TAXATION
FUNDAMENTALS OF INCOME TAXATION
INCOME
All wealth which flows into the taxpayer other than a mere return of capital and includes gains
Why is income taxed?
Income is the best measure of a taxpayer’s ability to pay.
Basic Definitions:
Gross Income – refers to what is income for taxation purposes
Taxable Income – as the pertinent items of gross income that are subject to tax after allowable deductions
Tax Base – the value of a certain goods, or property for taxation purposes
Characteristics of Gross Income:
1.
Return on capital and resulted increased networth at the moment of its generation
2.
Realized benefit by the taxpayer (realization means actual or constructive receipt of in cash)
Example of constructive receipts of income:
1. credit to an account own by the taxpayer
2. declaration of a share of the profits of a general professional partnership
3. offsetting debt with right to received dividends
4. cancellation of debt in payment of service
Which do not constitute gross income?
1. Receipts representing returns of capital
Examples:
a. Proceeds of life insurance policy (upon death of the insured)
b. Proceeds received by the insured (still living) representing return of premium
2.
Unrealized income
Examples:
a. Appreciation of value of properties
b. Unrealized gains on investments
3. Those exempted by the Constitution, statues or treaty or contract with taxpayers
Examples:
a. Receipt of non-profit institutions from their main activities
b. Contributions to GSIS, SSS, PhilHealth, Pag-Ibig and
c. Retirement and separation benefits under certain circumstances
d. Tax holiday for entities registered pursuant to the Omnibus Investment Code
e. Income of foreign government or corporations owned or controlled by them
Taxation of Gross Income under the NIRC:
A.
Passive Income Tax
1.
Capital gains tax – few final tax is imposed on certain gains on dealings on properties
Examples include final tax on:
a. Final tax on net gain on sale of domestic stocks directly to buyer (withheld at source)
b. Final tax on gains on sale of real property located in the Philippines classified as capital asset
2.
Other withheld final tax – these are groups of passive income that are subject to withholding by the income payor.
Examples include final tax on:
a. Interest on deposits with banks d. Winnings
b. Prizes e. Royalties
c. Dividends received from domestic corporation
B.
Regular (Active) Income Tax – applies to all items of gross income that are generated by the taxpayer in the ordinary course of business or to
those items of passive income that are not covered by final taxes.
Regular income tax is either:
1. Progressive tax (0-32% schedular rates) – applicable to individual and taxable trusts and estates
2. Final tax (35%) – applicable to corporations
Examples active income:
1. Compensation income
2. Professional income
3. Business income
4. Those items of income that are excluded from capital gains tax
a. Gain on sale of properties located abroad
b. Gain on sale of properties located in the Philippines by non-residents
c. Gain on sale of other non-domestic stocks and non-real property capital assets
5. Those items of income that are excluded from other final taxes
a. Interest income on notes receivable (not deposit)
b. Prizes where the taxpayer has no intention or active effort to compete (Nobel Prize, cash awards to “Most Outstanding Citizens of Baguio”)
c. Dividends from foreign corporations
6. Others
a. Certain tax benefits (example: items of deductions claimed in the past that are subsequently recovered)
b. Obligations waived by the creditors in consideration of service
SITUS OF INCOME
A.
Interest – debtor’s residence
B.
Dividends
1. By a domestic corporation – within the Philippines
2. By a foreign corporation – apply the income dominance test
Basis:
World gross income for the three-year period ending the current taxable year preceding the declaration of such dividends
a. If Philippine gross income is more than 85%, the whole dividends are considered within.
b. If Philippine gross income is less than 50% of the basis, the whole dividend is considered earned outside the Philippines
c. If Philippine gross income is at least 50% of this, the ratio of Philippine gross income over the basis multiplied by the dividend received is
considered earned within the Philippines.
C.
Service – place of performance of the service
D.
Rent – location of the property
E.
Royalties – place where the intangible is used
F.
Gain on sale
a.
Real property – location of the property
b.
Domestic shares of stock – always within the Philippines
c.
Personal property – place of sale
G.
Mining – location of mine
H.
Farming - location of farm
I.
Merchandising – place of sale
Place of Puchase Place of Sale Income is earned
a. Within within within
b. within abroad abroad
c. abroad within within
d. abroad abroad abroad
J.
Manufacturing – place of production and place of sale (Sec. 42(E), NIRC):
Whether full or partial processing, for example:
Place of Production Place of Sale Income is earned
a. Within within within
b. within abroad within and abroad
c. abroad within within and abroad
d. abroad abroad abroad
Allocation methods:
1. With factory or production price – the value as transfer price of the factory to the selling segment is deemed the selling price of the commodity
transferred.*
2. Without factory or production price – the portion deemed earned within the Philippines is:
(Property value, Philippines/ Property value, world) * 50% of income P xxx
(Gross sales, Philippines/ Gross sales, world) * 50% of income xxx
Manufacturing income earned from the Philippines P xxx
TAX ACCOUNTING PERIODS
Gross income accumulates over a period of time. Income taxation would require adoption of an accounting period wherein to measure the income. The
NIRC provides that “taxable income shall be computed upon the basis of the taxpayer’s annual accounting period in accordance with the methods of
accounting regularly employed in keeping the books of such taxpayer.”
There are two types of tax accounting periods:
1.
Calendar year – the 12-month period ending December 31 and is applicable to:
a. Individuals
b. taxpayers who do not keep booksd. taxpayers with accounting periods other than the fiscal year
c. taxpayers with no annual accounting period
2. st
Fiscal period – any 12 months period ending the last day of any month other than December 31 . This is Not available to non-corporate
taxpayers.
Normally, accounting period are uniformly 12 months, however, short accounting period may arise in the following cases:
1. death of a taxpayer 3. dissolution of a business
2. newly organized business 4. changes in accounting period
TAX PAYMENTS
th
Tax shall be paid on the 15 day of the fourth month following the close of the taxpayer’s taxable year.
TAX ACCOUNTING METHODS
So as the reporting of items of gross income would be consistent, tax accounting methods should be applied such as the following:
A.
Principal Methods
1.
Cash Basis Method – income is recorded in the year it is actually or constructively received; expenses are generally reported in the year it is
paid
2.
Accrual Method – income is reported in the year it is earned and expenses are deducted in the year incurred
3.
Hybrid method – combination of both cash basis and accrual basis method
B.
Deferred Payment Sales
1.
Installment method – applicable in the following three cases only:
a. Sale of personal property by a dealer
b. Casual sale of personal property where:
a. selling price is over P1,000.00
b. initial payment do not exceed 25% of the selling price
c. property is of a kind which would be included in the taxpayer’s inventory if on hand at the close of the taxable year
c. Sale of real property where the initial payment do not exceed 25% of the selling price
Initial Payment – refers to payments which the seller receives upon the execution of the instruments of sale and those scheduled to be received in the year
of sale or disposition. It simply means “total first year payments” but do not include receipts of evidence of indebtedness of the buyer such as notes.
2.
Deferred payment basis – applicable when the buyer has issued evidence of obligation (notes). The notes shall be valued at its market value at
the date of receipt. The difference between the fair value and the face value is reported as interest income in future taxable period. This is an alternative to
delaying tax payments when the installment method is not available.
C.
Long-term Construction Contracts
1.
Percentage of completion – this is applicable only to long-term construction contracts covering a period in excess of one year ( Architect or
engineer’s certification is required)
2.
Completed contract basis – gross income is recognized upon completion of construction contract
D.
Farming income
Crop year basis – applicable only to farmers engaged in the production of crops which takes more than a year from the time of planting to the process of
gathering and disposal. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops is realized.
E.
Leasehold improvement
1.
Outright method – the value of the leasehold improvement attributable to the lessor is reported in taxable income at the time of completion of
the leasehold
2.
Spread-out method – the value of the leasehold improvement attributable to the lessor is recognized in taxable income over the lease term
Reminders on Tax Accounting Methods:
a.
Absence of accounting method or use of one that do not clearly reflects the income
If the taxpayer has no accounting method or if the method employed does not clearly reflect the income, the computation shall be made in accordance with
such method as in the opinion of the Commissioner clearly reflects the income.
b.
Consolidation of gross income from two or more methods
If a taxpayer adopted the cash basis and accrual basis in accounting for income earned on separate trade or business, he may opt to combine the two
income determined from the respective methods as a consolidated income for tax purposes.
c.
Change of Tax Method
-
Prior BIR approval is required
-
If the taxpayer changes its accounting methods from accrual to installment method, he should include in future periods the collection of
receivables in future gross income.*
d.
Expenditures benefiting future periods
Expenditures benefiting more than one taxable period is deferred and allocated to those periods expected to be benefited by the expenditure.
e.
Advanced receipt of items of gross income
Receipt of income in advance is taxable in the year of receipt.
GENERAL RULE IN INCOME TAXATION
Income Taxable in the Philippines
Type of Taxpayers Earned Philippines Earned Abroad
I.
Individuals
A. Citizens
✔ ✔
1. Resident
✔
2. Non-resident
B. Aliens
✔
1. Resident
2. Non-resident
✔
a. In business
✔
b. Not in business
C. Estate and Trusts same rule with individuals
II.
Corporations
✔ ✔
A. Domestic
✔
B. Foreign
✔
1. Resident
✔
2. Non-resident
TAX COMPLIANCE
The Philippines follows the “self-assessment method” wherein taxpayers determine their gross income, prepare their income tax returns and pay the tax
accordingly. The return filed is presumed correct unless proven otherwise by the government. However, in cases of failure to file a return, the
Commissioner of Internal Revenue shall file a return from best available information and such return thus filed is presumed correct. The taxpayer has the
burden of proof in this case. The same rule applies when tax authorities has reasons to believed that the tax return of the taxpayer is grossly misstated.
Income tax return is required for items of gross income that are subject to:
1. Regular Income Tax (quarterly and annual consolidated return)
2. Capital Gains Tax (per transaction and an annual consolidated return)
Who shall file income tax returns?
1. Every resident Filipino citizen
2. Every non-resident Filipino citizen on his income from sources within the Philippines
3. Every resident alien on income from sources within the Philippines; and
4. Every non-resident alien engaged in trade or business or in the exercise of profession in the Philippines, on income from sources within the
Philippines
Who are not required to file individual returns for income tax?
1. An individual whose gross income does not exceed his total personal and additional exemptions, except those engaged in business or profession
2. An individual with respect to pure compensation income, derived from sources in the Philippines, the income tax on which has been correctly
withheld, except those with concurrent employment
3. An individual whose income has been subjected to final income tax
4. An individuals who is exempt from filing income tax returns in pursuant to other provisions of the Tax Code and other laws.
Where to file income tax returns?
1. Authorized agent bank
2. Revenue District Officer
3. Collection Agent
4. Duly authorized Treasurer of the city or municipality in which the taxpayer has his legal residence or principal place of business in the
Philippines or
5. Office of the Commissioner if the taxpayer has no legal residence or place of business in the Philippines
Payment of Income Tax
1. Outright
2. Installments (for individual taxpayers)
The Networth Method
The Networth Method serves as a test of the existence of income when not specifically disclosed.
Possible Gross Income = Personal Expenditures + Change in Networth*
*The change in Networth is computed as:
Asset, end - Liabilities, end = Net Worth, end
Less: Assets, beginning - Liabilities, beginning = Networth, beginning
Change in networth
The possible gross income is generally taxable, except when it:
1. is excluded by law, contract, treaty, public policy from taxation
2. result from additional investment
3. is not income for income tax purposes (i.e. does not meet the three characteristics of gross income)