M11 INCOME AND BUSINESS TAXATION
are: delegation to the President, local government
Taxation
Taxation is the process by which a government, through its
lawmaking body, imposes charges on its inhabitants to raise
money for public use.
Purposes of Taxation
The primary purpose of taxation is to raise revenue that will be
used in defraying government expenses (also called the
‘revenue purpose’)
Secondarily, taxation may also be used to achieve
certain social and economic objectives (‘non-revenue purposes’),
such as the following:
a. regulate inflation (e.g., taxes may be adjusted in order
to prevent economic depression)
b. minimize the adverse effects of certain activities (e.g.,
tobacco is taxed to discourage smoking, imported
goods are taxed to protect local producers, and the
like)
c. equitable distribution of wealth (e.g., higher taxes are
imposed on those who earn more)
Nature of Taxation
1. Inherent power
Taxation is one of the following three inherent powers of a
sovereign state:
1. Eminent domain – the right of the government to
appropriate private property for particular uses to
promote public welfare;
2. Police power – the power of the government to enact
laws to promote peace and order, public welfare,
security, health and safety; and
3. Taxation
The government cannot exist without money. It needs
the power of taxation to raise the money needed to support its
existence. This is why tax is often referred to as the lifeblood or
the ‘bread and butter’ of the government.
2. Legislative
Taxation is a process that is legislative in nature. This means
that tax laws must first be enacted before taxed can be
imposed.
3. Subject to constitutional and inherent limitations
The power of taxation is considered plenary (absolute or
supreme), subject only to constitutional and inherent
limitations. This means that the government can tax anything
or anyone within its jurisdiction.
 Inherent limitations on the power of taxation:
a. Purpose – taxes can only be levied for public purposes.
b. Territorial jurisdiction – the government may levy taxes
only on persons and properties within its jurisdiction.
c. Non-delegation of legislative power to tax – the power to
create tax laws rests with the Congress (Congressmen
and Senators) and this power cannot be delegated,
except as expressly allowed by law (the exceptions
units, and administrative bodies).
d. Tax exemption government entities
e. International comity – the government may not tax the
property belonging to a foreign government.
 Constitutional limitations on the power of taxation:
a. Due process and equal protection of the laws
b. Rule of uniformity and equity in taxation.
 Items (a) and (b) protect the taxpayer from the
promulgation of tax laws that are
unconstitutional, unjust or unreasonable.
c. President’s power to veto tax bills.
d. A law granting any tax exemption needs the concurrence
of the majority of the Members of the Congress.
e. Supreme Court’s power to make final judgment on tax
cases.
 Items (c) and (e) protect the taxpayer from the
potential abuse by the Congress of its power to
promulgate tax laws.
f. Non-imprisonment for non-payment of poll tax.
g. Exemption of religious, charitable, or educational entities,
non-profit cemeteries, and churches from property
taxation.
h. Exemption of revenues and assets of non-stock, non-profit
educational institutions from taxation.
Theory and basis of taxation
The government cannot exist without money. The government
therefore, has the right to compel those within its jurisdiction
to pay taxes. This is based on the following:
a. Reciprocal duties of protection and support – the government
protects the welfare of its people, in return, the people
support the government.
b. Benefits received principle – taxes are used for the benefit of
the public.
Aspects of taxation
1. Levy – tax laws, specifying the object and amount of
taxation, are enacted.
2. Collection – the tax laws are implemented and
administered.
After tax laws are enacted, the Bureau of Internal
Revenue (BIR) is tasked in collecting national taxes and
administering the provisions of national tax laws, while
the Local Government is tasked in collecting local taxes and
administering local tax laws.
Principles of a sound tax system
a. Fiscal adequacy – revenues should be sufficient to defray 5. As to rate or graduation:
expenditures. a. Proportional – tax based on a fixed rate (Example:
value-added tax)
b. Theoretical justice – taxes are proportionate to the b. Progressive – tax based on an increasing rate as
taxpayer’s ability to pay. the taxable amount increases (Example: income
tax)
c. Administrative feasibility – tax laws can be implemented c. Regressive – tax based on a decreasing rate as the
efficiently and effectively, avoiding unnecessary taxable amount increases
inconvenience and confusion on the part if the taxpayers.
Tax distinguished from Other Fees
Taxes
Taxes are mandatory contributions imposed upon persons and Tax vs. License fee
property for the support of the government. - Imposed through - Imposed through police
power of taxation. power.
Characteristics of tax - The primary purpose is - The primary purpose is
a. It is mandatory. to raise revenue. to regulate certain
b. It levied by the lawmaking body. business activities.
c. It is imposed primarily to raise revenues for the - Amount is unlimited. - Amount is limited to
government. the costs of regulation.
d. It is generally payable in money.
e. It is proportionate in character. Tax vs. Toll fee
f. It is levied on persons and property (or the exercise - Paid for the support of - Paid for the use of
the government. property, e.g., road.
of a right or privilege) over which the taxing
authority has jurisdiction.
Tax vs. Special assessment
g. It is levied for public purposes.
- Imposed regardless of - Imposed because of an
public improvement. increase in the value of
land due to public
Classification of taxes improvement.
1. As to subject matter:
a. Personal, capitation or poll tax – a fixed amount charged
to all persons residing within a specified territory Scope of this Book
irrespective of their occupation or property. Example: There are various types of taxes. The scope of this book is
community tax of ‘cedula’. limited to only the following types of taxes:
b. Property tax – tax imposed on properties based on their 1. Income taxes (Compensation, Business income and
value or some other method of apportionment. some Passive income only); and
Example: real estate tax. 2. Business taxes (VAT and Percentage Tax only)
c. Excise tax – tax imposed upon the performance of an There are also various types of taxpayers. The scope
act, the enjoyment of a privilege, or the engaging in an of this book is limited only to individual taxpayers (other types
occupation. Example: value-added tax of taxpayers, like corporations, estates, etc., are outside the
scope of this book). The topics excluded are discussed in
2. As to who bears the burden: higher learning of taxation.
a. Direct tax – tax which the taxpayer must pay and
cannot shift to another. Examples: personal tax,
income tax Income Tax vs. Business Tax
b. Indirect tax – tax which the taxpayer can shift to Income tax is a tax on a person’s income derived from
another. Example: value-added tax employment, business, trade, practice of profession, or from
property, after excluding the deductions allowed under the
3. As to the determination of the amount: law.
a. Ad Valorem – tax based on the value of the property.
Example: real estate tax Business tax is a tax on the production, sale, or consumption of
b. Specific – tax based on weight, volume or other goods and services, leasing or property, or other business
physical unit of measurement. Example: excise tax on activities.
wines.
Simply stated and as the terms imply, income tax is
4. As to scope: tax on income, while business tax is tax on business. A person
a. National tax – tax levied by the national government who has earned income is liable to pay income tax. A person
(Examples: income tax, value-added tax) who engages in business is liable to pay business tax, whether
b. Local tax – tax levied by the local government, e.g., city, or not he or she earns income therefrom.
municipal (Examples: community tax, real estate tax,
municipal licenses tax) Example 1:
Mr. A is an employee earning salary.
 2. Business income, including income from practice of
Analysis: Mr. A is liable for income tax but not business tax. profession
3. Passive income (such as, interest income, royalty
However, if Mr. A does not earn salary during a income, prizes and winnings, and cash or property
taxable period, for example he is on leave without pay, Mr. A dividend income)
is not liable to pay income tax because he did not earn any
income.
Gross Compensation Income
Example 2: Compensation income is income that is typically derived from
Ms. B is self-employed. She owns a business. employment. Examples: salaries and wages.

Analysis: Ms. B is liable for business tax whether or not she  Salaries – compensation that is normally quoted
earns income from the business. If Ms. B earns business on a per month (per year) basis and is paid
income, Ms. B is liable for both income tax an business tax. If periodically (e.g., twice a month) for the
Ms. B does not earn business income, for example the business performance of a regular work, e.g., salary of a
incurs loss, Ms. B is still liable for business tax but not income policeman or a teacher.
tax.  Wages – compensation that is quoted on a per
hour basis and is paid based on the number of
hours worked, e.g., wages of a manual laborer.
Classification of Individual Income Taxpayers
Individual income taxpayers are classified into the following:
1. Resident citizen – a Filipino citizen residing Taxable income
permanently in the Philippines Taxable income is gross income minus the deductions allowed
2. Non-resident citizen – a Filipino citizen residing by law. Taxable income is the amount on which the tax is
permanently abroad or works abroad most of the time computed.
(i.e., at least 183 days during the taxable year). The following are allowed deductions from gross
Example: overseas contract workers (OCWs) income:
3. Resident alien – a foreigner residing in the 1. Contributions for the following:
Philippines. a. Social Security System (SSS) – for private
4. Non-resident alien – a foreigner not residing in the employees and self-employed
Philippines. b. Government Service Insurance System (GSIS) –
for government employees
Resident citizens are taxed on all income they derive c. Philippine Health Insurance Corporation
from sources within and without (outside) the Philippines. (PhilHealth)
Nonresident citizens and aliens are taxed only on d. Home Development Mutual Fund (HDMF) or
income they derive within the Philippines. popularly known as Pag-IBIG (Pagtutlungan sa
Kinabukasan: Ikaw, Bangko, Industria at
Individual Source of income Gobyerno)
Within the Outside the e. Union dues
Phils. Phils.
1. Resident citizen   2. Compensation for Injuries or Sickness – received
2. Non-resident   through Accident of Health Insurance or under
citizen Workmen’s Compensation Act.
3. Resident alien  
4. Non-resident  
alien

In all the succeeding discussions in this book, we will

assume that the taxpayer is a resident citizen.

Income Taxation
Income includes all inflows of wealth to the taxpayer other than
those that represents a mere return of capital.
In our succeeding discussions, we will be using the
term “gross income” to refer to the taxpayer’s income for
taxation purposes.
Gross income refers to all income derived from
whatever source, including (but not limited to):
1. Compensation income