Tomas Claudio Colleges

College of Business and Accountancy

Professor: Mycriwel Louis F. Manapat

TAXATION
INCOME TAX IN GENERAL

Income Tax is a tax on person’s income, emoluments, profits arising from property,
practice of profession, conduct of trade or business or on the pertinent items of gross
income specified in the Tax Code of 1997 (Tax Code), as amended, less the deductions
and/or personal and additional exemptions, if any, authorized for such types of income,
by the Tax Code, as amended, or other special laws.

Income tax has been defined as a tax on all yearly profits1 arising from property,
profession, trade or business, or as a tax on a person’s income, emoluments, profits
and the like (whether legal or illegal).

A person means an individual, a trust, estate or corporation.

Definition of income

Income, in its broad sense, means all wealth which flows into the taxpayer other than
as a mere return on capital. [Section 36, Revenue Regulations 2]

Income means accession to wealth, gain or flow of wealth.

Elements of Gross Income

1. It is a return on capital that increases net worth – there must be a gain or profit
2. It is a realized benefit2 - the gain must be realized or received
3. It is not exempted by law, contract, or treaty

Income Tax Systems

1. Global – all income received by the taxpayer are grouped together, without any
distinction as to the type or nature of the income, and after deducting therefrom
expenses and other allowable deductions, are subjected to a tax at a fixed rate.
2. Schedular – the various types/items of income (e.g, compensation, business
income, income from profession) are classified accordingly and accorded
different tax treatments, in accordance with schedules characterized by
graduated tax rates.
3. Semi-schedular or semi-global – partly global or partly schedular in features.

The Philippine Income Tax System: is primarily schedular for individuals and primarily
global for corporations.

1 For individuals, the accounting period shall be calendar year or that which is a 12-month period that ends in December 31.
For Corporations, the accounting period can either be calendar or fiscal year, the latter being an accounting period of 12 months
ending on the last day of the month other than December.

2 Under the realization principle, revenue is generally recognized when both of the following conditions are met: a) the earning
process is complete or virtually complete, and b) an exchange has taken place.

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

When is income considered received?

1. Actual receipt – involves actual physical taking of the income in the form of cash
or property.
2. Constructive receipt – involves no actual physical taking of the income but the
taxpayer is effectively benefited.
Examples:
a. Interest coupons which have matured and are payable, but have not been
cashed.
b. Partner’s distributive share in the profits of a general professional partnership is
regarded as received by the partner, although not yet distributed.
c. Offset of the debt of the taxpayer in consideration for the sale of goods or
services.
d. Deposit of the income to the taxpayer’s checking account3. However, “deposits”
which are payments for future services cannot be treated as part of the gross
income until the earning process is complete.

Not exempted by law, contract, or treaty

The following items of income are exempted by law from taxation; hence, they are
not considered items of gross income:
1. Income of qualified employees trust fund
2. Revenue of non-profit non-stock educational institutions
3. SSS, GSIS, PAG-IBIG, Philhealth benefits
4. Salaries and wages of minimum wage earners and qualified senior citizen
5. Regular income of Barangay Micro-business Enterprises (BMBEs)
6. Income of foreign governments and foreign government-owned and controlled
corporations.
7. Income of international missions and organizations with income tax immunity.

- More will be discussed in Income taxation on Individuals and Corporations

3 Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is
subject to tax for the year during which so credited or set apart, although not then actually reduced to possession.

To constitute receipt in such a case, the income must be credited to the taxpayer without any substantial limitation or
restriction as to the time or manner of payment or condition upon which payment is to be made. [Section 52, Revenue
Regulations 2]

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

Illustration
Mr. Keem Soak Gin lists the following possible items of gross income

Compensation Income Php 500,000

Proceeds from embezzlement 300,000
Winnings from gambling 150,000
Increase in value of investments 75,000
Appreciation in the value of land owned 450,000
Loans received from bank 600,000
Debt of Kim Soak Gin cancelled by his creditor out of 350,000
affection
Debt of Kim Soak Gin cancelled by his creditors in 250,000
consideration for services he rendered to them
Proceeds of life insurance policies 1,000,000
13th month pay and other employee benefits 150,000

Solution
Compensation Income Part of gross Rationale
income? Y/N
Compensation Income
Proceeds from embezzlement
Winnings from gambling
Increase in value of investments
Appreciation in the value of land owned
Loans received from bank
Debt of Kim Soak Gin cancelled by his
creditor out of affection
Debt of Kim Soak Gin cancelled by his
creditors in consideration for services he
rendered to them
Proceeds of life insurance policies
13th month pay and other employee
benefits

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

CLASSES OF INCOME

Kinds of taxable income or gain

1. capital gain

2. ordinary gain

a. business income
b. compensation income
c. passive income
d. other income from whatever source derived i.e. found treasure

Capital gains

• Capital gains are gains or income from the sale or exchange of capital assets. These include:

1. Income from dealings in shares of stock of domestic corporation whether or not through the stock
exchange;
2. Income from dealings in real property located in the Philippines; and
3. Income from dealings in other capital assets other than (a) and (b).

Ordinary gains

• Ordinary gains are gains or income from the sale or exchange of property which are not capital assets.

Business income

1. Income from trading, merchandising, manufacturing or mining

2. Income from practice of profession

Note: The term “trade or business” includes the performance of the functions of a public office. [Section 22(S),
NIRC]

Passive income

1. Passive income from Philippine sources subject to final tax

2. Passive income from Philippine sources not subject to final tax
3. Passive income from sources outside the Philippines

Passive income again

1. Interest income
2. Rentals/Leases
3. Royalties
4. Dividends
5. Annuities and proceeds of life insurance/other types of insurance
6. Prizes and winnings, awards, and rewards
7. Gifts, bequests, and devises
8. Other types of passive income

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

CLASSES OF INCOME TAXPAYERS

Basis of classification of taxpayers

1. corporations v. individuals
2. nationality
3. residence

Classes of income taxpayers

1. Individuals
a. Resident citizens
b. Non-resident citizens
c. Resident aliens
d. Non-resident aliens
i) engaged in trade or business in the Philippines, or
ii) not engaged in trade or business in the Philippines
Note: A non-resident alien individual who shall come to the Philippines and stay therein for an aggregate period of
more than one hundred eighty (180) days during any calendar year shall be deemed a non-resident
alien doing business in the Philippines. [Section 25(A)(1), NIRC]

2. Corporations
a. Domestic corporations
b. Resident foreign corporations
c. Non-resident foreign corporations

3. Special
a. Proprietary educational institutions and hospitals that are non-profit
b. Insurance companies
c. General professional partnerships
d. Estates and trusts

Note: Estates and trusts are treated as individual taxpayers.

Who is a non-resident citizen?

• The term “non-resident citizen” means:

1. A citizen of the Philippines who established to the satisfaction of the Commissioner the fact of his
physical presence abroad with a definite intention to reside therein.
2. A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad,
either as an immigrant or for employment on a permanent basis.
3. A citizen of the Philippines who works and derives income from abroad and whose employment
thereat requires him to be physically present abroad most of the time during the taxable year.
4. A citizen who has been previously considered as a non-resident citizen and who arrives in the
Philippines at any time during the taxable year to reside permanently in the Philippines.

Corporation

• A corporation, as used in income taxation, includes partnerships, no matter how created or organized,
joint stock companies, joint accounts (cuentas en participacion), and associations or insurance companies.

• However, it does not include:

1. a general professional partnership; and

2. a joint venture or consortium formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or
consortium agreement under a service contract with the government.

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

Resident foreign corporation

The term applies to a foreign corporation engaged in trade or business within the Philippines.

Non-resident foreign corporation

The term applies to a foreign corporation not engaged in trade of business in the Philippines.

GENERAL PROFESSIONAL PARTNERSHIP V. ORDINARY BUSINESS PARTNERSHIP

General professional partnerships

• General professional partnerships are partnerships formed by persons for the sole purpose of exercising their
common profession, no part of the income of which is derived from engaging in any trade or business.
[Section 22(B), NIRC]

• Persons engaging in business as partners in a general professional partnership shall be liable for income tax only in
their separate and individual capacities. [Section 26, NIRC]

• For purposes of computing the distributive share of the partners, the net income of the partnership shall be
computed in the same manner as a corporation. [Section 26, NIRC]

• Each partner shall report as gross income his distributive share, actually or constructively received, in the net
income of the partnership. [Section 26, NIRC]

• Income of a general professional partnership are deemed constructively received by the partners. [Section 73(D),
NIRC]

Ordinary business partnership

• An ordinary business partnership is considered as a corporation and is thus subject to tax as such.

• Partners are considered stockholders and, therefore, profits distributed to them by the partnership are considered
as dividends.

GENERAL PRINCIPLES OF TAXATION

SEC. 23. General Principles of Income Taxation in the Philippines. - Except when otherwise provided in this Code:

(A) A citizen of the Philippines residing therein is taxable on all income derived from sources within and without the Philippines;

(B) A nonresident citizen is taxable only on income derived from sources within the Philippines;

(C) An individual citizen of the Philippines who is working and deriving income from abroad as an overseas contract worker is taxable
only on income derived from sources within the Philippines: Provided, that a seaman who is a citizen of the Philippines and who
receives compensation for services rendered abroad as a member of the complement of a vessel engaged exclusively in
international trade shall be treated as an overseas contract worker;

(D) An alien individual, whether a resident or not of the Philippines, is taxable only on income derived from sources within the
Philippines;

(E) A domestic corporation is taxable on all income derived from sources within and without the Philippines; and

(F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income
derived from sources within the Philippines.

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

Taxability of Individuals:

Earned within the Earned outside

Philippines the Philippines
Resident Citizens Taxable Taxable
Non-Resident Citizens Taxable Non-Taxable
Resident Alien Taxable Non-Taxable
Non-Resident Aliens (whether Taxable Non-Taxable
engaged in trade or business or
not)
For simplicity, resident citizens are taxable on their worldwide income, while all the rest (Non-resident Citizen and Aliens [whether
resident or non-resident) are taxable only on their income from sources within the Philippines.

Taxability of Corporations:

Earned within the Earned outside

Philippines thevPhilippines
Domestic Corporations Taxable Taxable
Resident Foreign Corporations Taxable Non-Taxable
Non-Resident Foreign Corporations Taxable Non-Taxable

How To Determine Income Within and Income Without

Income Test of source of income

Interest income Residence of the debtor
Income from services Place of performance
Rent Location of property
Royalty Place of use of intangible
Gain on sale of real property Location of property
Gain on sale of personal property purchased in Place of sale
one country and sold in another
Dividend
A. From Domestic Corp. Income within
B. From Foreign Corp. Income without
Except: If 50% or more of the gross income of
the foreign corporation for the preceding three (3)
years prior to the declaration of dividend or for
such part of such period as the corporation
has been in existence, was derived from
sources within the Philippines, then part of the
dividend is income within.

Income within = (Phil. Gross Income/Total

Gross Income) x
Dividend
Sale of domestic shares Income within
Sale of foreign shares Income without
Income from transportation and Partly within and partly without
other services rendered partly
within and partly without the
Philippines

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

Situs of Income
The situs of the income is the place of taxation of the income or the country
which has jurisdiction to impose the tax. For income tax purposes, income may
be taxed in one or more or all of the following places or countries –

1. The place where the taxpayer is a citizen;

2. The place where the taxpayer is a resident; and
3. The place where the income is earned or derived.

Income Tax System of the Philippines

The income tax system of the Philippines may be characterized under two
general categories, namely:
1. Gross income taxation, whereby a final tax is imposed on the gross
amount of specified types of income, such as interest income, royalty,
prizes, dividends, and capital gains.
This is also known as the schedular system of taxation.

2. Net income taxation, whereby certain deductions are allowed and

subtracted from the aggregate of incomes not subject to final tax, and
the tax computed is based on the resulting net income therefrom. This is
also known as the global system of taxation.

Illustration:

A taxpayer had the following income:

- Interest income from deposits in a foreign bank P 230,000

- Professional fees for services rendered in the 520,000
Philippines to non-resident clients (paid in USD)
- Rent income from properties abroad (the lease 85,000
Contracts were executed in the Philippines)
- Royalties from books published in the Philippines 175,000
- Dividends from a corporation listed in the Philippines 55,000
- Gain on sale of jewelry purchased in the Philippines,
sold in South Korea 87,000
- Dividends from a resident foreign corporation 30,000
- Dividends from a non-resident foreign corporation 62,000
- Sold a land in Philippines while the taxpayer is in Canada 375,000
- Income from loans to a taxpayer – resident of the USA 45,000
- Sales from lanterns made from abaca produced in in Laguna,
sold and exported to Europe 200,000

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 Tomas Claudio Colleges
College of Business and Accountancy
Professor: Mycriwel Louis F. Manapat

Types of Taxable Income

Steps on How to Compute the Tax of an Individual

Step 1: Type Returnable Income Passive income Capital gains

of Income

Step 2: Type Generally, subject to Subject to Subject to Capital

of Tax Net Income Taxation Final Gains Tax (FWT)
Liability Tax (FWT)
EXC: NRANETB
Step 3: Gross Income xxx Passive income x “Capital gains” x
Actual Less: Deductions (xxx) FT rate CGT rate
Computation Net taxable income xxx
then Compute Tax (using
graduated rate table)9

------------------------------- end of discussion -----------------------------

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