Unit IV – Income Tax – (Continuation)

2. GROSS INCOME

Gross income – means the total income of a taxpayer subject to tax, which includes, gains, profits and
income derived from whatever sources, whether legal or illegal, including (but not limited to the
following items):

Inclusion from Gross Income

1. Compensation for services in whatever form paid, including but not limited to fees, salaries,
wages, commissions and similar items.
2. Gross income derived from the conduct of trade and business or the exercise of a profession;
3. Gains derived from dealings in property;
4. Interests;
5. Rents;
6. Royalties;
7. Dividends;
8. Annuities;
9. Prizes and winnings;
10. Pensions;
11. Partner’s distributive share from the net income of the general professional partnership.

Items of Gross Income:

1. Compensation for personal services - Compensation for servces of whatever kind and in
whatever form paid, forms part of gross income.

a. Gross compensation income means all remuneration for services performed by an employee for
his employer, whether paid in cash or in kind, unless specifically excluded under the Tax Code
(e.g. salaries, wages, emoluments, honoraria, bonuses, allowances, director’s fees).
b. In the absence of an employer-employee relationship’ compensation for personal services shall
be considered as gross professional fee (e.g. audit fee received by CPA from his client, lawyer’s
fee).
c. If a taxpayer is receiving compensation income from two or more employers, he/she must
combine all compensation income received from all employers for a particular calendar year.

d. Fringe Benefits
 Taxable Fringe benefits received by:
a. Rank and file - subject to basic tax
b. Supervisory or managerial - subject to Fringe Benefits Tax ( a final tax)
 Tax exempt Fringe Benefits
a. Exempt under the law
b. If the grant is required by the nature or necessary to the trade , business or profession of
the employer.
c. If the grant is for the convenience of the employer.
d. De minimis benefits:
 Conforming to the ceiling - tax exempt and not included in the P 90,000 threshold
 In excess of the ceiling - subject to tax only on the excess over P 90,000

 Tax exempt 13th month pay and other benefits –

 threshold beginning January 1, 2018 – P 90,000.

e. Retirement Benefits, Separation Pay, Pension

 with reasonable private benefit plan
 retirement pay as a rule is taxable, except those received by officials and employees of
private firms, whether individual or corporate , under a reasonable private benefit plan
maintained by the employer which meets the following requirements:
1. the retirement plan must be approved by the BIR;
2. the retiring official or employee must have been in the service of the same employer
for at least 10 years, and
3. is not less than fifty (50) years of age at the time of retirement, and

 in the absence of reasonable private plan

an employee may receive tax-exempt retirement benefits who has reached the age of
60 years or more , but not more than 65 years, who has served at least 5 years in the
establishment (BIR Ruling No. 495-14 dated December 11, 2014)

2. Business Income – arises from self-employment or practice of profession.

a. Gross income derived from business.
Gross sales P xxx
Less: Sales returns and allowances xxx
Sales discount xxx xxx
Net sales xxx
Less: Cost of sales xxx
Gross income xxx
Other income xxx
Taxable income P xxx `

3. Gains derived from dealings in property

a. Determination of amount and recognition of gain or loss
1) Property acquired by purchase on or after March 1, 1913
Selling price P xxx
Less: Cost xxx
Gain (loss) P xxx

2) Property acquired by inheritance

Selling price P xxx
Less: FMV (date of inheritance) xxx
Gain (loss) P xxx

3) Property acquired by gift

Selling price P xxx
Less: Value in the hands of the donor xxx
Gain (loss) P xxx

4) Property acquired for less than adequate consideration

Selling price P xxx
Less: amount paid by the transferee xxx
Gain (loss) P xxx

e) Exercises– Gross Income

1. Mr. Juan Jose bought a car in 2014 for P 500,000. In 2018, Mr. Jose died leaving an estate
of P 3,000,000 including the car valued at P 300,000 which was inherited by his son, Juan,
Jr. In 2019 Juan, Jr. sold the car for P 400,000. How much was the gain from the sale of car

Answer: P 100,000 ( P 400,000 – 300,000)

2. In 2010, Cecille bought shares of stock not through the local stock exchange for P 150,000.
She donated the shares to Toks in 2018 when the shares fair market value was P 400,000. In
2019, Toks sold the shares for P 500,000. How much was the gain from the sale of the
shares?
 Answer: P 100,000 ( P 500,000 – 400,000)

4) Interest Income

a. Interest includes such interest arising from indebtedness, whether business or nonbusiness.
b. Interest received from Philippine bank deposits is subject to final tax, hence, no longer
included in the taxable gross income.

5) Rent Income
LESSOR LESSEE
a) Income of lessor under lease agreement
1. Rent Income Expense
2. Obligation of lessor to third person paid
by lessee Income Expense
3. Advance Rent Income in full in the Expense, to be
year received prorated over the
regardless of the period covered
accounting method regardless of
accounting method
4. Leasehold improvement Income: Expense
a) Outright method (depreciation over
a) Term of lease or
b) Annual or spread out life whichever is
method shorter)
b) Estimated

a) Advance payment not representing rent

1) Advance payment representing loan to the lessor is not taxable unless applied to rent.
2) Advance payment representing security deposit is not taxable unless violation in the
lease contract arises.

c. Leasehold improvement
1) Additional income to the lessor if it shall become his upon the expiration of the lease.
2) Income is recognized either under:
a) Lump sum (or outright) method - Income is the FMV to be reported in the year the
improvement is completed.
b) Annual (or spread out method)
(1) Computation of annual income
Cost of leasehold improvement P xxx
Less: Accumulated depreciation
remaining term of leases) xxx
Book value, end of lease P xxx

Book value, end of lease

Annual income = ----------------------------
Remaining term of lease

(2) Lease is terminated before the expiration of contract.

FMV of improvement (when lessor took possession) P xxx
Less: Amount already reported as income xxx
Income (year of termination) P xxx

(3) Leasehold improvement is destroyed before expiration of lease contract.

Amount already reported as income P xxx
Less: Insurance recovery xxx
Salvage value xxx xxx
Loss (year improvement was destroyed) P xxx
 d. Exercises:

1. The following advance rentals for one year, were received by a lessor who is under accrual
method of accounting:
a. P 48,000 for the period August 1, 2018 to July 31, 2019
b. P 60,000 for the period June 1, 2019 to May 31, 2020
c. P 120,000 for the period October 1, 2020 to September 30, 2021

a) How much is the accounting and the taxable income?

Accounting income Taxable income
2018 __P 20,000 _____ P 48,000___
2019 ___ 63,000 ( 28,000 + 35,000) ____ 60,000___
2020 ___55,000 ( 25,000 + 30,000) ___120.0000___
2020 ___90,000_(120,000 - 30,000) ________---____

2. The following security deposits were received from different leassees:

Year Year contract
Deposit received was violated
Property A 2018 – P 500,000 2019
B 2019 - 600,000 2020
C 2019 - 800,000 No violation

How much is the lessor’s income?

2018_________zero________
2019 ______ 500,000_______
2020_______600,000_______

3. Janice, lessor, leased a lot to Johan, lessee, for 15 years beginning January 1, 2019,
subject to the following terms and conditions:

a) will pay rental of P 30,000 per month.

b) Lessee will pay the real estate tax on the land which is P 10,000 per year
c) Lessee will construct a building on the lot which shall be owned by the lessor after the
lease expires. Data on the building follow:
Cost of building completed on January 1, 2020 P 2,800,000
Estimated life of building 20 years

Compute the following:

a. Taxable income of lessor for 2020 assuming he is going to use spread out method in
determining income on leasehold improvement.
b. Deductible expenses of the lessee for 2019 and 2020.
c. Income of lessor in 2024, assuming that the lease was terminated on January 1, 2024 due
to lessee’s fault.

Solution: (Janice)

a) Taxable Income of the lessor:

2019 2020
a) Monthly rental = ( P 30,000 x 12) P 360,000 P 360,000
b) real estate tax paid by lessee 10,000 10,000
c) Leasehold improvement (Schedule 1) 60,000
 370,000 430,000

Schedule 1: Computation of income on leasehold improvement:

Cost of leasehold improvement P 2,800,000
Less: accumulated depreciation for 14 years (remaining term of lease):
(2,800,000/20 years x 14 years)………………………………….. 1,960,000
Net book value at the end of term of lease P 840,000

Annual Income to be reported on leasehold improvement under spread out method : ( from 2020
to 2034) (net book value divide by remaining term of lease) 840,000 / 14 years = P 60,000

b) Rent Expense for 1 year (2019) = 30,000 x 12 = P 360,000

real property tax paid ……………………………. 10,000
Total P 370,000

c) Income of lessor in 2024, assuming that the lease was terminated on January 1, 2024 due to
lessee’s fault.
Cost of leasehold improvement P 2,800,000
Less: accumulated depreciation for 4 years (2020 - 2023):
(2,800,000/20 years x 4 years)……………………………………….. 560,000
Net book value as of January 1, 2024 P 2,240,000
Less: Income on leasehold improvement already recognized ( 60,000 x 4 years)
( 2020 – 2023)…………………………………………………………… 240,000
Income to be reported by the lessor in 2024. ………………………………… P 2,000,000

6) Royalties
1) Subject to Final tax Royalties from Philippines
2) Subject to tax rate in general Royalties from foreign sources

7) Dividend Income

a. Kinds:
1. Cash and property dividends – taxable upon declaration
2. Stock dividends:
General rule: not taxable because they are not realized income
Exception: constitute an income if it gives the shareholder an interest different from that
which his former stockholdings represented.

3. Liquidating dividends – tax exempt up to the extent of the cost of investment being the return
of capital, amount in excess of cost shall be considered income and taxable. If the amount
received is less than the cost of investment, the difference is a loss and is deductible to
the extent allowed for capital losses.

b. Sources/Situs of Dividend Income

a From domestic corporation - dividend income from within

b) From Foreign Corporation

a. in general - Dividends from without the Philippines

b. based on the ratio of gross income Philippines over worldwide income of the foreign
corporation for the preceding three years prior to the declaration of the dividends
derived from Philippine sources..
Ratio:
 Gross Income Philippines
Gross Income World

 If ˂ 50% - Income is treated as entirely derived from sources without the

Philippines

 if ≥ 50% - Income is derived partly within and partly without the

Philippines.

c. Dividends that are exempt from tax -

- Intercorporate dividends received from domestic corporation by other domestic
corporation and resident foreign corp.

8. Annuities:
annuity is a specified income payable at stated intervals for a fixed or a contingent period, often for
the recipient’s life, in consideration of a stipulated premium paid either in prior installment payments
or single payment.

9. Prizes and other winnings

a. Subject to 20% Final tax
1. Prizes received by individuals (except NRA-NETB – 25%FWT) from sources within the
Philippines exceeding P 10,000.
2. Other winnings from sources within the Philippines regardless of the amount, except
a. PCSO/Lotto winnings by (RA and RC) below P 10,000. – exempt
b. PCSO/Lotto winnings by NRA-ETB regardless of amount – exempt

b. Subject to basic tax

1. Prizes and other winnings derived by resident citizens and domestic corporation from sources
without the Philippines.
2. Prizes and winnings received by corporations
3. Prizes received by individuals from sources within the Philippines amounting to P 10,000 or
less

c. Subject to 25% final tax – Prizes and other winnings including PCSO/Lotto winning by NRA-NETB

d. Exempt from income tax

1. Prizes and awards made primarily in recognition of religious, charitable, scientific, educational
artistic, literary, or civic achievement, provided: that the recipient was selected without any
action on his part to enter the contest or proceeding (not constituting gains from labor) and not
required to render substantial future services as a condition to received the prize or award.

2. All prizes and awards granted to athletes in local and international sports competition and
tournaments, whether held in the Philippines or abroad sanctioned by their respective national
sports association.

3. winnings under Sec. 126 of the tax Code ( winnings on horse racing).

9) Income from whatever sources ( income coming from legal or illegal sources)
a. Examples of income from whatever source

1) Gambling gains/income from jueteng

2) Income from illegal business or from embezzlement or swindling activities
3) Damage recovery (compensation for damages)
4) Forgiveness of debt
5) Bad debt recovery
6) Tax refunds

b. Damage recovery
 1) Rules
(a) Taxable : Recovery of lost profit.
(b) Not taxable : Recovery of lost capital.

2) Exercise:
An accident solely attributable to the criminal negligence of the driver of Harabas Bus
Line resulted in the death of Jose’s wife, physical injuries to Jose that prevented him
from working for one month, and the total wreck of Jose’s brand new Toyota car
bought for P 500,000.
In the action for damages filed by Jose against the bus line, the court awarded him
the following:
For injury (one arm lost) P 30,000
For loss of one month salary 25,000
For wife’s death 25,000
Exemplary damages 100,000
For the car 500,000
Total P 680,000

How much is the taxable income? 125,000

c. Forgiveness of debt
1) Forgiveness of debt may result in any of the following:
a) Taxable income - if debtor rendered service in favor or the creditor.
b) Taxable gift - if debtor did not render service in favor of the creditor.
c) Dividend distribution - if creditor-corporation forgives the debt of its stockholder.

d. Bad debt recovery

1) Bad debt recovery is generally taxable.
2) Tax benefit rule: If in the year the bad debt was written off there was a reduction of
taxable income, bad debt recovery shall constitute a taxable income.

3) Exercise:
A taxpayer has the following data on net income, bad debt write off and recovery:
2019 Case 1 Case 2 Case 3
Net income (loss) P 80,000 (P60,000) P 20,000
Less: Bad debt write off (20,000) ( 20,000) ( 30,000)

Net income (loss) after write off P 60,000 (P80,000) (P10,000)

2020
Bad debt recovered P 20,000 P 20,000 P 30,000
20,000 none 20,000
Taxable income ======== ======== ========

e. Tax refunds
1) Rules
a) Taxable : Refunded tax is a deductible tax.
b) Not taxable : Refunded tax not a deductible tax.

Exclusion from Gross Income:

The following shall not be included in gross income and shall be exempt from income tax:
1. Life insurance
2. Amount received by insured as a return of premium
3. Gifts, bequests and devises
4. Compensation for injuries or sickness
5. Income exempt under treaty
 6. Retirement benefits, gratuities, pensions, etc.
7. Miscellaneous items
a. Income derived by foreign government
b. Income derived by the government or its political subdivisions
c. Prizes and awards
d. Prizes and awards in sports competition
e. 13th month pay and other benefits not exceeding P 90,000.
f. GSIS, SSS, Medicare and other contributions
g. Gains from sale of Bonds, Debentures and other Certificate of Indebtedness
h. Gains from redemption of shares in mutual fund.

Activity 1 - Gross Income

Exercises: Gross Income

1. Antonio, a rank and file employee, derived the following income during the year:
Gross salaries 335,000
13th month pay and other benefits 68,000
SSS, Philhealth and Pag-ibig contributions 21,225
Commission income 21,000
Deductions fro loan repayments 45,000
Deductions for withholdings tax 42,000

The compensation income subject to regular tax is: ________________________________

2. Anna, resigned in 2022 after 13 years of service. She had the following income during the year:
 Gross salaries 550,000
13th month pay and other benefits 55,000
SSS, Philhealth and Pag-ibig contributions 32,000
Separation pay 950,000

The gross income subject to regular tax is ______________________

3. A worked for a manufacturing firm but due to business reverses, the firm offered a voluntary redundancy
program in order to reduce overhead expenses. Under the program, an employee who offered to resign would
be given separation pay equivalent to his months basic salary for every year of service. A accepted the offer
and received P 800,000 as separation pay under the program. After all the employees who accepted the offer
was paid , the firm found its overhead still excessive. Hence it adopted another rogram, where various
unprofitable departments were closed. As a result, B was separated from the service. B also received P
800,000 as separation pay. At the time of separation both A and B rendered at least 10 years of service but A
was 55 years old while B was only 45 years old. As a result:
a) Both amounts are exempt from income tax c) Only A is subject to income tax
b) Both amounts are subject to income tax d) Only B is subject to income tax.

4. ARC Corporation is engaged in the sales of goods. It reported the following summarized financial statements
during the year.
Sales 38,000,000
Less: Cost of sales 26,000,000
Gross profit 12,000,000
Consignment income 100,000
Interest income from customers 8,000
Interest income, net of final tax 12,000
Total income 12,120,000
Less: administrative and selling expenses 11,050.000
Net income 1,070,000

The gross income subject to regular tax is _________________________________

TREE Corporation , reported the following income for 2021:

Philippines Abroad
Service fees P 1,400,000 P 1,800,000
Interest income – bank 35,000 45,000
Royalties – franchise 200,000 150,000

5. If Tree Corp is a domestic corporation, the gross income subject to regular tax is _____________________

6. If Tree Corp is a resident foreign corporation, the gross income subject to regular tax is
_____________________

7. Mr. Cruz leases a building to Mr. Tan. During the year he received the following remittances from Mr. Tan:
Rental, net of 5% creditable withholding tax 1,368,000
Real property tax on the leased building 45,000
Reimbusrement for utilities used by the lessee paid by Mr. Cruz 150,000

The gross income of Mr. Cruz subject to regular tax is _________________________

11. . A taxpayer has the following data on net income, bad debt write off and recovery:
2020: Case 1 Case 2 Case 3
Net income (loss) P 80,000(P60,000) P 20,000
Less: Bad debt write off (20,000) ( 20,000) ( 30,000)

Net income (loss) after write off P 60,000(P80,000) (P10,000)

 2021:
Bad debt recovered P 20,000P 20,000P 30,000

Taxable income ======== ======== ========

The records of RFT Corporation organized in 2009 showed the following data for 2020.
Gross Income P 2,000,000
Less: allowable business expenses (other than bad debts) P 1,850,000
Bad debts written off 100,000 1,950,000
Taxable net income P 50,000

In 2021, 80% of the bad debts written off in 2020 was collected.

The income tax due in 2021 is:

a) P 40,000 b) P 45,000 c) P 15,000 d) P 25,000

12. An employee of X company retired at the age of 50 years old after serving the company for 10 years. He
received retirement benefits from X company amounting to P 2,500,000. the following year after his
retirement, he was invited by Y Corporation to join it as its Executive Vice President. After serving Y
corporation for 10 years, he retired at the age of 61. Y Corporation gave him P 3,000,000 retirement benefits.

Which retirement benefits should be subject to tax?

a) Retirement benefits from X company. c) Both retirement benefits
b) Retirement benefits from Y company d) Neither retirement benefits

13. A was selected as the most outstanding teacher in her region. Her name was submitted by the school principal
Without her knowledge. She received a trophy and a cash award of P 15,000. The cash award is:
a) taxable income c) exempt from income tax
b) subject to final tax d) partly taxable, partly exempt

14.Edward sold his residential house and lot located in Manila on January 30, 2021 for P 8,000,000. The property
was purchased in 2006 for P 3,000,000. The current market value of the property at the time of sale was:
BIR Commissioner’s zonal value - P 9,000,000
City Assessor’s schedule of values - 6,000,000

How much is the capital gain tax on sale? ______________

15. If Edward in the preceding number, within 6 months after the sale, purchases another residence for P 8,000,000,
what will be the capital gain tax on the sale and what would be the cost (basis) of the new residence for income
tax purposes?
_______________

Mr. A farmer, had the following data for the year:

Sales of livestock and farm products raised P 270,000
Sales of livestock and farm products purchased 160,000
Cost of raising livestock and farm products 190,000
Cost of livestock and farm products purchased and sold 140,000
Rental income of farm equipment 105,000
Inventory of livestock and farm products, January 1 110,000
Inventory of livestock and farm products, December 31 113,000

14.. Using cash method of accounting, the income is:

a) P 205,000 b) P 208,000 c) P 395,000 d) P 202,000

15. Using accrual method of accounting, the income is:

a) P 205,000 b) P 208,000 c) P 395,000 d) P 202,000
16 In 2021, Vic constructed a commercial building with spaces for lease to the public. Vic required Edward, a
prospective lessee, to sign a pre-lease agreement which principally provided: (a) that the lessee shall
extend to the lessor non-interest bearing loan of P100,000 payable in one year; and (b) that in consideration
of the loan, the lessee and rentals shall not be increased while the loan remains unpaid. Edward extended the
loan of P100,000 to Vic and was given a space in its ground floor.
a. the rent income is taxable, while the loan is not.
b. the loan is taxable to Vic while the rent income is not.
c. neither the income from rent nor the loan is taxable
d. both the loan of P100,000 and the income from rent are taxable

End