INCOME TAXATION

Income taxation is in the nature of an excise taxation system, or taxation on the

exercise of privilege, the privilege to earn yearly profits from various sources. It is a
system that does not provide for the taxation of property (Domondon, 2013).

Income tax systems

1. Global Tax System – system employed where the tax system views indifferently the
tax base and generally treats in common all categories of taxable income of the
individual (Tan v. Del Rosario, Jr., 237 SCRA 324, 331).
2. Schedular Tax System – system employed where the income tax treatment varies
and is made to depend on the kind or category of taxable income of the taxpayer (Tan
v. Del Rosario, Jr., 237 SCRA 324, 331).
3. Semi- schedular or semi- global tax system – all compensation income, business
or professional income, capital gain, passive income, and other income not subject to
final tax are added together to arrive at the gross income. After deducting the allowable
deductions and exemptions from the gross income, the taxable income is subjected to
one set of graduated tax rate (individual) or normal corporate income tax rate
(corporation) (Mamalateo, 2014).
SCHEDULAR TREATMENT GLOBAL TREATMENT
Different tax rates Unitary or single tax rate
Different categories of taxable income No need for classification as all taxpayers
are subjected to a single rate
Usually used in the income taxation of Applied to corporations
individuals
(Business income, professional income, (Business income, professional income,
passive income, illegal income) You passive income, illegal income) All of
cannot add all of them together. them will be added together and be
subjected to one tax rate.

Criteria in imposing Philippine income tax

1. Citizenship or nationality principle – A citizen of the Philippines is subject to
Philippine income tax a. On his worldwide income, if he resides in the Philippines; b.
Only on his Philippine source income, if he qualifies as a non-resident citizen.
2. Residence or domicile principle – A resident alien is liable to pay Philippine income
tax on his income from sources within the Philippines but is exempt from tax on his
income from sources outside the Philippines.
3. Source principle - An alien is subject to Philippine income tax because he derives
income from sources within the Philippines. A non-resident alien or nonresident foreign
corporation is liable to pay Philippine income tax on income from sources within the
Philippines, despite the fact that he has not set foot in the Philippines (Mamalateo,
2014).

Types of Philippine income tax [MC2F3 – BINGS]

1. Minimum corporate income tax (MCIT)
2. Capital gains tax on sale or exchange of unlisted shares of stock of a domestic
corporation classified as a capital asset
3. Capital gains tax on sale or exchange of real property located in the Philippines
classified as capital asset
4. Final withholding tax on certain passive investment incomes
5. Final withholding tax on income payments made to non-residents (individual or
corporation)
6. Fringe benefit tax (FBIT)
7. Branch profit remittance tax
8. Improperly accumulated earnings tax (IAET)
9. Normal corporate income tax on corporations
10. Graduated income tax on individuals
11. Special income tax on certain corporations

Taxable Period
Taxable period is the calendar year or the fiscal year ending during such calendar year,
upon the basis of which the net income is computed for income tax purposes.

Kinds of taxable period.

1. Calendar period
The twelve (12) consecutive months starting on January 1 and ending on
December 31.
NOTE: Taxpayers other than a corporation are required to use only the calendar
year.
2. Fiscal period
It is a period of twelve (12) months ending on the last day of any month other
than December (NIRC, Sec. 22 [Q]).
NOTE: The final adjustment return shall be filed on or before the fifteenth (15th)
day of April, or on or before the fifteenth (15th) day of the fourth (4th) month
following the close of the fiscal year, as the case may be.

3. Short period
GR: The taxable period, whether it is a calendar year or fiscal year always
consists of twelve (12) months.
 XPN: Instances when the taxpayer may have a taxable period of less than twelve
(12) months:
1. When the corporation is newly organized and commenced operations on any
day within the year
2. When the corporation changes its accounting period
3. When a corporation is dissolved
4. When the Commissioner of Internal Revenue, by authority, terminates the
taxable period of a taxpayer (NIRC, Sec. 6[D]).
5. In case of final return of the decedent and such period ends at the time of his
death.

Kinds of Taxpayers:
1. Individuals
a. Citizen
i. Resident Citizen (RC)
ii. Non- Resident Citizen (NRC)
b. Aliens
i. Resident Alien (RA)
ii. Non- Resident Alien (NRA)
(1) Engaged in Trade or Business (NRAETB)
(2) Not Engaged in Trade or Business (NRA- NETB)
iii. Special Aliens
c. Special class of individual employees
i. Minimum wage earner
2. Corporations
a. Domestic
b. Foreign
i. Resident foreign corporation (RFC)
ii. Non-resident foreign corporation (NRFC)
c. Joint venture and consortium
3. Partnerships
4. General Professional Partnerships
5. Estates and Trust
6. Co-ownerships

Importance of knowing the classification of taxpayers. In order to

determine the applicable [GREED]
1. Gross income
2. Income tax Rates
3. Exclusions from gross income
4. Exemptions
5. Deductions
 INCOME TAX
Income tax is a tax on all yearly profits arising from property, profession, trade or
business, or a tax on person’s income, emoluments, profits and the like (Fisher v.
Trinidad, G.R. No. L-19030, October 20, 1922).

It is generally regarded as an excise tax. It is not levied upon persons, property,

funds or profits but on the privilege of receiving said income or profit.

Purposes of income tax

1. To provide large amounts of revenue
2. To offset regressive sales and consumption taxes
3. To mitigate the evils arising from the inequality in the distribution of income
and wealth which are considered deterrents to social progress, by a progressive
scheme of taxation (Madrigal v. Rafferty, G.R . No. 12287, August 8, 1918).

State Partnership Theory

It is the basis of the government in taxing income. It emanates from its partnership
in the production of income by providing the protection, resources, incentive and proper
climate for such production (CIR v. Lednicky, G.R. Nos. L-18169, L-18262 & L-21434,
July 31, 1964).

Income Tax vs. Property Tax

BASIS INCOME TAX
Incidence The incidence of an income
tax falls on the earner.
Who pays the tax The earner pays income
tax.
How measured Income tax is measured by
the amount of income
received over a period of
time.
Frequency of taxation Income is taxed only once.
PROPERTY TAX
The incidence of a property
tax is on the property itself.
The owner of the property
pays the property tax.
Property tax is measured
by the value of the property
at a particular date
Property may be taxed on a
recurrent basis.

General Principles
Except when otherwise provided in the NIRC:
1. A RC is taxable on all income derived from sources within and without;
2. A NRC is taxable only on income derived from sources within;
3. An individual citizen who is working and deriving income from abroad as an overseas
contract worker (OCW) is taxable only on income from sources within;
4. An alien, (RA or NRA), is taxable only on income within;
5. A domestic corporation (DC) is taxable on all income derived within and without;
6. A foreign corporation, (engaged or not in trade or business in the Philippines), is taxable
only on income derived from sources within.
Income refers to all wealth which flows into the taxpayer other than as mere return of
capital. It includes the forms of income specifically described as gains and profits,
including gains derived from the sale or other disposition of capital assets (R.R. No. 2,
Sec. 36).

An income is an amount of money coming to a person or corporation within a specified

time, whether as payment for services, interest or profit from investment. Unless
otherwise specified, income means cash or its equivalent (Conwi v. CIR, G.R. No. 48532,
August 31, 1992).

Income is a flow of service rendered by capital by payment of money from it or any benefit
rendered by a fund of capital in relation to such fund through a period of time (Madrigal v.
Rafferty, G.R. No. 12287, August 8, 1918).

Objects being taxed in income taxation

1. Fruit of Capital
2. Fruit of Labor
3. Fruit of Labor and Capital combined

When income is taxable

The following are important considerations to discover whether or not there is income for
tax purposes:
1. Existence of income
A primary consideration in income taxation is that there must be income before
there could be income taxation. (Domondon, 2013)
2. Realization of income
Under the realization principle, revenue is generally recognized when both of the
following conditions are met:
a) The earning process is complete or virtually complete
b) An exchange has taken place (Manila Mandarin Hotels, Inc. v. CIR, CTA
Case No. 5046, March 24, 1997).
NOTE: Mere increase in the value of property is not considered as income
since it is an unrealized increase in capital. --- Q: Mr.
3. Recognition of income
When income considered received for Philippines income tax purposes: a. If
actually or physically received by taxpayer; or b. If constructively received by
taxpayer.

Actual vis-a-vis constructive receipt

1. Actual receipt – income may be actual receipt or physical receipt.
2. Constructive receipt – occurs when money consideration or its equivalent is
placed at the control of the person who rendered the service without restriction by
the payor (Sec. 4.108-4, R.R. 16-2005).
 The income is credited to the account of the taxpayer and set apart for him which
he can withdraw at any time without restrictions and/or conditions although not yet
actually received by him physically or reduced to his possession is already taxable
to him.
4. Methods of accounting
Accounting methods for tax purposes comprise a set of rules for determining how
to report income and deductions.

As a general rule, the law does not provide for a specific method of accounting to
be employed by the taxpayer. The law only authorizes the CIR to employ particular
method of accounting of income where:
a. The taxpayer does not employ a method for computing income, or
b. The taxpayer’s method for accounting does not clearly refect the income
(Domondon, 205, citing Sec. 43 of NIRC).

Tests in determining whether income is earned for tax purposes

1. Realization test – There is no taxable income unless income is deemed realized.
Revenue is generally recognized when both conditions are met:
a. The earning process is complete or virtually complete; and
b. An exchange has taken place (Manila Mandarin Hotels, Inc. v. CIR, CTA Case
No. 5046, March 24, 1997).

2. Claim of Right Doctrine / Doctrine of Ownership, Command, or Control – A taxable

gain is conditioned upon the presence of a claim of right to the alleged gain and the
absence of a definite unconditional obligation to return or repay.

3. Economic - Benefit test / Doctrine of Proprietary Interest – Taking into

consideration the pertinent provisions of law, income realized is taxable only to the extent
that the taxpayer is economically benefited.

4. Severance test – Income is recognized when there is separation of something which

is of exchangeable value (Eisner v. Macomber, 252 US 189).

5. All Events test Requisites:

a. Fixing of a right to income or liability to pay; and
b. Availability of the reasonable accurate determination of such income or liability

Situs of income taxation

Income from sources within the Philippines
1. Interests derived from sources within the Philippines
2. Dividends from domestic and foreign corporations, if more than 50% of its gross income
for the three year period ending with the close of the taxable year prior to the declaration
of dividends was derived from sources within the Philippines
3. Compensation for services performed within the Philippines
4. Rentals and royalties from properties located in the Philippines or any interest in such
property including rentals or royalties for the use of or for the privilege of using within the
Philippines intellectual property rights such as trademarks, copyrights, patents, etc.
5. Gains on sale of real property located in the Philippines
6. Gains on sale of personal property other than shares of stock within the Philippines
7. Gains on sale of shares of stock in a domestic corporation

Summary rules on determination of situs according to kinds of income

Kinds of income Tax situs

Service or compensation income Place of performance of service
Rent Location of property (real or personal)
Royalties Place of use of intangibles
Merchandising Place of sale
Gain on sale of personal property Place of sale
Gain on sale of real property Location of property
Mining income Location of the mines
Farming income Place of farming activities
Gain on sale of domestic stock Income within the Philippines
Interest Residence of the debtor
Gain on sale of transport document Place of activity that produces the income
Manufacturing:
a. Produced in whole within and sold Income purely within
within
Income purely without
b. Produced in whole without and sold
without Income partly within and and partly without

c. Produced within and sold without Income partly within and and partly without

d. Produced without and sold within

Dividend income from:
a. Domestic Corporation Income within

b. Foreign Corporation –
If for the 3-year period preceding the
declaration of dividend, the ratio of such
corporation’s Phil income to the world
(total) was:
- Less than 50% Entirely without
 - 50% to 85% - Proportionate*
More than 85% Entirely within

GROSS INCOME
Except when otherwise provided, gross income means all income derived from whatever
source, including but not limited to the following items: [CG2I- R2DAP3]
1. Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions and similar items
2. Gross income derived from the conduct of trade or business or the exercise of a
profession
3. Gains derived from dealings in property
4. Interests
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions and
11. Partner’s distributive share from the net income of the general professional
partnership (NIRC, Sec. 32 [A]).

The above enumeration of gross income under NIRC is NOT exclusive.

Concept of income from whatever source derived Under Sec. 32 (A) of the NIRC, gross
income means all income derived from whatever source.
“Income from whatever source” includes all income not expressly excluded or
exempted from the class of taxable income, irrespective of the voluntary or involuntary
action of the taxpayer in producing the Income (Gutierrez v. CIR, CTA Case No. 65,
August 31, 1955).

Therefore, the source is immaterial – whether derived from illegal, legal, or immoral
sources, it is taxable. As such, income includes the following among others:
1. Treasure fund;
2. Punitive damages representing profit lost;
3. Amount received by mistake;
4. Cancellation or condonation of the taxpayer’s indebtedness;
5. Receipt of usurious interest;
6. Illegal gains;
7. Taxes paid and claimed as deduction subsequently refunded;
8. Bad debt recovery.
INCOME FROM BUSINESS
Business income refers to income derived from merchandising, mining, manufacturing
and farming operations.

NOTE: Business is any activity that entails time and effort of an individual or group of
individuals for purposes of livelihood or profit.

Gross income derived from business

The term “gross income” derived from business shall be equivalent to gross sales less
sales returns, discounts and allowances and cost of goods sold. In the case of taxpayers
engaged in the sale of service, “gross income” means gross receipts less sales returns,
allowances and discounts (NIRC, Sec. 27 [A]).

Cost of goods sold It includes all business expenses directly incurred to produce the
merchandise to bring them to their present location and use such as invoice cost of the
goods sold, for a trading concern, or cost of production for a manufacturing concern.
Cost of services All direct costs and expenses necessarily incurred to provide the service
required by the customers and clients including:
1. Salaries and employee benefits of personnel, consultants, and specialists
directly rendering the service; and
2. Cost of facilities directly utilized in providing the service (NIRC, Sec. 27 E [4]).

INCOME FROM DEALINGS IN PROPERTY

Types of properties from which income may be derived

1. Ordinary assets – refer to properties held by the taxpayer used in connection

with his trade or business which includes the following: [SOUR]
a) Stock in trade of the taxpayer or other property of a kind which would
properly be included in the inventory of the taxpayer if on hand at the close of the
taxable year
b) Property held by the taxpayer primarily for sale to customers in the
Ordinary course of trade or business
c) Property Used in the trade or business of a character which is subject to
the allowance for depreciation provided in the NIRC
d) Real property used in trade or business of the taxpayer

Examples of ordinary assets

a) The condominium building owned by a realty company, the units
of which are for rent or for sale
b) Machinery and equipment of a manufacturing concern subject to
depreciation
c) The motor vehicles of a person engaged in transportation business
 2. Capital assets - include property held by the taxpayer (whether or not
connected with his trade or business) other than SOUR above. Examples of capital assets
a) Jewelry not used for trade or business
b) Residential houses and lands owned and used as such
c) Automobiles not used in trade or business
d) Stock and securities held by taxpayers other than dealers in securities

ORDINARY GAIN
A gain derived from the sale or exchange of ordinary assets such as SOUR.
-Percentage Tax and VAT

CAPITAL GAIN
A gain derived from the sale or exchange of capital assets or property whether or
not connected with the trade or business of the tax payer other than SOUR.
-Capital gains tax