CHAPTER 3
 Excess amount received over premiums
INTRODUCTION TO INCOME TAXATION
Why is income subject to tax?
 Income is regarded as the best measure of
taxpayer’s ability to pay tax.
 It is an excellent object of taxation in the
allocation of government costs
INCOME FOR TAXATION PURPOSES
“GROSS INCOME” – taxable income in layman’s
term. Tax concept of income under NIRC
Taxable income in NIRC refers to certain items of
gross income less deductions and personal
exemptions allowable by law
Taxable item of income – “item of gross income” or
“inclusion in gross income”
GROSS INCOME – any inflow of wealth to the
taxpayer (legal or illegal) that increases net worth.
Ex. income for employment, trade,
business/exercise of profession, income from
properties
ELEMENTS OF GROSS INCOME
1. RETURN ON CAPITAL THAT INCREASES NET
WORTH
CAPITAL – any wealth or property. Gross income is
a return or wealth or property
Ex. purchased goods at 300, sold for 500
SP 500 Total Return
Cost (300) Return OF Capital
Mark-up 200 Return ON Capital
RETURN ON CAPITAL – increases net worth.
Subject to income tax
RETURN OF CAPITAL – merely maintains net
worth, not taxable.
*Improvement in net worth indicates ability to pay
tax
Capital Items with INFINITE VALUE
 Life – proceeds from life insurance policies paid
to heirs/beneficiaries upon death of insured,
proceeds of life insurance contract collected by
an employer as beneficiary from the life
insurance of an officer are exempt from income
tax. (viewed as advance recovery of future loss)
Taxable return on capital from insurance policies
paid by the insured upon surrender or
maturity of the policy
 Gain realized by the insured from the
assignment or sale of his insurance policy
 Interest income from the unpaid balance of
the proceeds of the policy
 Any excess of the proceeds received over
the acquisition costs and premium
payments by an assignee of a life insurance
policy
 Health – compensation received in
consideration for the loss of health such as
compensation for personal injuries or tortuous
acts is deemed a return of capital
 Human Reputation – any indemnity received as
compensation for its impairment is deemed a
return of capital exempt from income tax
Ex. moral damages from oral defamation or
slander, alienation of affection, breach of
promise to marry.
Recovery of lost capital vs. Recovery of lost
profit
Loss of Capital Decrease in net worth
Recover of Lost Capital Merely maintains net
worth
Los of Profits DO NOT decrease net
worth
Recover of Lost Profits Return on capital
Taxable recovery of lost profits
- recovery of lost profits through insurance,
indemnity contracts, or legal suits (taxable return on
capital)
Taxable recoveries of lost profits
a) proceeds of crop or livestock insurance
b) guarantee payments
c) indemnity received from patent infringement
suit
2. REALIZED BENEFIT
“BENEFIT CONCEPT” – benefit means advantage
derived by taxpayer. There is benefit when net
worth of taxpayer is increased (increase when
receives income, donation, or inheritance)
NOT BENEFITS (NOT taxable)
a) Receipt of a Loan – properties and obligation
increase (off set)
b) Discovery of lost properties – finder has an
obligation to return to owner
c) Receipt of money property – to be held in trust
for or to be remitted to another person
*if taxpayer is entitled to keep for his account
portion of a receipt, only that portion is a benefit.
“REALIZED CONCEPT” – realized means earned.
Requires a degree of undertaking/sacrifice from the
taxpayer to be entitled of the benefit.
Requisites of a realized benefit
1. there must be an exchange of transaction
2. transaction involves another entity
3. increases the net worth of the recipient
TYPES OF TRANSFERS
1. Bilateral Transfers or Exchanges – onerous
transactions; benefits are “earned or realized”
thus subject to income tax
a. Sale
b. Barter
2. Unilateral Transfers or Transfers – gratuitous
transactions; benefits are NOT realized
because of the absence of an earning process.
Subject to TRANSFER TAX, NOT income tax
a. Succession – transfer of property upon
death
b. Donation
3. Complex Transactions – partly gratuitous and
partly onerous; “transfers for less than full and
adequate consideration”. Gratuitous portion
subject to TRANSFER TAX, while Onerous
portion is subject to INCOME TAX.
Ex. excess of FV over selling price is gratuity,
excess of SP over cost is item of gross income.
NOTES:
- sales of a home office to its branch office are NOT
taxable as they pertain to one and the same
taxable entity.
- income between businesses of proprietor should
NOT be taxed since proprietorship business are
taxable upon the same owner.
BENEFITS IN THE ABSENCE OF TRANSFERS
- increase in wealth through appreciation or
decrease in obligation in the absence of a sale or
barter transaction is NOT TAXABLE. Referred to as
UNREALIZED GAINS OR HOLDING GAINS as
they have NOT yet materialized in an exchange
transaction. Examples
a. Increase in value of investments in equity or
debt securities
b. Increase in value of real properties held
(revaluation increment)
c. Increase in value of foreign currencies held or
receivable
d. Decrease in value of foreign currency
denominated debt by virtue of favorable
fluctuation in exchange rates
e. Birth of animal offspring, accruals of fruits in an
orchard or growth of farm vegetables
f. Increase in value of land due to the discovery of
mineral reserves
Rendering of Services – considered an exchange
but does NOT cause a loss of capital. Hence, entire
consideration received (compensation income,
services fee) is an item of gross income.
Ex. debt cancelled in consideration for services
rendered. This is considered realized gains from
exchanges thus an item of gross income.
BASIS OF EXEMPTION OF UNREALIZED
INCOME
- income received in NON-cash consideration is
taxable at the FV of property received.
MODE OF RECEIPT/REALIZATION BENEFITS
taxable income may be realized by taxpayer in:
1. Actual Receipt – actual physical taking of
income in form of cash or property
2. Constructive Receipt – NO actual physical
taking of income, but the taxpayer is effectively
benefited (ex. offset of debt, deposit of income
in checking account)
Inflow of wealth without increase in net worth
- inflow that does NOT increase net worth is income
due to total absence of benefit
Examples: receipt of property in trust, borrowing
money under an obligation to return (LOAN)
*proceeds of embezzlement or swindling where
money is taken without original intention to return is
considered income because of the increase in net
worth of the swindler.
3. NOT EXEMPTED BY LAW, CONTRACT, OR
TREATY
- item of gross income is NOT exempted by the
Constitution, law, contracts of treaties from taxation.
Following items are exempted by LAW from
taxation (NOT considered items of gross income):
1. Income of qualified employee trust fund
2. Revenues on non-profit, non-stock educational
institutions (ex. AdDU)
3. SSS, GSIS, Pag-IBIG, or PhilHealth benefits
4. Salaries and Wages of Minimum Wage earners
and qualified senior citizen
5. Regular income of barangay Micro-business
enterprise (BMBEs)
6. Income of foreign governments and foreign
Government owned controlled corporations
(GOCC)
7. Income form international missions and
organizations with income tax immunity
TYPES OF INCOME TAXPAYERS
A. INDIVIDUALS
1. Citizen
a. Resident Citizen
b. Non-Resident Citizen
2. Alien
a. Resident Alien
b. Non-Resident Alien
i. Engaged in trade or business
ii. NOT engaged in trade or
business
3. Taxable estates and trust
B. CORPORATIONS
1. Domestic Corporation
2. Foreign Corporation
a. Resident foreign Corporation
b. Non-Resident Foreign Corporation
INDIVIDUAL INCOME TAXPAYERS
Citizens
 Citizens of PH at time of adoption
Constitution on Feb. 2, 1987
 Father and mother are citizen of PH
 Born before Jan. 17, 1973 of Filipino Mothers
who elected Filipino citizenship upon reaching
the age of majority
 Naturalized in accordance with the law
Classification of Citizens
A. Resident Citizen – filipino citizen residing in PH
B. Non-resident Citizen
 Citizen of PH with physical presence
abroad with a definite intention to reside
therein
 Leaves PH during taxable year to reside
abroad (immigrant or employment on
permanent basis)
 Citizen of PH who works and derives
income from abroad and whose
employment threat requires him to be
physically present abroad most of the
time during the taxable year
 Citizen previously considered as NON-
resident citizen who arrives in the PH at
anytime during the taxable year to
reside permanently in PH shall be
treated as NON-resident citizen for the
taxable year in which he arrives in the
PH with respect to his income derived
from sources abroad until the date of his
arrival in the PH
*Filipinos working in PH embassies or PH
consulate offices are NOT considered non-resident
citizens.
Alien
1. Resident Alien – residing in the PH but is NOT
citizen
 Lives in the PH without definite intention
as to his intention
 Comes to PH for a definite purpose
which in its nature would require an
extended stay and to that end makes his
home temporarily in the PH although
intention at all times is to return to his
domicile abroad
*if acquired residence in PH retains his
status as such until he abandons the same
or actually departs from the PH
of
2. Non-Resident Alien – NOT residing in PH
retains his status as such until he abandons the
same or actually departs from PH
 a. Non-Resident Aliens Engaged in
Business (NRA-ETB) – aliens who
stayed in PH for an aggregate period of
MORE THAN 180 days during the year
b. Non-Resident Aliens NOT Engaged in
Business (NRA-NETB)
i. Comes to PH for a definite
purpose which in its nature may
be promptly accomplished
ii. Comes to PH and stay therein
for aggregated period for NOT
more than 180 days during the
year
THE GENERAL CLASSIFICATION RULE FOR
INDIVIDUALS
1. Intention – the intention shall determine his
appropriate residential classification. Taxpayers
submit to the CIR of the BIR documentary
proofs (visas, work contracts, etc.) indicating
intention. Documents with short term stay
(tourist visa) shall NOT result in reclassification
of normal residency. If long-term stay
documents (immigration visa, working visa) for
an extended period would result to automatic
reclassification of residency
2. Length of Stay – in default of such
documentary proof, the length of stay is
considered:
a. Citizens staying abroad for a period of at
least 183 days are considered non-
resident.
b. Aliens who stayed in PH for more than 1
year as of the end of taxable year are
considered resident
c. Aliens who are staying in PH for not
more than 1 year, but more than 180
days are deemed non-resident aliens
engaged in business
d. Aliens who stayed in PH for NOT more
than 180 days are considered non-
resident aliens NOT engaged in trade or
business
TAXABLE ESTATES AND TRUSTS
1. ESTATE
- Refers to properties, rights, and obligation of
deceased person NOT extinguished by his
death.
- Estates under judicial settlement are treated as
individual taxpayers. Estate is taxable on
income of properties left.
- Estates under extrajudicial settlement are
exempt entities. Income under these properties
is taxable to the heirs
2. TRUST
- An arrangement where one person
(grantor/trustor) transfers (donates) property to
another person (beneficiary), which will be held
under the management of a third party
(trustee/fiduciary)
- Trust irrevocably designated by the grantor is
treated as if it’s an individual taxpayer
- Income of property held in trust is taxable to the
trust
- Trust designated as revocable by grantor are
NOT taxable entities and NOT considered as
individual taxpayers. Income is taxable to the
grantor
- When trust agreement is silent as to
revocability, presumed to be revocable
CORPORATE INCOME TAXPAYERS
Term ‘corporation’ includes OPC (One Person
Corporation), partnerships, joint-stock companies,
joint accounts, associations, insurance companies
(EXCEPT: general professional partnerships, joint
venture in consortium formed for undertaking
construction project or engaging petroleum, coal,
geothermal and other energy operations pursuant
to an operating consortium agreement under
service contract with the govt). hence, corporation
includes profit-oriented and non-profit institution
(charitable institutions, cooperatives, government
agencies and instrumentalities, associations,
leagues, civic or religious and other organizations.
DOMESTIC CORPORATION – organized in
accordance with PH laws. Includes OPC owned
and registered by resident citizens in PH. Still a
domestic corporation if controlled by foreigners but
incorporated in PH
FOREIGN CORPORATION – organized under
foreign law
TYPES OF FOREIGN CORPORATION
1. RESIDENT FOREIGN CORPORATION (RFC)
– operates and conducts business in PH
through permanent establishment (ex. branch).
taxable on transaction through branch
2. NONRESIDENT FOREIGN CORPORATION –
does NOT operate or conduct business in PH.
Transacts directly to residents outside its
branch, taxable on the direct transactions.

SPECIAL CORPORATIONS – domestic or foreign

corporation subject to special tax rules or
preferential tax rates.
OTHER CORPOARATE TAXPAYERS THE GENERAL RULES IN INCOME TAXATION

1. One Person Corporation (OPC) – single Taxable On Income Earned

stockholder (can be natural, trust, or estate). INDIVIDUAL WITHI WITHOUT
Banks etc. and practice for procession cannot TAXPAYERS N (outside
incorporate as OPC. PH)
2. Partnership Resident Citizen / /
Non-Resident Citizen /
a. General Professional Partnership
Resident Alien /
(GPP) – sole purpose of exercising
Non-Resident Alien /
profession (NO part of income can
CORPORATE
be derived from trade or business). TAXPAYERS
NOT treated as corporation and is Domestic Corporation / /
NOT a taxable entity. Exempt from Resident Foreign /
income tax but partners are taxable Corporation
individually with respect to share in Non-Resident Foreign /
income of the partnership. (ex. Corporation
practice in same professions – both Note: “territoriality rule” – ALL taxpayers (except
accountants) resident citizens and domestic corporations) are
b. Business Partnership – formed for taxable only on income earned within the PH
profit. Taxable as corporation. (ex.
practice of two different profession – THE RESIDENCY AND CITIZENSHIP RULE
atty and accountant) Resident Citizens of PH and Domestic
3. Joint Venture Corporations – taxable on ALL income from
a. Exempt Joint Ventures – for purpose sources WITHIN and WITHOUT
of undertaking construction projects
or engaging petroleum, coal, *corporation is a citizen of the country where it
geothermal and other energy incorporated.
operations. NOT treated as
BASIS OF THE EXTRATERRITORIAL TAXATION
corporation thus tax-exempt on
regular income, but venturers are Resident citizens and domestic corporation have
taxable on share on net income of full access on benefits from government. The
JV taxation on their foreign income properly reflects
b. Taxable Joint Ventures – other than this difference in benefits consistent with the
JV (residual) Benefit Received Theory. The extraterritorial
4. Co-Ownership treatment is intended as a safety net to the
- joint ownership of property formed for potential loss of tax revenues brought by situs
preserving the same and/or dividing its income. relocation or practice of executing or structuring
- If limited to property preservation or income transaction transactions such that income will be
collection, NOT taxable entity but co-owners are realized abroad to avoid PH income taxes.
taxable on their share on income of co-owned
property. ISSUE OF INTERNATIONAL DOUBLE TAXATION
- If reinvests income of co-owned property to Rule on extraterritorial taxation exposes resident
other income producing properties/ventures, it citizens and domestic corporation to DOUBLE
will be considered an unregistered partnership TAXATION. However, NIRC allows a tax credit for
taxable as corporation
taxes paid in foreign countries. They also pay  Less than 50%, the entire dividends are
minimal taxes in PH on their foreign income earned abroad
because of tax credit.
NOTE: If ratio is less than 50% then the gross
SITUS OF INCOME – place of taxation of income. income from abroad will be deemed earned outside
It is the jurisdiction that has the authority to impose the PH, thus dividends will NOT be split to
tax upon the income. Determines whether or not an Within/Without PH (Refer to page 80)
income is taxable in the PH. Particularly important
C. Merchandising Income – earned where the
to taxpayers taxable only on income WITHIN but
also important on global income for computation of property is sold
D. Manufacturing Income – earned where the
foreign tax credit.
goods are manufactured and sold
SOURCE OF INCOME – pertains to
OPERATIONS REMARK
activity/property that produces the income
PRODUCTION DISTRIBUTION
(different with SITUS OF INCOME) Within Within Total Income from
INCOME SITUS RULES production and
distribution earned
Types of Income Place of Taxation (situs) WITHIN the PH
1. Interest Income Debtor’s Residence Without Without Total Income from
2. Royalties Where the intangible is the production and
employed distribution is earned
3. Rent Income Location of Property WITHOUT the PH
4. Service Income Place where service is Within Without Production Income
rendered is earned within,
Distribution Income
is earned WITHOUT
OTHER INCOME SITUS RULES Without Within Distribution Income
is earned within,
A. Gain on Sale of Properties Production Income
a. Personal Property – is earned WITHOUT
i. Domestic Securities – presumed
earned within PH
ii. Other Personal Properties – NOTE: page 82
earned where property is sold
 Home Office and Branch – NOT separate
b. Real Property – earned where the
 Parent and Subsidiary - Separate
property is located

B. Dividend Income
a. Domestic Corporation – presumed
earned within
b. Foreign Corporation
i. Resident Foreign Corporation –
depends on predominance test
ii. Non-Resident Foreign
Corporation – earned abroad

*PRE-DOMINANCE TEST – if ratio of PH gross

income over world gross income of the resident
foreign corporation in the three-year period
preceding the year of dividend declaration is:
 At least 50% the portion of the dividend
corresponding to the PH gross income ratio
is earned within