The Concept of Income

Why is income subject to tax?

Income is regarded as the best measure of taxpayer’s ability to pay tax. It is an excellent object of
taxation in the allocation of government costs.

What is income for taxation purposes?

The tax concept of income is simply referred to as “gross income” under the NIRC. A taxable item of
income is referred to as an “item of gross income” or “inclusion in gross income”.

Gross income simply means taxable income in layman’s term. Under the NIRC however, the term
“taxable income” refers to certain items of gross income less deductions and personal exemptions
allowable by law. Technically, gross income is broader to pertain to any income that can be subjected to
income tax.

Gross income is broadly defined as any inflow of wealth to the taxpayer from whatever source, legal or
illegal, that increases net worth. In includes income from employment, trade, business or exercise of
profession, income from properties, and other sources such as dealings in properties and other regular
or casual transactions.

ELEMENTS OF GROSS INCOME

1. It is a return on capital that increases net worth.
2. It is a realized benefit.
3. 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 or property that increases the
taxpayer’s net worth.

Illustration
ABC purchased goods for P300 and sold them for P500. The P500 consideration can be analyzed as
follows:

Selling price (total consideration received) P 500 Total Return

Cost (value of inventory forgone) 300 Return of capital
Mark-up (gross income) P 200 Return on capital

The return on capital that increases net worth is income subject to income tax. Return of capital merely
maintains net worth; hence, it is not taxable. An improvement in net worth indicates an ability to pay
tax.
REALIZED BENEFIT

What is meant by realized benefit?

The “benefit” concept
The term “benefit” means any form of advantage derived by the taxpayer. There is benefit when there is
an increase in the net worth of the taxpayer. An increase in net worth occurs when one receives income,
donation or inheritance.

The following are not benefits, hence, not taxable:

a. Receipt of a loan – properties increase but obligations also increase resulting in an offsetting effect in
networth.
b. Discovery of lost properties – under the law, the finder has an obligation to return the same to the
owner.
c. Receipt of money or property to be held in trust for, or to be remitted to, another person.

If the taxpayer is entitled to keep for his account portion of a receipt, only that portion is a benefit.

Illustration:
1. An employee was granted P20,000 transportation advance. He liquidated P18,000 transportation
expenses and was allowed by his employer to keep the P2,000. Only the P2,000 retained by the
employee is considered income since this was the extent he was benefited. [RR2-98]

2. A security agency receives P120,000 from clients, P100,000 of which is for the salaries of security
guards. Under RMC 39-2007, only the P20,000 attributable to the agency is considered income of the
agency since it is the extent it is benefited. The P100,000 pertaining to salaries of security guards is
recognized by the agency as a liability upon receipt.

The “realized” concept

The term realized means earned. It requires that there is a degree of undertaking or sacrifice from the
taxpayer to be entitled of the benefit.

Requisites of a realized benefit:

1. There must be an exchange transaction.
2. Te transaction involves another entity.
3. It increases the net worth of the recipient.

Types of Transfers
1. Bilateral transfers or exchanges, such as:
a) Sale
b) Barter
These are referred to as “onerous transactions”.

2. Unilateral transfers, such as:

a) Succession – transfer of property upon death
 b) Donation
These are also referred to as “gratuitous transactions”

Under current usage, unilateral transfers are simply referred to as “transfers” while bilateral transfers are
called “exchanges”. Benefits derived from onerous transactions are “earned or realized”; hence, they are
subject to income tax. Benefits derived from gratuitous transactions are not realized because of the
absence of an earning process. Benefits derived from gratuitous transactions are subject to transfer tax,
not income tax.

3. Complex transactions
Complex transactions are partly gratuitous and partly onerous. These are commonly referred to as
“transfers for less than full and adequate consideration”. The gratuitous portion of the transaction is
subject to transfer tax while the benefit from the onerous portion is subject to income tax.

Illustration:
A taxpayer sold his car which was previously purchased for P100,000 and with a current fair value of
P180,000 for only P130,000.

The transaction will be analyzed as follows:

Fair value P 180,000
50,000 – Subject to transfer tax
Selling price 130,000
30,000 – Subject to income tax
Cost 100,000

The excess fair value over selling price is a gratuity or gift whereas the excess of the selling price over
the cost is an item of gross income.