INCOME TAXATION

Rex B. Banggawan, CPA, MBA

 Topic Arrangement
• Overview of basic income tax concepts
• The income tax structure
• Gross income
• Final income taxation
• Capital gains taxation
• Regular income taxation
Overview of Basic Income Tax concepts

• Taxpayer classifications
• Accounting periods
• Accounting methods
 Taxpayers
• Individuals
– Citizens
• RC
• NRC
– Aliens
• RA
• NRA (ETB or NETB)
• Corporations
– Domestic corporation
– Foreign corporation
• RFC
• NRFC
 Accounting periods
• Calendar year
• Fiscal year
 Accounting methods
• Cash basis
• Accrual basis
• Installment basis
• Percentage of completion
• Deferred payment basis
• Crop year basis
• Spread-out method
• Outright method
 Structure of Income Taxation

Gross Income

Final Income Capital Gains Regular Income

Taxation Taxation Taxation

Gross Income XXX

Less:
Deductions (XXX)
Personal exemptions (XXX)
Taxable income XXX
 What is Gross Income?
• A Return on Capital
• A Realized Benefit
• An inflow not exempted by law
 The concept of capital
• Capital with infinite value
– Life
– Health
– Reputation /Dignity
• Capital with finite value
 Return of capital vs. Return on capital

Identify whether return on or return of capital:

1. Inventories costing P300,000 sold for
P400,000
2. P540,000 proceeds of property insurance
(Book value lost is P500,000)
3. P200,000 salaries and wages
4. P10,000 Dividend
 Recovery of lost profit vs. recovery of lost
capital
• Recovery of lost capital is a return of capital
but the recovery of lost profit is a return on
capital.

• Examples of Recovery of loss profits

– Proceeds of crop insurance
– Indemnity from patent infringement suit
– Income guarantee payments
 The Concept of Realized Benefit
• Concept of benefit = an increase in networth
• Concept of realization:
– There must be a sale or barter
– The sale involves third parties
 Analysis of realized benefit
Benefit? Realized?
Gain on sale of goods or services YES YES
Donation YES NO
Inheritance YES NO
Holding gains YES NO
Receipt of loans or agency monies NO YES
 NOTE!
• Only benefit arising from sale or barter is
taxable!
 Not Exempted by law
• Exemption may be sourced from
– The Constitution
– Law
– Contracts
 Structure of Income Taxation

Gross Income

Final Income Capital Gains Regular Income

Taxation Taxation Taxation

Gross Income XXX

Less:
Deductions (XXX)
Personal exemptions (XXX)
Taxable income XXX
 FINAL INCOME TAXATION
• Attributes:
– Withholding of tax at source
– Imposition of final taxes
– Applies to certain passive income
– Applies to taxpayers with high risk of non-
compliance:
• Non-resident alien not engaged in trade or business
• Non-resident foreign corporations
– Jurisdictional
 Certain passive income subject to FIT

• Interest
• Dividends
• Royalties
• Prizes
• Winnings
• Tax informers reward
 Interest income
• From banks only

• LCU deposit – 20%

• Long-term – exempt for individuals only

• FCU deposit – 7.5% on residents, non-

residents are exempt
 Dividends
• From domestic corporations only

• If received by individuals – 10%

• If received by corporations – exempt
 Royalties
• Passive royalties only. Active royalties is
subject to RIT.

• From books, musical compositions and literary

works – 10%
• Other passive royalties – 20%
 Prizes (Individual only)
• Without effort – exempt
• With effort – taxable
– From sports competition
• If sanctioned by the NSA, exempt
• If not sanctioned taxable
– From others, taxable
• Tax rate:
– if prize exceeds P10,000 – 20%
– If prize is P10,000 or below – subject to RIT
 Winnings (Individual only)
• Winnings in general – 20%
• Winnings from PCSO or lotto – exmept
 Tax informer’s reward
• Reward = 10% of the recovered tax
• Reward is subject to 10% final tax

• Example:
– Recovered tax = P30,000,000
– What is the tax informer’s reward?
 Structure of Income Taxation

Gross Income

Final Income Capital Gains Regular Income

Taxation Taxation Taxation

Gross Income XXX

Less:
Deductions (XXX)
Personal exemptions (XXX)
Taxable income XXX
 CAPITAL GAINS TAXATION
• Applies to certain capital gains only, namely:
– Capital gains on the sale of stocks directly to buyer
– Capital gains on the sale of real property
 What is a capital gain?
• Capital gain are gains derived from dealings in
capital assets?

• What are capital assets?

• Capital assets are any assets other than
ordinary assets.
 So what is an ordinary asset?
• Ordinary assets used in the trade or business
of the taxpayer in a productive capacity.

• Examples:
– Inventory
– Supplies
– Property, plants and equipments
 The classification rule
• The boundary between ordinary asset and
capital asset is delineated by the nature of the
taxpayer’s business
 Asset classification
Security Dealer Realty dealer Merchandiser
Stocks or bonds OA CA CA
Vacant lot CA OA CA
Accounts CA CA CA
receivables
Office equipment OA OA OA
 Tax rules on capital assets
Capital assets:
1. Domestic stocks
– Sold directly to buyer – 5% & 10% CGT
– Sold through the PSE – ½ of 1% stock transaction tax
2. Real property located in the Philippines – 6%
CGT
3. Others – subject to Regular income tax (under
dealings in properties)
 The 5% & 10% capital gains tax
• Applies to domestic stocks only such as:
– Preferred stocks
– Ordinary stocks
– Stock options
– Stock warrants
– Stock rights
 Example 1
• Mr. A sold domestic shares with P200,000 fair
value directly to buyer for P180,000. The
shares cost P150,000.

• What is the capital gains tax?

 Example 2
• Mr. B sold shares directly to buyer for
P600,000. The shares were acquired for
P450,000.

• What is the capital gains tax?

 Example 3
• Mr. C, a security dealer, sold stocks directly to
buyer at a gain of P180,000.

• What is the capital gains tax?

 5%&10% CGT Compliance
• Transactional compliance – within 30 days
from the date of sale
• Annual compliance – on or before the 15th day
of the 4th month from the end of year
 Example
• Mr. D, a realty dealer, made the following
dealings in domestic stocks in 2015:
– January 1 – P80,000 gain
– March 25 – P160,000 gain
– October 1 – P10,000 loss
– December 7 – P40,000 gain

• What is the annual capital gains tax?

 NOTE!
• The 5%-10% capital gains tax applies to all
taxpayers regardless of classification.

• This means even NRA-NETB and NRFC shall file

a capital gains tax return.
 The 6% capital gains tax
• All sales, exchange and other dispositions of
real property capital assets located in the
Philippines shall be subject to 6% tax on
whichever is higher of:
– Fair market value:
• Zonal value
• Assessed value
– Gross selling price
 Example 1
• Mr. E, a dealer of personal properties, sold a
house and lot for P5,000,000. The house and
lot had the following fair values:
– Zonal value = P6,500,000
– Appraisal value = P8,000,000
– Assessed value = P4,500,000

What is the capital gains tax?

 Example 2
• Mr. F sold his boarding house for P5,000,000.
The house has a zonal value of P6,000,000,
assessed value of P4,500,000 and cost of
P7,000,000.

• What is the capital gains tax?

 Example 3
• Mr. G’s residence was foreclosed by the bank
due to his failure to pay his P3,000,000
mortgage loan. The residence has a zonal
value of P4,000,000. The bank paid Mr. G
P1,500,000 after the auction sale.

• What is the capital gains tax?

 Scope of the 6% CGT
• Generally, all sales, exchange and other
dispositions, such as foreclosure and
expropriations sales

• Exception rules:
1. Exemption rule
2. Alternative taxation rule
 The Exemption Rule
(CGT = 0)
• Requisites:
– Sale of principal residence for the reacquisition of
another principal residence
– By citizens or resident aliens
– Within 18 months
– Once every 10 years
– Deposit in escrow
– Full utilization of proceeds
– Tax basis of the old residence must carried to the new
residence
 The Alternative Taxation Rule
(6% CGT OR RIT)
Requisites:
• Seller = an individual taxpayer
• Buyer = government
 NOTE!
• The 6% CGT applies to all individual taxpayers
regardless of classification and domestic
corporations only.

• The 6% CGT is due within 30 days

• Both the 5%-10% CGT and the 6% CGT can be

paid in installment if initial payment do not
exceed 25% of the selling price.
 Structure of Income Taxation

Gross Income

Final Income Capital Gains Regular Income

Taxation Taxation Taxation

Gross Income XXX

Less:
Deductions (XXX)
Personal exemptions (XXX)
Taxable income XXX
 The Regular Income Tax
Nature:
• General in scope.
• Applies to all active income and other passive
income not subjected to final tax and capital
gains tax
 Types of Regular Income Tax
• Progressive income tax – tax rate is
determined from a tax table under Sec 24 (A)
of the NIRC

• Proportional income tax – 30% tax is imposed

upon the taxable income
 The regular tax structure

• Gross Income XXX

• Less:
• Deductions (XXX)
• Personal exemptions (XXX)
• Taxable income XXX
 Regular tax – gross income
• Exclusions in gross income
• Inclusions in gross income

• Special cases
– Fringe benefits
– Dealings in properties
 List of Exclusions in gross income
• Proceeds of life insurance policy
• Amount received by the insured as a return of
premiums
• Gifts, bequest, devise and descent
• Compensation for injuries and sickness
• Income exempt under treaty
 Exclusions …continued
• Retirement benefits
• Termination/Separation benefits
• Retirement benefits, social security benefits
and other benefits from foreign sources
• USVA benefits
• SSS benefits
• GSIS benefits
 Exclusions… continued
• Investment income in the Philippines from
stocks, bonds or other domestic securities by
foreign governments
• Income of the government and its political
subdivisions
• Prizes and awards in recognition of religious,
charitable, scientific, educational, artistic,
literary or civic achievements
 Exclusions… continued
• 13th month pay and other benefits
• De minimis benefits
• Contributions to GSIS, SSS, PhilHealth, HDMF
and union dues
• Gains from the sale of bonds, debentures and
other certificates of indebtedness with
maturity of more than 5 years
 Exclusions continued
• Gains from the redemption of shares in
mutual funds
• Certain benefits of minimum wage earners
 List of inclusions in gross income
• Compensation for services rendered
• Trade, business or exercise of a profession
• Gains derived from dealings in properties
• Interests
• Rents
• Royalties
 Inclusions… continued
• Dividends
• Annuities
• Prizes and winnings
• Pensions
• Partner’s distributive share from the net
income of a general professional partnership
• Tax benefits
• Other sources
 Compensation income
• Components:
– Regular compensation income
– Supplemental compensation income
– 13th month pay and other benefits in excess of
P30,000 (P82,000 under current proposed law)
 Presentation of compensation income

• Gross Compensation XXX

• Less: Non-taxable compensation XXX
• Gross taxable compensation income XXX

Note: Some employees are taxable on net

compensation while others are subject to tax on the
gross taxable compensation
 Fringe benefits
• Fringe benefits includes any benefits not
classified or classifiable as compensation
income
• Examples:
– Management perquisite benefits
– Employee expenses shouldered, paid or assumed
by the employer
– Taxable de minimis benefits
 Exempt fringe benefits
• Those required or mandated by law
• Those provided for the convenience of the
employer (Convenience of the employer rule)
• Those provided because of a necessity of the
employer (Necessity of the employer rule)

• Other fringe benefits are TAXABLE.

 Treatment of taxable fringe benefits

• For rank and file employees, taxable fringe

benefits are added to the “13th month pay and
other benefits”

• For supervisory or managerial employee,

taxable fringe benefits are subject to a final
tax – Fringe benefits tax
 The fringe benefits tax
• Attributes:
– A final tax
– Withheld at source
– Imposed upon the employee
– Paid by the employer
– Paid quarterly
Determining the fringe benefits tax
• Determine monetary value
• Determine the grossed-up monetary value
• Compute the fringe benefits tax

(Please note board illustration)

 Dealings in properties
• Dealings in ordinary assets
– Ordinary gains – included as part of gross income
– Ordinary losses – included as part of deductions

• Dealings in capital assets

– Capital gains/losses on domestic stocks or real
properties – subject to CGT
– Capital gains or losses from other sources – subject
to RIT
Treatment of capital gains/losses from other
capital assets
• Capital gains and capital losses from other
capital assets are OFFSET
– Net capital gains – included as part of gross
income
– Net capital loss – not deductible from gross
income

In short: Capital loss is deductible only to the extent

of capital gains..
 Determination of the net capital gains/net
capital loss
Individuals Corporations
Holding period rule
- Up to 1 year 100% 100%
- More than 1 year 50% 100%
Net capital loss carry-over Allowed Not allowed
 Rules on capital loss carry-over
• One year period only
• Not to exceed:
– The net income in the period the capital loss was
sustained
– The net capital gain in the following year

(Check cases to be flashed)

 Determination of taxable income
• Our current tax law employs the

“Classification and Globalization rule”

The classification and globalization rule

• The gross income of the taxpayer is classified

into:
– Compensation income, AND
– Business/Professional income

• If there is business or professional income,

other income is classified as part of business
or professional income
 Determination of the taxable income

• Gross taxable compensation incomeXXX

• Less: Personal exemption XXX
• Taxable compensation income XXX

• Gross income from business/profession XXX

• Less: Deductions XXX
• Net income XXX
• TAXABLE INCOME XXX
Rules in computing taxable income
• A negative compensation income is deductible
against net income
• A net loss is not deductible against taxable
compensation income
 What are deductions?
• Deductions are expenses of business or the
exercise of a profession
 Basic principles of deductions
• The L.O.A.N. Principle
• The matching rule
• The related party rule
• The withholding rule
 Classifications of deductions
• Cost of goods sold or cost of sales
• Regular allowable itemized deductions
• Special allowable itemized deductions
• Net operating loss carry-over
 Mode of claiming deductions
• Itemized deduction
• Optional standard deductions
– For individuals: Deduction is presumed 40% of
sales
– For corporations: Deductions is presumed 40% of
gross income
 What are personal exemptions?
• Personal exemptions are amounts presumed
by law to be equivalent to the cost of
subsistence or support of the individual
taxpayer
 Types of personal exemptions
• Basic personal exemption
• Additional personal exemption
• Premiums on health and hospitalization
insurance

(Note board illustration)

 Thank you!

May God bless us all!