subject to 10%
CGT.
• Net gain is determined as follows:
Selling price P xxxx
Less: Basis of stocks disposed P xxxx
Selling expenses xxxx
Documentary stamp tax xxxx xxxx
Net capital gain (loss) P xxxx

In the computation of CGT on sale, exchange or disposition of domestic stocks directly to

buyer, what does selling price mean?

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 Selling price shall mean:
1. In case of cash sale, the total consideration received per deed of sale
2. If total consideration is paid partly in money and partly in property, the sum of
money and fair value of property received
3. In case of exchanges, the fair value of the property received.

In the computation of CGT on sale, exchange or disposition of domestic stocks directly to

buyer, what is the tax basis of stocks?
1. If acquired by purchase, tax basis is the cost of the property which will be
determined by the following methods in descending order of priority:
a. Specific identification, it the shares can be specifically identified
b. Moving average method, if books of accounts are maintained by the seller
where transaction of every particular stock is recorded.
c. First-in, first out method, if the stocks cannot be specifically identified.
2. If acquired by devise, bequest, or inheritance, the tax basis is the fair value at the
time of death of the decedent.
3. If acquired by gift, the tax basis is the lower of the fair market value at the time of
gift and the basis in the hands of the donor or the last preceding owner by whom it
was not acquired by gift.
4. If acquired for inadequate consideration, the tax basis is the amount paid by the
transferee for the property.
5. If acquired under tax-free exchanges, the tax basis is the substituted basis of the
stocks.

When is the deadline for filing the CGT return?

The CGT return shall be filed within 30 days after each sale, exchange and other disposition
of stocks. If the tax is qualified for payment under the installment method, the tax is due
within 30 days after each installment. The taxpayer is also required to file an annualized
CGT return. The CGT paid per sale/disposition will be deducted from the annual CGT due
and the difference will be the tax payable/refundable.

Illustration:
Date Stocks Selling Cost
& Capital gain Capital gains
price
(loss) Expenses tax
1/12 Preferred stock P210,000 P100,000
P110,000 P16,500
3/18 Common stocks 80,000
( 10,000) 90,000
5/14 Stock rights 160,000
90,000 70,000 13,500
6/17 Stock option 80,000
( 20,000) 100,000
Total P170,000 P30,000
The final capital gains tax payable (refundable) would be:

Annual net capital gain P170,000

Multiply by CGT rate ____15% P25,500
Less: Total transactional capital gains taxes paid 30,000
Capital gains tax payable (refundable) (P 4,500)

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 Can the CGT be paid on installment?
When domestic stock is sold in installments, the capital gains tax may also be paid in
installments if the:
1. Selling price exceeds P1,000; and
2. Initial payment does not exceed 25% of the selling price.

What is the formula for the computation of the installment payment of the CGT?
The CGT payable every installment shall be computes as: Collection/Contract price x CGT.

What is a wash sale?

Wash sale of securities is deemed to occur when within 30 days before and 30 days after
the losing sale of securities, the taxpayer acquired or entered into a contract or option to
acquire the same or substantially identical securities. Capital losses on wash sales by non-
dealers in securities are not deductible against capital gains because they are effectively
unrealized. For example, X had the following transaction in the stocks of Y Corporation:
Date Transaction Shares Price Cost
January 4 Purchase 10,000 P20.00 P200,000
February 28 Sale 10,000 18.00 180,000
March 4 Purchase 12,000 16.00 192,000

The capital gains/loss shall be computed as follows:

Selling price P180,000
Less: Cost of shares sold 200,000
Capital loss P 20,000

Since there is a full replacement cover (12,000 shares) within 61 day period (March 4), the
capital loss shall be deferred and included as part of the cost of the replacement shares.

The basis of the replacement shares purchased on March 4 shall be P212,000 (P192,000 +
20,000)

Are there exchanges that are not subject to CGT?

The following are not subject to CGT:
1. Exchange of stocks pursuant to merger or consolidation – because the transaction
merely involves a replacement of shares of stocks.
• But if the stocks are exchanged not solely for stocks but with other consideration
such as cash and other properties, the gains but not losses are recognized up to
the extent of cash and other properties received.
2. Transfer of stocks resulting in corporate control – Initial acquisition of corporate
control by not more than 5 persons is an investing transaction rather than an income
generating transaction.

Are there persons who are not liable to the 15% CGT?
The following are not liable to the 15% CGT:
1. Dealers in securities
2. Investors in shares of stocks in a mutual fund company for gains realized upon
redemption of stocks in the mutual company

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 3. All other persons, whether natural or juridical, who are specifically exempt from
national revenue taxes under existing investment incentives and other special laws
such as:
a. Foreign governments ad foreign GOCCs
b. Qualified employee trust fund.

What is the rate of CGT for the sale, exchange or other disposition of real property classified
as capital asset located in the Philippines?
The rate of tax is 6% of the selling price or the fair value, whichever is higher. Fair value is
whichever is higher between the zonal value which is the value prescribed by the
commissioner of Internal Revenue for real properties for purposes of enforcement of
internal revenue laws and fair market value as shown in the schedule of market values of
the Provincial and City Assessors.
• The 6% CGT applies even if the sale resulted to a loss.

Are there sale/exchange/disposition of real capital assets which are exempt from CGT?
The following are exempt from the CGT:
1. An individual seller of real property capital assets has the option to choose between
the 6% CGT and the regular income tax if the buyer is the government, its
instrumentalities or agencies including GOCCs.
2. The sale, exchange and other disposition of a principal residence for the
reacquisition of a new principal residence by individual taxpayers is exempt from
the 6% capital gains tax provided the following requisites are present:
a. The seller must be a citizen or resident alien.
b. The sale involves the principal residence of the seller-taxpayer.
c. The proceeds of the sale is utilized in acquiring a new principal residence.
d. The BIR is duly notified by the taxpayer of his intention to avail of the tax
exemption within 30 days of the sale.
e. The reacquisition of the new residence must be within 18 months from the date
of sale.
f. The capital gain is held in escrow in favor of the government.
g. The exemption can only be availed of once in every 10 years.
h. The historical cost or adjusted basis of the principal residence sold shall be
carried over to the new principal residence built or acquired.
3. Sale of land pursuant to the Comprehensive Agrarian Reform Program.
4. Sale of socialized housing units by the National Housing Authority.

Can the CGT be paid on installment?

Yes, if the capital asset is sold on installment, the tax can also be paid on installment if the
initial payment does not exceed 25% of the selling price.

What is the formula for the computation of the installment payment of the CGT?
The CGT payable every installment shall be computes as: Collection/Contract price x CGT.

When is the deadline for payment of the CGT?

The CGT shall be paid within 30 days from the date of sale or exchange or from the
expiration of the redemption period in the case of foreclosure sale or from receipt of every
installment in the case of an installment sale. Late filing/paying will be subject to penalties.

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