CHAPTER 03: Introduction to Income Taxation

THE CONCEPT OF INCOME Capital Items Deemed with Infinite Value

(return of capital)
Why is income subject to tax?
1. Life
Income is regarded as the best measure
of taxpayers' ability to pay tax. It is an excellent  Value of Life: immeasurable by money
object of taxation in the allocation of  Tax Exemption under Sec. 32 of the NIRC
government costs. o Proceeds of life insurance policies paid
to heirs or beneficiaries upon the
What is income for taxation purposes?
insured's death are exempt from income
 Gross Income (taxable income) tax.
 includes any inflow of wealth that o Proceeds collected by an employer as a
increases net worth, from any source beneficiary from the life insurance of an
(legal or illegal) officer or related person are also
 Taxable Item of Income exempt.
 an "item of gross income" or "inclusion  View on Insurance Proceeds
in gross income"  considered as advanced recovery of
 Taxable Income future loss
 gross income minus deductions and
Taxable Return on Capital from Insurance
personal exemptions allowed by law
Policies
 gross income is broader and includes
any income subject to income tax a. Any excess amount received over premiums
 Sources of Gross Income paid by the insured upon surrender or maturity
 Employment of the policy (i.e. the insured outlives the policy.
 Trade, business, or profession
 If you have a life insurance policy and you outlive it, meaning the
 Properties policy matures while you're still alive, you might get some money
 Dealings in properties 
from it.
This money includes what you paid in premiums plus any extra
 Other regular or casual transactions amount.
 The extra amount you receive, beyond what you paid in, is
considered taxable income.
ELEMENTS OF GROSS INCOME
b. Gain realized by the insured from the
1. It is a return on capital that increases
assignment or sale of his insurance policy
net worth.
2. It is a realized benefit.  If you sell or transfer your life insurance policy to someone else, you
might make a profit.
3. It is not exempted by law, contract, or  This profit, which is the extra money you get beyond what you paid
treaty. into the policy, is considered taxable income.

I. RETURN ON CAPITAL c. Interest income from the unpaid balance of

the proceeds of the policy
 capital – any wealth or property
 If you receive life insurance proceeds and some of the money is paid
 gross income – a return on wealth property out to you over time, the unpaid balance might earn interest.
 This interest you earn on the unpaid balance is considered taxable
that increases the taxpayer's net worth income.
 return on capital
 increases net worth d. Any excess of the proceeds received over
 considered income and subject to the acquisition costs and premium payments by
income tax an assignee of a life insurance policy
 return of capital  If someone else (an assignee) buys your life insurance policy, they
 merely maintains net worth will pay acquisition costs and premium payments.
 When they eventually receive the proceeds from the policy, any
 not taxable amount they get that is more than what they paid for it (acquisition
costs and premiums) is considered taxable income.
 Taxation Principle
 improvement in net worth indicates an
ability to pay tax

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2. Health The following are not benefits, hence, not
taxable:
 any compensation received in consideration
for the loss of health such as compensation a. Receipt of a loan properties increase but
for personal injuries or tortuous acts obligations also increase resulting in an
offsetting effect in net worth.
3. Human Reputation (indemnity received for
b. Discovery of lost properties under the
its impairment)
law, the finder has an obligation to
EXAMPLES include moral damages received return the same to the owner.
from: c. Receipt of money or property to be held
in trust for, or to be remitted to another
a. Oral defamation or slander person.
b. Alienation of affection
c. Breach of promise to marry NOTE: If the taxpayer is entitled to keep for his
account portion of a receipt, only that portion is
Recovery of Lost Capital vs. Recovery of a benefit.
Lost Profits
The "realized" concept
 Loss of Capital results in a decrease in net
worth.  realized – earned; requires that there is a
 Loss of Profits does not decrease net degree of undertaking or sacrifice from the
worth. taxpayer to be entitled of the benefit
 Recovery of Lost Capital merely maintains
Requisites of a Realized Benefit
net worth.
 Recovery of Lost Profits increases net 1. There must be an exchange
worth, return on capital transaction.
2. The transaction involves another entity.
Taxable Recovery of Lost Profits
3. It increases the net worth of the
The recovery of lost profits through insurance, recipient.
indemnity contracts, or legal suits constitutes a
Types of Transfers
taxable return on capital.
1. Bilateral transfers or exchanges (onerous
The following are taxable recoveries of lost
transaction) – subject to income tax
profits:
a. Sale
a. Proceeds of crop or livestock insurance
b. Barter
b. Guarantee payments
c. Indemnity received from patent 2. Unilateral transfers (gratuitous transaction)
infringement suit – subject to transfer tax, not to income tax
NOTE: The recovery of lost income or profits is a. Succession
not intended to compensate for the loss of b. Donation
capital. It is as good as realization of income;
3. Complex transactions (partly gratuitous
hence, it is an item of gross income.
and partly onerous) – gratuitous portion:
II. REALIZED BENEFIT transfer tax; onerous portion: income tax
What is meant by realized benefit? "transfers for less than full and adequate
consideration”
The “benefit” concept
 the excess of fair value over selling
 benefit - any form of advantage derived by
price is a gratuity or gift
the taxpayer; an increase in net worth
 the excess of the selling price over the
occurs when one receives income, donation
cost is an item of gross income
or inheritance

What is meant by another entity?

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  Every person, natural or juridical, is an o Ability to pay tax arises when income
entity. materializes in an exchange transaction.
 Taxable Transactions o Tax is generally payable in money.
o Gains or income between separate  Taxation of Non-Cash Income
entities (relatives, corporations, o Income realized in non-cash properties
partners and partnerships) are is taxable.
taxable. o Such income is treated as if it were
o Income between affiliated received in cash used to acquire the
companies (parent companies, non-cash property.
subsidiaries, sister companies) is o Taxable at the fair value of the property
taxable since each corporation is a received.
separate entity.  Prevention of Tax Evasion
 Non-Taxable Transactions o Exempting non-cash income would
o Sales from a home office to its enable tax evasion.
branch office are NOT taxable o Taxpayers could easily divert income
(same entity). into non-cash forms to avoid taxation.
o Income between businesses of a
proprietor is NOT taxed since Mode of Receipt/Realization Benefits
proprietorships are not juridical 1. Actual receipt – actual physical taking of the
entities and are taxed as part of the income in the form of cash or property
owner.
2. Constructive receipt – no actual physical
Benefits in the Absence of Transfers taking of the income but the taxpayer is
Unrealized Gains or Holding Gains effectively benefited

 These are gains that have not yet Inflow of Wealth without Increase in Net
materialized through an exchange Worth
transaction.  not income due to the total absence of
 Not Taxable benefit
 increase in wealth from appreciation in
property value or decrease in EXAMPLES:
obligations (no sale or barter
a. Receipt of property in trust
transaction)
b. Borrowing of money under an obligation
EXAMPLES of unrealized gains or holding to return
gains:
NOTE: In law, the proceeds of embezzlement
a. Increase in value of investments in or swindling where money is taken without an
equity or debt securities original intention to return are considered as
b. Increase in value of real properties held income because of the increase in net worth of
(revaluation increment) the swindler.
c. Increase in value of foreign currencies
III. NOT EXEMPTED BY LAW, CONTRACT,
held or receivable
OR TREATY
Compensation from Rendering of Services
An item of gross income is not exempted by the
 an item of gross income since it is an Constitution, law, contracts or treaties from
exchange, no capital taxation.

Basis of Exemption of Unrealized Income TYPES OF INCOME TAXPAYERS

 Taxpayer Ability to Pay A. Individuals

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 1. Citizen A. Resident Alien - an individual living in the
a. Resident citizen Philippines who is not a citizen.
b. Non-resident citizen
1. An alien with no definite intention
2. Alien
regarding the length of stay.
a. Resident alien
2. An alien with a specific purpose
b. Non-resident alien
requiring an extended stay and
i. engaged in trade or business
temporarily makes the Philippines
ii. not engaged in trade or business
home, intending to return abroad
3. Taxable estates and trusts
eventually.
B. Corporations
 Residency Status: retained until the alien
1. Domestic corporation
abandons residence or leaves the
2. Foreign corporation
Philippines.
a. Resident foreign corporation
b. Non-resident foreign corporation B. Non-resident alien - an individual who is not
residing in the Philippines and who is not a
INDIVIDUAL INCOME TAXPAYERS
citizen thereof
Citizens
1. Non-resident aliens engaged in business
Under the Constitution, citizens are: (NRA-ETB) - aliens who stayed in the
Philippines for an aggregate period of MORE
a. Citizens as of February 2, 1987
THAN 180 DAYS during the year
(adoption of the Constitution)
b. Individuals with Filipino parents. 2. Non-resident aliens not engaged in
c. Born before January 17, 1973, to business (NRA-NETB)
Filipino mothers and chose Filipino
a. Aliens who come to the Philippines for a
citizenship at age of majority.
definite purpose which in its nature may
d. Naturalized according to the law.
be promptly accomplished;
Classification of Citizens b. Aliens who shall come to the Philippines
and stay therein for an aggregate period
A. Resident citizen – a Filipino citizen residing
of NOT MORE THAN 180 DAYS during
in the Philippines
the year
B. Non-resident citizen
THE GENERAL CLASSIFICATION RULE FOR
1. A Filipino with a physical presence abroad INDIVIDUALS
and a definite intention to reside there.
1. Intention
2. A Filipino who leaves the Philippines to
reside abroad as an immigrant or for  Residency Classification
permanent employment.  determined by the taxpayer’s intention
3. A Filipino who works abroad and is regarding the nature of their stay in or
physically present there most of the year. outside the Philippines
4. A previously non-resident Filipino returning  Documentation
to the Philippines to reside permanently is o Taxpayer must submit proofs (e.g.,
considered non-resident for the year of visas, work contracts) to the CIR of the
return, for foreign income until arrival date. BIR to support their residency
classification.
EXPN: Filipinos working in Philippine
 Effect of Documents
embassies or consulate offices are not non-
1. Short-term documents (e.g., tourist
resident citizens.
visa) do not change the taxpayer’s
normal residency.
2. Long-term documents (e.g.,
Alien immigration or working visa) lead to
automatic reclassification of residency.

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2. Length of stay operations under government service
contracts
 Citizens
 Scope: includes profit-oriented and non-
o Staying abroad for at least 183 days are
profit institutions
considered non-resident citizens. 1. Charitable institutions
 Aliens (staying in the Philippines) 2. Cooperatives
o RA: for more than 1 year by the end of 3. Government agencies and
the taxable year instrumentalities
o NRA-ETB: 180 days ≤ 1 year 4. Associations
o NRA-NETB: <180 days 5. Leagues
Taxable Estates and Trusts Domestic Corporation
1. Estate - properties, rights, and obligations of  a corporation that is organized in
a deceased person not extinguished by death accordance with Philippine laws
 Tax Treatment of Estates Foreign Corporation
a. Judicial Settlement
o Treated as individual taxpayers  one organized under a foreign law
o Estate is taxable on the income from Types of Foreign Corporations
the PROPERTIES left by the
decedent 1. Resident foreign corporation (RFC)
b. Extrajudicial Settlement  a foreign corporation which operates
o Treated as exempt entities and conducts business in the
o Income from the estate's properties Philippines through a permanent
is taxable to the HEIRS establishment (i.e. a branch)
2. Trust 2. Non-resident foreign corporation (NRFC)
 Tax Treatment of Trusts  a foreign corporation which does not
a. Irrevocable Trust operate or conduct business in the
 treated as an individual taxpayer Philippines
 income from the property held in
trust is taxable to the TRUST NOTE:
b. Revocable Trust 1. Domestic Corporation
 NOT a taxable entity  a corporation incorporated in the
 income from the property held in Philippines, even if controlled by
trust is taxable to the GRANTOR foreigners
 Presumption of Revocability 2. Foreign Corporation
o If the trust agreement does not specify,  Resident Foreign Corporation
the trust is presumed to be revocable.  taxable on transactions with
CORPORATE INCOME TAXPAYERS residents through its branch in the
Philippines
 Includes:  Non-Resident Foreign Corporation
1. One person corporations (OPC)  taxable on direct transactions with
2. Partnerships residents outside its branch
3. Joint-stock companies
4. Joint accounts
5. Associations
6. Insurance companies
 Excludes: 3. One-Person Corporation (OPC)
1. General professional partnerships  The individual establishing an OPC is
2. Joint ventures or consortia for taxable as a corporate taxpayer for OPC
construction projects or energy business transactions.

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  The individual is taxable as an individual Types of Joint Ventures
for personal transactions.
1. Exempt Joint Ventures
Special Corporations  formed for construction projects or
energy operations under a government
 domestic or foreign corporations which are
service contract
subject to special tax rules or preferential
 not treated as a corporation and is tax-
tax rates
exempt on regular income
OTHER CORPORATE TAXPAYERS  venturers are taxable on their share of
the joint venture's net income
1. One-person corporation (OPC) 2. Taxable Joint Ventures
 has a single stockholder who can be a  all other joint ventures are taxable as
natural person, trust, or estate corporations
 Restrictions: The following cannot 4. Co-ownership
incorporate as OPCs:
1. Banks and quasi-banks  joint ownership of a property for
2. Preneed, trust, insurance companies preservation or income division
3. Public and publicly-listed companies  not a taxable entity if limited to property
4. Non-chartered Government-Owned and preservation or income collection
Controlled Corporations (GOCCs)  co-owners are taxable on their share of
 Professional Restrictions the income
o A natural person licensed to exercise a  Taxable as a Corporation
profession cannot organize an OPC to o If co-ownership reinvests income
practice that profession, UNLESS into other income-producing
special laws allow it. properties or ventures, it is
considered an unregistered
2. Partnership partnership taxable as a corporation.
 a business organization owned by two or THE GENERAL RULES IN INCOME
more persons who contribute their industry TAXATION
or resources to a common fund for the
purpose of dividing the profits from the Taxable on
venture Income Earned
Within Without
Types of Partnership Individual Taxpayers
Resident citizen ✔ ✔
1. General Professional Partnership (GPP) Non-resident citizen ✔
 formed by persons to exercise a Resident alien ✔
COMMON profession Non-resident alien ✔
 no income from trade or business Corporate Taxpayers
 not treated as a corporation; not a Domestic corporation ✔ ✔
taxable entity Resident corporation ✔
 exempt from income tax Non-resident ✔
 partners are taxable individually on their corporation
share of the partnership income Basis of the Extraterritorial Taxation
2. Business Partnership
 Resident Citizens and Domestic
 formed for profit
Corporations
 taxable as a corporation
 derive most benefits from the Philippine
government due to proximity
3. Joint venture  enjoy preferential privileges over aliens
 Taxation of Foreign Income
 a business undertaking for a particular  reflects the difference in benefits
purpose; a partnership or a corporation consistent with the benefit received
theory
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  resident citizens and domestic B. Dividend income from:
corporations have full access to public
1. Domestic corporation – presumed earned
services
within
 Extra-Territorial Tax Treatment
 acts as a safety net against loss of tax 2. Foreign corporation – situs depends on the
revenues from income relocation or pre-dominance test
structuring to avoid Philippine taxes
The pre-dominance test
The Issue of International Double Taxation
• Philippine Gross Income Ratio (three-year
 Extraterritorial Taxation period preceding the year of dividend
 exposes resident citizens and domestic declaration)
corporations to double taxation
 Tax Credit o At least 50%: portion of the dividend
 NIRC allows a tax credit for taxes paid corresponds to the Philippine gross
in foreign countries income ratio
 resident citizens and domestic o Less than 50%: entire dividends
corporations pay minimal taxes in the received are considered earned abroad
Philippines on their foreign income due
• Dividends from Non-Resident Foreign
to this tax credit
Corporations
SITUS OF INCOME
o GENERALLY presumed earned abroad
 the place of taxation of income
due to the absence of Philippine
Situs of Income vs. Source of Income operations

 source of income - the activity or property C. Merchandising income – earned where the
that produces the income property is sold
 situs of income - determining whether or D. Manufacturing income – earned where the
not an income is taxable in the Philippines goods are manufactured and sold
INCOME SITUS RULES Operation
Productio Distributio Remarks
Types of Income Place of Taxation n n
(situs) Within Within Total income from
1. Interest income Debtor’s residence production and
distribution is earned
2. Royalties Where the intangible within the Philippines
is employed Without Without Total income from
3. Rent income Location of the production and
property distribution is earned
4. Service income Place where the without the Philippines
Within Without Production income is
service is rendered earned within, Distribution
income is earned without
Without Within Distribution income is
OTHER INCOME SITUS RULES earned within, Production
income is earned without
A. Gain on sale of properties
1. Personal property
a. Domestic securities – presumed
earned within the Philippines
b. Other personal properties –
earned in the place where the
property is sold
2. Real property – earned where the
property is located

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