De La Salle University

Commercial Law Department

CLWTAXN (Atty. Abu)

Notes on Income Taxation

I. Taxation of non-individual taxpayers

A. Corporations – the term corporation shall include partnerships no matter how created or
organized, joint-stock companies, joint accounts, associations, or insurance companies. But
it does not include:

1. General professional partnerships (GPPs); and

2. 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 contract with the government

B. Rates of tax (as amended by CREATE Law):

1. Domestic corporations and partnerships (but excluding GPPs, in general are

subject to a tax equal to 25% effective July 1, 2020.
2. For corporations with net taxable income not exceeding Five Million Pesos
(Php5,000,000) AND total assets not exceeding One Hundred Million
(Php100,000,000), excluding the land on which the particular business entity’s
office, plant and equipment are situated, the tax rate is 20% effective July 1, 2020.
3. Resident foreign corporations (July 1, 2020), Offshore Banking Units (date of
effectivity of CREATE), Regional Operating Headquarters (January 1, 2022), and
Nonresident Foreign corporations (January 1, 2021) will also transition into the
25% corporate income tax rate on the dates indicated above.
4. Proprietary educational institutions and non-profit hospitals are liable to a tax of
1% effective July 1, 2020 to June 30, 2023. The preferential tax rate will revert to
10% on July 1, 2023.
5. Domestic and resident foreign corporations are also subject to a final tax on certain
passive incomes.
6. On the fourth year immediately following the year in which they commenced their
business operations, a minimum corporate income tax (MCIT) of 1% effective July
1, 2020 to June 30, 2023. The MCIT rate will revert to 2% on July 1, 2023.
7. Under certain conditions, the are given the option to be taxed at 15% of their gross
income. (repealed by CREATE Law)
8. Lower rates are paid by the following nonresident foreign corporations:
i. Owners, lessors, or distributors of cinematographic films – 2.5% of gross
income;
ii. Vessels chartered by Philippine nationals – 4.5% of gross rentals or charter
fees; and
iii. Owners and lessors or aircrafts, machineries and other equipment – 7.5%
of gross rentals or fees.
9. An improperly accumulated earnings tax equal to 10% of the improperly
accumulated income is imposed on every corporation formed or availed of for the
purpose of avoiding the income tax with respect to its stockholders of any other
Notes on Income Taxation
CLWTAXN (Atty. Abu)

corporation, by permitting earnings and profits to accumulate instead of being

divided or distributed. (repealed by CREATE Law)
10. A final tax of 35% payable by the employer is imposed on the grossed up monetary
value (i.e. determined by dividing the actual monetary value of the fringe benefit
by 65%) of fringe benefits (ex. housing, expense account, vehicle, insurance
premiums, etc.) furnished or granted to employees (except rank-and-file
employees) by the employer, unless the fringe benefit is required by the nature of,
or necessary to the trade, business or profession of the employer, or when the
fringe benefit is for the convenience or advantage of the employer.

C. GPPs are partnerships formed by persons for the sole purpose of exercising their common
professions and not from engaging in any trade or business. They are not considered as
separate taxable entities and are not subject to income tax, but the partners are liable for
income tax in their separate and individual capacities.

GPPs are nevertheless required to file income tax returns for purposes of furnishing
information as to the share in the gains or profits which each partner shall include as gross
income in his or her individual income tax return.

For income earned by GPPs. The income tax is ultimately imposed on the partners
themselves on their separate and respective distributive shares of the net income of the
GPP which is computed in the same manner as a corporation. GPPs are deemed to be
no more than a mere mechanism or flow-through entity in the generation of income by,
and the ultimate distribution of such income to each of the partners respectively.

D. General co-partnerships or business partnerships are organized for the purpose of

engaging in trade or business and are treated as corporations for income tax purposes.
After deduction of the income tax, the income of the partnership shall be deemed to have
been actually or constructively received by the partners in the same taxable year, whether
actually or constructively distributed.

A business partnership is considered a corporation for income tax purposes regardless of

whether it is registered with the Securities and Exchange Commission as such or not
(since it is created by agreement between parties involved, see: Art.1767, Civil Code).

E. Estates and trusts – the income tax imposed upon individuals applies to the income of
estates or any kind of property held in trust:

1. Estate refers to all the property, rights and obligations of a person which are not
extinguished by death and also those which have accrued thereto since the
opening of succession (which is the mode of acquisition by virtue of which the
property rights and obligations to the extent of the value of the inheritance of a
person are transmitted through his death to another or others either by will or by
operation of law, Art. 774, Civil Code).
2. Trust is an arrangement created by will, agreement, or law under which no title to
property is held by one person (trustee) for the benefit of another (beneficiary). The
person who established the trust is called a trustor or guarantor. (Art. 1440, Civil
Code).

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

II. Gross income defined

Gross income is defined as income of whatever kind and derived by a taxpayer from whatever
source but not including exempt income (exclusions) and items of gross income subject to final
income tax (passive income). (Sec. 32[A], NIRC, as amended)

Gross income encompasses compensation income, as well as gains derived from expropriation
of property (i.e., when the government exercises its eminent domain powers to take private
property for public purpose in exchange of just compensation).

Income from gambling and even illegal activities are likewise part of gross income and are hence
taxable. All forms of income not expressly falling under any items in the enumeration under Sec.
32[A] are taxable. The intent of the law is to make the concept of income for purposes of taxation
all-inclusive, without excluding other items not mentioned, but which are includible in the
determination of gross income.

Under Sec. 32(A) of the NIRC, gross income means all income derived from whatever source,
including (but not limited to) the following items:

- Compensation inform services in whatever form paid, including, but not limited to,
fees, salaries, wages, commissions and similar items;
- Gross income derived from the conduct of trade or business or the exercise of a
profession;
- Gains derived from dealings in property;
- Interests;
- Rents;
- Royalties (payment made by the licensee or franchisee to another that owns a
particular intellectual property right or asset, in exchange for the right to use
intellectual property rights of another);
- Dividends;
- Annuities (amount paid yearly or at other regular intervals (e.g. quarterly) for a
certain/uncertain period);
- Prizes and Winnings;
- Pensions; and
- Partner’s distributive shares from the net income of the general professional
partnership.

Since the above is not an exclusive list, there can be other sources of income other than those
listed that may be considered as part of gross income.

III. Requisites of taxable income

For there to be taxable income:

1. There must be gain or profit;

Gain need not be in cash, it may be in any form, such as property or services. However, under
the law, it is sufficient that it may be appraised in terms of money.

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

Mere increase in value of property is not income but merely an increase in capital. No income is
actually derived from such increase until the owner disposes of the property in excess of its
original costs.

2. The gain must be received or realized; and

Constructive receipt of income occurs when taxable income is realized without actual receipt
of cash or property. (ex. interest credited by banks or partner’s distributive share on the net income
of a GPP is subject to tax for the year when credited although not yet actually received)

3. The gain must not be excluded or exempt by law or treaty from taxation.

IV. Exclusions

Exclusions are income that are exempt from tax. Such tax-free income is not to be included in
the tax return unless information regarding it is specifically called for.

The following are considered exclusions for purposes of determining gross income:

- Life insurance proceeds paid to the heirs/beneficiaries upon the death of the insured
are not subject to tax as they are considered more of an indemnity rather than as gain
or profit. [Sec. 32(B)(1)]

- Compensation for injuries or sickness - payment for injuries or sickness as they are
compensatory in nature. [Sec. 32(B)(4)]

- Value of property acquired by inheritance or donation as they are subject to estate tax
or donor’s tax.

- Retirement benefits, pensions, gratuities, etc. received by government officials (GSIS)

and employees (SSS) in recognition of their services, and retirement benefits received
by officials and employees of private firms under certain conditions. [Sec. 32(B)(6)]

NOTE: requisites under RA No. 4917: (1) retiree is with the same employer for at least
10 years, (2) at least 50 years at the time of retirement, and (3) retiree has not yet
previously availed of the privilege under the retirement benefit plan of the
same/different employer.

- Christmas bonus, 13th month pay, and other benefits received by officials up to a
maximum of P90,000.00. (As amended by TRAIN Law, Sec. 32[B][7][e])

- Gains from sale or retirement of bonds or other certificates of indebtedness with a

maturity of more than 5 years. Sec. 32[B][7][g]

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

V. Deductions

A. Definition

Deductions are items or amounts which the law allows to be deducted under certain conditions
from the gross income of a taxpayer in order to arrive at the taxable income and thereby determine
the amount of tax which is due.

Some basic rules governing deductions include:

1. Taxpayer seeking deduction must point to a provision of the statute/law clearly

authorizing the deduction claimed (Sec. 34 of the Tax Code);
2. Taxpayer must be able to prove that he is entitled to the deduction authorized/allowed;
3. Where particular deductions are authorized by the statute, no others may be made;
4. Deductions must be claimed under the particular category to which under the law they
belong (ex. Taxes should not be claimed as losses);
5. Sec. 34 covers all deductions in arriving at taxable business income of corporations,
partnerships and individuals. There is no more distinction between corporations and
individuals with respect to deductions from gross income from business. Gross
compensation income is taxable without deductions except premium payments and
personal and additional exemptions. (repealed by TRAIN Law)
6. As a rule, a taxpayer does not, within any year, deduct all his authorized allowances,
he cannot deduct them from the income of the next succeeding year. (Sec. 76, RR No.
2)

Exclusions
Items of income (excluded or exempt from
income tax or are subject to a different tax
treatment)
Not considered or “excluded” for purposes of
determining gross income.
Deductions
Items of expense (incurred in connection with
the trade or business of a taxpayer)
Deductions made from the gross income
determined in order to arrive at the net income
subject to the applicable income tax rate.

FORMULA:

Gross Receipts xxx

Less: Exclusions/Exemptions xxx
Gross Income xxx
Less: Deductions xxx
Net Income xxx
Multiply by: Applicable Tax Rate x%
Tax Due xxx

Taxable “gross income” is affected by exclusions because the latter are omitted from the former
and are not reported on the income tax return but it is not affected by deductions because they
are subtracted after gross income is determined and are reported on the return.

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

B. Kinds of deductions

Deductions for compensation income earners (i.e., personal and additional exemptions, as well
as the premiums for health and hospitalization insurance not to exceed P2,400.00 per annum)
have been repealed by TRAIN Law.

Individual/self-employed taxpayers earning business and/or professional income may deduct

itemized deductions under Sec. 34 although they have the option to elect Optional Standard
Deduction (OSD) of 40%. If the taxpayer opts for OSD, he/she cannot deduct premium payments
on health/hospital insurance, if applicable. (repealed by TRAIN Law)

C. Itemized deductions

Itemized deductions refer to items of ordinary and necessary expenses allowed under Section
34 and special laws, if applicable.

- Ordinary and necessary business expenses, including research and development;

- Interests (paid on indebtedness);
- Taxes (except certain taxes like income tax, estate, donor’s tax, VAT, income tax imposed
by any other jurisdiction);
- Losses (not compensated by insurance or other forms of indemnity, incurred in trade or
business);
- Bad debts (actually ascertained to be worthless);
- Depreciation of property;
- Depletion of natural resources (oil, gas well and mines on qualified/related industries only);
- Charitable and other contributions;
- Research and development expenditures;
- Pension trust contributions of an employer for the payment of reasonable pensions to his
employees;
- Premium payments on health and/or hospitalization insurance taken by the individual
taxpayer. (repealed by TRAIN Law)

Only business-connected expenses are deductible from income derived from the practice of
profession or from trade or business or simply business income. The only exception (not
connected) expenses are charitable contributions and premium payments for
health/hospitalization insurance. (Note that in view of TRAIN Law, only charitable contributions
are the allowable expenses that are not business-related.)

Also, a taxpayer may claim 40% OSD in lieu of itemized deductions.

There are special deductions allowable to insurance companies (Sec. 37), and proprietary
educational institutions and hospitals which are non-profit. Note that the tax is 10% of the taxable
income.

Republic Act (RA) No. 7432 as amended by R.A. No. 9257 allows business establishments to
claim as deductions from gross income the 20% sales discounts granted to senior citizens. Under
RA No. 7277 as amended by RA No. 9442, business establishments granting the 20% sales
discounts to PWDs shall also be entitled to be deducted from gross income. Such deduction will
only be allowed if it is shown by the payor that the tax (due from the payee) required to be
deducted and withheld by him (payor) from such payment has been paid to the BIR.

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

D. Optional standard deduction (OSD)

OSD is the deduction which an individual other than a non-resident alien subject to income tax,
may elect in an amount not exceeding 40% of his gross sales or gross receipts, or a corporation
other than a non-resident, in an amount not exceeding 40% of its gross income, in lieu of taking
itemized deductions.

As a rule, compensation earners are not allowed to claim OSD. This makes sense since they are
not allowed to claim any deductions, to begin with.

Only domestic and resident foreign corporations can claim. NRFCs are subject to 30% final tax
on their gross income.

- For corporations engaged in the sale of goods, the gross income is determined by
subtracting cost of goods sold and sales returns, discounts and allowances from the gross
sales. (Note that gross sales must include only sales that are contributory to the taxable
income of a corporation. If the company sells a parcel of land, gain from the sale does not
form part of the gross income.) For trading/manufacturing concerns, cost of goods sold
include import duties, freight and insurance. On the other hand, for manufacturing
concerns, the cost of goods sold must include all costs incurred in the production of
finished goods, such as raw materials, direct labor, manufacturing overhead, freight cost,
insurance premiums and other costs.

- For corporations engaged in the sale of services, the gross income is determined by
subtracting cost of services and sales returns, discounts and allowances from gross
receipts. Cost of services means all direct costs and expenses necessarily incurred to
provide the services required by the customers and clients, including salaries and
employee benefits, cost of facilities directly utilized in providing the service (depreciation
and rental expenses, and cost of supplies. But the term excludes interests unless in the
case of banks and financial institutions.

- Gross receipts are amounts actually or constructively received during the taxable year.
However, for seller of services employing accrual basis of accounting, gross receipts shall
mean amount earned as gross revenue during the taxable year.

- Passive incomes are subject to final tax at source. Thus, they are not included in the gross
income of a taxpayer for purposes of determining the OSD amount.

E. OSD for GPPs

GPPs are allowed to claim OSD in lieu of itemized deductions as a GPP is considered as a
separate taxable entity for purposes of making various elections (selecting accounting period,
claiming OSD or itemized deductions), and treated by law as a separate legal entity with the right
to transact business and own property under its own name. For purposes of computing net
distributive share of partners, the net income of GPP shall be computed in the same manner as
a corporation.

- If GPP availed of itemized deductions, partners may still claim itemized deductions from
their respective net distributive share (ex. Ordinary and necessary expenses incurred in

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

the practice of their profession, not claimed by the GPP, such as representation expenses,
travel expenses, depreciation of car used in practice of profession).

- If GPP availed of itemized deductions. Partners are not allowed to claim OSD on their
shares because OSD is a proxy for all items and deductions allowed in arriving at the
taxable income.

- If GPP avails of OSD in computing net income, partners can no longer claim further
deduction from their share (RR 16-2008, RR 2-2010).

VI. Other implications (OSD)

It is necessary for a taxpayer to signify intention to opt for OSD in the tax returns. The election
must be signified by checking the appropriate box in the income tax return filed for the first quarter
of the taxable year adopted by the taxpayer. Once OSD is elected in the return, it is irrevocable
for the taxable year which the return is made. If he fails to file the first quarterly IT return, or
indicate the election, he shall be considered as having availed of the itemized deductions option
for the taxable year.

An individual taxpayer electing for OSD is no longer required to submit with the tax return a copy
of his financial statements. However, records pertaining to gross sales or receipts, or gross
income (for corporations) shall be kept (Sec. 34[L]).

A corporation is still required to submit its financial statements when it files its annual income tax
return and to keep such records pertaining to gross income (Sec. 7)

VII. Personal and additional exemptions

NOTE: Section 35 has already been repealed under the TRAIN Law.

Basic personal exemption is P50,000.00 for individual taxpayers. The law treats married
individuals as separate taxable units. Non-resident aliens engaged in trade or business may only
claim personal exemptions (not additional exemptions). If not so engaged, not entitled to both.

Additional exemption is P25,000.00 for each qualified dependent. A dependent is a legitimate,

illegitimate, or legally adopted child chiefly dependent for support upon and living with the
taxpayer if such dependent is not more than 21 years of age, unmarried, not gainfully employed,
or if even more than 21 y/o, is not capable of self-support because of mental or physical illness.

Additional exemption may be claimed subject to the following:

- Number of dependents shall not exceed 4

- Additional exemption can only be claimed by 1 of the spouses in case of married
individuals
- For legally separated spouses, exemption may only be claimed by the spouse in custody
and number of exemptions claimed by each shall not exceed the maximum additional
exemptions allowed (Sec. 35)

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

VIII. Computations

Computation of individual income tax

Pure compensation income

Gross compensation income within and/or without the PH

Less: premium payments on health and/or hospitalization
Net income from all sources
Less: personal and/or additional exemptions
Taxable income/tax base
Multiply by: Tax rate in Sec. 24(A), as amended
Amount of income tax payable

Business and or professional income

Gross income within and/or without the Philippines

Less: Allowable itemized deductions or 40% OSD
Net income from all sources
Less: personal and/or additional exemptions
Taxable income/tax base
Multiply by: Tax rate in Sec. 24(A), as amended
Amount of income tax payable

For mixed income earners (i.e., those earning both compensation and business/professional
income) compensation income is globalized or aggregated with the net income from
business/profession. No more deductions on compensation income allowed after TRAIN Law.

To determine the value of income from abroad paid in foreign currency, such income must be
converted at the average rate of exchange prevailing during the taxable year. If income from
business, taxpayer must attach the signed statement showing the amount of gross receipts, cost
of sales and gross income.

IX. Passive income

Passive income that are subject to final tax and are not included for purposes of computing the
gross income of a taxpayer. (Sec. 27[D]) (Misnomer of being called as “items of gross income” in
the book.)

If tax is a final one, the gain taxed is not included and the tax paid is not deducted in the regular
income tax return of the taxpayer in computing his income tax liability. The tax is deducted and
withheld by the payor and paid by him to the BIR in accordance with Sec. 58 and 81.

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Notes on Income Taxation
CLWTAXN (Atty. Abu)

Passive Income Tax rate

Interest from deposits and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements,
royalties (except on books, literary works, and musical 20%
compositions), prized amounting to more than P10,000 and other
winnings (except PCSO and lotto winnings)
Cash and/or property dividends 10%
Capital gains from sales of shares of stock not traded/listed in the 5/10%
stock exchange 15%
Sale of shares listed and traded in the stock exchange ½ of 1%
6/10 of 1% (0.006) of
GSP/ value in money
Capital gains from sale of real property 6% of GSP or FMV
(higher)

To distinguish capital gains from the sale or disposition of real assets, ordinary assets include
stock in trade, property primarily held for sale to customers, property used in trade or business
subject to depreciation, and real property used in trade or business (ex. Condominium units being
sold by a person engaged in the business of selling condominiums.)

If gain is derived from sale of ordinary assets, then it is considered as ordinary income subject to
regular income tax. On the other hand, if gain is derived from sale of capital assets, it is subject
to Capital Gains Tax (CGT).

CGT at the rate of 6% based on gross selling price or current fair market value of the capital asset,
whichever is higher. If an individual sells real property to the government, he or she can be taxed
either under the graduated tax rates of the Tax Code or to CGT at the option of the taxpayer.

If capital asset sold is the principal residence of a taxpayer, such sale or disposition shall be
exempt from CGT if proceeds are fully utilized in acquiring or constructing a new principal
residence within 18 calendar months from the date of sale or disposition.

X. Informer’s reward

The informer’s reward is a reward to persons instrumental in the discovery of violations of the
NIRC or in the discovery and seizure of smuggled goods subject to income tax. The reward is a
sum equivalent to 10% of the revenues, surcharges or fees recovered and/or fine
imposed/collected or Php1,000,000, whichever is lower. (Sec. 282)

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