Course Code and Title: BACR 5 – INCOME TAXATION

Lesson Number : 8

Topic : Exclusions from Gross Income

Instructor: Prof. Rosario A. Calamba, CPA,MBM, Phd Cand.

__________________________________________________________

LEARNING OBJECTIVES:

At the end of this lesson, the student should be able to:

1. Identify the various items of exempt income as provided by the NIRC and special
laws; and

2. Explain the scope of the income tax exemption of minimum wage earners and
BMBEs.
PRE-ASSESSMENT

Try to answer the following questions.

1. Are gifts received subject to income tax?
2. When are proceeds of life insurance subject to income tax?
3. What is the difference between retirement benefits and separation pay?

LESSON PRESENTATION

INTRODUCTION
As discussed from the previous module, exclusions from gross income are items of
income which are not reported anymore in the gross income in the income tax return.
In this module, the discussion will focus on those exempt income on regular income tax
provided by the tax code and other special laws.

PROCEEDS OF INSURANCE POLICIES

As discussed from previous modules, life is a capital item with infinite value, thus, proceeds
from life insurance policies as a result of the death of the insured is not taxable. This is only
applicable if the proceeds are paid to the heirs of beneficiaries. Proceeds, however, from sale of
an insurance policy or outliving a life insurance policy is taxable to the extent to the amount
exceeding the return on capital.

Illustration 8.1
Solui applied for a P5,000,000 insurance policy requiring payment of P10,000 monthly
premiums for ten years.

Scenario 1: It is a life insurance policy on Solui and he dies after three years.
The whole amount of the P5,000,000 proceed is not taxable.
 Scenario 2: It is a life insurance policy on Solui and he sells it for P600,000 after paying 52
months of premium. Solui dies after the buyer pays five months of premium.
The amount of P520,000 (52 months x P10,000) is a return of capital, therefore, it is not taxable.
The excess of P80,000 from the proceeds, however, is taxable to Solui since it constitutes a return
on capital.

The buyer of the policy shall be exempt on the P650,000 (P600,000 purchase price + P50,000
premiums paid) received. The excess of P4,350,000 is taxable since he is not the heir or beneficiary.

Scenario 3: It is a life insurance policy on Solui and he dies at the end of second year. The
heirs received P5,100,000 six months after his death.
The excess of P100,000 over the face of the insurance policy constitutes an interest income which is a
return on capital, hence, taxable.

Scenario 4: It is a life insurance policy on Solui and he outlives the policy. He received the
maturity value of P1,400,000.
Only the total amount of premiums paid is exempt. The excess of P200,000 is an item of gross income.

Scenario 5: It is a property insurance for a building with a tax basis of P3,000,000. The
building was burnt.
The tax basis of P3,000,000 is an exclusion from gross income. Only the excess of P2,000,000 is
taxable.

The exemption extends to that of corporations insuring their officers with the corporation as
the beneficiary. Premium paid on such are non-deductible against gross income.

GIFTS, BEQUESTS AND DEVISES

The value of property acquired by gift, bequest, devise, or descent: Provided, however, that
income from such property as well as gift, bequest, devise, or descent of income from any
property, in cases of transfers of divided interest, shall be included in gross income.

Illustration 8.2
Mark received a restaurant business as a gift on April 1, 2020. On that date, the restaurant had
total properties amounting to P400,000 including P50,000 cash income earned since January 1,
2020. The restaurant posted an additional P150,000 cash income from April 1 to December 31,
2020.
The transfer of business properties worth P400,000 to Mark is a gratuity subject to transfer tax, not
income tax. However, the P50,000 donated income shall be included in gross income, but in the income
tax return of the donor. The P150,000 income of the donated property after the perfection of the
donation is included as item of gross income in the tax return of Mark, the donee.

COMPENSATION FOR DAMAGES

As a rule, amounts received through Accident or Health Insurance or under Workmen's
Compensation Acts, as compensation for personal injuries or sickness, plus the amounts of any
damages received whether by suit or agreement on account of such injuries or sickness are
excluded from gross income.

Nontaxable, if the compensation for damages is on account of

a. Personal physical injuries or sickness;

b. Any other damages recovered on account of personal injuries or sickness;
c. Exemplary and moral damages for out-of-court settlements including attorney's fees;
d. Alienation of affection, or breach of promise to marry; and
e. Any amount received as a return of capital or reimbursement of expenses.

Taxable, if the compensation for damages is a payment for

a. Actual damages for loss of anticipated profits;

b. Moral and exemplary damages awarded as a result of breach of contract;
c. Interest for nontaxable damages above: and
d. Any damages as compensation for unrealized income.

Illustration 8.3
Mr. Sammy Haban, a supervisor in a Milling Company, was accidentally bumped by Zigzag
Taxi resulting to his severe physical injuries. The court decided that Zigzag would pay Haban the
following Moral
damages which Zigzag paid for a certain period of time:
Damages 100,000
Exemplary Damages 50,000
Damages for permanent loss of earning capacity 200,000
Actual liquidated damages 50,000
Compensation for unrealized earnings 30,000

Only the P30,000 compensation is taxable for since it is a recovery of lost earnings. The
remaining
P400,000 will be exempted from income tax.
INCOME EXEMPT UNDER TREATY
Income items that are excluded by international agreement to which the Philippine government
is a signatory are excluded from income tax. It must be recalled that treaty agreements override
provisions of our revenue tax laws in case of conflict under the exemption doctrine of
international comity.

RETIREMENT BENEFITS
Exempt from income tax are retirement benefits received under R.A. 7641 and those received by
officials and employees of private firms in accordance with a reasonable private benefit plan
maintained by the employer.

Requisites of Exemption
All of the following requisites must be satisfied to avail of the exemption.

a. This is the first time availment of retirement benefit exemption.

b. The retiring official or employee has been in the services of the same employer for
at least cumulative ten (10) years.
c. The retiring employee is at least fifty (50) years of age at the time of retirement.
d. The employer maintains a reasonable private benefit plan.

Illustration 8.4
Yorla, a new year baby, started working on January 17, 1983 at the age of 22 years old.
Following is the timeline of her employment. All companies maintain a reasonable private
benefit plan.
Availed Retirement
Company Inclusive Dates Program?
Boom Aleck Co. January 15, 1983 – July 15, 1986 No
Loom Ipat Corp. July 16, 1986 – September 19, 2002 Yes
Naumay Inc. September 21, 2002 – October 14, 2011 Yes
Boom Alik Co. October 17, 2011 – March 18, 2018 Yes

The benefit from Loom Ipat is taxable since Yorla was still 41 years old back then. The retirement
benefit from Naumay is still taxable since even though she was 50 years old, the years of service is less
than 10 years. The retirement benefit from Boom Aleck is exempt even though it is not the first time
that Yorla avails the retirement program since the exemption is not availed for the former retirement
benefits received. In addition, Yorla satisfies the 10-year period of service and 50-year age.
SEPARATION AND TERMINATION BENEFIT
Requisite of Exemption
Either of the following requisites must be satisfied to avail of the exemption.

1. The separation or termination must be due to job-threatening sickness, deaths, or

other physical disability; and
2. The same must be due to any cause beyond the control of the employee or official
such as:
a. Redundancy
b. Retrenchment
c. Closure of employer's business
d. Employee lay-off
e. Downsizing of employer's business
f. Sickness or death of the employee

The phrase "beyond the control of the employee" connotes involuntariness on part of the
employee. In other words, the separation must not be of his making.

Limitation
The exemption of termination or separation benefits does not extend to:

1. Backwages or illegal deductions repaid by the employer upon termination

2. Terminal leave pay or the commutation of accumulated unused leave credits

Availment
To avail of the tax exemption, the employee or his heirs shall request for a ruling or certificate of
exemption (CTE) from the BIR. The request for a CTE and other required documents shall be
filed at the RDO where the employer is registered.

Illustration 8.5
Kala is an employee of Goship Company which closed its business during the year. Kala's last
Unpaid salary in the last two months 30,000
paycheck shows the following details:
Current month salary 15,000
Separation pay 100,000

Scenario 1: Kala was chosen to be laid off first because she was the last person to be hired.
Only the P100,000 received is exempt. The backwages and current salary are taxable.
Scenario 2: Kala was chosen to be laid off first because she was had allergic rhinitis.
The whole amount of the last paycheck is taxable since the reason does not normally render the
employee incapable of working.

Scenario 3: Kala chose to resign first.

The whole amount is taxable as the resignation violates the beyond the employee’s control rule.

SOCIAL SECURITY BENEFITS

Received from Foreign Income

This would include social security benefits, retirement gratuities, and other similar benefits
from foreign government agencies and other institutions, private or public, received by resident
or non-resident citizens or aliens who come to settle permanently in the Philippines.

Illustration 8.6
John was an OFW employed by Microsoft Corporation in the USA. John retired and returned
to permanently settle in the Philippines. He is paid a $2,000 monthly pension from Microsoft's
pension fund and another $800 monthly benefit from the US social security benefit.

Both the pension and the social security benefits are exempt. Note that these benefits were earned
abroad when the taxpayer was a non-resident Under situs rule, the foreign Income of non-residents is
not taxable in the Philippines. This holds true even if the taxpayer subsequently receives the income as
a resident of the Philippines.

SSS Benefits
This would be the social security benefits under RA 8282.

GSIS Benefits
These are benefits under RA 8291 including retirement gratuity received by government
officials and employees.

USVA BENEFITS
These are United States Veterans Administration – administered benefits under the law of the
United State received by any person residing in the Philippines.
Illustration 8.7
Mr. Jackson is a retired US serviceman from the Iraqi war. He married a beautiful Filipino
and settled in the Philippines. He is receiving a $1,000 monthly benefit from the USVA.

The USVA benefit is excluded in gross income. The same rule applies to USVA benefits for
beneficiaries of Filipino veterans who fought under the American flag in World War II.

MISCELLANEOUS ITEMS
Income from Domestic Securities
Exempt are those income derived on investments in the Philippines in loans, stocks, bonds, or
other domestic securities, or from interest on deposits in banks in the Philippines by:

a. Foreign governments
b. Financing institutions owned, controlled, or enjoying refinancing from
foreign government
c. International or regional financial institutions established by foreign

governments These are exempt under the exemption doctrine of international comity.

Government Income
Exempt are those income derived by the government and its political subdivisions from:

a. Any public utility; or

b. Exercise of essential government function Government agencies and instrumentalities

The general rule with government agencies and instrumentalities is exemption because of their
public service nature. However, taxation applies when they engage in income-producing
activities which are proprietary or commercial in nature. This exemption does not extend to
government-owned and controlled corporations (GOCCs). GOCCs are generally taxable as
regular corporations because their operations are proprietary in nature.

Mandatory Payroll Deductions

These pertain to the employee share in the premium contributions to GSIS, SSS, PhilHealth,
Pag-Ibig and union dues. The portion of the salary thus contributed is exempt from income
tax. Under RMC No. 21-2011, the exclusion pertains only to the mandatory or compulsory
monthly c ontributions. Voluntary contributions to Pag-Ibig II, GSIS or SSS in excess of the
mandatory monthly contribution are taxable. Note that Pag-Ibig is now called the Home
Development Mutual Fund or HDMF. This will not be illustrated anymore since the same has
been discussed in your BAINTE1X class.
Personal Equity and Retirement Account
PERA is a contributor's voluntary retirement account established from qualified contributions
of the contributor and or his employer for the sole purpose of being invested in qualified PERA
investment products.

C ontributions to PERA accounts are exclusions in gross income. This is an additional exclusion
and is separate with the exclusion for contributions to SSS or GSIS. Moreover, PERA
contributors are allowed to claim 5% of their PERA contributions as tax credit against any
internal revenue taxes.

PERA i nvestment income are exempt from taxes (i.e. final tax, capital gains tax and regular
income tax). The PERA account assets will be distributed back to the contributor either in lump
sum, life pension or in installment upon reaching the age of 55 or to his heirs or beneficiaries
upon his or her death. PERA d istributions are likewise exclusions in gross income of the
contributor or his heirs or beneficiaries as the case may be.

13th Month Pay and Other Benefits

The amount received as such by officials and employees of public or private entities not
exceeding P90,000. This will be further discussed in detail in Module 9.

Gains on Sale of Long-Term Indebtedness

Gains from sale of bonds, debentures, or other certificate of indebtedness with a maturity of
more than 5 years are exempted. This exemption is grounded upon the same assumption that
long-term indebtedness is diverted to the financing of long-term projects which is viewed as
beneficial to the development of the country. The term "gain" however, does not include
"interest."

Illustration 8.8
On September 1, 2020, an individual taxpayer sold a 6-year term bond investment for
P1,100,000. These bonds bear 8% interest payable every December 31 were previously
acquired at P1,000,000 face value on January 1, 2020.

The interest accrued of P60,000 (P1,000,000 x 8% x 9/12) is taxable. The gain of P40,000 (P1,100,000
– P1,000,000 – P60,000) is exempt.

Gain on Redemption of Shares in a Mutual Fund Company

The term mutual fund company shall mean an open-end and close-end investment company as
defined under the Investment Company Act.
Mutual funds pool the money invested by different investors and invest the money to earn
investment income which shall add up to the net assets of the fund. A participating investor
must purchase participation shares from the fund at their Net Asset Value (NAV). Upon
redemption of his participation shares, the investor gains or losses by his proportionate share in
the increase or decrease in the Net Asset Value of the fund.

Illustration 8.9
A taxpayer bought 10,000 shares from Golden Dragon Mutual Fund at P120 NAV per share.
The taxpayer redeemed his shares when the NAV per share was P180.

The P600,000 gain, computed as [(P180 - P120) x 10,000], on redemption is excluded from gross
income; hence, exempt from taxation.

The exemption is apparently intended to mitigate double taxation. Most of the items of income
of mutual funds are subject to final tax at source. The subsequent distribution of these to the
investors at redemption should no longer be subject to income tax. On the other hand, the
exemption may have been intended to promote the growth of mutual funds which are widely
regarded as key participants in providing liquidity in most financial markets.

MINIMUM WAGE EARNERS

A minimum wage earner is an individual recipient of a minimum wage as fixed by the
Regional Tripartite Productivity Wage and Productivity Board of the Department of Labor and
Employment. A minimum wage earner is exempt from income tax on the minimum wage
including h oliday pay, overtime pay, night shift differential pay and hazard pay. This
exemption, however, does not extend to gross income from business or profession. The
presence of income besides that obtain from employment does not impair the exemption.

BARANGAY MICRO-BUSINESS ENTERPRISE (BMBE)

BMBE is a business entity or enterprise engaged in the production, processing or manufacturing
of products or commodities, including agro-processing, trading and services, whose total assets
including those arising from loans but exclusive of the land on which the particular business
entity's office, plant, and equipment are situated, do not exceed P3,000,000. The term service
excludes those rendered by licensed professionals and partnership and corporations engaged in
consultancy, advisory and similar services which are essentially carried out through licensed
professionals. A BMBE shall include any individual owning such business entity or enterprise,
partnership, cooperative, corporation, association, or other entity incorporated and/organized
and existing under Philippine laws and registered with the office of the treasurer of a city or
municipality.

To qualify as a BMBE, an enterprise must not be a branch or a subsidiary of a large scale

enterprise and its policies, and modus operandi must not be determined by a large scale
enterprise such as in the case of franchises. To avail of the benefits and privileges of a BMBE, an
applicant must secure a certificate of authority to operate as a BMBE from the Office of the
Treasurer of the city or municipality that has jurisdiction.

Tax Exemption on Income from Operations

Aside from other incentives afforded by the law, the income of BMBE from their operation is
exempt; hence, excluded from the gross income subject to regular income tax. BMBEs file an
Annual Information Return in lieu of the income tax return. However, their non-operating,
passive, and capital gains are subject to the appropriate type of income tax.

Illustration 8.10
William has a bakery with total assets of P4,000,000 inclusive of a lot with a book value of
P1,200,000.

Since the total assets, net of the land, is P2,800,000, William is qualified as a BMBE. If he obtained a
Certificate of Authority to Operate as BMBE, his income is exempt from regular income tax but is still
subject to other income taxation schemes.

COOPERATIVES
Cooperatives that transact business purely with members are exempt from all taxes and fees.
Cooperatives that transact business with non-members likewise exempt from all taxes and fees
if their accumulated reserve and undivided savings do not exceed P10,000,000. Otherwise, the
amount of allocated for interest on capitals is subject to regular tax. However, the income of any
cooperative from non-related sources is fully taxable to regular tax.

NON-STOCK AND NON-PROFIT ENTITIES

Non-stock entities that are not organized for profit are exempt from income tax on their income
from operations. However, their income from unrelated sources is taxable.
QUALIFIED EMPLOYEES' TRUST FUND
An employees' trust fund which forms part of a pension, stock bonus or profit sharing plan of
an employer for the benefit of some or all his employees is exempt from any income tax
under the NIRC.

Conditions for exemptions of employee trust funds:

a. Contributions are made to the trust by such employer, or employees, or both for
the purpose of distributing to such employees the earnings and principal of the
fund accumulated by the trust in accordance with such plan.
b. The asset of the fund shall not be diverted for other purposes other than the
exclusive benefit of the employees.

ACTIVITY/EVALUATION
TRUE OR FALSE:
Determine whether the following statements are true or false.
1. Physical, exemplary and moral damages except damages except
damages as loss of profit are not taxable.
2. GSIS and SSS benefits are included in gross income to the extent
they exceed P90,000.
3. A BMBE must have net assets not exceeding P3,000,000.
4. The proceeds of life insurance received by employer from
insurance policy coverage taken and paid by such employer
constitute taxable income.
5. An employee must have rendered a continuous 10 years of service
to avail exemption for retirement benefit.
6. If the minimum wage earner earns other income subject to regular
income tax, his statutory minimum wage becomes taxable.
7. The employer’s share to SSS, PhilHealth and HDMF
contributions are an exclusion to gross income.
8. Cooperatives, regardless of their classification, are taxable on
income from their unrelated activities.
9. Income subject to treaty obligation binding upon the
Government of the Philippines is exempted from income
taxation.
10. Termination pay for any cause beyond the control of an
employee is not subject to tax, except I dismissal is with a
cause.
 INCLUSION OR EXCLUSION
Write EX if the item is an exclusion from gross income, otherwise, write IN.
1. USVA-administered benefits
2. Dividend income derived in the Philippines by the Taiwan government
3. Magsaysay Award
4. Interest received from life insurance’s annuity
5. Separation pay received resulting from business merger
6. Separation pay due to voluntary resignation
7. Overtime pay of minimum wage earner
8. Interest income from bank deposits of a minimum wage earner
9. Union dues
10. PCSO winnings worth P10,000
11. Proceeds from sale of land held as capital asset
12. Income derived from smuggling
13. GSIS retirement benefits
14. Gains from redemption of shares in a mutual fund
15. Premium contributions to Modified PAG-IBIG 2 savings

REINFORCEMENT/ASSIGNMENT
Problem 8.1 NON-RESIDENT TAXPAYER
Gina is a Filipino citizen residing in Australia. She earned the following during the
taxable year: P900,000 from compensation, P40,000 interest income from EFCDU,
P60,000 dividends from a domestic corporation. The interest income from EFCDU
has a resident co-depositor.

How much of the P1,000,000 should be excluded from gross income?

Basic Pay 96,0 PhilHealth Contribution 2,000

00
Overtime Pay 5,000 HDMF Contribution 1,500
13th Month Pay 8,000 Cellphone Repair Revenue 200,000
SSS Contributions 3,000 Operating Expenses 80,000
Problem 8.2 NON-STOCK, NON-PROFIT ENTITY
A non-stock, non-profit charitable entity received the following during the taxable
year.
Contributions from the public 1,400,000
Income from sale of merchandise 500,000
Gain on the sale of properties 300,000

How much is the total exclusion from gross income subject to regular tax?
Problem 8.3 COOPERATIVE
Koop Eratiba, a multi-purpose credit cooperative, had the following income during
the taxable year.
Income from related activities 400,000
Income from unrelated activities:
Dividends from stocks 20,000
Income from time deposits 18,000
Rent Income 60,000

Answer the following questions.

1. How much of the income is taxable?
2. How much of the income is non-taxable?

REFERENCES:
 Income Taxation with Special Topics and Properly Filled BIR Forms, 2020
Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA
 Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S.
Tamayo, CPA, MBA
 Income Taxation-Laws, Principles and Applications- Rex B. Banggawan,
CPA, MBA
 National Internal Revenue Code of 1997
 Bureau of Internal Revenue Regulations
 Bureau of Internal Revenue Memorandum Circulars
 Supreme Court Jurisprudence on Tax Cases