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Chapter 3
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” - a tax concept of income
“item of gross income” or “inclusion gross
income” - A taxable item of income.
“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.
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 on 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 is
subject to income tax. (note: taxable)
RETURN OF CAPITAL – merely maintains net
worth, (note: not taxable)
*Improvement in net worth indicates ability to
pay tax
Capital Items with INFINITE VALUE
Anything received as compensation for their loss
is deemed a return of capital.
Examples:
Life – the value of life is immeasurable by money.
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)
The ff. are Taxable return on capital from
insurance policies:
a. Excess amount received over premiums paid
by the insured upon surrender or maturity of
the policy
b. Gain realized by the insured from the
assignment or sale of his insurance policy
c. Interest income from the unpaid balance of
the proceeds of the policy
d. 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 (not taxable-rofc) – a value of
one’s reputation cannot be measured.
- any indemnity received as compensation for its
impairment is deemed a return of capital exempt
from income tax
Ex. moral damages from:
a. oral defamation or slander,
b. alienation of affection,
c. breach of promise to marry.
Recovery of lost capital vs. Recovery of lost
profit
Loss of Capital results in decrease in net worth
Loss of Profits do not decrease net worth.
Recovery of Lost Capital merely maintains net worth

Recovery Lost of Profits - increases net worth.
(return on capital)
Taxable recovery of lost profits
- recovery of lost profits through insurance,
indemnity contracts, or legal suits (taxable return
on capital)
The ff. are 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)
Ff. 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 derived 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
Unilateral transfers are simply referred to as
“transfers”
Bilateral transfers are called “exchanges”
3. Complex Transactions – partly gratuitous and
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partly onerous;
Commonly referred to as “transfers for less than
full and adequate consideration”.
Gratuitous portion subject to TRANSFER TAX,
while Onerous portion is subject to INCOME TAX.
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 of unrealized gains / holding gains:
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
two ways:
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)
- in the form of depositing on your account.
Inflow of wealth without increase in net worth
- inflow of wealth that does NOT increase net
worth is income due to total absence of benefit
Examples:
A. receipt of property in trust,
B. borrowing money under an obligation to
return
- 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
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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
a. Citizens of PH at time of adoption of
Constitution on Feb. 2, 1987
b. Father and mother are citizen of PH
c. Born before Jan. 17, 1973 of Filipino Mothers
who elected Filipino citizenship upon reaching
the age of majority
d. Naturalized in accordance with the law
Classification of Citizens
A. Resident Citizen – filipino citizen residing in PH
B. Non-resident Citizen
1. Citizen of PH with physical presence
abroad with a definite intention to
reside therein
2. Leaves PH during taxable year to

abroad (immigrant or employment on
permanent basis)
3. 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
4. Citizen previously considered as
NONresident 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 such as:
a. Lives in the PH without definite intention
as to his intention
b. 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
B. Non-Resident Alien – NOT residing in PH and
who is not a citizen
1. 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
2. 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
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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 nonresident.
b. Aliens who stayed in PH for more than 1
year as of the end of taxable year are 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 nonaliens 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
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- 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
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
taxable on transaction through branch
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
1. One Person Corporation (OPC) – single
stockholder (can be natural, trust, or estate).
Banks etc. and practice for procession cannot
incorporate as OPC.
2. Partnership - owned by two or more persons
who contribute the industry.
Types of Partnerships
a. General Professional Partnership (GPP) –
formed for the exercise of a common profession.
All partners must belong to the same profession.
3. Joint Venture - business undertaking for a
particular purpose. It may be organized as
partnerships or a corporation.
Types of joint ventures:
a. Exempt Joint Ventures – for purpose of
undertaking construction projects or engaging
petroleum, coal, geothermal and other energy
operations. NOT treated as corporation thus tax-
exempt on regular income, but venturers are
taxable on share on net income of JV
b. Taxable Joint Ventures – other than
JV are taxable as corporations. (residual)
4. Co-Ownership
- joint ownership of property formed for
preserving the same and/or dividing its income.
- If limited to property preservation or income
collection, NOT taxable entity but co-owners are
taxable on their share on income of co-owned
property.
- If reinvests income of co-owned property to
other income producing properties/ventures, it
will be considered an unregistered partnership
taxable as corporation

FOREIGN CORPORATION – organized under Not treated as corporation and its not taxable THE GENERAL RULES IN INCOME TAXATION
foreign law entity. It is exempt from income tax, but the INDIVIDUAL TAXPAYERS
Taxable On Income Earned
WITHIN WITHOUT

partners are taxable in their individual capacity Resident Citizen

Non-Resident Citizen
/
/
/

TYPES OF FOREIGN CORPORATION with respect to their share in the income of the Resident Alien
Non-Resident Alien
/
/

parnetships. CORPORATE TAXPAYERS

Domestic Corporation / /

1. RESIDENT FOREIGN CORPORATION (RFC) Resident Foreign Corporation

Non-Resident Foreign Corporation
/
/

– operates and conducts business in PH b. Business Partnership – formed for profit.

through permanent establishment (ex. branch). Taxable as corporation.

Note: “territoriality rule” – ALL taxpayers (except
resident citizens and domestic corporations) are
taxable only on income earned within the PH
THE RESIDENCY AND CITIZENSHIP RULE
Resident Citizens of PH and Domestic
Corporations – taxable on ALL income from
sources WITHIN and WITHOUT the PH
*corporation is a citizen of the country where it
incorporated.
BASIS OF THE EXTRATERRITORIAL TAXATION
Resident citizens and domestic corporation have
full access on benefits from government. The
taxation on their foreign income properly reflects
this difference in benefits consistent with the
Benefit Received Theory.
The extraterritorial treatment is intended as a
safety net to the potential loss of tax revenues
brought by situs relocation or practice of
executing or structuring transaction transactions
such that income will be realized abroad to avoid
PH income taxes.
ISSUE OF INTERNATIONAL DOUBLE TAXATION
Rule on extraterritorial taxation exposes resident
citizens and domestic corporation to DOUBLE
TAXATION. However, NIRC allows a tax credit for
taxes paid in foreign countries. They also pay
minimal taxes in PH on their foreign income
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because of tax credit. b. Foreign Corporation
a. Resident Foreign Corporation –
SITUS OF INCOME – place of taxation of income. depends on predominance test
It is the jurisdiction that has the authority to
impose tax upon the income. Determines ii. Non-Resident Foreign Corporation –
whether or not an income is taxable in the PH. earned abroad
Particularly important to taxpayers taxable only *PRE-DOMINANCE TEST – if ratio of PH gross
on income WITHIN but also important on global income over world gross income of the resident
income for computation of foreign tax credit. foreign corporation in the three-year period
preceding the year of dividend declaration is:
SOURCE OF INCOME – pertains to  At least 50% the portion of the dividend
activity/property that produces the income corresponding to the PH gross income ratio
(different with SITUS OF INCOME) is earned within
 Less than 50%, the entire dividends are
INCOME SITUS RULES earned abroad
Types of Income
1. Interest Income
Place of Taxation (situs)
Debtor’s Residence NOTE: If ratio is less than 50% then the gross
2. Royalties
3. Rent Income
Where the intangible is employed
Location of Property income from abroad will be deemed earned
4. Service Income Place where service is rendered
outside the PH, thus dividends will NOT be split
to Within/Without PH (Refer to page 80)
OTHER INCOME SITUS RULES
C. Merchandising Income – earned where the
A. Gain on Sale of Properties
property is sold
a. Personal Property – presumed earned within
the ph
D. Manufacturing Income – earned where the
b. Other Personal Properties – earned where
goods are manufactured and sold
property is sold
B. Real Property – earned where the property is
located
B. Dividend Income from;
a. Domestic Corporation – presumed
earned within