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LEARNING OUTCOMES
At the end of this module, you are expected to:

1. Identify the different sources of reportable gross income; and

2. Explain the different principles to be considered in reporting items of income under gross
income; and
3. Eliminate the effects of value-added tax and creditable withholding tax in computing the
gross income

Pre-Activity
Try to answer the following questions.
1. Remembering what you learned from Module No. 5, what is the difference between
prizes and winnings?
2. Get a copy of a receipt from your recent purchase, what are the taxes that you can see
on the document?

For purposes of the discussions in this module, when the phrase “inclusion in gross income”
is used, it would mean the items of income which are reportable under gross income in the
income tax return for the regular income taxation scheme.

GENERAL CRITERIA
Items of gross income subject to regular income tax are not limited to those mentioned under the
NIRC. The regular income taxation scheme is a catch-all provisions for all income derived from
whatever sources that are:

a. Not subject to final tax, capital gains tax and special tax regimes, and
b. Not excluded or exempted by law, treaty, or contract from taxation.

COMPENSATION FOR SERVICES

Under current tax rules, the term "compensation income" technically pertains to the types of
employee benefits that are subject to regular tax. The fringe benefits of managerial or supervisory
employees are not considered compensation income and are subject to final tax. This will be
extensively discussed in the next module.
BUSINESS INCOME
This includes income from any trade or business, legal or illegal, and whether registered or
unregistered. This has been discussed mostly on Module 7.

The following business income shall not be included in gross income subject to regular income
tax:

1. Business income exempt from income tax such as:

a. Gross income from a Barangay Micro-Business Enterprise (BMBE) under RA
9178
b. Gross income from enterprises enjoying tax holiday incentives under E0 226
which have not yet graduated to their income tax holiday incentives
2. Business income subject to special tax regime such as:
a. Philippine Economic Zone Authority (PEZA)-registered enterprises subject to 5%
gross income tax
b. Tourism Infrastructure and Enterprise Zone Authority (TIEZA)-registered
enterprises subject to 5% gross income tax
c. Income of self-employed and or individuals (SE/P) who opted to be taxed under
the 8% income tax
3. Business income subject to final tax when not subjected to final tax by the payor
a. Subcontractors of petroleum service contractors subject to 8% final tax
b. Business income of foreign currency deposit units (FCDUs) and offshore banking
units (OBUs) from Philippine residents subject to 10% final tax

GAINS FROM DEALINGS IN PROPERTIES

This will be extensively in Module No. 12.

INTEREST INCOME
This particularly refers to interest income other than passive interest income subject to final tax.
A taxable interest income must have been actually paid out of an agreement to pay interest. It
cannot be imputed.

The following are exempt from regular income taxation:

1. Interest income earned by landowners in disposing their lands to their tenants pursuant
to the Comprehensive Agrarian Reform Law
2. Imputed interest income
 Illustration 9.1
EGA Finance reported the following interest income during the year:
From loans 3,000,000
From deposits with banks 400,000
Notes rediscounting 100,000
Treasury notes 50,000

The interest income from deposits and T-notes are subject to final tax, therefore, not inclusions as gross
income under regular taxation.

RENT INCOME
Rent income arises from leasing properties of any kind. It is a passive income but is not subject to
final tax under the NIRC; hence, it is subject to regular income tax. Aside from the periodic
receipts of such, the following should be considered.

1. Obligations of the lessor that are assumed by the lessee are additional rental income to
the lessor.
2. Leasehold improvements made by the lessee on the leased property are recognized by
the lessor as income using the spread-out method or outright method.
3. On advance rentals,
Inclusion Exclusion
 Unrestricted  It constitutes a loan
 Restricted to be applied in future years or  It is a security deposit to guarantee
upon the termination of the lease payment or rent subject to contingency
which may or may not happen

ROYALTIES
Royalties earned from sources within the Philippines are generally subject to final income tax
except when they are active by nature. Active royalty income and royalties earned from sources
outside the Philippines are subject to regular income tax.

Type/Source Within Abroad

Passive X ✓
Active ✓ ✓
 Illustration 9.2
Maestra Rihanna has the following royalties during the year.
From mining properties in the Philippines 550,000
From musical compositions in the Philippines 450,000
From books published abroad 250,000
From licensing earned by her domestic business 800,000

All but the royalty from musical compositions is inclusions in gross income since it is subject to final
tax.

DIVIDENDS
These pertain to dividends declared by foreign corporations. It should be recalled that dividends
declared by domestic corporations are generally subject to 10% final tax if the recipient is an
individual taxpayer and exempt if the recipient is a domestic or a resident foreign corporation.
Cash, property, and script dividends from foreign corporations are items of gross income subject
to regular income tax.

Source (right) / Non-Resident

Domestic Resident Foreign
Recipient (below) Foreign
RC, DC X ✓ ✓
NRC, RA, NRA-ETB,
X Pre-dominance test X
RFC, NRFC

Illustration 9.3
A portfolio of equity investments held by a taxpayer received cash dividends from the
following during the year.
Domestic Corporation 400,000
Resident Foreign Corporation 300,000
Non-Resident Foreign Corporation 200,000
The pre-dominance test on the RFC revealed a 60% rate.

The P400,000 dividend from domestic corporation is excluded regardless of the recipient. If the taxpayer
is a resident citizen or domestic corporation, the gross income of P500,000 should be included, otherwise,
only the P180,000 relating from the pre-dominance test is an item of gross income.
ANNUITIES
The excess of annuity payments received by the recipient over premium paid is taxable income
in the year of receipt.

Illustration 9.4
Andrew purchased an annuity contract for P100,000 which shall pay him P10,000 annually
until he dies.

The receipt of the first 10 annual annuity payments is a return of capital. Any further receipt from year
11 onwards is an item of gross income subject to regular income tax.

PRIZES AND WINNINGS

Prizes and winnings that are exempted from final tax are not items of gross income subject to
regular income tax.

Earned within by Earned within by

Nature Earned abroad
individuals corporations
Prizes and PCSO
✓ ✓ ✓
winnings at most P10,000
Prizes and PCSO
winnings more than X ✓ ✓
P10,000
Winnings from other
X ✓ ✓
sources

PENSIONS
These pertain to pensions and retirement benefits that fail to meet the exclusion criteria and hence
subject to regular tax.

SHARE IN NET INCOME OF SPECIAL CORPORATIONS

Shares in the net income of pass-through entities are subject to the regular income tax. These
would include income earned from exempt partnerships, joint ventures and co-ownerships.

Taxability of Entity Organized Within Organized Abroad

Taxable X ✓
Exempt ✓ ✓
INCOME DISTRIBUTIONS FROM TAXABLE ESTATES AND
TRUSTS
Recall that income earned by estates and trusts which are distributed to the heirs/beneficiaries
are deemed deductions against the gross income of the estate or trust. These, however, are taxable
to the beneficiary.

Illustration 9.5
Continuing Illustration 7.7, The P1,250,000 income distributed to the heirs is taxable to the heirs.
The same goes with the P300,000 received by Mr. Salamat in Illustration 7.8.

RECOVERIES OF PAST DEDUCTIONS

Tax benefit rule is a general principle in taxation which states that if a taxpayer deducted an item
on his income tax return and enjoyed a tax benefit (reduced his income tax) thereby, and in a
subsequent year recovers all or part of that item, he will recognize gross income in the year the
deducted item is recovered to the extent of the benefit realized.

Past deductions that created tax benefits to the taxpayers must be reverted back to gross income
in the year of recovery so that the government will recover the tax lost from the deduction.

The rule has both an inclusionary and an exclusionary component, i.e., the recovery is included
in the taxpayer's gross income to the extent that the taxpayer obtained a tax benefit from the prior
year's deduction, and the recovery is excluded to the extent that the prior year's deduction did
not provide a tax benefit.

Illustration 9.6
A taxpayer incurred P60,000 bad debt expense in 2018 out of which P35,000 was recovered in
2020:
2018 2019 2020
Net income before bad debts expense 100,000 80,000 120,000
(Bad Debts Expense)/Recoveries (60,000) - 35,000
Net Income after bad debts expense 40,000 80,000 ???

The entire P60,000 deduction in 2018 is a tax benefit to the taxpayer. Hence, the P35,000 recovery from
this deduction is a tax benefit which must be reverted back to gross income in 2020. The taxable net
income in 2020 shall be P155,000.
Illustration 9.7
A taxpayer incurred P90,000 bad debt expense in 2018 out of which P60,000 was recovered in
2020.
2018 2019 2020
Net income before bad debts expense 70,000 100,000 120,000
(Bad Debts Expense)/Recoveries (90,000) - 60,000
Net Income after bad debts expense (20,000) 100,000 ???
NOLCO (20,000)
Net income 80,000

The entire P90,000 deduction is a tax benefit. The taxpayer benefited by the P70,000 reduction in 2018
taxable income plus the P20,000 carry-over of NOLCO. The P60,000 recovery from the deduction in
2020 is a tax benefit subject to tax. The reportable net income in 2020 shall be P180,000.

Illustration 9.8
A taxpayer incurred P60,000 bad debt expense in 2018 out of which P35,000 was recovered in
2020:
2016 2017 2018 2019 2020
Net income before bad debts expense 100,000 (130,000) 80,000 (160,000) (70,000)
(Bad Debts Expense)/Recoveries (500,000) 500,000
Net Income after bad debts expense (400,000) (130,000) 80,000 (160,000) ???
NOLCO (80,000)
Net Income -

The interest expense saved the 2016 P100,000 pre-tax income and the 2018 P80,000 net income from
taxation. Note that NOLCO can be deducted only against net income in the next three years. The
P320,000 remaining NOLCO expired in 2019 without tax benefit The P500,000 interest deduction only
benefited the taxpayer P180,000. Hence, only P180,000 of the P50,0000 recovery in 2020 shall be
reverted back to the 2020 gross income.
Illustration 9.9
A taxpayer incurred P90,000 bad debt expense in 2019 out of which P45,000 was recovered in
2020:
2019 2020
Net income before bad debts expense 70,000 (15,000)
(Bad Debts Expense)/Recoveries (90,000) 45,000
Net Income after bad debts expense (20,000) ???

An increase in NOLCO which has not expired before the beginning of the taxable year in which the
recover), takes place shall be treated as tax benefit. Thus, the entire P90,000 is a tax benefit to the
taxpayer. Hence, the P45,000 recovered out of it is a tax benefit which must be reverted back to gross
income in 2020.
The 2020 net income shall be computed as follows:
Net loss before recovery (15,000)
Recovery 45,000
Net Income 30,000
NOLCO (20,000)
Taxable net income 10,000

Illustration 9.10
A corporate taxpayer had a change in 80% of its shareholders in 2020. Thus, any net operating
loss incurred before 2019 is not allowed to be carried over. A P90,000 bad debt write-off was
made in 2019 out of which P60,000 was recovered in 2021.
2019 2020 2021
Net income before bad debts expense 70,000 100,000 120,000
(Bad Debts Expense)/Recoveries (90,000) - 60,000
Net Income after bad debts expense (20,000) 100,000 ???

The tax benefit of the P90,000 bad debt expense to the corporation in this case shall be determined using
the As-If Approach. Re-compute the net income in the year of deduction by adjusting the deduction as if
the subsequent deduction recovery is known. The computed net income is compared to what was
previously reported to determine the income that is saved from taxation.
Assuming the future recovery is known, the 2019 net income should have been:
Net income before bad debt expense 70,000
Bad debt expense if recovery was known 30,000
Net income if recovery was known 40,000
 The tax benefit is the income that escaped taxation in 2019 computed as:
Net income if recovery was known 40,000
Net income as reported in 2019 (recovery is known) 0
Tax benefit of the bad debt expense 40,000
P40,000 out of the P60,000 recovery in 2021 constitutes tax benefits which must be included in the 2021
gross income. The 2021 net income shall be P160,000.

REIMBURSEMENTS OF EXPENSES
Expenses of the taxpayer that are reimbursed or paid by the customer or client constitute
additional income to the taxpayer.

Examples:

1. When the lessee pays the ownership costs of the lessor such as real property tax and
insurance on the property, the payment constitutes income to the lessor.
2. When a client reimburses the out-of-pocket expenses of a professional practitioner, the
reimbursements are income to the practitioner.

CANCELLATION OF INDEBTEDNESS
The cancellation of indebtedness may amount to gratuity or payment of income.

The cancellation of debt:

a. In consideration of service or goods - treated as income

b. As an act of gratuity - treated as gift; not as income
c. As capital transaction such as forfeiting the right to receive dividends in exchange of the
debt - treated as dividend income

EFFECTS OF CONCURRENT TAXES

The effects of creditable withholding taxes and value-added taxes should be removed.

Illustration 9.11
Charles Paul Adizon, CPA obtains his only income from professional fees on his practice of
accounting profession. He is a VAT taxpayer whose income is subject to 10% creditable
withholding tax. During the year, the cash inflows from professional fees totaled P3,468,000.
Allowable deductions amount to P1,400,000.
 His tax payable will be:
Net Professional Receipts Received 3,468,000
Divide by: (100%+12%-10%) 102%
Professional Income 3,400,000
Less: Allowable Deductions 1,400,000
Taxable Income 2,000,000

Tax Due 490,000

Less: Tax Credits (3,400,000 x 10%) 340,000
Tax Payable 150,00
Let us check the amount of the professional fee.
Professional Income 3,400,000
Value-Added Tax (3,400,000 x 12%) 408,000
Less: Creditable Withholding Tax (3,400,000 x 10%) 340,000
Net Cash Received 3,468,000

References:
Banggawan, R. (2019). Income Taxation. Pasay City: Real Excellence Publishing.
Valencia, G. & Roxas, E. (2016). Income Taxation. Baguio City: Valencia Educational Supply.
Reyes, V. (2019). Income Tax Law and Accounting under the TRAIN Law. Manila: GIC Enterprises & Co., Inc.
Ampongan O. (2018). Income Taxation. Mandaluyong City: Millennium Books, Inc.
Self-Check!
Basing on your readings, answer the following questions.
1. What are the different sources of taxable gross income?
2. What is the effect of past deductions which are subsequently recovered?
3. What is the effect of reimbursement of expenses paid?
4. What is the effect of cancellation of indebtedness?
5. How are creditable withholding taxes and value-added taxes reflected under gross
income?

Exercise 9.1 TRUE OR FALSE

Determine whether the following statements are true or false.
___________1. Income that is not realized is not taxable, but illegal income is taxable.
___________2. Income received under a mistake of fact or law is to be included as part of
gross taxable income.
___________3. If the advance rental is received as a security deposit without restriction, then
such amount should be excluded in the determination of rental income.
___________4. The amount of bad debts which resulted to reduction of taxable income will
become a taxable income in the subsequent year when such is eventually
recovered.
___________5. The cancellation of a taxpayer’s indebtedness is an income unless such
cancellation is intended as a gift.
___________6. If debt is cancelled due to services rendered by the debtor, the basis of tax is
the value of the services rendered.
___________7. Gross income includes all income from whatever sources whether legal or
illegal.
___________8. Income that is not realized is taxable.
___________9. When stock dividends received are of a different class from shares previously
acquired, the stock dividends are taxable income.
___________10. Passive income earned abroad by a resident citizen that has been subjected to
foreign final tax shall not anymore be taxed in the Philippines.
___________11. In terms of partnerships, joint ventures and co-ownerships, shares in their net
income are subject to regular tax is the entity is taxable.
___________12. The refund or recovery of non-deductible taxes shall not be reverted back to
gross income.
___________13. Corporate prizes are exclusions in gross income subject to final tax but are
inclusions in gross income subject to regular income tax.
___________14. Capital gains are, in general, subject to capital gains tax, therefore, are not
inclusions in gross income for regular income tax.
___________15. The interest income from bonds issued by banks is subject to final tax.

Exercise 9.2 MULTIPLE CHOICE

Choose the best answer from the choices provided.
______1. Which of the following is not an inclusion?
a. Prize received by a resident individual from a foreign source
b. Prize received by a domestic corporation from a foreign source
c. Winnings received by a non-resident foreigner from a foreign source
d. Winnings received by a resident corporation from a domestic source

______2. Which of the following dividends should be reported as an item of gross income?
a. From domestic corporation to resident citizen
b. From non-resident foreign corporation to resident citizen
c. From domestic corporation to resident alien
d. From non-resident foreign corporation to resident alien

______3. Which of the following will not be reported in gross income?

a. Receipt of inheritance
b. Share in the net income of a foreign partnership
c. Royalties from foreign sources
d. Income distribution from a taxable estate

______4. Interest income from which of the following sources is an exclusion from gross
income?
a. Notes
b. Bonds
c. Lending
d. Deposits

______5. Which is subject to regular tax to a resident foreign corporation?

a. Service fee abroad
b. Gain from sale of real property capital assets in the Philippines
c. Dividends from a domestic corporation
d. Gain from dealings in properties abroad
Problem 9.1 COMPREHENSIVE
Valkyrie reported the following income during the year.
Within Abroad
Service Fees 400,000 300,000
Interest Income from bank deposits 40,000 70,000
Royalties from franchise 80,000 30,000
Gains on property dealings 10,000 100,000
Winnings 60,000 50,000
Prizes 5,000 -
Determine the total amount of gross income if Valkyrie is a:
_____________1. Domestic corporation
_____________2. Resident Citizen
_____________3. Resident Alien
_____________4. Resident Foreign Corporation

Problem 9.2 CONCURRENT TAXES

Dr. Ken Jeong is a famous celebrity doctor. He is a VAT taxpayer and is subject to 10%
expanded withholding tax. The following are his items of income and expenses during the year.
Professional medical fees from a hospital (gross of VAT and EWT) 2,016,000
Professional medical fees from his clinic (net of VAT and EWT) 432,000
Talent fees from TV guestings (gross of VAT, net of EWT) 2,040,000
Talent fees from endorsements (net of VAT, gross of EWT) 1,450,000
Allowable Deductions 650,000
Compute for his tax due.

Problem 9.3 COMPREHENSIVE

Mang Jose has several interests in various businesses and partnerships. He received the
following income during the year.
Dividends from a domestic corporation 120,000
Dividends from a resident foreign corporation 80,000
Share in net income of a business partnership 200,000
Share in net income of a professional partnership 100,000
Share in net income of a joint venture 50,000
Share in net income of a co-ownership 20,000
How much is the total income to be reported in gross income?

Problem 9.4 DIVIDENDS

AMC received the dividends from the following sources:
Domestic corporation 245,000
Resident foreign corporation (40% pre-dominance rate) 150,000
Resident foreign corporation (70% pre-dominance rate) 200,000
Non-resident foreign corporation 50,000
Compute the total income to be reported as gross income if AMC is a:
___________1. Resident Citizen
___________2. Non-resident Citizen
___________3. Domestic Corporation
___________4. Resident Foreign Corporation

Problem 9.5 RECOVERY OF PAST DEDUCTIONS

In 2018, Uno Company wrote-off P80,000 worth of receivables. These were fully recovered in
2021. The following were the net income/(loss) before bad debts expense.
2019 (80,000)
2020 20,000
2021 100,000
Compute for the 2021 taxable income assuming the net income before bad debts expense
during 2018 is:
_____________1. P120,000
_____________2. P50,000
_____________3. P70,000