INCOME TAXATION A personal tax based on A tax on income-

 Income Tax Systems the income of the producing activities.

- is defined as a tax on all yearly profits arising from taxpayer.
property, professions, trades, or offices, or as a tax on Emphasizes the burden Emphasizes revenue and

the person’s income, emoluments, profits and the like. It allocation aspects. administrative aspects/
Most equitable systems Because of its multiple
may be succinctly defined as a tax on income, whether
yet developed for rates, the tax burden of a
gross or net, realized in one taxable year. (definition)
distributing tax burden. person does not
- is generally classified as an excise tax. It is not levied
The burden of an correspond to his income
upon persons, property, funds or profits but upon the
individual is closely but rather falls
right of a person to receive income or profits. (nature)
related to his ability to fortuitously on the type
1. Global - under a global tax system, it does not matter
pay. of his income. It is fixed
whether the income received by the taxpayer is
and final.
classified as compensation income, business or It serves as a means for This function is alien to
professional income, passive investment income, capital redistributing income and schedular system where
gain, or other income. All items of gross income, wealth. Big income in times of plenty or in
deductions, and personal and additional exemptions, if earners are subject to times of need, people pay
any, are reported in one income tax return, and one set higher taxes than small tax on their income.
of tax rates are applied on the tax base. income earners.
A global tax system is one where the tax Administration is not The administration is

treatment views indifferently the tax base and generally quite as easy as schedular simple, being confined to

treats in common all categories of taxable income of the because one has to each transaction or

taxpayer. consider all income from activity.

2. Schedular - under a schedular tax system, different whatever source.

types of income are subject to different sets of

3. Semi-schedular or Semi-global Tax System - all
graduated or flat income tax rates. The applicable tax
compensation income, business or professional income,
rate(s) will depend on the classification of the taxable
capital gain and passive income not subject to final tax,
income and the basis could be gross income or net
and other income are added together to arrive at the
income. Separate income tax returns (or other types of
gross income, and after deducting the sum of allowable
return applicable) are filed by the recipient of income
deductions, the taxable income is subjected to one set of
for the particular types of income received.
graduated tax rates or such income the computation is
A schedular approach in taxation is one where
global. For those other income not mentioned above,
the income tax treatment varies and is made to depend
they remain subject to different sets of tax rates and
on the kind or category of taxable income of the
covered by different returns.
taxpayer.
GLOBAL SYSTEM SCHEDULAR
SYSTEM
Note: The Philippines, under the NIRC, follows a semi- ii. Realization of Income
schedular and semi-global tax systems. Income is realized when there is a gain or profit derived
from a closed and completed transaction. The
 Income means all wealth which flows to the realization of gain may take the form of actual receipt
taxpayer other than a mere return of capital. of cash or may occur as a constructive receipt of
Income is a gain derived from labor or capital, or income.
both labor and capital; and includes the gain Mere increase in the value of property without actual
derived from the sale or exchange of capital assets. realization, either through sale or other disposition, is
Income includes earnings, lawfully or not taxable.
unlawfully acquired, without consensual recognition, ACTUAL VS. CONSTRUCTIVE RECEIPT
express or implied, of an obligation to repay and 1. Actual Receipt - income is actually reduced to
without restriction as their disposition. Income may be possession. The realization of gain may take the form of
received in the form of cash, property, service, or a actual receipt of cash.
combination of the three. 2. Constructive Receipt - an income is considered
1. Income vs. Capital constructively received when it is credited to the
- the essential difference between capital and income is account of, or segregated in favor of, a person.
that capital is a fund; income is a flow. A fund of Examples of Constructive Receipt:
property existing at an instant of time is called capital. 1. Interest credited on savings bank deposit
A flow of services rendered by that capital by the 2. Matured interest coupons not yet collected by the
payment of money from it or any other benefit rendered taxpayer
by a fund of capital in relation to such fund through a 3. Dividends applied by the corporation against the
period of time is called income. indebtedness of a stockholder
INCOME CAPITAL 4. Share in the profit of a partner in a general
Denotes a flow of wealth Fund or property existing professional partnership, although not yet distributed, is
during a definite period at one distinct point in regarded as constructively received
of time. time. 5. Intended payment deposited in court (consignation).
Service of wealth Wealth itself
Subject to tax Return of capital is not
subject to tax The doctrine of constructive receipt is designed to
Fruit Tree prevent the taxpayer using the cash basis from deferring
or postponing the actual receipt of taxable income.
2. When Income is Taxable?
Without the rule, the taxpayer can conveniently select
i. Existence of Income
the year in which he will report the income.
Requisites for income to be taxable:
iii. Recognition of Income
1. There is INCOME, gain or profit
Income realized pertains to the accrual basis of
2. RECEIVED or REALIZED during the taxable year
accounting.
3. NOT EXEMPT from income tax
Recognition of income in the books is when it is
realized and expenses are recognized when incurred. It
is the right to received and not the actual receipt that
determines the inclusion of the amount in gross income.
Examples:
A. Interest or rent income earned but not yer received
B. Rent expense accrued but not yet paid
C. Wages due to workers but remaining unpaid.
Tests in Determining whether Income is earned for
Tax Purposes
i. Realization Test
No taxable income until there is a separation
from capital of something of exchangeable value,
thereby supplying the realization or transmutation
which would result in the receipt of income. Thus, stock
dividends are not income subject to income tax on the
part of the stockholder when he merely holds more
shares representing the same equity interest in the
corporation that declared stock dividends.
Income is recognized when both of the
following conditions are met:
(a) the earning is complete or virtually complete
(b) An exchange has taken place.
REVENUE REGULATIONS NO. 02-40 INCOME TAX
REGULATIONS SECTION 38. Bases of computation.
— Approved standard methods of accounting will be
ordinarily regarded as clearly reflecting income. A
method of accounting will not, however, be regarded as
clearly reflecting income unless all items of gross
income and all deductions are treated with reasonable
consistency. All items of gross income shall be included
in the gross income for the taxable year in which they
are received by the taxpayer and deductions taken
accordingly, unless in order clearly to reflect income
such amounts are to be properly accounted for as of a
different period. For instance, in any case in which it is
necessary to use an inventory, no accounting in regard
to purchases and sales will correctly reflect income
except an accrual method. A taxpayer is deemed to
have received items of gross income which have been
credited to or set apart for him without restriction. On
the other hand, appreciation in value of property is not
even an accrual of income to a taxpayer prior to the
realization of such appreciation through sale or
conversion of the property. (For methods of accounting
and determination of accounting period, see Sections
166 to 169 of these regulations.) (Section 29(a) of the
Code)
ii. Claim of Right Doctrine
aka doctrine of ownership, command, or
control
In the claim-of-right doctrine, if a taxpayer
received money or other property and treats it as its own
under the claim of right that the payments are made
absolutely and not contingently, such amounts are
included in the taxpayer’s income, even though the right
to the income has not been perfected at that time. It
does not matter that the taxpayer’s title to the property
is in dispute and that the property may later be
recovered from the taxpayer.
iii. All events test
A test that applies to accrual method taxpayers
to determine when a liability is incurred and therefore
deductible for federal income tax purposes. Under the
accrual method of accounting, a liability is generally
recognized for federal income tax purposes in the
taxable year in which:
 All events have occurred that establish the fact of
the liability.
 The amount of the liability can be determined with
reasonable accuracy.
 Economic performance has occurred regarding the
liability.
Section 461(h) of the Internal Revenue Code
provides that if the liability of the taxpayer arises out of
the provision of services to the taxpayer by another
person (for example, an employee providing services to
an employer), then economic performance occurs when
the services are provided.
All events that establish the fact of the liability
generally have occurred on the earlier of the date:
 The event fixing the liability occurs.
 Payment is unconditionally due.
While it is possible for the fact of liability to be
established before an amount becomes due and payable,
legal rights and obligations must exist. No deduction is
allowed for anticipated expenses, no matter how likely
they are to occur.
In the case of bonus liabilities, where certain
conditions must be met after services are performed but
before payment (for example, if under the terms of a
company's annual bonus plan the bonuses are subject to
the approval of the compensation committee), the
conditions may prevent the liabilities from meeting the
fact of liability and amount of liability prongs of the all
events test until the year in which the conditions are
satisfied (in this example, the year in which the
approval is obtained). Recent informal guidance from
the Internal Revenue Service highlights this issue.
 Accounting Periods and Methods – correlate
with recognition of income and expense.
1. Sec. 43-50 of the NIRC
2. Change in Accounting Period
Principal Methods:
1. Cash Method - income, profits and gains earned are
not included in gross income until received, and
expenses are not deducted until paid.
2. Accrual Method - income, profits and gains are
included in gross income when earned, whether
received or not, and expenses are allowed as deductions
when incurred, although not yet paid. It is the right to
receive and not the actual receipt that determines the
inclusion of the amount in gross income.
3. Hybrid Method - income and expenses are reported
by employing the combination of cash and accrual
method. Example: where a taxpayer is engaged in more
than one trade or business, he may use a different
method of accounting for each trade or business.
 INDIVIDUAL INCOME TAXATION
1. KINDS OF INDIVIDUALS (Sec. 22)
A. Citizens
i. Resident Citizen
ii. Non-resident Citizen
1. PH citizen who establishes to the satisfaction of the
CIR the fact of his physical presence abroad with a
definite intention to reside therein.
2. PH citizen who leaves the Philippines
during the taxable year to reside abroad, either as an
immigrant or for employment on a permanent basis.
3. PH citizen who works and derives income from
abroad and whose employment there at requires him to
be physically present abroad most of the time during the
taxable year. To be considered physically present
abroad most of the time during the taxable
year, a contract worker must have been outside the PH
for not less than 183 days during such taxable year.
4. PH citizen previously considered as a
non-resident citizen and who arrives during the taxable
year to reside permanently in the PH - Treated as NRC
with respect to his income derived from sources abroad
until his arrival in the PH.
Note: The term ‘residence’ is to be understood not in its
common acceptation as referring to ‘dwelling’ or
‘habitation,’ but rather to ‘domicile’ or legal residence,
that is, ‘the place where a party actually or
constructively has his permanent home, where he, no
matter where he may be found at any given time,
eventually intends to return and remain (animus
manendi).
B. Alien
i. Resident Alien - An alien actually present in the
Philippines who is not a mere transient or sojourner is a
resident for income tax purposes.
a. No/Indefinite Intention = RESIDENT: If he lives
in the Philippines and has no definite intention as to his
stay, he is a resident. A mere floating intention
indefinite as to time, to return to another country is not
sufficient to constitute him a transient.
b. Definite Intention = TRANSIENT: One who comes
to the Philippines for a definite purpose, which in its
nature may be promptly accomplished, is a transient.
Exception: Definite Intention but such cannot be
promptly accomplished; If his purpose is of such nature
that an extended stay may be necessary for its not
accomplishment, and thus the alien makes his home
temporarily in the Philippines, then he becomes a
resident.
ii. Non-resident Alien
A. Engaged in trade or business - If the
aggregate period of his stay in the Philippines is
more than 180 days during any calendar year.
[Sec. 25(A)(1), NIRC]
B. Not engaged in trade or business
- If the aggregate period of his stay in
the Philippines does not exceed 180 days.