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10. Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows.

III. Professional income- refers to the fees received by a professional from the practice of his profession provided that there is no employer-employee relationship
between him and his clients. The existence or nonexistence of employer-employee relationship is material to determine whether the income is a compensation income
or professional income. If the employer-employee relationship is present, when it is considered compensation income otherwise it is a professional income.
Professional income shall be subject to creditable withholding tax rates prescribed.

IV. Income from business- business income refers to income derived from merchandizing, mining, manufacturing and farming operations. Business is only activity that
entails time and effort of an individual or group of individuals for purposes of livelihood or profit.

Gross Income derived from business- the term “gross income” derived from business shall be equivalent to gross sales less sales return, discounts and allowances
and cost of goods sold. In the case of taxpayers engaged in the sale of service. “Gross Income” means gross income receipt less sales return allowances and
discounts.

Costs of goods sold- it includes all business expenses directly incurred to produce the merchandise to bring them to their present location and use such as invoice
cost of the goods sold for a trading concern or cost of production for a manufacturing concern.

Cost of Services- all directs cost and expenses necessarily incurred to provide the service required by the customers and clients including:
1. Salaries and employee benefits of personnel consultants and specialists directly rendering the service.
2. Cost of facilitates directly utilized in providing the service.

V. Income from dealings in property

1. Distinguish ordinary asset and capital asset
Ordinary Asset- refer to properties held by the taxpayer used in the connection with his trade or business which includes:
1. Stock in trade of the taxpayer or other property of a kind which would property be included in the inventory of the taxpayer if on hand at the close
of taxable year.
2. Property held by the taxpayer primarily for sale to customers in the ordinary course of trade or business.
3. Property used in the trade or business of a character which is subject to the allowance for depreciation provided in the NIRC.
4. Real property used in trade or business of the taxpayer (SOUR)

Examples of Ordinary assets:

1. The condominium building owned by a realty company the units of which are for rent or for sale.
2. Machinery/equipment of a manufacturing concern subject to depreciation.
3. The motor vehicles of a person engaged in transportation business.

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Capital Assets- include property held by the taxpayer (whether or not connected with his trade or business) other than (SOUR) above.
Example of Capital Assets
1. Jewelry not used for trade or business.
2. Residential houses and lands owned and uses as such
3. Automobiles not used in trade or business
4. Stock/ Securities held by taxpayer other than decisions of securities.

Construction and Interpretation of Capital Assets- The general rule has been laid down that the codal definition of a capital assets must be narrowly construed
while the exclusions from such definitions must be interpreted broadly.

2. Types of gains
ORDINARY INCOME VIS-À-VIS CAPITAL GAIN.
1. If the asset involved is classified as ordinary, the entire amount of the gain from the transaction shall be included in the computation of gross income [Sec
32(A)], and the entire amount of the loss shall be deductible from gross income. [Sec 34(D)]. (See Allowable Deductions from Gross Income – Losses.
2. If the asset involved is a capital asset, the rules on capital gains and losses apply in the determination of the amount to be included in gross income. (See
Capital Gains and Losses).

These rules do not apply to:

• real property with a capital gains tax (final tax), or
• shares of stock of a domestic corporation with a capital gains tax (final tax).

ACTUAL GAIN VIS-À-VIS PRESUMED GAIN

Presumed Gain: In the sale of real property located in the Philippines, classified as capital asset, the tax base is the gross selling price or fair market value,
whichever is higher. The law presumes that the seller makes a gain from such sale. Thus, whether or not the seller makes a profit from the sale of real
property, he has to pay 6% capital gains tax.

Actual Gain: The tax base in the sale of real property classified as an ordinary asset is the actual gain.

3. Special rules pertaining to income or loss from dealings in property classified as capital asset (loss limitation rule, loss carry-over rule, holding period rule)

a. Capital Loss Limitation Rule-Losses from sale or exchanges of capital assets shall be allowed only up to the extent of the gains from such sales or exchanges
(NIRC, Sec. 39 (C)). Thus, under this capital loss limitation rule, capital loss is deductible only up to the extent of capital gain. The taxpayer can only
deduct capital loss from capital gain. If there is no capital gain, then no deduction is allowed because you cannot deduct capital loss from ordinary gain.

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Rationale: To allow the deduction of non-business (capital) losses from business (ordinary) income or gain could mean the reduction or even elimination
of taxable income of the taxpayer through personal, non-business-related expense, resulting in substantial losses of revenue to the government
(Mamalateo, 2014).

Wherethe capital loss limitation rule will not apply:

➢ If a bank or trust company is incorporated under the laws of the Philippines,
➢ a business whose substantial part is the receipt of deposits,
➢ sells any bond, debenture, note or certificate or other evidence of indebtedness issued by any corporation, with interest coupons or in registered
form,
➢ any losses resulting from such sale shall not be subject to the above limitations and shall not be included in determining the applicability of such
limitation to other losses (NIRC, Sec. 39 [C]).

b. Net Capital Loss Carry Over (NOLCO)- If any taxpayer, other than a corporation, sustains in any taxable year a net capital loss, such loss (in an amount
not in excess of the net income for such year) shall be treated in the succeeding taxable year as a loss from the sale or exchange of a capital asset held
for not more than 12 months (NIRC, Sec. 39 [D]).

Rules with regard to NCLCO

➢ NCLCO is allowed only to individuals, including estates and trusts.
➢ The net loss carry-over shall not exceed the net income for the year sustained and is deductible only for the succeeding year.
➢ The capital assets must not be real property or stocks listed and traded in the stock exchange.
➢ Capital asset must be held for not more than 12 months.

c. Holding period rule (long term capital gain vis-àvis short term capital gain)-Where the taxpayer held the capital asset sold for more than 12 months, the
gain derived therefrom is taxable only to the extent of 50%. Consequently, if the taxpayer held the capital asset sold for a year or less, the whole gain
shall be taxable. The same also applies to capital loss. It is a form of tax avoidance since the taxpayer can exploit it in order to reduce his tax due (NIRC,
Sec. 39 [B]).

Holding period does not find application in the case of disposition of:
➢ Shares of stock; and
➢ Real property considered as capital asset, whether the seller is an individual, trust, estate or a private corporation.

Only individual taxpayers can avail of the holding period rule. It is not allowed to corporations.

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4. Tax-free exchanges- tax free exchanges refer to those instances enumerated in Sec 40 (c) (2) of the National Internal Revenue Code of 1997 that are not
subject to income tax, capital gains tax, documentary stamp tax and/or Value added Tax.In general there are 2 kinds of tax-free exchange (1) transfer to a
controlled corporation, (2) merger or consolidation:

In the first instance no gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in
such corporation of which as a result of such exchange said person, alone or together with others, not exceeding four persons, gains of said corporations.

In the 2nd instance, no gain or loss shall be recognized if in pursuance of a plan or merger or consolidation; (a) a corporation which is a party to the merger
or consolidation or, (b) a shareholder exchanges stock in a corporation which is a party to the merger or consolidation solely for the stock of another corporation
also a party to the merger or consolidation or (c) a security holder of a corporation, which is a party to the merger or consolidation exchanges his securities
in such corporation, solely for stock or securities in another corporation, a party to the merger or consolidation.

VI. Passive investment income- Passive income refers to income derived from any activity in which the taxpayer has no active participation or involvement.

CLASSIFICATION OF PASSIVE INCOME:

a. Subject to Schedular Rates
b. Subject to Final Taxes.

INCOME SUBJECT TO FINAL TAX- refers to an income wherein the tax due is fully collected through the withholding tax system. Under this procedure, the payor of
the income withholds the tax remits it to the government as a final settlement of the income tax due on said income. The recipient is no longer required to include
the item of income subjected to final tax as part of his gross income in his income tax returns.

SOURCES OF INCOME APPLIED TO INDIVIDUALS

1. Interest
➢ On interest on currency bank deposits, yield or other monetary benefits from deposit substitutes, trust, funds and similar arranges
XPN: If the depositor has an employee trust fund or accredited retirement plan such interest income, yield or other monetary benefits is exempt from
final withholding tax.
➢ Interest income under expanded foreign currency deposit system
NOTE: If the loan is granted by a foreign government or an international or regional financing institutions established by government the interest
income of the lender shall not be subject to final withholding tax.
➢ Interest income form long term deposit or investment in the form of savings common or individual trust funds deposit substitute investment
management accounts and other investments evidenced by certificates in such form prescribed by the BSP.
2. Dividend- dividend from DC from a joint stock company, insurance or mutual fund company and regional operating headquarters of a multinational company
or on the share of an individual in the distributable net income tax after tax of partnership (except that of a GPP) of which he is a partner or on the share of

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an individual in the net income after income tax of an association, a joint account or joint venture of consortium taxable as a corporation of which he is a
member of co-venture.
3. Royalty income-Where a person pays royalty to another for the use of its intellectual property, such royalty is generally a passive income of the owner thereof
subject to withholding tax.
4. Rental income-Refers to earnings derived from leasing real estate as well as personal property. Aside from the regular amount of payment for using the
property, it also includes all other obligations assumed to be paid by the lessee to the third party in behalf of the lessor (e.g., interest, taxes, loans, insurance
premiums, etc.) [RR 19-86].

APPLIED TO CORPORATION:
1. Interests from any currency bank deposits, yield or any other monetary benefits from deposit substitutes and from trust fund and similar arrangement/royalties
derived from sources within a Philippines.
2. Interest Income derived under expanded foreign currency deposit system
3. Interest derives from depositary bank under the expanded foreign currency deposit system from foreign currency loans granted to residents other than offshore
banking units.
4. Interest received by NIRC
5. Dividends received from domestic corporation

VII. Annuities and proceeds from life insurance or other types of insurance
ANNUITIES
it refers to the periodic installment’s payments of income or pension by insurance companies during the life of a person or for a guaranteed fixed period of time
whichever is longer, in consideration of capital paid by him. The portion representing return of premium is not taxable while that portion that represents interest is
taxable.
NOTE: The portion of annuity net of premiums is taxable being interest or earnings of the premium and not return of capital.

PROCEEDS OF LIFE INSURANCE

Amounts received under a life insurance endowments or annuity contact whether in a single sum of in installments paid to the beneficiaries upon the death of the
insured are excluded from the gross income of the beneficiary.
XPN:
1. If such amounts, when added to the amounts already received before the taxable year under such contract, exceed the aggregate premiums or
consideration paid, the excess shall be included in the gross income.
NOTE: However, in case of a transfer for a valuable consideration by assignment or otherwise of a life insurance, endowments on annuity contract or any
interest therein, only the actual value of such considerations and the amount of the premiums and other sums subsequently paid by the transferee are
exempt from taxation.

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2. Interest payments thereon if such amounts are held by the insurer under an agreement to pay interest shall be taxable. If paid to a transferee for a
valuable consideration, the proceeds are not exempt.
NOTE: The life insurance proceeds must be paid by reason of death of the insured. Payments for reasons other than death are subject to tax up to the
excess of the premiums paid. Any policy loans or borrowings made on the policy shall be deducted as advances from the life insurance proceeds received
upon death.

RECIPIENTS OF NON-TAXABLE LIFE INSURANCE PROCEED

proceeds of life insurance policies paid to individual beneficiaries upon the death of the insured are exempt. Also, it has also been held that proceeds of life insurance
policies taken by a corporation on the life of an executive to indemnify it against loss in case of his death do not constitute taxable income.

DIFFERENCES BETWEEN THE TAX TREATMENT OF LIFE INSURANCE PROCEEDS UNDER INCOME/ ESTATE TAXATION
In estate taxation, the concept of revocability or irrevocability in the designation of the beneficiary is necessary to determine whether the life insurance proceeds are
included in the gross estate or not. However, if the appointed beneficiary is the estate, executor or administrator, the proceeds shall be included from the gross
estate.
NOTE: Under the Insurance Code, the insured shall have the right to change the beneficiary he designated in the policy, unless he has expressly waived this right in
said policy. Notwithstanding the foregoing tin the event the insured does not change the beneficiary during the lifetime, the designation shall be deemed irrevocable.

On the other hand, in income taxation, there is no need for the determination or revocability or irrevocability if the beneficiary for the purposes of exclusions of such
proceeds from the gross income. They are non-taxable regardless of who the recipient is.

VIII. Prizes and awards- It refers to amount of money in cash or in kind received by chance or through luck and is generally taxable except if specifically mentioned under
the exclusion from computation of gross income under Sec. 32[B] of NIRC.

Tax treatment for prizes and winnings

1. Generally, prizes exceeding ₱10,000 and other winnings from sources within the Philippines shall be subject to 20% final withholding tax, if received by a
citizen, resident alien or non-resident engaged in trade or business in the Philippines.
2. If the recipient is a non-resident alien not engaged in trade or business in the Philippines, the prizes and other winnings shall be subject to 25% final
withholding tax.
3. If the recipient is a corporation (domestic or foreign), the prizes and other winnings are added to the corporation’s operating income and the net income is
subject to 30% corporate income tax.

Prizes and winning subject to income tax

1. Prizes derived from sources within the Philippines not exceeding ₱10,000 are included in the gross income.
2. Winnings derived from sources within the Philippines is subject to final tax on passive income except PCSO and lotto winnings which are tax exempt.

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3. Prizes and winnings from sources outside the Philippines

Exempt from tax

1. Prizes and award made primarily in recognition of
a. Religious, charitable;
b. Scientific;
c. Educational artistic, literary; or
d. Civic achievement.
Provided the recipient was:
a. Selected without any action on his part to enter the contest or proceeding (not constituting gains from labor); and
b. Not required to render substantial future services as a condition to receive the prize/award.
2. All prizes and awards granted to athletes in local and international sports competitions and tournaments, whether held in the Philippines or abroad and
sanctioned by their respective national sports association
3. PCSO/Lotto winnings (except NRANETB)

IX. Pension, retirement benefit, or separation pay

➢ It refers to amount of money received in lump sum or on staggered basis in consideration of services rendered given after an individual reaches the age of
retirement.
➢ Pension being part of gross income is taxable to the extent of the amount received except if there is a BIR approved pension plan.
➢ The amounts that do not qualify as exclusions are considered as part of income subject to tax.

X. Income from any source- “Income from whatever source derived “implies that all income not expressly exempted from the class of taxable income under our laws
form part of the taxable income, irrespective of the voluntary or involuntary action of the taxpayer in producing the income. The source of the income may be legal
or illegal.
1. Condonation of indebtedness
➢ When cancellation of debt is income. If an individual performs services for a creditor, who in consideration thereof, cancels the debt, it is income to
the extent of the amount realized by the debtor as compensation for his services.
➢ When cancellation of debt is a gift. If a creditor merely desires to benefit a debtor and without any consideration therefore cancels the amount of the
debt, it is a gift from the creditor to the debtor and need not be included in the latter’s income. The creditor is subject to donor’s tax.
➢ When cancellation of debt is a capital transaction. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect
of payment of a dividend.
➢ An insolvent debtor does not realize taxable income from the cancellation or forgiveness.
➢ The insolvent debtor realizes income resulting from the cancellation or forgiveness of indebtedness when he becomes solvent.

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2. Recovery of accounts previously written off
Bad debts claimed as a deduction in the preceding year(s) but subsequently recovered shall be included as part of the taxpayer’s gross income in the
year of such recovery to the extent of the income tax benefit of said deduction. There is an income tax benefit when the deduction of the bad debt in the prior
year resulted in lesser income and hence tax savings for the company.

“Tax Benefit Rule” or Equitable Doctrine of Tax Benefit

It is a principle that if a taxpayer recovers a loss or expense that was deducted in a previous year, the recovery must be included in the current year's
gross income up to the extent that it was previously deducted.

Two instances where Tax benefit rule applies

a. Recovery of bad debts
b. Receipt of tax refund or credit

Recovery of bad debts

The recovery of bad debts previously allowed as deduction in the preceding year or years shall be included as part of the taxpayer’s gross income in
the year of such recovery to the extent of the income tax benefit of said deduction. If the taxpayer did not benefit from deduction of the bad debt written-off
because it did not result in any reduction of his income tax in the year of such deduction as in the case where the result of the taxpayer’s business operation
was a net loss even without deduction of the bad debts written-off, his subsequent recovery thereof shall be treated as a mere recovery or a return of capital,
hence, not treated as receipt of realized taxable income.

3. Receipt of tax refunds or credit

If a taxpayer receives tax credit certificate or refund for erroneously paid tax which was claimed as a deduction from his gross income that resulted in
a lower net taxable income or a higher net operating loss that was carried over to the succeeding taxable year, he realizes taxable income that must be
included in his income tax return in the year of receipt.
XPN: The foregoing principle does not apply to tax credits or refunds of the following taxes since these are not deductible from gross income:
a. Income tax;
b. Estate tax;
c. Donor’s tax; and
d. Special assessments.
d. Exclusions
Exclusions from gross income refer to the flow of wealth to the taxpayers which are not considered part of gross income for purposes of computing the taxpayer’s taxable
income due to the following:
a. It is exempted by the fundamental law or by statute;
b. It does not come within the the definition of income.

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The exclusion of income should not be confused with the reduction of gross income by application of allowable deductions. Exclusions are not taken into account in
determining gross income, however, deductions are subtracted from the gross income.

Construction of exclusions
Exclusions are in the nature of tax exemptions; thus, they must be strictly construed against the taxpayer and liberally in favor of the Government. It behooves upon the
taxpayer to establish them convincingly

I. Rationale. There are exclusions from the gross income either because they:
1. Represent return of capital;
2. Are not income, gain or profit; or
3. Are subject to another kind of internal revenue tax;
4. Are income, gain or profit that is expressly exempt from income tax under the Constitution, Tax treaty, NIRC, or general or a special law.

II. Taxpayers who may avail

All kinds of taxpayers – individuals, estates, trusts and corporations, whether citizens, aliens, whether residents or non-residents may avail of the exclusions.
Rationale: The excluded receipts are not considered as income for tax purposes.

III. Distinguish: exclusions, deductions, and tax credits

EXCLUSIONS DEDUCTIONS TAX CREDIT
Incomes received or earned but are These are included in the gross income It refers to foreign taxes paid
not taxable because of exemption by but are later deducted to arrive at net beforehand but are claimed as credits
virtue of a law or treaty; hence, not income against Philippine income tax to arrive
included in the computation of gross at the tax due and payable
income

IV. Exclusions under the Constitution

➢ Income derived by the Government or its political subdivisions from the exercise of any essential government function
➢ Income derived by the Government or its political subdivision is exempt from gross income, if the source of the income is from any public utility or from the
exercise of any essential governmental functions.

4. Deductions
a. General rule- these refers of amount allowed as deductions, or items authorized by law to be subtracted from pertinent items of gross income to arrive at the taxable
income.

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Nature of Deductions
The items of amounts allowed as deductions represent the expenses (reduction of wealth) of the taxpayer (other than personal expenses and capital expenditures) in
earning the income (increase of wealth) subject to tax as well as reasonable living expenses.

Requisites before deductions are allowed

a. There must be specific provision of law allowing the deductions, since deductions do not exist by implication.
b. The requirements of deductibility must be met. (Refer to discussions on itemized deductions for the requirements of each deduction).
c. There must be proof of entitlement to the deductions. The burden of proof to establish the validity of claimed deduction is on the taxpayer. This is consistent with
the rule that tax exemptions must be strictly construed against the taxpayer and liberally in favor of the State.
d. The deductions must not have been waived. 5. The withholding and payment of tax required must be shown.

General Rules in Claiming Deductions

a. Deductions must be paid or incurred in connection with the taxpayer’s trade, business, or profession.
Matching concept of deductibility
➢ This posits that the deductions must, as a general rule, “match” the income, i.e. helped earn the income.
➢ Ordinary and necessary expenses must have been paid or incurred during the taxable year for it to be deductible from gross income. Further, the
deduction shall be taken for the taxable year in which 'paid or accrued' or 'paid or incurred.' Otherwise, the expenses are barred as deductions in
subsequent years.
b. Deductions must be supported by adequate receipts or invoices (XPN: standard deduction).
c. The withholding and payment of tax required must be shown.
Any income payment which is otherwise deductible shall be allowed as a deduction from gross income only if it is shown that the income tax required to be
withheld has been paid to the BIR.

Where the withholding made but still deductible

a. The payee reported the income and the withholding agent/taxpayer pays the tax, including the interest incident to the failure to withhold the tax, and surcharges,
if applicable, at the time of the original audit and investigation.
b. The recipient/payee failed to report the income on the due date thereof, but the withholding agent/taxpayer pays the tax, including the interest incident to the
failure towithhold the tax and surcharges, if applicable, at the time of the original audit and investigation; or
c. The withholding agent erroneously underwithheld the tax but pays the difference between the correct amount and the amount of tax withheld, including the
interest, incident to such error, and surcharges, if applicable, at the time of the original audit and investigation (Sec. 2.58.5, RR 2-98).

Persons who are not allowed to claim deductions from gross income. Non-Resident Alien-Not Engaged in Trade or Business and Non-Resident Foreign Corporation are subject
to final tax on their gross income derived from sources within the Philippines, hence, no deductions allowed to them.

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