GROSS INCOME longer at the time when payment is made between the

person in whose employ the services had been performed

- Means the pertinent items of income referred to in and the individual who performed them.
Sec 32 of the tax code
- It includes all income from whatever source (unless Compensation income subject to tax is based on gross income less
exempt from tax by law) including but not limited to, applicable exemptions. No business and personal expenses are
the following items: allowed as deductions from gross compensation income
1. Compensation for services in whatever form paid The rule on compensation income applies only to resident citizens,
including fees, salaries, and wages, commissions, resident aliens and non-resident citizens and non-resident aliens
and similar items engaged in business in the Philippines. It does not apply to non-
2. Gross Income derived from the conduct of trade or resident aliens not engaged in business. Neither does it apply to
business or the exercise of a profession corporations, estate and trusts because compensation presupposes
3. Gains from dealings in property personal service.
4. Interests
Classification of Gross Compensation Income
5. Rents
6. Royalties 1. Basic Salary or Wage
7. Dividends Salary refers to earnings received periodically for a
8. Annuities regular work other than manual labor, such as a
9. Prizes and winnings monthly salary of an employee
10. Pensions
11. Partners’ distributive share from the net income of Wages are earnings received usually according to
general professional partnership specified intervals of work, as by the hour, day or
week. E.g. carpenter’s daily wage
Gross Compensation Income – means any remuneration for
rendering personal services. It is obtained from an employer-
Backwages are subject to income tax and the
employee relationship between payor and recipient
withholding tax on wages
The basis upon which the remuneration is paid is immaterial
in determining whether the remuneration constitutes 2. Honoraria are payments given in recognition for
compensation. Thus, it may be paid on the basis of services performed for which established practice
piecework, or percentage of profits and may be paid hourly, discourages charging a fixed fee. The honorarium of
daily, weekly, monthly or annually. a guest lecturer is an example.

There is no determination of compensation until the service is 3. Fixed or variable allowances

rendered In general, fixed or variable transportation,
representation, COLA and other allowances that are
Exception: the compensation income including overtime pay,
received by a public officer or employee or officer or
holiday pay, night shift differential pay, and hazard pay,
employee of a private entity in addition to the
earned by Minimum Wage Earners (MWE) who has no other
regular compensation fixed for his position or office,
returnable income are non-taxable and not subject to
are compensation subject to withholding tax
withholding tax on wages
Any amount paid specifically, either as advances or
reimbursements for travelling, representation and
When does an employer-employee relationship exist? other bona fide ordinary and necessary expenses
incurred or reasonably expected to be incurred by
Generally, an employer-employee relationship exists when the employee in the performance of his duties are
the person for whom services are rendered has the right to not compensation subject to withholding tax, if the
control and direct the individual who performs the services, following conditions are satisfied:
not only as to the result in accomplishing the work but also as
to the details and means by which that result is accomplished a. It is for ordinary and necessary travelling and
representation or entertainment expenses paid
Remuneration for services constitutes compensation even if
or incurred by the employee in the pursuit of
the relationship of employer and employee does not exist any
 the employee in the pursuit of the employer’s Marriage fees, baptismal offerings, sums paid for
trade business or profession conducting masses for the dead and other
b. The employee is required to account/liquidate contributions received by a clergyman, evangelist, or
for the foregoing expenses pursuant to religious worker for services rendered are
substantiation requirements of Sec. 34 of the considered compensation
tax code
6. Tips and gratuities – paid directly to an employee
The excess of actual expenses over advance made shall (by a customer of the employer) which are not
constitute taxable income if such amount is not returned to accounted for by the employee to the employer are
the employer considered taxable income, but not subject to
withholding tax
Latest Rulings on Allowances:
7. Hazard or Emergency pay – an additional payment
a. Transportation and cell phone allowances given to received due to workers’ exposure to danger or
call center employees are not taxable compensation harm while working. This is normally night
1. Fixed monthly transportation allowance of differential pay to arrive at gross salary.
P1500 for rank-and-file employees and P3000 Hazard, overtime, night shift differential and holiday
for supervisory employees precomputed on a pay of a minimum wage earner is non-taxable as
daily basis long as the MWE has no other reportable income
2. Mobile phone allowance of P1200 for
supervisors, managers, and directors who are 8. Retirement pay – it refers to a lump sum payment
expected to be on call 24 hours a day received by an employee who has served a company
b. Transportation and Night Shift Allowances granted for a considerable period of time and has decided to
to night shift employees and Meal and/or Out-of- withdraw from work into privacy.
Town Allowances granted to employees assigned to
conduct field work are not subject to FBT, income in general, retirement pay is taxable except in the
tax and withholding tax. following instances:
c. Taxi/transportation allowance of P100 per day given I. SSS or GSIS retirement pays
by BPO company servicing global businesses 24 II. Retirement pay due to old age provided
hours a day to employees who work overtime that the following requisites are met:
beyond 10PM or whose work shift starts at 10 PM a. The retirement program is approved by
onwards is exempt from tax the BIR Commissioner
d. Where taxi/transportation allowance is b. It must be a reasonable benefit plan. Its
precomputed on a daily basis and is paid to implementation must be fair and
employees while they are on assignment or duty, it equitable for the benefit of all
is not subject to substantiation requirement or to employees (from president to labour)
income and withholding tax c. The retiree should have been employed
for 10 years in the said company
d. The retiree should have been 50 years
4. Commission is usually a percentage of total sales or old at the time of retirement
on certain quota of sales volume attained as part of e. It should have been availed of for the
incentive such as sales commission first time

5. Fees are received by an employee for the services 9. Separation pay – taxable if voluntarily availed of. It
rendered to the employer including a director’s fee shall not be taxable if involuntary. Examples of
of the company, fees paid to the public officials, such involuntary separation are:
as clerks of court or sheriffs for service rendered in a. Death
the performance of their official duty over and b. Sickness
above their regular salaries. c. Disability
d. Reorganization/merger of company
Legal fees paid by a union on behalf of its president e. Company at the brink of bankruptcy
constitute compensation
When a company is at the brink of bankruptcy, the sequence 12. Thirteenth month pay and other benefits
of satisfying the company’s indebtedness should be in this As a general rule, thirteenth month pay and other
order benefits are not taxable if the total amount received
is P82000or less. Any amount exceeding P82000 is
a. BIR taxable.
b. Employee
c. Creditors 13. Fringe benefits and de Minimis
FRINGE BENEFITS - as any good, service, or other
As a rule, any amount received by an official or employee or
benefit furnished or granted by an employer, in cash
by his heirs from the employer due to death, sickness or
or in kind, in addition to basic salaries of an
other physical disability or for any cause beyond the control
individual employee
of the said official or employee(such as retrenchment,
redundancy, or cessation of business) are exempted from tax
De Minimis benefits - privileges of relatively small
The phrase for any cause beyond the control of the said value as given by the employer to his employees.
official or employee connotes involuntariness on the part of They are not considered as compensation subject to
the official or employee. The separation from the service of income tax and consequently to withholding tax.
the official or employee must not be asked for or initiated by
him. 14. Overtime Pay – refers to premium payment received
for working beyond regular hours of work which is
Amounts received by reason of involuntary separation remain included in the computation of gross salary of
exempt from income tax even if the official or the employee, employee. Back pay and overtime pay constitute
at the time of separation, had rendered less than 10 years of compensation.
service and/or is below 50 years of age.
15. Profit sharing – proportionate share in the profits of
Any payment made by an employer to an employee on
the business received by the employee in addition to
account of dismissal constitutes compensation regardless of
his wages
whether the employer is legally bound by contract, statute or
otherwise, to make such payment
16. Awards for Special Services – the amount received
10. Pension is a stated allowance paid regularly to a as an award for special services of employee, or
person on his retirement or to his dependents on his suggestions to employer resulting in the prevention
death, in consideration of past services, meritorious of theft or robbery. Awards for past services and the
work, age, loss or injury. like are also compensations
Pension pay is TAXABLE unless the law states
otherwise, or unless the BIR approves the pension 17. Beneficial payments – such as where an employer
plan of a private company. pays the income tax owned by an employee are
additional compensation income
11. Vacation and Sick Leave
18. Other forms of Compensation – received due to
Taxable or Not: service rendered are compensation paid in kind. It is
to be noted that compensation can be paid in kind
a. If paid or availed of as salary of an employee who is but taxes are generally paid in money. For example,
on vacation or on sick leave notwithstanding his an insurance premium paid by employer for
absence from work, it constitutes taxable insurance coverage where the heirs of employee are
compensation income the beneficiaries is the employee’s income
b. Monetized value of unutilized vacation leave credits
of 10 days or less which were paid to private
employees during the year are not subject to tax and Shares of Stock Received as Compensation
to the withholding tax
c. Monetized value of vacation and sick leave credits Compensation paid to an employee of a corporation in its
paid to government officials and employees are not stock is to be treated as if the corporation sold the stock at its
subject to income tax and to the withholding tax market value and paid the employee in cash
Hence, if compensation is received in the form of shares of of his duties are not taxable. Examples are food and lodging
stock, the fair market value of the shares of stock at the time benefit by a household maid, driver, etc.
the service is rendered is the basis of tax.
Living Quarters
Employee stock option
The following rules govern the living quarters and meals:
A stock option is a privilege granted to some key employees
of a corporation to avail of the said corporation’s share of 1. When living quarters are furnished in addition to
stock in the future for a certain price. cash salary, the rental value of such quarters should
be reported as income
The following rules shall be observed when a company issues 2. However, if living quarters or meals are furnished to
a stock option to its employees: an employee for the convenience of the employer,
the value thereof need not be included as part of
1. Compensation income – if the market price is compensation income
greater than the option price, the difference is a
compensation income at the date of grant. Unless provided for the exclusive benefit of the employer, the
2. Capital gain – when the stocks are sold, the excess rental value of living quarters is compensation income to the
of the market price at the date of sale over the employee to the extent of his reasonable needs, and the
market price at the date of grant is a capital gain excess shall be considered as expenses of the corporation.

Cancellation of Debt Meals Subsidized by Employer

The cancellation and forgiveness of indebtedness may The value of any board and lodging furnished by an employer
amount to a payment of income, gift, or capital transaction, is ordinarily taxable to the employee
depending upon the circumstances. The following rules shall
then be observed: The exclusion for meals is allowed only when meals are
furnished or subsidized to an employee for the convenience
1. If a creditor merely desires to benefit a debtor and of the employee and incidental to the requirement of his
without any consideration cancels the debt, the work or position
amount of the cancelled debt is a gift, not an income
of debtor. Remuneration for Casual Labor
2. If a corporation to which a stockholder is indebted
1. Remuneration for casual labor not in the course of
forgives the debt, the transaction has the effect of
an employer’s trade or business is not considered
the payment of a dividend income to debtor
compensation
3. If however a debtor performs services for a creditor,
who, in consideration thereof cancels the debt, the
The term casual labor includes labor which is
debtor realizes income for his services to the extent
occasional, incidental or regular. The expression not
of the amount of debt cancelled
in the course of the employer’s trade or business
Insurance Premiums as Compensation includes labor that does not promote or advance
the trade or business of the employer
These are premiums paid by the employer on life insurance 2. Any remuneration paid for casual labor( that is, labor
coverage of the employee wherein the beneficiary is the which is occasional, accidental or irregular, but
employee’s family. These constitute taxable income on the which is rendered in the course of the employer’s
basis of the amount of premium paid. trade or business) is considered compensation
3. Any remuneration paid for casual labor performed
Income Tax Paid as Compensation for a corporation is considered as compensation

For income tax paid by the employer in favour of the Gross Income from Business and Profession
employee, the basis of tax is the amount of tax paid.
Business – means any commercial activity engaged in as a
Convenience of the Employer’s Rule means of livelihood or profit of an individual or group of
individuals. Examples are trading, merchandising,
This tax rule provides that allowances in kind furnished to the
manufacturing and other similar benefits
employee for and as a necessary incident to the performance
Profession – primarily any endeavour or work requiring of Services shall include the direct costs and
specialized training in the field of learning, art, or science expenses necessarily incurred to provide the services
engaged in as a means of livelihood or profit of an individual required by the customers and clients which include
or group of individuals. In general, a practice or profession is the following items:
a service business. a. Salaries
b. Benefits of personnel, consultants and specialists
Gross income from Business directly rendering the service
c. Cost of facilities directly utilized in providing the
1. Manufacturing
service such as depreciation or rental of equipment
2. Merchandising
used and cost of supplies
3. Servicing
d. In the case of banks, costs of services shall include
4. Farming
interest expense.
5. Long-term contract
Telegraph and Cable Services of a foreign corporation – shall
include income from services within the Philippines only.
In case of manufacturing, merchandising or mining business, Specifically, the income may be derived from the following:
Gross income shall mean gross sales less sales returns,
1. Gross revenues derived from messages originating in
discounts and allowances, and cost of goods sold, plus any
the Philippines
income from investment and other incidental or outside
2. Amount received by the company collected abroad
operations or sources
on collect messages originating in the Philippines
In determining gross income, subtractions should not be and deducting from such amounts paid or accrued
made for depreciation, depletion, selling expenses or losses for transmission of messages beyond the company’s
or for items not ordinarily used in computing the cost of own circuit
goods sold
Amounts received by the foreign company in the Philippines
In the case of taxpayers engaged in the sale of service, gross with respect to collect messages originating outside the
income is based on gross receipts less returns Philippines.

The Cost of Sales Rental Income – refers to earnings derived from leasing real
estate as well as personal property. Aside from the regular
Cost of Goods Sold shall include all business expenses directly amount of payment for using the property, rental income also
incurred to produce the merchandise to bring them to their includes all other obligations assumed to be paid by the
present location and use. The cost of sale is deducted from lessee to the third party in behalf of the lessor
the net sales to calculate gross income from business. Cost of
Sales of a business may be classified as follows: Rental income is generally determined by the gross receipts
for the year, (earned and unearned under accrual basis)
1. Cost of Goods Manufactured and Sold – it shall because the nature of business involved is service.
include all costs of finished goods that are sold such
as raw materials used, direct labor and
manufacturing overhead, freight cost, insurance
1. Prepaid rental – if the advance payment is a prepaid
premiums and other costs incurred to bring the raw
rental received without restriction as to its use the
materials to the factory or warehouse
entire amount is taxable in the year it is received
2. Cost of goods sold of trading or merchandising
whether the lessor uses cash or accrual method of
concern – refers to the invoice cost of goods sold,
accounting
plus import duties and freight incurred in
2. Security Deposit with Restriction – if the advanced
transporting the goods to the place where they are
payment is a security deposit which restricts the
actually sold, including insurance while the goods are
lessor as to its use, then such amount should be
in transit
excluded in the determination of rental income
3. Cost of Service of Servicing Concern – for minimum
3. Security Deposit with an Acceleration Clause – if the
corporate income tax purposes, gross income from
advanced payment is a loan deposit, or option
service business is gross receipts less returns,
money for the property or security deposit for the
allowances, discounts and cost of services. The Cost
 faithful compliance of the lessee of the lease The general rule is that the entire amount of the gain or loss
contract, such advance payment is not an income to arising there from is a taxable gain or deductible loss.
the lessor. The income to the lessor inures when the
lessee violates the terms of the contract. Passive Income

Income from Leasehold Improvement – when the lessee A final tax is imposed upon gross passive income of citizen
erected or built permanent improvements on the leased and resident aliens
property which will become the property of the lessor upon
An income is considered passive if the taxpayer merely waits
the expiration of the lease, the value of the improvements
for it to be realized. Examples of passive income are:
should be reported as income of the lessor using either
outright method or spread out method. 1. Yield from deposit substitutes and trust fund

a. Outright method – the income from leasehold improvement

Deposit substitute – is a debt instrument issued by
shall be recognized when the improvement is completed at
the bank to borrow money from the public other
its fair market value
than from the client’s deposit
[Link]-out method – the estimated book value of the
leasehold improvement at the end of the lease is spread
Trust fund – is any estate, especially stock,
over the term of the lease and is reported as income for
securities, or money which is held in trust by a
each year of the lease an aliquot part thereof
person in behalf of another person

Termination of the Contract of Lease Both deposit substitute and trust fund yield earnings
that are to be treated as interest income
Where there is an immovable improvement made by the
lessee on the lease property and the termination of the 2. Interest income – an earning derived from
contract of lease is made before the expiration of the lease depositing or lending of money, goods, or credits.
term, the following rules should regulate the circumstances: Unless exempted by law, interest income received
by the taxpayer, whether or not usurious, is subject
1. If the improvement is destroyed BEFORE the to income tax
expiration of the lease, the lessor is entitled to
deduct as a loss for the year, when such destruction For individuals, except non-resident aliens not engaged
takes place, the amount previously reported as in trade or business in the Philippines, interest income
income less any salvage value, to the extent that from long-term deposit or investment shall be exempt
such loss was not compensated for by insurance from income tax, provided that the following conditions
2. If for any reason other than a bona fide purchase must be met:
from the lessee by the lessor, the lease is terminated
so that the lessor comes into possession of the a. The deposit or investment must be evidenced by
property prior to the final fixed period of the lease certificates conforming to the Bangko Sentral ng
contract, the lessor receives additional income for Pilipinas prescribed form
the year if the value of improvement exceeds the b. The same must have a maturity period of not less
amount of income already reported than five years and in denominations of P10,000 or
other denominations as may be approved by BSP
No appreciation in value due to causes other than issued by banks(not by non-bank financial
the premature termination of lease shall be intermediaries or finance companies)
included.
However, should the holder of the certificate pre-
Gains from Dealings in Property terminate the deposit or investment before the fifth
year, a tax shall be imposed on the entire income and
This refers to the income derived from the sale, and/or shall be deducted and withheld by the depository bank
exchange of assets, which results in gain because of the from the proceeds of the long term deposit or
excess of the amount or value received by the taxpayer over investment certificate based on the remaining maturity
the determined value of the property he has disposed of. thereof, as follows:
 Final tax of 5% ------------------- 4 years to less than 5 years Such earnings may be exempt from income tax, or
Final tax of 12% ------------------3 years to less than 4 years subject to either final tax or on the normal year-end tax
Final tax 20% ---------------------less than 3 years of individuals or corporations

Tax Rules on Dividend Income

Classifications of Interest Income
1. If received by a domestic or resident corporation
a. Exempt from Income tax – if received from: from a domestic corporation subject to tax, such
1. By members from a duly-registered dividend is tax exempt (non-taxable inter-corporate
cooperative principle)
2. BSP prescribed form of investments 2. Pure stock dividends, dividends received from
maturing more than 5 years cooperative, and pure liquidating dividends are tax-
3. Expanded foreign currency deposit system exempt
by non-resident citizens/aliens 3. Cash or property dividend is subject to final tax if
4. A tenant who paid to a landowner on the received by an individual or non-resident
price of land under a tenant-purchaser corporation from a domestic corporation subject to
agreement as part of CARP income tax
b. Subject Final Withholding tax
Interest income on deposits made in banking a. If received by a resident citizen, non-resident
institutions is a passive income which is usually citizen and resident alien, the final tax
subjected to final withholding tax of 20% applicable is 10%
c. Subject to Normal Tax (lending is the Main Course b. If received by a non-resident alien engaged in
of Business) business in the Philippines, the final tax is 20%
These are earnings derived from lending money, c. If received by a non-resident alien not doing
goods or credits from one person to another without business within, the final tax is 25%
any withholding tax made. Since these interest d. If received by a non-resident foreign corporation
earnings are received in its total amount, they from a domestic corporation, the final
should be subject to normal tax of the taxpayer withholding tax is 15%

Since the interest income is earned in the normal 4. Other dividends excluded from rules 1,2, and 3 are
conduct of business, this shall be included as part of included in the computation of the taxable income
income to be reported in the Annual Income Tax and income tax at the end of the year
Return
Forms and Valuations of Dividend Income
3. Royalty income – is a payment or portion of
For income tax purposes, the form of dividend income
proceeds paid to the owner of a right, such as an oil
shall determine its applicable treatment. Dividends that
right or a patent for the use of it, or a portion of the
are usually received by a stockholder are as follows:
proceeds from the work of an author or composer.
1. Cash dividend – the most common form of dividend.
a. In general, royalty income includes those which are It is valued and taxable to the extent of amount of
derived from natural resources or products such as money received by the stockholder
coal, gas, oil, copper, silver, gold, and other similar 2. Property dividend – a dividend payable in property
products. These kinds of royalty income are subject of an issuing corporation is a property dividend. The
to 20% final tax property dividend is usually valued and taxable to
b. Royalties on books, literary works and musical the extent of the fair market value of the property
composition are royalty income subject to 10% final received at the time of declaration
tax a. Merchandise inventory, supplies, etc.
b. Shares of stock of another corporation
4. Dividend income – is a form of earnings derived c. Treasury stock of issuing corporation if
from the distribution made by a corporation out of acquired at cost different from its par value
its earnings or profits and payable to its
stockholders, whether in money or in other property
 3. Stock Dividend – pure stock dividends are not liquidation of the stock is a capital gain or a capital
subject to tax because they simply involve a transfer loss. The gain realized or loss sustained by the
of the retained earnings to the paid-in capital stockholder is a taxable income or deductible loss, as
account, except when the following circumstances the case may be. Consequently, the capital gain on
exists: liquidating dividend is not subject to final tax.
a. There is an option that some stockholders could
take cash or property dividends instead of stock 5. Prizes and winnings
dividends
b. Some stockholders exercised the option to take Prize – is a reward for a contest or a competition. It
cash or property dividends represents remuneration for an effort reflecting one’s
c. The exercise of option resulted in a change of superiority, like prize money of a boxing contest
the stockholder’s proportionate share in the
Winnings – is a reward for an event that depends on chance
outstanding shares of the corporation
such as winnings from gambling, lottery or raffle ticket
Redemption of Stock Dividend
In general, prizes are subject to final tax of 20% except if the
If the corporation cancels or redeems stock issued as a amount of the prize is ten thousand (P10,000) or less which
dividend at such time and in such manner as to make the shall be subjected to normal tax. Winnings are subject to
distribution and cancellation or redemption, in whole or in final tax final tax of 20% regardless of amount
part, essentially equivalent to the distribution of a taxable
Prize and winnings are generally taxable except when the law
dividend, the amount so distributed in redemption or
provides for their exemption
cancellation of the stock is considered taxable income to the
extent that it represents a distribution of earnings or profits.

Stock Dividends Different from Shares Previously Acquired PARTNERS’ DISTRIBUTIVE PROFITS FROM PROFESSIONAL
PARTNERSHIP’S NET INCOME
When stock dividends received are of a different class from
shares previously acquired, the stock dividends are not The partner’s share in the distributive profit of a professional
income, and therefore, not taxable. The original cost of the partnership represents his gross income
investment is allocated between the original shares and the
stock dividends on the basis of their respective market value Other Sources of Income – generally incidental earnings or
at the date of receipt not common source earnings

4. Scrip Dividend – is issued in the form of promissory 1. Bad debt recovery

note and is taxable to the extent of its fair market 2. Tax refund or credit
value. It is taxable in the year when the warrant was 3. Damages recovery
issued. 4. Annuities
5. Indirect Dividends – are those other dividends 5. Income from whatever source
representing payments or rights received by the
Tax Benefit Rule – a general principle in taxation which states
taxpayer, which are really dividends
that if a taxpayer deducted an item on his income tax return
6. Liquidating Dividend – are return of stockholders
and enjoyed a tax benefit (reduced his income tax) thereby,
investment. It arises from the distribution of assets
and in a subsequent year recovers all or part of that item, he
by a corporation to its stockholders upon corporate
will recognize gross income in the year the deducted item is
dissolution
recovered

As a rule, the excess amount of liquidating dividends

over cost of shares surrendered is taxable. Such
excess is a gain realized which is taxable.

Distribution of liquidating dividends is to be treated

as a sale of stock. The difference between the cost or
Bad Debt Recovery
other basis of the stock and the amount received in
The following are the requisites for deductibility of bad debts: payments represent a part that is taxable and not taxable. If
the part of annuity payment represents interest, then it is
1. There must be a valid and existing debt arising from TAXABLE income. If the annuity is a return of premium, it is
business or trade of the taxpayer NOT TAXABLE.
2. The debt must be actually ascertained to be
worthless and uncollectible during the taxable year Under the contract of life annuity, the debtor binds himself to
3. The debt must be charged off during the taxable pay an annual pension or income during the life of one or
year more determinate persons in consideration of a capital
consisting of money or other property, whose ownership is
For taxation purposes, bad debts are considered the amounts transferred to him at once with the burden of the income
of receivable being ascertained worthless to be written off
during the taxable year Income from whatever sources – inclusion of all income not
expressly exempted within the class of taxable income under
When a written off receivable has been recovered in the the laws irrespective of the voluntary or involuntary action of
succeeding year, the recovered amount must be included in the tax payer in producing the gains and whether derived
the gross income during the taxable year of recovery. from legal or illegal sources
However, under the doctrine of equitable benefit, the
amount recovered is only taxable to the extent of the tax Examples of Income from legal source are:
benefit in the year the account was written off
a. Employee’s salary bonus
Tax Refund or Credit b. Commissions/rebate of a medical representative

As a rule, refunds from taxes paid are taxable except for the Examples of Income from illegal sources are:
following:
a. Gambling
a. Estate or Donor’s tax b. Kidnapping
b. Philippine income tax c. Extortion
c. Stock transaction tax d. Smuggling
d. VAT, claimed as input tax e. Embezzlement

Tax refund is subject to the tax benefit rule which states that Illegal Obtained Income
the refund of tax would only be subjected to tax if such tax
was previously deducted from gross income resulting in the As a rule, illegal income is taxable. Income obtained through
reduction of reported taxable income illegal means is included in the wrongdoer’s gross income
even though he is obligated to return it when discovered
As a rule, if the tax paid is deductible, refund is taxable. If the
tax paid is not deductible, refund is not taxable. The mere fact that a transaction is illegal does not exempt it
from income tax laws. Gains from such transactions as
TAX REFUND OR CREDIT shall be included as part of gross gambling, extortion, swindling and the like are all taxable
income in the year of receipt to the extent of the income tax
benefit of the said deduction Income that is not realized is not taxable, even though its
absence is due to an illegal act. Moral turpitude is not a
Damages Recovery – an amount received by an injured touchstone of taxability
person as payment for loss income or payment to
compensate damage to property, injury to person, or loss of The courts have sustained the BIR Commissioner’s
life. determination of the illegal gains from such records as bank
deposits, or on the basis of commissions paid out, and even
As a rule, recoveries of damage representing compensation from a formula determination based upon the nationwide
for loss of profit or income are TAXABLE experience. The burden is on the taxpayer to offer
independent evidence to contradict such determination
Recoveries that are to compensate for damages to property,
injury to person, or loss of life are not taxable Embezzled funds - are income without consent (express or
implied) with an obligation to repay. If the embezzler reaps
Annuities – are instalment payments received for life the fruit of his crime without restriction as to disposition, he
insurance sold by insurance companies. The annuity
is in receipt of income though it may be claimed he is not
entitled to the money and may be adjudged liable to restore
its equivalent. When reported as income, actual repayment
of embezzled fund will give rise to deduction.

Income Received by Error

When income is received under a mistake of fact or law, the

income is included in the gross taxable income of the
recipient notwithstanding the fact that the recipient may be
required to return the income item to the payor when the
error is discovered.