TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y.

2022 – 2023

INCOME TAX (ITEMS OF GROSS INCOME)

1. Meaning of income
a. Broad sense Income means all wealth, which flows into the taxpayer’s hands other than as
a mere return of capital.

It includes the form of income specifically described as gains and profits

including gains derived from the sale or other disposition of capital assets.
(Section 36, Revenue Regulations No. 2 defining income under the NIRC
of 1977 ((RR 2-40))

Income cannot be merely determined by reckoning in cash receipts, for the

statute recognizes as income determining factors other items among which
are inventories, accounts receivable, property exhaustion and accounts
payable for expenses incurred. (Section 36, Revenue Regulations No. 2
defining income under the NIRC of 1977)

An amount of money coming to a person or corporation within a specified

time, whether as payment for services, interest or profit from investment.
Unless otherwise specified, income means cash or its equivalent (Conwi v.
CTA and Commissioner, 213 SCRA 83).

b. Judicial Income is the gain derived from labor, or from capital, or from both labor and
definition capital, including the gain derived from the sale or exchange of capital asset.

Income is a flow of service rendered by capital by the payment of money

from it or any other benefit rendered by a fund of capital in relation to such
fund through a period of time (Madrigal v. Rafferty, 38 Phil. 414).

Income covers gain derived from capital, from labor, or from both combined,
provided it be understood to include profit gained through a sale or
conversion of capital assets (Fisher v. Trinidad, supra).

Income includes earnings, lawfully or unlawfully acquired, without consensual

recognition, express or implied, of an obligation to repay and without
restriction as to their disposition (James v. U.S., 366 U.S. 213).

The famous analogy used by the Supreme Court described property, labor
and capital as trees and income as their fruits. Thus, income is synonymous
with profit or gain. (Malayan Zurich Insurance Company, Inc. vs. CIR, CTA
No. 6474 dated 2 September 2004, the Court of Tax Appeals, citing the case
of Nippon Life Insurance Company of the Philippines, Inc. vs. CIR, CA-G.R.
SP No. 69224, 15 November 2002)

c. Requisites of a The three elements in the imposition of income tax are:

taxable income a. There must be gain;
b. The gain must be realized or received;
c. The gain must not be excluded by law from taxation.
(CIR v. Court of Appeals et al, GR No. 108576, 20 January 1999, reiterated
in CREBA v. Executive Secretary et al, GR no. 160756, 9 March 2010)
d. Return on The return on capital that increases net worth is income subject to income
Capital vs tax. Return of capital merely maintains net worth; hence, it is not taxable. An
Return of improvement in net worth indicates an ability to pay tax.
Capital
e. Recovery of lost The recovery of lost capital merely maintains net worth while the recovery of
capital vs. lost profits increases net worth. Therefore. the recovery of lost profits is a
Recovery of lost return on capital. The recovery of lost profits through insurance, indemnity
profits contracts, or legal suits constitutes a taxable return on capital.

f. Realized Benefit The term realized means earned. It requires that there be a degree of
undertaking or sacrifice from the taxpayer to be entitled of the benefit. For a
benefit to be realized, there must be an exchange transaction and the
transaction involves another entity.

Bilateral transfers such as sale and barter are onerous transactions and
gains from these transactions are more likely taxable as income. For unilateral
transfers such as donations and succession, these gratuitous transfers do not
involve an earning process. Complex transactions like transfers for less than
full and adequate consideration are taxable under income tax and transfer tax.
g. Tax Treatment The increase in wealth of the taxpayer in the form of appreciation or increase
of Increase in in the value of his properties or decrease in the value of his obligations in the
the Value of absence of a sale or barter transaction is not taxable. A mere increase in the
Property value of property is not income, but merely and unrealized increase in capital.

SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 1

INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

h. Rendering of The rendering of services for a consideration is an exchange but does not
Services cause a loss of capital.
Hence, the entire consideration received from rendering of services such as
compensation income or service fees is an item of gross income.
i. Doctrines
j. Not Exempted An item of gross income is not exempted by the Constitution, law, contracts
by Law, or treaties from taxation.
Contract, or The following items of income are exempted by law from taxation; hence,
Treaty they are not considered items of gross income:
1. Income of qualified employee trust fund
2. Revenues of non-profit non-stock educational institutions
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 Enterprises (BMBEs)
6. Income of foreign governments and foreign government-owned and
controlled (MFBI)
corporations
7. Income of international missions and organizations with income tax
immunity
k. NOT income The following are not income:
a. Deposit of property that does not increase net worth of taxpayer
(e.g. the increase in asset has a corresponding increase in liability;
b. Increase in net worth is due to correction of errors in book entries
c. Voluntary assessments by a corporation paid by its shareholders
under Revenue Regulation No. 2
d. Security deposit paid to a lessor until it is applied in payment of
accrued rent
e. Contributions by lot owners for the memorial park

2. Taxable income
Taxable income defined The term “taxable income” means the pertinent items of gross income
specified in the Code, less deductions, if any, authorized for such types of
income by the Code or other special laws (Sec. 31, Revised NIRC).
Corporation Gross income PXXX
Less: deductions XXX
Taxable income PXXX
Individual Gross income PXXX
Less: deductions XXX
Taxable income PXXX
Note: basic personal exemption and additional exemptions are no longer
allowed to be deducted from the gross income of an individual taxpayer.

“Net income” means gross income less statutory deductions and exemptions (Sec. 36, Rev. Regs. No. 2). It is referred to as
“taxable income” under Section 31 of the 1997 Tax Code. Net income must be computed with respect to a fixed taxable
period.

3. Gross income defined

Gross income [Sec. 32 Except when otherwise provided, gross income means all income from
(A)] whatever source (whether legal or illegal), unless exempt from tax
under the Constitution, tax treaty or statute, including (but not limited
to the following items):
a. Compensation for services in whatever form paid, including
but not limited to fees, salaries, wages, commissions, and
similar items;
b. Gross income derived from the conduct of trade or business or
the exercise of a profession;
c. Gains derived from dealings in property;
d. Interests;
e. Rents;
f. Royalties;
g. Dividends;
h. Annuities;
i. Prize and winnings;
j. Pensions; and
k. Partner’s distributive share from the net income of the general
professional partnership.
Tax Law recognizes that there illegal income from illegal activities.

“Whatever source” encompasses all income not expressly exempted

As long as there is an income, there is tax liability

The term “gross income, for purposes of computing the minimum corporate income tax, shall include items of income, gain or
profit, except exempt income and income subject to final tax (Sec. 27 [E] [4], NIRC). Revenue Regulations No. 9-98, however,
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 2
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

expanded the definition of “gross income,” by including “other or miscellaneous income” of the corporation such as gain from
non-recurring sale of equipment.

Gross income from business – In the case of manufacturing merchandising, or mining business, “gross income” means the
total sales, less cost of goods sold, plus any income from investments and from incidental or outside operations or sources. In
determining the gross income, subtractions should not be made for depreciation, depletion, selling expenses or losses, or for
other items not ordinarily used in computing the cost of goods sold (Sec. 43, Rev. Regs. No. 2). In the case of sellers of
services, their gross income is computed by deducting all direct costs and expenses as prescribed in Revenue Memorandum
Circular No. 4-2003 and 30-2008 dated April 1, 2008.

4. Income distinguished from other items

a. From capital 1. Capital is the fund or property existing at one distinct time, while
income denotes a flow of wealth during a definite period.
2. A fund of property existing at an instant of time is called capital,
while a flow of services rendered by that capital by the payment of
money from it or any other benefit rendered by a fund of capital in
relation to such fund through a period of time is called income;
3. Capital is wealth, while income is the service of wealth;
4. Capital is the tree, while income is the fruit; labor is a tree, income
the fruit; property is a tree; income the fruit (Madrigal v. Rafferty);
5. Return or recovery of capital is not subject to income tax, while
income is subject to income tax.
b. From receipts Receipts have reference to all wealth that flows into the taxpayer, which
includes returns of capital. Receipts are broader in scope than income.
c. From revenue 1. Revenue, as applied to taxation, refers to all funds or income
derived by the government, whether from tax or any other source
while income, for tax purposes, is employed in its “natural and
obvious sense” to mean money or to gain received, coming to a
person (natural or juridical) during a given period of time.
2. Revenue is to the government while income is to a person (natural
or juridical)

5. CLASSIFICATIONS OF TAXPAYERS
a. Individuals 1. Citizen
a. Resident Citizen
b. Non-resident Citizen
2. Alien
a. Resident Alien
b. Non-resident Alien
b.1. Engaged in trade/business
b.2. not engaged in trade or business
3. Taxable Estates and Trusts
b. Corporations 1. Domestic Corporation
2. Foreign Corporation
2.1. Resident Foreign Corporation
2.2. Non-resident Foreign Corporation
C. Definition of a Under the Constitution, citizens are:
Citizen under a. Those who are citizens of the Philippines at the time of adoption of the
the Constitution Constitution on February 2, 1987
b. Those whose father or mother are citizens of the Philippines
c. Those born before January 17, 1973 of Filipino mothers who elected
Filipino citizenship upon reaching the age of majority
d. Those who are naturalized in accordance with the law
D. Resident Citizen (RC)
A Filipino citizen residing in the Philippines

Non-Resident Citizen (NRC)

The following are considered as non-resident citizens:
a. A citizen of the Philippines who establishes to the satisfaction of the BIR
Commissioner the fact of his physical presence abroad with a definite
intention to reside therein
b. A citizen of the Philippines who leaves the country during the taxable year
to reside abroad, either as an immigrant or for an employment on a
permanent basis
c. A citizen of the Philippines who works and derives income from abroad
and whose employment thereat requires him to be physically present abroad
most of the time during the taxable year;
d. A citizen who has been previously considered as non-resident citizen and
who arrives in the Philippines at any time during the taxable year to reside
permanently in the Philippines shall likewise be treated as non-resident
citizen for the taxable year in which
he arrives in the Philippines with respect to his income derived from sources
abroad
until the date of his arrival in the Philippines

SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 3

INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

e. In the absence of information on taxpayer’s intent, citizens staying abroad

for a period of at least 183 days are considered non-resident citizens.

Filipinos working in Philippine embassies or Philippine Consulate Offices are

not considered non-resident citizens.
E. Resident Alien (RA)
A resident alien is someone who is residing in the Philippines but is not a
citizen.
a. An alien who lives in the Philippines without definite intention as to his
stay
b. One who comes to the Philippines for a definite purpose which in its
nature would require an extended stay and to that end makes his home
temporarily in the Philippines,
although it may be his intention at all times to return to his domicile abroad
c. In the absence of information on intention, aliens who stayed in the
Philippines for more than 1 year as of the end of the taxable year are
considered resident aliens.
An alien who has acquired residence in the Philippines retains his status as
such until he abandons the same or actually departs from the Philippines.
F. Non-Resident Alien Engaged in Trade or Business (NRA-ETB)
An individual who is not residing on the Philippines and is not a resident
thereof, intends to conduct trade, business or exercise of his profession.

In the absence of information as to taxpayer’s intent, aliens who stayed in the

Philippines for an aggregate period of more than 180 days during the year
are presumed to be engaged in trade or business.

Non-Resident Alien not Engaged in Trade or Business (NRA-NETB)

An individual who is not residing on the Philippines and is not a resident
thereof, not intending to conduct trade, business or exercise of his
profession. Aliens who come to the Philippines for a definite purpose which in
its nature may be promptly accomplished shall not be considered to be
engaged in trade or business.
G. Estate This refers to the properties, rights and obligations of a deceased person not
extinguished by death. Estates under judicial settlement are treated as
individual taxpayers. Estates under
extrajudicial settlement are exempt entities. The income of properties of the
estate under extrajudicial settlement is taxable to the heirs.
H. Trust A trust is an arrangement whereby one person called the grantor or trustor
transfers property to another person called the beneficiary, which will be held
under the management of a third party called the trustee or fiduciary.
I. Corporate Domestic Corporation (DC)
Taxpayers A corporation formed and authorized to conduct trade and business under
the Philippine law.
Resident Foreign Corporation (RFC)
A corporation organized, authorized, or existing under the laws of any foreign
country but is authorized to engage in trade or business in the Philippines
through a permanent
establishment.
Non-Resident Foreign Corporation (NRFC)
A corporation organized, authorized, or existing under the laws of any foreign
country and is not authorized to engage in trade or business in the
Philippines.
J. Other Corporate Partnership
Taxpayers A partnership is a business organization owned by two or more persons who
contribute their industry or resources to a common fund for the purpose of
dividing the profits from the
venture.

Joint Venture
A joint venture is a business undertaking for a particular purpose. It may be
organized as a
partnership or corporation.

Co-Ownership
It is a joint-ownership of a property formed for the purpose of preserving the
same and/or
dividing its income.

One-person Corporation

SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 4

INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

6.

7.

8.

9.

10. Items of gross income explained

a. Compensation for personal services
1. Gross Gross compensation income means all remuneration for services
compensation performed by an employee for his employer, whether paid in cash or in kind,
defined unless specifically excluded under the Tax Code (e.g. salaries, wages,
emoluments, honoraria, bonuses, allowances, director’s fees).
2. Director’s fee Director’s fee is part of the gross compensation income if the director is
at the same time an employee of the employer/corporation. If the director is
not an employee, the director’s fee is subject to 5% creditable withholding
tax if the current year’s gross income is P3M and below (10% if current
year’s gross income exceeds 3M – TRAIN LAW 2018).
3. Compensation In the absence of employer-employee relationship, compensation for
in the absence personal services shall be considered as gross professional fee (e.g. audit
of employer- fee received by CPA from his client, lawyer’s fee).
employee
relationship Summary:
Under Employer-Employee Subject to Withholding Tax on
Relationship? Wages?
YES (i.e. corporate president sitting YES
as member of the BOD)
NO (i.e. directors whose duties are (subject to EWT – conduct of trade
confined to the or exercise of profession)
attendance/participation in the
meetings of the BOD
4. Examples of All kinds of compensation for services rendered constitute gross income.
compensation They include:
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 5
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

for services a. Salaries, wages and fees;

rendered b. Commissions paid to salesmen;
c. Compensation for services on the basis of a percentage of profits;
d. Commissions on insurance premiums;
e. Tips
f. Pensions or retiring allowances paid by private persons or by the
government (except pension exempt from tax); and
g. Marriage fees, baptismal offerings, sums paid for saying masses for
the dead, and other contributions received by a clergyman,
evangelist, or religious worker for services rendered.
5. Forms of Forms of compensation Taxable amount
compensation a. Payments made in cash The full amount received
b. Services paid for with The fair market value (FMV) of the
something other than thing taken in payment
money (in kind)
c. Services rendered at a In the absence of evidence to the
stipulated price contrary, the stipulated price shall
be presumed to be fair market
value (FMV)
6. Examples of Payments in kind Taxable amount
payments in a. Compensation Fair market value of the stock at the time
kind paid to an received by the employee
employee of a
corporation in its
stock
b. Promissory note a. Promissory note is not interest
and other bearing
evidence of Yr. received – Fair discounted
indebtedness in value
payment of Yr. collected – face value less fair
services, and not discounted value
merely as security b. Promissory note is interest bearing
for such payment Yr. received – Fair discounted
value
Yr. collected – face value less fair
discounted value
7. Source Rule For services: Place of performance of the services – if the services is
performed in the Philippines, the income is treated as from sources within the
Philippines.

Enumeration of source rules in Section 42 of the Tax Code is not

exhaustive,
it does not state or imply that an income not listed therein Reinsurance
premium paid to a foreign corporation is income from sources within
the Philippines – Reinsurance premiums remitted by a domestic insurance
company to foreign reinsurance companies are considered income of the
latter derived from sources within the Philippines.

8. Statutory Statutory Minimum Wage (SMW) – shall refer to the rate fixed by Regional
Minimum Wage Tripartite Wage and Productivity Board, as defined by the Bureau of Labor
and Employment Statistics Board, as defined by the Bureau of Labor and
Employment Statistics of DOLE. The RTWPB of each region shall determine
the wage rate in the different regions based on established criteria and shall
be the basis of exemption from income tax for this purpose.

Compensation income falling within the meaning of “statutory minimum

wage” (SMW) under R.A. 9504, effective July 6, 2008, as implemented by
Revenue Regulation No. 10-2008 dated July 8, 2008, shall be exempt from
income tax and withholding tax.

Also, holiday pay, overtime pay, night shift differential pay, and hazard pay
earned by Minimum Wage Earner (MWE) shall likewise be covered by the
above exemption, provided that an employee who receives/earns additional
compensation such as commissions, honoraria, fringe benefits in excess of
the allowable statutory amount of P90,000, taxable allowances and other
taxable income other than the SMW, holiday pay, overtime pay, hazard pay
and night shift differential pay in excess of the threshold shall not enjoy the
privilege.

9. De Minimis There are certain fringe benefits denominated as “de minimis benefit” that
Benefit are exempt from income tax and withholding tax, even if received by rank-
and-file employees and supervisory or managerial employees. Below is the
updated list of de minimis benefits updated in amounts by Revenue
Regulations No. 11 – 2018 (RR 11-2018), the implementing rule of Tax
Reform for Acceleration and Inclusion (TRAIN) or Republic Act No. 10963
effective January 1, 2018:
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 6
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

a. Monetized unused vacation leave credits of private employees not

exceeding ten (10) days during the year.
b. Monetized value of vacation and sick leave credits paid to
government official and employees
c. Medical cash allowance to dependents of employees, not exceeding
P1,500 per employee per semester or P250 per month (as
amended by RR 11-2018)
d. Rice subsidy of P2,000 or one (1) sack of rice 50-kilogram rice per
month amounting to not more than P2,000 (as amended by RR 11-
2018)
e. Uniform and clothing allowance not exceeding P6,000 per annum
(as amended by RR 11-2018)
f. Actual medical assistance, e.g. medical allowance to cover medical
and healthcare needs, annual medical/executive check-up,
maternity assistance, and routine consultations, not exceeding
P10,000 per annum.
g. Laundry allowance not exceeding P300 per month
h. Employees achievement awards, e.g. for length of service or safety
achievement, which must be in the form of tangible personal
property other than cash or gift certificate, with an annual monetary
value not exceeding P10,000 received by the employee under an
established written plan which does not discriminate in favor of
highly paid employees
i. Gifts made during Christmas and major anniversary celebrations not
exceeding P5,000 per employee per annum
j. Daily meal allowance for overtime work and night/graveyard shift
not exceeding twenty-five percent (25%) of the basic minimum
wage on a per region basis.
k. Benefits received by an employee by virtue of a collective
bargaining agreement (CBA) and productivity incentive schemes
provided that the total monetary value received from both CBA and
productivity incentive schemes combined do not exceed P10,000.00
per employee per taxable year.
As further provided under Revenue Regulations No. 15-2011 that has
become effective starting the year 2011, all other benefits given by
employers which are not included in the above enumeration shall not be
considered “de minimis benefits, and hence, shall be subject to income tax
as well as withholding tax on compensation income.
10. Tax Treatment 1. In the event the option was granted by an employer involving
of Stock the employer’s own shares of stock or shares it owns, UPON
Option Plans the exercise of the option by a RANK-AND-FILE EMPLOYEE, an
additional compensation equivalent to the difference of the
book value/ fair market value of the shares, whichever is
higher, at the time of the exercise of the stock option and the
price fixed on the grant date, SHALL be recognized and
SUBJECT TO INCOME TAX, and consequently to withholding
tax.
2. If the employee which exercises the option occupies a
SUPERVISORY OR MANAGERIAL POSITION, the difference of
the book value/ fair market value of the shares, whichever is
higher, at the time of exercise of the stock option and the price
fixed on the grant date, shall be treated as fringe benefit
subject to FBT imposed under Section 33 of the Tax Code, as
amended (See Module 9).
3. Also applicable to options other than stock (i.e. options to
purchase real or personal properties).

b. Gross income derived from the conduct of trade or business, or the exercise of profession
Format computation Gross sales/ receipts XXX
Less: Sales return and allowances XXX
Sales discount XXX XXX
Net sales/ receipts XXX
Less: Cost of sales/ services XXX
Gross income from operation XXX
Add: Other income XXX
Total gross income XXX

Except:
1. Bus. Income Exempt from Income Tax (BMBE, enterprises enjoying Tax Holiday)
2. Bus. Income Subject to Special Tax (PEZA, TIEZA, 8% option)\
3. Bus. Income Subject to Final Tax

(If deriving from 2 or more sources..)

c. Gains derived from dealings in property

>Ordinary Assets
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 7
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

>Capital Assets other than real properties (CGT) and domestic stocks (FT)

1. Property acquired by purchase Selling price XXX

on or after March 1, 1913 Less: Cost XXX
Gain XXX
2. Property acquired by Selling price XXX
inheritance Less: FMV, date of inheritance XXX
Gain XXX
3. Property acquired by gift Selling price XXX
Less: Value in the hands of the donor XXX
Gain XXX

d. Sale of personal property

a. Personal property produced (in whole or in part) by the taxpayer within the Philippines and sold without the
Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines
i. Any gain, profit or income shall be treated as derived partly from sources within and partly from
sources without the Philippines
b. Purchase of personal property within and its sale without the Philippines or purchase of personal property without
and its sale within the Philippines (Merchandise)
i. Any gain, profit or income shall be treated as derived entirely from sources within the country in
which sold. Accordingly, if the goods are shipped in a foreign port under “Free-on-Board (FOB)
shipping point” arrangement, title to the goods is transferred at the foreign port and any gain from the
sale of such goods to a Philippine importer shall be treated as income from sources outside the
Philippines.
c. Shares of stock in a domestic corporation
i. Gain, profit or income is treated as derived entirely from sources within the Philippines, regardless of
where the said shares are sold. Thus, a non-resident alien who owns shares of stocks of a domestic
corporation acquired through a foreign stock exchange is still liable to the Philippine income tax even if
such shares are sold also through a foreign stock exchange.

e. Sale or exchanges of real property

a. Exchanges of real property classified as capital assets by individuals are subject to the capital gains tax based
on the fair market value of the real property (BIR Ruling No. 037, February 10, 1988). So is a deed of
reconveyance with resumption of mortgage (BIR Ruling No. 091, May 2, 1989). In mortgage foreclosure sales,
the amount of loan secured by the mortgage is not considered as basis in computing the capital gains tax (BIR
Ruling No. 455, September 16, 1988); hence, the basis, for income tax purposes, is the highest bid price.

f. Interest income
1. Included in Interest includes such interest arising from indebtedness, whether
interest income business or non-business. Unless exempted by law, interests received
by a taxpayer, whether business or non-business. Unless exempted by
law, interests received by a taxpayer, whether or not usurious, are taxable.
2. Subject to final Interest income from Philippine sources subject to final tax (not included in
tax the taxable net income subject to tax rates in general)
a. Interest from any currency bank deposit
b. Yield or any other monetary benefit from deposit substitute
c. Interest on government debt instrument and securities (regardless
number of lenders)
d. Yield or any other monetary benefit from trust funds and similar
arrangements
e. Interest income received from a depository bank under expanded
foreign currency deposit system
f. Interest income from long-term deposit or investment evidenced by
certificates prescribed by Bangko Sentral ng Pilipinas if pre-
terminated before fifth year or received by individual issued by
financial institution other than a bank
3. Subject to tax a. Interest income from foreign sources
rates in general b. Interest income from debt instrument not within the coverage of
deposit substitute
c. Interest from long-term deposit or investment received by domestic
and resident foreign corporation
4. Exempt from Interest income from Philippine sources exempt from tax:
income tax a. Interest income received from a depository bank under expanded
foreign currency deposit system by non-residents (individuals or
corporations)
b. Interest income from long-term deposit or investments evidenced by
certificates prescribed by Bangko Sentral ng Pilipinas (issued by
banks to individuals in P10,000 denomination).
5. Source Rule Residence of the debtor or obligor – if the obligor or debtor (corporation or
otherwise) is a resident of the Philippines, the interest income is treated as
income from within the Philippines. It does not matter whether the loan
agreement is signed in the Philippines or abroad or the loan proceeds will be
used in a project inside or outside the country.
6. Tax treatment Passive income that is subject to final withholding tax (FWT) is no
longer included in the computation of the taxable income. The following

SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 8

INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

types of passive income earned by incorporated businesses are subject to

the following FWT:
a. 20% final tax on the amount of interest on currency bank deposit
and yield or any other monetary benefit from deposit substitutes
and from trust funds and similar arrangements, and royalties
derived from Philippine sources. And 25% if received by non-
resident alien NOT engaged in trade or business or 30% if non-
resident foreign corporation.
b. 15% final tax on interest income from a depository bank under the
expanded foreign currency deposit system. However, interest
income is exempt if received by non-residents alien engaged in
trade or business or by non-resident foreign corporation, and
subject to 25% FWT if received by non-resident alien NOT engaged
in trade or business or 7.5% for resident foreign corporation.
c. Interest income from long term deposit or investment of 5 years or
more, are exempt from income tax, unless received by non-resident
alien NOT engaged in trade or business, subject to 25% FWT.
All other income not subject to final withholding tax are subject to the
graduated tax rates if individual and to the 30% corporate income tax rate if
corporation

g. Rent income
1. Income of lessor under lease agreement – rental income is treated as business income to which the lessor may
claim allowable deductions under Section 34 of the 1997 Tax Code.
Payments Made Lessor Lessee
a. Rent Income Expense
b. Obligation of lessor to third Income Expense
person paid by lessee
c. Advancement Income in full in the year received Expense to be prorated over the
>Item of Gross income if: regardless of accounting method period covered regardless of
i. Unrestricted used accounting method
ii. Restricted to be
applied in future years or
upon termination of lease
> Not an Item if Gross
Income
i. It constitutes a loan
ii. Deposit to Guarantee
payment or rent subject to
contingency which may or
may not happen
d. Leasehold improvement Income reported under lump sum or Expense (depreciation) over the
annual method term of the lease or estimated life
whichever is shorter

2. Advance payment not representing rent

a. Loan Advance payment representing loan to the lessor is not taxable unless
applied to unpaid rent.
b. Security Advance payment representing security deposit is not taxable unless
deposit violation in the lease contract arises.

3. Leasehold improvement
a. Additional Leasehold improvement is a source of additional income to the lessor
income to the if it shall become his upon the expiration of the lease.
lessor
b. Recognition 1. Lump sum or outright method – lessor may report as income,
of income at the time when such buildings or improvements are
from completed, the FMV of such buildings or improvements
leasehold subject to the lease.
improvement 2. Annual or spread out method
Cost of leasehold improvement XXX
Less: Accumulated depreciation (remaining term
of lease) XXX
Book value, end of lease XXX

Annual income
Book value, end of lease divided by the remaining XXX
term of lease
3. Computation of income resulting from premature termination
of lease
FMV of improvement when lessor took possession XXX
Less: amount already reported as income XXX
Income, year of termination XXX
c. Computation Amount already reported as income XXX
of loss due to Less: insurance recovery and salvage value XXX
destruction of Loss XXX
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 9
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

leasehold
improvement
before the
term of the
lease expires
4. Source Rule
a. Location or use of the property or interest in such property – if the property or interest is located or
used in the Philippines, the gain or income is treated as income from sources within the Philippines.
5. Lease of Real Property Rule
a. If the lessor is a citizen, resident alien or non-resident alien engaged in trade or business in the Philippines,
his net taxable income shall be subject to the graduated income tax rates provided for in Sec. 24 of the Tax
Code.
b. If the lessor is a non-resident alien not engaged in trade or business in the Philippines, the rental income
from real property located in the Philippines shall be subject to 25% final withholding tax (Sec. 25 [B].
Revised NIRC), unless a lower rate is imposed pursuant to an effective tax treaty, such tax to be withheld
and remitted by the lessee in the Philippines to the BIR within the prescribed dates (Secs. 57 and 58,
Revised NIRC).
c. If the lessor is a domestic corporation or a resident foreign corporation, its net taxable income shall be
subject to 30% normal corporate income tax, or its gross income will be subject to the 2% minimum
corporate income tax, whichever is higher (Sec. 27[A] and Sec. 28[A], Revised NIRC).
d. However, if the lessor is a non-resident foreign corporation, the gross rental income from real property
located in the Philippines shall be subject to the 30% corporate income tax (Sec. 28[A]. Revised NIRC),
such tax to be withheld and remitted by the lessee in the Philippines to the BIR within the prescribed dates.

f. Royalties
1. Subject to final tax Royalties from Philippine sources

2. Subject to tax rates in general A. If considered from regular conduct of business (with
reference to the Company’s primary / secondary
purpose in the articles of incorporation) – Royalties
therefore were part of the regular income; thus subject
to tax rates in general

B. Royalties from foreign sources

a. Location or use of the property or interest in such property – if the property or interest is located or
used in the Philippines, the gain or income is treated as income from sources within the Philippines.
b. Tax Treatment
20% final tax on the amount of interest on currency bank deposit and yield or any other monetary benefit
from deposit substitutes and from trust funds and similar arrangements, and royalties derived from
Philippine sources, except for royalties on books, literary works and musical compositions they shall be
subject to 10% final withholding tax (FWT).

However, 25% if received by non-resident alien NOT engaged in trade or business or 30% if non-resident
foreign corporation.

g. Dividend income (including shares in the net income of certain entities)

1. Difference between A direct dividend is one where the paying corporation acknowledges
direct and indirect that the distribution is a dividend payment.
dividends
An indirect dividend is a distribution of profits disguised as payment
of services, properties, etc.

2. Dividends/ shares a. Cash and/or property dividends actually or constructively

in net income received by individuals from domestic corporation of
subject to final tax from a joint stock company, insurance or mutual fund
company and regional operating headquarters of
multinationals;
b.
c. Inter-corporate dividends received from domestic
corporation by non-resident foreign corporations;
d. Share of an individual in the distributable net income
after tax of a partnership (other than a general
profession partnership) of which he is a partner;
e. Share of an individual in the net income after tax of an
association, a joint account, or a joint venture or
consortium taxable as a corporation of which he is a
member of co-venturer.
3. Dividends/shares in a. Dividends from foreign corporations
net income subject b. Share in the net income of a general professional
to tax rates in partnership
general

SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 10

INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

4. Dividends that are a. Inter-corporate dividends received from domestic

exempt from tax corporation by other domestic corporation and resident
foreign corporation.
b. Foreign-sourced dividends – A foreign-sourced
dividends remitted into the Philippines or actually
received by domestic corporation shall be EXEMPT
subject to the following conditions:
i. The domestic corporation holds directly at
least 20% of the outstanding shares of the
foreign corporation and has held the
shareholdings for a minimum of 2 years at the
time of dividend distribution
ii. Funds are reinvested in the business
operations of the domestic corporation in the
Philippines;
iii. Funds are reinvested within the next taxable
year from the time the dividends were received
; and
iv. Reinvestment shall be limited to funding the
working capital requirements, capital
expenditures, dividend payments, investment
in domestic subsidiaries and infrastructure
projects.

5. Source Rule Residence of the corporation paying dividend – Dividends

received from a domestic corporation or from a foreign
corporation are treated as income from sources within the
Philippines, unless less than 50% of the gross income of the
foreign corporation for the three (3) year period preceding the
declaration of such dividends was derived from sources within
the Philippines, dividends was derived from sources within the
Philippines, in which case, only the amount which bears the
same ratio to such dividends as the gross income of the
corporation for such period derived from sources within the
Philippines bears to its gross income from all sources shall be
treated as income from sources within the Philippines.

6. Tax Treatment A. When corporations declare dividends to their shareholders, or

profits to their partners, in the case of partnerships that are
considered corporations, these dividends and profits are again
taxed at the shareholder – or partner – level. Individual
shareholders and partners are generally subject to 10% final
tax on dividends. Dividends declared by a domestic
corporation to another domestic corporation or to a resident
foreign corporation are not subject to income tax.

Sole proprietorships, on the other hand, have no separate

juridical personality. Proprietors are taxed as individuals, and
the income tax rates range from 0%-35%.

B. Cash and property dividends received by citizens or resident

aliens from their shares in domestic corporations (including
closely held corporations) are subject to a final tax of 10%,
while those received by non-resident aliens engaged in trade
or business in the Philippines and non-resident aliens not
engaged in trade or business in the Philippines are subject to
a final tax of 20% and 25%, respectively.

C. Dividends earned by non-resident foreign corporations are

generally subject to FWT of 30%. This rate is reduced to 15%
if the country of domicile of the non-resident foreign
corporation allows a credit against the tax due from the non-
resident foreign corporation taxes deemed to have been paid
in the Philippines equivalent to 15%, which represents the
difference between the RCIT rate of 30% and the 15% tax rate
on dividends. This is referred to as tax sparing credit.

D. However, the local branch’s remittance of branch profits to the

foreign head office is subject to branch profit remittance tax of
15%, while remittance of dividends by the local subsidiary to
the foreign head office is subject to FWT of 30% subject to the
tax sparing credit.
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 11
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

E. Stock dividends are not subject to income tax if the number of

shares received is in proportion to the existing shareholding of
the stockholder. However, the issuance of shares through the
declaration of a stock dividend is subject to DST at the rate of
PHP2 for every PHP200 of the par value of the shares issued.

F. Dividends received by local corporations from foreign

subsidiaries are included in the local corporations’ gross
income, which, after taking into account the allowable
deductions provided under the Philippine Tax Code, is subject
to an RCIT rate of 30%, or subject to MCIT of 2%.

h. Annuities
1. Meaning of annuity An annuity is a specified income payable at stated intervals for a
fixed or a contingent period, often for a recipient’s life, in
consideration of a stipulated premium paid either in prior installment
payments or in a single payment.
2. Non-taxable annuity Annuity representing return of premium
3. Taxable annuity Excess of the amount returned as premium

i. Prizes and winnings

1. Subject to tax rates a. Prizes and winnings from foreign sources received by
in general individuals and corporations
b. Prizes and winnings from Philippine sources received by
corporations
c. Prizes from Philippines sources received by individuals
amounting to P10,000 or less.
2. Subject to final tax a. Prizes received by individuals from Philippine sources
[except prizes amounting to P10,000 or less which shall be
subject to tax under Sec. 24 (A)]
b. Other winnings of individuals from Philippine sources
(except Philippine Charity sweepstakes and Lotto winnings
amounting to P10,000 or less which shall be exempt)

Under CREATE Act, winnings (except those amounting

P10,000 or less from PCSO games which shall be exempt)
SHALL be taxed at 20% on the total amount. In other
words, the EXEMPTION of Lotto winnings from final taxes
has been deleted.

3. Exempt/ excluded a. Philippine Charity sweepstakes and Lotto winnings;

from gross income b. Prizes and awards made primarily in recognition of
achievements in the following fields; RCC-SEAL
1. Religious;
2. Charitable;
3. Scientific;
4. Educational;
5. Artistic;
6. Literary;
7. Civic
Conditions for the exemption of prizes and awards:
a. The recipient was selected without any action on
his part to enter the contest or proceedings; and
b. The recipient is not required to render substantial
future services as a condition to receiving the
prize or award.
c. All prizes and awards granted to athletes to local and
international sports competitions and tournaments whether
held in the Philippines or abroad and sanctioned by their
national sports association.

j. Pensions

k. Partner’s distributive share from the net income of the general professional partnership [Subject to Section 24 (A)]

l. Income from whatever source

1. Examples of 1. Gains arising from exploration of property;

income from 2. Gambling gains;
whatever source 3. Income from illegal business or from embezzlement;
4. Damage recovery (compensation for damages);
5. Forgiveness of debt;
6. Bad debt recovery;
7. Tax refunds; and
8. Prizes and awards
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 12
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

2. Damage recovery 1. Recovery of lost profit is taxable

2. Recovery of lost capital is not taxable
3. Forgiveness of debt 1. If debtor rendered service in favor of the creditor
forgiveness of debt results in a taxable income to the
debtor
2. If the debtor did not render service in favor of the creditor
forgiveness of debt results in a taxable indirect gift.
3. If the debtor is a stockholder of a corporation forgiveness of
debt by the creditor – corporation results in dividend
distribution
4. Bad debt recovery 1. Bad debt recovery is generally taxable.
2. Tax benefit rule: If in the year the bad debt was written
off there was a reduction of taxable income, bad debt
recovery shall constitute a taxable income.
5. Tax refunds 1. If the refunded tax is a deductible tax, the tax refund is
taxable. Ex. Percentage Tax (Expense – ITR)
2. If the refunded tax is not a deductible tax, the tax refund is
not taxable.
Examples of non-deductible taxes:
1. Philippine income tax;
2. Transfer tax (estate tax and donor’s tax)
3. Special assessment;
4. Foreign income tax claimed as tax credit;
5. Value-added tax;
6. Stock transaction tax

To whom income is taxable

1. Income from sale of goods or properties is taxable to the owner seller of the goods or properties, including rights thereto, but
income from sale of services is taxable to the person who renders the services.
2. In the case of fringe benefits tax, the tax is imposed on the employee who receives the fringe benefits paid by the employer on
account of the employer-employee relationship, although the tax is assumed and paid by the employer to the BIR. The fringe
benefit tax cannot be imposed on the employer that paid by the fringe benefits because it is the payor of the expense;
otherwise, income tax can be said to be imposed not on the income, but on expense.
3. In the case of branch profit remittance tax, the tax is imposed on the branch profit remitted by the Philippines branch to its
foreign head office, although the tax is paid by the Philippine branch to the BIR.
4. Dividends are prima facie the income of the record-owner of the stock and are taxable to such owner. But where the record-
owner has sold the stock under an escrow agreement under which title is to be retained by him, the dividends received by
such owner and applied in reduction of the purchase price are not taxable to him (Moore v. Commissioner, 124 F[2d] 991).
5. Ownership of building by an individual makes the assessment against the corporation improper (Mercy’s, Inc. v.
Commissioner, CTA Case No. 895, May 11, 1982).
6. Where legal title over the Fund is transferred to the trustee, the income of the Fund shall accrue to the trustee, not to the
trustor. – In a trust, one person has an equitable ownership in the property, while another person owns the legal to such
property. The equitable ownership of the former entitles him to the performance of certain duties and the exercise of certain
powers by the latter. A person who establishes a trust is the trustor. One in whom the confidence is reposed as regards
property for the benefit of another is the trustee. The person for whose benefit the trust is created is the beneficiary.

SUMMARY OF SOURCES OF INCOME

1. Classification of Income as to Sources

a. Income purely within
b. Income purely without
c. Income purely within and partly without

2. Determination of Income as to Sources (SECTION 42 OF THE TAX CODE, AS AMENDED)

ITEMS OF INCOME TEST OF SOURCE OF INCOME

A. Interest Residence of the debtor
B. Dividends
1. From domestic corporation Income within

2. From foreign corporation (based on the ratio of General rule: Income within
the gross income of the foreign corporation for
the preceding 3 years prior to declaration of OR
dividends derived from Philippine sources)
(PH Gross Income/ Total Gross Income) Income partly within AND partly
without IF the ratio LESS THAN 50%
(Computed % x Dividends = income
from within PH)

C. Income from services Place of performance

D. Rent Location of property
E. Royalties Place of use of intangibles
F. Gain on sale of real property Location of property
G. Gain on sale of personal property purchased in one Place of sale
country and sold in another
SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 13
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

H. Gain on sale of domestic shares Income within

3. Deductions of Taxpayers Whose Taxable Income Is From Philippine Sources Only

Gross income within XXX

Less: Expenses, interest, losses and other deductions properly allocated to income
within XXX
Relatable portion of unallocated expenses, interest, etc.
(PH Gross Income/ Total gross income) x Unallocated expenses XXX XXX
Net income XXX

4. Income partly from sources within and partly from sources without
a. Examples a. Income from transportation and other services rendered partly within
and partly without the Philippines.
b. Income from the sale of personal property produced in whole or in part
by the taxpayer within and sold without the Philippines.
c. Income from sale of personal property produced, in whole or in part by
the taxpayer without and sold within the Philippines.
b. Computation (Taxable income/ 2) x (Value of property, within / Value of property, within and
of income without)
within when
independent Add:
factory or (Taxable income/ 2) x (Gross sales, within / Gross sales, within and without)
production
price has not = Income within
been
established

SOURCES:

[1] Revised National Internal Revenue Code of 1997

[2] Conwi v. CTA and Commissioner, 213 SCRA 83
[3] Madrigal v. Rafferty, 38 Phil. 414
[4] Fisher v. Trinidad, supra
[5] James v. U.S., 366 U.S. 213
[6] Sec. 43, Rev. Regs. No. 2
[7] Revenue Regulations No. 11 – 2018 (RR 11-2018)
[8] RA No. 10963 – “An Act Amending Sections 5, 6, 24, 25, 27, 31, 32, 33, 34, 51, 52, 56, 57, 74, 79, 84, 90,91, 97, 99, 100,
101, 106, 107, 108, 109, 110, 112, 114, 116, 127, 128, 129, 145, 149, 151, 155, 171, 174, 175, 177, 178, 179, 180, 181, 182,
183, 186, 188, 189, 190, 191, 192, 193, 194, 195, 196, 197, 232, 236, 237, 249, 254, 264, 269, and 288; Creating New
Sections 51-A, 148-A, 150-A, 150-B, 237-A, 264-A, 264-B, and 265-A; and Repealing Sections 35, 62 and 89; All Under
Republic Act No. 8424, Otherwise Known as the National Internal Revenue Code of 1997, as amended, and for Other
Purposes,” also known as Tax Reform for Acceleration and Inclusion (TRAIN) Law, Approved 19 December 2017; with
Presidential veto on certain portions; Effective 1 January 2018
[9] Moore v. Commissioner, 124 F[2d] 991
[10] Mercy’s, Inc. v. Commissioner, CTA Case No. 895, May 11, 1982

EXERCISE 1

Mr. C. Conte bought a 2,000 square meter land at a cost of P500,000. He leased the land at a cost of P500,000. He leased the
land to Mr. Damian at an annual rental of P40,000. The term of the contract of lease was 15 years. The contract of lease
provided that Mr. Damian will construct a building on the land, which will belong to the lessor at the end of the term of the
lease or at the termination of the lease. The building was constructed for a total cost of P400,000 and has an estimated useful
life of 20 years which was the basis of a straight-line method of depreciation. The remaining term of the lease when the
building was completed was 14 years.

Requirement:

1. Compute the income from lease contract in the year the improvement was completed assuming Mr. Conte will report
his income from leasehold improvement using outright or lump sum method.
2. Compute the yearly income assuming Mr. Conte will spread his income from leasehold improvement over the term of
the contract of lease.
3. Compute the income of Mr. Conte in the 11th year assuming the contract of lease was terminated after the 10th year or
at the beginning of the 11th year due to the fault of the lessee; fair market value when lessor took possession,
P250,000.
4. Compute the deductible loss of the lessor assuming the leasehold improvement was destroyed at the beginning of
the 9th year of the lease contract; salvage value is P10,000 and insurance recovery is P20,000.

Answer:

1. Total Income Using Outright or Lump Sum Method

Annual rental P40,000
Income from leasehold improvement 120,000
Total income P160,000

Cost of leasehold improvement P400,000

SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 14
INVALID FOR ANY OTHER PURPOSE.
TAX 11 - Income Taxation  Prof. Balderama, CPA  1st Semester A.Y. 2022 – 2023

Less: Accumulated depreciation (P400,000 / 20 x 14) P280,000

Book Value, end of Lease P120,000

2. Total Income Using Spread-Out or Annual Method

Annual rental P40,000
Income from leasehold improvement 8,571
Total income P48,571

Cost of leasehold improvement P400,000

Less: Accumulated depreciation (P400,000 / 20 x 14) 280,000
Book Value, end of Lease P120,000

Income from leasehold improvement (P120,000 / 14) P8,571

3. Income due to Premature Termination

Fair market value, end of 10th year P250,000
Less: Income already reported (P8,571 x 9) 77,139
Income, year of premature termination P172,861

4. Deductible Loss Due to Destruction of Leasehold Improvement

Income to be reported (P8,571 x 7) P59,997
Less: Salvage value (10,000)
Insurance recovery (20,000)
Loss due to destruction of the leasehold improvement P29,997

SOLELY FOR EDUCATIONAL PURPOSE. NONDISTRIBUTABLE & NONSALABLE. 15

INVALID FOR ANY OTHER PURPOSE.