Regular Income

Tax: Inclusion in
Gross Income
Chapter 9
ITEMS OF GROSS INCOME SUBJECT TO REGULAR
TAX
Gross income includes, but is not limited to, the following items:

1. Compensation for services in whatever form paid

2. Gross income from the conduct of trade, business, or exercise of a profession
3. Gains derived from dealings in properties
4. Interest
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and Winnings
10. Pensions
11. Partner’s distributive share from the net income of general professional partnership
• COMPENSATION FOR SERVICES IN WHATEVER FORM PAID
ㅡ “ compensation income” pertains to the types of employee benefits that are subject to regular tax.

• GROSS INCOME FROM THE CONDUCT OF TRADE, BUSINESS, OR EXERCISE OF A

PROFESSION
ㅡ This includes income from any trade or business, legal or illegal, and whether registered or
unregistered.
The following business income shall not be included in gross income subject to regular income tax:
1. Business income exempt from income tax such as:
a. Gross income from a Barangay Micro-Business Enterprise (BMBE) under RA 9178
b. Gross income from enterprises enjoying tax holiday incentives under EO 226
2. Business income subject to special tax regime such as:
a. Philippine Economic Zone Authority (PEZA) - registered enterprises subject to 5% gross
income tax
 b. Tourism Infrastructure and Enterprise Zone Authority (TIEZA) - registered enterprises
subject to 5% gross income tax
c. Income of self-employed and or individuals (SE/P) who opted to be taxed under 8%
income tax
3. Business income subject to final tax
ㅡ when not subjected to final tax by the payor
a. Subcontractors of petroleum service contractors subject to 8% final tax
b. Business income in Foreign Currency Deposit Units (FCDUs) and Offshore Banking
Units (OBUs) from Philippine residents subject to 10% final tax
• GAINS DERIVED FROM DEALINGS IN PROPERTIES
ㅡ Gains or losses in dealing in ordinary assets
ㅡ Dealings in capital assets other than domestic stocks and real properties
ㅡ Net capital gain from other capital assets after deducting capital losses
• INTEREST INCOME
ㅡ interest income other than passive interest income subject to final tax
ㅡ a taxable interest income must have been actually paid out of an agreement to pay interest
Examples of interest income subject to regular income tax:
1. Interest income from lending activities to individuals and corporations by bank finance companies
and other lenders
2. Interest income from bonds and promissory notes
3. Interest income from bank deposits abroad
Exempt interest income:
The following are exempt from regular income taxation:

1. Interest income earned by landowners

ㅡ in disposing their lands to their tenants pursuant to the Comprehensive Agrarian Reform Law

2. Imputed interest income

ㅡ imputed interest income (the opportunity cost of money) does not constitute an actual income;
hence, it is exempt from income tax
The power of the Commissioner to allocate income and deduction does not include the power to
impute “theoretical interest”.
• RENTS
ㅡ Rents Income arises from leasing properties of any kind
ㅡ it is passive income but is not subject to final tax under the NIRC; hence, it is subject to regular
income tax

Special considerations on rent:

1. Obligations of the lessor that are assumed by the lessee are additional rental income to the lessor.
2. Advance rentals are:
a. Item of gross income upon receipt if:
i. Unrestricted
ii. Restricted to be applied in future years or upon the termination of the lease

b. Not item of gross income if:

i. It constitutes a loan
ii. It is a security deposit to guarantee payment or rent subject to contingency which may or
may not happen.
3. Leasehold improvements made by the lessee

• ROYALTIES
ㅡ Active royalty income and royalties earned within and outside the Philippines

• DIVIDENDS
ㅡ These pertains to dividends declared by foreign corporations.
ㅡ Declared by domestic corporations are generally subject to 10% final tax if the receipt is an
individual taxpayer and exempt if the receipt is a domestic or a resident foreign corporation.
ㅡ Cash, property, and script dividends from foreign corporations are items of gross income subject to
regular income tax.

Stock dividends
ㅡ are exempt from income tax, but when the declaration confers to the recipients a different interest
or right after the stock dividend declaration
ㅡ are subsequently redeemed such that it amounts to payment of cash dividend
Liquidating dividends
ㅡ is not income
ㅡ considered an amount in exchange for the investment of the investor and are subject to the rules of
dealings in properties

• ANNUITIES
ㅡ The excess of annuity payments received by the recipient over premium paid is taxable income in
the year of receipt.

• PRIZES AND WINNINGS

ㅡ Prizes and winnings that are exempted from final tax are not items of gross income subject to
regular income tax

Exempt prizes and winnings:

1. Prizes received without effort to join a contest

2. Prizes in athletic competitions sanctioned by their respective national sports association
3. Winnings from PCSO or lotto, not exceeding P20,000 in amount
Summary rules of prizes and winnings for individual taxpayers:

Earned from sources

Within Abroad
Prizes

P10,00 and below Regular tax Regular tax

More than P10,000 Final tax Regular tax

PCSO and lotto, exceeding P20,000 Final tax N/A

PCSO and lotto, not exceeding P20,000 Exempt N/A

Winnings from other sources Final tax Regular tax

• PENSIONS
ㅡ These pertain to pensions and retirement benefits that fail to meet the exclusion criteria and hence
subject to regular tax

• PARTNER’S DISTRIBUTABLE SHARE FROM THE NET INCOME OF THE GENERAL

PROFESSIONAL PARTNERSHIP
ㅡ General professional partnerships are not subject to income tax (i.e., final tax, capital gains tax or
regular income tax) because they are merely viewed as pass-through entities.
ㅡ Partners are the ones subject to regular tax or their share in the net income of the general
professional partnership.
ㅡ Partners shall include their respective share in their gross income subject to regular income tax

Note that this rule applies to other pass-through entities such as:

1. Exempt joint ventures

2. Exempt co-ownership
*Business partnership and taxable joint venture or co-ownership
ㅡ These entities are next to corporate income tax. The distributive share of a partner, venturer, or co-
owner from the net income of these entities, if organized within the Philippines, is subject to 10% final
withholding tax
ㅡ If these entities are organized or constituted abroad, the share from their profit is subject to regular
income tax for taxpayers taxable on global income. It should be recalled again that the final income
taxation is territorial and does not apply to foreign income.

GENERAL CRITERIA FOR ITEMS OF GROSS INCOME

Under the NIRC, the regular income tax has a catch-all provision for all income derived from whatever
sources that are:

1. not subject to final tax, capital gains tax, and special tax regime
2. not excluded or exempted by law, treaty, or contract from taxation.
OTHER SOURCES OF GROSS INCOME SUBJECT TO REGULAR INCOME TAX
1. Income distribution from taxable estates or trusts
2. Share from the net income of other pass-through entities:
a. Exempt joint venture
b. Exempt co-ownership
3. Farming income
4. Recovery of past deductions
5. Reimbursement of expenses
6. Cancellation of indebtedness for a consideration
1. INCOME DISTRIBUTION FROM TAXABLE ESTATES OR TRUSTS
ㅡ any income distribution received by an heir or beneficiary from a taxable estate or trust shall be
included in his gross income subject to regular tax (such income must not have been subjected to final
tax or capital gain tax)

2. SHARE FROM THE NET INCOME OF EXEMPT JOINT VENTURES AND CO-
OWNERSHIPS
ㅡ The same tax treatment on recognition of share in the net income of a general professional
partnership applies to the share from the net income of exempt joint ventures and co-ownerships.
3. FARMING INCOME
Farming operations can be classified as:
1. Raise and Sell operation
ㅡ proceeds on the sales of livestock of farm products

2. Purchase and Sell operation

ㅡ gross profit from the sale (sales less cost of purchase)

📍crop year basis for long-term crops

📍proceeds of crop or livestock insurance (recovery of lost profits)

4. RECOVERIES OF PAST DEDUCTIONS

ㅡ Past deductions that created tax benefit to the taxpayer must be reverted back to gross income in
the year of recovery

Examples of recoveries of past deductions:

1. Recovery of previously claimed bad debt expense

2. Refund of local tax expense
3. Refund of foreign tax previously claimed as deduction
4. Recommissioning of abandoned petroleum service contracts or mining tenements
5. Release of reserve funds of insurance companies
6. Interest expense which were subsequently condoned by the lender

TAX BENEFITS
There are two ways a taxpayer may benefit from a deduction:

1. Directly, through reduction of taxable income in the year deduction is made

2. Indirectly, through reduction of future taxable income through carry-over of net operating loss

REFUND OF NON-DEDUCTIBLE EXPENSES

ㅡ Expenses or payments which are non-deductible against gross income in the computation of
taxable net income will never create tax benefit to the taxpayer
ㅡ their recovery should not be included in gross income
Hence, the refund of the following non-deductible items is not taxable:

1. Philippine income tax

2. Estate or donor’s tax
3. Income tax paid or incurred to a foreign country if the taxpayer claimed a credit for such tax in the
year it was paid or incurred.
4. Stock transaction tax in disposing stocks through the Philippine Stock Exchange
5. Special assessment

5. REIMBURSEMENTS OF EXPENSES
ㅡ Expenses of the taxpayer that are reimbursed or paid by the costumer or client constitute additional
income to the taxpayer,

Examples:
1. When the lessee pays ownership costs of the lessor such as real property tax and insurance on the
property, the payment constitutes income to the lessor.
2. When a client reimburses the out-of-pocket expenses of a professional practitioner, the
reimbursements are income to the practitioner.
6. CANCELLATION OF INDEBTEDNESS
ㅡ cancellation of indebtedness may amount to gratuity or payment of internet

The cancellation of debt:

a. In consideration of service or goods ㅡ treated as income
b. As an act of gratuity ㅡ treated as gift; not as income
c. As capital transactions such as forfeiting the right or receive dividends in exchange of the
debt ㅡ treated as dividend income

SPECIAL CONSIDERATIONS IN REPORTING OF GROSS INCOME

1. Accounting methods
2. Situs rules
3. Effect of value added tax
4. Creditable withholding tax
5. Power of the CIR to redistribute income and expenses
1. ACCOUNTING METHODS
ㅡ adopted by the taxpayer has a direct effect on the reportable amount of gross income subject to
regular income tax
CASH BASIS ㅡ report gross receipt or collection as gross income
ACCRUAL BASIS ㅡ report revenue consisting collected and uncollected income as
gross income
• Regardless of these methods, advanced income must be included in gross income of the period
received.

2. SITUS RULES
ㅡ all taxpayers are taxable only on Philippine income except resident citizens and domestic
corporation which are taxable on global income.

• For taxpayers taxable only on Philippine income, only their items of gross income subject to regular
tax from sources within the Philippines are included in gross income.

• For taxpayers taxable on Global income, their items of gross income subject to regular tax from
sources within and without the Philippines are included in gross income.
3. EFFECTS OF VALUE ADDED TAX ON REPORTABLE GROSS INCOME
Remember that business taxpayers are required to either register as:
a. VAT Taxpayers ㅡ if their sales or receipt exceeds P3,000,000 in the last consecutive 12-
month period
b. Non-VAT Taxpayers ㅡ if their sales or gross receipts is below the VAT threshold or are
specifically designated by the law to pay percentage taxes
Every VAT TAXPAYER is mandatory required to charge 12% output tax on thier sales or receipt. The
regulations presume that the amount charged to customers is inclusive of the 12% VAT.
4. CREDITABLE WITHHOLDING TAX
ㅡ CWTs are tax credit that are deductible against the annual income tax due of the taxpayer. These
should be added back to the reportable amount of gross income.

5. POWER OF THE CIR TO REDISTRIBUTE INCOME AND DEDUCTIONS

ㅡ In the case of two or more organizations, trade or businesses (whether or not incorporated and
whether or not organized in the Philippines) owned or controlled directly or indirectly by the same
interests
THE PROBLEM OF UNFAIR PRICING BETWEEN ASSOCIATED ENTERPRISES
ㅡ There is a risk that the pricing of the transfer of goods and services between associated enterprises
will be controlled in such a way to further the interest of the associated enterprises as a whole in
disregard of their social responsibility on taxes.

THE TRANSFER PRICING GUIDELINE

ㅡ To limit this unfair practices and to properly reflect the income of associated enterprises, the BIR
and the Department of Finance promulgated Revenue Regulations No. 2 series of 2013 (RR2-2013) on
transfer pricing.

What are associated enterprises?

ㅡ also called “related parties”

ㅡ Under RR2-2013, two or more enterprises are associated if one participates directly or indirectly in
the management, control, or capital of the other
ㅡ if the same persons participate directly or indirectly in the management, control, or capital of the
enterprises
Examples of associated enterprises:
1. Parent corporation and its subsidiary corporation
2. Sister companies or businesses owned by the same parent corporation
3. All corporations controlled under the same holding company
4. Businesses owned by the same person
THE ARM’S LENGTH PRINCIPLE
ㅡ Under RR2-2013
ㅡ an uncontrolled pricing method determined by free market forces, arm’s length pricing is preferred.
The arm’s length principle shall be applied to:
1. Cross-border transactions between associated enterprises
2. Domestic transactions between associated enterprises

ADVANCED PRICING AGREEMENT

ㅡ (cross-border operations may enter) a pricing rate is pre-agreed to apply for a period of time
ㅡ not a mandatory requirement, this may serve as a safety net for the taxpayer to avoid the risk of
transfer pricing examination and adjustment and the inconvenience it may possibly cause.
TRANSFER PRICING METHODS
When the pricing methods between associated enterprises do not reflect arm’s length pricing, the BIR
will adjust the controlled transactions to their arm’s length values using the most appropriate of the
following method considering the circumstances of the taxpayer:

1. Comparable Uncontrolled Price (CUP) Method

ㅡ The transaction is valued in reference to the amount changed in a comparable uncontrolled
transaction under comparable circumstances.
ㅡ This method works best for standard tangible goods sold in an open market.

2. Resale Price Method (RPM)

ㅡ The transaction is valued based on the functions performed by the reselling party to the product.
This is used when products purchased from a related party are resold to an independent party.
3. Cost Plus Method (CPM)
ㅡ The transaction is measured by valuing the function performed by the supplier of the property or
services.

4. Profit Split Method (PSM)

ㅡ The profit or loss on the transaction is split based on the division of profits (or losses) that
independent enterprises would have expected to realize from engaging in the transaction or
transactions.

a. Residual profit split approach ㅡ Profit is first allocated to provide a basis return, the
residual profit after such allocation is allocated among the parties
b. Contribution profit split approach
ㅡ the combined profits from controlled transactions are divided in a single stage based upon
the parties’ relative contribution or functions performed

5. Transactional Net Margin Method (TNMM)

ㅡ This is similar to the CPM and RPM in the sense that is uses the margin approach by reference to
the operating profit earned in comparable uncontrolled transactions
SELECTION OF TRANSFER PRICING METHOD

ㅡ To minimize the risk of transfer pricing adjustment, taxpayers may also consider using transfer
pricing methods used by the BIR in pricing their transactions with associated enterprises. The taxpayer
must support the propriety of the method adopted through proper documentation.

PERIOD IN WHICH ITEMS OF GROSS INCOME ARE INCLUDED

ㅡ The amount of all items of gross income shall be included in the gross income for the taxable year
in which received by the taxpayer, unless, under methods of accounting permitted, any such amounts
are to be properly accounted for as of a different period.