SOURCES OF INCOME

SOURCES OF INCOME

1. Income received in full from sources within;

2. Income derived in full from sources without; and

3. Income derived partly from sources within and partly from sources without.

INCOME FROM SOURCES WITHIN

Income received from sources within

a) Interest

b) Dividends

c) Services

d) Rentals and Royalties

e) Sale of Real Property

f) Sale of Personal Property

Interests: residence of the debtor

Interest means the amount which a depositary bank may pay on savings and time deposits in accordance with the rates
authorized by Bangko Sentral ng Pilipinas.

Interests: residence of the debtor

Interests derived from sources within the Philippines, and interests on bonds, notes or other interest-bearing obligation
of residents, corporate or otherwise are treated as income within the Philippines.

If the obligor or debtor is a resident of the Philippines, the interest income is treated as income from within the
Philippines.

Illustration

Beldua Corporation, a domestic corporation, was granted a loan of $500,000 by the New York Bank. The interest earned by the
bank was P250,000.

Is the interest earned an income within or without?

Answer

The interest is an income within. The test of source of income on interests is dependent upon the residence of the
debtor/obligor.

Considering that Beldua Corporation is a domestic corporation, its residence is within the Philippines, hence, the interest
is an income within.

Dividends: residence of corporation paying dividend

A dividend is defined as a corporate profit set aside, declared and ordered by the directors to be paid to the stockholders
on demand or at a fixed time.
 Dividends: residence of corporation paying dividend

The amount received as dividends:

(a) From a domestic corporation; and

(b) From a foreign corporation, unless less than fifty percent (50%) of the gross income of such foreign corporation for
the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such
part of such period as the corporation has been in existence) was derived from sources within the Philippines as
determined under the provisions of this Section; but only in an amount which bears the same ratio to such dividends as
the gross income of the corporation for such period derived from sources within the Philippines bears to its gross income
from all sources;

Dividends from a Foreign Corporation

Exercises

1. Dividends received from Sofi Corporation, a foreign corporation whose gross income from the Philippines during the last
three(3) years is 48% of the total gross income.

2. Dividends received from Eco Corporation, a foreign corporation whose gross income from the Philippines during the last
three(3) years is 60% of the total gross income.

Answers

1. Income without, because the gross income of Sofi Corporation from the Philippines is less than 50%.

2. Income within, because the gross income of Eco Corporation is more than 50%.

Dividends

The amount received as dividends:

(a) From a domestic corporation; and

(b) From a foreign corporation, unless less than fifty percent (50%) of the gross income of such foreign corporation for
the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such
part of such period as the corporation has been in existence) was derived from sources within the Philippines as
determined under the provisions of this Section; but only in an amount which bears the same ratio to such dividends as
the gross income of the corporation for such period derived from sources within the Philippines bears to its gross income
from all sources;

Illustration

In 2016, Xerah Corporation, a domestic corporation received a dividend of P150,000 from Kenneth Corporation, a Swiss
Corporation whose gross income form 2012 to 2015 are as follows:

How much of the dividend income is considered income from Philippine sources?

Computation

Computation

4,000,000

Dividend income within = ----------------- = 53%

7,500,000
 = (P150,000 x 53%) = P 79,500

Services: place of performance of service

Compensation for labor or personal services performed in the Philippines regardless of the residence of the payor, of the
place which the contract for service was made, or of the place of the payment;

Illustration

Dodong is contracted in the Philippines by Abdel Corporation, a domestic corporation, to work in Saudi Arabia. The contract
provides that Dodongs monthly salary of P 20,000 in Saudi Arabia will be paid to his family in the Philippines.

Is Dodongs income within or without?

Answer

It is income without. The salary of Dodong is an income from services. When an income is earned from rendering
services, the test of source of income is the place of performance. Since the services were rendered in Saudi Arabia, it is
income without.

Rentals and Royalties:

location or use of the property or interest in such property

Rent means the amount paid for the use or occupancy of a property whether payment is made on a monthly or other
basis.

Royalty is a valuable property that can be developed and sold on a regular basis for consideration.

Rentals and Royalties:

location or use of the property or interest in such property

If the property or interest is located or used in the Philippines, the gain or income is treated as income from sources
within the Philippines.

Rentals and Royalties

(a) The use of or the right or privilege to use in the Philippines any copyright, patent, design or model, plan, secret
formula or process, goodwill, trademark, trade brand or other like property or right;

(b) The use of, or the right to use in the Philippines any industrial, commercial or scientific equipment;

(c) The supply of scientific, technical, industrial or commercial knowledge or information;

Rentals and Royalties

(d) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application
or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in
paragraph (b) or any such knowledge or information as is mentioned in paragraph (c);

(e) The supply of services by a nonresident person or his employee in connection with the use of property or rights
belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from such
nonresident person;

Rentals and Royalties

 (f) Technical advice, assistance or services rendered in connection with technical management or administration of any
scientific, industrial or commercial undertaking, venture, project or scheme; and

(g) The use of or the right to use:

(i) Motion picture films;

(ii) Films or video tapes for use in connection with television; and
(iii) Tapes for use in connection with radio broadcasting.

Exercises

a) Rent income received from apartment located in Marawi City.

b) Rent income received from apartment located in Seoul, South Korea.

c) Royalties on patents used in Syria.

d) Royalties on patents used in Davao City.

Answers

a) Rent income from Marawi - income within

b) Rent income from South Korea - income without

c) Royalties used in Syria - income without

d) Royalties used in Davao - income within

Sale of Real Property:

Location of real property

If the real property sold is located within the Philippines, the gain is considered as income from the Philippines.

Illustration

Agnes and Midzmar entered into a contract whereby the latter will lease to the former his apartment house located in
Makati. It was also agreed that the monthly rental will be remitted to Cuba where Midzmar is a resident. After a year,
Midzmar decided to sell the apartment house to Agnes realizing a gain of P100,000.

a. Is the monthly rental an income within?

b. How about the gain on the sale of the property?

Answer

a. The rental income is an income within because the property is real and it is located in the Philippines.

b. The gain on the sale of the property is also an income within because the property is located in the Philippines.

Sale of Personal Property

a. Any gain, profit or income from purchase of property within and its sale without the Philippines, or purchase of
personal property without and its sale within the Philippines shall be treated as derived entirely within the country in
which it is sold.

Sale of Personal Property

 b. Any gain, profit or income from sale of shares of stock in a domestic corporation shall be treated derived entirely from
sources within the Philippines, regardless of where the said shares are sold.

Exercises

a) Gain on sale of a car purchased in Japan and sold in the Philippines.

b) Gain on sale of a car purchased in the Philippines and sold in Japan.

c) Gain on sale of shares of stock of Shalini Corporation, a domestic corporation. The shares were sold in Hong Kong.

Answers

a) Purchased in Japan, sale in the Philippines - income within

b) Purchased in the Philippines, sale in Japan - income within

c) Gain on sale of shares of a domestic corporation - income within

INCOME FROM SOURCES WITHOUT

Income derived in full from sources without

The following items of gross income shall be treated as income from sources without the Philippines:

(1) Interests other than those derived from sources within the Philippines;

(2) Dividends other than those derived from sources within the Philippines;

(3) Compensation for labor or personal services performed without the Philippines;

Income derived in full from sources without

(4) Rentals or royalties from property located without the Philippines or from any interest in such property including
rentals or royalties for the use of or for the privilege of using without the Philippines, patents, copyrights, secret
processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties; and

(5) Gains, profits and income from the sale of real property located without the Philippines.

Exercises

a) Salaries received for working as a domestic helper in Singapore.

b) Salaries received for working as a domestic helper in Basilan.

c) Gain on sale of a residential house located in Pasonanca, Zamboanga City

d) Interest income on a bank deposit in a bank in Afghanistan.

Answers

a) Domestic helper in Singapore income without

b) Domestic helper in Basilan income within

c) Sale of house located in Pasonanca income within

d) Interest income from Afghanistan income without

INCOME FROM SOURCES PARTLY WITHIN AND PARTLY WITHOUT

 Income from sources partly within and partly without

Gains, profits and income from the sale of personal property produced (in whole or in part) by the taxpayer within and
sold without the Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines,
shall be treated as derived partly from sources within and partly from sources without the Philippines.

TAXABLE INCOME

a) From sources within the Philippines;

b) From sources without the Philippines;

c) From sources partly within and partly without the Philippines.

Taxable Income from Sources within the Philippines

General Rule. - From the items of gross income from sources within the Philippines, there shall be deducted the
expenses, losses and other deductions properly allocated thereto and a ratable part of expenses, interests, losses and
other deductions effectively connected with the business or trade conducted exclusively within the Philippines which
cannot definitely be allocated to some items or class of gross income: Provided, That such items of deductions shall be
allowed only if fully substantiated by all the information necessary for its calculation. The remainder, if any, shall be
treated in full as taxable income from sources within the Philippines.

(2) Exception. - No deductions for interest paid or incurred abroad shall be allowed from the item of gross income
specified in subsection (A) unless indebtedness was actually incurred to provide funds for use in connection with the
conduct or operation of trade or business in the Philippines.

Taxable Income from Sources without the Philippines

From the items of gross income specified in Subsection (C) of this Section, there shall be deducted the expenses, losses,
and other deductions properly apportioned or allocated thereto and a ratable part of any expense, loss or other
deduction which cannot definitely be allocated to some items or classes of gross income. The remainder, if any, shall be
treated in full as taxable income from sources without the Philippines.

Taxable Income from Sources partly within and partly without the Philippines

In the case of gross income derived from sources partly within and partly without the Philippines, the taxable income may
first be computed by deducting the expenses, losses or other deductions apportioned or allocated thereto and a ratable
part of any expense, loss or other deduction which cannot definitely be allocated to some items or classes of gross
income; and the portion of such taxable income attributable to sources within the Philippines may be determined by
processes or formulas of general apportionment prescribed by the Secretary of Finance.

Illustration

Itchay, single, an American residing in the United States, engaged in business in the Philippines, has the following data in 2016:

Gross income, Philippines P200,000

Gross income, United States 300,000

Expenses, Philippines 20,000

Expenses, United States 30,000

Unallocated expenses 50,000

How much is the taxable income of Amanda?

 Computation

Taxpayer is a non-resident alien engaged in trade of business

Gross Income, Philippines P200,000

Less: Expenses, Philippines P20,000

Ratable part of unallocated deductions

[(P200,000/P500,000) x P50,000] 20,000 40,000

Taxable Income P160,000

Less: Personal exemptions 50,000

Taxable income P140,000

ALLOWABLE DEDUCTIONS

Deductions

are the amounts which the laws allow to be deducted from gross income to arrive at taxable income.

Exclusion v Deduction v Personal Exemption

Exclusion v Deduction v Personal Exemption

Deductions are construed strictly against the taxpayer claiming it.

Types of Deductions from Gross Income

a) Itemized Deductions;

b) Optional Standard Deduction; and

c) Special Deductions.

Itemized Deductions

a) Trade, Business, or Professional Expenses;

b) Interest;

c) Taxes;

d) Losses;

e) Bad Debts;

f) Depreciation;

g) Depletion of oil and gas wells and mines;

h) Charitable and other contributions;

i) Research and Development; and

j) Pension Trusts.

Trade, Business, or Professional Expenses

 Trade, Business, or Professional Expenses

Requisites for Deductibility: (D-STOWN)

a) Must be paid or incurred During the taxable year;

b) Must be Substantiated with sufficient evidence such as official receipts or other adequate records;

c) Must be paid in connection with the conduct of Trade or business, or the exercise of profession by the taxpayer, or
attributable to the development, management, or operation of the trade business;

d) Must be Ordinary and necessary;

e) If subject to withholding taxes, have been properly Withheld and remitted on time to the BIR; and

f) Not contrary to law, public policy, or morals.

Must be paid or incurred during the taxable year

CIR v. Isabela Cultural Corporation:

Hence, under an accrual method of accounting, professional fees incurred in prior years but which were claimed as
deductions only in the year the billings were received shall be disallowed.

Substantiation Rule

Official receipts or other adequate records should show:

a) Amount of the expense being deducted; and

b) Direct connection or relation of the expense being deducted to the development, management, operation and/or
conduct of trade, business or profession.

Directly connected with the conduct of TBE

Hospital de San Juan de Dios, Inc. v CIR:

Expenses paid or incurred on mere passive investments are not deductible from any interest or dividend earned thereby because
they do not come within the purview of carrying on any trade or business.

Ordinary and Necessary Expenses

Ordinary Expenses

Expenses normal or usual in relation to the taxpayers trade and the surrounding circumstances.

Necessary Expenses

Expenses appropriate and helpful in the development of the taxpayers business and are intended to minimize
losses or to increase profits.

Two Tests of Ordinary and Necessary Expenses

a. Reasonableness of the amount based on various factors such as, but not limited to:

i. Type and size of the business;

ii. Volume and amount of earnings;

iii. Nature of the expenditure itself;

 iv. Intention of the taxpayer; and

v. General economic conditions.

b. Amount incurred must not be a capital expenditure to create good will for the product and/or business.

Amount incurred must not be a capital expenditure to create good will for the product and/or business.

Commissioner v General Foods Phil.:

Advertising expenses in this case are considered as capital expenditure since the amount was incurred to create or
maintain some form of goodwill for the taxpayers trade or business or for the industry or profession of which the
taxpayer is a member.

Goodwill generally denotes the benefit arising from connection and reputation, and efforts to establish reputation are
akin to acquisition of capital assets. Therefore, it is not a business expense, but is a capital expenditure. Thus, it is not
deductible.

Kinds of Business Expenses

a) Compensation Payments;

b) Travelling Expenses;

c) Rentals and/or Other Payments; and

d) Entertainment, Amusement and Recreation Expenses.

Compensation Payments

A reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered,
including the grossed-up monetary value of fringe benefit furnished or granted by the employer to the employee:
Provided, that in the case of fringe benefit the final tax imposed therein has been paid.

Illustration

Suzie, President of Mapun Corporation, received an annual salary form the latter in the amount of P480,000. Presidents
of other corporations with the same nature, size and volume of business in the locality only receive P120,000 a year. Her
son, Ali who is studying abroad is receiving also an annual salary of P60,000.

a. Is the salary being paid to Suzie deductible fro the gross income of Mapun Corporation?

b. How about the payment of salary to Ali?

Answers

a. Out of the annual salary of P480,000 that is being paid by the corporation to its President, only the amount of P120,000
is deductible because it is the only amount that can be considered as reasonable.

b. The payment of salary to Ali is not deductible from the gross income of the corporation because no services were
actually rendered by him to the company.

Travelling Expenses

A reasonable allowance for travel expenses, here and abroad, while away from home in the pursuit of trade, business or
profession;
 Travelling expenses shall include transportation expenses and meals and lodging paid by the employer. It also includes
laundry and incidental expenses that are directly connected with the trip.

Requisites for deductibility of TE

a) Must be reasonable and necessary;

b) Must be incurred while away from home, here and abroad; and

c) Must be paid or incurred in the conduct of trade or business.

Exercises

Baddiri Company is claiming deduction of P30,000 as travelling expenses. Such amount is broken down as follows:

a) P7,000 plane fare and hotel bills of Ron who was sent by the company on a business trip to Cebu.

b) 12,000 transportation expenses of Jordanna, employee, from its office to a customers place of business and back.

c) 11,000 transportation expenses of Eryl, employee, from her residence to her office and back.

Which of the travel expenses incurred are deductible to the company?

Answer

a. The plane fare and hotel bills are deductible because they are connected with business. Moreover, these expenses
were incurred while away from home.

b. The expenses incurred by an officer or employee from office to a customers place of business and back are deductible
as transportation expenses and not as travelling expenses because they were incurred not away from home.

c. The transportation expenses incurred by an employee reporting to office from her residence are not deductible
because they are personal expenses. They are not connected with trade of business of the company.

Rentals and/or Other Payments

A reasonable allowance for rentals and/or other payments which are required as a condition for the continued use or
possession, for purposes of the trade, business or profession, or property to which the taxpayer has not taken or is not
taking title or in which he has no equity other than that of a lessee, user or possessor.

Illustration

Mamshie Corporation is operating a restaurant in the downtown. One of the expenses that it usually incurs is the monthly rental
of the place owned by Vince in the amount of P5,000.

Is the rent expense deductible for income tax purposes?

Answer

If the amount of rental is reasonable, then it is deductible from the gross income of the taxpayer. After all, it is apparent
that the occupancy of the place is in connection with business, and the taxpayer has not taken or is not taking title to the
property because the place is owned by Vince.

Entertainment, Amusement and Recreation Expenses

EARE are deductible if the following requirements are satisfied:

1) Must be ordinary, reasonable and necessary;

2) Must be directly connected to the development, management and operation of the trade, business or profession of the
taxpayer;

3) Must not exceed the ceilings as the Secretary of Finance may prescribe;

4) Must not be contrary to law, morals public policy or public order; and

5) Must be supported by official receipts or adequate records.

EARE includes: (RR No. 10-2002)

1. Representation expenses; and

2. Depreciation or rental expenses relating to entertainment facilities.

EARE exludes:

1. Expenses treated as compensation or fringe benefits;

2. Expenses for charitable or fund raising activities;

3. Expenses for bona fide business meeting of stockholders, partners or directors;

4. Expenses for attending or sponsoring an employee to a business league or professional organization;

5. Expenses for events organized for promotion, marketing and advertising including concerts, conferences, seminars,
workshops, conventions and other similar events; and

6. Other expenses of similar nature.

Limitations on the Deductibility of EARE

INTEREST

Interest, defined.

Interest is defined as compensation for the use or forbearance or detention of money, regardless of the name it is called
or denominated

Requisites for deductibility:

1. There must be a valid and existing indebtedness;

2. The indebtedness must be that of the taxpayer;

3. The interest must be legally due and stipulated in writing;

4. The interest expense must be paid or incurred during the taxable year;

5. The indebtedness must be connected with the taxpayers TBE;

6. Interest payment must not be between related taxpayers;

7. Interest is not expressly disallowed by law to be deducted from taxpayers gross income; and

8. Amount of interest deducted from gross income does not exceed the limit set forth in the law.

CIR v. Vda. De Prieto

1. If there exists no obligation or where the obligation, interest paid thereon is not deductible.
2. Interest on delinquent taxes partake the nature of interest on indebtedness and not as taxes, thus deductible.

TAXES

All taxes, national or local, paid or accrued during the taxable year in connection with the trade or business or profession
of the taxpayer are deductible from gross income, except:

1. Philippine income tax;

2. Foreign income tax;

3. Estate and donors taxes;

4. Special assessments on real property; and

5. Electric energy consumption tax.

Requisites for deductibility

1. Payments must be for taxes;

2. Taxes are imposed by law upon the taxpayer;

3. Taxes must be paid or accrued during the taxable year in connection with the taxpayers trade, business or profession;
and

4. Taxes are not specifically excluded by law from being deducted from the taxpayers gross income.

BIR Ruling 123-13

Unutilized creditable input taxes attributable to zero-rated sales can only be recovered through the application for
refund or tax credit.

Unapplied input taxes after the expiration of the two(2)-year prescriptive period may not be expensed outright.

Tax exemptions are strictly construed against the taxpayer, and deductions are in the nature of tax exemptions.