A.

Introduction to Income Taxation

1. The concept of gross income

Concept of Income

Income is seen as the willingness of the taxpayer to

pay tax. In the redistribution of government costs, it
is an ideal object of taxes.

Gross Income and its elements

GROSS INCOME

Means taxable income in layman’s term. NIRC:

“taxable income” refers to certain items of gross
income less deduction and personal exemptions
allowable by law.

ELEMENTS OF GROSS INCOME

● It is a return on capital that increases net worth.

● It is a realized benefit.
● It is not exempted by law, contract, or treaty.
.

Capital items deemed with infinite value

There are capital items that have infinite value and

are incapable of pecuniary valuation. Anything
received as compensation for their loss is deemed a
return of capital. Examples are life, health, and
human reputation.

LIFE - Pursuant to Sec. 32 of the NIRC, the life

insurance proceeds paid to the heirs or claimants on
the insured's death shall be exempt from tax either in
one amount or another. An employer as a beneficiary
of a life insurance firm or anyone personally involved
in his or her trade shall also be removed from life
insurance income.

HEALTH - any compensation received in

consideration for the loss of health such as
compensation for personal injuries or tortuous acts is
deemed a return of capital.

HUMAN REPUTATION - any indemnity received as

compensation for its impairment is deemed a return
of capital exempt from income tax.

Recovery of lost capital vs. Recovery of lost

profits

Recovery of lost capital

• Results in decrease in net worth

• Merely maintains net worth

Recovery of lost profits

• Does not decrease net worth

• Increases net worth

Taxable Recovery of lost profits

1. Proceeds of drop or livestock insurance

2. Guarantee payments
3. Indemnity received from patent infringement
suit.

The Concept of Realized Benefit

Benefit is any form of advantage derived by taxpayer.

The following are not benefits, therefore, not taxable:

1. Receipt of loan
2. Discovery of lost properties
 3. Receipt of money or property to be held in trust
for, or to be remitted to, another person.

Realized is earned. It requires the degree of

undertaking or sacrifice from the taxpayer. Realized
benefit must be; an exchange transaction, the
transaction involves another entity, and it increases
the net worth of the recipient.

Complex Transactions

Types of transfers

• Bilateral transfers or exchange such as sale or

barter.
• Unilateral transfers such as succession or
donation
• Complex transaction- these are partly
gratuitous and partly onerous and are
commonly referred as “transfers for less than
full and adequate consideration”.

Benefits in the absence of transfers

Increase in the wealth of a taxpayer in the form of an

appreciation or increase in the value of his property
or a reduction in the value of his commitments in the
absence of a scale or exchange agreement is not
taxable. They are referred to as unrealized gains or
profits kept because they have not yet materialized
in an exchange transaction.

Rendering of services

Rendering of services for a consideration is an

exchange but not cause a loss of capital. Hence, the
entire consideration received from rendering of
services such as compensation income.

Basis of exemption of unrealized income

Income received in non-cash considerations is
taxable at the fair value of the property received.
Moreover, exempting income realized in non-cash
considerations would open a wide avenue for tax
evasion.

Mode of receipt/realization benefits

Taxable items of income may be realized in two

ways:

1. Actual receipt- involves actual physical taking

of income.
2. Constructive receipt- no actual physical taking
of income.

The inflow of wealth to a person that does not

increase his net worth is not income due to the total
absence of benefit.

Example:

1. Receipt of property in trust.

2. Borrowing of money under an obligation to
return.

An item of gross income is not exempted by the

Constitution, laws, contracts, or treaties.

The items of income that are exempted by law from

taxation are:

• Income of qualified employee trust fund

• SSS, GSIS, Pag-ibig, or PhilHealth benefits.
• Salaries or wages of minimum earners and
qualified senior citizens.
• Regular income of Barangay Micro-business
Enterprises.
 • Income of foreign government and foreign
government-owned and controlled
corporations.
• Income of international missions and
organizations with income tax immunity.

2. The types of income taxpayers

A. Individuals

1. Citizen
2. Alien

B. Corporations

1. Domestic
2. Foreign

Individual Income taxpayers

1. Citizens

Based on the 1987 Constitution, citizens are:

a) Those who are citizen of the Philippines at the

time of adoption of the Constitution on
February 2, 1987.
b) Those whose fathers or mothers 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.

Classifications of citizen:

a. Resident citizen
 A citizen of the Philippines who establishes to
the satisfaction of the Commissioner the fact of
his physical presence in the Philippines with a
definite intention to reside therein.

b. Non-resident citizen

(1) A citizen of the Philippines who establishes

to the satisfaction of the Commissioner the
fact of his physical presence abroad with a
definite intention to reside therein.
(2) A citizen of the Philippines who leaves the
Philippines during the taxable year to reside
abroad, either as an immigrant or for
employment on a permanent basis.
(3) 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.
(4) A citizen who has been previously
considered as nonresident 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
a nonresident 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.
(5) The taxpayer shall submit proof to the
Commissioner to show his intention of
leaving the Philippines to reside
permanently abroad or to return to and
reside in the Philippines as the case may be
for purpose of this Section.

Classifications of alien:
 a. Resident alien – an individual who is residing
in the Philippines but is not a citizen.

b. Non-resident alien – an individual who is not

residing in the Philippines and is not a citizen.

• Nonresident Alien Engaged in trade or

Business Within the Philippines -
nonresident alien individual who shall
come to the Philippines and stay therein
for an aggregate period of more than one
hundred eighty (180) days during any
calendar year shall be deemed a
'nonresident alien doing business in the
Philippines'.
• Nonresident Alien Not Engaged in
trade or Business Within the
Philippines - nonresident alien
individual who shall come to the
Philippines and stay therein for an
aggregate period of one hundred eighty
(180) days or less during any calendar
year.

Aliens subject to special income tax rates

1. Alien Individual Employed by Regional or Area

Headquarters and Regional Operating
Headquarters of Multinational Companies.
2. Alien Individual Employed by Offshore Banking
Units.
3. Alien Individual Employed by Petroleum
Service Contractor and Subcontractor.

The general classification rule for individuals

• Intention- the intention of the taxpayer regarding

the nature of his stay within or outside the
Philippines shall determine appropriate residency
classification. Example an alien with a tourist visa
 would still be classified as non-resident alien, and
a citizen who would go abroad under a tourist visa
would still be considered a resident citizen.

• Length of stay- citizens staying abroad for a

period of at least 183 days are considered non-
resident, while aliens who are staying in the
Philippines for not more than one year but more
than 180 days are deemed non-resident aliens
engaged in business.

Taxable estates and trusts

• Estate - is properties, rights, and obligations of a

deceased person not extinguished by his death.
The income of the estate under extrajudicial
settlement is taxable to the heirs.

• Trust - a trust that is irrevocably designated by the

grantor is treated in taxation as if it is an individual
taxpayer. The income of the properties held in
trust is taxable to the trust. Trusts that are
designated as revocable by the grantor are not
taxable entities and are not considered as
individual taxpayers.

Corporate income taxpayers

A. Domestic corporation - corporations organized

in accordance with Philippine laws.

B. Foreign corporations - one organized under a

foreign law.

• Resident foreign corporation applies

to a foreign corporation engaged in trade
or business within the Philippines.
• Nonresident foreign corporation
applies to a foreign corporation not
 engaged in trade or business within the
Philippines.

Nonresident foreign corporations

subject to special tax rates

1. Nonresident Cinematographic Film

Owner, Lessor or Distributor.
2. Nonresident Owner or Lessor of Vessels
Chartered by Philippine Nationals.
3. Nonresident Owner or Lessor of Aircraft,
Machineries and Other Equipment.

C. Special corporations - are domestic or foreign

corporations which are subject to special tax
rules.

D. Other corporate taxpayers such as partnership,

joint venture, and co-ownership.

The residency and citizenship rule

Taxpayers who are residents and citizens of the

Philippines such as resident citizen and domestic
corporations are taxable on all income from sources
within and without the Philippines.

Basis of the extraterritorial taxation

The extra-territorial tax treatment of resident citizens

and domestic corporations is also intended as a
safety net to the potential loss of revenues brought
by situs relocation or the practice of executing or
structuring transactions such that income will be
realized abroad to avoid Philippine income taxes.

The issue of international double taxation

The rule on extra-territorial taxation on resident

citizens and domestic corporations exposes them to
double taxation; however, the NIRC allows tax credit
for taxes paid in foreign countries.

3. The general rules in income taxation

SEC. 23. General Principles of Income Taxation

in the Philippines. - Except when otherwise
provided in this Code:
(A) A citizen of the Philippines residing therein is
taxable on all income derived from sources
within and without the Philippines;
(B) A nonresident citizen is taxable only on income
derived from sources within the Philippines;
(C) An individual citizen of the Philippines who is
working and deriving income from abroad as an
overseas contract worker is taxable only on
income derived from sources within the
Philippines: Provided, That a seaman who is a
citizen of the Philippines and who receives
compensation for services rendered abroad as
a member of the complement of a vessel
engaged exclusively in international trade shall
be treated as an overseas contract worker;
(D) An alien individual, whether a resident or not of
the Philippines, is taxable only on income
derived from sources within the Philippines;
(E) A domestic corporation is taxable on all income
derived from sources within and without the
Philippines; and
(F) A foreign corporation, whether engaged or not
in trade or business in the Philippines, is
taxable only on income derived from sources
within the Philippines.

4. The rules on situs of income tax

Situs Of income

Situs of income is the place of taxation of income.

Situs of income should be differentiated from the
source of income. Source of income pertains to the
activity or property that produces the income.

Income Situs Rules in the Philippines

1. Interest Income – Debtor’s residence

2. Royalties – Where the intangible is employed
3. Rent Income – Location of the property
4. Service Income – Where the service is
rendered.
5. Gains on sale of real property– Location of
property sold.
6. Gains on sale of personal property –
a. Dividend Income
• Domestic Corporation – earned within
• Foreign Corporation – based on pre-
dominance test.

Pre-dominance test – if 50% or more

of the gross income of the corporation
for three-year period preceding the
declaration of the dividend is derived
from sources within the Philippines –
situs of income is in the Philippines,
otherwise, the situs is outside the
Philippines.
b. Merchandising income – situs of income
is the place where the property was sold.
c. Manufacturing income – situs of income
is the place where the goods is
manufactured and sold.

Production Distribution Situs

Within Within Total Income
Within
Without Without Total Income
Without
Within Without Production Income
is earned within
 Distribution
Income is earned
without
Without Within Production Income
is earned without
Distribution
Income is earned
within

7. Gain from sale of stocks of domestic

corporation – situs of gain is within the
Philippines.

B. Income Tax Schemes, accounting periods,

accounting methods, and reporting

1. Types and scopes of income taxation

schemes

There are three income taxation schemes

under the NIRC:

A. Final Income taxation

B. Capital gains taxation
C. Regular income taxation

MUTUALLY EXCLUSIVE COVERAGE

The tax schemes are mutually exclusive.

An item of gross income that is subject tax
in one scheme will not be taxed by the other
schemes. Similarly, items income that are
exempted in ore scheme are not taxable by
the other schemes.

CLASSIFICATION OF ITEMS OF GROSS

INCOME
Because of the different tax schemes, items
of gross income can be classified as
follows:

a. Gross income subject to final tax

b. Gross income subject to capital gains tax
c. Gross income subject to regular tax

FINAL INCOME TAXATION

Final income taxation is characterized by

final taxes wherein full taxes are withheld by
the income payor at source. The recipient
income taxpayer receives the income net of
taxes.

The payor is the one required by law to remit

the tax to the government consequently, the
recipient income taxpayer does not need to
the income tax returns because the withheld
tax constitutes the full tax due and are
therefore deemed final payments.

This system of taxation is referred to as the

final withholding tax system. Final taxation is
applicable only on certain passive income
listed by the law. Not all items passive
income is subject to final tax

PASSIVE INCOME VS ACTIVE INCOME

Passive incomes are earned with very

minimal or even without active involvement
of the taxpayer in the earning process

Examples of passive income:

1. Interest income from banks

2. Dividends from domestic corporations
3. Royalties
Active or regular income arises from
transactions requiring a considerable
degree of effort or undertaking from the
taxpayer. It is the direct opposite of passive
income.

Examples of active income:

1. Compensation Income
2. Business income
3. Professional income

CAPITAL GAINS TAXATION

Capital gains tax is imposed on the gain

realized on the sale, exchange dispositions
of certain capital assets.

Capital assets are assets not used in

business, trade or profession and are the
opposites of ordinary assets.

Ordinary assets are assets used in trade or

profession such as inventory, supplies or
property, plant and equipment.

Also, not all capital gains are subject to

capital gains tax. Most of them are subject
to regular income tax.

REGULAR INCOME TAXATION

The regular income tax is the general rule in

income taxation and covers all or income
such as:

1. Active income
2. Other income
a. Gains from dealings in properties, not
subject to capital gains tax
 b. Other passive income not subject to
final tax

2. Concept of the accounting period and its

types

ACCOUNTING PERIOD

Accounting period is the length of time over

which income reported measured and
reported.

Types of Accounting Periods

1. Regular accounting period 12 months

in length
a. Calendar
b. Fiscal
2. Short accounting period- less than 12
months

CALENDAR YEAR

The calendar accounting period starts from

January 1 and ends December 31. This
accounting period is available to both
corporate taxpayers and individual
taxpayers.
Under the NIRC, the calendar year shall
be used when the:

1. taxpayer's annual accounting period is

other than a fiscal year (i.e. longer than
12 months in length)
2. taxpayer has no annual accounting
period (ie. less than 12 months in length)
3. taxpayer does not keep books
4. taxpayer is an individual
FISCAL YEAR

A fiscal accounting period is any 12-month

period that ends on any day other than
December 31. The fiscal accounting period
is available only to corporate income
taxpayers and is not allowed to individual
income taxpayers.

DEADLINE OF FILING THE INCOME TAX

RETURN

Under the NIRC, the return is due for filing

on the fifteenth day of the fourth month
following the close of the taxable year of the
taxpayer. The regular tax due is payable
upon filing of the income tax return.

ILLUSRATION: Due date of the annual

income return.

1. Taxpayers under the calendar year must

file their annual income tax return for the
current period not later than April 15 of
the following year.
2. A corporate taxpayer with fiscal year
ending June 30, 2019 must file its annual
income tax return not later than October
15, 2019

INSTANCES OF SHORT ACCOUNTING

PERIOD

1. Newly commenced business- The

accounting period covers the date of the
start of the business until the designated
year-end of the business.

Illustration:
 Palawan Inc. started business
operation on June 30, 2019 and opted
to use the calendar year accounting
period. Palawan should file its first
income tax return covering June 30 to
December 31, 2019 for the year 2019.
The return must be filed on or before
April 15, 2020.

2. Dissolution of business- The

accounting period covers the start of the
current year to the date of dissolution of
the business.

Illustration:
Tawi-tawi Inc. is on a fiscal year
accounting period ending every March
31. It ceased business operation on
August 15, 2019.
Tawi-tawi should file its last income tax
return covering April 1 to August 15,
2019.

3. Change of accounting period by

corporate taxpayers - If a taxpayer,
other than an individual, with the
approval of the Commissioner, changes
the basis of computing net income from
fiscal year to calendar year, a separate
final or adjustment return shall be made
for the period between the close of the
last fiscal year for which return was
made and the following December 31. If
the change is from calendar year to
fiscal year, a separate final or
adjustment return shall be made for the
period between the close of the last
calendar year for which return was
made and the date designated as the
close of the fiscal year. If the change is
 from one fiscal year to another fiscal
year, a separate final or adjustment
return shall be made for the period
between the close of the former fiscal
year and the date designated as the
close of the new fiscal year.

Illustration
Effective February 2019, Sulu
Corporation changed its calendar year
period to a fiscal year ending every June
30.
Sulu Corporation shall file on
adjustment return covering the income
from January to June 30, 2019 on or
before October 15 2019.

4. Death of the taxpayer- The accounting

period covers the start of the calendar
year until the death of the taxpayer.

Illustration
Mr. Jacob died on November 2,
2019. The heirs of Mr. Jacob or his
estate administrators or executors shall
file his last income tox return covering
his income from January 1 to November
2, 2019. There is no requirement for
early filing in case of death of taxpayers.
Hence, the income tax return shall be
filed on or before the usual deadline,
April 15, 2020.

5. Termination of the accounting period

of the taxpayer by the Commissioner
of Internal Revenue -The accounting
period covers the start of the current
year until the date of the termination of
the accounting period.
 Illustration
The accounting period of a
taxpayer under the calendar year basis
was terminated by the CIR on August 2,
2019. The taxpayer must file an income
tax return covering January 1 to August
2, 2019. The income tax return and the
tax shall be due and payable
immediately.

3. Concept of accounting methods and their

accounting procedures

TYPES OF ACCOUNTING METHODS

1. The general methods

a. Accrual basis
b. Cash basis
2. Installment and deferred payment
method
3. Percentage of completion method
4. Outright and spread-out method
5. Crop year basis

TAX AND ACCOUNTING CONCEPTS TO

ACCRUAL BASIS AND CASH BASIS
DISTINGUISHED

1. Advances income is taxable upon

receipt
2. Prepaid expense is non- deductible
3. Special tax accounting requirement
must be followed

TAX ACCRUAL BASIS INCOME IS

DETERMINED AS FOLLOWS:

Cash Income XXX,[Link]

Accrued (uncollected) income XXX,[Link]
Gross Income XXX,[Link]
 The tax accrual basis expense is determined
as follows:
Cash expense XXX,[Link]
Accrued (unpaid expenses) XXX,[Link]
Amortization of prepayments
and depreciation of capital
expenditures XXX,[Link]
Deductions XXX,[Link]

The tax cash basis income is determined as

follows:
Cash income XXX,[Link]
Advanced income XXX,[Link]
Gross Income XXX,[Link]

The tax cash basis expense is determined as

follows:
Cash expenses XXX,[Link]
Amortization of prepayments
and depreciation of capital
expenditures XXX,[Link]
Deductions XXX,[Link]

HYBRID BASIS

The hybrid basis is any combination of accrual basis,

cash basis and or other methods of accounting. It is
used when the taxpayer has several businesses
which employ different accounting methods.

Illustration:
Mr. Roxas has two proprietorship businesses:
a service business which uses cash basis and a
trading business which uses accrual basis. The gross
income as determined by cash basis in the service
business and the gross income as determined by the
accrual basis in the trading business are simply
combined There is no requirement to measure the
income of different businesses under a single
accounting method.

SALE OF GOODS WITH EXTENDED PAYMENT

TERMS

The sale of goods with extended payment terms may

be reported using the accrual basis, installment
method, or deferred payment method.

INSTALLMENT METHOD

Under the installment method. gross income is

recognized and reported in proportion to the
collection from the installment sales.
Installment method is available to the following
taxpayers:

1. Dealers of personal property on the sale of

properties they regularly sell
2. Dealers of real properties, only if their initial
payment does not exceed 25% of the selling
price
3. Casual sale of non-dealers in property, real or
personal, when their selling price exceeds
P1,000 and their initial payment does not
exceed 25% of the selling price.

INITIAL PAYMENT

Initial payment means total payments by the buyer,

in cash or property, in the taxable year the sale was
made. The term initial payment is broader than down
payment It also includes the installment payments in
the year of sale.

SELLING PRICE
Selling price means the entire amount for which the
buyer is obligated to the seller. It is computed as
follows:

Cash received and/or receivable XXX,XXX

Fair market value of property XXX,XXX
received/receivable
Mortgage or any indebtedness
assumed by the buyer XXX,XXX
Selling price XXX,XXX

CONTRACT PRICE

The contract price is the amount receivable in

cash or other property from the buyer. It is usually the
selling price in the absence of an agreement whereby
the debtor assumes indebtedness on the property.

DEFERRED PAYMENT METHOD

The deferred payment method is a variant of the

accrual basis and is used in reporting income when
a non-interest-bearing note is received as
consideration in a sale.

THE PERCENTAGE OF COMPLETION METHOD

FOR CONSTRUCTION CONTRACTS

Under the percentage of completion method, the

estimated gross completion from construction is
reported based on the percentage of completion of
the construction project.
There are several methods of estimating project
completion in practice, but the output method based
on engineering survey is prescribed by the NIRC.

INCOME FROM LEASEHOLD IMPROVEMENT

Leasehold improvements are tangible

improvements made by the lessee to the property of
the lessor. Improvements will benefit the lessor when
their useful life extends beyond the lease term. This
benefit is referred to as income from leasehold
improvement.

Under Revenue Regulations No. 2, the income

from leasehold improvement can be reported using
either of the two methods at the option of the
taxpayer:

1. Outright method
2. Spread-out method

OUTRIGHT METHOD

The lessor may report as income the fair market

value of such buildings or improvements subject to
the lease at the time when such buildings or
improvements are completed.

SPREAD-OUT METHOD

The lessor may spread over the life of the lease the
estimated depreciated value of such buildings or
improvements at the termination of the lease and
report as income for each year of the lease an aliquot
part thereof.

AGRICULTURAL OR FARMING INCOME

Farming income is commonly measured using the

cash basis or accrual basis, such as in the following:

a. Animal husbandry
b. Short- term crops

The accounting for long term crops depends on the

harvesting frequency:
 a. Perennial crops- those that yield harvest
through years.
b. One-time crops- those that are harvested once
after several years.

CROP YEAR BASIS

Under the crop year basis, farming income is

recognized as the difference between the proceeds
of harvest and expenses of the particular crop
harvested. The expenses of each crop are
accumulated and deducted upon the harvest of the
crop.

4. Types of tax returns, their deadlines and

place of filing

TYPES OF RETURNS TO THE GOVERNMENT

1. Income tax returns - provides details of the

taxpayer's income, expense, tax due and tax
due, tax credit and tax still due the government
2. Withholding tax returns - provides reports of
income payments subjected to withholding tax
by the taxpayer-withholding agent
3. Information returns

MODE OF FILING INCOME TAX RETURNS

1. Manual Filing System

2. e-BIR Forms
3. Electronic Filing and Payment System (eFPS)

PAYMENT OF INCOME TAXES

The general rule is "pay as you file”. The capital gains

tax and regular income tax are paid as the taxpayer
files his return. Installment payment of income taxi
allowed on certain conditions.
Taxpayers under the EFPS system shall e-pay their
tax online through internet banking service. The
account of the taxpayer will be auto-debited for the
amount of taxes to be paid.

BASIC COMPARISON OF FILING AND PAYMENT

SYSTEMS

e-BIR
Manual eFPS
Forms
Data entry Manual Electronic Electronic
Filing/Submission Manual Electronic Electronic
Tax payment Manual Manual Electronic

PENALTIES FOR LATE FILING OR

PAYMENT OF TAX

1. Surcharge

a. 25% of the basic tax for failure to file or pay

deficiency tax on time
b. 50% for willful neglect to file and pay taxes

The non-filing is considered ‘willful neglect” if the BIR

discovered the non-filing first. This is the case when
the taxpayer received a notice from the BIR to file
return prior to his actual fling. If the taxpayer filed a
return before the receipt of such notice, the same is
considered simple neglect subject to the 25%
surcharge.

2. Interest- Double of the legal interest rate for loans

or forbearance of any money in the absence of
any express stipulation.

Since the legal interest is currently set at 6%.

the interest penalty is therefore 12% per annum
effective January 1, 2018. Note that NIRC imposed
an interest penalty of 20% per annum until December
31, 2017.

Under the new rules established by RR21-

2018, the interest period shall be computed based on
actual days divided 365 days. The additional day in
February during a leap year will be counted. The
yearly-monthly-daily counting method established in
prior regulations is already abandoned.

A month normally have 30 days. The best way

to put this in mind is that 31-day and 30-day months
are alternating from January to July, but the
sequence is reset in August. Also put in mind that
February is a 28-day month, except on a leap year.

3. Compromise penalty- Compromise penalty is an

amount paid in lieu of criminal prosecution over a
tax violation.

Exceeds But not exceed Compromise is

₱20,000.00 ₱50,000.00 ₱10,000.00
50,000.00 100,000.00 15,000.00
100,000.00 500,000.00 20,000.00