INCOME TAXATION, in general

8/13/2019 INCOME TAXATION, in general

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INCOME TAXATIONINCOME TAX, defined

- As a tax on all yearly profits arising from property, professions, trades, or offices,or as a tax on a persons income, emoluments, profits, and the like.

- Is a direct tax on actual or presumed income (gross/net) of a taxpayer received,accrued, or realized during the taxable year.

- Simply, a tax on income or on amount which increases the net worth or netvalue of the taxpayer

This definition is included because it is not in all cases where the BIR candetermine the income tax of a person based on his income alone. In somecases, taxpayers do not reflect their true sales or income, and they overstateor over claim their expenses in order to arrive at a lower taxable base ortaxable income as against which the income tax rates are to be computed. So,what the BIR does in order to assess taxpayers of their true income and

collect the true tax, is to simply determine the net worth of a taxpayer. What is net worth? Simply stated, it is your value. Assets less liabilities, this isyour net value. What the BIR does when it does not have books on which toaudit or no reliable books. Some taxpayers have at least two sets of books.They maintain two books of account. (refer to the illustration below) So,what they do is determine the net worth of the taxpayer from one point intime to another point in time, any increase, so if this is 2007 to 2009, no taxesare paid in between, would the BIR simply agree on no tax payment? Whatthey will do is compare the value. If this is 1 million and this is 10 million,there is an increase in the net worth of the taxpayer which is 9 million. 9million is an income although not fully declared as an income.

- So, income tax is a tax on declared income and those which is reflected from anincrease in the net worth or net value of the taxpayer because it will reflect thesources of the income by the taxpayer which is actually undeclared.

- Tax on all yearly profits arising from property, profession, trade or business, oras a tax on a persons income, emoluments, profits and the like. It is generallyregarded as an excise tax. It is not levied upon persons, property, funds orprofits but upon the right of a person to receive income or profits.

FEATURES OF THE PHILIPPINE INCOME TAX LAW1. Direct tax- The tax burden is borne by the income recipient upon whom the tax is imposed. It isa tax demanded from the very person whom it is intended or desired to pay for it.- In context, direct taxes are those that are exacted from the very person who, it isintended or desired, should pay them, they are impositions for which the taxpayer isdirectly liable on transaction or business he is engaged in (Silkair vs. CIR)


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- On the other hand, indirect tax are those that are demanded, in the first instance,from or are paid by, one person in the expectation and intention that he can shift theburden to someone else.- Direct tax vis--vis indirect tax, the difference lies in the liability to pay the tax andthe burden to pay the tax.

2. Progressive- as the tax base increases, the tax rate increases (5%-32%)- it is founded on the ability to pay principle and is consistent with the constitutional

provision that Congress shall evolve a progressive system of taxation.

3. Comprehensive Tax Situs-Criteria in imposing Philippine income tax

a. nationality/citizenship principle- A citizen of the Philippines is subjected to Phil income tax:

1. on his worldwide income from within and without the Phils, if he resides inthe Phils

2. only his income from sources within the Phil, if he qualifies as a non-resident citizen

b. Residence Principle-an alien is subject to Phil income tax on his worldwide income because of his

residence in the Phil. Thus, a resident alien is now liable to pay income tax only onhis income from sources within the Phil and is exempt from tax on his income fromsources outside the Phils.

c. Source Principle-an alien is subject to Phil income tax because he derives income from

sources within the Phils. Thus, a non-resident alien is liable to pay income tax fromsources within the Phil such as dividend, interest, rent or royalty despite the fact thathe has not set foot in the Phils.

4. Partly scheduler or party-global income tax system

- Under this system, the compensation income, business, or professional income,capital gain and passive income not subject to final withholding tax, and otherincome are added together to arrive at the gross income and after deducting thesum of allowable deductions is subjected to one set of graduated tax rates ornormal corporate income tax. --- GLOBAL

- Active and passive income are separated. In that Passive income is subjectedto a scheduler system of taxation and active income is subjected to global incometax system.

- However, passive investment income subject to final tax and capital gains fromthe sale or transfer of shares of stocks of a domestic corporation and real


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properties are subject to different tax rates and covered by different tax returns.--- SCHEDULAR

- The Philippine law is following the semi-global and semi-schedular system oftaxation because this is what is provided in the Tax Code.

- Why is it semi-schedular? Give me an example of a scheduler tax rate. Because

the income is treated differently according to a taxpayers ability to pay. An example is Income tax on individuals.- Illustration:

Active (compensation + illegal source)PassiveTax RateTax

Systems of Income Taxation

a. Schedular Income Tax System

- follows a schedule of rates. The Tax Code or Congress treats differently everycategory of income earners.

- Under the schedular tax system, different types of incomes are subject todifferent sets of graduated or flat income tax rates. The applicable tax rate(s) willdepend on the classification of the taxable income. A separate tax return orcomputation is required for each type of income.

- Each type of income is subjected to a different rate and the taxpayer filesdifferent income tax returns.

- Ex.:Passive Income xxTax Rate %Tax xx

Business Income xxTax Rate %Tax xx

Compensation Income xxTax Rate %Tax xx

b. Global Income Tax System- A global income tax system views indifferently the tax base and treats all the

categories of income the same which is a uniform tax rate applied to the incomeof corporate taxpayers.

- In a global tax system, all items of gross income, deductions and personal andadditional exemptions, if any, are reported in one income tax return, and theapplicable tax rate is applied on the tax base.


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- This system treats indifferently the tax base and generally treats in common allcategories of taxable income of the taxpayer without any distinction as to theirtype or nature, and subjects them to a single set of graduated or fixed tax rates.

- All income from whatever source is recorded in one return and only one rate isapplied to the taxable income.

Ex.:Business Income xxPassive Income xxCompensation Income xxTotal Income xxLess: Deductions (xx)Taxable Income xxTax Rate %Tax xx

5. Gross or net income taxation

a. Gross income taxation- Gross income means income, gain or profit subject to tax. It includes

compensation for personal and professional services, business income, profits,and income derived from any source whatever (whether legal or illegal), unlessexempt from tax under the Constitution, tax treaty or statute. In other words,gross income is derived at without deducting expenses . profit plus expensesand exemptions

- Gross income taxation income is taxed at gross without the benefit ofdeductions and expenses found under Sec. 34 of the Tax Code. Sometimes, itcould even mean that it is taxed at a revenue.

- What are the advantages and disadvantages of gross income taxation?

If we follow gross income taxation and your income is sourced from service,service income (i.e. working in Junquera), what is your concrete source that youcan deduct? If we follow the gross income of taxation, you will be taxed directlywith the amount paid by your customers. No deductions allowed.

Advantageous to the government:More revenue going to the coffers of the governmentSimplified method of taxation. There is nothing to determine whether theexpenses is allowable or not.

DisadvantagesInequitable to the taxpayer. It is unjust. Why are they not allowed to deductthe costs incurred in order to get that income of revenue?It will not encourage taxpayers to earn more because everything goes to thegovernment. And would lead mainly to tax evasion because taxpayers wouldnot declare their true income due to high tax rate. WON the tax rate is high, it


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is still high because it is directly computed against your gross incomewithout the benefit of gross deductions.

2. Net income taxation- Net income means gross income less statutory deductions and exemptions .

It is referred to as taxable income . Net income must be computed with respect toa fixed period. That period is twelve months ending December 31st of every year,except in the case of a corporation filing returns on a fiscal year basis, in whichcase net income will be computed on the basis of such fiscal year.

- Net income taxation as the word net implied, is taxation based on net incomeafter you are allowed to deduct some items.

- What are the advantages and disadvantages of net income taxation?

Advantageous more on the taxpayer because he is given the chance to deduct all theexpenses and deductions there is so long as it is applicable in the business for whichhe is engaged in or the profession he is practicing.

Disadvantageous on the part of the government because of the allowance fordeduction, it will be more tedious for the government to determine whether theexpenses or deductions claimed are valid or not; legal or not. It becomes an avenuefor over claiming expenses especially in family owned corporations. There is no 3 rd person investor who is interested whether the income you are declaring is the truenet income. In one actual case, for example, part of a cost of a service company wasthe cost of the motor vehicle, which is personal, owned by one of the ownerschildren. Can the BIR plug that loophole? Of course it is very difficult unless wedemand for the gross income taxation. But then again, applying gross incometaxation is not equitable in all cases.

NOTA BENE:Modified gross income as regards pure compensation earnerIf you are a pure compensation income earner in the Philippines, meaning allyour income is derived from pure employment, then, you will be subjected togross income taxation although modified. Modified in the sense that you willbe allowed to deduct personal and additional exemptions, remember, the 15kexemption and the 25k exemption. For every child, 25k exemption. Thatswhat makes it modified but it is still gross. It is still gross because you are notallowed to deduct expenses like transportation expenses to and from youroffice, or your food during office hours. No deductions, like depreciation toyour car etc.

So, it is gross but modified. There are a few, one or two, deductions that youcan make.

But as regards those individual taxpayers that derive business, trade orprofessional income, we adopt the net income system


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For example, you are the president of a multi-national company but at nightyou perform services. You have two incomes, two types compensationincome from employment and compensation income that you have at nightbut not thru employment (from your profession). By the time that you payyour income tax, you have to consolidate everything at the end of the year.

Will you be subjected to gross income taxation or net income taxation? Areyou allowed to make deductions(net income taxation)?--You are subjected to net income taxation. By the process of elimination,your modified gross income taxation will only be applicable if you are a purecompensation income earner. Once you cross that boundary, meaning youare a pure business income earner, pure profession income earner ormodified (both income and employment), you will now be allowed to claimdeductions. You will be covered by net income taxation. But in all cases, theschedular rates will have to be applied for individuals.

6. Features of Individual Income Taxation

1. Always, always the rates will be scheduler/graduated/progressive with regards to the value of the taxpayer/his status.

2. WON an individual is allowed deductions. The rules would be: If you are a pure compensation income earner, your

deductions would only be personal additional exemptionswhich will subject you to modified gross income taxation.

If you earn compensation PLUS business or profession ortrade, you are now shifted to the other type of taxing yourincome which is net income taxation. You will be alloweddeductions. Logic behind this is once you earn income otherthan from employment, you will be expected to have incurredexpenses for your business, trade or profession.

3. Pay as you file system Whenever you file for your return, you are expected to pay within the

same day.

4. Under certain cases, pay as you earn system, as applicable toincome subject to withholding tax

Individuals are also subjected to the rule that they pay the taxes asthey earn. It is covered by the withholding tax system because you areexpected to be withheld of your taxes the moment you earn it. When youreceive your salary, it is already net of withholding taxes. The moment youreceive interest from bank deposits, it is already net of taxes. Pay as you earn.

7. Features of Corporate Income Taxationa. Global concept of taxation

Because you are taxed at the same rate (30%). Example is that ofcorporations. It is taxed at the same rate regardless of what type of


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corporation it is (whether domestic, foreign resident, or non-resident foreigncorporation) and regardless of the amount of income that it has earned. So, itis global.

If corporation is doing business in the Philippines, net income taxation

applies.

Non-resident foreign corp not doing business in the Philippines

b. Corporate taxpayer, particularly domestic corporations are entitled todeductions insofar as domestic corporations and resident foreign corporationsare concerned, we adopt the net income tax system.

Corporations, as a rule, are following net income taxation (Ex. SM deductingfrom its gross income the salary of its employees) because they are allowedto deduct business expenses. But this is not absolute. A resident foreigncorporation is subject to gross income taxation. --- unsa man jud?

c. Non-resident foreign corporations are not allowed to deduct businessexpenses because they are not doing business here in the Philippines. Forevery income that they earn they are subjected to gross income taxation.The concept of a corporation is to do business and earn profit or income.Therefore, only domestic corporations which are engaged in business aresubject to net income taxation. Resident foreign corporations which registereditself in the Philippines is registered outside as well. The registration startsoutside.

Difference between domestic and resident foreign corporation

Company B is a domestic corporation because it is registered in thePhilippines. Company A is foreign. It becomes resident when it alsoregisters in the Philippines. If it is not registered, it remains a non-resident foreign corporation.

d. Only those corporations doing business in the Philippines areallowed to claim exemptions. When you do business in the Philippines,you incur expenses which are deductible.

e. Pay as you file system (except insofar as the electronic filing system isapplied)

COMPANY A

99% owned by Filipinos

COMPANY B

99% owned by Germans


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If you file the return, you are expected to pay unless they avail ofelectronic filing system which gives them 5 days thereafter to pay thetaxes.

D. INCOME, in general

1. Definition of Terms

a. Income- In its broad sense all wealth which flows into the hands of thetaxpayers contrasted from being a mere return of capital.

Why? Everything which comes to the taxpayer as an addition to his assetexcept for those which are merely returns, because it is his capital, are consideredincome already. It is the broad definition because it includes everything whichcomes to the hands of the taxpayer.

In its strict/ more specific meaning sense it is an amount of money comingto the taxpayer for the service performed, for an activity which he engaged in, or foran investment he has made but it is not all inclusive because as we have said,anything that is seen without anybody owning that income or wealth can beconsidered as income insofar as the finder is concerned.

So, if you file for illegal dismissal, aside from back wages because that iscompensation income, and you are awarded damages (exemplary and moraldamages), is this subject to income tax? Is it an income?

Yes, it is income because it increases your patrimony or your asset. Alldamages that you receive are considered income except actual damages.

As to moral, exemplary damages, arising from various reasons such asbreach of promise to marry, accidents, physical injury, illegal termination, illegaldismissal is considered income. WON it is taxable, it is a different story. It has tosatisfy all the other requirements in order to be taxable.

How about actual damages, is that an income? Youre driving your car andyou met an accident, and you were awarded damages? The actual damages was paidas a breach of a promise to marry, is that an income?

No, it is not considered income because it is an actual loss awarded to theperson who suffered actual damages. So long as the actual damages is equivalent tothe actual loss suffered by the recipient, then, that is not an income. It does notincrease your asset or wealth. It simply to recover the value of the property that waslost. So, it is not income. But once the actual damages has been miscomputed and itis more than the actual damages that you have suffered, then it is considered as partof your income.


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If you find treasure in your backyard, is it considered income? Yes, it isincome.

Are all kinds of dividend considered income? (this was answered in the laterpart of the lecture)

How about illegal gains, is that an income? Yes, it is income.

b. Capital- is that which provides the income

c. Income vs. Capital- Capital is the fund, while income is a flow- A fund of property existing at an instant of time is called capital, while a flow of

services rendered by that capital by the payment of money from it or any otherbenefit rendered by a fund of capital in relation to such fund through a period of

time is called income.- Capital is wealth, while income is the services of wealth- Capital is the tree, while income is the fruit; labor is a tree, income the

fruit;property a tree, income the fruit- Return of capital is not subjected to income tax, while income is subject to tax

2. Sources of Income- Is the source of income a place? it is not a place. it is a property, activity or servicethat produces the income. To be considered as an income coming from thePhilippines, it is enough that the income is derived from within. You would knowthat there is a source within and without the Philippines.

a. Capital - Fund or property existing at one point of time. It can be an investmentor capital in order for it to grow.

b. Labor without any tangible capital, you can derive income out from the laborperformed

c. Labor and Capital- like construction businessesd. Sale of Property- dealings in real property such sale or barter

3. Criteria to determine if an income is taxablea. Existence of Income (there is gain or profit)- Amount received/realized LESS cost of property = PROFIT

What is gain or profit? its the result from reducing the proceedsfrom the cost

The tax is only a tax on the profit or income (not capital/ puhunan )

The only exception where there is a tax on the capital is Sec. 24(d)or Sec. 27(d) --- capital gains tax on sale, barter, exchange of realproperty located in the Philippines and classified as a capital asset


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Example: parcel of land bought at 1 million sell at 2 million --- taxhere is on the capital because basis of capital against tax is thegross selling price. So regardless if you sold it at a profit, or sold itat a loss, you will be taxed on your selling price. *this is the onlyexemption if you read through the income tax where there is taxon capital and not the income

Had this not been a parcel of land (capital asset) bought at 1million, sell at 2 million --- income tax is applied only to the 1million profit

Is income merely a tax on the difference at of the price and cost?(that tax only profit/ income) but what we study in income tax isto study all the revenue, the cost and the income. Once you getgross income, this is where you apply the tax rates.

Prizes winning from sports competitions --- are winnings taxableunless sanctioned by the PSA (Philippine sports association) andapproval Phil. Olympic committee

So Manny Pacquio is practicing it as a profession, his fightsare not sanctions so his income is subject to general rulethat all income are subject to income tax

b. Realization of Income- The gain or profit is realized or received, actually or constructively- Tests in determining whether income is earned for tax purposes

1. Realization Test- separation of capital and income2. Claim of right doctrine or doctrine of ownership, command or control3. Economic benefit test, doctrine of proprietary interest (eg stock options)4. Severance test

Constructive receipt- you have control over the income despite no actual delivery.

Exceptions: Stock dividends are taxable when there is dilution of stock of other stockholdersownership.

Illustration: You purchased a parcel of land in 1961 for 1 million. Today, its value is 100million. Do you have an income? Do you have a 99 million income that is taxable?

A. Parcel of Land

Purchased in 1961 Php 1,000,000.00

Today Php 100,000,000.00


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Do you consider Php 99 Million as taxable income based on the criteria that you havejust mentioned? So its not taxable because it has not yet been sold? What if nobodybuys the property? Will you pay the tax on the Php99M if no one is buying the property?

Therefore, it is not taxable. Because it failed to follow number 2 criteria. Its not anincome that you have realized or you have received. What is the difference between realizing an income and receiving an income?

o So you own this one and has the power to dispose it, is it not realizing anincome? Not all economic gains constitute taxable income. Mere increase in thevalue of the property without such value having been actually realized does notconstitute an income but is merely an unrealized income or unrealized gain. Inthis case, until and unless you dispose of this property and actually sell it for thevalue that you expect. It is not a realized income and not being realized, withmore reason it is not a received income.

o There is a big difference between receiving an income and realizing it. Which

comes first? Whats the difference between constructive receipt of an incomeand realizing it? You must know what comprises of profit. The formula asprovided in your outline is simple:

Proceeds or the revenues less the cost is equals your gain or profit. So ifyou were able to sell it at Php 100M for a cost of Php1M, your profit isPhp 99M. Is it taxable or not? Depends whether the income is received orrealized.

When you say its received, there are 2 connotations there: Actual Receipt of Income

o Example is there is a general professional partnershipwhich you created, 48 lawyers. You decided that at the endof every month, each of you will get Php 100,000.00. That isactual receipt of income when you get it.

Second, it could be constructive receipt.o It is constructive if after distributing the Php 100,000 each,

there still remains at the end of the year, Php 1B in incomeof the general professional partnership. Even if the share isundistributed, it is considered constructive receipt ofincome in so far as the partners are concerned because itwill be now taxable on the individual partners. It is uponyour free disposal to get hold of your share of the Php 1B.Its constructive receipt. You can get it anytime. Its just thatit is not with you yet.

REALIZED

ACTUAL CONSTRUCTIVE


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How about realized? You say that income is realized when your right tohave it has already ripened in simple words.

Example: You have an apartment. You entered into a contract oflease for 1 year. All rents payable at the end of the 1 year contract.Say for example, you started out the rent or leasing out of your

apartment July 1, 2010. Ending June 30, 2011, midway for thecalendar year. At the end of the calendar year, December 31, 2010.Are you expected to declare a taxable income from leasing yourapartment as owner? YES.

The mere fact that you are able to lease out 6 months over 12months, the activity has been finished from July 1 to December 31,2010, your right to collect has already ripened. It is already due. Soyou should at the end of the year declare it as a realized income.

c. The gain or profit is not excluded or exempt under any law or treaty

- Illustration: So if it taxable or not, should you end there? If you have answeredwhether it is realized or received. Can you at that point say whether it is taxableor not? Can you say that after determining that the income has been realized orreceived, that is already automatically subject to income tax? Not yet.

o You may say that it is a realized income but it is not taxable because there is alaw exempting it.

Given an example. Look into Section 32B on compensation for injuries. Abank for example, if you have been awarded moral and exemplarydamages for physical injuries inflicted upon you, will the damagesawarded be subject to income tax? If you have received Php1M in cash?You have been awarded moral and exemplary damages plus actualdamages. Awarded Php 6M, received Php 1M as actual and Php5M formental damages. You received it and it was wir ed to your account. Thatsactual receipt because your account. Can we now say that this incomeactually received is subject to income tax?

ANSWER: In outline no. 2, letter K number 4. It is compensation forinjuries or sickness. This will be exempt to income tax. If you are awardeddamages as compensation for physical injuries or sickness, the damages,whether its actual or moral, exemplary, nominal, temperate, liquidateddamages, are all exclusions from gross income. It is not subject to incometa x. Despite the fact that you have actually received it. Its a wealth whichis given to your hands.

Awarded Php 6M

1 Million ACTUAL

5 Million Mental (Moral, Exemplary, etc)


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Tests to determine realization of income

1. Severance test

2. Substantial alteration of interest test

3. Flow of wealth test

Severance test

As capital or investment is not income subject to tax, the gain or profit derivedfrom the exchange or transaction of said capital by the taxpayer for his separate use,benefit and disposal is income subject to tax.

Substantial alteration of interest test

Income is earned when there is a substantial alteration of the interest of ataxpayer, i.e. increase in proportionate share of a stockholder in a corporation.

Income to be returnable for taxation must be fully and completely realized.Where there is no separation of gain or profit, or separation of increase in valuefrom capital, there is no income subject to tax.

Thus, stock dividends are not income subject to tax on the part of theshareholder for he had the same proportionate interest in the assets of thecorporation as he had before, and the stockholder was no richer and the corporationno poorer after the declaration of the dividend.

However, if the pre-existing proportionate interest of the stockholder issubstantially altered, the income is considered derived to the extent of the benefitreceived.

Moreover, if as a result of an exchange of stocks, the person receivedsomething of value which are essentially and fundamentally different from what hehad before the exchange, income is realized within the meaning of the revenue law.

Flow of wealth test

The essential difference between capital and income is that capital is a fundwhereas income is the flow of wealth coming from such fund; capital is the tree,income is the fruit. Income is the flow of wealth

Methods of Accounting


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The tax code does not prescribe any specific method of accounting for taxes.However it allows the taxpayer to adopt any standard as long as it can properly reflect hisincome and his deductions and is used by him with consistency.

The following are the principal accounting methods:

1. Cash basis - considers as income that which is actually and constructivelyreceived and as deduction that which is actually paid. The term constructive receiptrefers to availability of the income to the taxpayer, but by his own and exclusivechoosing, he prefers not to actually receive the income.2. Accrual basis - treats as part of taxable income that which is already earnedalthough not yet actually/constructively received and as possible deductions thosewhich although not paid, have already been incurred by the taxpayer.

3. Installment basis-

4. Net worth/inventory method - which proceeds upon the general theory that

money and other assets in excess of liabilities not accounted for by his income taxreturn leads to the inference that part of his income has not been reported. If ataxpayers net worth in a given year has increased to an amount larger that hisreported income, then he must hve either underdeclared his income or overstatedhis deductions.Formula: Difference in net worth (DNW) + Non-deductible expenditures (NDE) Non-taxable receipts (NTR) = Taxable net income (TNI)

5. Excess cash expenditures - which proceeds upon the premise that if thetaxpayer spends more money that what is his return show was available to him asincome, then he must gave either underdeclared his income or overstateddeductions.

6. Percentage/comparison- which proceeds by the commissioners comparing theresults of business operations of a taxpayer with those others who are similarlysituated and operating under the same conditions.

d. Summary1. Determine whether there is income or profit. Meaning your revenues less the

cost to get those revenues, do you have a net gain or profit?2. Have you realized the income? Or have you received actually or constructively

the income. If yes, proceed down to the next.3. Is there a law or a tax treaty granting exemption? If none, which we always

actually construe strictly against the tax payer in exemption, if there is none,proceed on to compute for the income tax.

4.Kinds of taxable income or gain


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a. Capital gains: gains or income from the sale or exchange of capital assetsincluding:

a. Income from dealings in shares of stock of domestic corporation whether ornot through the stock exchange

b. Income from dealings in real property located in the Philippines not used in

business and tradec. Income from dealings in other capital assets other than (a) and (b).b. Ordinary gains: gains or income from the sale or exchange of property which

are not capital assets:a. Business Incomeb. Compensation Incomec. Passive Incomed. Other income from whatever source

Last meeting as mentioned, Is income tax always a tax on income alone? No capital caneven be subjected to tax? Capital gains.

Proceeds Cost = Income / Profit

o If you found Php100M in treasures at zero cost, everything is taxable.o If you have a real property sold for 1M, put purchased it for Php5M, you lost

Php4M, is this transaction taxable?o If you have siomai business, at a cost of Php500k, taxable.o There is an exemption to the rule that income tax is a tax on income not tariff. All

taxes that you will see in the chapter of income tax, is income tax. Differentlynamed, differently collected. Meaning the mode of collection is different, themanner of how it is paid is different. But everything you see in the chapter is anincome tax.

o So capital gain stocks is an income tax. It is the exemption to the rule that incometax is only a tax on income because in cases of sale of real properties classified ascapital assets located in the Philippines, you may be taxed on that capital. Capitalis actually the cost. You may be taxed because it is not dependent on the ruleproceeds less cost equals profit. It is based on the gross selling price or fairmarket value whichever is higher.

o If the gross selling price is 1M but the fair market value is Php10M, then you are

taxed at Php10M, a portion of that Php10M is the cost of Php5M in buying thatproperty before hand. It is the exemption to the rule that income tax is a tax onincome.

What about capital asset. We said that it must be a capital asset. Becauseif this is not a capital asset, it does not become subject to capital gainstock.

We move on to the kinds of taxable income for gain. 2 kinds: Capital Gains

Proceeds - Cost = Income/Profit

FT 100Million - 0 = 100Million Taxable


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Ordinary Gainso In a car rental business, is the car a capital asset or an

ordinary asset? Because only capital asset produces capitalgains and only ordinary asset produces ordinary gains.Why is it an ordinary asset? In capital gains, be careful with

letter C, it is a catch-all-provision, that which is not in A orB, means all others. So is it in letter C? It is under the 3 rd classification of an ordinary asset, which is used in businessand subject to depreciation.

Gross Income Definition: Means all income from whatever source derived including (but

not limited to):

i. COMPENSATION for services (including fees, commissions, andsimilar items);ii. GAINS derived from dealings in property;

iii. INTEREST;iv. RENTS;v. ROYALTIES;vi. DIVIDENDS;vii. ANNUITIES;viii. PRIZES and winnings;ix. PENSIONS;x. PARTNERs distributive share of the gross income of GPPs.MEMORY TEASER: C.G.I.R.R.D.A.P.P.P.

*The enumeration is not exclusiveSpecial treatment:a. Forgiveness/Cancellation of indebtedness subject to donors tax not income tax sincethe debt is forgiven without you doing something in return it now becomes an act ofliberality.

However, if forgiveness of debt is due to the performance of service, then it nowbecomes subject to income tax

Concept of Income from whatever source derived: Gross Income, in Section 32A, is all income derived from whatever source. By

the phrase whatever source, it means legal or illegal, whatever type ofincome that is. Including but not limited to the following to thoseenumerated in Section 32 (A).

Those list in Section 32 in not an all in exclusive list. There can be as manysources of income except those enumerated. What is enumerated in Section32A is simply a list of the major items we classify as income.

Gross Income vs. Taxable Income vs. Net Income


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Gross income - means income, gain or profits subject to tax. It is derived atwithout deducting expenses

Net income - means gross income less statutory deductions and exemptions. It isalso referred to as taxable income. Net income must be computed with respect to a

fixed period. That period is 12 months ending December 31st

of every year, except inthe case of a corporations filing returns on a fiscal basis, in which case net incomewill be computed on the basis of such fiscal year.

Classification of income as to source Gross income and table income from sources within the Philippines Gross and taxable income from sources without the Philippines Income partly within and party without the Philippines

INCLUSIONS TO GROSS INCOME, Section 32A (Situs of Income) Memorize

1. First, compensation income, The situs is the place where the services are rendered.

Example, if you are a resident alien and you perform. If you are Usher andperform a 1 night concert here. Subject to income tax? The service isrendered in the Philippines or was conducted in the Philippine, thereforethere is Situs in the Philippines. So Philippines has the right to tax thatincome.

For compensation or any service that you performed, always it is wherealways the service is performed.

Same holds true for example if a Filipino celebrity performs a concert

abroad, the question of whether it is taxable or not is not fully captured inthis situs. The service performed abroad, will we automatically say it issubject to tax only abroad? No because he is still a national or a residentof the Philippines. But for compensation per se lang, it is where theservice is rendered.

2. Gross Income from business. Situs is the place where the business is undertaken.

Merchandising, mining, farming or agricultural business, the situs ismore stable. It has definite place, thus the situs is where the businessis undertaken. Therefore, it is taxable in the Philippines. We cannotbring the actual mining from abroad here. It can only be an extensionoffice which is not the actual mining. Manufacturing business, takes into consideration where the productsare manufactures and where the products are sold. If the products aremanufactured here, sold here, entirely we have jurisdiction over it.Everything is 100% taxable.

If it is manufactured abroad, sold abroad, we dont tax it, it isbeyond our jurisdiction.


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But if it is manufactured abroad, and sold in the Philippines, wehave the right to tax it. The business of selling is here.

If manufactured here, sold abroad, we have the right to tax it.The situs is partly within and partly without. Partly withinbecause the manufacturing here and if the contract of sale,

before it is shipped abroad is perfected here, then we havesitus here.3. Income from Sale or Exchange of Property. Distinguish from real or personal

property

(1) If it involves personal property the place of sale

(2) In the case of sale of transport documents the place where the transportdocument is sold.

(3) If it involves real property the place or location of the real property

- For real property in so far as income taxation is concerned. Its easy. It isimmobilized by nature therefore wherever the real property is situated, it is thestate exercising jurisdictio n over it which has the power to tax. So if its in thePhilippines then it is taxable to Phil. income tax.

- How about personal property? The goods that cross borders? Will the Phil. havejurisdiction over a personal property that is sold like motor vehicle, equipments,machineries? Its not easy to answer because it is the place of sale. Where could bethe place of sale?

o For example: Company A would like to purchase machineries andequipments from Japan. Its a personal property that is movable, where is t he

place of sale? Is it in Japan or in the Philippines? It depends with the arrangement. If the contract is perfected abroadand ownership is actually relinquished at the point of delivering it tothe carrier abroad, then the sale has been consummated abroad. But ifownership is retained by the seller until it reaches Philippine portsand if its consummated here, then the sale is undertaken in thePhilippines, then it will be subject to Phil. income tax.

4. Interest Income

Tax Situs: residence of the debtor

- Interest Income is something that cannot really be seen except payment of money.o So if a domestic corporation, needing capital for its operations, obtains a loan

from a non-resident foreign bank in Japan. Of course, domestic has to pay theprincipal and interest. The payment of principal or the loan amount is merereturn of capital while the payment of interest is the income. There is here aterritorial boarder. So who has the right to tax the interest, the Phil. or Japan?

COMPANY A

Obtained a loan

Bank B

Territorial Border

Note: INTEREST is the INCOME


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Note: There is a difference between a domestic corporation and aFilipino corporation. Domestic is that which is incorporated in thePhil. Filipino is at least owned 60% by Filipinos.

Phil. because the domestic corporation, who is the debtor, resides inthe Phil. Benefits-received theory for the Phil. government who haveprotected domestic corporation and allowing it to raise money inorder for it to pay interest to bank Japan abroad, it will havejurisdiction. The situs is where the debtor is residing. So no matterwho the creditor is, always, the Philippines has taxing jurisdictionover such interest income. Remember that the income-interest earnerhere is bank Japan, thus, technically, it should be Japan who will betaxing the interest income because such bank is residing in Japan butbecause we have our own situs rule here in the Phil. which says thatany interest income where the debtor is a resident of the Phil. will becovered by the Phil. taxing jurisdiction. Therefore, the Phil. will alsohave to tax it.

How will the Phil. government get the tax of such interest income?Will it require bank Japan to declare the income, remit the tax or someother arrangement?

For payments to a non-resident foreign corporation who is notregistered in the Phil., it will have to be withheld by the payingcompany.

o So payments to Usher concert, will have to be withheldby the production team, before it is given to the non-resident foreign corporation as net.

o Such non-resident foreign corporation or individual, isnot within the hold of the Phil. tax authorities. Theycannot be required to actually pay because they are notregistered tax payers in the Phil.

5. Rent Income

Tax Situs: place where the property subject of the contract of lease is located

6. Royalties

Tax Situs: place where the intangible property is used


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- Royalties are fees you pay for the use of intangible property such as intellectualproperty rights.

o Example: McDonalds is originally a non-resident foreign corporation theactual source. If we obtain a franchise from McDonalds, the monthly paymentfor the franchise is called a royalty fee. So does the Phil. have taxing

jurisdiction over the royalty income that is remitted by a franchisee to thefranchisor abroad? Yes since McDonalds, the intangible property, is used in the Phil. then

it is the Phil. who has taxing jurisdiction over such royalty income.o Another example: In manufacturing companies wherein they have to get

technical knowledge and technical know- how in creating microchips, etc.They have to pay royalty fees, lets say, 3% for the annual revenues here inthe Phil. so that any payment to the non-resident foreign corporation abroadwould have to be withheld of the tax because the situs of the royalty incomeis in the Phil. The technical know-how is exercised and being used in the Phil.So although it is intangible, you will see the effects of where it is actually used

and who is benefiting.

7. Dividend- the situs is where the issuing corporation is incorporated.

a. received from domestic corporation income purely within

b. received from foreign corporation consider the income/operations of theforeign corporation in the Philippines during the last preceding 3 taxable years:

(1) The income is purely within if the income derived from the Philippinesources is more than 85%- situs is philippines

(2) It is purely without if the proportion of its Phil. income to the total incomeis less than 50%- situs is outside the Philippines

(3) There should be an allocation if it is more than 50% but not exceeding85% (partly within and partly without)- pro-rata

- Dividends are company profits paid pro rata to stockholders. It is a fruit out of thestockholders investment in a corporation. Dividends come in many forms.

- Kinds of Dividends:o Cash Dividends you receive cash out of the profits of the business

Example: If youre a 10% owner of PLDT, you get 10% out of theentire dividends that will be declared to the owner so if its 1Bdividends then you will get 100M share because youre a 10% owner.

o Sometimes what the corporati on gives if its not so liquid, meaning no cash,is property dividends if its a subdivision company, you may be given ahouse and lot. Its property dividend; its property; its income because it is awealth it is an increase in your assets.

o Sometimes it can be stock dividends


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- The dividend referred to here is cash &/or property dividend because both of themare considered income while stock dividend is not included since stock dividend isnot considered income as a rule because it is not yet a realized income, it is inchoate.

o Illustration: Tiu makes a corporation. You all contribute 1M each so you get47M since the class consists of 47 students and no loans so net worth is 47M.But after 10 years of operation, youre assets became 100M and liabiliti es10M so you will have a net worth of 90M. Did the net worth increase? Yes thenet worth increase to 43M. This 43M is your earnings from the start-up ofyour business and your cut-off point, which is 10 years of operation. Youwould actually would want to distribute the 43M as dividends if you havecash. Say for example, the 43M is in real estate property (you invested it inreal estate valued at 100M) so you dont have cash. What you will do is that

you will simply say that youre ownership becomes 1.5M a lready, thus, Tiuwill increase your investment from 1M to 1.5M to each of you but it is notgiven in cash, it will simply increase your investment in the corporation. Thatis stock dividend your ownership is increased but nothing is given to you,its i nchoate. Until and unless it will be given to you and you have freedisposal of that, it remains a non- taxable stock dividend because itsunrealized income. Who knows by next year the corporation will be losing sothat there is negative net worth.

- The reason why dividend is taxable in the Phil. if it is issued by a domesticcorporation or paid by a domestic corporation without regard to where and who theowner of the dividend is its because the domestic corporation receives protection

from the government such that being an intangible property, it does not follow thegeneral rule where the domicile of the owner is since its receiving benefits andprotection from the government, the Phil. government has the right to fully tax adividend that is given by a domestic corporation wherever and whoever therecipient of the dividend is (100%).

- If its a foreign corporation abroad such as for example, Ms. Dumagad owns a sharein a mining corporation in Africa and she gets millions out of it annually, the situs ofthe dividend for Africa is where the corporation is issuing the dividend but thats aseparate issue as to being her a resident citizen. But the point is, it follows where theissuing corporation is except that if a foreign corporation performs business 85% ormore. Why? If its operation amounts to 85% or more located in the Philippines, it is

as if it acquired situs already in the Phil. It is receiving, at most, the benefits andprotection from the Phil. government, therefore, it will have full situs here in thePhil. But if its less than 50% operation in the Phil., it will have situs abroad wherethe domicile of that foreign corporation is. If its in between 50% and 85%, it ispartly within and partly without according to the percentage of the operation in thePhil.8. Annuities

10 Years After

Assets 47Million 100Million


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Tax Situs: place where the contract was made

9. Prizes and Winnings

- given on account of services rendered place where the services were rendered

- not given on account of services rendered place where the same was given

- Winnings are those not given on account of services rendered while Prizes maybegiven on account of services rendered or not given on account of services rendered.

- Every time you receive something and it is attached to a service that you haverendered, its like a compensation for services you have rendered so you back to thefirst rule, a compensation given is taxable where the service has been rendered. Soprizes given for services rendered is taxable on the place where such services wererendered while prizes and winnings not for services rendered is taxable on the placewhere the same was given.

o Example: Lets say Mr. Pelinio went to the U.S on March 31 and he has his betand he won $100M lotto there. Where is the situs?

The situs is in the U.S. because Mr. Pelinio did not render any serviceso situs is in the place where the winnings was given, which is in thiscase, it is in the U.S.

But is it taxable in the Phil.? Knowing where the situs is does nottotally equate whether its taxable or not. Is it taxable in the Phil.?

Yes, because Mr. Pelinio is a resident citizen and he is taxablefor all his income within and without the Phil.

So what should Mr. Pelinio do so that his $100M winnings willnot be subject to tax?

o Mr. Pelinio will not come back for a certain period. Sec.22E of the Tax Code provides that if youre a citizen whowill qualify as non-resident because you have stayed forthe most part of the year abroad, meaning more than183 days abroad or more, then all your income abroadwill not be subject to Phil. income tax. So if Mr. Peliniowill just stay after winning plus 183 days or more thenyou come back after that, then the winnings will not besubject to Phil. tax. So Mr. Pelinio earn it abroad, for theyear he is considered non-resident citizen.

10. Pension

Tax Situs: place where this may be given on account of services rendered

- Since pension is something that is more related to a service such as that you haverendered in the past and youre given retirement or pension pay then the situs is theplace to where the services were rendered.


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11. Professional income of professional partners

Tax Situs: place where the exercise of profession is undertaken

- Since it is more on the exercise of a profession, its an activitiy, so its where theactivity or the profession is undertaken. It follows the place where such professionis exercised.

E. Exclusions from Gross Income

- For all the enumerations in gross income Sec. 32A, all income from whateverincluding but not limited to the following, from compensation income down topartners distributive share, you now know where the situs is.

1. Proceeds of Life Insurance PolicySubject to tax if:

a) Insurer and insured agreed that the amount of the proceeds shall be withheld by theinsurer with the obligation to pay interest in the same, the interest is the one subject totax.

b) there is transfer of the insurance policy

- What is referred to here is the proceeds of life insurance given to the beneficiaryonce the insured dies.

- Reason: since it is a contract of indemnity; not a profit or gain-

Proceed of life insurance policy is receivable by the beneficiary, not the insured onewho already died. Will it be taxable in the hands of the beneficiary?o No, because it is paid by reason of death and is considered an indemnity

rather than a gain or profit on those who are aggrieved.

Example: Company A took out a life insurance policy on the life of its President, Mr.B, in order to protect itself from the sudden loss of its chief operating officer. Say forexample, there are 2 life insurance policies taken by company A with different insurancecompanies. The insurance was for 1M each. The beneficiary of the first insurance policy isCompany A. The beneficiary of the second insurance policy is the heirs of Mr. B. Mr. Bdied. 2M was released, one by one insurance company and the other one by the second

COMPANY A

MR. B

Insurance Details:

Worth Beneficiary INCOME TAX

For the life of

Premium:


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insurance company. Will the 1M proceeds received by company A be subject to incometax or an exclusion to income tax? Will the 1M received by the heirs of B subject toincome tax or an exclusion to income tax? Will they be subject to estate tax?

For income tax, the 1M each received by company A and the heirs of B areexempted because the provision in Sec. 32B (1) does not distinguish the kind of

beneficiaries who will receive the proceeds of a life insurance policy, therefore, proceedsof life insurance policy, regardless of who the beneficiary is (whether it be a juridical ornatural person), as a rule, are exempted from income tax or excluded from gross income.

Lets say, company A has to pay a total of 400,000 premiums for each policy. Will thepremiums be part of the compensation or salary on the part of Mr. B who is actuallyindirectly benefited (his life is insured) and thus subject to income tax?

For the 400,000 premiums paid by company A in order to secure the secondinsurance policy wherein the beneficiary is the heirs of Mr. B, such premiums are subjectto income tax for they form part of Mr. Bs salary as an indirect benefit on Mr. Bs part. Sothe 400,000 premiums for the second insurance policy is subject to the tax on Mr. Bssalary. However, for the 400,000 premiums paid by company A in order to secure the

first insurance policy wherein the beneficiary is company A itself, such premiums is notsubject to tax bec ause it is merely a return on capital of company A. Therefore, its notsubject to tax on the part of Mr. Bs salary.

The 1M received by company A will never form part of the estate of Mr. B and ajuridical person has no estate, thus it is not subject to estate tax. However, the 1M receivedby the heirs of B will form part of the estate of B, and thus, it may be subject to estate tax.But can estate tax and income tax co-exist in one and the same 1M?

No, because in exclusions from gross income, once an income is subject to estate tax,it will never be subject to income tax.

But if there is a third person, lets say, in the life insurance policy, C, a very closefriend of Mr. B, was designated as a beneficiary. Will the proceeds received by C uponBs death form part of the estate of B? If the designation is revocable, which is the default, it goes to the estate of B,

thus it will be subject to estate tax. If the designation is irrevocable, it willnever form part of the estate of B, thus it will not be subject to estate tax.

The enumeration sec32b are substantive exclusion from gross income. So it is by law anexclusion regardless of the point of realization. There is what we call a temporaryexclusion from gross income from gross income. The word temporary means that in somepoint in time, the income is excluded from the gross income because either it has not been

realized or it has not yet been perfected.Ex. although there is a gain or profit, so long as it has not yet been realized, it is not ataxable income as yet. It is excluded.

But once it is realized, it ripens into an income that is taxable. Those are the types ofincome that is listed in 32b. Those that are listed in 32b whether it is received, realized,


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unrealized, etc, these are already exclusions from gross income. And we started offdiscussing number 1 last meeting.

PROCEEDS FROM LIFE INSURANCE

What is the reason why proceeds from life insurance are excluded? It is toindemnify the beneficiary of the death of the person

There are insurance policies which are life insurance policies but are theother type. At the point of maturity of that insurance policy, even lifeinsurance policy, the insured has the option of receiving the proceeds fromthe insurance company. Is that the same type that is not taxable?

To be totally free from income tax, the proceeds of the life insurance policymust result to the death of the insured? True or False. The proceeds from lifeinsurance policy regardless of the designated beneficiary is not subject toincome tax. False.

As an exception to the rule, if and when the insurance proceeds are withheldby the insurance company on the condition that interest will be paid uponrelease, the interest or any income derived from the withholding, meaningthe point of not yet releasing the insurance proceeds will be subject toincome tax. It is already an income of insurance proceeds.

But the life insurance proceeds, the reason why its not subject to income taxor is an exclusion from gross income is because its simply a paymen t or anindemnity for a loss or a death of a person.

We are looking here at somebody who died. The person who is insured willnever get the chance to receive the insurance proceeds. Otherwise, if he doesso receive it, it will only be covered by exclusion number 2.

Another exception to the rule why it is false. Since we are talking aboutexception to the rule, this means to say that there will be tax implication orsome form of taxes that need to be paid. Just like number 1, we said anyinterest derived from withholding the release of the life insurance proceeds

is already an inclusion from gross income which is taxable.

Second exception is when there is a transfer to life insurance policy. What doyou mean by that one? If an insurance policy is subsequently sold ortransferred to another person, what will happen is that any differencebetween the amount paid to get the insurance policy versus the proceeds willalready be subject to income tax.


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But it does not mean to say that if the proceeds or life insurance proceeds isan exclusion from life insurance program, totally there would be no other taxapplicable.

What are the applicable tax, just in case? Lets talk about the beneficiary.

Life insurance proceeds; if the beneficiary is any of the relations of theinsured: heirs, estate, administrator executive, is it subject to income tax Is itan inclusion to gross income? Yes. Therefore it is not subject to tax.

If the beneficiary is a third person other than those related to the estate ofthe decedent or the insured; ex. the company who took the life insurancepolicy of the insured or any other friend, would it be an exclusion from grossincome of the beneficiary?

Is the recipient beneficiary be subject to income tax or would that lifeinsurance proceeds be part of his gross income? It is one of the exclusionsbecause its regardless of who the beneficiary is. Its no longer taxable insof aras the beneficiary whether he is beneficiary class number and number 2; heis not required to pay income tax on the proceeds.

But would the estate of the decedent be liable for estate tax by the meretransfer? Or would it be liable for estate tax because it is part of his estateupon death? Yes. Because if the beneficiary is the estate itself, then it goes tothe estate. If the heirs, it goes still to the estate. If the executor or

administrator, it goes still to the estate. Therefore it just goes to sho w that itspart of the property of the decedent upon death.

Remember estate taxation is taxing the decedent on all properties existing atthe point of death. How about life insurance proceeds, when does it accrue?Upon death of the insured.

Beneficiaries would not have to pay the income tax but the estate itself isliable for estate tax. Remember an estate if the decedent is a separate entity.Its an individual for tax purposes.

If the beneficiary is a third person; the company who took the insurancepolicy, a friend, a relative who is not near the heirs, is the estate liable?

At the point of computing the estate tax, will the BIR include the proceeds aspart of the estate and be liable for estate tax?

Mr. A, the insured is the president of company B who took out the insurancecompany in favor of the prior. There are two scenarios. One, beneficiary is in


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relation of Mr. A which can be the estate of Mr. A itself, heir, administrator orexecutor. Second scenario is the company made itself the beneficiary.

Insofar as recipient beneficiary is concerned, we dont have any problem. Itsnever subject to income tax. But how about estate tax? Will it be subject to

estate tax if the beneficiary of the policy is the third person, the companyitself? NO. Because ownership of the proceeds belongs to the company who isnot part of the estate of the decedent.

Therefore it is not subject to the estate tax. Estate tax refers only to the estateof the dead person. And if its now the ownership of the company who hasdesignated itself as the beneficiary, of course you do not co-mingle thecompany with the estate. So there is the irrevocable designation of thecompany as the beneficiary, no way is it subject to income tax.

But if in default, the company is the designated beneficiary, then it is. Andwhat is default of insurance policy? The designation is revocable. Only if thedesignated beneficiary is irrevocably designated that it not belong to theestate of the decedent. So as a general rule, you will see that majority, it willalways form part of the estate of the decedent, relations or third partyrevocably designated. It will only be excluded from the estate of the decedentif it is irrevocably designated. And irrevocable designation must be clearfrom the policy itself. Otherwise, default is revocable.

Mr.A took out a life insurance policy wherein the terms of the contract is 10

years payment of premium and on the 20 th , it will mature.If he outlives thepolicy he gets the insurance proceeds. If he dies before the 20 year period, hisbeneficiaries or heirs will get the life insurance proceeds. What is the tax if heoutlives the policy and if he has not?

If he outlives the policy, meaning he himself outlives the policy, it will betaxable except for the portion which represents the return of the premiumpayments that he has made.

If he gets 100m after outliving the policy after it has matured on the 20 th

year, and by computation he was only able to pay 5m in premiums, then the95m difference will have to be declared as part of his gross income taxable to32%. If he dies before maturity of the policy, then we will follow exclusionnumber 1.

COMPENSATION FOR INJURIES AND SICKNESS.


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What injury are we talking about? Would all types of injury be covered in theexclusion? What type of compensation do you get out of a physical injurycase? What are the sources wherein you derive compensation for physicalinjury?

Compensation for injuries, do you agree that it refers only to physicalinjuries? As discussed by some of the authors, when you say compensationfor sickness and injuries, it would have to refer to physical injuries andsickness. And when you say compensation for physical injuries, its related tosickness. You have to take it with the other.

The law itself says that, for compensation maybe by virtue of a suit or a caseor paid by virtue of a health insurance, personal heath insurance, accidentinsurance, and workmans compensation act. It simply boils down with therebeing something wrong with the physical body or physical disability.

Would the damages received as part of the compensation for injuries andsickness be subject to income tax? No. Its not subject to income tax becauseit is derived not from labor, capital, labor or capital and properties.

And again, its exclusion is not stemmed from the other laws but because ofthis 32b which actually says that any compensation received includingdamages on account of such injury or sickness is not part of the gross incomesubject to income tax. The only gray area there is the compensation for lossfor future earnings.

If you have studied torts, somewhere along the way you will come across SCgranting compensation for the loss of the future earnings which could havebeen derived by the person who met the accident. So whatever is derivedfrom that; EX. if the dead or injured is expected to receive 50k a month timesthe number of years of his life expectancy. That will be awarded by SC. As towhether it is taxable or not, there are conflicting views.

Some of the authors would say that it is subject to income tax because it iscompensation for future services which could have been rendered. But some

of the authors would also say that it is not subject to income tax because it ispart of the compensation for the injury or sickness.

We can say that it is not taxable. We use the word compensation. And itmeans all types of awards given by either the SC or insurance companies.

INCOME EXEPMT UNDER TREATY


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Since the doctrine of incorporation, any agreement we have entered intowith the other countries that there are exemption to be granted to thetaxpayers earning income here, the principle of reciprocity will be respected.

We consider those as exclusions from gross income. But mind you, this is not

even self executing. Whatever the provisions of the tax treaties are, we haveto seek confirmation from the national office of the bureau of internalrevenue in Quezon City.

Otherwise, if we dont seek for a confirmation ruling, even if youre situationfalls squarely with what the treaty provides, you will not be allowed to availof the exemption or the preferential treatment of the treaty.

So again, its like lifeblood doctrine that in construing exemptions, it has to bestrictly construed against the tax payer.

RETIREMENT BENEFITS

What retirement benefits are subject to tax?

1. If it falls under RA 7641 which actually is part of the labor code, art 287 on retirementbenefits.

2. If it is part of the private retirement fund.

So, what are the conditions for excluding from income the benefits received underretirement benefits plan?

1. recipient must be at least 50 years old

2. at least 10 years of services

3. retirement plan is reasonable

4. in nature of pension, stock option or profit sharing

5. availed once

6. approved by BIR7. employer must contribute and for the common benefit

How many situations are the in 6a, how many retirement benefits are we referring?

If you are 48 years old and you have rendered 48 years with the company, can youretire with the retirement pay tax free? If you retire at the age of 51 and have


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rendered 8 years of service, can you retire tax free? Should both (age, years ofservice) requirements co exist in all cases? This matters. Because most of thecompanies I know, most of the employees will wait until the point that they can getthe retirement benefit free of tax. Otherwise they will have to pay 30%. When canyou say that 60 year old rule will apply rather than the 50 year old rule? Can bothrequirement co exist?

Can we expect the two types of benefits under the 7641 and the reasonableretirement benefit plan to be applied in one and the same company?So that somecan retire at 60 tax free while others can retire at 50? Would the two situationsmentioned before co exist in one company? This rule is under the tax code reasonable private benefit plan.

If the company sets up a reasonable retirement benefit plan, retirements for it to beexempt from tax must be by a person at least 50 years old, having rendered servicefor at least 10 years and it is his first availment of retirement.

When will the 60 year old, 5 years of service apply? In the absence of a reasonableprivate benefit plan established by the company, In the absence of collectivebargaining agreement, In the absence of the employment contract designating whenthe retirement is.

If there is no reasonable private benefit plan, there is no collective bargainingagreement, no employment contract, no other agreement entered into by theemployee and employer, then use this. He gets to retire tax free at the age of 60,

having rendered five years of service. But in more cases than not, companies, sincethey are encouraged to establish a reasonable retirement benefit plan, then thedefault is the retiree should at least be 50 years old with at least 10 years of service.

So if there is a reasonable private benefit plan, to be tax free, it should be:

1. duly approved by the BIR

2. gratuity plan

3. employer established the fund, contributing to the fund itself

4. fund will be for the sole benefit of employees

What are the requi rement of private benefit plans proceeds to be tax free ?

1. employee is at least 50 years old

2. has rendered at least 10 years


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3. first availment of retirement

For you to be exempt, not only must you be at least 50 years old and had at least 10years of service. It must be the first time that you have availed of a tax freeretirement, exclusive of the government retirement. Of course if its a government

retirement, its totally tax free. So in this case, for example, you have reached 50years old and have rendered 5 years of service with company A. This is the first timeyou have availed of the retirement. Are you tax free? Yes.

Then you got yourself hired with the government at age 51. You rendered 10 yearsof service with the government and retired at the age of 60. Is the retirement paythat you will receive from the government exempt from tax? No.

The rule is to exclude retirements from government. So if the second retirement isfrom the government institution, it will have to be exempt from tax. But if your

second retirement after you first private institution retirement, is still with anotherprivate institution, regardless of how old you are, it is already taxable. Even if yourely on the law itself, it says there retirement benefit plan of a private institutionor private corporation So if its not a private institution, its government, its notavailing twice with the private. So if its private -government, both are exempt. If itsprivate-private, that is taxable. This will apply if there is a reasonable private benefitplan.

Let us say there is no private benefit plan. A collective bargaining agreement is ineffect. And it says that an employee can retire at the age of 60 or after rendering 20

years of service. A, 40 years old, wants to retire after rendering 21 years of service.Taxable or not? Not taxable.

Another case, no collective bargaining agreement, no employment policy, noreasonable private benefit plan. A, 60 years old, wants to retire after rendering 4years of service in the company? Taxable or not? Taxable.

Theres an existing retirement benefit plan, 50 years old, ten years of service.Taxable or not? Not taxable

You always consider if there is an existing retirement benefit plan with thecompany. Because the law says; retirem ent benefits derived are exempt if itsderived from RA 7641 or a reasonable private benefit plan RPBP. But the law alsosays that for the benefits derived in RPBP would only be exempt if it satisfies therequirements: 50 years old, 10 years of service, and first availment of in a privateinstitution. Well of course the RPBP would also be duly approved with all therequirements. But would that 10 years- 50 years old apply to 7641? No. because this


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is a different law. This is the tax code itself. If there is no retirement benefit plan, youhave to apply the retirement benefits derived from 7641. But 7641 is not exclusiveto 60 years old or 5 years. It says that it will only be applicable if there is no CBA,employer policy, etc.. Now if there is a CBA, do not use this as yet. If the CBA saysyou can retire at the age of 60 plus 20 years of service, then it must be PLUS. Bothconditions must exist. If the CBA says 60 years old or more than 20 years of service,if you can satisfy just 1, then it is exempt. So long as the CBA is not moreburdensome than the 60-5 year rule. It says in 641, any CBA or policy that is notmore burdensome than the 60-5 year rule can be acceptable. The 60-5 year rule willbe applied if there are no agreements existing.

So in the case of 60 years old or at least 20 years of service, and the employee hasbeen working for 21 years, this is exempt. Because the CBA says OR. So even if youare still young at the age of 40, you can still retire if you have rendered at least 20

.**If there is a CBA and RPBP at the same time, it has to be well defined in the CBA towhom and to what extent it will be applied. I dont really know if it can co -exist

But in this ruling in BIR, an employee retired at less than 50, and rendered 21 yearsof service. His retirement benefits are granted with exempt by BIR. Why? Becausethe CBA itself which is duly approved, says than employee may be retired at theoption of the company upon reaching the age of 60 years or upon having completedmore than 20 years of service. So it can even be more than 10 years of service. At theage of 30 he can retire. And that is exempt. But then again, if you get yourself rehiredin a private institution, and you get again your retirement, that is taxable na.

You retired and got the retirement pay of 10m. Because of your excellent service,you receive a gratuity pay of 4m. Plus 15 days of work, 50k. Your vacation leave andsick leave credits that have not been used are 500k and 500k respectively. You are50 years old with 10 years of service. In total, you receive 15,050k.

Which of the items are subject to tax if the you are under the RPBP? If the companyhas a retirement fund, and you retire, your retirement pay will not be taken out ofthe retirement funds. It will be taken out from a plan, which plan is a separate entityitself. It is usually handled by insurance companies or banks.

If you did your job well, you can be given gratuity pay which is outside of the fund. Itis bonus. Is the gratuity pay subject to tax? No.

Is the 50k taxable? Yes because it is compensation for the service rendered.


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How about the leave credits? If you work and you are given vacation leave and youdont utilize them, in some companies it can be converted to cash and can beaccumulated for as long as you want. Are they subject to tax? No.

If you have plans of retiring, do not compute or convert your leave credits before

retiring. Because usually if you convert your leave credits on a regular basis withoutbeing connected to any retirement, they are taxable in excess of ten days. But if youretire and its the only time that you convert all leave credits, it becomes a terminalleave pay, everything is taxable.

Everything given during retirement if your retirement is qualified, tax free, isexempt. So even the gratuity pay is not taxable. Only the 15 day salary is taxable. Butall the rest, retirement pay, bonuses, gratuity pay, leave credits, whatever it isnamed, basta lang the basic is exempt, everything that follows will also be exempt. Ifthe retirement pay is exempt, any bonus, gratuity or cash equivalent are alsoexempt. If given separately from retirement, then they are not tax free.

SEPARATION PAY

Separation pay. Is it subject to tax? What are the rules for it to be exempt from tax?Is separation pay taxable if it is given out of pity? You were hired by the governmentas one of the midnight appointees of GMA. When Aquino came in you will beseparated from work. You got 100k separation pay. Is that taxable?

if you are given separation pay at the age of 48 years old after rendering 9 years of

service due to occupying a redundant position, is it an inclusion to gross income?For separation pay, there is no age requirement, no years of service renderedrequirement for the payment to be tax free.

All that it requires is that your separation from the company must be due to death,sickness, physical disability or indury and those other causes beyond your control.For example, redundant position, or those that you find in you LC, labor savingdevice, retrenchment, occupying a co terminus position.

SSS Benefits

How about social security benefits? Is that an exclusion from gross income? Socialsecurity benefits for us Filipinos receiving from our Philippine social securitysystem is not taxable. Even from the GSIS as well as social security benefits fromabroad. Ex. you have been a citizen or a resident in the US and you retired here, you


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will get your pension and social security benefits, its also tax free. Probably thatsthe reason why there are so many retirees here.

Winnings, prizes and awards

requirements should be satisfied.1. without any action on the part of the recipient to enter the contest

2. not required to render substantial future services

In sports competitions, for your awards to be tax free or excluded in gross income,the competition must have been duly approved by the national sports associaltionand approved as well by the Philippine Olympic committee, whether it may be aninternational competition or neld in the Philippines or not. What it means to say isthat the exclusion from gross income would never include a professional fight. Many

is a professional boxer. He is not representing any sports in the Olympics.Everything that he earns is taxable.

In one of the BIR rulings, there is this one boxer who sought for exemption. He wasgranted an exemption on the ground of bringing glory to the Philippines. But if itgranted to that boxer, no other boxer can avail or use that ruling for an exemption.

Why do you think other boxers cannot avail of the exemption if the exemption isgranted by BIR to one of them? Exemptions are personal.

So whenever rulings or SC says that this person is exempt, then no other person canuse that provision unless the law is general.

In any case, if and when prizes and award granted in sports competition or if anyliterary, religious, charitable educational achievements that you get, if it does notsatisfy the condition, therefore it is taxed; it will now be withheld of tax. Because thenature of prizes and awards is that it will be given to the recipient net of taxes.

Now if you happen to win in SM 1m, do not expect to get 1m. its only 800k becausethe tax withheld is 20%. If in the posters it is said to be tax free, will you receive 1m?Yes. But do not be misled. There is tax but the burden of tax is shifted to the onegiving the price. SM will pay 1250k. the 1m you received is as if it is the 80% of theprice. If it is not tax free, the price (motor vehicle) will not be given unless thewinner pays the tax.

INCOME DERIVED BY GOVERNMENT OR POLITICAL SUBDIVISIONS


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When it says income from investment, it does not mean to say lang investment inthe business. It includes and it has expanded the meaning to those extending a loanto domestic corporation. But if the extension of the loan is to a foreign corporationor not a domestic corporation, then its not income having situs here.

GAINS DERIVED FROM REDEMPTION OF SHARES OF STOCK BY THE MUTUAL FUNDCOMPANY

It should be the mutual fund company. If not, no exclsions, no exemptions.

CONTRIBUTIONS TO SSS, GSIS, PAGIBIG AND UNION DUES

You will notice that your sa lary is already deducted with these contributions. Itsyour share. Because the share of you employer is not reflected in the pay slips.

In the computation of you tax, those items are deducted from your income because

of the provision of the law. After the law made in 1997, they were already made asdeductions.

If your have monthly salary, you will give PAGIBIG 100. Your employer will also give100. Your PAGIBIG account will be added 200. But if you have a housing loan andyou want to contribute to PAGIBIG 1100 and your taxable income if 8900, this willactually benefit you. This will reduce your taxable income.

The exempted is up to the allowed contribution

Benefits in the form of 13 th month pay

Up to 30, 000.

Gains derived from the sale, exchange, retirement of bonds, debentures, or othercert of indebtedness with maturity of more than 5 years

Under Special laws

PEZA- Economic Zones- if you are exempted from 4-6 years , income taxholidays, 4 years non pioneering, 6 years for pioneer

Cooperative- agricultutral and multipurpose are exempted from income tax

Barangay micro business enterprises, agricultural, and multipurposecooperatives

DEDUCTIONS

F. DEDUCTIONS


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The amount received by the seller consists of return of capital and gain fromsale of goods or properties. That portion of the receipt representing return ofcapital is not subject to income tax.

b. Sale of stock in trade by a real estate dealer and dealer in securities-

required to deduct the total cost specifically identifiable to the real property orshares of stock sold and exchanged.

c. Sale of services- entire gross receipt are treated as part of income since theydont buy and cary nor sell any stocks or goods.

Formula:

ProceedsLess: cost or return of capitalGross incomeLess: DeductionsTaxable incomeX tax rateTax dueLess: tax creditTax payable

3. Basic Principles governing deductions- The basic principles that would guide you in determining whether an item is

allowed to be deducted is:1. The taxpayer or you seeking for deduction must be able to pin point

some specific provision of the law authorizing you to deduct and2. Prove that you are entitled to the deduction authorized because you

satisfy all the conditions required.3. All deductions are always strictly construed against the taxpayer. That

is the 3 rd principle.4. An additional requirement for the deductibility of an expense is when

a tax is required to be withheld by you, as the payer of the expense,you should have withheld the tax, otherwise, you cannot deduct theexpense.- Let me put it in simple terms. If you have a business and you rent a

place, a boutique perhaps in ayala at Php100k per month, perspace. The law requires you to withhold 5% of your rentalpayments and remit it to the government. So you will only pay orgive ayala Php 100k less 5% or less Php 5000. Where does thePhp5000 go? To the government. Ayala will only receive 95%. Ifyou failed to deduct even if you have given Ayala the full Php100k,you forgot to deduct the 5%, you will not be allowed to deductentirely the Php100k rent expense. Thats what will happen if you


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- Any of the deductions claimed by a tax payer will fall under any of these categories. It

may be an itemized deduction or expenses or in lieu of that an optional standarddeduction at a fixed rate of 40% of your gross income. Or you can claim, if you are anindividual tax payer, you can also claim the personal and additional exemptions in lieuof family and living expenses.

- What are the personal and additional exemptions as mentioned before? Php50,000 for Single, head of the family or married, the personal exemption. Php25,000 additional exemption for every dependent child that you have, legitimate,illegitimate, acknowledged or legally adopted. So if you compute your income taxdue, you may be able to claim anyone of these, but not all of these. Becauseoptional standard deduction is only in lieu of itemized.

NON-DEDUCTIBLE ITEMS

- Would all your expenses incurred be deductible? If you engage in business and you hadincurred expenses of Php1M but your sales proceeds is only Php500,000. Are youguaranteed that you can claim your Php1M expenses? There are non-deductible itemsidentified by the Tax Code.

- What are the non-deductible items? Not all expenses that you paid for or have incurredmay be allowed as deduction in the computation of your taxable income. Let us identifywhat are the items that you have spent for but are totally non-deductible items.

1. Personal living or family expenses2. Amount paid for new buildings or permanent improvements, or betterment to

increase the value of any property or estate;3. Any amount expended in restoring property or in making good the exhaustion

thereof for which an allowance is or has been made;4. Premiums paid on any life insurance policy covering the life of any officer or

employee, or of any person financially interested in any trade or businesscarried on by the taxpayer, individual or corporate, when the taxpayer is directlyor indirectly a beneficiary under such policy

5. Losses from sales or exchanges of property directly or indirectly a) Between members of a family (brother, sister of half or full blood, spouse,

ascendant, lineal descendants)

Sale Php 500,000.00

Expenses (Php 1,000,000.00)


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b) Except in case of distributions in liquidation, between an individual and acorporation more than 50% in value of the outstanding stock of whichis owned directly, by or for such an individual

c) Except in case of distributions in liquidation, between 2 corporations more than 50% in value of the outstanding stock of each of which is

owned directly or indirectly, by or for same individual, if either one ofsuch corporation is a personal holding company or a foreign personalholding company

d) Between the grantor and a fiduciary of any truste) Between fiduciary of a trust and the fiduciary of another trust, if the same

person is a grantor with respect to each trustf) Between a fiduciary of trust and a beneficiary of such trust

(1) Personal living or family expenses- Why non-deductible?

1. Its not related to the business. It is personal and for the family.2. The personal exemption of Php 50,000 for single and married individual and

additional exemption for every child already child already approximatesyour personal and family living expenses for the entire year. That is whypersonal and family living expenses are non-deductibl

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