INCOME TAXATION

RECONCILIATION OF FINANCIAL INCOME AND TAXABLE INCOME

GAAP/PFRS NET INCOME xx
Concepts of Income xx(xx)
Concepts of Deduction xx(xx)
Income subject to Tax xx
Income subject to Final Tax (xx)
Income subject to CGT
TAXABLE INCOME
(xx) xx

Mid-Term Exam Coverage:

The Concepts of Income
A. The Gross Income Test
GROSS INCOME is any inflow of wealth to the taxpayer from whatever source that increases net worth
Elements of a Gross Income
1. It is return on capital – increases net worth
2. It is a realized benefit
 there must be an exchange transaction
 the transaction involves another entity
 it increases the net worth of the recipient
3. It is not exempted by law, contract, or treaty

GROSS INCOME TEST

Mr. Ocampo lists the following inflows as possible items of gross income:
Compensation income 200,000 onerous -
excha
Winings from gambling
Increase in value of investments 100,000 realized
Appreciation in the value of land owned 50,000 no party
Debt cancelled by creditors in consideration for services 300,000 involved
he rendered 150,000 onerous -
Debt cancelled by his creditor out of affection excha
Loan received from a bank
250,000 donation
400,000 offset effect of
n
How much is the gross income?
How much is the gross income? [200k+100k+150k = 450k]
Kinds of Taxpayers
Taxability of income earned from
Philippines Abroad
A. Individuals
Resident Citizen  
Non-resident Citizen 

Resident Alien 
Non-resident Alien
Engaged in trade or business 

Not engaged in trade or business  (FIT)

Taxable Estates 

Taxable Trusts 
B. Corporations
Domestic Corporation  
Foreign Corporation
Resident FC 

Non-resident FC 
 Residency Rules:
1. The intention of the taxpayer of his stay within or outside the Philippines shall determine his appropriate
residency classification
2. Length of stay
a) Citizens staying abroad for a period at least 183 days becomes a non-resident citizen.
b) Aliens who stayed in the Philippines for more than 1 year as of the end of the taxable year becomes
resident alien.
c) Aliens who stayed in the Philippines for not more than 1 year but more than 180 days are deemed
nonresident alien engaged in trade or business
d) Aliens who stayed in the Philippines for not more than 180 days are non-resident aliend not engaged
in trade or business.

B. Situs and Extent of Taxation

Types of Income Place of Taxation
1. Interest income debtor’s residence
2. Royalties where the intangibles is employed
3. Rent income location of the property
4. Service income place where the service is rendered
5. Gain on sale of properties
real property location of the property personal properties:
domestic stocks always w/n the Philippines
other personal properties where the property is sold
6. Dividend income from
Domestic Corporation earned within Philippines
Foreign Corporation
Resident FC subject to predominance test
Non-resident FC earned abroad

SITUS OF INCOME
A taxpayer had the following income:

Interest income from deposits in a foreign bank 300,000

Interest from domestic bonds 50,000
Royalties from books published in the Philippines 100,000 Rent
income from properties abroad, lease contract 150,000 is
executed in the Philippines
Professional fees for services rendered in the Philippines
400,000 to non-resident clients paid in US Dollars
Applying the situs rules, what income is earned within and outside?

TOTAL
Within Without
300,0
Interest income from deposits in a foreign bank 300,000 00
Interest from domestic bonds 50,000 50,000
Royalties from books published in the Philippines 100,000 100,000
150,0
00
Rent income from properties abroad 150,000
400,0
Professional fees for services rendered in the Philippines 400,000 00

TOTAL 550,000 450,000 1,000,000

PRE-DOMINANCE TEST
In 2021, Barbie received a P400,000 dividend income from Rich Corporation. The corporation
had the following gross income in 2018 through 2020:

2018 2019 2020 TOTAL

100,000 200,000 300,000 600,00
200,000 100,000 100,000 0
Philippines 400,00
Abroad 0
TOTAL 300,000 300,000 400,000 1,000,000
 How much is the dividend income earned within the Philippines under the following instances:

a. If Rich Corporation is a domestic corporation

b. If Rich Corporation is a non-resident foreign corporation
c. If Rich Corporation is a resident foreign corporation

a. If Rich Corporation is a domestic corporation

The entire P400,000 is earned within the Philippines

b. If Rich Corporation is a non-resident foreign corporation The entire P400,000 is earned abroad

c. If Rich Corporation is a resident foreign corporation

G.I ratio = 600/1000 = 60% Earned within Philippines
[400k x 60%] 240,000

Earned abroad [400k x 40%] 160,000

*Supposed that the ratio is only 49%, the entire P400,000 is deemed earned abroad.

C. Accounting Methods
Income Taxation Schemes under NIRC
 These tax schemes are mutually exclusive. Meaning, an item of gross income subjected any one of the
schemes will not be taxed by the other schemes. Likewise, if an item of gross income is exempted in one
scheme, are not taxed by the other schemes.
1. Final income taxation – G.I subject to final tax
• Applies only to certain passive income listed by law. Not all passive income are subject to final tax.
• Passive incomes are those earned with very minimal or even without active involvement of the
taxpayer in the earning process
• Examples: interest income from banks, dividend income from domestic corporations, royalties

2. Capital gains taxation – G.I subject to capital gains tax

• This is imposed on the gain realized on the sale, exchange and other dispositions of a certain capital
assets.
• Capital Assets are assets not used in business, trade or profession. Not all capital gains are subject to
capital gains tax.
• Only applies to (1) sale or disposition of domestic stocks directly to a buyer, and (2) sale of real
properties classified as capital assets

3. Regular income taxation – G.I subject to regular tax

• Covers all types of active income and other income not subjected to final tax and gains from dealings
of properties not subjected to capital gains tax.

Accounting Periods
Individual Corporations
a. Regular accounting period (12 months)
Calendar  
Fiscal  b.
Short accounting period (less than 12 months)  

Short accounting period may arise in the following instances:

a) newly commenced business d) change of accounting period by corporation
b) dissolution of business e) termination of an accounting period by the CIR c)
death of a taxpayer

Accounting Methods
a) Accrual and cash basis
 • Advanced income is taxable upon receipt – applies to sale of services only, not on goods  Prepaid
expenses is non-deductible

b) Installment and deferred payment method

• Gross income is recognized and reported in proportion to the collection from the installment sales 
This is available to the following taxpayers:
 dealers of personal property on the sale of properties they regularly sell
 dealers of real properties, only if their initial payment does not exceed 25% of the selling
price
 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
Wherein,
INITIAL PAYMENT means total payments made by the buyer, in cash or property, in the year of sale.
SELLING PRICE means the entire amount for which the buyer is obligated to pay
CONTRACT PRICE is usually the selling price in the absence of an agreement whereby the debtor
assumes indebtedness on the property

INSTALLMENT METHOD
Roxas Company, a car dealer, sold a machine with a tax basis of P1.2M on installment

in January 3, 2022. Roxas received a P200,000 cash downpayment and a P1.8M promissory
note for the balance payable in six months of P300,000 every July 3 and January 3
thereafter. Compute for the taxable income.

Under casual sales, because Roxas

Selling price [200k+1.8M] 2,000,0
00
800,0
Less: tax basis of machine sold 1,200,0
00
Gross profit 00

500,0
Initial payment
Gross [200k+300k]
income using 00
the installment basis: (Collection/Contract Price) x Gross Profit
Gross income ratio [500k/2M] 25% At
the date of sale [200k/2Mx800k] 80,000 Upon every
installment [300k/2Mx800k] 120,000

If Roxas is a dealer or machinery, it can avail of the installment method regardless of G.I
ratio so long as the selling price on the installment sale exceeds P1,000.

In January 3, 2021, Tagaytay Inc., a real property dealer, sold a lot costing P1.4M for P2M. The
lot was encumbered by a P1M mortgage which was assumed by the buyer. The buyer paid
P200,000 downpayment. The balance is due over four installments of P200,000 every July 3
and 2,000,000 Contract price [2M-1M] 1,000,0
1,400,000 Or alternatively computed as: 00
Selling price
Less: tax basis of lot sold
January 3. Compute for the taxable income for the year 2021.
Gross 600,000 Downpayment 200,00
Installment [200kx4] 0
profit
800,00
0

Initial payment [200k+200k] 400,000 Total 1,000,000

Gross income ratio 20%

Gross income using the installment basis: (Collection/Contract Price) x Gross Profit
At the date of sale [200k/1Mx600k] 120,000 Upon every
installment [200k/1Mx600k] 120,000

c) Percentage of completion
• The estimated gross income from construction is reported based on the percentage of completion of
the construction project
• Output method based on engineering survey is prescribed by the NIRC

d) Outright and spread-out method

 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.
Income from leasehold improvement can be reported either
a) Outright method – recognize in full the fair value of such building or improvements at the time it
is completed
b) Spread-out method – report as income the estimated depreciated value of the building or
improvement at the termination of the lease, spread-out over the lease term
LEASEHOLD IMPROVEMENTS
In January 1, 2021, Ivan leased a vacant lot to Greg under a 20-year lease contract. Greg
immediately constructed a building on the lot at a total cost of P4.5M. The building has a useful
life of 30 years. Compute for the leasehold improvement income under the following method: a.
Outright Method
b. Spread-out Method

a. Outright Method
--> Ivan shall recognize the entire P4.5M as gross income upon the completion of the
improvement

b. Spread-out Method

The depreciated value of the property at the termination of the lease becomes the value of the
years of usage of the lessor.

used by the lessee - 20 yrs used by the lessor - 10 yrs

0 10 20 30
(end of lease term) (useful life)
Therefore, annual leasehold income over the lease term is P75,000 [1.5M/20 years]
Cost allocation:
Lessee [20/30 x P4.5M] 3,000,000
1,500,000 depreciated value of the improvement at the termination
Lessor [10/30 x P4.5M]
4,500,000 of the lease becomes income by the lessor spread-out over
Total the lease term.

D. Accounting for Gains and Losses

Taxpayer’s properties can be:
a) Ordinary Assets – assets used in business
• Ordinary gains – arises from sale, exchange and disposition of ordinary sales
• Subject to regular income tax
• Ordinary gain is an item of gross income, ordinary loss is deduction of gross income
b) Capital Assets – any other assets other than ordinary assets
• Capital gains – arises from sale, exchange and disposition of capital assets
• Generally subject to regular income tax except for capital gains subject to CGT
• Capital gains other than subjected to CGT is an item of gross income, for capital loss it is simply ignored.
However, it can be recovered or deducted up to the extent of actual capital gain
 Net capital loss is subjected to holding period

MidTerm Exam Coverage:

Income Subject to Final Tax (Passive Income)
Features of Final Income Taxation:
• Tax withheld is FINAL. No more tax return required on the part of the payee
• Withheld at source by the payor
• Territorial imposition. Applies to passive income earned in the Philippines only.
• Imposed on certain passive income and persons not engaged in business in the Phils,

A. Interest Income from bank deposits

interest income or yield from local currency bank deposits, including deposit substitutes, trust funds, and
similar arrangements
 Individual Corporate
Local currency (₱) short term – less than 5 years 20% 20%
long term – 5 years or more exempt* RIT
* If a long term deposit is pre-terminated:
Placement period is less than 3 years 20%

3 years to less than 4 years 12%

4 years to less than 5 years 5%

Examples of long term deposits: investment certificates, time deposits, trust funds – these are
prescribed by the BSP and issued by banks only.

Note that NRFC is generally subject to 25% final tax.

Foreign currency ($) residents – 15%,

(FCDU, eFCDS) non-residents – exempt
 If a bank account is jointly in the name of a resident and non-resident taxpayer, 50% of the
interest shall be exempted while the other 50% shall be subjected to the 15% final tax

Example 1: A taxpayer earned the following interest income from various time deposits:
6-month time deposit P8,000
2-year time deposit 12,000
5-year time deposit 40,000
Required: Compute the final tax if the taxpayer is an individual and if a corporation.
Solution: Individual Corporation
6-month time deposit P8,000 1,600 1,600
2-year time deposit 12,000 2,400 2,400
5-year time deposit 40,000 exempt RIT
Final tax withheld 4,000 4,000

Example 2: A resident taxpayer received P16,000 interest income from a bank. Determine the final tax
withheld at source
P16,000 /80% P20,000
Final tax withheld [20k x 20%] P4,000
Example 3: Mr. Jose, OFW deposited all his savings under the FCDU of a domestic bank. During the month,
the savings deposit account earned $1,000 interest or P41,500. Compute the final tax under the following
instances:
a) Mr. Jose deposited his savings through the account of his resident wife. [41,500 x 15% = 6,225]
b) Mr. Jose deposited his savings through a joint account with his resident wife. [6,225x50%=3,112.5]
c) Mr. Jose deposited his savings through his own account. [exempt]

Interest income subject to regular tax:

1. lending activities
2. investments in corporate bonds
3. promissory notes
3. foreign sources, whether bank or non-bank
5. penalty for legal delay or default

B. Dividend Income
 these are distribution made by the corporation to its shareholders out of its earnings or profit, whether in
money or in kind

Types of Dividends
a. cash dividend – paid in cash
b. property dividends – paid in non-cash properties including stock dividends or securities of another corp.
c. scrip dividends – paid in notes or evidences of indebtedness of the corp
d. stock dividends – paid in stock of the corp
 e. liquidating dividends – distribution of corporate assets not taxable, they are not income for taxation
purposes

Source: Recipient
Individual Corp
Domestic corp 10% exempt (to minimize double taxation)
Foreign corp RIT RIT

Special rates for: NRA-ETB (20%), NRA-NETB (25%),

NRFC is not exempt, 25%, but when tax sparing rule applies, 15% Exempt
dividends:
• dividends from cooperatives
• qualified foreign-sourced dividends

Dividends or share in the net income of the following entities is subject to 10% final tax since they are
considered corporations under the NIRC:
 Real estate investment trusts
 business partnership
 taxable associations
 taxable joint ventures
 taxable co-ownerships

Example: Bayog Company, a domestic corporation, declared a total of P1M dividends in March 2021.
Recipients are the following:
Resident aliens and citizens 500,000

NRAs engaged in TB 100,000

NRAs not engaged in TB 50,000

Non-resident corporation 100,000

Total dividends 750,000

Required: Total final tax to be withheld.
Resident aliens and citizens 500,000 x 10% 50,000
NRAs engaged in TB 100,000 x 20% 20,000
NRAs not engaged in TB 50,000 x 25% 12,500
Non-resident corporation 100,000 x 25% 25,000
Total tax withheld 107,500
C. Royalties
 these are income received from licensing agreements to use the right of a certain technology or
trademark

w/ active involvement – subject to RIT

w/o active involvement: Individual Corp NRA-ETB,NETB,NRFC
books, literary works, and musical compositions 10% 20%
cinematography films, and others 20% 20% 25%
pertain to printed literatures. E-books are subject to 20% final tax

D. Prizes – element of effort

Exempt prizes
• prizes received by a recipient without any effort on his part to join a contest
Examples: Nobel Prize Award, Ramon Magsaysay Award
• prizes from sports competition that are sanctioned by their respective accredited national sports
organizations
Example: Phils. Olympic Committee
 Other forms of prizes other than an award or sports related prizes:
Individual Corp
Prizes exceeding P10,000 20% RIT
Prizes not exceeding P10,000 RIT RIT

E. Winnings – element of chances

Individual Corp.
PCSO winnings not exceeding P10,000 Exempt Exempt
PCSO winnings exceeding P10,000 20% 20%
Other winnings, in general 20% RIT
 PCSO winnings of NRA-NETBs and NRFC, regardless of the amount, are subject to 25% final
tax  PCSO winnings shall be applied on a per ticket basis

F. Informant’s Reward
cash reward given to any person instrumental in the discovery of violations of the NIRC or discovery and
seizure of smuggled goods.
 10% final tax of whichever is the lower of the following per case:
10% of revenues, surcharges, or fees recovered and or fine or penalty imposed and collected or
P1,000,000

Final Withholding Tax Reporting

Monthly Filing:
• BIR Form 0619-F [Monthly Remittance Return of Final Income Taxes Withheld] – shall be filed by the
agent or payor for the first two months of the quarter
• Deadline: Shall be filed and paid on or before the 10 th day of the month following the month in which
withholding was made

Quarterly Filing:
• BIR Form 1601-FQ [Quarterly Remittance Return of Final Income Taxes Withheld]
• Deadline: Shall be files and paid on or before the last day of the month following the month after each
quarter

Income Subject to Capital Gains Tax

A. Sale of domestic stocks directly to a buyer – 15%
Selling price xx
Less: Cost xx
Net Gain xx
x CGT Rate 15%
CGT xx

Selling price means:

• cash sale – total consideration received per deed of sale
• if partly paid in money and partly in property – sum of money and fair value of the property received 
exchanges – fair value of the property received

Cost or tax basis of stocks

• if acquired by purchase – cost of the property acquired
• by devise, bequest, or inheritance – fair value of the time of death of the decedent
• by gift – fair market value at the time of gift or cost of the donor, whichever is lower
 • inadequate consideration – amount paid by the transferee for the property  under tax-free
exchanges – substituted basis of the stocks

Cost of stocks also includes selling expenses, like commission expense and documentary stamp tax if
assumed by the seller. Documentary stamp tax is computed as: a. for par value shares - P1.50 for every
P200
b. no par value shares or stated value per shares – 25% of DST paid on the original issuance

Nature of 15% CGT

1. It is a universal tax – applies to all taxpayers disposing stocks classified as capital assets regardless of
classification of the taxpayer
By situs, the gain on sale of domestic stocks is within, even if the sale is executed outside the Philippines.
2. It is an annual tax – imposed on the annual net gain on the sale of domestic stocks directly to a buyer

Tax compliance:
1. Transactional capital gains tax – BIR Form 1707, within 30 days after each sale, exchange, and other
disposition 2. Annual capital gains tax – BIR Form 1707A, on or before 15th day of the fourth month following the
close of the taxable year of the taxpayer (Individual/calendar period: April 15, fiscal period: varies)

B. Gains arising from sale of capital assets

- these are gains arising from sale, exchange, and other disposition of real property capital assets in the
Philippines subject to 6% of the GSP or FMV, whichever is higher.
Under NIRC, the FMV of real property is whichever is higher of the Zonal Value prescribed by CIR and the
Assessed Value by the Office of the Assessor.

Nature of 6% CGT
1. It is presumptive capital gain – the tax applies even if the sale resulted to a loss. Gain is always presumed to
exist.
2. It does not consider the involuntariness of the sale – ex: foreclosure sales, dispositions by judicial order
3. It is a final tax – tax shall be withheld by the buyer against the selling price of the seller and remit the same to
the government

Alternative taxation – applies only to individual seller, and the buyer is the government, its instrumentalities or
agencies.
 an individual seller of real property capital assets has the option to be taxes at either:
a. 6% CGT or
b. regular IT

Exempt from the 6% CGT

1. Sale of land under the Comprehensive Agrarian Reform Program
2. Sale of socialized housing units by the National Housing Authority
3. Sale, exchange, and other disposition of a principal residence
RESIDENCE is the house and lot w/c is the primary domicile of the taxpayer. For taxpayers with multiple
residences, it is deemed the one that is shown in his latest tax declaration.
Requirements for the exemption:
1. The seller must be a citizen or resident alien
2. The sale involves the principal residence of the seller-taxpayer
3. The proceeds of the sale is fully utilized in acquiring a new principal residence
4. The BIR is notified by the taxpayer of his intention to avail the tax exemption within 30 days of the
sale
5. The reacquisition of the new residence must be within 18 months from the date of sale
6. The capital gain is held in escrow in favor of the government – released only to the taxpayer if
exemption qualifies
7. The exemption can only be availed once in every 10 years
*Sale of the principal residence must precede the acquisition of the new principal residence
 Basis of the new residence:
A. Proceeds fully utilized
Cost of the old residence xx
Add: Additional costs [actual costs – proceeds] xx
Basis of the new residence xx

B. Proceeds partially utilized – proportionate

Utilized proceeds x cost of the old residence
Total proceeds

- the unutilized proceeds is taxable

Tax compliance:
BIR Form 1706, within 30 days after each sale, exchange, and other disposition

Documentary stamp tax: P15 for every P1,000 on the GSP or FMV whichever is higher

Pre-Final Exam Coverage:

Regular Income Tax: The Gross Income
A. Inclusions
B. Exclusions
C. Fringe Benefit Tax
D. Dealings of Properties

The Concepts of Deductions and Expenses

A. Principles of Deductions
B. Deduction Limits
C. Deduction Incentives
D. NOLCO

Final Exam Coverage:

Regular Income Tax: Computation
A. Individuals
B. Corporations
C. Special Corporations
D. Tax Filing and Reporting