INCOME TAXATION SCHEMES

a. Final income taxation

b. Capital gains taxation
c. Regular income taxation

CLASSIFICATION ITEMS OF GROSS INCOME

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

1. Gross income subject to final tax

2. Gross income subject to capital gains tax
3. Gross income subject to regular tax

FINAL INCOME TAXATION]

Final income taxation is characterized by financial taxes wherein full taxes are withheld by the income
tax payor at source. The recipient income taxpayer receives the income net of taxes. The payor is the
one required by the law to remit the tax to the government.

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

PASSIVE INCOME VS ACTIVE INCOME

Passive incomes are earned with very minimal or even without active involvement of the taxpayer in the
earning process.

EXAMPLES OF PASSIVE INCOME:

1. Interest income from banks

2. Dividends from domestic corporations
3. Royalties

Active or regular income arises from transactions requiring a considerable degree of effort or
undertaking from the taxpayer. It is the direct opposite of the passive income.

EXAMPLES OF ACTIVE INCOME:

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

CAPITAL GAINS TAXATION

Capital gains tax is imposed on the gain realized on the sale, exchange and other dispositions of cerain
capital assets.
Capital assets are assets not used in business, trade or profession. Capital assets are the opposites of
ordinary assets. Ordinary assets are assets used in business trade or profession such as inventory,
supplies or property, plant and equipment

Also, not all capital gains are subject to capital gains tax. Most of them are subject to regular income tax.

REGULAR INCOME TAXATION

The regular income tax is the general rule in income taxation and covers all other income such as:

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

Items of gross income from these sources are valued or measured using an accounting method,
accumulated over an accounting period, and reported to the government through an income tax return

ACCOUNTING PERIOD

Accounting period is the length of time over which income is measured and reported

Types of accounting period

1. Regular accounting period – 12 months in length

a. Calendar
b. Fiscal
2. Short accounting period – less than 12 months

Calendar year

The calendar accounting period starts from January 1 and ends December 31. This accounting period is
available to both corporate taxpayers and individual taxpayers.

Under the NIRC, the calendar year shall be used when the:

1. Taxpayer’s annual accounting period is other than a fiscal year (i.e. longer than 12 months in
length)
2. Taxpayer has no annual accounting period (i.e. less than 12 months in length)
3. Taxpayer does not keep books
4. Taxpayer is an individual

Fiscal year

A fiscal accounting period is any 12-month period that ends on any day other than December 31. The
fiscal accounting period is available only to corporate income taxpayers and is not allowed to individual
income taxpayers.
Deadline of Filling the Income Tax Returns

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

INSTANCES OF SHORT ACCOUNTING PERIOD

1. Newly commenced period – The accounting period covers the date of the start of the business
until the designated year-end of the business.
2. Dissolution of the business – the accounting period covers the start of the current year to the
date of dissolution of the business.
3. Change of accounting period by corporate taxpayers – The accounting period covers the start
of the previous accounting period up to the designated year-end of the new accounting period.
Note that BIR approval is required in changing an accounting period. It is not automatic
4. Death of taxpayer – The accounting period covers the start of the calendar year until the death
of the taxpayer
5. Termination of the accounting period of the taxpayer by the Commissioner of Internal
Revenue – The accounting period covers the start of the current year until the date of the
termination of the accounting period

ACCOUNTING METHODS

Accounting methods are accounting techniques used to measure income.

Types of Accounting Methods

1. General methods
a. Accrual basis
b. Cash basis
2. Installment and deferred payment method
3. Percentage of completion method
4. Outright and spread-out method

General methods for income from sale of goods or service

1. Accrual Basis
Under the accrual basis of accounting, income is recognized when earned regardless when
received. Expense is recognized when incurred regardless of when paid.
2. Cash Basis
Under the cash basis of accounting, income is recognized when received and expense is
recognized when paid.

1. Advanced income is taxable upon receipt – income received in advance is taxable upon receipt in
pursuant to the LIFEBLOOD DOCTRINE and the ABILITY to PAY THEORY. The subsequent taxation of
 advanced income in the period earned will expose the government to risk of non-collection. This
rule is applicable in the sale of services not on goods.
2. Prepaid expense is non-deductible – prepaid expenses are advanced payment for expenses of
future taxable periods. They are not deductible against gross income in the year paid. They are
deducted against income in the future period they expire or are used in the business, trade or
profession of the taxpayer.
Normally, the expensing of prepayments does not properly reflect the income of the taxpayer. It
also contradicts the Lifeblood Doctrine as it effectively defers the recognition of income.
3. Special tax accounting requirement must be followed – there are cases where the tax law itself
provides for a specific accounting treatment of an income or an expense. The specified method
must be observed even if it departs from the basis regularly employed by the taxpayer in keeping
his books.

The tax accrual basis income is determined as follows:

Cash income P XXX,XXX
Accrued (uncollected) income XXX,XXX
Advanced income XXX,XXX
Gross income P XXX,XXX
The tax accrual basis expense is determined as follows:
Cash expenses P XXX,XXX
Accrued (unpaid) expense XXX,XXX
Amortization of prepayments and
depreciation of capital expenditures P XXX,XXX
Deductions P XXX,XXX
The tax cash basis income is determined as follows:
Cash income P XXX,XXX
Advanced income XXX,XXX
Gross income P XXX,XXX
The tax cash basis expense is determined as follows:
Cash expenses P XXX,XXX
Amortization of prepayments and
depreciation of capital expenditures P XXX,XXX
Deductions P XXX,XXX
Installment method
Under the instalment method, gross income is recognized and reported in proportion to the collection
from the instalment sales
Installment method is available to the following taxpayers:
1. Dealers of personal property on the sale of properties they regularly sell
2. Dealers of real properties, only if their initial payment does not exceed 25% of the selling price
3. Casual sale of non-dealers in property, real or personal, when their selling price exceeds P1,000
and their initial payment does not exceed 25% of the selling price
Initial payment

Initial payment means total payments by the buyer, in cash or property, in the taxable year the sale
was made. The term initial payment is broader than downpayment. It also includes the installment
payments in the year of sale

Selling price

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

Cash received and/or receivable P XXX,XXX

Fair market value of property received or receivable XXX,XXX

Mortgage or any indebtidness assumed by the buyer XXX,XXX

Selling price P XXX,XXX

Contract price

The contract price is the amount receivable in cash or other property from the buyer. It is usually the
selling price in the absence of any agreement whereby the debtor assumes indebtedness by the
property.

Comprehensive illustration

Canlubang Company, a car dealer, sold a machine with a tax basis of P 1,200,000 on installment on
January 3, 2020. Canlubang received a P 200,000 cash downpayment and a P 1,800,000 prommisory
note for the balance payable in six installment of P 300,000 every July 3 and January 3 thereafter.

The selling price and gross profit on the sale is computed as follows:

Cash downpayment P 200,000

Notes receivables 1,800,000

Selling price P 2,000,000

Less: tax basis of machine sold ( 1,200,000)

Gross profit P 800,000

ACCRUAL BASIS

Under the accrual basis, the entire P800,000 gross profit shall be reported as gross income in 2016, the
year of sale

Installment basis
Canlubang cannot readily use the instalment method because it is a dealer of cars rather than a dealer
of machineries. The sale of properties of which the seller is not a dealer is referred to as a casual sale.
Hence, the ratio of the initial payment shall be tested first.

The initial payment of Canlubang can be computed as follows:

Cash downpayment (January 3,2020) P 200,000

First installment (July 3 2020) 300,000

Initial payment P 500,000

Ratio of initial payment (P 500,000/ P 200,000) 25%

The gross profit will be reported in gross income throughout the installment period by the formula
(Collection/contract price) x Gross profit

Canlubang shall recognize the following gross income:

At the date of sale (P200K/P2M x P800,000) P 80,000

Upon every instalment (P300K/P2M x P800,000) P 120,000

With indebtedness assued by the buyer

The application of the installment method will slightly vary when the buyer assumes indebtedness on
the property sold

In this case, the selling price is no longer the contract price. The contract price is the residual amount
after deducting the mortgage from the selling price. Thus,

Selling price P XXX,XXX

Less: Mortgaged assumed by the buyer XXX,XXX

Contract price P XXX,XXX

Deferred payment method

The deferred payment method is a variant of the accrual basis and is used in reporting income when a
non-interest bearing note is received as consideration in a sale.

Under the deferred payment method, the gross income is computed based on the present value
(discounted value) of a note receivable from the contract. The discount interest on the note is
amortized (i.e. spread) as interest income over the installment term.
INCOME FROM LEASEHOLD IMPROVEMENT

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

Under Revenue Regulations No.2, the income from leasehold improvement can be reported using
either of the following method at the option of the taxpayer:

1. Outright method – The lessor may report as income the fair market value of such building or
improvements subject to the lease at the time when such buildings or improvements are
completed.
2. Spread-out method – The lessor may spread over the life of the lease the estimated depreciated
value of such buildings or improvements at the termination of the lease and report as income for
each year of the leasevan aliquot par thereof.
The depreciated value of the leasehold improvement is computed as:
Cost of improvement X Excess over life over lease term
Useful life f the improvement