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 Final tax N/A
P20,000
PCSO and lotto, not exceeding Exempt N/A
P20,000
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
their 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.
END