INCLUSIONS AND

EXCLUSIONS FROM THE Chapter 8

GROSS INCOME
GROSS INCOME (INCLUSIONS)
1. Compensation for services, "in whatever form paid", including but not limited to
fees, salaries, wages, commissions and similar item
2. Gross income derived from the conduct of trade or business or the exercise of
profession (business income)
3. Gains derived from dealings in property
4. Interest
5. Rents
GROSS INCOME (INCLUSIONS)
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions
11. Partner's distributive share from the net income of the general. professional
partnerships
COMPENSATION INCOME
Compensation income is income arising out of an employer - employee relationship. It encompassed all
remuneration for services performed by an employee for his employer whether paid in cash or in kind
(RR2-98).
COMPENSATION INCOME
Compensation income includes salaries, honoraria, and wages, emoluments, taxable bonuses, allowances
(such as and transportation, entertainment, representation and the like), fringe benefits, fees (including
directors' fees if the director is at the same time an employee of the employer), taxable pay, commission,
compensation for services on the basis of a percentage of profits, commissions on insurance premiums,
tips, marriage fees, baptismal offerings, sums paid for saying masses for the dead, and other
contributions received by a clergyman, evangelists, or religious worker for services rendered, and other
income pensions and retirement of a similar nature.
FORMS/MEASUREMENT OF
COMPENSATION
Compensation may be paid in money or in some medium other than money such as stocks, bonds or other
forms of property. If compensation is paid in cash, the full amount received is the measure of
compensation income. If the services are paid in a medium other than money, the fair market value of the
thing taken in payment is the amount of compensation. If compensation is paid in kind, such as stocks of
the employer, the fair market value of the stock at the time the services were rendered is the measure of
compensation. Likewise, income tax of the employee assumed or paid by the employer in consideration
of the latter's services is considered compensation income of the latter.
CLASSIFICATION OF
COMPENSATION INCOME
1. Regular compensation - includes basic salary, fixed allowances for
representation, transportation and others paid to an employee per payroll period
(RR 10-2008)
2. Supplemental compensation - includes payments to an employee in addition to
the regular compensation such as but not limited to the following: overtime pay,
fees, including director's fees, commission, profit sharing, monetized vacation
and sick leave, fringe benefits received by rank & file employees’ hazard pay,
taxable 13th month pay and other benefits, other remunerations received from an
employee-employer relationship, with or without regard to payroll period.
COMPENSATION INCOME RECEIVED
AFTER TERMINATION OF
EMPLOYEE-EMPLOYER RELATIONSHIP
Remuneration for services constitutes compensation income even if the relationship of
employer and employee does not exist any longer at the time when payment is made
between the person in whose employ the services had been performed and the
individual who performed them. Obviously, the related compensation income was
earned at the time the employer-employee relationship was not yet terminated.
Hence, the income was derived out of an employer-employee relationship.
 TH
FRINGE BENEFITS AND 13 MONTH
PAY
A fringe benefit is any goods, service or other benefit furnished or granted by an
employer in cash or in kind, in addition to basic salaries, to individual employees.
Fringe benefits subject to fringe benefit tax cover only those fringe benefits given or
furnished to a managerial or supervisory employee. On the other hand, fringe
benefits furnished to rank and file employees are subject to basic tax and
consequently to withholding tax on compensation in accordance with RR 2-98 (as
amended).
FIXED OR VARIABLE ALLOWANCES
In general, fixed or variable allowances which are received by a public officer or
employee or officer or employee of a private entity, in addition to the regular
compensation, fixed for his position or office, is compensation subject to income tax
and consequently, creditable withholding tax on compensation income [Section 2.78.1
(A) of RR 2-98 as amended by RR 10-2008). Examples of fixed or variable
allowances are transportation allowance, representation allowance, communication
allowance, living away from home allowance (LAFHA), and the like.
ADVANCES AND REIMBURSEMENTS
FOR TRAVELING AND
ENTERTAINMENT EXPENSES
Reasonable amounts of reimbursements/advances for travelling ana entertainment
expenses which are pre-computed on a daily basis and are paid to an employee while
he is on an assignment or duty need not be subject to the requirement of substantiation
and to withholding. On the other hand, any amount paid specifically, either as advances
or reimbursements for travelling, representation and other bona fide ordinary and
necessary expenses incurred or reasonably expected to be incurred by the employee in
the performance of his duties are not compensation subject to withholding; if the
following conditions are satisfied:
ADVANCES AND REIMBURSEMENTS
FOR TRAVELING AND
ENTERTAINMENT EXPENSES
1. It is tor ordinary and necessary travelling and representation or entertainment
expenses paid or incurred by the employee in hne pursuit of the trade, business
or profession; and
2. The employee is required to account/liquidate for the foregoing expenses in
accordance with the specific requirements of substantiation for each category of
expenses pursuant to Sec. 34 of the Tax Code.
PREMIUMS ON LIFE INSURANCE
Premiums on life insurance covering [Link] employee paid by the employer is
taxable income to the employee, where the insured employee. directly or indirectly is
the beneficiary under the policy.
DEDUCTIBLE EXPENSE OF THE
EMPLOYER
Any amount given by the employer as benefits to its employees, whether classified as
de minimis benefits or fringe benefits shall constitute as deductible expense upon such
Employer.
RETIREMENT BENEFITS, SEPARATION
PAY, PENSION, ETC.
Retirement benefits, separation pay, cost of living allowances and other tax exempt
income received by employees from employers are discussed under “exclusions from
gross income .
TIPS AND GRATUITIES
Tips or gratuities paid directly to an employee by a customer of the employer that
are not accounted for by the employee to the employer are considered as taxable
income subject to basic. tax. However, the same shall not be subject to withholding for
the reason that tips are not accounted for by the employee to the employer (RR
2-98).
VACATION AND SICK LEAVE
ALLOWANCES
Vacation and sick leave allowances are amounts of "vacation allowances or sick leave
credits" which are paid to an employee treated as compensation income. Thus, the
salary of an employee on vacation or on sick leave, which are paid notwithstanding
his absence from work, constitutes compensation. However, the monetized value of
unutilized vacation leave credits of ten (10) days or less' which were paid to the
employee during the year, being de minimis benefits are not subject to income tax
and to withholding tax.
REPRESENTATION AND
TRANSPORTATION ALLOWANCES
(RATA)
Representation and Transportation Allowances (RATA) granted under Section 34 of
the General Appropriations Act to certain officials and employees of the government
are considered reimbursements for the expenses incurred in the performance of one's
duties rather than as additional compensation. However, the excess of RATA, if not
returned to the employer, constitutes taxable compensation income of the employee.
STIPENDS OF RESIDENT PHYSICIANS
The stipends received by resident physicians during their intensive training in the
residency program of a hospital are subject to creditable withholding tax (CWT). The
amount subject to CWT shall include not only fees, but also per diems, allowances,
and any other form of income payments not subject to withholding tax on
compensation [BIR Ruling No. DA (C-004)024-2010, February 4, 2010].
COST OF LIVING ALLOWANCE
COLA of minimum wage earners is exempt from income tax. The COLA forms part of
the new wage rates or statutory minimum wage Hence, it is covered by the income tax
exemption of MWES under RA 9504, as implemented by Revenue Regulations No.
10-08, which covers the statutory minimum wage (inclusive of COLA under NCR
Wage Order No. NCR-16), including holiday pay, overtime pay, night shift
differential pay and hazard pay.
INCOME OR GAIN FROM THE
EXERCISE OF STOCK OPTION PLANS
The BIR-ruled under BIR Ruling 119-2012 dated February 22, 2012 that any income
or gain derived by an employee from the exercise or stock option is considered as
additional compensation subject to income tax and consequently, to withholding tax
on compensation (WTC).
BUSINESS INCOME
Gross income derived from the conduct of trade or business or the exercise of
profession is known as business income. They may arise from the sale of products or
'services. For example, fees received by a professional person are considered
business income. Rents received by a person in the real estate business are business
income.
BAD DEBT RECOVERY
Subsequent recovery of a bad debt previously written off in the books is a taxable
income provided that the write-off of the account resulted in a lower taxable income
at the time of write-off. This rule is known as "Tax Benefit Rule. The aforementioned
rule states that the taxpayer is obliged to declare as taxable income is subsequent
recovery of bad debts in the year they were collected to the extent of the tax benefit
enjoyed by the taxpayer when the bad debts were written-off and claimed as a
deduction from income. Thus, if the taxpayer realizes a reduction of the income tax
due him on account of a deduction for bad debts, his subsequent recovery of the
same from the debtor shall be treated as a receipt of taxable income. However, if
the taxpayer did not benefit from the deduction of the said bad debt written off
because it did not result in any reduction of his income tax in the year of such
deduction, the subsequent recovery shall not be treated as receipt of realized
taxable income but a mere recovery or return of capital which is not taxable.
TAX REFUND
The Tax Benefit Rule" also applies with respect to refund or credit for taxes. Thus, tax
refunds are taxable if the tax, when paid, was deducted from gross income (i.e., local taxes
and fringe benefit tax). Taxes which were not previously allowed as deductions from the
gross income should not form part of taxable income when refunded. The following tax
refunds are not taxable:
1. Income tax (except fringe benefit tax)
2. Estate Tax
3. Donor’s tax
4. Special assessment
5. Stock transaction tax
6. Income tax paid to a foreign country if the taxpayer claimed a credit for such tax in the
year it was paid.
CANCELLATION OR CONDONATION
OF DEBTS
Income can come in many forms, including the cancellation or condonation of debts.
The following tax rules shall be observed with respect to cancellation/condonation of
debts:
CANCELLATION OR CONDONATION
OF DEBTS
GAINS DERIVED FROM DEALINGS IN
PROPERTY
Gross income derived from dealings (sale, barter or exchange) in property includes
all income derived from the disposition of property (real or personal, for sale or in
exchange of other property, or both) which results in gain or loss The gain from the
transaction shall be taxable gain and the loss shall be deductible if incurred in trade,
profession, or business.
INTEREST INCOME
Generally, interests are taxable income, unless exempted by law, whether or not
usurious. Gross income derived from interest should only refer to such interest as
arising from indebtedness (whether business or non-business, legal or illegal), that is,
Compensation for the loan or forbearance of money, goods, or credits For instance,
interest derived from lending money, goods, or credits from one person to another or
interest earned in the normal conduct Or trade or business are subject to basic tax.

On the other hand, interest income on deposits made in banking institutions as well as
interest income on deposit substitutes are passive Income subject to 20% final
withholding tax. Interest income derived from investments in 9overnment securities are
also subject to 20% final tax.
RENTAL INCOME
Section 32(A)5) of the Tax Code provides that "rent" paid by the lessee for the use or
lease of property is taxable income to the lessor. Rent is the amount paid for the use or enjoyment of
a thing (real or personal) or right

RENT INCOME may be in the FORM of:

1. Cash, at stipulated price
2. Obligations of the lessor to third persons paid or assumed by the lessee in consideration
of the contract of lease such as real property taxes assumed by the lessee on the property
being leased, insurance or other fixed charges. Such payments shall be considered rental payments
to be reported by the lessor aspart of its taxable income.
3. Advance payment, which may be:
a. Prepaid rent
b. A security deposit that is applied to rental is a taxable income of the lessor
NON-TAXABLE RENT
Advance rentals representing option money for the property as well as security
deposits to insure faithful performance of certain obligations of the lessee are not
considered as income on the part of the lessor.
LEASEHOLD IMPROVEMENT
A leasehold improvement is an improvement made to a leased asset. Buildings erected or
improvements made by the lessee on the leased premises are taxable only if the same were
made pursuant to an agreement with the lessor and the buildings erected or improvements
made are not subject to removal by the lessee. However, the lessor does not realize taxable
gain from leasehold improvements turned over by the lessee at the end of the lease where
leasehold improvements are considered fully depreciated and where the condition of said
property is such that necessary renovations and extraordinary repairs have to be
undertaken to restore the same to useful condition. On the other hand, the lessee may claim
depreciation of the improvements as deduction from the lessee's gross income over the
remaining term of the lease or the life of the improvements, whichever is shorter.
PRETERMINATION OF LEASE
If for any reason other than a bona fide purchase from the lessee by the lessor, the
lease is terminated, the lessor realizes additional income for the year to the extent
that the value of such improvement exceeds the amount already reported as income
on account of such improvement.
ROYALTY INCOME
Royalty was not defined under the Tax Code, nonetheless, Webster Dictionary defined
the same as a share of the earnings as from invention, book or play, paid to the
inventor, writer, etc. for the right to make, use or publish the same.
SERVICE FEES AND ROYALTIES,
DISTINGUISHED
To distinguish between compensation for service and royalty payments, the tax payer
must inquire on whether the payee has proprietary interest in the property that gave
rise to the income. If the payee has none, the payment constitutes compensation for
personal services. If the payee has proprietary interest, the payment constitutes
royalty income.
DIVIDEND INCOME
Dividends are payments made by a corporation to its shareholder members. It is the
portion of corporate profits paid out to stockholders, direct or indirect Direct dividend
is one where the paying corporation acknowledges the distribution of dividend
through a resolution of the Board of Directors declaring such distribution as
distribution of dividend. Indirect Dividend is a distribution of Profits disguised as
payment of services, properties, etc. Direct and indirect dividends are subject to tax.
 TYPES OF DIVIDENDS
1. Cash Dividend – paid out in currency and are usually taxable to the recipient in
the year they are paid.
2. Property Dividend – paid out in the form of non-cash asset from the issuing
corporation or another corporation. Also known as dividends in kind.
3. Liquidating dividends – considered a sale or exchange of property between the
corporation and the shareholder
4. Stock dividend – reflects the corporation transferring an amount from surplus to
capital stock or paid up capital.
ANNUITY INCOME
Specified income payable at stated intervals for a fixed or a contingent period, often
for the recipient’s life, in consideration of a stipulated premium pad either in prior
installment payments or in a single payment.
PRIZES AND OTHER WINNINGS
A prize is an award to be given to a person or a group of people to recognize and
reward actions or achievements. Prizes are also given to publicize noteworthy or
exemplary behavior, and to provide incentives for improved outcomes and
competitive efforts. Winnings, on the other hand, for tax purposes, should refer to
rewards/income by virtue of chance or bets. As a rule, prizes and winnings are
taxable unless exempt.
PENSIONS
Pensions, in general are subject to income tax, except pensions and retirement
benefits exempt under the law.
PARTNER’S SHARE IN THE NET
INCOME OF A GPP
General Professional Partnership is not a subject to income tax. However partners
shall be liable for income tax on their separate and individual capacities. Each
partner shall report as gross income, his or her distributive share in the net income of
GPP.
EXCLUSIONS FROM THE GROSS
INCOME
Exclusions from the gross income refer to flow of wealth to the taxpayers which are
not considered part of gross income for purposes of computing the taxpayers'
taxable income due to the following:
1. It is exempted by the fundamental law or by statute
2. It does not come within the definition of income

The exclusion of income should not be confused with the reduction of gross income by
the application of allowable deductions. Exclusions are not taken into account in
determining gross income, however, deductions are subtracted from the gross income.
NATURE OF EXEMPTIONS FROM
TAXATION
Exemptions from taxation is a grant of immunity to particular persons or corporations
or to persons or corporations of a particular class from a tax which persons and
corporations generally within the same jurisdiction are obliged to pay It is an immunity
or a mere "privilege which may be revoked by the government unless the exemption
is founded on a contract which is protected from impairment. It is freedom from a
financial charge or burden to which others are subjected.
GROUNDS FOR GRANTING TAX
EXEMPTION
1. Based on contract, law or treaty.
Based on Law
a. Tax exemptions granted to cooperatives registered under the Cooperative
Development Authority
b. Travel tax exemption as provided for by Presidential Decree (PD) 1183
Based on Treaty
a. Salaries of officials of the United Nations assigned in the Philippines.
b. Citizens of the United States working in consular offices in the Philippines are exempt from
payment of all taxes (national or local, salaries, allowances, fees, or wages).
c. Salaries of diplomatic officials and agents
GROUNDS FOR GRANTING TAX
EXEMPTION
2. Based on some ground of public policy such as to encourage direct foreign
investments, encourage new industries, or foster charitable institutions, and the like.
a. Tax holidays granted by the Bureau of Investments (BOI) to foreign investors and
pioneer companies in new industries
b. Tax exemptions granted to companies incurring heavy losses due to legitimate
business reverses such as exemption from MCIT

3. Based on grounds of reciprocity or to lessen the rigors of international double or

multiple taxation
a. Exemptions granted to nonresident aliens engaged in trade or business .
TAX EXEMPTION, TAX AMNESTY AND
TAX CONDONATION
Tax exemption, as discussed in the foregoing paragraphs, refers to a grant of
immunity to particular persons or corporations or to persons or corporations of a
particular class from a tax which persons and corporations generally within the same
state or taxing district are obliged to pay. Tax exemptions are not favored and are
construed strictissimi juris (strictly) against the taxpayer.
TAX EXEMPTION, TAX AMNESTY AND
TAX CONDONATION
A tax amnesty is never favored nor presumed in law, and is granted by statute. The
terms of the amnesty must be strictly construed against the taxpayer and liberally in
favor of the government.
TAX EXEMPTION, TAX AMNESTY AND
TAX CONDONATION
There is tax condonation or remission when the State desists or refrains from exacting,
inflicting or enforcing something as well as to restore what has already been taken.
The condonation of a tax liability is equivalent to and is in the nature of a tax
exemption. Thus, it should be sustained only when expressed in the law
NATURE OF POWER TO GRANT TAX
EXEMPTION: NATIONAL
GOVERNMENT
It is inherent in the exercise of the power to tax that the sovereign state be free to
select the subjects of taxation and to grant exemptions therefrom. Unless restricted by
the Constitution, the legislative power to exempt is as broad as its power to tax.
NATURE OF POWER TO GRANT TAX
EXEMPTION: LOCAL GOVERNMENT
Municipal corporations are clothed with no inherent power to tax or to grant tax
exemptions. But the moment the power to impose a particular tax is granted, they
also have the power to grant exemption therefrom unless forbidden by some provision
of the Constitution or the law. The legislature may delegate its power to grant tax
exemptions to the same extent that it may exercise the power to exempt.
 ITEMS OF INCOME OR PROCEEDS
EXCLUDED FROM THE GROSS
INCOME
1. Life Insurance - the proceeds of life insurance policies paid to the heirs or
beneficiaries upon the death of the insured, whether in a single Sum or
otherwise, but if such amounts are held by the insure under an agreement to pay
interest thereon, the interest payments shall be included in gross income.
2. Amount received by the insured as a return of premium. The amount received by
the insured, as a return of premiums paid by him under life insurance,
endowment, or annuity contracts, either during the term or at the maturity of the
term mentioned in the contract or upon surrender of the contract.
 ITEMS OF INCOME OR PROCEEDS
EXCLUDED FROM THE GROSS
INCOME
3. Value of property acquired by gratuitous transfer (gifts, bequests, and devises)
but not the income from such property. The value of the property acquired by gift,
bequest, devise, or descent: Provided, however, that income from such property,
as well as gift, bequest, devise or descent of income from any property, in cases
of transfers of dividend interest, shall be included in the gross income.
4. Compensation for Injuries or sickness. Amounts received, through Accident or
Health Insurance or under Workmen's Compensation ACIs, as compensation for
personal injuries or sickness, plus the amounts of any damages received, whether
by suit or agreement, on account of such injuries or sickness.
 ITEMS OF INCOME OR PROCEEDS
EXCLUDED FROM THE GROSS
INCOME
5. Income exempt under treaty
6. Retirement benefits, pensions, gratuities, etc.
a) Retirement benefits – taxable except; retirement benefits received under RA 7641 and; those
received by officials and employees of private firms.
b) Separation pay – any amount received by an official or employee or y his heirs from the employer
as consequence of separation of such official or employee from the service of employer.
c) Social security benefits.
d) Benefits received under US Veterans Administration
e) SSS Benefits
f) GSIS benefits
 ITEMS OF INCOME OR PROCEEDS
EXCLUDED FROM THE GROSS
INCOME
7. Miscellaneous items
a) Income derived by a foreign government
b) Income derived by the government or its political subdivisions
c) Prizes and Awards
d) Prizes and Awards in Sport Competition
e) 13th month pay
f) GSIS,SSS, Medicare and other contributions and union dues of individuals
g) Gains from sale of bonds debentures and other certificates of indebtedness with maturity of more
than 5 years
h) Gains from redemption of shares in mutual funds