Items and Concept of

Income
  Income means all wealth which flows into the taxpayer
other than a mere return of capital. It includes the
forms of income specifically described as gains derived
from the sale or other disposition of capital.
 For tax purposes, income is defined as the amount of
Definition of money coming to a person or corporation within a
specified time whether as payment for services,
income interest, or profits from investment. It includes
earnings lawfully or unlawfully acquired, without
consensual recognition, express or implied, of an
obligation to repay and without restriction as to their
disposition.
 Gross income is income reduced by exclusions
  Taxable income refers to the pertinent items of gross
Definition of income specified in the Code, less deductions, if any,
income authorized for such types of income by the Code or
other special laws.
  Income tax is referred to as tax on all yearly profits
arising from property, professions, trades or offices, or
as a tax on a person’s income, emoluments, profits and
the like.
Definition of  Our income tax is classified as:
income tax a. A national tax
b. An excise tax
c. A direct tax
d. A general tax
 Individuals Natural persons (Filipino citizens or
not, resident or non-resident of the
Philippines)
Corporation Partnership, joint- stock companies, joint
accounts, or insurance companies except
general professional partnerships and a
joint venture formed for the purpose of
undertaking construction projects or

Classification engaging in petroleum, geothermal and

other energy operations under a service

of income Estate
contract with government.
All property, rights and obligations of a
taxpayers person which are not extinguished by his
death and also those which have accrued
since the opening of succession.
Trust Arrangement created by will under which
property is passed to another for
conservation or investment with the
income therefrom and ultimately the
corpus to be distributed in accordance
with the directions of the creator as
expressed in the governing instrument.
  Gross income means all income derived from whatever source
including but not limited to the following items:
1. Compensation to services in whatever form paid (fees, salaries,
wages, commissions and similar items
2. Gross income derived from the conduct of trade or business or
exercise of profession.
3. Gains derived from dealings in property.
General 4. Interests
definition of 5. Rents
6. Royalties
Gross Income 7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions; and
11. Partner’s distributive share from the net income of the general
professional partnership.
  Compensation may be paid in money or some medium
other than money like stocks, bonds or other forms of
property.
 If payment is made in cash, the whole amount is taxable.
However, the withholding tax required by law to be
deducted by the employer from the compensation of an
employee, is considered as part of the compensation
income subject to tax.
Compensatio  If the compensation is paid in kind, the ff. rules shall apply:
n paid in kind a. If services are paid for in a medium other than money, the
fair market value of the thing taken in payment is the
amount included as compensation income.
b. If the services are rendered at a stipulated price, such
price will be presumed to be the fair market value.
c. If the corporation transfers to its employees its own stock
as remuneration for services rendered, the amount of
such is the fair market value of the stock at the time the
services were rendered.
Compensatio  Promissory notes received in payment of services
n paid in constitute income to the extent of their fair market
value at the time of receipt. If subject to the
promissory discounting of notes, the fair market value is the
note discounted value.
 Illustration:
In 2016, Samar received from Balay a promissory note with a face
Compensatio value of P100,000 for services rendered. The note will mature after
one year. At the time of receipt in 2016 the note was sold to a bank
n paid in at a discount of 18%. Balay paid the note upon maturity in 2017.

promissory a. How much income is subject to tax in 2016?

Face value 100,000
note
Less: Discount (100,000 x 18%) 18,000
Taxable income 82,000
Compensatio b. How much income is subject to tax in 2017?
n paid in Face value 100,000
promissory Less: Amount already declared as income 82,000

note Income subject to tax 18,000

  Tips and gratuities paid directly to an employee by a
Tips and customer of the employer which are not accounted for
by the employee to the employer are considered as
gratuities taxable income of the employee but not subject to
withholding tax.
  In general, fixed or variable transportation, representation
and other allowances which are not accounted for by the
employee to the employer are considered as taxable income
of the employee but not subject to withholding tax.
 Any amount specifically, either as advances or
Transportatio reimbursements for traveling, representation and other
n, bona fide expenses which are reasonably expected to be
incurred by the employee in the performance of his duties
representatio are not compensation, if the ff. conditions are met:
a. They are ordinary and necessary expenses
n and other
b. They are paid or incurred by the employee in the pursuit
allowances of the trade, business or profession; and
c. The employee is required to account/liquidate the
foregoing expenses in accordance with the specific
requirements of substantiation for each category of
expenses.
  The excess of advances made over actual expenses
Transportatio shall constitute taxable income if not returned to the
employer.
n,  Reasonable amounts of reimbursements/advances for
representatio travelling and entertainment expenses which are pre-
n and other computed on a daily basis and are paid to an employee
while he is on an assignment or duty need not be
allowances subject to the requirement of substantiation and to
withholding.
RATA, PERA
 Representation and Transportation Allowance (RATA)
and ACA granted to public officers and employees under the
granted to General Appropriations Act and Personnel Economic
Relief Allowance (PERA) granted to government
government personnel are non-taxable compensation income
employees
  Vacation allowances or sick leave credits which are paid to
employees constitute compensation. Thus, the salary of an
employee on vacation or on sick leave even in his absence from
Vacation and work constitute compensation.
sick leave  However, the monetized value of unutilized vacation leave credits
of ten days or less which were paid to employees of private firms
allowances during the year are not subject to income tax because they are
classified as de minimis benefits which are exempt from income
tax.
 Illustration:
Manda was sent by his manager for a two-day official business in
Manila. He was given P10,000 to answer for whatever expenses he
will incur in connection with his travel. When he returned back to
Naga City, he liquidated the following expenses:
Bus fare (Naga to Manila and back) 2,000
Vacation and Hotel Accomodation 2,000

sick leave Meals

One night hapi-hapi with his barkada in Manila
1,500
500
allowances Total 6,000
A day after his arrival, he had a flu and was forced to go on leave for
2 weeks. Despite his absence, he was paid a complete salary and
other allowances for that month in the amount of P13,000.
Based on the above information and assuming that the unspent
portion of the cash advance had been returned to the employer,
how much income is subject to tax?
 Answer:
Amount spent with barkada 500
Salary and other allowances 13,000
Income subject to tax 13,500
Vacation and
sick leave • The bus fare, hotel accommodation and meals are not taxable
because they were incurred in the pursuit of business of the
allowances employer and had been subjected to liquidation.
• The expenses of P500 for hapi-hapi with friends is not connected
with the business of the employer.
• The salary received while on a 2-week sick leave is taxable. Hence,
the entire salary is subject to tax.
  If the creditor condones the indebtedness of the debtor, the
following rules shall apply:
a. On account of the debtor’s services to the creditor, taxable
income of the debtor.
b. If no services were rendered but the creditor simply condones
Forgiveness of the debt, it is taxable gift not taxable income.
Indebtedness c. If the creditor is a corporation and the debtor is a stockholder,
the forgiveness of indebtedness has the effect of a payment of
dividend.
d. If the creditor is a stockholder and the debtor is the corporation
– the forgiveness of indebtedness shall be considered as an
additional investment.
 Illustration:
 Ferdie, an architect owes Mel, a businessman P30,000. the latter
engaged the services of the former to remodel his house. The
value of the services rendered amounted to P30,000.
Subsequently, Mel cancelled the debt of Ferdie.
a. Is the P30,000 value of services taxable to Ferdie?
Forgiveness of
 Yes, it is a simple case of paying the indebtedness to Mel, making
Indebtedness it taxable to Ferdie.
b. Suppose Mel condoned the debt of Ferdie without requiring the
latter to render any service. Is the P30,000 subject to income tax?
 This case is a condonation based on the liberality of the
benefactor. Therefore not an income, it’s considered more as a gift
which is governed by law on donor’s taxation.
  Remuneratory donation are those which remunerate past services
Remunerator which do not constitute demandable debts. The motivating cause
is gratitude acknowledgment of a debt or a desire to compensate
y donations and not the liberality of the donor. They are deemed income
subject to tax.
 Illustration:
 Berganio saved the life of Buenafe who met a car accident. The
latter in a display of gratitude gave him cash of P50,000.
a. Is the P50,000 a taxable income?

Remunerator - yes, this is the case of a remuneratory donation which is subject to

income tax.
y donations b. Suppose without doing anything, Berganio received P50,000 from
Buenafe due purely to the liberality of the latter. Is the P50,000 a
taxable income.
- no, the situation does not concern remuneratory donation
anymore. The cause of the gift is purely the liberality of Berganio,
Hence, it is not considered a taxable income.
  When bad debts are ascertained to be worthless and charged-off
during the year, they are allowed as deductions from the gross
income of the taxpayers, whether individual or corporate.
However, where bad debts that have been legally claimed as
deductions from gross income in the preceding years are
Recovery of recovered by the taxpayer in the succeeding periods, they shall be
bad debts included as part of the gross income in the year or recovery to the
extent of the income tax benefit of said deduction (tax benefit
previously rule).

deducted  Tax benefit arises when the taxpayer realized a tax deduction of
the income tax due on account of said bad debt deduction from
gross income.
 Interest on the amount recovered is a taxable income and is not
covered by the tax benefit rule.
 Illustration:
Indicate the amount of taxable income or deductible loss in each of the following
independent cases:
2017 Case 1 Case 2 Case 3
Income/loss before write-off 60,000 -30,000 60,000
Less: Bad debt written off 10,000 10,000 100,000
Net income/loss after bad debt 50,000 -40,000 -40,000

Recovery of 2018

bad debts Bad debt recovered 10,000 10,000 100,000

previously Case 1: Taxable to the extent of P10,000.

- The deduction of bad debt resulted in tax benefit to the taxpayer.
deducted Case 2: Not taxable.
- There was no tax benefit to the taxpayer because when the bad debt was claimed
as deduction, the taxpayer was already at a net loss. Thus, it did not result to a
reduction in the tax liability of the taxpayer.
Case 3: Only the amount of P60,000 is taxable.
- The tax benefit to the taxpayer is limited only to P60,000.
  A tax refund is taxable if the tax was previously deducted as an
expense in computing the tax during the previous year. It shall be
included as part of the gross income in the year of receipt to the
extent of the income tax benefit of said deduction.
Refund of tax  If the tax is not deductible, refund of which is not taxable. Taxes
which are not deductible from gross income include income tax,
estate tax and donor’s tax, and special assessments.
 “Tax benefit rule” applies also to tax refunds which have been
claimed as deductions during the previous years.
 Illustration
Sol Dranto had the following data in 2017:
Taxable income before dedcution of taxes 150,000
Taxes paid:
Income tax 12,000
Common carrier's tax 15,000
Local business taxes 10,000
Donor's tax 6,000
Refund of tax These taxes have been refunded to her in 2018.
How much is the taxable income of Sol in 2018 if her income before
tax refund is P200,000?
Answer: Taxable income before tax refund 200,000
Add: Common carrier's tax 15,000
Local business taxes 10,000 25,000
Taxable income 225,000
  If the tax is an indirect tax, the proper party to question, or seek a
refund of an indirect tax is the statutory taxpayer, the person on
whom the tax is imposed by law and who paid the same even if he
shifts the burden thereof to another.
Illustration:

Refund of Bart Company purchased from Grace Gasoline Station 100,000 liters
of aviation fuel from January to December 2017. such product is
indirect tax subject to excise tax (an indirect tax) which is added to the price it
paid to the gasoline station.
If Bart Company is exempt from excise tax, who is entitled to claim
refund on the excise taxes erroneously paid to the government –
Bart Company or Grace Gasoline Station?
 Answer:
In the refund of indirect taxes, the statutory taxpayer (Grace
Company) is the proper party who can claim the refund.
Refund of In indirect taxation, the purchaser and end consumer ultimately
indirect tax bears the tax burden, but this does not transform his status into a
statutory taxpayer.
Bart Company should invoke its tax exemption to Grace Gasoline
Station before buying the aviation fuel.
  A lease contract is a consensual, bilateral, onerous and
commutative contract by which one person binds himself to grant
temporarily the use of a thing or the rendering of some service to
another who undertakes to pay some rent, compensation, or
price.
 When the lessee makes useful improvement to the leased
premises, such as the construction of fence or building, the ff.
Leasehold rules shall apply if such improvements are relinquished to the
lessor without demanding reimbursement of its value:
Improvement 1. The consideration for the use of property paid by the lessee is
taxable income to the lessor.
s 2. Taxes paid by the lessee on behalf of the lessor for a business
property are additional rent and constitutes income taxable to
the lessor.
3. When the lessee makes improvements on leased premises and
said improvements will belong to the lessor upon the
termination of the lease, the lessor may at his option report
income as follows:
 a. Outright method – report as income the fair market value of the
improvements in the year of completion;
b. Spread-out method – spread over the remaining term of the
lease the book value of such improvements at the termination
of the lease computed as follows:
Cost of leasehold improvements xx
Leasehold Less: Accumulated depreciation xx
Improvement Book value, end of lease
Divide by remainign term of the lease
xx
xx
s Annual income xx
4. Deduction of lessee
The lessee may claim depreciation of the improvements over the
remaining term of the lease or the life of the improvements,
whichever is shorter.
Leasehold 5. Premature termination of lease – income to be reported by the
Improvement lessor shall be computed as follows:

s Book value of upon termination

Less: Amount already reported as income
xx
xx
Income in the year of completion xx
 Illustration:
Tony, lessor, leased a lot to Aljon, lessee, for 20 years beginning
January 1, 2016, subject to the following terms and conditions:
a. Lessee will pay rental of P30,000 per month.
b. Lessee will pay the real estate tax on the land of P10,000 a year.
Leasehold c. Lessee will construct a building on the lot to be owned by the
Improvement lessor when the lease expires.
Cost of building completed, July 1, 2018 P2,800,000
s Life of building 25 years
Required:
1. Compute the taxable income of Tony for 2018. Use spread-out
method of determining income on leasehold improvements.
2. Determine deductible expenses of Aljon for 2018.
Leasehold 3. Assume that due to the fault of Aljon, the lease was terminated on
January 1, 2021. Compute the income of Tony for the year 2021.
Improvement 4. Compute the income to be reported by Tony in 2018 using
s outright method.
 1. Income of the lessor Tony in 2018 using spread-out method.

Rent (30,000 x 12) 360,000

Leasehold Tax paid by lessee 10,000
Income on leasehold improvement:
Improvement Cost 2,800,000
s Less: Depreciation for 17.5 years
(2,800,000/25) x 17.5 1,960,000
Book value, end of lease 840,000
(840,000/17.5) x 6/12 24,000
394,000
 2. Expense of lessee Aljon for 2018.

Rent 360,000
Tax 10,000
Depreciation-leasehold improvement
(2,800,000/17.5) x 6/12 80,000
450,000
Leasehold 3. Income of lessor Tony for the year 2021.
Improvement Cost 2,800,000
s Less: Depreciation for 2.5 yrs. (2,800,000/25) x 2.5 280,000
Book value upon termination 2,520,000
Less: Income already reported
2018 24,000
2019 (840,000/17.5) 48,000
2020 (840,000/17.5) 48,000 120,000
2,400,000
Leasehold 4. Income of lessor in 2018 using Outright Method
Improvement
Rent (30,000 x 12) 360,000
s Tax 10,000
Leasehold improvement 2,800,000
3,170,000
Gross income
from  Gross income means the total sales, less the cost of goods sold
manufacturin plus any income from investments and from incidental or outside
operations or sources.
g,  In determining the gross income, subtraction should not be made
merchandisin fro depreciation, depletion, selling expenses or losses or for items
not ordinarily used in computing the cost of goods sold.
g or mining
business
 Illustration:
Gibsons Company is a merchandising business. It is engaged in the
Gross income business of selling school and office supplies, novelties and gift
items. The summary of its income and expenses during the year are
from as follows:

manufacturin Sales 850,000

Sales returns and allowances 35,000
g, Cost of sales 350,000
merchandisin Rent income (net of 5% withholding tax)
Income on sale of capital assets
79,800
20,000
g or mining Deductible expenses 230,000

business How much is the gross income and the taxable income of Gibsons
Company?
Gross income Answer:

from Sales
Less: Sales returns and allowances
850,000
35,000

manufacturin Net sales

Less: Cost of sales
815,000
350,000
g, Gross profit
Add: Other income
465,000

merchandisin Rent (79,800/95%)

Gain on sale of capital assets
84,000
20,000 104,000
g or mining Gross income 569,000
Less: Deductible expenses 230,000
business Taxable income 339,000
  The term farm embraces the farm in ordinary accepted sense, and
includes stock, dairy, poultry, fruit and truck farms, also
plantations, ranches, and all lands used for farming operations.
 Farmers are individuals, partnerships or corporations that
cultivate, operate or manage farms for gain or profit either as
owners or as tenants.
Gross income  The following are the prescribed methods of reporting gross
income from farming:
from farming a. Cash basis or receipts and disbursement basis – no inventory is
used to determine profits.
b. Accrual basis – inventory is used to determine profits.
c. Crop basis – used when farmer is engaged in producing crops
w/c take more than a year to gather and dispose of from the
time of planting
 Illustration:
The following data pertains to Bukirin:
Beginning inventory:
Farm products 30,000
Livestock 25,000

Ending inventory:
Gross income Farm products 20,000
Livestock 34,000
from farming Sale of products raised in the farm 450,000
Sale of livestock 325,000
Gain on sale of farm equipment 40,000
Rent income of farm equipment 7,000
How much is the gross income of Bukirin if he is using:
a. Cash method
b. Accrual method
 a. Taxpayer is using cash method of accounting:

Sale of farm products 450,000

Sale of livestock 325,000
Gross income Total
Add: Other income
775,000

from farming Gain on sale of farm equipment 40,000

Rent income of farm equipment 7,000 47,000
Gross income 822,000
 b. Taxpayer is using accrual method of accounting:

Ending inventory:
Farm products 20,000
Livestock 34,000 54,000
Gross income Sale of farm products
Sale of livestock
450,000
325,000
from farming Total 829,000
Less: Beginning inventory
Farm products 30,000
Livestock 25,000 55,000
774,000
Add: Other inome
Gain on sale of farm equipment 40,000
Rent income of farm equipment 7,000 47,000
Gross income 821,000
  For income tax purposes, the term “dividends” means any
distribution whether in money or in kind made by a corporation to
its stockholders out of its earnings or profits and payable to its
stockholders.
 The more common form are:
1. Cash dividend – paid in cash; income is measured by the
amount of cash received.
Receipts of 2. Stock dividend – distribution by a corporation to its
shareholders of the corporation’s own stock. A stock dividend
dividends representing the transfer of surplus to capital account shall not
be subject to tax unless;
a. These shares are later redeemed for a consideration by the
corporation or otherwise conveyed by the stockholder to the
extent of such consideration;
b. The recipient is other than a stockholder; or
c. A change in the stockholders equity results by virtue of the
stock dividend issuance.
  When a stockholder receives a stock dividend w/c is a taxable
income, the measure of income is the fair market value of the
stocks received.

Receipts of 3. Property dividend – paid in shares of stock of another corporation

or other property of the corporation. The measure of income is the
dividends fair market value of the property received at the tie of receipt or
distribution.
A distribution of stock dividend is taxable as a distribution of
property dividend.
 Illustration:
Ara, Barbara, Criselda, Diana and Ellen are the stockholders of Brave
Corporation. Each of then owns 1,000 shares of stock. During the
Receipts of year, the corporation declared 10% common stock dividend.

dividends a. Are the stock dividends taxable to the shareholders?

b. How about if the corporation gave the stockholders an option
to choose between property dividends and stock dividends and
Ara, Criselda and Ellen chose to be paid in property dividends?