Tax 1 Unit 1.

Chapter 3

Chapter 3: Introduction to Income Taxation

I. Concept of Income
Rationale of Taxing Income
Under the “ability to pay theory”, tax is imposed on those who have the capacity to
contribute to the state. Undoubtedly, income is the best measure of capacity to pay.

Income for Taxation purposes

a. Income, in the broad sense, means all wealth which flows into the tax-payer
other than as a mere return of capital. It includes the forms of income
specifically described as gains and profits, including gains derived from the
sale or other disposition of capital assets. Income cannot be determined
merely by reckoning cash receipts, for the statute recognizes as income
determining factor other items, among which are inventories, accounts
receivable, property exhaustion, and accounts payable for expenses incurred.
b. Gross income, meaning income (in the broad sense) less income which is by
statutory provision or otherwise exempt from the tax imposed by law.
Requirements for an item to be a part Gross Income
1. It should be a return on capital not a mere return of capital
2. It should be a realized benefit from bilateral transfer or exchanges.
3. It is not exempted by law, contract, treaty and conventions.

II. Capital v. Profits

Capital Profits

Funds or property, existing at one distinct Denotes a flow of wealth during a definite
point of time, which can be used in period of time. All wealth other than as a
producing goods or services. mere return of capital

Wealth Service of Wealth

“Tree” “Fruit”

Capital items deemed with infinite value - items that have infinite value and are incapable
of pecuniary valuation. Anything received as compensation for their loss is deemed a
return of capital.

Recovery of lost capital Recovery of lost profits

Merely maintains net worth Increases net worth

Return of Capital. Hence, not taxable Return on Capital. Hence taxable

Ex. The recovery of lost profits through
insurance, indemnity contracts, or legal

Sources: Philippine TAX Code; Income Taxation, Banggawan; R.R. No. 2-40, Sec 36; CPA Reviewer in
Taxation, Ampongan; Income Taxation, Ballada; 1987 Philippine Constitution; CPAR Reviewer, The Tax
Reviewer 2021e, Soriano; Income Taxation, Dimaampao
Tax 1 Unit 1. Chapter 3

suits constitutes a taxable return on

capital

III. Realization of Income

“Realized” = earned.
Requisites of a realized benefit
1. There must be an exchange transaction.
2. The transaction involves another entity.
3. It increases the net worth of the recipient.
Test of Realization:
1. Actual Receipt - When income is actually reduced to possession. The realization
of gain may take the actual receipt of cash. (R.R. No.2-40. Sec 52.)
2. Constructive Receipt - when income 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 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.
(R.R. No.2-40. Sec 52.)
Benefits without transfers - these are considered unrealized gains or holding gains not
yet realized in an exchanged transaction, therefore, not yet taxable. Increases in
the value of assets such as stock investments, animals, real properties among others
are the examples.

IV. Types of Income Taxpayers:

A. Individual Taxpayers
1. Citizen
a. Resident Citizen
b. Non-Resident citizen
2. Alien
a. Resident Alien
b. Non-resident alien
01. Engaged in trade or business
02. Not engaged in trade or business
3. Taxable Estates and Trusts
B. Corporations
1. Domestic Corporation
2. Foreign Corporation
a. Resident foreign corporation
b. Non-resident foreign corporation

V. Individual Taxpayers

Sources: Philippine TAX Code; Income Taxation, Banggawan; R.R. No. 2-40, Sec 36; CPA Reviewer in
Taxation, Ampongan; Income Taxation, Ballada; 1987 Philippine Constitution; CPAR Reviewer, The Tax
Reviewer 2021e, Soriano; Income Taxation, Dimaampao
Tax 1 Unit 1. Chapter 3

A. Citizens
a. Those who are citizens of the Philippines at the time of the adoption of the
Constitution (on February 2, 1987);
b. Those whose fathers or mothers are citizens of the Philippines;
c. Those born before January 17, 1973 of Filipino mothers who elect
Philippine citizenship upon reaching the age of majority;
d. Those who are naturalized in accordance with law.

A.1 Resident Citizen(RC) - a citizen of the Philippines residing therein.

A.2. Non-resident Citizen(NRC)

a. A citizen of the Philippines who establishes to the satisfaction of
the Commissioner the fact of his physical presence abroad with a
definite intention to reside therein;
b. A citizen of the Philippines who leaves the country during the taxable year
to reside abroad, either as an immigrant or for employment on a
permanent basis*;
c. 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.
d. A citizen who has been previously considered as non-resident citizen and
who arrives in the Philippines at any time during the taxable year
to reside permanently in the Philippines shall likewise be treated as
non-resident citizen for the taxable year in which he arrives in the
Philippines with respect to his income derived from sources abroad until
the date of his arrival in the Philippines.

*Filipinos working in Philippine embassies or Philippine consulate offices are not

considered non-resident citizens.
**Citizens staying abroad for a period of at least 183 days are considered
non-resident

B. Aliens-individuals who are not Filipinos.

B.1 Resident Alien(RA) - an individual whose residence is within the Philippines
and who is not a citizen.
a. An alien who lives in the Philippines with no definite intention as to his
stay***.
b. One who comes to the Philippines for a definite purpose which in
its nature would require an extended stay and to that end makes his
home temporary in the Philippines, although it may be his intention at all
times to return to his domicile abroad.

Sources: Philippine TAX Code; Income Taxation, Banggawan; R.R. No. 2-40, Sec 36; CPA Reviewer in
Taxation, Ampongan; Income Taxation, Ballada; 1987 Philippine Constitution; CPAR Reviewer, The Tax
Reviewer 2021e, Soriano; Income Taxation, Dimaampao
Tax 1 Unit 1. Chapter 3

c. An alien who has acquired residence in the Philippines retains his status
as such until he abandons the same and actually departs from the
Philippines.
***Aliens who stayed in the Philippines for more than 1 year as of the end of
the taxable year are considered residents.
B.2. Non-resident Alien(NRA) - an individual whose residence is not within
the Philippines and who is not a citizen thereon.
a. Non-resident aliens engaged in business (NRA-ETB) - aliens who
stayed in the Philippines for an aggregate period of more than 180 days
(at least 181 days) during the taxable year.
b. Non-resident aliens not engaged in business (NRA-NETB) - aliens
who come to the Philippines for a definite purpose which in its nature may
be promptly accomplished. Aliens who shall come to the Philippines and
stay therein for an aggregate period of not more than 180 days
during the year are also included in this classification.
C. Taxable Estates and Trusts
Estates - The mass of properties left by a deceased person
Kinds of Estates
a. Estate under Judicial administration - settlement of which is the object of
testamentary or intestate proceedings;
Note: Income of the estate under judicial administration is TAXABLE under Sec.
60 (A) (3) of the NIRC to the fiduciary or trustee
b. Estate not under Judicial Administration - settlement of which is not object of
judicial testamentary or intestate proceedings;
Note: Income of Estate not under Judicial Administration, since no executor or
administration, is taxable to the heirs and beneficiaries. Each heir beneficiary
shall include said income (as distributive share of the net income of the estate)
on his or her income tax return.
Trust - is an agreement whereby one person (grantor or trustor) transfers property to
another person (beneficiary), which will be held under the management of a third
party (trustee or fiduciary).
Kinds of Trusts
a. Trusts that are irrevocably designated by the grantor are treated in taxation
as if it is an individual taxpayer. The income of the property held in trust is
taxable to the trust.
b. Trusts that are designated as revocable by the grantor are not taxable
entities and are not considered as individual taxpayers. The income of
properties held under revocable trust is taxable to the grantor, not to the
trust.
Note: When the trust agreement is silent as to revocability, the trust is presumed
revocable.

Sources: Philippine TAX Code; Income Taxation, Banggawan; R.R. No. 2-40, Sec 36; CPA Reviewer in
Taxation, Ampongan; Income Taxation, Ballada; 1987 Philippine Constitution; CPAR Reviewer, The Tax
Reviewer 2021e, Soriano; Income Taxation, Dimaampao
Tax 1 Unit 1. Chapter 3

VI. Corporate Taxpayers

A. Domestic - is a corporation that is created or organized in the Philippines or in
accordance with its Laws.
B. Foreign - is one organized in a foreign law.
B1. Resident Foreign Corporation (RFC) - a foreign corporation engaged in trade
or business within the Philippines
B2. Non-resident Foreign Corporation (NRFC) - a foreign corporation not engaged
in trade or business within the Philippines.

Other Corporate Taxpayers

A. Partnership - is a business organization owned by two or more persons
who contribute their money, property and industry to a common fund for the
purpose of dividing profits among themselves.
Types of Partnership
1. General Professional Partnership (GPP) - is a partnership formed
for the exercise of a common profession. All partners must belong
to the same profession. A GPP is not treated as corporation and is not
taxable entity, but the partners are taxable in their individual capacity with
respect to their share in the income of the partnership.
2. Business Partnership/ Ordinary Partnership - one formed for profit.
It is taxable as a corporation.
B. Joint Venture - a business undertaking for a particular purpose. It may be
organized as a partnership or a corporation.
Types of Joint Venture
1. Exempt Joint Ventures - are those formed for the purpose of
undertaking construction projects or engaged in petroleum, coal,
geothermal and other energy operations, pursuant to an operating
consortium agreement under a service contract with the Government.
This type of joint venture is taxed like a GPP, the joint venture itself is
exempt from tax but the venturers are taxable to their share in the net
income of the joint venture.
2. Taxable Joint Ventures - all other joint ventures are taxable as a
corporation.
C. Co-ownership - is a joint ownership of a property formed for the purpose
of preserving the same and/or dividing its income. a.A co-ownership is limited to
property preservation or income collection is not a taxable entity and is exempt
but the co-owners are taxable their share on the income of the co-owned
property.b.A co-ownership that reinvests the income of the co-owned property to
other income producing properties or ventures will be considered an unregistered
partnership taxable as a corporation.

Sources: Philippine TAX Code; Income Taxation, Banggawan; R.R. No. 2-40, Sec 36; CPA Reviewer in
Taxation, Ampongan; Income Taxation, Ballada; 1987 Philippine Constitution; CPAR Reviewer, The Tax
Reviewer 2021e, Soriano; Income Taxation, Dimaampao