Republic of the Philippines

Capiz State University

Pontevedra Campus

BA 223 – INCOME TAXATION

MODULE 3: INTRODUCTION TO
INCOME TAXATION

This module discusses the concept of tax income, the situs of income. And the types
of taxpayers.
After this module, readers are expected to comprehend and demonstrate
knowledge on the following:
1. The concept of gross income
2. The types of income taxpayers
3. The general rules in income taxation
4. The income tax situs rules

ELYCA S. ARIAGA, CPA

Course Facilitator
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COLLEGE OF MANAGEMENT
THE CONCEPT OF INCOME
Why is income subject to tax?
Income is regarded as the best measure of taxpayers’ ability to pay tax. It is an excellent object of taxation in the
allocation of government costs.
What is income for taxation purpose?
The tax concept of income is simply referred to as “gross income” under NIRC. A taxable item of income is
referred to as an “item of gross income” or “inclusion in gross income”.
Gross income simply means taxable income in layman’s term. Under the NIRC however, the term “taxable
income” refers to certain items of gross income less deduction allowable by law. Technically, gross income is
broader to pertain to any income that can be subjected to income tax.
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.
ELEMENTS OF GROSS INCOME
1. It is a return on capital that increases net worth.
2. It is realized benefit.
3. It is not exempted by law, contract, or treaty.
RETURN ON CAPITAL
Capital means any wealth or property. Gross income is a return on wealth or property that increases the taxayer’s
net worth.
Illustration:
ABC purchase goods for P300, and sold them for P500. The P500 consideration can be analyzed as follows:
Selling price (total consideration received) P500 Total return
Cost (value of inventory forgone) 300 Return of capital
Mark-up (gross income) P200 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 an ability to pay tax.
REALIZED BENEFIT
What is meant by realized benefit?
The “benefit” concept
The term “benefit” means any form of advantage derived by the taxpayer. There is benefit when there is increase
in the net worth of the taxpayer. An increase in net worth occurs when one receives income, donation or
inheritance.
The following are not benefits, hence, not taxable:
a. Receipt of a loan – properties increase but obligation also increase resulting in an offsetting effect in net
worth.
b. Discovery of lost properties – under the law, the finder has an obligation to return the same to the owner.
c. Receipt of money of property to held in trust for, or to be remitted to another person
If the taxpayer is entitled to keep for his account portion of a receipt, only that portion is a benefit.

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The “realized” concept
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 a realized benefit:
1. There must be an exchange transaction.
2. The transaction involves another entity.
3. It increases the net worth of the recipient.
Types of Transfers
1. Bilateral transfers or exchanges, such as:
a. Sale
b. Barter
These are referred to as “onerous transactions”.
2. Unilateral transfers, such as:
a. Succession – transfer of property upon death
b. Donation
These are also referred to as “gratuitous transactions”.
Under current usage, unilateral transfers are simply referred to as “transfers” while bilateral transfers are called
“exchanges”. Benefits derived from onerous transactions are “earned or realized”; hence, they are subject to
income tax. Benefits derived from gratuitous transactions are not realized because of the absence of an earning
process. Benefits derived from gratuitous transactions are subject to transfer tax, not income tax.
3. Complex transactions
Complex transactions are partly gratuitous and partly onerous. These are commonly referred to as “transfers
for less than full and adequate consideration’. The gratuitous portion of the transaction is subject to transfer
tax while the benefit from the onerous portion is subject to income tax.
Illustration:
The taxpayer sold his car which was previously purchased for P100,000 and with a current fair value of P180,000
for only P130,000.
The transaction will be analyzed as follows:
Fair value P180,000
P50,000 – Subject to transfer tax
Selling price P130,000
P30,000 – Subject to income tax
Cost P100,000
The excess of fair value over selling price is a gratuity whereas the excess of the selling price over the cost is an
item of gross income.
Basis of Exemption of Unrealized Income
Normally, taxpayers will have the ability to pay tax when their income materializes in an exchange transaction
since tax is generally payable in money.
This does not mean, however, that only income realized in cash is subject to tax. Income realized in non-cash
properties are, in effect, received in cash but the taxpayer used the same to acquire the non-cash property. Income
received on non-cash considerations is taxable at the fair value of the property received. Moreover, exempting
income realized in non-cash considerations would open wide avenue for tax evasion.
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Mode of Receipt/Realization Benefits
Taxable items of income may be realized by the taxpayers in two ways:
1. Actual receipt
Actual receipt involves actual physical taking of the income in the form of cash or property.
2. Constructive receipt
Constructive receipt involves no actual physical taking of the income but the taxpayer is effectively
benefited.
Examples:
a. Offset of debt of the taxpayer in consideration for the sale of goods or service
b. Deposit of the income to the taxpayer’s checking account
c. Matured detachable interest coupon bonds not yet encashed by the taxpayer
d. Increase in the capital of a partner from the profit of the partnership
Inflow of wealth without increase in net worth
The inflow of wealth to a person that does not increase his net worth is not income due to the total absence of
benefit.
Examples:
a. Receipts of property in trust
b. Borrowing of money under an obligation to return
In law, the proceeds of embezzlement or swindling where money is taken without an original intention to return
are considered as income because of the increase in net worth of the swindler.
NOT EXEMPTED BY LAW, CONTRACT, OR TREATY
An item of gross income is not exempted by the Constitution, law, contracts or treaties form taxation.
The following items of income are exempted by law from taxation; hence, they are not considered items of gross
income:
1. Income of qualified employee trust fund
2. Revenues of non-profit non-stock educational institutions
3. SSS, GSIS, Pag-Ibig, or PhilHealth benefits
4. Salaries and wages of minimum wage earners and qualified senior citizen
5. Income of foreign governments and foreign government-owned and controlled corporations
6. Income of international missions and organizations with income tax immunity
TYPE OF INCOME TAXPAYERS
A. Individuals
1. Citizen
a. Resident citizen
b. Non-resident citizen
2. Alien
a. Resident alien
b. Non-resident alien
i. Engaged in trade or business
ii. Not engaged in trade or business

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 3. Corporations
a. Domestic corporation
b. Foreign corporation
i. Resident foreign corporation
ii. Non-resident foreign corporation
INDIVIDUAL INCOME TAXPAYERS
Citizens
Under the Constitution, citizens are:
a. Those who are citizens of the Philippines at the time of adoption of the Constitution on February 2, 1987
b. Those whose fathers or mothers are citizens of the Philippines
c. Those born before January 17, 1973 of Filipino mothers who elected Filipino citizenship upon reaching
the age of majority
d. Those who are naturalized in accordance with law
Classification of citizens:
A. Resident citizen – A Filipino citizen residing in the Philippines
B. Non-resident citizen includes:
1. A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his
physical presence abroad with a definite intention to reside therein;
2. A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either
as an immigrant or for an employment on a permanent basis;
3. A citizen of the Philippines who works and derives income from abroad and whose employment
thereat requires him to be physically present abroad most of the time during the taxable year;
4. A citizen who has been previously considered as non-resident citizen and who arrives in the
Philippines at anytime during the taxpayer year to reside permanently in the Philippines shall
likewise be treated as a non-resident citizen for the taxable year in which he arrives in the Philippines
with respect to his income derived from sources abroad until the date of his arrival in the Philippines
Filipino working in the Philippine embassies or Philippine consulate offices are not considered non-
resident citizens.
Alien
A. Resident alien – an individual who is residing in the Philippines but is not a citizen thereof, such as:
1. An alien who lives in the Philippines without definite intention as to his stay; or
2. One who comes to the Philippines for a definite purpose which in its nature would require an
extended stay and to that end makes his home temporarily in the Philippines, although it may be
his intention at all times to return to his domicile abroad;
An alien who has acquired residence in the Philippines retains his status as such until he abandons the
same or actually departs from the Philippines.
B. Non-resident alien – an individual who is not residing in the Philippines and who is not a citizen
thereof
1. Non-resident aliens engaged in business (NRA-ETB) – aliens who stayed in the Philippines for
an aggregate period of more than 180 days during the year
2. Non-resident aliens not engaged in business (NRA-NETB) – include:
a. Aliens who come to the Philippines for a definite purpose which in its nature may be
promptly accomplished;
b. Aliens who shall come to the Philippines and stay therein for an aggregate period of not
more than 180 days during the year

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THE GENERAL CLASSIFICATION RULE FOR INDIVIDUALS
1. Intention
The intention of the taxpayer regarding the nature of this stay within or outside the Philippines shall
determine his appropriate residency classification. The taxpayers shall submit to the CIR of the BIR
documentary proofs such as visas, work contracts and other documents indicating such intention.
2. Length of stay
In default of such documentary proof, the length of stay of the taxpayer is considered:
a. Citizens staying abroad for a period of a least 183 days are considered non-resident.
b. Aliens who stayed in the Philippines for more than 1 year as of the end of the taxable year are
considered resident.
c. Aliens who are staying in the Philippines for not more than 1 year but more than 180 days are
deemed non-resident aliens engaged in business.
d. Aliens who stayed in the Philippines for not more than 180 days are considered non-resident
aliens not engaged in trade or business.
Illustration 1
Luiz Mario Aresmendi, a Mexican actor, was contracted by a Philippines television company to do a project in
the Philippines. He arrived in the country on February 29, 2015 and returned to Mexico three weeks later upon
completion of the project.
Luiz Mario Aresmendi shall be classified as an NRA-NETB in 2015. His stay is for a definite purpose which in its
nature will be accomplished immediately.
Illustration 2
Mamoud Jibril, a Libyan national, arrived in the country on November 4, 2015. Mr. Jibril stayed in the
Philippines since then without any working visa or work permit.
For the year 2015, Mr. Jibril would be considered an NRA-NETB because he stayed in the Philippines for less
than 180 days as of December 21, 2015. If he is still within the Philippines until December 31, 2016, he will
quality as a resident alien for 2016.
Illustration 3
Without any definite intention as to the nature of his stay, Juan Masipag, a Filipino citizen, left the Philippines
and stayed abroad from March 15, 2014 to April 1, 2015 before returning to the Philippines.
For the year 2014, Juan is a non-resident citizen because he is absent for more than 183 days but he will be
classified as resident citizen for the year 2015.
CORPORATE INCOME TAXPAYERS
The term ‘corporation’ shall include partnerships, no matter how created or organized, joint-stock companies,
joint accounts, association, or insurance companies, except general professional partnerships and joint venture 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 under a service contract
with the government.
Hence, the term corporation includes profit-oriented and non-profit institutions such as charitable institutions,
cooperatives, government agencies and instrumentalities, associations, leagues, civic or religious and other
organizations.
Domestic Corporation
A domestic corporation is a corporation that is organized in accordance with Philippine laws.

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Foreign Corporation
A foreign corporation is one organized under a foreign law.
Types of foreign corporations:
1. Resident foreign corporation (RFC) – a foreign corporation which operates and conducts business in
the Philippines through a permanent establishment (i.e. a branch)
2. Non-resident foreign corporation (NRFC) – a foreign corporation which does not operate or conduct
business in the Philippines
Special Corporations
Special Corporations are domestic or foreign corporations which are subject to special tax rules or preferential
tax rates.
OTHER CORPORATE TAXPAYERS
1. Partnership
A partnership is a business organization owned by two or more persons who contribute their industry or
resources to a common fund for the purpose of dividing the profits from the venture.

Types of partnership
a. General professional partnerships (GPP)
A GPP is a partnership formed for the exercise of a common profession. All partners must belong
to the same profession.
A GPP is not treated as a corporation and is not a taxable entity. It is exempt form income tax, but
the partners are taxable in their individual capacity with respect to their share in the income of the
partnership.
b. Business partnership
A business partnership is one formed for profit. It is taxable as a corporation.
2. Joint venture
A joint venture is a business undertaking for a particular purpose. It may be organized as a partnership or
a corporation.

Types of joint ventures:

a. Exempt joint venture
Exempt joint ventures are those formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating
consortium agreement under a service contract with the Government.
Similar to a GPP, this type of joint venture is not treated as corporation and is tax exempt on its
regular income, but their venturers are taxable to their share in the net income of the joint venture.
b. Taxable joint ventures
All other joint ventures are taxable as corporations.
3. Co-ownership
A co-ownership is joint ownership of a property formed for the purpose of preserving the same and/or
dividing its income.
A co-ownership that is limited to property preservation or income collection is not taxable entity and its
exempt but the co-owners are taxable on their share on the income of the co-owned property.
However, a co-ownership that reinvests in income of the co-owned property to other income-producing
properties or ventures will be considered an unregistered partnership taxable as corporation.

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THE GENERAL RULES IN INCOME TAXATION
Taxable on income earned
Individual taxpayers Within Without
Note:
Resident Citizen ✓ ✓
Non-resident Citizen ✓ 1. Consistent with the territoriality rule,
Resident Alien ✓ all taxpayers, except resident citizens
Non-resident Alien ✓ and domestic corporations, are taxable
only on income earned within the
Corporate taxpayers Philippines.
2. The NIRC uses the term “without the
Domestic Corporation ✓ ✓ Philippines” means outside the
Resident Foreign Corporation ✓ Philippines.
Non-resident Foreign Corporation ✓

The Residency and Citizenship Rule

Taxpayers who are residents and citizen of the Philippines such as resident citizens and domestic corporations are
taxable on all income from sources within and without the Philippines. A corporation is a citizen of the country
of incorporation. Thus, domestic corporation is a citizen of the Philippines.
SITUS OF INCOME
The situs of income is the place of taxation of income. It is the jurisdiction that has the authority to impose tax
upon the income.
Situs of income vs. source of income
Situs of income should be differentiated from the source of income. The latter pertains to the activity or property
that produces the income.
Situs is important in determining whether or not an income is taxable in the Philippines. Situs is particularly
important to taxpayers taxable only on income within. However, it is also important to taxpayers taxable on
global income for purposes of the computation of the foreign tax credit.
INCOME SITUS RULES
Types of income Place of taxation (situs)
1. Interest income Debtor’s residence
2. Royalties Where the intangible is employed
3. Rent income Location of the property
4. Service income Place where the service is rendered
OTHER INCOME SITUS
A. Gain on sale of properties
1. Personal property
✓ Domestic securities – presumed earned within the Philippines
✓ Other personal properties – earned in the place where the property is sold
2. Real property – earned where the property is located
B. Dividend income from:
1. Domestic corporation – presumed earned within
2. Foreign corporation
a. Resident foreign corporation – depends on the pre-dominance test

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 The pre-dominance test
If the ratio of the Philippine gross income over the world gross income of the resident foreign
corporation in the three-year period preceding the year of dividend declaration is:
✓ At least 50%, the portion of the dividend corresponding to the Philippine gross income ratio is
earned within
✓ Less that 50%, the entire dividends received is earned abroad
b. Non-resident foreign corporation – earned abroad
C. Merchandising income – earned where the property is sold
D. Manufacturing income – earned where the goods are manufactured and sold
Operations Remark
Production Distribution
Within Within Total income from production and distribution is
earned within the Philippines
Without Without Total income from production and distribution is
earned without the Philippines
Within Without Production income is earned within, Distribution
income is earned without
Without Within Distribution income is earned within, Production
income is earned without

Module Actitvity
Activity 1: Indicate the amount representing return on capital or return on capital

Consideration For the loss of Return OF Capital Return ON

Capital
P600,000 P400,000 building
P500,000 P350,000 car
P600,000 Income
Activity 2: Indicate the appropriate classification for each of the following taxpayers:
DC – Domestic Corporation RC – Resident citizen
RFC – Resident Foreign Corporation NRC – Non-resident citizen
NRFC – Non-resident Foreign Corporation RA – Resident alien
NRA- ETB – Non-resident alien engaged in trade or business
NRA- NETB – Non-resident alien not engaged in trade or business
NT – Not a taxpayer

PERSON OR ENTITY CLASSIFICATION

1 A hardworking overseas Filipino worker
2 A Filipino who is privately employed in the Philippines
3 An unemployed Filipino residing in the Philippines
4 A Chinese businessman who has his domicile in the Philippines
for 6 months
5 A Japanese who married a beautiful Filipina and has been residing
in the Philippines
6 An American tourist visiting Boracay for vacation
7 A 2nd year Korean College student studying in the Philippines
8 A corporation incorporated under Philippine law
9 Trust designated by the donor as revocable
10 A business partnership composed of lawyers and accountants

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 11 A taxable joint venture organized in the Philippines
12 Jose, Filipino, one of the partners in a General Professional
Partnership organized under Philippine laws
13 American who came to visit his facebook chat mate

Activity 3: CASE PROBLEM: Johnny earns franchise fees from his Hot Burger franchise. He also deals in
various properties. Johnny realized the following gains in 2018:
• P200,000 royalty fees from local Hot Burger outlets
• P100,000 royalty fees from foreign Hot Burger outlets
• P50,000 gain from sales of equipment to foreign franchisees
• P80,000 gain from sales of equipment to local franchisees
• P50,000 gains from sale of investment in domestic stocks to foreign investors
• P40,000 gains from sale of investment in domestic stocks to Filipino investors
Compute the total income earned from sources
a. Within the Philippines
b. Without the Philippines

*** end of module 3 ***

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