UA: Taxation – Fundamentals of Income Taxation

UA San Fernando
REX B. BANGGAWAN, CPA, MBA

TAXATION
FUNDAMENTALS OF INCOME TAXATION

INCOME
All wealth which flows into the taxpayer other than a mere return of capital and includes gains

Why is income taxed?

Income is the best measure of a taxpayer’s ability to pay.

Basic Definitions:
Gross Income – refers to what is income for taxation purposes
Taxable Income – as the pertinent items of gross income that are subject to tax after allowable deductions
Tax Base – the value of a certain goods, or property for taxation purposes

Characteristics of Gross Income:

1. Return on capital and resulted increased networth at the moment of its generation
2. Realized benefit by the taxpayer (realization means actual or constructive receipt of in cash)
Example of constructive receipts of income:
1. credit to an account own by the taxpayer
2. declaration of a share of the profits of a general professional partnership
3. offsetting debt with right to received dividends
4. cancellation of debt in payment of service

Which do not constitute gross income?

1. Receipts representing returns of capital
Examples:
a. Proceeds of life insurance policy (upon death of the insured)
b. Proceeds received by the insured (still living) representing return of premium
2. Unrealized income
Examples:
a. Appreciation of value of properties
b. Unrealized gains on investments
3. Those exempted by the Constitution, statues or treaty or contract with taxpayers
Examples:
a. Receipt of non-profit institutions from their main activities
b. Contributions to GSIS, SSS, PhilHealth, Pag-Ibig and
c. Retirement and separation benefits under certain circumstances
d. Tax holiday for entities registered pursuant to the Omnibus Investment Code
e. Income of foreign government or corporations owned or controlled by them

Taxation of Gross Income under the NIRC:

A. Passive Income Tax
1. Capital gains tax – few final tax is imposed on certain gains on dealings on properties
Examples include final tax on:
a. Final tax on net gain on sale of domestic stocks directly to buyer (withheld at source)
b. Final tax on gains on sale of real property located in the Philippines classified as capital asset
2. Other withheld final tax – these are groups of passive income that are subject to withholding by the
income payor.
Examples include final tax on:
a. Interest on deposits with banks d. Winnings
b. Prizes e. Royalties
c. Dividends received from domestic corporation
B. Regular (Active) Income Tax – applies to all items of gross income that are generated by the taxpayer in the
ordinary course of business or to those items of passive income that are not covered by final taxes.
Regular income tax is either:
1. Progressive tax (0-32% schedular rates) – applicable to individual and taxable trusts and estates
2. Final tax (35%) – applicable to corporations

Examples active income:

1. Compensation income
2. Professional income
3. Business income

SITUS OF INCOME
A. Interest – debtor’s residence
B. Dividends
1. By a domestic corporation – within the Philippines
2. By a foreign corporation – apply the income dominance test

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
Basis:
World gross income for the three-year period ending the current taxable year preceding the declaration of
such dividends
a. If Philippine gross income is less than 50% of the basis, the whole dividend is considered earned
outside the Philippines
b. If Philippine gross income is at least 50% of this, the ratio of Philippine gross income over the basis
multiplied by the dividend received is considered earned within the Philippines.
C. Service – place of performance of the service
D. Rent – location of the property
E. Royalties – place where the intangible is used
F. Gain on sale
a. Real property – location of the property
b. Domestic shares of stock – always within the Philippines
c. Personal property – place of sale
G. Mining – location of mine
H. Farming - location of farm
I. Merchandising – place of sale
Place of Puchase Place of Sale Income is earned
a. Within within within
b. within abroad abroad
c. abroad within within
d. abroad abroad abroad
J. Manufacturing – place of production and place of sale (Sec. 42(E), NIRC):
Whether full or partial processing, for example:
Place of Production Place of Sale Income is earned
a. Within within within
b. within abroad within and abroad
c. abroad within within and abroad
d. abroad abroad abroad

Allocation methods:
The allocation of manufacturing income is governed by the transfer pricing regulations which mandates
measurement of revenue or costs between affiliated enterprises at arm’s length price.

TAX ACCOUNTING PERIODS

Gross income accumulates over a period of time. Income taxation would require adoption of an accounting period
wherein to measure the income. The NIRC provides that “taxable income shall be computed upon the basis of the
taxpayer’s annual accounting period in accordance with the methods of accounting regularly employed in keeping
the books of such taxpayer.”

There are two types of tax accounting periods:

1. Calendar year – the 12-month period ending December 31 and is applicable to:
a. Individuals
b. taxpayers who do not keep books d. taxpayers with accounting periods other than the fiscal year
c. taxpayers with no annual accounting period
2. Fiscal period – any 12 months period ending the last day of any month other than December 31 st. This is Not
available to non-corporate taxpayers.

Normally, accounting period are uniformly 12 months, however, short accounting period may arise in the following
cases:
1. Death of a taxpayer
2. Newly organized business
3. Dissolution of business
4. Change in accounting period
5. Termination of accounting period by the CIR

TAX PAYMENTS
Tax shall be paid on the 15th day of the fourth month following the close of the taxpayer’s taxable year.

TAX ACCOUNTING METHODS

So as the reporting of items of gross income would be consistent, tax accounting methods should be applied such
as the following:
A. Principal Methods
1. Cash Basis Method – income is recorded in the year it is actually or constructively received; expenses are
generally reported in the year it is paid
2. Accrual Method – income is reported in the year it is earned and expenses are deducted in the year
incurred
3. Hybrid method – combination of both cash basis and accrual basis method
B. Deferred Payment Sales
1. Installment method – applicable in the following three cases only:
a. Sale of personal property by a dealer
b. Casual sale of personal property where:
a. selling price is over P1,000.00
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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
b. initial payment do not exceed 25% of the selling price
c. property is of a kind which would be included in the taxpayer’s inventory if on hand at the close of
the taxable year
c. Sale of real property where the initial payment do not exceed 25% of the selling price
Initial Payment – refers to payments which the seller receives upon the execution of the instruments
of sale and those scheduled to be received in the year of sale or disposition. It simply means “total
first year payments” but do not include receipts of evidence of indebtedness of the buyer such as
notes.
2. Deferred payment basis – applicable when the buyer has issued evidence of obligation (notes). The notes
shall be valued at its market value at the date of receipt. The difference between the fair value and the
face value is reported as interest income in future taxable period. This is an alternative to delaying tax
payments when the installment method is not available.
C. Long-term Construction Contracts
1. Percentage of completion – this is applicable only to long-term construction contracts covering a period in
excess of one year (Architect or engineer’s certification is required)
2. Completed contract basis – gross income is recognized upon completion of construction contract
D. Farming income
Crop year basis – applicable only to farmers engaged in the production of crops which takes more than a year
from the time of planting to the process of gathering and disposal. Expenses paid or incurred are deductible in
the year the gross income from the sale of the crops is realized.
E. Leasehold improvement
1. Outright method – the value of the leasehold improvement attributable to the lessor is reported in taxable
income at the time of completion of the leasehold
2. Spread-out method – the value of the leasehold improvement attributable to the lessor is recognized in
taxable income over the lease term

Reminders on Tax Accounting Methods:

a. Absence of accounting method or use of one that do not clearly reflects the income
If the taxpayer has no accounting method or if the method employed does not clearly reflect the income,
the computation shall be made in accordance with such method as in the opinion of the Commissioner
clearly reflects the income.
b. Consolidation of gross income from two or more methods
If a taxpayer adopted the cash basis and accrual basis in accounting for income earned on separate trade
or business, he may opt to combine the two income determined from the respective methods as a
consolidated income for tax purposes.
c. Change of Tax Method
- Prior BIR approval is required
- If the taxpayer changes its accounting methods from accrual to installment method, he should include
in future periods the collection of receivables in future gross income.*
d. Expenditures benefiting future periods
Expenditures benefiting more than one taxable period is deferred and allocated to those periods expected
to be benefited by the expenditure.
e. Advanced receipt of items of gross income
Receipt of income in advance is taxable in the year of receipt.

GENERAL RULE IN INCOME TAXATION

Income Taxable in the Philippines
Type of Taxpayers Earned Philippines Earned Abroad
I. Individuals
A. Citizens
1. Resident  
2. Non-resident 
B. Aliens
1. Resident 
2. Non-resident
a. In business 
b. Not in business 
C. Estate and Trusts same rule with individuals

II. Corporations
A. Domestic  
B. Foreign 
1. Resident 
2. Non-resident 

TAX COMPLIANCE
The Philippines follows the “self-assessment method” wherein taxpayers determine their gross income, prepare
their income tax returns and pay the tax accordingly. The return filed is presumed correct unless proven otherwise
by the government. However, in cases of failure to file a return, the Commissioner of Internal Revenue shall file a
return from best available information and such return thus filed is presumed correct. The taxpayer has the burden
of proof in this case. The same rule applies when tax authorities has reasons to believed that the tax return of the
taxpayer is grossly misstated.

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
Income tax return is required for items of gross income that are subject to:
1. Regular Income Tax (quarterly and annual consolidated return)
2. Capital Gains Tax (per transaction and an annual consolidated return)

Who shall file income tax returns?

1. Every resident Filipino citizen
2. Every non-resident Filipino citizen on his income from sources within the Philippines
3. Every resident alien on income from sources within the Philippines; and
4. Every non-resident alien engaged in trade or business or in the exercise of profession in the Philippines,
on income from sources within the Philippines

Who are not required to file individual returns for income tax?
1. An individual whose gross income does not exceed P 250,000, except those engaged in business or
profession
2. An individual with respect to pure compensation income, derived from sources in the Philippines, the
income tax on which has been correctly withheld, except those with concurrent employment
3. An individual whose income has been subjected to final income tax
4. An individuals who is exempt from filing income tax returns in pursuant to other provisions of the Tax
Code and other laws.

Where to file income tax returns?

1. Authorized agent bank
2. Revenue District Officer
3. Collection Agent
4. Duly authorized Treasurer of the city or municipality in which the taxpayer has his legal residence or
principal place of business in the Philippines or
5. Office of the Commissioner if the taxpayer has no legal residence or place of business in the Philippines

Payment of Income Tax

1. Outright
2. Installments (for individual taxpayers)

The Networth Method

The Networth Method serves as a test of the existence of income when not specifically disclosed.

Possible Gross Income = Personal Expenditures + Change in Networth*

*The change in Networth is computed as:

Asset, end - Liabilities, end = Net Worth, end

Less: Assets, beginning - Liabilities, beginning = Networth, beginning
Change in networth
The possible gross income is generally taxable, except when it:
1. is excluded by law, contract, treaty, public policy from taxation
2. result from additional investment
3. is not income for income tax purposes (i.e. does not meet the three characteristics of gross income)

EXAM DRILL PROBLEMS:

The Concept of Income

1. In particular, income is taxed because
a. When a person receive an income, it received a benefit from the government
b. Other sources of government revenues may not be sufficient to shoulder government expenditures
c. It represents the primary source of government revenue aside from business tax
d. It represents the best indicator of one’s ability to pay

2. Gross income means

a. The pertinent item of income that is subject to progressive rates.
b. The pertinent item of income that is subject to final tax rates.
c. Income that can be subject to income taxation.
d. Income that are actually realized in cash or property.

3. Mr. Basilio insured his life with his estate as beneficiary. In 2016, after Mr. Basilio had paid P65,000 in
premium, he assigned the policy to Mr. Jose Llamado for P60,000, and Mr. Llamado continued paying the
premiums. Mr. Basilio died and Mr. Llamado collected the total proceeds of P200,000. Mr. Llamado, after the
assignment and before Mr. Basilio’s death, paid a total premium of P80,000.

As a result of the above transaction, Mr. Llamado:

a. Derived a taxable income of P55,000 c. May consider the proceeds of P200,000 as exempt from tax
b. Derived a taxable income of P60,000 d. Answer not given

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
4. Mr. Monte was injured in a vehicular accident in 2015. He incurred and paid medical expense of P20,000 and
legal fees of P10,000 during the year. In 2016, he received P170,000 as settlement from the insurance
company which insured the car owned by the other party involved in the accident. From the above payments
and transactions, the amount of taxable income of Mr. Monte in 2016 is
a. P 0 b. P140,000 c. P 170,000 d. P150,000

5. Tony was hit by a wayward bus while on his way home. He survived but had to pay P150,000 for his
hospitalization. He was unable to work for 6 months and did not receive his usual P10,000 monthly salary. He
sued the bus company and was awarded by a final judgment a sum of P460,000: P150,000 as
reimbursement for his hospitalization, P60,000 for his lost salaries, and P250,000 as moral damages for his
pain and suffering. How much income did he realized when he collected form the judgment?
a. P460,000 b. P250,000 c. P60,000 d. P400,000

6. Which is not subject to income taxation?

a. Income from properties received from donations and inheritance
b. Proceeds of crop insurance
c. Damage recovered from patent infringement suit
d. Revenues of non-profit educational institutions

7. Which is subject to income tax?

a. Compensation for personal injuries
b. Investment income of foreign government in the Philippines
c. Income of resident aliens abroad
d. Business income from jueteng and sale of coccaine
`
8. Which is an item of gross income?
a. Tariff collected by the Bureau of Customs
b. License fees collected by the Professional Regulation Commission
c. Income of a government-owned and controlled corporation
d. Tithes received by religious organizations

9. Alexander is a foreign currency speculator. He currently held $100,000 dollar purchased by him at P40/$1. At
the close of his business on December 31, 2008, a dollar was selling P50. Which statement is correct?
a. The appreciation will be subject to tax since transaction in currencies is presumed to be a realized benefit.
b. The appreciation will not be subject to tax since it is not a realized benefit.
c. The appreciation will not be subject to tax since it is merely a return of capital.
d. The appreciation will be subject to tax since it will be reported in accounting income. The NIRC provides
that the methods of accounting of the taxpayer shall be followed in determining the taxable income.

10. Which of the following represents an item of gross income?

a. Revaluation surplus on building c. Appreciation in the value of land
b. Local tax refund d. Return of premium in a life insurance policy

11. Which is not an item of gross income?

a. Interest on a bank deposit c. Winnings
b. Interest on a notes receivable d. PhilHealth benefits

12. All of the following cannot be subject to income tax, except?

a. Proceeds of life insurance of a director received by the corporation as beneficiary
b. Excess of amounts received by the taxpayer over premium paid
c. Moral damages
d. Tuition fee earned by a public school

13. Jake was one of the passengers of a van that fell off a ravine. Jake sued the bus company and was awarded
an indemnity of P800,000 for the following:
 P500,000 for the impairment of his health resulting to the amputation of his legs
 P200,000 for his loss of salaries during his hospitalization
 P100,000 for his Attorney’s fees

Compute Jake’s return on capital.

a. P800,000 c. P200,000
b. P300,000 d. P0

14. Kendrick received the following items during the year:

 P200,000 donation from a girlfriend
 P150,000 service fee from professional services
 P300,000 inheritance from his deceased father
 P100,000 income from illegal gambling
 P50,000 gain on sale of his personal car
 P250,000 profits from his bar restaurant

Compute the total income subject to income tax.

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
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a. P1,050,000 c. P550,000
b. P750,000 d. P450,000

15. Pines Corporation has a branch in Manila and a 70%-owned subsidiary, Choco Hills, Inc. in Davao. The
following data shows Pines Corporation’s sales transactions during the year:
 Pines Corporation billed the Manila branch P1,500,000 for merchandise shipped to the latter at a mark-up
of 50% above acquisition cost. The branch resold half of the merchandise for P900,000.
 Sold merchandise to unrelated parties at a gain of P800,000
 Sold merchandise to Darrel Asuncion, Pines Corporation’s controlling stockholder, at a gain of P100,000
 Sold various merchandise to Choco Hills, Inc. at a gain of P300,000

Compute the total income of Pines Corporation subject to income tax.

a. P1,600,000 c. P900,000
b. P1,200,000 d. P800,000

16. Under the NIRC, income is received not only when it is actually or physically transferred to a person but even
when it is merely constructively received by him. An example of income constructively received is
a. Rental payments refused by the lessor, when the lessee tendered payment and the latter made a judicial
deposit of the rental due.
b. Interest coupons not yet due and payable.
c. Interest on savings deposit not yet credited to the account of the depositor.
d. Advanced deposit made by the lessee.

17. Which of the following is considered or construed as an example of constructive receipt?

a. Retirement benefits, pension, gratuities received by the taxpayer.
b. Fees paid to a public official.
c. Interest coupons that have matured and are payable but have not been cashed.
d. Deposits for rentals to answer for damages, restricted as to use.

INCOME TAXPAYERS

Taxpayer classification

Person or Entity Classification

1. A hardworking overseas Filipino worker
2. A Filipino who is privately employed in the Philippines
3. An unemployed Filipino residing in the Philippines
4. A Chinese businessman who has his domicile in the Philippines for 6 months
5. A Japanese who married a Filipina and has been residing in the Philippines for 2 years
6. A fat American tourist
7. A 2nd year Korean college student studying in the Philippines
8. A corporation incorporated under Philippine law
9. A foreign corporation doing business in the Philippines
10. Trust designated by the donor as irrevocable
11. Trust designated by the donor as revocable
12. A business partnership
13. A joint venture organized under a foreign law and is not operating in the Philippines
14. An estate of a Filipino citizen judicially administered in the Philippines
15. An estate of a Filipino citizen extra-judicially administered in the Philippines
16. A taxable joint venture organized in the Philippines

Multiple Choice:
1. Which is not an income taxpayer?
a. Business partnership c. Non-resident alien
b. Non-resident foreign corporation d. General professional partnership

2. Which of the following individual taxpayers is not covered by progressive tax?

a. Resident citizen c. Non-resident alien engaged in trade or business
b. Resident alien d. Non-resident alien not engaged in trade or business

3. Which is an income tax payer?

a. Revocable trusts and estates under extrajudicial settlements
b. Non-resident alien, not engaged in business
c. Joint ventures engaged in construction projects or energy operations in pursuant to an operating
consortium agreement under service contract with the government
d. Co-ownership which is limited to property preservation

4. Under the NIRC, a business partnership that is organized in the Philippines but dominantly operates abroad is
considered a/an
a. domestic corporation c. non-resident corporation
b. resident corporation d. absentee corporation

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
5. A corporation doing business in the Philippines but is not organized according to Philippine laws is classified
as
a. domestic corporation c. non-resident corporation engaged in business
b. resident corporation d. non-resident foreign corporation

6. All of the following taxpayers are taxable even on income earned outside the Philippines, except
a. Domestic corporation c. Resident alien
b. Resident citizen d. None of these

7. All of the following are taxable only on income earned within the Philippines, except
a. Resident alien c. Non-resident alien
b. Resident citizen d. Non-resident citizen

8. An alien who arrived in the Philippines during the year and showed proof to the satisfaction of the CIR
regarding his employment in the Philippines for an extended period of time.
a. Resident alien c. Non-resident citizen engaged in trade or business
b. Resident citizen d. Non-resident citizen not engaged in trade or business

9. In default of intention, an alien who is resident in the Philippines for 6 months is considered a
a. Resident alien c. Non-resident alien engaged in trade or business
b. Resident citizen d. Non-resident citizen not engaged in trade or business

10. A resident alien naturalized in accordance with law

a. Resident alien c. Non-resident citizen
b. Resident citizen d. Non-resident alien engaged in trade or business

11. Which is a large taxpayer?

a. A taxpayer with quarterly VAT of P900,000
b. A taxpayer with annual income tax of P900,000
c. A taxpayer with annual excise tax due of P900,000
d. A taxpayer with annual withholding tax remittances of P900,000

12. Which is a large taxpayer?

a. Those with gross receipts or sales of P500,000,000
b. Those with net worth of P30,000,000
c. Those with gross purchases of P80,000,000
d. Those top corporate taxpayers listed by the SEC

SITUS APPLICATIONS

18. Cindy Lim Co., a resident foreign corporation, declared P500,000 dividends on July 1, 2018, to its 100,000
outstanding ordinary shares. Becky, a resident alien, holds 20,000 of Cindy Lim Co’s ordinary shares. The
corporation has just started operation 3 years ago and has significant Philippine operation since its start-up.
Details of the gross income of THY is shown below:
Gross Income: 2016 2017 2018
Philippines P 1,200,000 P 4,000,000 P 6,000,000
Abroad 2,800,000 2,000,000 4,000,000

How much of the dividends received by Becky is considered earned within the Philippines and the pertinent
tax scheme that would apply?
a. P100,000; final tax c. P52,000; final tax
b. P56,000; progressive tax d. P52,000; progressive tax

Query:
1. What is your answer if the corporation above is domestic corporation?
2. How much is taxable within in the Philippines? What if Becky is a resident citizen?

19. A resident alien rendered professional advisory services to foreign businesses earning him P2,000,000
professional fees. The professional fee is
a. exempt from the Philippines. c. taxable both in the Philippines and abroad.
b. taxable from the Philippines. d. neither taxable in the Philippines nor abroad.

20. Which income is considered purely earned abroad?

a. A merchandise purchased abroad and sold in the Philippines
b. A merchandise purchased in the Philippines and sold abroad
c. A merchandise manufactured in the Philippines and sold abroad
d. A merchandise manufactured abroad and sold in the Philippines

21. When real property is sold at a gain, the situs of taxation is

a. the residence of the owner. c. the place where the deed of sale is executed.
b. the residence of the buyer. d. the place where the property is located.

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
22. Darrel Asuncion, a resident citizen, owns a commercial building in Las Vegas. The building is currently leased
to a resident Pilipino who pays P50,000,000 rentals annually. The rent is considered
a. earned abroad. c. earned within the Philippines.
b. earned in the Philippines. d. partly within and partly outside the Philippines.

23. All of the following income are considered earned without the Philippines, except one. Choose the exception.
a. Interest income from notes issued by a non-resident alien
b. Dividends paid by a non-resident foreign corporation
c. Management advisory fee earned from a foreign client abroad
d. Dividends declared by a domestic corporation received a non-resident alien investor

24. Mr. Wise, an NRA-NETB, exported to THI, a non-profit domestic corporation in the Philippines, a car for
P500,000. The sale is made at a mark-up of 25% on cost. Which is correct?
a. THI shall withhold 25% final withholding tax.
b. THI shall withhold 30% final withholding tax.
c. THI is not required to make withholding as the income is earned outside.
d. THI is not required to make withholding since THI is a non-profit not subject to tax.

25. An Indian citizen, who married a beautiful Filipina wife, owns a building in the United States and leases the
same to businesses owned by Filipino residents. The Indian national has his residence in the Philippines and
all his children are studying in elite Philippine universities. Which is true?
a. The rental income of the Indian national is taxable in the Philippines because he had his residence in the
Philippines.
b. The rental income of the Indian national is taxable in the Philippines because he married a beautiful
Filipina wife and his family is resident in the Philippines.
c. The rental income of the Indian national is taxable in the Philippines because he derives his income from
Filipino resident lessees.
d. The rental income of the Indian national is exempt in the Philippines because the property is located
abroad.

26. Benzon, a non-resident alien, invests in the capital stocks of a domestic corporation. Benzon subsequently
sold the stocks to another non-resident alien at a gain of P20,000. Which is true?
a. The income is taxable in the Philippines because domestic securities are by situs rules situated within.
b. The income is exempt in the Philippines because the place of sale applies with sale of personal property.
c. The income is exempt in the Philippines because the resident of the seller applies with sale of personal
property.
d. The income is exempt in the Philippines because both non-residents are involved in the transaction.

27. The place of taxation is

a. Situs rule c. Territoriality
b. Situs d. Gross income

28. Which is an incorrect statement regarding situs of income?

a. Interest income is earned in the residence of the debtor.
b. Royalty is earned where the intangible is employed.
c. Service income is earned in the domicile of the taxpayer.
d. Rent is earned in the location of the property.

29. Which statement is correct regarding situs of income?

a. The gain on sale of any property is earned in the place of sale.
b. The gain on the sale of real property is earned in the location of the property.
c. Merchandising income is earned in the residence of the proprietor.
d. Manufacturing income is earned in the place of sale

30. Pedro, a non-resident citizen, lent money to Shino, a resident Chinese. The indebtedness was collateralized
by a property located in Japan. The interest income is earned in
a. the Philippines. c. Japan.
b. China. d. Japan, China and the Philippines.

31. Gains on the sale of goods manufactured and sold by the taxpayer within the Philippines is subject to tax
a. wherever sold. c. within the Philippines only.
b. if sold abroad only. d. without the Philippines only.

32. Yvonne, a resident alien, bought a car manufactured in the Philippines and exported the same at a gain to
Carla, a non-resident citizen. Which is correct?
a. The gain is subject to tax in the Philippines since the commodity involved is manufactured in the
Philippines.
b. The gain is subject to tax in the Philippines since the buyer is a citizen of the Philippines.
c. The gain is both subject to tax in the Philippines and abroad since the commodity involved is
manufactured in the Philippines.
d. The gain is taxable in the Philippines because it is sold therein.

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
33. Juan, a resident alien, and Pedro, a non-resident alien, executed a contract of sale in Japan whereby Pedro
shall purchase the lot owned by Juan in the Philippines. Juan gains P1,000,000 in the exchange. Which is
true?
a. The gain is exempt since the gain is derived outside the Philippines.
b. The gain is subject to Philippine tax because the property is in the Philippines.
c. The gain is not subject to Philippine tax since Juan is a resident alien.
d. The gain is subject to Philippine tax because Juan is a resident alien.

TAX ACCOUNTING PERIODS

13. Which is incorrect? The calendar year accounting period is applicable to
a. individual income taxpayers only
b. taxpayers who do not keep book or with no annual accounting period
c. taxpayers with other than fiscal accounting period
d. individuals and corporations

14. Which is correct? The fiscal accounting period is applicable only to

a. domestic corporations. c. corporations and individuals by election.
b. resident corporations. d. Any taxpayers who are not individuals.

15. A short accounting period may arise under the following scenarios, except one. Select the exception?
a. When a taxpayer dies.
b. When a business is dissolved.
c. When the Commissioner of Internal Revenue terminates the taxpayer’s accounting period.
d. When an individual taxpayer changes his accounting period to a fiscal year.

16. QRZ Corporation changed its accounting period from a calendar year to a fiscal year ending every March 31.
QRZ Corporation should file its annual income tax return not late than
a. April 15, same year c. July 15, same year
b. August 15, following year d. July 15, following year

17. Bee Jay, a resident citizen, changed his accounting period for internal reporting purposes from a calendar
year to a fiscal year ending every June 30 after a significant change in the nature of his business. Bee Jay
should file his annual income tax not later than
a. June 30, same year c. October 15, following year
b. September 15, same year d. April 15, following year

18. Which is incorrect regarding a change in accounting period by non-individual taxpayers?

a. If the change is from fiscal year to calendar year, a separate final or adjustment return shall be made for
the period between the close of the last fiscal year for which return was made and the following
December 31
b. If the change is from calendar year to fiscal year, a separate final or adjustment return shall be made for
the period between the close of the last calendar year for which return was made and the date designated
as the close of the fiscal year
c. If the change is from one fiscal year to another fiscal year, a separate final or adjustment return shall be
made for the period between the close of the former fiscal year and the date designated as the close of
the new fiscal year
d. If the change is from fiscal year to a calendar year, a separate final or adjustment return shall be made for
the period between the close of the last calendar year and the last fiscal year

19. Starting August, 2018, ABC Corporation changed its accounting period from a fiscal year ending every June
30 to the calendar year. Which statement is correct?
a. ABC Corporation should file an adjustment return on April 15, 2019 covering the period of July 1, 2018 to
December 31, 2018.
b. ABC Corporation should file an adjusted return on April 15, 2019 covering the period of August 1, 2008 to
December 31, 2018.
c. ABC Corporation should file an adjustment return on October 15 covering the period of January 1, 2018
to June 30, 2018
d. ABC Corporation need not file an income tax return until April 15, 2019

20. Effective February 2018, DEF Corporation changed its accounting period from a fiscal year ending every
January 31 to another fiscal year ending every August 31. Which is correct?
a. DEF Corporation should file an adjustment return covering the period covering August 31, 2017 to August
31, 2018.
b. DEF Corporation should file an adjustment return covering the period January 1, 2018 to August 31, 2018
c. DEF Corporation should file an adjustment return covering the period of February 1, 2018 to August 31,
2018.
d. DEF Corporation should file an adjustment return covering the period of August 31, 2018 to December 31,
2018.

ACCOUNTING METHODS
1. Gross income is reported partially in each taxable year in proportion to collections made in such period as it
bears to the total contract price refer to

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
a. Crop year basis method c. Percentage of completion basis method
b. Accrual method d. Installment sales method

2. Which is correct?
a. The installment method of reporting income is applicable only to dealers in property.
b. The installment method can be availed only by any taxpayer when the initial payment do not exceed 25%
of the selling price of the property sold.
c. The casual sale of personal property cannot avail of the installment method if the selling price is below
P1,000.
d. Dealers in real properties can always avail of the installment method.

3. On July 1, 2018, Eliazar, a realty dealer, sold a piece of land which was acquired 5 years ago for P300,000 for
P600,000. 20% down-payment is due upon signing of the contract of sale. The balance is payable as follows:
6% December 31, 2018; 52% in 2019 and 42% in 2020. How much of the gain is taxable in 2018?
a. P 300,000 c. P 70,500
b. P 74,400 d. P 0

4. The following accounts relates to book of Zeus, a dealer of household appliances:

12/31/2019 12/31/2020
Installment sales P 1,000,000 P 2,000,000
Cost of installment sales 500,000 1,100,000
2020 Installment receivables - 500,000
2019 Installment receivables 300,000 50,000

How much taxable gain is to be reported in 2020?

a. P1,750,000 b. P800,000 c. P675,000 d. P900,000

5. A taxpayer who is reporting under the accrual basis reported the following GAAP net income:

Service fees (75% collected) P 800,000

Less: Expenses of professional practice (90% paid) 300,000
Income from profession P 500,000
Rental income:
Rental collections P 300,000
Unearned rent, beginning 100,000
Unearned rent, end ( 50,000) 350,000
Gain on increase in fair value of investment properties 50,000
Total net income P 900,000

Determine the net income for taxation purposes.

a. P900,000 b. P850,000 c. P800,000 d. P630,000

6. Determine the net income for taxation purposes assuming the taxpayer uses the cash basis of accounting.
a. P900,000 b. P850,000 c. P800,000 d. P630,000

7. ABC, Inc. reported the following income in 2019 using GAAP cash basis:

Professional fees P 600,000

Less: Expenses
Salaries expense 120,000
Supplies expense 40,000
Rental expense (1/2 relates to 2020) 80,000
Operating Income P 360,000
Unrealized gain on marketable equity securities 20,000
Net income P 380,000

Year-end additional information:

a. There were P20,000 accrued salaries unpaid to staffs.
b. There were P80,000 accrued professional fees.
c. A total of P40,000 fees were advanced by various clients.

Compute the taxable income of the taxpayer using the cash basis of accounting
a. P400,000 b. P460,000 c. P480,000 d. P500,000

8. Compute the taxable income of the taxpayer using the accrual basis of accounting
a. P400,000 b. P440,000 c. P460,000 d. P480,000

9. Which is incorrect regarding change in accounting methods?

a. If the taxpayer changes from accrual to installment basis, he should include the amounts received from
sales or other dispositions of property made in any prior year in the computation of his income for the year
of change or any subsequent year.
b. Any change in accounting method or accounting period require the BIR’s approval

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03
UA: Taxation – Fundamentals of Income Taxation
c. If a taxpayer adopted the cash basis and the accrual basis in computing income earned on separate trade
or business, he may opt to combine the two income determined from the respective methods as a
consolidated income for tax purposes
d. If the taxpayer changes from accrual to installment basis, he should include only receipts that relates to
current sales or dispositions

10. Mr. Monte bought a 2,000 square meter of land at a cost of P500,000. He leased the land to Mr. D. Asuncion
at an annual rental of P40,000. The term of the contract of lease was 15 years. The contract of lease provide
that Mr. Asuncion will construct a building on the land, which will belong to the lessor at the end of the term of
the lease or at the termination of the lease. The building was constructed for a total cost of P400,000 and has
an estimated useful life of 20 years which was the basis of a straight-line method of depreciation. The
remaining term of the lease when the building was completed was 14 years.

Compute the income from the leasehold improvement using the outright method
a. P180,000 b. P160,000 c. P200,000 d. P120,000

11. Compute the yearly income assuming Mr. Monte will spread his income from leasehold over the term of the
lease contract
a. P42,000 b. P45,667 c. P48,571 d. P51,327

12. Compute the income of Mr. Monte assuming the contract of lease was terminated just after the 10 th year due
to the fault of the lessee.
a. P182,861 b. P160,000 c. P180,450 d. P183,231

13. Compute the deductible loss of the lessor assuming the leasehold improvement was destroyed at the
beginning of the 9th year of the lease contract
a. P59,997 b. P58,250 c. P59,342 d. P61,287

14. Mr. Mario was alleged to have under-declared his income during the previous year. An examiner conducted
an evaluation of Mr. Mario based on his statement of assets and liabilities. The following information were
available:

Net assets, beginning P 780,000

Net assets, ending 850,000

During the year, Mr. Mario received a P100,000 inheritance from his deceased father. Mr. Mario donated a
parcel of land worth P200,000 to his son who is getting married. He also presented a personal and business
expenses aggregating P250,000. Using the net worth method, determine Mr. Mario’s possible taxable net
income?
a. P70,000 b. P270,000 c. P420,000 d. P220,000

15. Income tax return may be filed on the following, except

a. Authorized agent bank c. Authorized City or Municipal Treasurer
b. Collection agent of the BIR d. Barangay treasurer of the taxpayer’s residence

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That in all things God will be glorified! Rex B. Banggawan, CPA, MBA TAX –HQ03