Module 1

Introduction to Taxation

Objectives:
1. Describe taxation, its theories and concepts.
2. Name and explain the inherent powers of the state.
3. Enumerate and explain the limitations on the power of taxation.
4. Identify and explain the situs of taxation.
5. Explain various related terms used in taxation.

A - What is Taxation?
Taxation is the process or means by which the sovereign, through its law-making body, raises revenues to defray the necessary
expenses of the government. Expressed in another way, it is a method of apportioning the cost of the government among those who in
some measure are privileged to enjoy its benefits, thus, must bear its burdens.
Taxation may also be defined as a state power, a legislative process, and a mode of government cost distribution.

1. As a state power, it is an inherent power of the state to enforce a proportional contribution from its subjects for public purposes.
2. As a process, it is a process of levying taxes by the legislature of the state to enforce proportional contributions from its subjects for
public purposes.
3. As a mode of cost distribution, it is a mode by which the state allocates its costs or burden to its subjects who are benefited by its
spending.

The theory of taxation

Every government provides a vast array of public services including defense, public order and safety, health, education, and social
protection among others. A system of government is indispensable to every society. Without it, people will not relish the benefits of a
civilized and orderly society. However, a government cannot exist without a system of funding. The government’s necessity for funding
is the so called “theory of taxation”. (Banggawan, Rex B., 2019)

Theories of cost allocation

1. Benefit received theory – presupposes that the more benefit one receives from the government, the more taxes he should pay.
2. Ability to pay theory – presupposes that taxation should also consider the taxpayer’s ability to pay. Taxpayers should be required to
contribute based on their relative capacity to sacrifice for the support of the government.

Taxes
Taxes are the enforced proportional contributions, generally payable in money, levied by the law-making body of the state by virtue of
its sovereignty upon persons or properties within its jurisdiction for the support of government and all its public needs.

B - Inherent Powers of the State

A government has its basic needs and rights which co-exist with its creation. It has rights to sustenance, protection, and properties.
The government sustains itself by the power of taxation, secures itself and the well-being of its people by police power, and secures its
own properties to carry out its public services by the power of eminent domain. These rights, dubbed as “powers” are natural,
inseparable, and inherent to every government. No government can sustain or effectively operate without these powers. Therefore,
the exercise of these powers by the government is presumed understood and
acknowledged by the people from the very moment they establish their government. These powers are naturally exercisable by the
government even in the absence of an express grant of power in the constitution. (Banggawan, Rex B., 2019).

The inherent powers of the state are the following:

1. Taxation power – is the power of the state to enforce proportional contribution from its subjects to sustain itself.
2. Police power – is the general power of the state to enact laws to protect the well-being of the public.
3. Eminent domain – is the power of the state to take private property for public use after paying just compensation.

Scope of the taxation power

The scope of taxation is widely regarded as comprehensive, plenary, unlimited and supreme. However, despite the seemingly
unlimited nature of taxation, it is not absolutely unlimited. Taxation has its own inherent limitations imposed by the constitution.

C - Limitations of the Taxation Power

1. Inherent limitations
a) Territoriality of taxation – public services are normally provided within the boundaries of the State, thus the government can only
demand tax obligations upon its subjects or residents within its territorial jurisdiction.
b) International comity – is the fundamental concept of co-equal sovereignty wherein all nations are deemed equal with one another
regardless of race, religion, culture, economic condition or military power.
c) Public purpose – the tax is intended for the common good.
d) Exemption of the government – the government normally does not tax itself as this will not raise additional funds but will only impute
additional costs.
e) Non-delegation of the taxing power – the legislative taxing power is vested exclusively in Congress and is non-delegable pursuant
to the doctrine of separation of the branches of the government except in some important cases.
2. Constitutional limitations
a) Due process of law – no one should be deprived of his life, liberty, or property without due process of law.
b) Equal protection of law – taxpayers should be treated equally both in terms of right conferred and obligations imposed.
c) Uniformity rule in taxation – the rule of taxation should be uniform and equitable.
d) Progressive system of taxation – the tax rates increase as tax base increases.
e) Non-imprisonment for non-payment of debt or poll tax – as a policy, no one shall be imprisoned because of his poverty, and no one
shall be imprisoned for mere inability to pay debt.
f) Non-impairment of obligation and contract – the State should not set aside its obligations from contracts by the exercise of its taxing
power. Tax exemptions granted under contract should be honored and should not be cancelled.
g) Free worship rule – the government adopts free exercise of religion and does not subject its exercise to taxation.
h) Exemption of religious, charitable or educational entities, non-profit cemeteries,
churches and mosque from property taxes – used exclusively for the purpose.
i) Non-appropriation of public funds or property for the benefit of any church, sect or
system of religion – this highlight the separation of religion and the State.
j) Exemption from taxes of the revenues and assets of non-profit, non-stock
educational institutions – this will include grants, endowments, donations, orcontributions for educational purposes.
k) Concurrence of a majority of all members of Congress for the passage of law
granting tax exemption – tax exemption must proceed only upon a valid basis.
l) Non-diversification of tax collections – should be used only for public purposes.
m) Non-impairment of the jurisdiction of the Supreme court to review tax cases-
n) The requirement that appropriations, revenue, or tariff bills shall originate
exclusively in the House of representatives –
o) The delegation of taxing power to local government units – to create its own
sources of revenues and have a just share in the national taxes.

D - Situs of Taxation
Situs is the place of taxation. It is the tax jurisdiction that has the power to levy taxes upon the tax object. Situs rules serves as frames
of reference in gauging whether the tax object is within or outside the tax jurisdiction of the taxing authority.

Examples of situs rules:

1. Business tax situs – Businesses are subject to tax in the place where the business is conducted.
Illustration:
A taxpayer is involved in car dealership abroad and restaurant operation in the Philippines.
Rule: The restaurant business will be subject to business tax in the Philippines since the business is conducted herein, while the car
dealing business is exempt because the business is conducted abroad.

2. Income tax situs on services – Service fees are subject to tax where they rendered.
Illustration:
A foreign corporation leases a residential space to a non-resident Filipino citizen abroad.
Rule: The rent income will exempt from Philippine taxation as the leasing service is rendered abroad.

3. Income tax situs on sale of goods – The gain on sale is subject to tax in the place of sale.
Illustration:
While in Japan, a non-resident OFW citizen agreed with Japanese friend to sell his diamond necklace to the latter. They stipulated that
the delivery of the item and the payment will be made a week later in the Philippines. The sale was consummated as agreed.
Rule : The contract of sale is consensual and is perfected by the meeting of minds of the contracting parties. The perfection of the
contract of sale is in Japan. The situs of taxation is Japan thus, the gain on sale of the necklace will be taxable abroad and exempt in
the Philippines.

4. Property tax situs – Properties are taxable in their location.

Illustration:
An overseas Filipino worker has a residential lot in the Philippines.
Rule: He will still pay real property tax despite his absence in the Philippines because his property is located in the Philippines.
5. Personal tax situs – Persons are taxable in their place of residence.
Illustration:
Gary Williams is an American studying laws in the Philippines.
Rule: Gary will pay personal tax in the Philippines even if he is an alien because he is residing in the Philippines.

E - Related Terms used in Taxation

Double Taxation
Double taxation occurs when the same taxpayer is taxed twice by the same tax jurisdiction for the same thing.

Elements of double taxation

1. Primary element - relates to same object.
2. Secondary elements:
a) Same type of tax
b) Same purpose of tax
c) Same taxing jurisdiction
d) Same tax period

Types of double taxation

1. Direct double taxation – this occurs when all the elements of double taxation exists for both impositions
Examples:
a) An income tax of 5% on monthly sales and a 2% income tax on annual sales.
b) A 4% tax on bank reserve deficiency and another 1% penalty per day as a consequence of such deficiency.

2. Indirect double taxation – this occurs when at least one of the secondary elements of double taxation is not common for both
impositions.
Examples:
a) The national government levies business tax on the sales or gross receipts of business while the local government levies business
tax upon the same sales or receipts.
b) The national government collects income tax from a taxpayer on his income while the local government collects community tax
upon the same income.
c) The Philippine government taxes foreign incomes of domestic corporations and resident citizens while a foreign government also
taxes the same income.

Escapes from Taxation

Escapes from taxation are the means available to the taxpayer to limit or even avoid
the impact of taxation.

Categories of escapes from taxation:

1. Those that result to loss of government revenue
a) Tax evasion – also known as tax dodging, which refers to any act or trick that tends to illegally reduce or avoid the payment of tax.
Examples:
1. Gross understatement of income, non-declaration of income, overstatement of expenses or tax credit.
2. Misrepresenting the nature or amount of transaction to take advantage of lower taxes.
b) Tax avoidance – also known as tax minimization, which refers to any act or trick that reduces or totally escapes taxes by any legally
permissible means.

Examples:
1. Selection and execution of transaction that would expose taxpayer to lower taxes.
2. Maximizing tax options, tax carry-overs or tax credits.
3. Careful tax planning.

c) Tax exemption – also known as tax holiday, which refers to the immunity, privilege or freedom from being subject to a tax which
others are subject to. It could be granted by Congress, law, or contract.

2. Those that do not result to loss of government revenue

a) Shifting – this is the process of transferring tax burden to other taxpayers.
Forms of shifting:
1. Forward shifting – this is a shifting of tax which follows the normal flow of distribution. (from manufacturer to
wholesalers; retailers to consumers)
2. Backward shifting – the reverse of forward shifting, which is common with non-essential commodities where buyers have
considerable market power and commodities with numerous substitute products.
3. Onward shifting – this refers to any tax shifting in the distribution channel that exhibits forward shifting or backward shifting. This is
common with business taxes where taxes imposed on business revenue can be shifted or passed-on
to the customers.
b) Capitalization – this pertains to the adjustment of the value of asset caused by changes in tax rates.
For instance, the value of mining property will correspondingly decrease when mining output is subjected to higher taxes.
c) Transformation – this pertains to the elimination of wastes or losses by the taxpayer to form savings to compensate for the tax
imposition or increase in taxes.

Tax Amnesty
Amnesty is a general pardon granted by the government for erring taxpayers to give them a chance to reform and enable them to
have a fresh start to be part of a society with a clean slate. It is an absolute forgiveness or waiver by the government on its right to
collect and is retrospective in application.

Tax Condonation
Tax condonation is forgiveness of the tax obligation of a certain taxpayer under certain justifiable grounds. This is also referred to a tax
remission. Because they deprive the government of revenues, tax exemption, tax refund, tax
amnesty and tax condonation are construed against the taxpayer and in favor of the Government.

Tax Amnesty vs. Tax Condonation

Amnesty covers both civil and criminal liabilities, but condonation covers only civil liabilities of the taxpayer.
Amnesty operates retrospectively by forgiving past violations while condonation applies prospectively to any unpaid balance of the tax;
hence, the portion already paid by the taxpayer will not be refunded.
Amnesty is also conditional upon the taxpayer paying the government a portion of the tax whereas condonation requires no payment.

Module 2
Concepts and Items of Income
Objectives:
1. Describe what an income is?
2. Explain the different sources of income.
3. Categorize and explain the different types of income.
4. Enumerate and explain the requisites of income to be taxable.
5. Name and explain the types of income taxpayers.

A - Definitions of Income
In a broad sense, income means all wealth that flows into the taxpayer other than as a return of capital. It includes the forms of income
specifically described as gains and profits including gains derived from the sale or other disposition of capital assets. For tax purposes,
income may also be defined as the amount of money coming to a person or corporation within a specified time, whether as payment
for services, interest, or profits from investment.
1. Under the Regulations, income means all wealth which flows into the taxpayer other than a mere return of capital.
2. It is also defined as money (or some equivalent value) that an individual or business receives in exchange for the providing a good
or service or through investing capital.
3. Income is used to fund day to day expenditures. Investments, pensions and Social Security are the primary sources of income for
retirees. Individual income is most often received in the form of salary. Business income can refer to a company’s remaining revenue
after paying all the expenses and taxes. In this case, income is referred to as “earnings”. Most form of income is subject to taxation.
4. Income refers to gain derived from capital or from labor or from both capital and labor including the gain derived from the sale or
exchanged of capital assets.
5. Income means amount of money coming to a person or corporation within a specified time, whether as payment for services,
interest of profit from investment.
6. Income also refers to money value of the net accretion to one’s economic power between two points of time.
7. Income cannot be determined by reckoning cash receipts, other income determining factors, inventories, accounts receivables,
property acquisition, and accounts payable for expenses incurred.

Income, Capital, Revenue, Receipts, Distinctions (as cited in Dimaampao, 2018)

Capital Income
Fund Flow
Wealth v. Service of wealth -Fruit
Tree (Property) (metaphorical language)

Gross receipts include receipts which may constitute capital as well as income, therefore, broader in scope. Income connotes
narrower concept limited only to gain derived from labour, capital or property, excluding non-income items such as capital invested,
cost of goods sold or those excluded by law from income taxation.
Revenue refers to all funds or income derived by the government whether from tax or other sources. Revenue is to the government as
income is to a private persons or corporations.

Distinctions between Income and other income

1. Capital is a fund or property existing at one distinct point of time. Income, on the other hand, denotes a flow of wealth during a
definite period of time. While capital is wealth, income is service of wealth.
2. Receipts have reference to all wealth that flows into the taxpayer which included return of capital. It is evident that “receipts” is
broader in scope than receipts.
3. Revenue, as applied in taxation, refers to all funds or income derived by the government, whether from tax or any other source.
Income for tax purposes is employed in its “natural and obvious sense” to mean money or gained received
coming to a person or corporation during a gross period of time. In time, revenue is to the government, as income is to a person or
corporation.

Forms of Income
1. That which is not income cannot be made taxable by calling it income, and income which is not the taxpayer’s, cannot be made
taxable to him by calling it his.
2. Income need not, be however be money or that which is convertible into money.
B - Sources of Income
The source of income is any property, activity or service that produced income. It may also be in the form of proceeds from sales of
goods or merchandise. Under the tax code, however, income derived from whatever source forms part of the taxpayer’s income. On
the other hand, when we talk about the place where income comes from, it will be a matter of whether it is derived within or outside the
Philippines.

The sources from which income is derived are the following:

1. Labor (Definitions, Labor Code of the Philippines)
a) Worker means member of the labor force, whether employed or unemployed. Thus, labor, in broad strokes, means the exertion of
human effort.
b) While manpower refers to the portion of the nation’s population which has actual or potential capability to contribute directly to the
production of goods and services.
c) Entrepreneurship means training for self-employment or assisting individual or small industries.

2. The use of capital.

Capital is the money or wealth used to produce goods and services. In basic terms capital refers to money.
3. Profits derived from the sale or exchanges of capital assets.
Profits refer to financial gain especially the difference between the buying, operating, or producing goods or rendering services. Under
the Tax Code, however, income derived from whatever source forms part of the taxpayer’s income.
This includes the following:
1. Treasure found or punitive damages representing profit lost.
2. Amount received by mistake.
3. Cancellation of the taxpayer’s indebtedness.
4. Payment of usurious interest.
5. Illegal gains – gambling, theft, embezzlement, extortion, fraud – income to embezzler
if forgiven by the owner.
6. Tax refund must be claimed as deduction from gross income in the preceding year. It means that the tax must be a deductible one.
7. Bad debt recovery must be claimed as deduction from gross income in the preceding year. It assumes that the taxpayer has a net
income not a net loss. Further, recovery of bad debt and tax refund finds a jurisprudential hook in Tax Benefit Rule. It is a rule which
limits the recognition of income from the recovery of an expense or loss properly deducted in a prior taxable year to the amount of the
deduction that generated a tax savings. Under the rule, if an amount deducted from gross income in a prior taxable year is recovered
in a later year, the recovery is income in the last year.

C - Categories of Income
1. Compensation Income – In general, the term “compensation” means all remunerations for services performed by an employee for
his employer under an employer-employee relationship. It includes salaries, wages, emoluments, honoraria,
bonuses, allowances (transportation, representation, etc.) and other fringe benefits.
2. Business Income Derived By Self-employed – Self-employed means a person engaged in trade or business or performs services
for others for a fee and who derived personal income from such activities. Self-employment income therefore, consists of earnings
derived by the individual from trade or business or from rendering services.
3. Professional Income Derived by Professionals – Professionals refer to persons who derived income from the practice of their
profession. The term includes lawyers, doctors, CPAs and other persons who are registered with the Professional Regulatory
Commission (PRC). It may also refer to one who pursues an art and makes a living there from, such as artists, athletes and others.
4. Passive Investment Income – It is an income that requires little to no effort to earn and maintain. It includes rentals, interest,
dividends, royalties, prizes, winnings, and partner’s share in the net income after tax of partnership, joint venture or consortium. As
with active income, passive income is also taxable and usually subjected to final tax rather than graduated tax.
5. Gains Derived from Dealings in Property – Sales or dealings in property, whether real or personal may result in gain or loss to the
taxpayer. The general rule is that the entire amount of gain or loss arising from the transaction shall be taxable or deductible as the
case may be.

D - Requisites of Income to be Taxable

1. There must be a gain or profit – Gain or profit is essential to the existence of taxable income. In other words,
there must be in fact an income.
2. The gain must be realized or received – Admittedly, not all economic gain is taxable income. Thus, a mere increase in
the value of property is not income but merely an unrealized increased in capital. The gain can only be taxed when a disposition or
sale of the property has occurred. In case of a service or trading activities, income is realized upon sale or rendering of service
although payment has not yet been received. In other words, the method of realizing income is under accrual basis of accounting.
Doctrine of Constructive Receipt of Income - Income which is credited to the account of and set apart for a taxpayer and which may be
drawn by him at any time is subject to tax for the year during which it was so credited or set apart although not yet then actually
received or reduced to his possession. To constitute receipt in such case, the income must be credited to the taxpayer without any
substantial limitation or condition upon which payment is to be made.
Examples of constructive receipts:
-Matured interest coupons due and demandable (convertible into cash);
-Share in the profits of a partner in a partnership;
-Interest credited on savings bank deposit
-Dividends applied by the corporation against the indebtedness of astockholder
-Rental payments refused by the lessor when the lessee tendered payment and the latter made a judicial deposit of the rental
-Amount credited to shareholders of a building and loan association when such credit passes without restriction to the shareholder.
3. The gain must not be excluded by law or treaty from taxation – There are incomes which under the law are excluded from taxation.
Some of them are Proceeds of life insurance, compensation for injuries, retirement benefits of
employees, etc.

Doctrines on Determination of Taxable Income

1. Claim of Right Doctrine- A taxable gain is conditioned upon the presence of a claim of right to the alleged gain and the absence of a
definite and unconditional obligation to return or repay (as cited in [Link]).
2. Severance Test Theory- Separation from capital of something which is of exchangeable value.
3. Control Test- Power to procure the payment of income and enjoy the benefit thereof.
4. Doctrine of Proprietary Interest- Treats stock options, shares of stocks or other assets transferred by an employer to an employee to
secure better service as taxable.
5. Realization Test- Revenue is generally recognized when the earning process is complete or virtually complete and exchange has
taken place.

Taxable Income Defined

Taxable income means the pertinent items of gross income specified in this Code, less the deductions and/or personal and additional
exemptions, if any, authorized for such types of income by this Code or other special laws (Chapter V Computation of Taxable Income,
Tax Code).

Situs of Income for Tax Purposes (as cited in Gargoles, 2011)

a) Situs of taxation means a place of taxation, the country that has the power and jurisdiction to levy and collect the tax.
b) The general rule is that the taxing power cannot go beyond the territorial limits of the taxing authority.
c) Basic rule is that the state where the subject to be taxed has a situs may rightfully levy and collect the tax, and the situs is
necessarily in the state which has jurisdiction or which exercises dominion over the subject in question.
d) Although there are situs rules that are generally recognized one may find differences in tax rules legislated in each taxing
jurisdiction. The taxable situs, as legislated, will depend upon various factors including the nature of the and the
nature thereof (which may be a person, property, act, or activity), the possible protection and benefit that may accrue both to the
government and the taxpayer, the residence or the citizenship of the taxpayer, and source of income.

The taxable situs will depend upon the nature of income, as follows:
1. Interest income is treated as income from within the Philippines if the debtor or lender, whether an individual or corporation, is a
resident of the Philippines
2. Dividends received from a domestic corporation are treated as income from sources within the Philippines. Dividends received from
a foreign corporation are treated as income from sources within the Philippines -- unless only 50% of the gross income of the foreign
corporation for the three-year period preceding the declaration of such dividends was derived from sources within the Philippines -- but
only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period derived from
sources within the Philippines against its gross income from all sources.
3. Services performed in the Philippines shall be treated as income from sources within the Philippines.
4. Rentals and royalties gain or income from property or interest located or used in the Philippines is treated as income from sources
within the Philippines.
5. Sale of real property gain from the sale of real property located within the Philippines is considered as income within the Philippines.
6. Sale of personal property gain, profit or income from sale of shares of stock of a domestic corporation is treated as being derived
entirely from sources within the Philippines, regardless of where the said shares are sold. Gains from sale of other personal property
can be considered income from within or without -- or partly within or partly without -- depending on the rules provided in Section 42 E
of the Tax Code.

Income tax, Basis, Nature, Functions, Etc. (as cited in Dimaampao, 2018)
1. It is a tax on all yearly profits arising from property, profession, trades or offices or as a tax on a person's income, emoluments,
profits and the like.
2. It is based on income, either gross or net, realized in one taxable year.
3. Excise tax is not levied upon the person or property but upon the right of a person to receive income or profits.
4. Functions of income tax:
a) to provide large amounts of revenues;
b) to offset regressive sales and consumption taxes;
c) to mitigate the evils arising from the inequalities in the distribution of income and wealth which are considered deterrents to social
progress, by a progressive scheme of taxation.
5. The basis of the right of the government to tax income emanates from its partnership in the production of income by providing the
protection, resources, incentive and proper climate for such production. This is called the Partnership Theory which has spawned the
following principles:
a) Protection theory. It dictates that when the flow of wealth proceeded from, and occurred within, Philippine territory, enjoying the
protection accorded by the Philippine government, the same, in consideration of such protection should share the burden of
supporting the government.
b) Theory of favourable business climate. Domestic corporations owe their corporate existence and privilege to do business to the
government. They also benefit from the efforts of the government to improve the financial market and to ensure a favourable business
climate. It is therefore fair for the government to require them to make a reasonable contribution to the public expenses.

Taxpayer, taxable year, and fiscal year (National Tax Research Center)
1. Taxpayer means any person subject to tax imposed under the law.
2. Taxable year means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income
is computed. The accounting period starts on January and ends on December.
3. Fiscal year means an accounting period of twelve (12) months ending on the last day of any month other than December.
Types of income Taxpayers
1. Resident citizens (RC) – Citizens of the Philippines who are residing therein. They are taxed on income derived within and outside
the Philippines using graduated rates for taxable income.
2. Non-resident citizens (NRC) – Citizens of the Philippines who are residing in other country. They are taxed on income derived within
the Philippines using graduated rates for taxable income.
3. Resident aliens (RA) – Non-citizens or foreigners who are residing in the Philippines. They are taxed on income derived within the
Philippines using graduated rates for taxable income.
4. Non-resident aliens engaged in trade or business in the Philippines (NRA-ETB) – Neither citizens nor resident foreigners who come
and stay in the Philippines for an aggregate period of more than 180 days during the calendar period to attend to their business. They
are taxed on income derived within the Philippines using graduated rates for taxable income.
5. Non-resident aliens not engaged in trade or business in the Philippines (NRA-NETB) –Neither citizens nor resident foreigners who
are not engaged in trade and business in the Philippines. Generally, they are taxed on gross income derived within the Philippines at
the rate of 25%.
6. Domestic corporations (DC) – corporations formed or organized under the laws of the Philippines. They are taxable on all income
derived from sources within and outside the Philippines.
7. Foreign corporations (FC) – corporations formed or organized under the laws of other country. They are taxable on all income
derived within the Philippines.
8. Taxable Estates and Trusts (ET) – Estate refers to the properties, rights and obligations of a deceased person not extinguished by
his death. Estates under judicial settlement are treated as individual taxpayers. The estate is taxable on the income of the properties
left by the decedent. Estates under extrajudicial settlement are exempt entities. The income of the properties of the estate is taxable to
the heirs.
Trust refers to an arrangement whereby one person (grantor or trustor) transfers property to another person (beneficiary), which will
be held under the management of a third party (trustee or fiduciary). A trust that is irrevocably designated by the grantor is treated in
taxation as if it is an individual taxpayer. The income of the property 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. The income of the properties held
under revocable trusts is taxable to the grantor not to the trust. When the trust agreement is silent as to revocability of the trust, it is
presumed to be revocable.

Module 3
Gross Income
Objectives:
1. Describe what a gross income is?
2. State and explain the characteristics of gross income
3. Name and explain the sources or items of gross income
4. Identify the exclusions from gross income.

A - What is Gross Income?

The tax concept of income is simply referred to “gross income” under the NIRC. A taxable item of gross income is referred to as “items
of gross income” or “inclusion in gross income”.
Gross income is broadly defined as any inflow of wealth to the taxpayer from whatever source, legal or illegal, that increases net
worth. It includes income from employment, trade business or exercise of profession, income from properties and other sources such
as dealings in properties and other regular or casual transactions.

Chapter IV of Tax Code on Corporations States

a) The term gross income derived from business shall be equivalent to gross sales less sales returns, discounts and allowances and
cost of goods sold. Cost of goods sold shall include all business expenses directly incurred to produce the
merchandise to bring them to their present location and use.
b) For a trading or merchandising concern, cost of goods sold shall include the invoice cost of the goods sold, plus import duties,
freight in transporting the goods to the place where the goods are actually sold, including insurance while the
goods are in transit.
c) For a manufacturing concern, cost of goods manufactured and sold shall include all costs of production of finished goods, such as
raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the
raw materials to the factory or warehouse.
d) In the case of taxpayers engaged in the sale of service, gross income means gross
receipts less sales returns, allowances and discounts.

B - Characteristics of Gross Income

1. It is a return on capital that increases net worth.
2. It is a realized benefit.
3. It is not exempted by law, contract, or treaty.

Return on capital VS. Return of capital

Capital means any wealth or property. Gross income is a return on wealth or property that increases the taxpayer’s net worth.
Example:
XYZ purchased merchandise worth Ᵽ10,000 and then sold at Ᵽ15,000. The Ᵽ15,000 consideration can be analyzed as follows:
 Sale’s amount ( total consideration Ᵽ 15,000 Total return
received)

Cost (value of inventory forgone) 10,000 Return of capital

Mark-up (gross income) Ᵽ 5,000 Return on capital

The “return on capital” that increases net worth is income subject to income tax. “Return of capital” merely maintains net worth; hence,
it is not taxable. An improvement in net worth indicates the ability to pay tax. (Banggawan, Rex B., 2019)
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:
1. Life – the value of life is immeasurable by money. Under Sec 32 of the NIRC, the proceeds of life policies paid to the heirs or
beneficiaries upon death of the insured, whether in a single sum or otherwise, are exempt from income tax. However, any excess
amount received over premiums paid by the insured or collected by the employer as a beneficiary are taxable return on capital.
2. 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.
3. Human reputation – the value of one’s reputation cannot be measured financially. Any indemnity received as compensation for its
impairment is deemed a return of capital and therefore exempt from tax. (ea. oral defamation or slander; alienation of affection or
breach of promise to marry).
The loss of capital results in decrease in net worth while the loss of profits does not decrease net worth. The recovery of lost capital
merely maintains net worth while the recovery of lost profits increases net worth. Therefore, the recovery of lost profits is a return on
capital. (Banggawan, Rex B., 2019).

Examples of taxable recovery of lost profits:

1. Proceeds of crop or livestock insurance
2. Guarantee payments
3. Indemnity received from patent infringement suit

Realized benefit
The term “benefit” means any form of advantage derived by the taxpayer. There is benefit when there is an increase in the net worth of
the taxpayer. An increase in net worth occurs when one receives income, donation or inheritance. The term “realized” means earned.
It requires that there is a degree of undertaking or sacrifice from the taxpayer to be entitled of the benefit.

Requisites of realized benefit

1. There must be n exchange of transactions.
2. The transactions involved another entity.
3. It increases the net worth of the recipient.

Types of transfers
1. Bilateral transfer or exchanges. (onerous transactions)
a) Sale
b) Barter
2. Unilateral transfers. (gratuitous transactions)
a) Succession – transfer of property upon death
b) Donation

C - Sources of Gross Income

In a broad sense, gross income means all items of income before exclusions, deductions, exemptions or other tax reductions. Stated
in a narrow sense, gross income means all income derived from whatever source, including but not limited to the following: (Sec. 23 of
NIRC of 1997) ([Link]
1. Compensation for services in whatever form paid including but not limited to fees, salaries, wages, commissions and similar items.
2. Gross income derived from the conduct of business or the exercise of profession.
3. Gains derived from dealings in property. (subject to 6% capital gains tax if land or building is not used in business).
4. Interests (generally subject to 20% final withholding tax)
5. Rents
6. Royalties (generally subject to 20% final withholding tax; 10% for books and literary / musical compositions)
7. Dividends (generally subject to 10% final withholding tax for individuals, tax exempt for corporation. If distributed by foreign
corporation, subject to regular income tax)
8. Annuities
9. Prizes and winnings – (over P10,000 subject to 20% withholding tax. Tax exempt in case of PCSO and Lotto winnings of P10,000
and below and graduated tax, if it is in the case of prizes).
10. Pensions
11. Partner’s distributive share from the net income of the general professional
partnership.
GENERAL FORMULA
(1) Gross Income All income less exclusions.
(2) Net or Taxable Income Gross income less allowable deductions.
(3) Taxable Compensation Income Gross compensation less personal and additional exemptions.
(4) Income Tax Due Taxable or net income multiplied by income tax rate.
(5) Income Tax Payable Income Tax due less creditable withholding tax or tax credit.

D - Exclusions from Gross Income

Reasons for Exclusion
1. The item of receipt does not fall within the definition of income for income tax purposes.
- Damages recovered in libel and slander suits
- Damages recovered for alienation of affection
- Damages recovered for alienation of affection
- Damages recovered for loss of life of spouse
- Damages recovered for loss of life of spouse

2. A provision of the Tax Code or special law exempts it from income tax.

Exclusions from Gross Income (NIRC, 2017)

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 insurer under an agreement to pay interest thereon, the interest
payments shall be included in gross income.
2. Amount Received by Insured as 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.
3. Gifts, Bequests, and Devises. The value of 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 divided interest,
shall be included in gross income.
4. Compensation for Injuries or Sickness. Amounts received, through Accident or Health Insurance or under Workmen’s
Compensation Acts, 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.
5. Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of
the Philippines. It must be recalled that treaty agreements override provisions of our revenue tax laws in case of conflict under the
exemption doctrine of international comity.
6. Retirement Benefits, Pensions, Gratuities, etc.
a) Retirement benefits received under Republic Act No. 7641 and those received by officials and employees of private firms, whether
individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer:
Provided, That the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less
than fifty (50) years of age at the time of his retirement: Provided, further, That the benefits granted under this subparagraph shall be
availed of by an official or employee only once. For purposes of this Subsection, the term reasonable private benefit plan means a
pension, gratuity, stock bonus or profit-sharing plan maintained by an employer
for the benefit of some or all of his officials or employees, wherein contributions are made by such employer for the officials or
employees, or both, for the purpose of distributing to such officials and employees the earnings and principal
of the fund thus accumulated, and wherein it is provided in said plan that at no time shall any part of the corpus or income of the fund
be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and
employees.
b) Any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or
employee from the service of the employer because of death, sickness or other physical disability or for any cause beyond the control
of the said official or employee.
c) The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other
similar benefits received by resident or non-resident citizens of the Philippines or aliens who come to reside permanently in the
Philippines from foreign government agencies and other institutions, private or public.
d) Payments of benefits due or to become due to any person residing in the Philippines under the laws of the United States
administered by the United States Veterans Administration.
e) Benefits received from or enjoyed under the Social Security System in accordance with the provisions of Republic Act No. 8282.
f) Benefits received from the GSIS under Republic Act No. 8291, including retirement gratuity received by government officials and
employees.

Miscellaneous Items:
1. Income Derived by Foreign Government. Income derived from investments in the Philippines in loans, stocks, bonds or other
domestic securities, or from interest on deposits in banks in the Philippines by:
- foreign governments,
- financing institutions owned, controlled, or enjoying refinancing from foreign governments, and
- international or regional financial institutions established by foreign governments.
2. Income Derived by the Government or its Political Subdivisions. Income derived from any public utility or from the exercise of any
essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof.
3. Prizes and Awards. Prizes and awards made primarily in recognition of religious,charitable, scientific, educational, artistic, literary,
or civic achievement but only if:
- The recipient was selected without any action on his part to enter the contest or proceeding; and
- The recipient is not required to render substantial future services as a condition to receiving the prize or award.
4. Prizes and Awards in Sports Competition. All prizes and awards granted to athletes in local and international sports competitions
and tournaments whether held in the Philippines or abroad and sanctioned by their national sports associations.
5. 13th Month Pay and Other Benefits. Gross benefits received by officials and employees of public and private entities: Provided,
however, That the total exclusion under this subparagraph shall not exceed ninety thousand pesos (PhP90,000) which shall cover:
- Benefits received by officials and employees of the national and local government pursuant to Republic Act No. 6686;
- Benefits received by employees pursuant to Presidential Decree No. 851, as amended by Memorandum Order No. 28, dated August
13, 1986;
- Benefits received by officials and employees not covered by Presidential Decree No. 851, as amended by Memorandum Order No.
28, dated August 13, 1986; and
- Other benefits such as productivity incentives and Christmas bonus.
6. GSIS, SSS, Medicare and Other Contributions. GSIS, SSS, PhilHealth and Pag-Ibig contributions, and union dues of individuals.
Under RMC No. 21-2011, the exclusion pertains only to the mandatory or compulsory monthly contributions. Voluntary contributions to
Pag-ibig II, GSIS or SSS in excess of the mandatory monthly contribution are taxable. Note that Pag-ibig is now called Home
Development Mutual Fund (HDMF).
7. Contribution to Personal Equity Retirement Account (PERA). PERA is a contributor’s voluntary retirement account established from
qualified contributions of the contributor or his employer for the sole purpose of being invested in qualified PERA investment products.
Contributions to PERA accounts are exclusions in gross income.
This is an additional exclusion and is separate with exclusion for contribution to GSIS, SSS. Moreover, PERA contributors are allowed
to claim 5% of their PERA contributions as tax credit against any internal revenue taxes.
8. PERA Investment Income and PERA Distributions. PERA investment income is exempt from taxes (final tax, capital gains tax,
regular income tax). The PERA account assets will be distributed back to the contributor either in lump sum, life pension, or in
instalment upon reaching the age of 55 or to his heirs or beneficiaries upon his or her
death. PERA distributions are likewise exclusion in gross income of the contributor or his heirs or beneficiaries as the case may be.
9. Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. Gains realized from the sale or exchange or
retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years.
10. Gains from Redemption of Shares in Mutual Fund. Gains realized by the investor upon redemption of shares of stock in a mutual
fund company as defined in Section 22 (BB) of this Code. Mutual funds pool the money invested by the different investors and invest
the money to earn investment income which shall add up to the net asset of the fund. A participating investor must purchase
participation shares from the fund at their Net Asset Value (NAV). Upon redemption of his participation shares, the investor gains or
losses by his proportionate share due to the increase or decrease in
the net asset value of the funds.

Other Exempt Income under the NIRC and Special Laws

1. Minimum wage and certain benefits of Minimum wage earners. A minimum wage earner is an individual recipient of minimum wage
as fixed by Regional Tripartite Productivity Wage and Productivity Board of the Department of Labor and
Employment. A minimum wage earner is exempt from income tax on the minimum wage including holiday pay, overtime pay, night
shift differential pay and hazard pay.
2. Income of Barangay Micro-Business Enterprise Act (RA 9178). A Barangay Micro- Business Enterprise (BMBE) is a business entity
or enterprise engaged in the production, processing or manufacturing of products or commodities, including agro- processing, trading
and services, whose total assets including those arising from loans but exclusive of the land on which the particular business entity’s
office, plant, and equipment are situated, do not exceed P3,000,000.
3. Income of Cooperatives (RA 9520). Cooperatives that transact business purely with members are exempt from all taxes and fees.
Cooperatives that transact business with non-members are likewise exempt if their accumulated reserve and undivided savings do not
exceed P10M.
4. Income of non-stock, non-profit entities. Non-stock entities that are not organized for profit are exempt from income tax on their
income from operations. However, their income from unrelated sources is taxable.
5. Income of qualified employee trust funds. An employees’ trust fund which forms part of a pension, stock bonus or profit sharing plan
of an employer for the benefit of some or all of its employees is exempt from any income tax under the NIRC.

Exclusions Vs. Deductions

Exclusions from gross income are not included in the amount reportable gross income
in the income tax return while the amount of deductions is initially included in the amount of
gross income but is separately presented as deduction against gross income in the income tax
return. (Banggawan, Rex B., 2019).

4 Deductions from Gross Income:

1. Describe the nature and concepts of deductions from gross income.
2. Explain the general principles of deductions from gross income.
3. Enumerate and explain the allowable itemized deductions from gross income.
A - Nature and Concepts of Deductions from Gross Income
Deductions from gross income pertain to business expenses incurred by a taxpayer engaged in business or engaged in the practice of
profession.
Business means habitual engagement in a commercial activity involving the regular sale of goods and services to customers or
clients. In taxation, the term business is generally used to include the exercise of a profession. Self-employment is a business but
employment is not a business.

Business expenses Vs. Personal expenses

Business expenses are costs of doing trade, business or practice of profession such as employee salaries, office supplies, utilities,
rent, taxes, losses, bad debts, depreciation on business properties, research and development and the like.
Personal expenses include the living and family expenses of individual taxpayers such as family food, personal recreation and
transportation, medication, home rentals and utilities, tuition fees of dependents, and other similar expenses.
Business expenses Vs. Business capital expenditures
Business expenses benefit only the current accounting period. They are costs of generating income or gains for the current period.
Hence, they are deductible against gross income in the current period.
Examples:
1. Rent
2. Salaries and wages
3. Utilities expense (like, electricity, telephone, water, etc.)
4. Selling expenses (like, delivery and commission expenses)
5. Taxes and licenses

[Link] expenditures are expenses that benefit future accounting periods. They are initially recorded as assets upon acquisition then
later deducted against future gross income when used in the trade, business or profession of the taxpayer. The advanced deduction of
capital expenditures is not warranted as it contradicts the “Lifeblood Doctrine”.
Examples:
1. Inventory
2. Investments
3. Prepayments
4. Expenses to promote business goodwill
5. Rentals on capital lease or finance lease that transfer ownership
6. Items of property, plant and equipment including its improvements.
7. Acquisition of intangible assets such as patent or franchise, including costs of
defending the same in court.

The Cohan Rule Principle

If there is showing that expenses have been incurred but the exact amount thereof cannot be ascertained due to the absence of
documentary evidence, it is the duty of the BIR to make an estimate of deduction that may be allowed in computing the taxpayer's
taxable income bearing heavily against the taxpayer whose inexactitude is of his own making. A disallowance of 50% of the taxpayer's
claimed deduction is valid.
B - General Principles of Deductions from Gross Income
1. Expenses must be” legitimate”, “ordinary”, “actual” and “necessary” (LOAN) –
Characteristics of legitimate expenses
a) It is incurred in and for the current taxable period.
b) It is not a capital expenditure.
c) It pertains to the business or profession of the taxpayer.
d) It is not contrary to law, public policy or morals.
e) It is adequately substantiated with receipts or other documents.
Ordinary and necessary expense
An expense is “necessary” if reasonable and essential to the development,
management, operation, or conduct of trade, business or exercise of profession of the taxpayer. It is “ordinary” when it is normal in
relation to the business of the taxpayer and
[Link] circumstances. An expense is also said to be ordinary if it is normally incurred by the taxpayers under the same line of
business. (Banggawan, Rex B., 2019).
Actual expense
An expense is “actual” if it is paid or resulted to an incurrence of an obligation to
the taxpayer. In case of loss, it must be sustained or realized by the taxpayer in a closed and completed transaction. (Banggawan,
Rex B., 2019).
2. The matching principle – Only business expenses, which contribute to, or are incurred in connection with the generation of income,
gain, or profits subject to regular income tax are deductible. (Banggawan, Rex B., 2019).
3. The related party rule – In case of transactions between related parties, gains are taxable but losses are not deductible. Also,
pursuant to the transfer pricing rule, non- arm’s length expenses incurred between associated enterprises may be restated to their
arm’s length fair values to reflect the correct income of each of the associated enterprise. (Banggawan, Rex B., 2019)
4. The withholding rule – No deduction is allowed unless the withholding tax required by the law or regulations to be withheld on the
income payment (i.e. expense) is withheld and remitted by the taxpayer to the government.
Mode of claiming deductions from gross income:
1. Itemized deductions – Under the itemized deductions, taxpayers list every item of business expense they claim as deductions.
Deductions are strictly construed against the taxpayer.
2. Optional standard deductions – The optional standard deduction is in lieu of the itemized deductions, regular or special, including
NOLCO. The deduction is merely presumed as a fixed percentage of gross income for corporations and gross sales or receipts for
individuals.
C - Allowable Itemized Deductions from Gross Income
Itemized deductions:
a) Business expenses
b) Interest
c) Taxes
d) Losses
e) Bad debts
f) Depreciation
g) Depletion (drain, exhaust, impoverish, bankrupt)
h) Charitable and other contributions
i) Contributions to pension trusts
j) Research and development

Business Expenses
Requisites for business expense deductibility:
1) The expense must be ordinary and necessary.
a. Recapitalization and reorganization expenses are capital expenditure as well as cost of obtaining stock subscription and promotion
expenses.
b. Ransom money paid to secure the return of an individual is not deductible as it has nothing to do with profit-making.
c. Payment of the debts of bankrupt company to which the taxpayer was an officer to establish his credit is, according to U.S.
Supreme Court not ordinary.
2) The expenses must be incurred in trade or business carried on by the taxpayer.
3) The expenses must be substantiated by proof.
a. It is incumbent upon the taxpayer to establish proximate relation between the expense and the taxpayer's business.
b. Receipts are the best proof. Burden of proof lies upon the taxpayer.
4) The expenses must be reasonable.
5) Paid or incurred during the taxable year.
a. Cash basis method deducts expenses in the year in which they are paid.
b. Accrual basis method-recognizes expenses in the year they accrue.
6) Expenses must not be against public policy, public moral or law
a. Fines and penalties.
b. Attorney's fee incurred in defending civil action-based on illegal act.
c. Even though the defense is unsuccessful.
d. Entertainment expenses incurred by officer of a corporation to
entertain certain government officials.
e. The purchase price of political influence to obtain or hold public
contracts; dollar allocations from the Central Bank; import control

[Link]; payments in excess of the maximum amount authorized by

law.
f. Bribe to obtain protection from arrest or prosecution.
7) If subject to withholding tax, proof of payment to BIR must be shown.
Kinds of Business Expenses
1) Compensation for personal services:
a. Personal services actually rendered;
b. Compensation is for such services rendered;
c. Reasonable.
Factors/tests which determine whether compensation paid for services rendered is deductible or not:
Any amount paid in the form of compensation which does not partake of the purchase price of services is not deductible.
Bonuses are deductible under the following conditions:
a. Paid in good faith as additional compensation for services rendered;
b. Reasonable amount. To hold otherwise would open the gate to
rampant tax evasion;
c. Not to exceed reasonable compensation when added to salaries.
2) Travelling expenses
3) Representation and entertainment expenses
4) Advertising and promotional expenses
5) Rent expenses
6) Cost of material and supplies
7) Repairs
Interest Expense
Requisites for interest expense deductibility:
1) There must be a valid indebtedness.
2) Incurred in connection with taxpayer's trade or business.
3) Indebtedness must be that of the taxpayer.
4) The interest must have been stipulated in writing.
5) Paid or accrued within the taxable year.
[Link] interest expenses:
a) Interest on taxes.
b) Interest paid by corporation on scrip dividends.
c) Interest on deposits paid by authorized bank of the Central Bank.
d) Interest paid by legal or equitable owner on mortgage of real property.
Taxes
Taxes paid or incurred within the taxable year in connection with the taxpayer’s trade, business, or exercise of profession shall be
allowed except:
1. Philippine income taxes except fringe benefit tax
a) Final income tax
b) Capital gains tax
c) Regular income tax
2. Foreign income tax, if claimed as tax credit
3. Estate tax and donor’s tax
4. Special assessment tax
Examples of deductible taxes
1. Percentage tax
2. Excise tax
3. Documentary stamp tax
4. Occupational tax
5. License tax
6. Fringe benefit tax
7. Local taxes except special asse
8. Community tax
9. Municipal tax
10. Foreign income tax if not claimed as tax credit
Requisites for taxes deductibility:
1) Paid or incurred within the taxable year;
2) Paid or incurred in connection with taxpayer's business;
3) Deductible only by the person upon whom the tax is imposed by law.
[Link] (Chapter VII Allowable Deductions, Tax Code)
In General - Losses actually sustained during the taxable year and not compensated
for by insurance or other forms of indemnity shall be allowed as deductions:
1. If incurred in trade, profession or business;
2. Of property connected with the trade, business or profession, if the loss
arises from fires, storms, shipwreck, or other casualties, or from robbery,
theft or embezzlement.
3. No loss shall be allowed as a deduction under this Subsection if at the
time of the filing of the return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return.
Kinds of Losses:
1. Ordinary Losses
2. Profit Losses
3. Casualty Losses
4. Capital Losses
Special Kinds of Losses:
1. Wagering Losses
a) A gambling loss is a loss resulting from games of chance or wagers on events with uncertain outcomes (gambling). These losses
can only be claimed against gambling.
b) Deductible only to the extent of the gain.
2. Property Losses
3. Capital Asset Losses
Requisites for Loss Deductibility:
1. The loss claimed as deduction must be that of taxpayer.
2. The loss must have been sustained during the taxable year.
3. Loss evidenced by a closed and completed transaction.
4. Loss not compensated by insurance or otherwise.
Bad Debts
Bad debts refer to debts due to the taxpayer which were actually ascertained to be worthless and were charged off within the taxable
year.
7Requisites for bad debts deductibility:
1. Existence of a valid debt and subsisting debt.
2. Debts must be actually ascertained to be worthless.
3. Debt must be charged off within the year of worthlessness.
4. Debt arises from business or trade.
5. Does not arise from transactions between related taxpayers.
6. Debt is indeed uncollectible in the future.
Measures of bad debts deductible:
1. Generally, the entire amount of the bad debt.
2. Unpaid wages paid in promissory note.
3. Distribution of the decedent's assets.
4. Account receivable becoming worthless in the hands of the purchaser.
Depreciation
There should be allowed as a depreciation deduction a reasonable allowance for the exhaustion and wear and tear (including
reasonable allowance for obsolescence) of property used in the trade or business.
Requisites for depreciation deductibility:
1. The allowance for depreciation must be reasonable.
2. It must be for property used in trade or business or profession.
Depreciable assets:
1. Tangible property
2. Intangible property
Non-depreciable assets:
1. Inventories or stock
2. Land and improvements
3. Bodies of minerals subject to depletion
4. Automobiles or transportation equipment for personal use
5. Building and furniture for personal use
6. Intangible
7. Personal effects and clothing
[Link]
Depletion expense is a provision for the periodic return of capital investment s in wasting assets such as minerals, gas, and oil.
Requisites for depletion deductibility:
1. Depletable asset
2. Charged off within the taxable year
3. Allowance for depletion is computed in accordance with the cost depletion
method.
Charitable and other Contributions
Contributions or gifts made to the government or non-government organizations (NGOs) may be deducted against gross income.
Requisites of claim for deduction on contributions:
1. The donee institution must be a domestic institution.
2. No income of the donee institution must inure to the benefit of any private
stockholder or individual.
3. The contribution must be valued at the tax basis of the property donated.
4. The taxpayer must be engaged in trade or business.
5. The donee must issue a certificate of donation (BIR Form 2322) which includes a
donor’s statement of values.
6. If the amount of donation is at least P50,000 the donor shall file a notice of
donation to the RDO where he is registered within 30 days upon receipt of the certification of donation.
Employer’s Contribution to Pension Trust
Types of employee pension plan:
1. Defined contribution plan
2. Defined benefit plan
Under the defined contribution plan, the employer is merely obligated to make
certain amounts of contribution to the pension fund on a regular basis. The employer does not guarantee the amount of benefits to the
employees. The amount of benefits to be received by the employees shall be dependent upon the investment performance of
[Link] pension fund. Because the employer’s liability to the plan is defined in terms of contributions, actuarial computation is not
necessary. In a defined contribution plan, the deductible expense of the employer is simply the amount of contributions (i.e. funding)
made by the employer to the fund. (Banggawan, Rex B., 2019).
Under the defined benefits plan, the employer guarantees the amount of benefits to the employees. The amount of funding which the
employer makes to the fund shall be dependent upon the investment performance of the fund. This means less funding if the fund
performs and more if it underperforms. (Banggawan, Rex B., 2019).
Requisites for employer’s contribution to pension trust deductibility:
1. Employer must have established a pension or retirement plan for the payment of
reasonable pension to its employees.
2. Pension plan is reasonable and actuarially sound.
3. Funded by the employer.
4. Amount contributed must no longer be subject to control of the employer.
5. Payment has not yet been allowed as deduction.
Treatment of income from pension plan:
1. Not taxable to the employee
2. In case any portion of the funds is reverted back to the employer, said fund forms part
of the income of the employer during the taxable year of reversion
Research and Development Costs
Research activities are geared towards discovery of new knowledge. Development activities are geared towards determining
application of research knowledge which could provide income and benefits for the business.
Tax treatment of R&D costs:
1. Research and development costs related to capital accounts such as property used in business are capitalized as part of the cost of
the property and deducted through depreciation expense.
2. Research and development costs not related to capital accounts are treated as follows at the option of the taxpayer.
a) Outright expense
b) Deferred expense amortized over a period of not less than 60 months beginning
from the month when benefits from R&D expenditures were realized.
odule 4 Deductions from Gross Income
1. Describe the nature and concepts of deductions from gross income.
2. Explain the general principles of deductions from gross income.
3. Enumerate and explain the allowable itemized deductions from gross income.
A - Nature and Concepts of Deductions from Gross Income
Deductions from gross income pertain to business expenses incurred by a taxpayer engaged in business or engaged in the practice of
profession.
Business means habitual engagement in a commercial activity involving the regular sale of goods and services to customers or
clients. In taxation, the term business is generally used to include the exercise of a profession. Self-employment is a business but
employment is not a business.
Business expenses Vs. Personal expenses
Business expenses are costs of doing trade, business or practice of profession such as employee salaries, office supplies, utilities,
rent, taxes, losses, bad debts, depreciation on business properties, research and development and the like.
Personal expenses include the living and family expenses of individual taxpayers such as family food, personal recreation and
transportation, medication, home rentals and utilities, tuition fees of dependents, and other similar expenses.
Business expenses Vs. Business capital expenditures
Business expenses benefit only the current accounting period. They are costs of generating income or gains for the current period.
Hence, they are deductible against gross income in the current period.
Examples:
1. Rent
2. Salaries and wages
3. Utilities expense (like, electricity, telephone, water, etc.)
4. Selling expenses (like, delivery and commission expenses)
5. Taxes and licenses
[Link] expenditures are expenses that benefit future accounting periods. They are initially recorded as assets upon acquisition then
later deducted against future gross income when used in the trade, business or profession of the taxpayer. The advanced deduction of
capital expenditures is not warranted as it contradicts the “Lifeblood Doctrine”.
Examples:
1. Inventory
2. Investments
3. Prepayments
4. Expenses to promote business goodwill
5. Rentals on capital lease or finance lease that transfer ownership
6. Items of property, plant and equipment including its improvements.
7. Acquisition of intangible assets such as patent or franchise, including costs of
defending the same in court.
The Cohan Rule Principle
If there is showing that expenses have been incurred but the exact amount thereof cannot be ascertained due to the absence of
documentary evidence, it is the duty of the BIR to make an estimate of deduction that may be allowed in computing the taxpayer's
taxable income bearing heavily against the taxpayer whose inexactitude is of his own making. A disallowance of 50% of the taxpayer's
claimed deduction is valid.
B - General Principles of Deductions from Gross Income
1. Expenses must be” legitimate”, “ordinary”, “actual” and “necessary” (LOAN) –
Characteristics of legitimate expenses
a) It is incurred in and for the current taxable period.
b) It is not a capital expenditure.
c) It pertains to the business or profession of the taxpayer.
d) It is not contrary to law, public policy or morals.
e) It is adequately substantiated with receipts or other documents.
Ordinary and necessary expense
An expense is “necessary” if reasonable and essential to the development,
management, operation, or conduct of trade, business or exercise of profession of the taxpayer. It is “ordinary” when it is normal in
relation to the business of the taxpayer and
[Link] circumstances. An expense is also said to be ordinary if it is normally incurred by the taxpayers under the same line of
business. (Banggawan, Rex B., 2019).
Actual expense
An expense is “actual” if it is paid or resulted to an incurrence of an obligation to
the taxpayer. In case of loss, it must be sustained or realized by the taxpayer in a closed and completed transaction. (Banggawan,
Rex B., 2019).
2. The matching principle – Only business expenses, which contribute to, or are incurred in connection with the generation of income,
gain, or profits subject to regular income tax are deductible. (Banggawan, Rex B., 2019).
3. The related party rule – In case of transactions between related parties, gains are taxable but losses are not deductible. Also,
pursuant to the transfer pricing rule, non- arm’s length expenses incurred between associated enterprises may be restated to their
arm’s length fair values to reflect the correct income of each of the associated enterprise. (Banggawan, Rex B., 2019)
4. The withholding rule – No deduction is allowed unless the withholding tax required by the law or regulations to be withheld on the
income payment (i.e. expense) is withheld and remitted by the taxpayer to the government.
Mode of claiming deductions from gross income
1. Itemized deductions – Under the itemized deductions, taxpayers list every item of business expense they claim as deductions.
Deductions are strictly construed against the taxpayer.
2. Optional standard deductions – The optional standard deduction is in lieu of the itemized deductions, regular or special, including
NOLCO. The deduction is merely presumed as a fixed percentage of gross income for corporations and gross sales or receipts for
individuals.
C - Allowable Itemized Deductions from Gross Income
Itemized deductions:
a) Business expenses
b) Interest
c) Taxes
d) Losses
e) Bad debts
f) Depreciation
g) Depletion (drain, exhaust, impoverish, bankrupt)
h) Charitable and other contributions
i) Contributions to pension trusts
j) Research and development
Business Expenses
Requisites for business expense deductibility:
1) The expense must be ordinary and necessary.
a. Recapitalization and reorganization expenses are capital expenditure as well as cost of obtaining stock subscription and promotion
expenses.
b. Ransom money paid to secure the return of an individual is not deductible as it has nothing to do with profit-making.
c. Payment of the debts of bankrupt company to which the taxpayer was an officer to establish his credit is, according to U.S.
Supreme Court not ordinary.
2) The expenses must be incurred in trade or business carried on by the taxpayer.
3) The expenses must be substantiated by proof.
a. It is incumbent upon the taxpayer to establish proximate relation between the expense and the taxpayer's business.
b. Receipts are the best proof. Burden of proof lies upon the taxpayer.
4) The expenses must be reasonable.
5) Paid or incurred during the taxable year.
a. Cash basis method deducts expenses in the year in which they are paid.
b. Accrual basis method-recognizes expenses in the year they accrue.
6) Expenses must not be against public policy, public moral or law
a. Fines and penalties.
b. Attorney's fee incurred in defending civil action-based on illegal act.
c. Even though the defense is unsuccessful.
d. Entertainment expenses incurred by officer of a corporation to
entertain certain government officials.
e. The purchase price of political influence to obtain or hold public
contracts; dollar allocations from the Central Bank; import control
[Link]; payments in excess of the maximum amount authorized by
law.
f. Bribe to obtain protection from arrest or prosecution.
7) If subject to withholding tax, proof of payment to BIR must be shown.
Kinds of Business Expenses
1) Compensation for personal services:
a. Personal services actually rendered;
b. Compensation is for such services rendered;
c. Reasonable.
Factors/tests which determine whether compensation paid for services rendered is deductible or not:
Any amount paid in the form of compensation which does not partake of the purchase price of services is not deductible.
Bonuses are deductible under the following conditions:
a. Paid in good faith as additional compensation for services rendered;
b. Reasonable amount. To hold otherwise would open the gate to
rampant tax evasion;
c. Not to exceed reasonable compensation when added to salaries.
2) Travelling expenses
3) Representation and entertainment expenses
4) Advertising and promotional expenses
5) Rent expenses
6) Cost of material and supplies
7) Repairs
Interest Expense
Requisites for interest expense deductibility:
1) There must be a valid indebtedness.
2) Incurred in connection with taxpayer's trade or business.
3) Indebtedness must be that of the taxpayer.
4) The interest must have been stipulated in writing.
5) Paid or accrued within the taxable year

Deductible interest expenses:

a) Interest on taxes.
b) Interest paid by corporation on scrip dividends.
c) Interest on deposits paid by authorized bank of the Central Bank.
d) Interest paid by legal or equitable owner on mortgage of real property.
Taxes
Taxes paid or incurred within the taxable year in connection with the taxpayer’s trade, business, or exercise of profession shall be
allowed except:
1. Philippine income taxes except fringe benefit tax
a) Final income tax
b) Capital gains tax
c) Regular income tax
2. Foreign income tax, if claimed as tax credit
3. Estate tax and donor’s tax
4. Special assessment tax
Examples of deductible taxes
1. Percentage tax
2. Excise tax
3. Documentary stamp tax
4. Occupational tax
5. License tax
6. Fringe benefit tax
7. Local taxes except special asse
8. Community tax
9. Municipal tax
10. Foreign income tax if not claimed as tax credit
Requisites for taxes deductibility:
1) Paid or incurred within the taxable year;
2) Paid or incurred in connection with taxpayer's business;
3) Deductible only by the person upon whom the tax is imposed by law.

Losses (Chapter VII Allowable Deductions, Tax Code)

In General - Losses actually sustained during the taxable year and not compensated
for by insurance or other forms of indemnity shall be allowed as deductions:
1. If incurred in trade, profession or business;
2. Of property connected with the trade, business or profession, if the loss
arises from fires, storms, shipwreck, or other casualties, or from robbery,
theft or embezzlement.
3. No loss shall be allowed as a deduction under this Subsection if at the
time of the filing of the return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return.
Kinds of Losses:
1. Ordinary Losses
2. Profit Losses
3. Casualty Losses
4. Capital Losses
Special Kinds of Losses:
1. Wagering Losses
a) A gambling loss is a loss resulting from games of chance or wagers on events with uncertain outcomes (gambling). These losses
can only be claimed against gambling.
b) Deductible only to the extent of the gain.
2. Property Losses
3. Capital Asset Losses
Requisites for Loss Deductibility:
1. The loss claimed as deduction must be that of taxpayer.
2. The loss must have been sustained during the taxable year.
3. Loss evidenced by a closed and completed transaction.
4. Loss not compensated by insurance or otherwise.
Bad Debts
Bad debts refer to debts due to the taxpayer which were actually ascertained to be worthless and were charged off within the taxable
year.

Requisites for bad debts deductibility:

1. Existence of a valid debt and subsisting debt.
2. Debts must be actually ascertained to be worthless.
3. Debt must be charged off within the year of worthlessness.
4. Debt arises from business or trade.
5. Does not arise from transactions between related taxpayers.
6. Debt is indeed uncollectible in the future.
Measures of bad debts deductible:
1. Generally, the entire amount of the bad debt.
2. Unpaid wages paid in promissory note.
3. Distribution of the decedent's assets.
4. Account receivable becoming worthless in the hands of the purchaser.
Depreciation
There should be allowed as a depreciation deduction a reasonable allowance for the exhaustion and wear and tear (including
reasonable allowance for obsolescence) of property used in the trade or business.
Requisites for depreciation deductibility:
1. The allowance for depreciation must be reasonable.
2. It must be for property used in trade or business or profession.
Depreciable assets:
1. Tangible property
2. Intangible property
Non-depreciable assets:
1. Inventories or stock
2. Land and improvements
3. Bodies of minerals subject to depletion
4. Automobiles or transportation equipment for personal use
5. Building and furniture for personal use
6. Intangible
7. Personal effects and clothing
Depletion
Depletion expense is a provision for the periodic return of capital investment s in wasting assets such as minerals, gas, and oil.
Requisites for depletion deductibility:
1. Depletable asset
2. Charged off within the taxable year
3. Allowance for depletion is computed in accordance with the cost depletion
method.
Charitable and other Contributions
Contributions or gifts made to the government or non-government organizations (NGOs) may be deducted against gross income.
Requisites of claim for deduction on contributions:
1. The donee institution must be a domestic institution.
2. No income of the donee institution must inure to the benefit of any private
stockholder or individual.
3. The contribution must be valued at the tax basis of the property donated.
4. The taxpayer must be engaged in trade or business.
5. The donee must issue a certificate of donation (BIR Form 2322) which includes a
donor’s statement of values.
6. If the amount of donation is at least P50,000 the donor shall file a notice of
donation to the RDO where he is registered within 30 days upon receipt of the certification of donation.
Employer’s Contribution to Pension Trust
Types of employee pension plan:
1. Defined contribution plan
2. Defined benefit plan
Under the defined contribution plan, the employer is merely obligated to make
certain amounts of contribution to the pension fund on a regular basis. The employer does not guarantee the amount of benefits to the
employees. The amount of benefits to be received by the employees shall be dependent upon the investment performance of

the pension fund. Because the employer’s liability to the plan is defined in terms of contributions, actuarial computation is not
necessary. In a defined contribution plan, the deductible expense of the employer is simply the amount of contributions (i.e. funding)
made by the employer to the fund. (Banggawan, Rex B., 2019).
Under the defined benefits plan, the employer guarantees the amount of benefits to the employees. The amount of funding which the
employer makes to the fund shall be dependent upon the investment performance of the fund. This means less funding if the fund
performs and more if it underperforms. (Banggawan, Rex B., 2019).
Requisites for employer’s contribution to pension trust deductibility:
1. Employer must have established a pension or retirement plan for the payment of
reasonable pension to its employees.
2. Pension plan is reasonable and actuarially sound.
3. Funded by the employer.
4. Amount contributed must no longer be subject to control of the employer.
5. Payment has not yet been allowed as deduction.
Treatment of income from pension plan:
1. Not taxable to the employee
2. In case any portion of the funds is reverted back to the employer, said fund forms part
of the income of the employer during the taxable year of reversion
Research and Development Costs
Research activities are geared towards discovery of new knowledge. Development activities are geared towards determining
application of research knowledge which could provide income and benefits for the business.
Tax treatment of R&D costs:
1. Research and development costs related to capital accounts such as property used in business are capitalized as part of the cost of
the property and deducted through depreciation expense.
2. Research and development costs not related to capital accounts are treated as follows at the option of the taxpayer.
a) Outright expense
b) Deferred expense amortized over a period of not less than 60 months beginning
from the month when benefits from R&D expenditures were realized.

Module 4 Deductions from Gross Income

1. Describe the nature and concepts of deductions from gross income.
2. Explain the general principles of deductions from gross income.
3. Enumerate and explain the allowable itemized deductions from gross income.
A - Nature and Concepts of Deductions from Gross Income
Deductions from gross income pertain to business expenses incurred by a taxpayer engaged in business or engaged in the practice of
profession.
Business means habitual engagement in a commercial activity involving the regular sale of goods and services to customers or
clients. In taxation, the term business is generally used to include the exercise of a profession. Self-employment is a business but
employment is not a business.
Business expenses Vs. Personal expenses
Business expenses are costs of doing trade, business or practice of profession such as employee salaries, office supplies, utilities,
rent, taxes, losses, bad debts, depreciation on business properties, research and development and the like.
Personal expenses include the living and family expenses of individual taxpayers such as family food, personal recreation and
transportation, medication, home rentals and utilities, tuition fees of dependents, and other similar expenses.
Business expenses Vs. Business capital expenditures
Business expenses benefit only the current accounting period. They are costs of generating income or gains for the current period.
Hence, they are deductible against gross income in the current period.
Examples:
1. Rent
2. Salaries and wages
3. Utilities expense (like, electricity, telephone, water, etc.)
4. Selling expenses (like, delivery and commission expenses)
5. Taxes and licenses

Capital expenditures are expenses that benefit future accounting periods. They are initially recorded as assets upon acquisition then
later deducted against future gross income when used in the trade, business or profession of the taxpayer. The advanced deduction of
capital expenditures is not warranted as it contradicts the “Lifeblood Doctrine”.
Examples:
1. Inventory
2. Investments
3. Prepayments
4. Expenses to promote business goodwill
5. Rentals on capital lease or finance lease that transfer ownership
6. Items of property, plant and equipment including its improvements.
7. Acquisition of intangible assets such as patent or franchise, including costs of
defending the same in court.
The Cohan Rule Principle
If there is showing that expenses have been incurred but the exact amount thereof cannot be ascertained due to the absence of
documentary evidence, it is the duty of the BIR to make an estimate of deduction that may be allowed in computing the taxpayer's
taxable income bearing heavily against the taxpayer whose inexactitude is of his own making. A disallowance of 50% of the taxpayer's
claimed deduction is valid.
B - General Principles of Deductions from Gross Income
1. Expenses must be” legitimate”, “ordinary”, “actual” and “necessary” (LOAN) –
Characteristics of legitimate expenses
a) It is incurred in and for the current taxable period.
b) It is not a capital expenditure.
c) It pertains to the business or profession of the taxpayer.
d) It is not contrary to law, public policy or morals.
e) It is adequately substantiated with receipts or other documents.
Ordinary and necessary expense
An expense is “necessary” if reasonable and essential to the development,
management, operation, or conduct of trade, business or exercise of profession of the taxpayer. It is “ordinary” when it is normal in
relation to the business of the taxpayer and

surrounding circumstances. An expense is also said to be ordinary if it is normally incurred by the taxpayers under the same line of
business. (Banggawan, Rex B., 2019).
Actual expense
An expense is “actual” if it is paid or resulted to an incurrence of an obligation to
the taxpayer. In case of loss, it must be sustained or realized by the taxpayer in a closed and completed transaction. (Banggawan,
Rex B., 2019).
2. The matching principle – Only business expenses, which contribute to, or are incurred in connection with the generation of income,
gain, or profits subject to regular income tax are deductible. (Banggawan, Rex B., 2019).
3. The related party rule – In case of transactions between related parties, gains are taxable but losses are not deductible. Also,
pursuant to the transfer pricing rule, non- arm’s length expenses incurred between associated enterprises may be restated to their
arm’s length fair values to reflect the correct income of each of the associated enterprise. (Banggawan, Rex B., 2019)
4. The withholding rule – No deduction is allowed unless the withholding tax required by the law or regulations to be withheld on the
income payment (i.e. expense) is withheld and remitted by the taxpayer to the government.
Mode of claiming deductions from gross income
1. Itemized deductions – Under the itemized deductions, taxpayers list every item of business expense they claim as deductions.
Deductions are strictly construed against the taxpayer.
2. Optional standard deductions – The optional standard deduction is in lieu of the itemized deductions, regular or special, including
NOLCO. The deduction is merely presumed as a fixed percentage of gross income for corporations and gross sales or receipts for
individuals.
C - Allowable Itemized Deductions from Gross Income
Itemized deductions:
a) Business expenses
b) Interest
c) Taxes
d) Losses
e) Bad debts
f) Depreciation
g) Depletion (drain, exhaust, impoverish, bankrupt)
h) Charitable and other contributions
i) Contributions to pension trusts
j) Research and development
Business Expenses
Requisites for business expense deductibility:
1) The expense must be ordinary and necessary.
a. Recapitalization and reorganization expenses are capital expenditure as well as cost of obtaining stock subscription and promotion
expenses.
b. Ransom money paid to secure the return of an individual is not deductible as it has nothing to do with profit-making.
c. Payment of the debts of bankrupt company to which the taxpayer was an officer to establish his credit is, according to U.S.
Supreme Court not ordinary.
2) The expenses must be incurred in trade or business carried on by the taxpayer.
3) The expenses must be substantiated by proof.
a. It is incumbent upon the taxpayer to establish proximate relation between the expense and the taxpayer's business.
b. Receipts are the best proof. Burden of proof lies upon the taxpayer.
4) The expenses must be reasonable.
5) Paid or incurred during the taxable year.
a. Cash basis method deducts expenses in the year in which they are paid.
b. Accrual basis method-recognizes expenses in the year they accrue.
6) Expenses must not be against public policy, public moral or law
a. Fines and penalties.
b. Attorney's fee incurred in defending civil action-based on illegal act.
c. Even though the defense is unsuccessful.
d. Entertainment expenses incurred by officer of a corporation to
entertain certain government officials.
e. The purchase price of political influence to obtain or hold public
contracts; dollar allocations from the Central Bank; import control
licenses; payments in excess of the maximum amount authorized by law.
f. Bribe to obtain protection from arrest or prosecution.
7) If subject to withholding tax, proof of payment to BIR must be shown.
Kinds of Business Expenses
1) Compensation for personal services:
a. Personal services actually rendered;
b. Compensation is for such services rendered;
c. Reasonable.
Factors/tests which determine whether compensation paid for services rendered is deductible or not:
Any amount paid in the form of compensation which does not partake of the purchase price of services is not deductible.
Bonuses are deductible under the following conditions:
a. Paid in good faith as additional compensation for services rendered;
b. Reasonable amount. To hold otherwise would open the gate to
rampant tax evasion;
c. Not to exceed reasonable compensation when added to salaries.
2) Travelling expenses
3) Representation and entertainment expenses
4) Advertising and promotional expenses
5) Rent expenses
6) Cost of material and supplies
7) Repairs
Interest Expense
Requisites for interest expense deductibility:
1) There must be a valid indebtedness.
2) Incurred in connection with taxpayer's trade or business.
3) Indebtedness must be that of the taxpayer.
4) The interest must have been stipulated in writing.
5) Paid or accrued within the taxable year.
Deductible interest expenses:
a) Interest on taxes.
b) Interest paid by corporation on scrip dividends.
c) Interest on deposits paid by authorized bank of the Central Bank.
d) Interest paid by legal or equitable owner on mortgage of real property.
Taxes
Taxes paid or incurred within the taxable year in connection with the taxpayer’s trade, business, or exercise of profession shall be
allowed except:
1. Philippine income taxes except fringe benefit tax
a) Final income tax
b) Capital gains tax
c) Regular income tax
2. Foreign income tax, if claimed as tax credit
3. Estate tax and donor’s tax
4. Special assessment tax
Examples of deductible taxes
1. Percentage tax
2. Excise tax
3. Documentary stamp tax
4. Occupational tax
5. License tax
6. Fringe benefit tax
7. Local taxes except special asse
8. Community tax
9. Municipal tax
10. Foreign income tax if not claimed as tax credit
Requisites for taxes deductibility:
1) Paid or incurred within the taxable year;
2) Paid or incurred in connection with taxpayer's business;
3) Deductible only by the person upon whom the tax is imposed by law.

Losses (Chapter VII Allowable Deductions, Tax Code)

In General - Losses actually sustained during the taxable year and not compensated
for by insurance or other forms of indemnity shall be allowed as deductions:
1. If incurred in trade, profession or business;
2. Of property connected with the trade, business or profession, if the loss
arises from fires, storms, shipwreck, or other casualties, or from robbery,
theft or embezzlement.
3. No loss shall be allowed as a deduction under this Subsection if at the
time of the filing of the return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return.
Kinds of Losses:
1. Ordinary Losses
2. Profit Losses
3. Casualty Losses
4. Capital Losses
Special Kinds of Losses:
1. Wagering Losses
a) A gambling loss is a loss resulting from games of chance or wagers on events with uncertain outcomes (gambling). These losses
can only be claimed against gambling.
b) Deductible only to the extent of the gain.
2. Property Losses
3. Capital Asset Losses
Requisites for Loss Deductibility:
1. The loss claimed as deduction must be that of taxpayer.
2. The loss must have been sustained during the taxable year.
3. Loss evidenced by a closed and completed transaction.
4. Loss not compensated by insurance or otherwise.
Bad Debts
Bad debts refer to debts due to the taxpayer which were actually ascertained to be worthless and were charged off within the taxable
year.
Requisites for bad debts deductibility:
1. Existence of a valid debt and subsisting debt.
2. Debts must be actually ascertained to be worthless.
3. Debt must be charged off within the year of worthlessness.
4. Debt arises from business or trade.
5. Does not arise from transactions between related taxpayers.
6. Debt is indeed uncollectible in the future.
Measures of bad debts deductible:
1. Generally, the entire amount of the bad debt.
2. Unpaid wages paid in promissory note.
3. Distribution of the decedent's assets.
4. Account receivable becoming worthless in the hands of the purchaser.
Depreciation
There should be allowed as a depreciation deduction a reasonable allowance for the exhaustion and wear and tear (including
reasonable allowance for obsolescence) of property used in the trade or business.
Requisites for depreciation deductibility:
1. The allowance for depreciation must be reasonable.
2. It must be for property used in trade or business or profession.
Depreciable assets:
1. Tangible property
2. Intangible property
Non-depreciable assets:
1. Inventories or stock
2. Land and improvements
3. Bodies of minerals subject to depletion
4. Automobiles or transportation equipment for personal use
5. Building and furniture for personal use
6. Intangible
7. Personal effects and clothing
Depletion
Depletion expense is a provision for the periodic return of capital investment s in wasting assets such as minerals, gas, and oil.
Requisites for depletion deductibility:
1. Depletable asset
2. Charged off within the taxable year
3. Allowance for depletion is computed in accordance with the cost depletion
method.
Charitable and other Contributions
Contributions or gifts made to the government or non-government organizations (NGOs) may be deducted against gross income.
Requisites of claim for deduction on contributions:
1. The donee institution must be a domestic institution.
2. No income of the donee institution must inure to the benefit of any private
stockholder or individual.
3. The contribution must be valued at the tax basis of the property donated.
4. The taxpayer must be engaged in trade or business.
5. The donee must issue a certificate of donation (BIR Form 2322) which includes a
donor’s statement of values.
6. If the amount of donation is at least P50,000 the donor shall file a notice of
donation to the RDO where he is registered within 30 days upon receipt of the certification of donation.
Employer’s Contribution to Pension Trust
Types of employee pension plan:
1. Defined contribution plan
2. Defined benefit plan
Under the defined contribution plan, the employer is merely obligated to make
certain amounts of contribution to the pension fund on a regular basis. The employer does not guarantee the amount of benefits to the
employees. The amount of benefits to be received by the employees shall be dependent upon the investment performance of
the pension fund. Because the employer’s liability to the plan is defined in terms of contributions, actuarial computation is not
necessary. In a defined contribution plan, the deductible expense of the employer is simply the amount of contributions (i.e. funding)
made by the employer to the fund. (Banggawan, Rex B., 2019).
Under the defined benefits plan, the employer guarantees the amount of benefits to the employees. The amount of funding which the
employer makes to the fund shall be dependent upon the investment performance of the fund. This means less funding if the fund
performs and more if it underperforms. (Banggawan, Rex B., 2019).
Requisites for employer’s contribution to pension trust deductibility:
1. Employer must have established a pension or retirement plan for the payment of
reasonable pension to its employees.
2. Pension plan is reasonable and actuarially sound.
3. Funded by the employer.
4. Amount contributed must no longer be subject to control of the employer.
5. Payment has not yet been allowed as deduction.
Treatment of income from pension plan:
1. Not taxable to the employee
2. In case any portion of the funds is reverted back to the employer, said fund forms part
of the income of the employer during the taxable year of reversion
Research and Development Costs
Research activities are geared towards discovery of new knowledge. Development activities are geared towards determining
application of research knowledge which could provide income and benefits for the business.
Tax treatment of R&D costs:
1. Research and development costs related to capital accounts such as property used in business are capitalized as part of the cost of
the property and deducted through depreciation expense.
2. Research and development costs not related to capital accounts are treated as follows at the option of the taxpayer.
a) Outright expense
b) Deferred expense amortized over a period of not less than 60 months beginning
from the month when benefits from R&D expenditures were realized.

Module 5
Individual Income Taxation I
Objectives:
1. Describe what an income tax is?
2. Explain who are required to pay tax and state the documentary requirements in filing.
3. Enumerate and explain the schemes in income taxation
4. Name and explain the categories of individual income
A - Introduction to Income Taxation
1. Income Tax Description
Income Tax is a tax on a person's income, emoluments, profits arising from
property, practice of profession, conduct of trade or business or on the pertinent items of
gross income specified in the Tax Code of 1997 (Tax Code), as amended, less the
deductions if any, authorized for such types of income, by the Tax Code, as amended, or
other special laws.
2. Who are Required to File Income Tax Returns?
a) Individuals
Resident citizens receiving income from sources within or outside the
Philippines.
o Employees deriving purely compensation income from two or more
employers, concurrently or successively at any time during the taxable year.
o Employees deriving purely compensation income regardless of the amount,
whether from a single or several employers during the calendar year, the
income tax of which has not been withheld correctly (i.e. tax due is not equal
to the tax withheld) resulting to collectible or refundable return.
o Self-employed individuals receiving income from the conduct of trade or
business and/or practice of profession.
o Individuals deriving mixed income, i.e., compensation income and income
from the conduct of trade or business and/or practice of profession.
o Individuals deriving other non-business, non-professional related income in
addition to compensation income not otherwise subject to a final tax.

o Individuals receiving purely compensation income from a single employer,

although the income of which has been correctly withheld, but whose spouse
is not entitled to substituted filing.
Non-resident citizens receiving income from sources within the Philippines
Aliens, whether resident or not, receiving income from sources within the
Philippines
b) Non-Individuals
Corporations including partnerships, no matter how created or organized.
Domestic corporations receiving income from sources within and outside the
Philippines.
Foreign corporations receiving income from sources within the Philippines.
Estates and trusts engaged in trade or business.
3. Annual Income Tax For Individuals Earning Purely Compensation Income (Including
Non-Business/Non-Profession Related Income)
BIR Form 1700 - Annual Income Tax For Individuals Earning Purely Compensation
Income (Including Non-Business/Non-Profession Related Income)
Documentary Requirements
Certificate of Income Tax Withheld on Compensation (BIR Form 2316)
Duly approved Tax Debit Memo, if applicable
Proofs of Foreign Tax Credits, if applicable
Income Tax Return previously filed and proof of payment, if filing an amended
return for the same taxable year.
Procedures
a) For Electronic Filing and Payment System (eFPS) Filer
Fill-up applicable fields in the BIR Form No. 1700
Pay electronically by clicking the "Proceed to Payment" button and fill-up the
required fields in the "eFPS Payment Form" click "Submit" button.
Receive payment confirmation from eFPS-AABs for successful e-filing and e-
payment.
b) For Non-eFPS Filer
Fill-up applicable fields in the BIR Form No. 1700 in the downloaded Electronic
Bureau of Internal Revenue Form (eBIRForm) Package
Print the duly accomplished BIR Form No. 1700
Proceed to the nearest Authorized Agent Bank (AAB) under the jurisdiction of
the Revenue District Office where you are registered and present the duly
accomplished BIR Form 1700, together with the required attachments and
your payment.
In places where there are no AABs, proceed to the Revenue Collection Officer
or duly Authorized City or Municipal Treasurer located within the Revenue
District Office where you are registered and present the duly accomplished BIR
Form 1700, together with the required attachments and your payment.
Receive your copy of the duly stamped and validated form from the teller of
the AABs/Revenue Collection Officer/duly Authorized City or Municipal
Treasurer.
c) For Manual Filer
Fill-up the BIR Form No. 1700 in triplicate copies.
Proceed to the Revenue District Office where you are registered or to any Tax
Filing Center established by the BIR and present the duly accomplished BIR
Form 1700, together with the required attachments.
Receive your copy of the duly stamped and validated form from the RDO/Tax
Filing Center representative.
Deadline
On or before the 15th day of April of each year covering taxable income for
calendar year 2018 and thereafter
4. Annual Income Tax For Individuals, Estates, and Trusts
BIR Form 1701 - Annual Income Tax Return Individuals, Estates and Trusts
Documentary Requirements
a) Certificate of Income Tax Withheld on Compensation (BIR Form 2316), if
applicable
b) Certificate of Income Payments Not Subjected to Withholding Tax (BIR Form
2304), if applicable
c) Certificate of Creditable Tax Withheld at Source (BIR Form 2307), if applicable
d) Duly approved Tax Debit Memo, if applicable
e) Proof of Foreign Tax Credits, if applicable
f) Income Tax Return previously filed and proof of payment, if filing an amended
return for the same year
g) Account Information Form (AIF) or the Certificate of the independent Certified
Public Accountant (CPA) with Audited Financial Statements if the gross annual
sales, earnings, receipts or output exceed three million pesos (P3,000,000.00)
h) Account Information Form or Financial Statements not necessarily audited by an
independent CPA if the gross annual sales, earnings, receipts or output do not
exceed P3,000,000.00 and is subject to graduated income tax rates under Section
24(A)(2)(a)
i) Proof of prior year’s excess tax credits, if applicable
Procedures
a) For eFPS Filer
Fill-up applicable fields in the BIR Form No. 1701
Pay electronically by clicking the “Proceed to Payment” button and fill-up the
required fields in the “eFPS Payment Form” then click “Submit” button.
Receive payment confirmation from eFPS-AABs for successful e-filing and e-payment.
b) For Non-eFPS Filer
Fill-up fields in the BIR Form No. 1701 in the downloaded Electronic Bureau of
Internal Revenue Form (eBIRForm) Package
Print the duly accomplished BIR Form No. 1701
Proceed to the nearest Authorized Agent Bank (AAB) under the jurisdiction of
the Revenue District Office where you are registered and present the duly
accomplished BIR Form 1701, together with the required attachments and your payment.
In places where there are no AABs, proceed to the Revenue Collection Officer
or duly Authorized City or Municipal Treasurer located within the Revenue
District Office where you are registered and present the duly accomplished BIR
Form 1701, together with the required attachments and your payment.
Receive your copy of the duly stamped and validated form from the teller of
the AABs/Revenue Collection Officer/duly Authorized City or Municipal
Treasurer.
c) For Manual Filer
Fill-up the BIR Form No. 1701 in triplicate copies.
Proceed to the Revenue District Office where you are registered or to any Tax
Filing Center established by the BIR and present the duly accomplished BIR
Form 1701, together with the required attachments.
Receive your copy of the duly stamped and validated form from the RDO/Tax
Filing Center representative. Deadline
Final Adjustment Return or Annual Income Tax Return - On or before the 15th
day of April of each year covering income for calendar year 2018 and thereafter
5. Account Information Form For Self-Employed Individuals, Estates And Trusts
(Including Those With Mixed Income, i.e., Compensation Income and Income from
Business and/or Practice of Profession)
BIR Form 1701 AIF - Account Information Form for Self-Employed Individuals,
Estates and Trusts (Including those with Mixed Income, i.e., Compensation Income
and Income from Business and/or Practice of Profession) and Estates and Trusts
(Engaged in Trade or Business)
NOTE: Pursuant to Sec. 71 of RA 10963, otherwise known as Tax Reform
Acceleration and Inclusion Act, amending Sec. 232 of the Tax Code, as amended, in
relation to Revenue Memorandum Circular No. 6 – 2001, corporations, companies or
persons whose gross annual sales, earnings, receipts or output exceed P3,000,000
may not accomplish this form. In lieu thereof, they may file their annual income tax
returns accompanied by balance sheets, profit and loss statement, schedules listing
income-producing properties and the corresponding income therefrom, and other
relevant statements duly certified by an independent CPA.
Documentary Requirements
None
Procedures
a) Accomplish BIR Form 1701 AIF in triplicate.
b) Attach the same to BIR Form 1701.
Deadline
Same deadline as BIR Form 1701 - On or before the 15th day of April of each
year covering taxable income for calendar year 2018 and thereafter
6. Quarterly Income Tax for Individuals, Estates and Trusts Including Those with Mixed
Income, i.e., Compensation Income and Income from Business and/or Practice of
Profession
BIR Form 1701Q - Quarterly Income Tax Return For Individuals, Estates and Trusts
Documentary Requirements
a) Certificate of Creditable Tax Withheld at Source (BIR Form 2307), if applicable
b) Duly approved Tax Debit Memo, if applicable
c) Proof of other payment/s made, if applicable
d) Summary Alphalist of Withholding Agents of Income Payments Subjected to
Withholding Tax at Source (SAWT), if applicable
Procedures
a) For eFPS Filer
Fill-up applicable fields in the BIR Form No. 1701Q
Pay electronically by clicking the “Proceed to Payment” button and fill-up the
required fields in the “eFPS Payment Form” then click “Submit” button.
Receive payment confirmation from eFPS-AABs for successful e-filing and e-
payment.
b) For Non-eFPS Filer
Fill-up applicable fields in the BIR Form No. 1701Q in the downloaded
Electronic Bureau of Internal Revenue Form (eBIRForm) Package
Print the duly accomplished BIR Form No. 1701Q
Proceed to the nearest Authorized Agent Bank (AAB) under the jurisdiction of
the Revenue District Office where you are registered and present the duly
accomplished BIR Form 1701Q, together with the required attachments and your payment.
In places where there are no AABs, proceed to the Revenue Collection Officer
or duly Authorized City or Municipal Treasurer located within the Revenue
District Office where you are registered and present the duly accomplished BIR
Form 1701Q, together with the required attachments and your payment.
Receive your copy of the duly stamped and validated tax return and BIR
prescribed deposit slip from the teller of the AABs or Electronic Revenue
Official Receipt (eROR) from the Revenue Collection Officer/duly Authorized
City or Municipal Treasurer.
c) For Manual Filer
Fill-up the BIR Form No. 1701Q in triplicate copies (Compensation Income
need not be reported in the Quarterly Income Tax Return and is to be declared
only on the Annual Income Tax Return).
Proceed to the Revenue District Office where you are registered or to any Tax
Filing Center established by the BIR and present the duly accomplished BIR
Form 1701Q, together with the required attachments.
Receive your copy of the duly stamped and validated form from the RDO.
Deadlines
May 15 of the current taxable year– for the first quarter
August 15 of the current taxable year – for the second quarter
November 15 of the current taxable year – for the third quarter
B – Income Taxation Schemes
1. 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 file
income tax returns because the withheld tax constitutes the full tax due and are
therefore deemed final payments.
Final taxation is applicable only on certain passive income listed by law. Thus,
not all items of passive income is subject to final tax. Passive incomes subject to final
tax are those earned with very minimal or even without active involvement of the
taxpayer in the earning process. (ea. Interest income from banks, Dividends from
domestic corporations, Royalties, etc.)
2. Capital Gains Taxation
Capital gains tax is imposed on the gain realized on the sale, exchange and
other dispositions of certain capital assets. Capital assets are assets not used in
business, trade or profession. Capital assets are the opposites of ordinary assets,
which are being used in business, trade or profession, like, inventory, supplies or
property, plant and equipment.
Also, not all capital assets are subject to capital gains tax. Most of them are
subject to regular income tax.
The NIRC identifies capital gains tax as a final tax but they are hybrid forms of
final taxes since it also employs self-assessment method. The taxpayer still files capital
gains tax returns to report the gain and pay the tax to the government. Capital gains
taxation applies only to two types of capital assets: domestic stocks and real property.
3. Regular Income Taxation
The regular income tax is the general rule in income taxation and covers all
other income such as:
a) Active income
b) Other income
Gains from dealings in properties not subject to capital gains tax
Other passive income not subject to final tax.
C - Categories of Individual Income
1. Compensation Income
In general, the term “compensation” means all remuneration for services
performed by an employee for his employer under an employer-employee
relationship, unless specifically excluded by the tax code. It includes salaries, wages,
emoluments, honoraria, bonuses, allowances, fringe benefits, director’s fee, taxable
pension and retirement pay and other income of similar nature including
compensation paid in kind.
Income of similar nature includes proceeds from property sharing, COLA,
PERA, housing allowance, overtime pay, emergency pay, hazard pay, rice, groceries,
clothing and medical allowances.
Special Rules on Fringe Benefits tax
Fringe benefits refer to goods, services, or other benefits furnished or granted
by an employer, in cash or in kind, in addition to the basic salaries to managerial or
supervisory employees. A Fringe Benefit tax (FBT) of 35% is being imposed based on
the gross-up monetary value of benefits (RA No. 10963), which will be paid by the employer.
Benefits which are considered necessary to the business of the employer, or
are granted for the convenience of the employer are not subject to FBT.
Determination of Fringe Benefit Tax
Supposing Mr. X received P32,500 from Y Company, for his holiday expenses
as President of the company. Y Company. withheld and paid P17,500 in fringe benefit tax.
Computation:
Net amount of money received P32,500
Divide by current year’s factor - (100% - 35%) 65%
Gross up monetary value P50,000
Multiply by FBT rate 35%
Fringe benefit tax P17,500
2. Business Income Derived By Self-employed
Self-employed means a person engaged in trade or business or performs
services for others for a fee and who derived personal income from such activities.
Thus, self-employment income consists of earnings derived by individual from trade
or business or from services.
3. Professional Income Derived by Professionals
Professionals refer to persons who derived income from the practice of their
profession. The term includes lawyers, doctors, CPAs and other persons who are
registered with the Professional Regulatory Commission (PRC). It may also include
artists, athletes and others.
4. Passive Investment Income
It is an income that requires little to no effort to earn and maintain. It includes
rentals, interest, dividends, royalties, prizes, winnings, and partner’s share in the net
income after tax of partnership, joint venture or consortium. As with active income,
passive income is also taxable and usually subjected to final tax rather than graduated tax.
Illustration: Juana, single and a resident citizen have the following passive income for the year 2019.
Income from savings deposit P 75,000.00
Royalty from invention 80,000.00
Prize in a painting competition 50,000.00
Dividend received from domestic corporation 30,000.00
Total P 235,000.00

Computation of the total final tax of Juana.

Interest (P75,000 x 20%) P 15,000.00
Royalty (P80,000 x 20%) 16,000.00
Prize (P50,000 x 20%) 10,000.00
Dividend (P30,000 x 10%) 3,000.00
Total …………………………………….. P 44,000.00

5. Gains Derived from Dealings in Property

Sales or dealings in property, whether real or personal may result in gain or
loss to the taxpayer. The general rule is that the entire amount of gain or loss arising
from the transaction shall be taxable or deductible as the case may be. The gain or
loss is measured by getting the difference between the selling price and the cost of an
asset minus the corresponding accumulated depreciation or amortization.
Example: Supposing a patent with cost of P50,000 and an accumulated amortization
of P30,000 was sold for P25,000. Compute for taxable gain.
Solution: Cost of the patent P 50,000.00
Less: Acc. amortization 30,000.00
Net book value P 20,000.00
Sales amount 25,000.00
Taxable gain P 5,000.00

Module 6 Individual Income Taxation II

1. Familiarize tax table for individual income tax under the Train Law.
2. Identify the reforms made under the Train law (RA 10963).
3. Determine the individual income tax under the regular and 8% tax option.
4. Compute individual income tax under the Optional Standard Deductions (OSD).
A - Rates of Tax on Taxable Income of Individuals (TRAIN LAW)
Tax schedule effective January 1, 2018 until December 31, 2022 is as follows:
AMOUNT
RATES
Not Over P250,000
0%
Over P250,000 but not over P400,000
20% of the Excess Over P250,000
Over P400,000 but not over P800,000
P30,000 + 25% of the Excess over P400,000
Over P800,000 but not over P2,000,000
P130,000 + 30% of the Excess over P800,000
Over P2,000,000 but not over P8,000,000
P490,000 + 32% of the Excess over P2,000,000
Over P8,000,000
P2,410,000 + 35% of the Excess over P8,000,000
Tax schedule effective January 1, 2023 and onwards:
AMOUNT
RATES
Not Over P250,000
0%
Over P250,000 but not over P400,000
15% of the Excess Over P250,000
Over P400,000 but not over P800,000
P22,500 + 20% of the Excess over P400,000
Over P800,000 but not over P2,000,000
P102,500 + 25% of the Excess over P800,000
Over P2,000,000 but not over P8,000,000
P402,5000 + 30% of the Excess over P2,000,000
Over P8,000,000
P2,202,500 +35% of the Excess over P8,000,000
B - Reforms (Under RA 10963 or the TRAIN LAW, National Tax Research Center)
- Reduces number of tax brackets from 7 to 6;
- Exempts the first 250,000 annual taxable income of taxpayers;
- Sets the highest amount at more than P8 million and subjects it to a higher
marginal rate of 35%;
- Repeals the provision on basic personal and additional exemptions and
premiums paid on health and/or hospitalization insurance which are deemed
integrated into the P250,000 exempt threshold;
- Retains the income tax exemption of minimum wage earners;
- Retains the exemption from tax of de minimis benefits as well as the non-
taxability of mandatory contributions such as those made to the GSIS, SSS,
PhilHealth, PAG-IBIG Fund and union dues;
- Increases the amount of tax-exempt benefits ceiling (13th month pay and other
benefits) from P82,000 to P90,000;
- Imposes a 20% final tax on PCSO and lotto winnings exceeding P10,000;
- Removes the preferential tax rate of 15% for employees of regional or area
headquarters, offshore banking units and petroleum contractors and
subcontractors.
- Increases the fringe benefits tax (FBT) rate from 32% to 35%; and
- Inserts a provision that the Optional Standard Deduction by a general
professional partnership (GPP) may only be availed once, either by the GPP or the partners compromising such
partnership.
Tax Provisions
1. For Purely Self-Employed Individuals and/or Professionals Whose Gross Sales/Receipts and Other Non-Operating
Income Do Not Exceed the VAT Threshold of P3,000,000, the taxpayer may opt to use 8% Income Tax on Gross Sales or
Gross Receipts in Excess of P250,000 in Lieu of the Graduated Income Tax Rates and the Percentage Tax.
a) 8% Income Tax on Gross Sales or Gross Receipts in Excess of P250,000 in Lieu of the Graduated Income Tax Rates
and the Percentage Tax; Or
b) Income Tax Based on the Graduated Income Tax Rates
2. For Individuals Earning Both Compensation Income and Income from Business and/or Practice of Profession, their
income taxes shall be:
a) For Income from Compensation: Based on Graduated Income Tax Rates; and
b) For Income from Business and/or Practice of Profession:
If the total Gross Sales/Receipts Do Not Exceed VAT Threshold of P3,000,000, the Individual Taxpayer May Opt to Avail:
a) 8% Income Tax on Gross Sales/Receipts and Other Non-Operating Income in Lieu of the Graduated Income Tax Rates
and the Percentage Tax; Or
b) Income Tax Based on Graduated Income Tax Rates
If the total Gross Sales/Receipts Exceed VAT Threshold of P3,000,000
a) Income Tax Based on Graduated Income Tax Rates
Optional Standard Deductions (OSD)
Optional standard deduction is in lieu of the itemized deductions including Net Operating Loss Carry Over (NOLCO)
allowable under the NIRC and special laws. Under the OSD, the allowable deduction of the taxpayer is simply presumed
as a percentage of gross sales or receipts of individuals and gross income for corporations. The rate is 40% and there is
no need to support every item of expenses.
OSD is a proxy for itemized deductions. As a rule, all taxpayers who are subject to tax on taxable net income can claim
deductions except the following:
1. Non-resident alien engaged in trade and business. (NRA-ETB)
2. Taxpayers mandated to use itemized deductions.
On Certain Passive Income
1. Individual Citizens and Resident Aliens
Passive Income
Tax Rate
1. Interest from currency deposits, trust funds and deposit substitutes
20%
2. Royalties (on books as well as literary & musical compositions)
10%
- In general
20%
3. Prizes (P10,000 or less )
Graduated Income Tax Rates
- Over P10,000
20%
4. Winnings (except from PCSO and Lotto amounting to 20% P10,000 or less )
- From PCSO and Lotto amounting to P10,000 or less
exempt
5. Interest Income from a Depository Bank under the Expanded Foreign Currency Deposit System
15%
6. Cash and/or Property Dividends received by an individual from a domestic corporation/ joint stock company/ insurance
or mutual fund companies/ Regional Operating Headquarter of multinational companies
10%
7. Share of an individual in the distributable net income after tax of a partnership (except GPPs)/ association, a joint
account, a joint venture or consortium taxable as corporation of which he is a member or co-venture
10%
8. Capital gains from sale, exchange or other disposition of real property located in the Philippines, classified as capital
asset
6%
9. Net Capital gains from sale of shares of stock not traded in the stock exchange
15%
10. Interest Income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit
substitutes, investment management accounts and other investments evidenced by certificates in such form prescribed by
the Bangko Sentral ng Pilipinas (BSP)
Upon pre-termination before the fifth year, there should be imposed on the entire income from the proceeds of the
long-term deposit based on the remaining maturity thereof:
Holding Period
Exempt
- Four (4) years to less than five (5) years
5%
- Three (3) years to less than four (4) years
12%
- Less than three (3) years
20%
2. For Non-Resident Aliens Engaged in Trade or Business
A. Tax Rate in General – on taxable income from all sources within the Philippines
same manner as individual citizen and resident alien individual
B. Certain Passive Income
Tax Rates
1. Interest from currency deposits, trust funds and deposit substitutes
20%
2. Royalties (on books as well as literary & musical compositions)
10%
- In general
20%
3. Prizes (P10,000 or less )
Graduated Income Tax Rate
- Over P10,000
20%
4. Winnings (except from PCSO and Lotto)
20%
- From PCSO and Lotto
exempt
5. Cash and/or Property Dividends received from a domestic corporation/ joint stock company/ insurance/ mutual fund
companies/ Regional Operating Headquarter of multinational companies
20%
6. Share of a non-resident alien individual in the distributable
net income after tax of a partnership (except GPPs) of which he is a partner or from an association, a joint account, a joint
venture or consortium taxable as corporation of which he is a member or co-venture
20%
7. Interest Income from long-term deposit or investment in the form of savings, common or individual trust funds, deposit
substitutes, investment management accounts and other investments evidenced by certificates in such form prescribed by
the Bangko Sentral ng Pilipinas (BSP)
Upon pre-termination before the fifth year, there should be imposed on the entire income from the proceeds of the
long-term deposit based on the remaining maturity thereof: Holding Period
Exempt
- Four (4) years to less than five (5) years
5%
- Three (3) years to less than four (4) years
12%
- Less than three (3) years
20%
8. Capital from the sale, exchange or other disposition of real property located in the Philippines classified as capital asset
6%
9. Net Capital gains from sale of shares of stock not traded in the Stock Exchange
- Not over P100,000
5%
- Any amount in excess of P100,000
10%
3. For Non-resident Aliens Not Engaged in Trade or Business
1. Gross amount of income derived from all sources within the Philippines
25%
2. Capital gains from the exchange or other disposition of real property located in the Philippines
6%
3. Net Capital gains from the sale of shares of stock not traded in the Stock Exchange
- Not Over P100,000
5%
- Any amount in excess of P100,000
10%
4. For Alien Individuals Employed by Regional Headquarters (RHQ) or Area Headquarters and Regional Operating
Headquarters (ROH) of Multinational Companies, Offshore Banking Units (OBUs), Petroleum Service Contractor and
Subcontractor
Classification of Individual Income Taxpayers
1. Pure compensation income earner
2. Pure business or professional income earner
3. Mixed income earner
A. Comprehensive illustrations
On the gross income consisting of salaries, wages, annuities, compensation, remuneration and other emoluments, such
as honoraria and emoluments derived from the Philippines
Graduated Income Tax Rates
Case 1 - Mr. Juan dela Cruz, a citizen of the Philippines has generated an annual gross compensation income of
P415,000 with tax withheld of P5,000 for the year 2019. Statutory payments made to SSS amounted to P18,900, Pag-ibig
contribution – P7,250 and Philhealth – P2,350. He has also received 13th month pay and other bonuses amounting to
P92,000.
Required: Determine Mr. dela Cruz income tax due and tax payable or refundable.
Gross compensation income
P 415,000
Less
Statutory payments (SSS, Phil. Health, Pag-ibig)
P 28,500
Tax exempt 13th month pay and bonuses
90,000
118,500
Net taxable compensation income
P 296,500
Tax Due:
Basic per table
P0
Additional (P296,500 – P250,000) x 20%
9,300
Total tax due
P 9,300
Less: Income tax withheld
5,000
Income tax payable
P 4,300
Case 2 - Mr. Juan dela Cruz is an owner-manager of JDC Trading. The net sales generated during the year
amounted to P1,450,000. Cost of goods sold is P607,500, other taxable income is P100,000 and the operating expenses
is 290,000. Mr. dela Cruz opted to use itemized deduction in computing taxable income.
Required: Determine Mr. Juan dela Cruz income tax due.
Sales
P 1,450,000
Less Cost of sales
607,500
Gross Income
P 842,500
Add Other income
100,000
Total income
P 942,500
Less Operating expenses
290,000
Taxable Income from business
P 652,500
Tax Due:
Basic per table
P 30,000
Additional (P652,500 – P400,000) x 25%
63,125
Total tax due
P 93,125
Case 3 – Supposing Mr. Juan dela Cruz opted to use Optional Standard Deduction (OSD) his tax due would be:
Sales plus other income
P 1,550,000
Less OSD – (P1,550,000 x 40%)
620,000
Taxable income
P 930,000
Tax Due:
Basic per table
P 130,000
Additional (P930,00 – P800,000) x 30%
39,000
Tax due
P 169,000
Case 4 - Supposing Mr. Juan dela Cruz opted to use 8% income tax on gross sales/receipts in lieu of regular
income tax and percentage tax, the computation would be as follows:
Sales
P 1,450,000
Other income
100,000
Total income
P 1,550,000
Less Minimum bracket for taxable amount
250,000
Taxable income
P 1,300,000
Tax Due:
P 1,300,000 x 8%
P 104,000
Note: Income tax computation for individuals engaged in the practice of Profession is the same with illustration
number 2 above.
Case 4 – Supposing Mr. Juan dela Cruz is a mixed income earner with net taxable compensation income of P296,500
(case 1) and at the same time has P652,500 taxable income from business computed under regular tax option (case 2),
his tax due would be computed as follows:
Taxable compensation income
P 296,500
Taxable business income
652,500
Total taxable income
P 949,000
Tax Due:
Basic per table
P 130,000
Additional (P949,000 – P800,000) x 30%
44,700
P 174,700
Less: Withholding tax on compensation
5,000
Tax still due and payable
P 169,700
Case 5 – Using 8% Income tax option for business, the combined tax due and payable of Mr. J. dela Cruz will be
computed as follows:
Taxable compensation income
P 296,500
Tax due:
Basic per table
P 00
Additional (P296,500 – P250,000) x 20%
9,300
P 9,300
Gross receipts:
Sales
P 1,450,000
Other income
100,000
Total
P 1,550,000
Tax due:
P1,550,000 x 8%
124,000
Total tax due
P 133,300
Less: Income tax withheld
5,000
Tax due and payable
P 128,300 ========

Module 7
Corporate Income Taxation
Objectives:
1. Describe what corporate income taxation is?
2. Explain the concept of corporation for income tax purposes.
3. Enumerate and explain the general classification of corporate taxpayers.
4. Identify corporate tax schemes on regular corporations.
5. Familiarize with the minimum corporate income tax (MCIT).
6. State the rationale behind improperly accumulated earnings tax (IAET).
7. Determine corporate income tax due.
A. Introduction to Corporate Income Taxation
Corporations are subject to Final tax, Capital gains tax, and the Regular income
tax. The final tax and capital gains tax of corporations will be discussed in the next
lesson. Here, we shall focus our discussion on regular income tax of regular and special
corporate taxpayers and provides integration of the three tax schemes. The regular
income tax of corporations covers any income not subject to final tax or capital gains tax of corporations.
The term corporation shall include partnership, no matter how created or
organized, joint-stock companies, joint accounts, associations, or insurance companies.
It excludes general professional partnerships and a joint ventures or consortium formed
for the purpose of undertaking construction projects or engaging in petroleum, coal,
geothermal, and other energy operations pursuant to an operating consortium
agreement with the government.
B. General Classification and Taxation of Corporations
1. Domestic corporations – subject to 30% regular tax on world taxable income.
2. Resident foreign corporations – subject to 30% regular tax on Philippine taxable
income.
3. Non-resident foreign corporations – subject to 30% final tax on Philippine gross
income.
Illustration:
A-1 Corporation recorded the following income and expense during the
current taxable year:
Particulars Philippines Abroad Total
Gross income P 1,800,000 P 1,200,000 P 3,000,000
Less: Business expenses 1,200,000 800,000 2,000,000
Net income from operation P 600,000 P 400,000 P 1,000,000
Add: Interest from bank deposit 150,000 50,000 200,000
Net income P 750,000 P 450,000 P 1,200,000
The regular income tax of a domestic corporation shall be computed as follows:
Net income from operations (P600,000 + P400,000) P 1,000,000
Other income not subject to final tax 50,000
Taxable net income P 1,050,000
Corporate tax rate 30%
Regular corporate income tax due P 315,000
The regular income tax of a resident foreign corporation shall be computed
as follows:
Taxable net income (Philippine income only) P 600,000
Corporate tax rate 30%
Regular corporate income tax due P 180,000
A non-resident foreign corporation is not subject to the regular corporate
income tax but to a 30% final tax based on gross income from all sources within the
Philippines. Resident payors of the P1,800,000 gross income shall withhold
P540,000, computed as P1,800,000 x 30%, and remit the same to the BIR.
C. Special corporations
Certain corporations are subject to special tax treatments or preferential tax
rates lower than the 30% regular corporate income tax. These are generally referred
to as special corporations.
For easier understanding let us further classify the three broad classifications
of corporations to wit:
1. Domestic corporations
a) Tax-exempt domestic corporations
1. Exempt non-profit corporations under the NIRC
2. Government agencies and instrumentalities
3. Certain government-owned and controlled corporations
4. Cooperatives
b) Special domestic corporations
1. Proprietary educational institutions and non-profit hospitals
2. Foreign currency deposit units (FCDUs) and Expanded FCDUs
3. PEZA or BOI-registered enterprises
c) Regular domestic corporations
2. Resident foreign corporations
a) Special resident foreign corporations
1. Offshore banking units (OBUs) and Expanded FCDUs
2. Regional area headquarters and regional operating headquarters of
multinational companies.
3. International carriers
4. BOI or PEZA-registered enterprises
b) Regular resident foreign corporations
3. Non-resident foreign corporations
a) Special non-resident foreign corporations
1. Non-resident cinematographic film owner, lessor or distributor.
2. Non-resident lessor of vessels, chartered by the Philippine nationals.
3. Non-resident owner or lessor of aircraft, machineries and other
equipment.
b) Regular non-resident foreign corporations
Note on Qualification of Tax Exemption:
Income tax exemption relates only to income from related activities. Income
from activities unrelated to the purposes for which an exempt corporation is
organized and income from activities conducted for profit including income from
properties are taxable regardless of the disposition made of such income.
Since exemption applies only to income from related activities, the income of
exempt corporations are classified into income from related activities and income
from unrelated activities. The income from unrelated activities is subjected to
Regular corporate income tax (RCIT).
Illustration 1
Bahay Kalinga, a social welfare charitable non-profit corporation, reported
the following statement of income and expenses:
Particulars Related
Activities
Unrelated
Activities Total
Gross income P 800,000 P 400,000 P 1,200,000
Less: Expenses 400,000 150,000 550,000
Net income P 400,000 P 250,000 P 650,000
The income tax due of the corporation shall be:
Net income from unrelated activities P 250,000
Corporate tax rate 30%
Regular corporate income tax P 75,000
Illustration 2
Toma Sengla Tumba, a non-profit fraternal organization, received total
membership dues of P300,000. To finance its community development project, it
conducted a fund-raising drive by selling souvenir items to local tourists. The fund-
raising generated P200,000 income.
The organization shall pay income tax on the fund raising income as follows:
Net income from fund-raising activities P 200,000
Corporate tax rate 30%
Regular corporate income tax P 60,000
Note: Fund raising activities being commercial in nature are taxable. The
membership dues are tax exempt.
Private Educational Institution and Non-profit Hospital
Domestic private or proprietary educational institution and non-profit
hospitals are subject to 10% tax on world taxable income subject to the pre-
dominance test. A proprietary educational institution is any private school
maintained and administered by private individuals or groups with an issued permit
to operate from any of the following:
1. Department of Education (DepEd)
2. Commission on Higher Education (CHED)
3. Technical Education and Skills Development Authority (TESDA)
The Pre-dominance Test
If the gross income from unrelated trade, business or other activity exceeds
fifty percent (50%) of the total gross income derived by such educational institutions
or hospitals from all sources, the 30% corporate income tax applies.
Illustration 1
A private educational institution reported the following revenues and
expenses during the year:
Particulars Related
Activities
Unrelated
Activities Total
Gross income P 700,000 P 500,000 P 1,200,000
Less: Expenses 400,000 100,000 500,000
Net income P 300,000 P 400,000 P 700,000
The gross income from related activities (P700,00/P1,200,000 = 58%) passes the pre-
dominance test. Thus, the tax due shall be computed as follows:
Taxable net income P 700,000
Corporate tax rate 10%
Income tax due P 70,000
Illustration 2
A non-profit hospital reported the following during a year:
Particulars Related
Activities
Unrelated
Activities Total
Gross income P 500,000 P 700,000 P 1,200,000
Less: Expenses 100,000 400,000 500,000
Net income P 400,000 P 300,000 P 700,000
The gross income failed the pre-dominance test (P500K/P1,200K = 42%);
hence, the non-profit hospital shall be taxable as a regular corporation to wit:
Taxable net income P 700,000
Corporate tax rate 30%
Regular corporate income tax P 210,000
Summary of Tax Rules on Educational Institutions and Hospitals
Owner Educational Institutions Hospitals
Private 10% of taxable income 30% of taxable income
Non-profit Exempt 10% of taxable income
Government Exempt Exempt
Foreign/ Expanded Currency Deposit Unit/ Offshore Banking Unit
Foreign Currency Deposit Units (FCDUs) and Expanded FCDUs (EFCDUs) refer
to a unit or department of a local bank or local branch of a foreign bank authorized
by the BSP to engage in foreign currency-dominated transactions pursuant to RA
6426, as amended.
FCDUs are limited to short-term foreign currency transactions while EFCDUs
are allowed both short-term and longer term foreign currency-dominated
transactions.
An FCDU is a division of a domestic bank. An Offshore banking unit (OBU) is
division of a foreign bank which is authorized to conduct foreign currency dominated
transactions. An EFCDU may be a division of a domestic bank or a resident foreign
bank authorized to conduct banking under the expanded foreign currency deposit
system.
D. Minimum Corporate Income Tax
The most peculiar feature of corporate income taxation is the “Minimum
corporate Income Tax” (MCIT). Corporations are subject to a minimum corporate
income tax of 2% of gross income. As a minimum tax, the MCIT is payable when:
1. The corporation has zero or negative taxable income.
2. MCIT is greater than the regular corporate income tax (RCIT).
The MCIT is applicable to every corporation taxable to the 30% regular
corporate income tax including non-profit, exempt, and special corporations with
respect to their taxable income subject to regular corporate income tax, but not to
their income subject to special rates of tax.
MCIT is imposed beginning on the fourth taxable year immediately following
the year in which such corporation commenced it operations. Simply stated, MCIT
applies on the X + 4 th year of operations.
For instance, a corporation which started operations on any day in 2012 will
be covered by MCIT in 2016. The rule is apparently intended to enable the business
to obtain competitive traction before being subjected to MCIT.
MCIT Gross income under the NIRC
For corporation involved in: “Gross income” means:
Sale of goods Gross sales less sales returns, allowances,
discounts and cost of goods sold.
Sale of services Gross receipts less sales returns, allowances,
discounts and cost of services.
Thus, MCIT shall be computed as 2% of the total gross income subject to
regular income tax. Needless to say, the MCIT concept of gross income is the same
with the Optional Standard Deduction (OSD) concept of gross income.
Illustration:
A corporate taxpayer subject to MCIT reported the following:
Gross sales P 1,000,000
Sales discounts and allowances for defects 30,000
Sales returned by customers 20,000
Interest income from bank deposit 20,000
Rental income from vacant premises 60,000
Inventory, at the start of the year 220,000
Gross purchases of merchandise 700,000
Net freight on purchases during the year 25,000
Purchase discounts and allowances on defective merchandise 40,000
Purchases returned to suppliers 50,000
Inventory, at the end of the year 160,000
The cost of goods sold shall be first computed as follows:
Beginning inventory P 220,000
Add Net purchases
Gross purchases P 700,000
Add Freight in 25,000
Total cost of purchases P 725,000
Less Purchase discounts & allowances 40,000
Purchase returns 50,000 635,000
Total cost of goods available for sale P 855,000
Less Ending inventory 160,000
Cost of goods sold P 695,000
The minimum corporate income tax shall be computed as follows:
Gross sales P 1,000,000
Less Sales discounts and allowances P 30,000
Sales returns 20,000 50,000
Net sales P 950,000
Less Cost of goods sold 695,000
Gross income from operations P 255,000
Gross income from operations P 255,000
Add Rental income (other income not subject to
FT)
60,000
Total gross income P 315,000
Multiply by: MCIT rate 2%
Minimum Corporate Income Tax (MCIT) P 6,300
E. Basic Application of MCIT
Illustrative 1
A corporate taxpayer which started operations in 2017 had the following
results in the years 2020 and 2021:
Particulars 2020 2021
Total gross income P 2,100,000 P 4,000,000
Dividend income (domestic) - 50,000
Business expenses ( 2,600,000) ( 3,300,000)
Net income (Net loss) ( P 500,000) P 750,000
Here, the MCIT will commence in 2021. Since there is no MCIT yet, the tax
payable in 2020 is zero. The 2021 income tax due of the corporation shall be
determined as follows:
Total gross income P 4,000,000
Less Itemized deductions
Regular allowable deduction P 3,300,000
Net operating loss carry over
(NOLCO) - 2020
500,000 3,800,000
Taxable net income P 200,000
Corporate income tax rate 30%
Regular corporate income tax - 2021 P 60,000
Total gross income P 4,000,000
Multiply by: MCIT rate 2%
Minimum corporate income tax - 2021 P 80,000
Since the minimum corporate income tax in 2021 is higher than the regular
corporate income tax, the income tax due in 2021 would be P 80,000. Note that the
dividend income is exempt from regular income tax because it is subjected to final tax.
Illustrative 2
A corporation which started operation in 2016 has reported the following:
Particulars 2020 2021
Total gross income P 3,000,000 P 3,200,000
Less Regular allowable deductions 1,600,000 2,800,000
Special allowable deductions 400,000 500,000
Taxable net income P 1,000,000
(P 100,000)
Based on the above information, the RCIT and MCIT are as follows:
Particulars 2020 2021
RCIT – (30% of taxable net income) P 300,000 P 0
MCIT – ( 2% of gross income) P 60,000 P 64,000
The income tax due shall be P 300,000 P 64,000
Illustrative 3
PC Repair, a business partnership providing computer repair services,
reported the following on its sixth year of operation:
Service fees, net of 5% withholding tax P 1,900,000
Salaries of staff, supplies and other direct costs 1,000,000
Interest from bank deposit, net 50,000
Gain on sale of land classified as capital asset 400,000
Gain on sale of used equipment 150,000
Administrative business expenses 500,000
Estimated quarterly income tax payments 60,000

The RCIT and MCIT shall be computed as follows:

Service fees {P1,900,000 / (100%-5%)} P 2,000,000
Less Direct cost of services 1,000,000
Gross income from operations P 1,000,000
Add Ordinary gain on sale of equipment 150,000
Total gross income P 1,150,000
Less Regular allowable deductions 500,000
Taxable net income P 650,000
Multiply by: Corporate income tax rate 30%
Regular corporate income tax P 195,000

Total gross income P 1,150,000

Multiply by: MCIT rate 2%
Minimum corporate income tax P 23,000
The income tax due and payable of PC Repair shall be computed as:
Income tax due – RCIT P 195,000
Less Tax credits
Withholding tax on gross income P 100,000
Quarterly estimated tax payments 60,000 160,000
Income tax payable P 35,000
F. Excess MCIT Carry-Over
The excess of the MCIT over the RCIT in any year is a tax credit that is
deductible against any RCIT tax due in the immediately succeeding three years.
Rules:
1. Excess MCIT can be used only as a tax credit against RCIT tax due in any of
the three subsequent years. Excess MCIT cannot be deducted against MCIT tax due.
2. Credit for the excess MCIT from prior years can be taken up to the full
amount of RCIT tax due in the next three years. This means that the income
tax payable when credit is made can get below the amount of MCIT for that year.
3. When there are several excess MCITs from prior years, tax crediting shall be
made in the first in-first out basis.
4. Unused excess MCIT at the end of the three-year period shall expire and will
no longer be used.
Illustration 1
A corporation had the following MCIT and RCIT data since 2018:
Particulars 2018 2019 2020 2021
MCIT P 80,000 P 95,000 P 20,000 P 60,000
RCIT 20,000 85,000 40,000 80,000
Income tax due P 80,000 P 95,000 P 40,000 P 80,000
MCIT Excess (MCIT-RCIT) P 60,000 P 10,000 - -
Required: Ignoring the effects of creditable withholding tax and estimated tax
payments, compute the income tax payable.
Solutions:
In 2018, the income tax payable is the P80,000 MCIT. The P60,000 excess
MCIT, is a tax credit referred to as Excess MCIT-2018 and is valid until 2021.
In 2019, the income tax payable is the P95,000 MCIT. The P10,000 excess
MCIT, referred to as Excess MCIT- 2019 and is valid until 2022. No tax credit shall be
made since Excess MCIT cannot be credited against MCIT tax due.
In 2020, the income tax due is zero.
Particulars 2018 2019 2020
Excess MCIT, prior year P 60,000 P 10,000 P -
Income tax due 40,000
Tax credit ( 40,000) ( 40,000)
Adjusted Excess MCIT P 20,000 P 10,000 P 0
Note that the full credit against the available RCIT tax due is taken. Since there are
two excess MCITs, first-in first-out (FIFO) crediting is employed.
In 2021, the income tax payable is P50,000 computed as follows:
Particulars 2018 2019 2020 2021
Adjusted Excess MCIT P 20,000 P 10,000 P - P -
RCIT tax due 80,000
Tax credit ( 20,000) ( 10,000) ( 30,000)
Income tax payable P 0 P 0 P 0 P 50,000
Illustration 2
A corporation, which became subject to MCIT in 2020 had the following
statement of income in 2020 and 2021.
Particulars 2020 2021
Gross income P 300,000 P 500,000
Less: Business expenses 420,000 250,000
Net income (loss) (P 120,000) P 250,000
Required: Compute the income tax payable in each year.
Solution:
The 2021 taxable net income and RCIT shall be computed as follows:
Particulars 2020 2021
Total gross income P 300,000 P 500,000
Less Allowable deductions 420,000 250,000
Net income (NOLCO) (P 120,000) P 250,000
Less NOLCO-2020 application 120,000
Taxable net income (P 120,000) P 130,000
Taxable income P 0 P 130,000
Regular corporate income tax (30%) P 0 P 39,000
Minimum corporate income tax (2%) P 6,000 P 10,000
Excess MCIT P 6,000 P -
Income tax due P 6,000 P 39,000
Less: Excess MCIT-2020 6,000
Income tax payable (still due) P 33,000
Note: Recall that net operating loss is carried over as a deduction over three years
after its incurrence. Excess MCIT is likewise creditable over the same period.
G. Improperly Accumulated Earnings Tax (IAET)
IAET is a 10% penalty tax imposed on the improper accumulation of
corporate earnings beyond the needs of business. It is intended as a deterrent for
corporations intending to defeat the 10% dividend tax by mere non-declaration of
dividends.
The imposition of the 10% IAET is not automatic. It is only due only upon
formal assessment by the BIR upon determination of an improper accumulation of
earnings by the corporation.
The IAET covers the improperly accumulated earnings or profits of domestic
corporations only, whether special or regular domestic corporations. Certain
“appropriations” of earnings are not subject to IAET (ea. Mandatory, contractual and
reasonable appropriations).