b.2.3.

Tests in Determining Whether Income is Earned for Tax

Purposes

i. Realization test – no taxable income until there is a separation

from capital of something of exchangeable value, thereby
supplying the realization or transmutation which would result in
the receipt of income no taxable income until there is a
separation from capital of something of exchangeable value,
thereby supplying the realization or transmutation which would
result in the receipt of incomeThus, stock dividends are not
income subject to income tax on the part of the stockholder
when he merely holds more shares representing the same
equity interest in the corporation that declared stock dividends
[Fisher v Trinidad, supra].

ii. Claim of right doctrine (or Doctrine of Ownership, command,

or control) – a taxable

gain is conditioned upon the presence of a claim of right to the

alleged gain and the absence of a definite unconditional
obligation to return or repay that which would otherwise. a
taxable

gain is conditioned upon the presence of a claim of right to the

alleged gain and the absence of a definite unconditional
obligation to return or repay that which would otherwise
constitute a gain.constitute a gain. To collect a tax would give
the government an unjustified preference as to the part of the
money that rightfully and completely belongs to the victim. The
embezzler’s title is void.

iii. Economic benefit test, Doctrine of Pro\prietary Interest – any

economic benefit to the employee that increases his net worth,
whatever may have been the mode by which it is effected, is
taxable. any economic benefit to the employee that increases
his net worth, whatever may have been the mode by which it is
effected, is taxable. Thus, in stock options, the difference
between the fair market value of the shares at the time the
option is exercised and the option price constitutes additional
compensation income to the employee at the time of exercise
(not upon the grant or vesting of the right).

iv. Severance Test – under the doctrine of severance test of

income, in order that income may exist, is necessary that there
be a separation from capital of something of exchangeable
value. The income required a realization of gain. under the
doctrine of severance test of income, in order that income may
exist, is necessary that there be a separation from capital of
something of exchangeable value. The income required a
realization of gain.

v. All Events Test – Under the accrual method of accounting,

expenses are deductible in the taxable year in which: (1) all
events have occurred which determine the liability; and (2) the
amount of liability can be determined with reasonable accuracy.

“All events test” requires:(a)

Fixingarighttoincomeorliabilitytopay;

and

(b) The availability of reasonably accurate determination of

such income or liability. Under the accrual method of
accounting, expenses are deductible in the taxable year in
which: (1) all events have occurred which determine the
liability; and (2) the amount of liability can be determined with
reasonable accuracy.

“All events test” requires:(a)

Fixingarighttoincomeorliabilitytopay;

and

(b) The availability of reasonably accurate determination of

such income or liability.

All of the above tests are followed in the Philippines for

purposes of determining whether income is received by the
taxpayer or not during the year

(e) Net Operating Loss Carry Over (NOLCO)

Net operating loss (NOL) is the excess of allowable deductions

over gross income for any taxable year immediately preceding
the current taxable year. Net operating loss (NOL) is the excess
of allowable deductions over gross income for any taxable year
immediately preceding the current taxable year.

NOLCO: The NOL of the business or enterprise which had not

been previously offset as deduction from gross income shall be
carried over as a deduction from gross income for the next
three (3) consecutive taxable years immediately following the
year of such loss, provided however, that any net loss incurred
in a taxable year during which the taxpayer was exempt from
income tax shall not be allowed as a deduction. The NOL of the
business or enterprise which had not been previously offset as
deduction from gross income shall be carried over as a
deduction from gross income for the next three (3) consecutive
taxable years immediately following the year of such loss,
provided however, that any net loss incurred in a taxable year
during which the taxpayer was exempt from income tax shall
not be allowed as a deduction. [Sec. 34(3)(D), NIRC]

Exception: Mines other than oil and gas wells, where a net
operating loss without the benefit of incentives provided for
under EO No. 226 (Omnibus Investments Code) incurred in any
of the first ten (10) years of operation may be carried over as a
deduction from taxable income for the next five (5) years
immediately following the year of such loss.

Requisites for NOLCO:

(1) The taxpayer was not exempt from income tax the year the
loss was incurred;

(2) There has been no substantial change in the ownership of

the business or enterprise wherein:
(3) AT LEAST 75% of nominal value of outstanding issued
shares is held by or on behalf of the same persons; or

(4) AT LEAST 75% of the paid up capital of the corporation is

held by or on behalf of the same persons.

5. Taxable period

The accounting periods used in determining the taxable income

of taxpayers are:

(1) Calendar Year - Accounting period of 12 months ending on

the last day of December. Instances when the Calendar Year is
used for the computation of income:

i. If the taxpayer's annual accounting period is other than a

fiscal year; or

ii. If the taxpayer has no annual accounting period; or

iii. If the taxpayer does not keep books of accounts; or

iv. If the taxpayer is an individual [Sec. 43, NIRC].

(2) Fiscal Year - Accounting period of 12 months ending on the

last day of any month other than December [Sec. 22(Q), NIRC].

(3) Short Period - Accounting period which starts after the first
month of the tax year or ends before the last month of the tax
year (less than 12 months). Instances whereby short
accounting period arises:

i. When a corporation is newly organized.

ii. When a corporation is dissolved.

iii. When a corporation changes accounting period.

iv. When the taxpayer dies.

"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 under Title II (Tax on Income). 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 under Title II (Tax on Income).

taxable year includes, in the case of return made for a

fractional part of a year under the

provisions of Title II, the period for which such return is made [

6. Kinds of taxpayersTaxpayer – any person subject to tax

imposed

by Title II of the Tax Code [Sec. 22(N), NIRC].

Person – means an individual, a trust, estate or corporation

[Sec. 22(A), NIRC].

For income tax purposes, taxpayers are classified generally as

follows:

(1) Individuals;

(2) Corporations ;

(3) Partnerships (Ordinary and General Professional

Partnerships);

(4) Estates and Trusts; (5) Co-ownerships

b.3.5. Classification of Income Subject to Tax

i. Compensation Income

Income arising from an employer-employee (ER-

EE) relationship. It means all remuneration for

b.3.5. Classification of Income Subject to Tax

relationship) such as salaries and commissions,. These earnings

are subject to normal tax.

(2) Profession or Business Income

The value derived from an exercise of profession, business or

utiliation of capital including profit and gain derived from sale
or converstion of assets.

Examples are net income from business and gain from the sale
of assets used in trade or business. These earnings are subject
to normal tax.

(3) Passive Income

An income in which the taxpayer merely waits for the amount

to come in. Examples are royalty, interest, prizes, and winnings.
Generally, passive income is subject to final tax.

(4) Capital Gain

An income derived from sale of assets not used in trade or

business. Examples are sale of family home and other sales of
shares of stocks which are subject to final taxes. Other sales of
capital assets are subject to normal tax. [Valencia and Roxas]

Fringe Benefits and De Minimis

Fringe Benefits – any good, service, or other benefit furnished

or granted by an employer, in cash or in kind, in addition to
basic salaries of an individual employee. Fringe Benefits – any
good, service, or other benefit furnished or granted by an
employer, in cash or in kind, in addition to basic salaries of an
individual employee [Sec. 33, NIRC]

De Minimis – privileges of relatively small value as given by the

employer to his employees. privileges of relatively small value
as given by the employer to his employees.

Fringe Benefits and De Minimis are not considered

compensation subject to income tax and withholding tax.

b.4.4. Optional Standard Deduction

(a) Individuals, except non-resident aliens

May be taken by an individual in lieu of itemized deductions

except those earning purely compensation income.

If an individual opted to use OSD, he is no longer allowed to

deduct cost of sales or cost of services.

Amount: 40% of gross sales or gross receipts

b) Corporations, except non-resident foreign corporations

The option to elect Optional Standard Deduction granted is now

granted to corporations (domestic and resident foreign
corporations) by virtue of RA 9504. The OSD is 40% of its gross
income

b.3.6. Exclusions from gross income

Exclusions from gross income refer to income received or

earned but is not taxable as income because it is exempted by
law or by treaty. Such tax-free income is not to be included in
the income tax return unless information regarding it is
specifically called for. Receipts which are not in fact income are,
of course, excluded from gross income.

The exclusion of income should not be confused with the

reduction of gross income by the application of allowable
deductions. While exclusions are simply not taken into account
in determining gross income, deductions are subtracted from
gross income to arrive at net income.

iii. Exclusions Distinguished from Deductions and Tax Credit

Exclusions from gross income refer to flow of wealth to the

taxpayer which are not treated as part of gross income for
purposes of computing the taxpayer’s taxable income, due to
the following reasons: (1) it is exempted by the Constitution or
a statute; or (2) it does not come within the definition of
income.

Exclusions from gross income refer to flow of wealth to the

taxpayer which are not treated as part of gross income for
purposes of computing the taxpayer’s taxable income, due to
the following reasons: (1) it is exempted by the Constitution or
a statute; or (2) it does not come within the definition of
income.

Deductions, on the other hand, are the amounts which the law
allows to be subtracted from gross income in order to arrive at
net income.

Deductions, on the other hand, are the amounts which the law
allows to be subtracted from gross income in order to arrive at
net income.

b.4. Deductions from gross income

Deductions are items or amounts which the law allows to be

deducted from the gross of income of a taxpayer in order to
arrive at taxable income.

In general, deductions or allowable deductions are business

expenses and losses incurred which the law allows to reduce
gross business income to arrive at net income subject to tax.
[Sec. 65, Rev. Reg. No. 2]

Deductions are in the nature of an exemption from taxation;

they are strictly construed against the claimant, who must point
to a specific provision allowing them and who has the burden of
proving that they falls within the purview of such provision.
Thus, all deductions must be substantiated, except when the
law dispenses with the records, documents or receipts to
support the deductions.

If the exemption is not expressly stated in the law, the taxpayer

must at least be within the purview of the exemption by clear
legislative intent

b.4.1. General rules

(a) Deductions must be paid or incurred in connection with the

taxpayer’s trade, business or profession

(b) Deductions must be supported by adequate receipts or

invoices (except standard deduction)

(c) Additional withholding

requirement

b.4.3. Itemized Deductions

These are enumerated in Section 34 of the NIRC. Additional

deductions are granted to insurance companies in Section 37,
while losses from wash sales of stock or securities by a dealer
in securities are provided for in Section 38 of the NIRC. Other
itemized deductions could be granted under general or special
laws, e.g. additional training expenses are allowed to
enterprises registered with PEZA, BOI, and SBMA.

(1) Requisites for deductibility of business expenses.—

(a) Ordinary AND necessary;

ORDINARY - normal and usual in relation to the taxpayer's
business and surrounding circumstances; need not be recurring

NECESSARY - appropriate and helpful in the development of

taxpayer's business or are proper for the purpose of realizing a
profit or minimizing a loss

COHAN Rule: This relief will apply if the taxpayer has shown
that it is usual and necessary in the trade to entertain and to
incur similar kinds of expenditures, there being evidence to
show the amounts spent and the persons entertained, though
not itemized. In such a situation, deduction of a portion of the
expenses incurred might be allowed even if there are no
receipts or vouchers. Absence of invoices, receipts or vouchers,
particularly lack of proof of the items constituting the expense
is fatal to the allowance of the deduction [

COHAN Rule: This relief will apply if the taxpayer has shown
that it is usual and necessary in the trade to entertain and to
incur similar kinds of expenditures, there being evidence to
show the amounts spent and the persons entertained, though
not itemized. In such a situation, deduction of a portion of the
expenses incurred might be allowed even if there are no
receipts or vouchers. Absence of invoices, receipts or vouchers,
particularly lack of proof of the items constituting the expense
is fatal to the allowance of the deduction [

v. Income from Dealings in Property

Dealings in property such as sales or exchanges may result in

gain or loss. The kind of property involved (i.e., whether the
property is a capital asset or an ordinary asset) determines the
tax implication and income tax treatment, as follows:

Taxable Net Income = Ordinary Net Income + Net Capital Gains

(other than those subject to final CGT)

ZV = Zonal Value = value of the land or improvement, as

declared in the Real Property Declaration Form
FMV = Fair Market Value = FMV as determined by the
Commissioner of Internal Revenue

iii. Prizes and Awards

A prize is a reward for a contest or a competition. It represents

remuneration for an effort reflecting one’s superiority.

Contest prizes and awards received are generally taxable. Such

payment constitutes gain derived from labor.

The EXCEPTIONS are as follows:

. (a) Prizes and awards made primarily in recognition of

religious, charitable, scientific, educational, artistic, literary
or civic achievements are EXCLUSIONS from gross income
if:

. (b) The recipient was selected without any action on his part
to enter a contest or proceedings; and

. (c) The recipient is not required to render substantial future

services as a condition to receiving the prize or award.

. (d) Prizes and awards granted to athletes in local and

international sports competitions and tournaments held in
the Philippines and abroad and sanctioned by their
national associations shall be EXEMPT from income tax.

ix. Pensions, Retirement Benefit, or Separation Pay

Paid for past employment services rendered.

A stated allowance paid regularly to a person on his retirement

or to his dependents on his death, in consideration of past
services, meritorious work, age, loss or injury. It is generally
taxable unless the law states otherwise. [
B) Losses from Sales or Exchanges of Property. -
chanrobles virtual law library

In computing net income, no deductions shall in any case

be allowed in respect of losses from sales or exchanges
of property directly or indirectly -

(1) Between members of a family.

For purposes of this paragraph, the family of an

individual shall include only his brothers and sisters
(whether by the whole or half-blood), spouse, ancestors,
and lineal descendants; or

(2) Except in the case of distributions in liquidation,

between an individual and corporation more than fifty
percent (50%) in value of the outstanding stock of which
is owned, directly or indirectly, by or for such individual;
or

(3) Except in the case of distributions in liquidation,

between two corporations more than fifty percent (50%)
in value of the outstanding stock of which is owned,
directly or indirectly, by or for the same individual if
either one of such corporations, with respect to the
taxable year of the corporation preceding the date of the
sale of exchange was under the law applicable to such
taxable year, a personal holding company or a foreign
personal holding company;

(4) Between the grantor and a fiduciary of any trust; or

 (5) Between the fiduciary of and the fiduciary of a trust
and the fiduciary of another trust if the same person is a
grantor with respect to each trust; or

(6) Between a fiduciary of a trust and beneficiary of such

trust.