Chapter 3: Introduction to Income Tax Life - The value of life is immeasurable by money.

Under
the Tax Code, the proceeds of life insurance policies paid
Why is income subject to tax?
to the heirs or beneficiaries upon death of the insured,
Income is regarded as the best measure of taxpayers’ whether in a single sum or otherwise, are exempt from
ability to pay tax. It is an excellent object of taxation in income tax.
the allocation of government costs.
However, the following are taxable return on capital
What is income for taxation purposes? from insurance policies:

Gross income means the total income from all sources, a) Any excess amount received over premiums paid by
before any deductions or taxes. the insured upon surrender or maturity of the policy
(i.e., insured outlives the policy)
Under the NIRC, taxable income refers to certain items
of gross income less deductions allowable by law. b) Gains realized by the insured from the assignment or
sale of his insurance policy
Gross income is broadly defined as any inflow of wealth
to the taxpayer from whatever source, legal or illegal, c) Interest income from the unpaid balance of the
that increases net worth. It includes income from proceeds of the policy
employment, trade, business or exercise of profession,
d) Any excess of the proceeds received over the
income from properties, and other sources such as
acquisition costs and premiums payments by an
dealings in properties and other regular or casual
assignee of a life insurance
transactions.
Health - Any compensation received in consideration for
Elements of Gross Income
the loss of health such us compensation for personal
 It is a return on capital that increases net worth. injuries or torturous acts is deemed a return of capital.
 It is a realized benefit.
Human reputation - The value of one’s reputation
 It is not exempted by law, contract or treaty.
cannot be measured financially. Any indemnity received
Return on Capital as compensation for its impairment is deemed a return
of capital exempt from income tax. E.g.: moral damages
Capital means any wealth or property.
received from oral defamation, alienation of affection,
Gross income is a return on wealth or property that breach of promise to marry.
increases the taxpayer’s net worth.
Recovery of loss capital vs Recovery of loss profits
Illustration: ABC purchased goods for P300 and sold
The loss of capital results in decrease of net worth while
them for P500.
the loss of profits does not decrease net worth. The
How much is the return of capital? The return on recovery of lost capital merely maintains net worth
capital? while the recovery of lost profits increases net worth.
Therefore, the recovery of lost profits is a return on
Selling price: 500 – total return or consideration
capital.
received
Cost: 300 – return of capital Taxable recovery of lost profits: The recovery of lost
Gross income: 200 – return on capital profits through insurance, indemnity contracts, or legal
suits constitutes a taxable return on capital.
The return on capital that increases net worth is subject
to income tax. Return of capital merely maintains net  Proceeds of crop or livestock insurance
worth, hence, not taxable.  Guarantee payments
 Indemnity received from patent infringement
Capital Items Deemed with Infinite Value
suit
Realized Benefit a) Increase in the value of investments in equity or debt
securities
The term “benefit” means any form of advantage
b) Increase in the value of real properties held
derived by the taxpayer. There is benefit when there is
(revaluation increment)
an increase in the net worth of the taxpayer. An increase
c) Increase in value of foreign currencies held or
in net worth occurs when one receives income,
receivable
donation, or inheritance.
d) Increase in the value of land due to the discovery of
The following are not benefits, hence, not taxable: mineral reserves

a) Receipt of a loan – properties increase but obligations Rendering of services – the rendering of services for a
also increase resulting in an offsetting effect in net consideration is an exchange but does not cause loss of
worth capital. Hence, the entire consideration received from
rendering of services such as compensation income or
b) Discovery of lost properties – under the law, the
service fees is an item of gross income.
finder has an obligation to return the same to the owner

c) Receipt of money or property to be held in trust for,

or to be remitted to, another person

If a taxpayer is entitled to keep for his account portion of

receipt, only that portion is a benefit.

The term “realized” means earned. It requires that there

Mode of Receipt/Realization of Benefit
is a degree of undertaking or sacrifice from the taxpayer
to be entitled of the benefit. Actual receipt – involves actual physical taking of the
income in the form of cash or property
Requisites of a realized benefit:
a) There must be an exchange transaction Constructive receipt – involves no actual physical taking
b) The transaction involves another entity of the income but the taxpayer is effectively benefited.
c) It increases the net worth of the recipient
 Offset of debt of the taxpayer in consideration for
Bilateral transfer – onerous transactions (Sale, Barter) the sale of goods or service
They are referred to as “exchanges”. Benefits derived  Deposit of the income to the taxpayer’s checking
from onerous transactions are “earned realized”. account
 Increase in the capital of a partner from the profit of
Unilateral transfer – gratuitous transactions (Succession
the partnership
– transfer of property upon death, Donation) Simply
referred to as “transfers”. Benefits derived from Not Exempt by Law, Contract, or Treaty
gratuitous transactions are not realized because of the
An item of gross income is not exempted by the
absence of earning process. They are subject to transfer
Constitution, law, contracts, or treaties from taxation.
tax and not income tax.
The following items of gross income are exempted by
Benefits in the absence of transfer
law from taxation, hence, not considered items of gross
The increase in wealth of the taxpayer in the form of income:
appreciation or increase in the value of his properties or
 Income of qualified employee trust fund
decrease in the value of his obligations in the absence of
 Discovery of lost properties – under the law, the
a sale or barter transaction is not taxable.
finder has an obligation to return the same to the
These are referred to as unrealized gains or holding owner
gains because they have not yet materialized in an  Revenues of non-profit, non-stock educational
exchange transaction. institutions
 SSS, GSIS, Pag-IBIG, or PhilHealth Benefits presence abroad with a definite intention to reside
 Salaries and wages of MWEs and qualified senior therein;
citizens
A citizen of the Philippines who leaves the Philippines
 Regular income of BMBEs
during the taxable year to reside abroad, either as
 Income of foreign governments and foreign GOCCs
immigrant or for an employment on a permanent basis;
 Income of international missions and organizations
with income tax immunity A citizen of the Philippines who works and derives
income from abroad and whose employment thereat
Types of Income Taxpayers
requires him to be physically present abroad most of the
1. Individual time during the taxable year;

Citizens A citizen of the Philippines who has been previously

a) Resident citizen considered as non-resident citizen and who arrives in
b) Non-resident citizen the Philippines at any time during the taxable year to
reside permanently in PH shall likewise be treated as
Aliens
NRC for the taxable year in which he arrives in PH with
a) Resident alien
respect to his income derived from sources abroad until
b) Non-resident alien
the date of his arrival in the Philippines.
a) engaged in trade or business
b) not engaged in trade or business Classification of Aliens

2. Corporation RESIDENT ALIEN – An individual who is residing in the

a) Domestic corporation Philippines but is not a citizen thereof, such as: One who
b) Foreign corporation comes to the Philippines for a definite purpose which in
a) resident foreign corporation its nature would require an extended stay and to that
b) non-resident foreign corporation end makes his home temporarily in the Philippines,
although it may be his intention at all times to return to
his domicile abroad;
Individual Income Taxpayers
NON-RESIDENT ALIEN – An individual who is not
Under the Constitution, citizens are: residing in the Philippines and who is not a resident
thereof.
 Those who are citizens of the Philippines at the time
Non-resident aliens engaged in trade or business
of adoption of the Constitution on February 2, 1987.
(NRA-ETB) – aliens who stayed in PH for an aggregate
 Those whose fathers or mothers are citizens of the
period of more than 180 days during the year.
Philippines.
 Those born before January 17, 1973 of Filipino Non-resident aliens not engaged in trade or business
mothers who elected Filipino citizenship upon (NRA-NETB) – includes:
reaching the age of majority. a) Aliens who comes to PH for a definite purpose which
 Those who are naturalized in accordance with the in its nature may be promptly accomplished;
law. b) Aliens who shall come to PH and stay therein for an
aggregate period of not more than 180 days during the
Classification of Citizens
year
RESIDENT CITIZEN – A Filipino citizen residing in the
Intention
Philippines.
The intention of the taxpayer regarding the nature of his
NON-RESIDENT CITIZEN – includes the following:
stay within or outside the Philippines shall determine his
A citizen of the Philippines who establishes to the appropriate residency classification. The taxpayer shall
satisfaction of the Commissioner the fact of his physical submit to the CIR of the BIR documentary proofs such as
visas, work contracts, and other documents indicating taxable entities and are not considered as individual
intention. taxpayers. The income of properties under revocable
trusts are taxable to the grantor to the trust.
Documents purporting short-term stay such as tourist
visa shall not result in reclassification of the taxpayer’s When the trust agreement is silent as to the revocability,
normal residency. Documents purporting long-term stay it is presumed to be revocable
such as immigration visa or working visa for an extended
Corporate Income Taxpayers
period would result in automatic reclassification of the
taxpayer’s residency. The term corporation shall include one person
corporations (OPCs), partnerships, joint-stock
companies, joint accounts, association, or insurance
companies except general professional partnerships and
joint venture or consortium formed for particular
purpose or undertaking.

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 – is a corporation that is

organized in accordance with Philippine laws. It includes
one-person corporations owned and registered by
resident citizens in the Philippines.

FOREIGN CORPORATION – is one organized under a

foreign law.
Resident Foreign Corporation – a foreign corporation
which operates and conducts business in the Philippines
Taxable Estate and Trusts
through a permanent establishment (i.e., branch)
Estate – refers to properties, rights, and obligations of a Non-resident Foreign Corporation – a foreign
deceased person not extinguished by his death. corporation which does not operate or conduct business
in the Philippines.
Estate under judicial settlement are treated as individual
taxpayers. The state is taxable on the income of the Special Corporations
properties left by the decedent. Estates under extra-
Special corporations are domestic or foreign
judicial settlement are exempt entities. The income of
corporations which are subject to special tax rules or
properties of the estate under extrajudicial settlement is
preferential tax rates.
taxable to the heirs.
ONE-PERSON CORPORATION – one with a single
Trust – is an arrangement whereby one person (grantor
stockholder who may be a natural person, trust, or
or trustor) transfers (i.e., donates) property to another
estate.
person (beneficiary), which will be held under the
management of a third party (trustee or fiduciary). PARTNERSHIP – is a business organization owned by two
or more persons who contribute their industry or
A trust that is irrevocably designated by the grantor is
resources to a common fund for the purpose of dividing
treated in taxation as if it is an individual taxpayer. The
the profits from the venture.
property held in trust is taxable to the trust. Trusts that
GENERAL PROFESSIONAL PARTNERSHIP – formed by
are designated as revocable by the grantor are not
persons for the sole purpose of exercising a common  Non-resident foreign corporation – earned
profession, no part of the income of which is derived abroad
from engaging in any trade or business.
BUSINESS PARTNERSHIP – is formed for profit. It is
taxable as a corporation.

JOINT VENTURE – is a business undertaking for a

particular purpose. It may be organized as a partnership
or a corporation.

CO-OWNERSHIP – is a joint ownership of a property

formed for the purpose of preserving the same and/or
dividing its income

General Rules in Income Taxation

Other Income Situs Rules

GAIN ON SALE OF PROPERTIES:

Personal properties –

 Domestic securities – presumed earned within the

Philippines
 Other personal properties – earned in the place
where the property is sold

Real properties – earned where the property is located

DIVIDEND INCOME (from):

 Domestic corporation – presumed earned within

 Foreign corporation
 Resident foreign corporation – depends on the
pre-dominance test If the ratio of PH gross
income over the world of the RFC in the three-
year period preceding the year of dividend
declaration is: At least 50%, the portion of the
dividend corresponding to PH gross income ratio
is earned within. Less then 50%, the entire
dividends is received abroad