Income Taxation Module Compilation Finals

Course Code and Title: BACR 5 – INCOME TAXATION
Lesson Number : 8
Topic : Exclusions from Gross Income
Instructor : Prof. Rosario A. Calamba, CPA, PhD
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LEARNING OBJECTIVES:
At the end of this lesson, the student should be able to:
1. Identify the various items of exempt income as provided by the NIRC and
special laws;
2. Understand the limitations of exemption of certain income items;
3. Explain the scope of the income tax exemption of minimum wage earners and
BMBEs.
PRE-ASSESSMENT
Try to answer the following questions.

1. Are gifts received subject to income tax?
The value of property acquired by gift: Provided, however, that income from
such property as well as gift of income from any property, in cases of
transfers of divided interest, shall be included in gross income.
2. When are proceeds of life insurance subject to income tax?
Proceeds from sale of an insurance policy or outliving a life insurance policy
is taxable to the extent to the amount exceeding the return on capital.
3. What is the difference between retirement benefits and separation pay?
Retirement benefits are those benefits received under R.A. 7641 and those received
by officials and employees of private firms in accordance with a reasonable private
benefit plan maintained by the employer. While the separation pay is the benefit
given to employees who have not reached the retirement age but have been
separated from the service.
LESSON PRESENTATION
INTRODUCTION
As discussed from the previous module, exclusions from gross income are items
of income which are not reported any more in the gross income in the income
tax return. In this module, the discussion will focus on those exempt income on
regular income tax provided by the tax code and other special laws.
PROCEEDS OF INSURANCE POLICIES

As discussed from previous modules, life is a capital item with infinite value,
thus, proceeds from life insurance policies as a result of the death of the insured
is not taxable. This is only applicable if the proceeds are paid to the heirs of
beneficiaries. Proceeds, however, from sale of an insurance policy or outliving a
life insurance policy is taxable to the extent to the amount exceeding the return
on capital.
Illustration 8.1
Solui applied for a P5,000,000 insurance policy requiring payment of P10,000 monthly
premiums for ten years.
Scenario 1: It is a life insurance policy on Solui and he dies after three years.
The whole amount of the P5,000,000 proceed is not taxable.
Scenario 2: It is a life insurance policy on Solui and he sells it for P600,000 after paying 52
months of premium. Solui dies after the buyer pays five months of premium.
The amount of P520,000 (52 months x P10,000) is a return of capital, therefore, it is not
taxable. The excess of P80,000 from the proceeds, however, is taxable to Solui since it
constitutes a return on capital.
The buyer of the policy shall be exempt on the P650,000 (P600,000 purchase price + P50,000
premiums paid) received. The excess of P4,350,000 is taxable since he is not the heir or beneficiary.
Scenario 3: It is a life insurance policy on Solui and he dies at the end of second year.
The heirs received P5,100,000 six months after his death.
The excess of P100,000 over the face of the insurance policy constitutes an interest income which is a
return on capital, hence, taxable.
Scenario 4: It is a life insurance policy on Solui and he outlives the policy. He received
the maturity value of P1,400,000.
Only the total amount of premiums paid is exempt. The excess of P200,000 is an item of gross income.
Scenario 5: It is a property insurance for a building with a tax basis of P3,000,000. The
building was burnt.
The tax basis of P3,000,000 is an exclusion from gross income. Only the excess of P2,000,000
is taxable.
The exemption extends to that of corporations insuring their officers with the
corporation as the beneficiary. Premium paid on such are non-deductible against
gross
GIFTS, BEQUESTS AND DEVISES

The value of property acquired by gift, bequest, devise, or descent: Provided,
however, that income from such property as well as gift, bequest, devise, or descent of
income from any property, in cases of transfers of divided interest, shall be included
in gross income.
Illustration 8.2
Mark received a restaurant business as a gift on April 1, 2020. On that date, the
restaurant had total properties amounting to P400,000 including P50,000 cash income
earned since January 1, 2020. The restaurant posted an additional P150,000 cash income
from April 1 to December 31, 2020.
The transfer of business properties worth P400,000 to Mark is a gratuity subject to transfer
tax, not income tax. However, the P50,000 donated income shall be included in gross income,
but in the income tax return of the donor. The P150,000 income of the donated property after
the
perfection of the donation is included as item of gross income in the tax return of Mark, the
COMPENSATION FOR DAMAGES

As a rule, amounts received through Accident or Health Insurance or under
Workmen's Compensation Acts, as compensation for personal injuries or sickness,
plus the amounts of any damages received whether by suit or agreement on account
of such injuries or sickness are excluded from gross income.
Nontaxable, if the compensation for damages is on account of
a. Personal physical injuries or sickness;

b. Any other damages recovered on account of personal injuries or sickness;
c. Exemplary and moral damages for out-of-court settlements including
attorney's fees;
d. Alienation of affection, or breach of promise to marry; and
e. Any amount received as a return of capital or reimbursement of expenses.
Taxable, if the compensation for damages is a payment for
a. Actual damages for loss of anticipated profits;

b. Moral and exemplary damages awarded as a result of breach of contract;
c. Interest for nontaxable damages above: and
d. Any damages as compensation for unrealized income.
Illustration 8.3
Mr. Sammy Haban, a supervisor in a Milling Company, was accidentally bumped by Zigzag
Taxi resulting to his severe physical injuries. The court decided that Zigzag would pay Haban the
following damages which Zigzag paid for a certain period of time:
Moral Damages 100,000
Exemplary Damages 50,000
Damages for permanent loss of earning capacity 200,000
Actual liquidated damages 50,000
Compensation for unrealized earnings 30,000
Only the P30,000 compensation is taxable for since it is a recovery of lost earnings. The remaining
P400,000 will be exempted from income tax.
INCOME EXEMPT UNDER TREATY

Income items that are excluded by international agreement to which the Philippine
government is a signatory are excluded from income tax. It must be recalled that treaty
agreements override provisions of our revenue tax laws in case of conflict under the
exemption doctrine of international comity.
RETIREMENT BENEFITS
Exempt from income tax are retirement benefits received under R.A. 7641 and those
received by officials and employees of private firms in accordance with a reasonable
private benefit plan maintained by the employer.
Requisites of Exemption
All of the following requisites must be satisfied to avail of the exemption.
a. This is the first time availment of retirement benefit exemption.

b. The retiring official or employee has been in the services of the same employer
for at least cumulative ten (10) years.
c. The retiring employee is at least fifty (50) years of age at the time of
retirement.
d. The employer maintains a reasonable private benefit plan.
Illustration 8.4
Yorla, a new year baby, started working on January 17, 1983 at the age of 22 years old.
Following is the timeline of her employment. All companies maintain a reasonable
private benefit plan.
Availed Retirement
Company Inclusive Dates Program?
Boom Aleck Co. January 15, 1983 – July 15, 1986 No
Loom Ipat Corp. July 16, 1986 – September 19, 2002 Yes
Naumay Inc. September 21, 2002 – October 14, 2011 Yes
Boom Alik Co. October 17, 2011 – March 18, 2018 Yes
The benefit from Loom Ipat is taxable since Yorla was still 41 years old back then. The
retirement benefit from Naumay is still taxable since even though she was 50 years old, the
years of service is less than 10 years. The retirement benefit from Boom Aleck is exempt even
though it is not the first time that Yorla avails the retirement program since the exemption is
not availed for the former retirement benefits received. In addition, Yorla satisfies the 10-year
period of service and
SEPARATION AND TERMINATION BENEFIT

Requisite of Exemption
Either of the following requisites must be satisfied to avail of the exemption.
1. The separation or termination must be due to job-threatening sickness, deaths, or other

physical disability; and
2. The same must be due to any cause beyond the control of the employee or official such
as:
a. Redundancy
b. Retrenchment
c. Closure of employer's business
d. Employee lay-off
e. Downsizing of employer's business
f. Sickness or death of the employee
The phrase "beyond the control of the employee" connotes involuntariness on part of the
employee. In other words, the separation must not be of his making.
Limitation
The exemption of termination or separation benefits does not extend to:
1. Backwages or illegal deductions repaid by the employer upon termination

2. Terminal leave pay or the commutation of accumulated unused leave credits
Availment
To avail of the tax exemption, the employee or his heirs shall request for a ruling or certificate
of exemption (CTE) from the BIR. The request for a CTE and other required documents shall
be filed at the RDO where the employer is registered.
Illustration 8.5
Kala is an employee of Goship Company which closed its business during the year. Kala's last
paycheck shows the following details:

Unpaid salary in the last two months 30,000
Current month salary 15,000
Separation pay 100,000
Scenario 1: Kala was chosen to be laid off first because she was the last person to be hired.
Only the P100,000 received is exempt. The backwages and current salary are taxable.
Scenario 2: Kala was chosen to be laid off first because she was had allergic rhinitis. The whole
amount of the last paycheck is taxable since the reason does not normally render the employee incapable
of working.
Scenario 3: Kala chose to resign first.

The whole amount is taxable as the resignation violates the beyond the employee’s control rule.
SOCIAL SECURITY BENEFITS
Received from Foreign Income

This would include social security benefits, retirement gratuities, and other similar benefits
from foreign government agencies and other institutions, private or public, received by
resident or non-resident citizens or aliens who come to settle permanently in the Philippines.
Illustration 8.6
John was an OFW employed by Microsoft Corporation in the USA. John retired and returned to
permanently settle in the Philippines. He is paid a $2,000 monthly pension from Microsoft's
pension fund and another $800 monthly benefit from the US social security benefit.
Both the pension and the social security benefits are exempt. Note that these benefits were earned abroad
when the taxpayer was a non-resident Under situs rule, the foreign Income of non-residents is not
taxable in the Philippines. This holds true even if the taxpayer subsequently receives the income as a
resident of the Philippines.
SSS Benefits
This would be the social security benefits under RA 8282.
GSIS Benefits
These are benefits under RA 8291 including retirement gratuity received by government
officials and employees.
USVA BENEFITS
These are United States Veterans Administration – administered benefits under the law of the
United State received by any person residing in the Philippines.
Illustration 8.7
Mr. Jackson is a retired US serviceman from the Iraqi war. He married a beautiful Filipino
and settled in the Philippines. He is receiving a $1,000 monthly benefit from the USVA.
The USVA benefit is excluded in gross income. The same rule applies to USVA benefits for
beneficiaries of Filipino veterans who fought under the American flag in World War II.
MISCELLANEOUS ITEMS
Income from Domestic Securities
Exempt are those income derived on investments in the Philippines in loans, stocks, bonds, or
other domestic securities, or from interest on deposits in banks in the Philippines by:
a. Foreign governments
b. Financing institutions owned, controlled, or enjoying refinancing from foreign
government
c. International or regional financial institutions established by foreign governments
These are exempt under the exemption doctrine of international comity.
Government Income
Exempt are those income derived by the government and its political subdivisions from:
a. Any public utility; or
b. Exercise of essential government function Government agencies and instrumentalities
The general rule with government agencies and instrumentalities is exemption because of their
public service nature. However, taxation applies when they engage in income-producing
activities which are proprietary or commercial in nature. This exemption does not extend to
government-owned and controlled corporations (GOCCs). GOCCs are generally taxable as
regular corporations because their operations are proprietary in nature.
Mandatory Payroll Deductions

These pertain to the employee share in the premium contributions to GSIS, SSS, PhilHealth,
Pag-Ibig and union dues. The portion of the salary thus contributed is exempt from income
tax. Under RMC No. 21-2011, the exclusion pertains only to the mandatory or compulsory
monthly contributions. Voluntary contributions to Pag-Ibig II, GSIS or SSS in excess of the
mandatory monthly contribution are taxable. Note that Pag-Ibig is now called the Home
Development Mutual Fund or HDMF. This will not be illustrated anymore since the same has
been discussed in your BAINTE1X class.
Personal Equity and Retirement Account

PERA is a contributor's voluntary retirement account established from qualified contributions
of the contributor and or his employer for the sole purpose of being invested in qualified
PERA investment products.
Contributions to PERA accounts are exclusions in gross income. This is an additional

exclusion and is separate with the exclusion for contributions to SSS or GSIS. Moreover, PERA
contributors are allowed to claim 5% of their PERA contributions as tax credit against any
internal revenue taxes.
PERA investment income are exempt from taxes (i.e. final tax, capital gains tax and regular
income tax). The PERA account assets will be distributed back to the contributor either in lump
sum, life pension or in installment upon reaching the age of 55 or to his heirs or beneficiaries
upon his or her death. PERA distributions are likewise exclusions in gross income of the
contributor or his heirs or beneficiaries as the case may be.
13th Month Pay and Other Benefits

The amount received as such by officials and employees of public or private entities not
exceeding P90,000. This will be further discussed in detail in Module 9.
Gains on Sale of Long-Term Indebtedness

Gains from sale of bonds, debentures, or other certificate of indebtedness with a maturity of
more than 5 years are exempted. This exemption is grounded upon the same assumption that
long-term indebtedness is diverted to the financing of long-term projects which is viewed as
beneficial to the development of the country. The term "gain" however, does not include
"interest."
Illustration 8.8
On September 1, 2020, an individual taxpayer sold a 6-year term bond investment for
P1,100,000. These bonds bear 8% interest payable every December 31 were previously
acquired at P1,000,000 face value on January 1, 2020.
The interest accrued of P60,000 (P1,000,000 x 8% x 9/12) is taxable. The gain of P40,000 (P1,100,000
– P1,000,000 – P60,000) is exempt.
Gain on Redemption of Shares in a Mutual Fund Company

The term mutual fund company shall mean an open-end and close-end investment company
as defined under the Investment Company Act.
Mutual funds pool the money invested by different investors and invest the money to earn
investment income which shall add up to the net assets of the fund. A participating investor
must purchase participation shares from the fund at their Net Asset Value (NAV). Upon
redemption of his participation shares, the investor gains or losses by his proportionate share
in the increase or decrease in the Net Asset Value of the fund.
Illustration 8.9
A taxpayer bought 10,000 shares from Golden Dragon Mutual Fund at P120 NAV per share.
The taxpayer redeemed his shares when the NAV per share was P180.
The P600,000 gain, computed as [(P180 - P120) x 10,000], on redemption is excluded from gross
income; hence, exempt from taxation.
The exemption is apparently intended to mitigate double taxation. Most of the items of income
of mutual funds are subject to final tax at source. The subsequent distribution of these to the
investors at redemption should no longer be subject to income tax. On the other hand, the
exemption may have been intended to promote the growth of mutual funds which are widely
regarded as key participants in providing liquidity in most financial markets.
MINIMUM WAGE EARNERS

A minimum wage earner is an individual recipient of a minimum wage as fixed by the
Regional
Tripartite Productivity Wage and Productivity Board of the Department of Labor and
Employment. A minimum wage earner is exempt from income tax on the minimum wage
including h oliday pay, overtime pay, night shift differential pay and hazard pay. This
exemption, however, does not extend to gross income from business or profession. The
presence of income besides that obtain from employment does not impair the exemption.
BARANGAY MICRO-BUSINESS ENTERPRISE (BMBE)
BMBE is a business entity or enterprise engaged in the production, processing or
manufacturing of products or commodities, including agro-processing, trading and services,
whose total assets including those arising from loans but exclusive of the land on which the
particular business entity's office, plant, and equipment are situated, do not exceed P3,000,000.
The term service excludes those rendered by licensed professionals and partnership and
corporations engaged in consultancy, advisory and similar services which are essentially
carried out through licensed professionals. A BMBE shall include any individual owning such
business entity or enterprise, partnership, cooperative, corporation, association, or other entity
incorporated and/organized and existing under Philippine laws and registered with the office
of the treasurer of a city or municipality.
To qualify as a BMBE, an enterprise must not be a branch or a subsidiary of a large scale

enterprise and its policies, and modus operandi must not be determined by a large scale
enterprise such as in the case of franchises. To avail of the benefits and privileges of a BMBE,
an applicant must secure a certificate of authority to operate as a BMBE from the Office of the
Treasurer of the city or municipality that has jurisdiction.
Tax Exemption on Income from Operations

Aside from other incentives afforded by the law, the income of BMBE from their operation is
exempt; hence, excluded from the gross income subject to regular income tax. BMBEs file an
Annual Information Return in lieu of the income tax return. However, their non-operating,
passive, and capital gains are subject to the appropriate type of income tax.
Illustration 8.10
William has a bakery with total assets of P4,000,000 inclusive of a lot with a book value of
P1,200,000.
Since the total assets, net of the land, is P2,800,000, William is qualified as a BMBE. If he obtained a
Certificate of Authority to Operate as BMBE, his income is exempt from regular income tax but is still
subject to other income taxation schemes.
COOPERATIVES
Cooperatives that transact business purely with members are exempt from all taxes and fees.
Cooperatives that transact business with non-members likewise exempt from all taxes and fees
if their accumulated reserve and undivided savings do not exceed P10,000,000. Otherwise, the
amount of allocated for interest on capitals is subject to regular tax. However, the income of
any cooperative from non-related sources is fully taxable to regular tax.
NON-STOCK AND NON-PROFIT ENTITIES

Non-stock entities that are not organized for profit are exempt from income tax on their
income from operations. However, their income from unrelated sources is taxable.
QUALIFIED EMPLOYEES' TRUST FUND
An employees' trust fund which forms part of a pension, stock bonus or profit sharing plan of
an employer for the benefit of some or all his employees is exempt from any income tax under
the NIRC.
Conditions for exemptions of employee trust funds:
a. Contributions are made to the trust by such employer, or employees, or both for the
purpose of distributing to such employees the earnings and principal of the fund
accumulated by the trust in accordance with such plan.
b. The asset of the fund shall not be diverted for other purposes other than the exclusive
benefit of the employees.
ACTIVITY / EVALUATION:
TRUE OR FALSE:
Determine whether the following statements are true or false.
1. Physical, exemplary and moral damages except damages except
damages as loss of profit are not taxable.
2. GSIS and SSS benefits are included in gross income to the extent
they exceed P90,000.
3. A BMBE must have net assets not exceeding P3,000,000.
4. The proceeds of life insurance received by employer from
insurance policy coverage taken and paid by such employer
constitute taxable income.
5. An employee must have rendered a continuous 10 years of
service to avail exemption for retirement benefit.
6. If the minimum wage earner earns other income subject to regular
income tax, his statutory minimum wage becomes taxable.
7. The employer’s share to SSS, PhilHealth and HDMF
contributions are an exclusion to gross income.
8. Cooperatives, regardless of their classification, are taxable on
income from their unrelated activities.
9. Income subject to treaty obligation binding upon the
Government of the Philippines is exempted from income
taxation.
10. Termination pay for any cause beyond the control of an
employee is not subject to tax, except I dismissal is with a cause.
INCLUSION OR EXCLUSION
Write EX if the item is an exclusion from gross income, otherwise, write IN.
1. USVA-administered benefits
2. Dividend income derived in the Philippines by the Taiwan
government
3. Magsaysay Award
4. Interest received from life insurance’s annuity
5. Separation pay received resulting from business merger
6. Separation pay due to voluntary resignation
7. Overtime pay of minimum wage earner
8. Interest income from bank deposits of a minimum wage
earner
9. Union dues
10. PCSO winnings worth P10,000
11. Proceeds from sale of land held as capital asset
12. Income derived from smuggling
13. GSIS retirement benefits
14. Gains from redemption of shares in a mutual fund
15. Premium contributions to Modified PAG-IBIG 2 savings
REINFORCEMENT/ASSIGNMENT
Problem 8.1 NON-RESIDENT TAXPAYER

Gina is a Filipino citizen residing in Australia. She earned the following during the
taxable year: P900,000 from compensation, P40,000 interest income from EFCDU,
P60,000 dividends from a domestic corporation. The interest income from EFCDU
has a resident co-depositor.
How much of the P1,000,000 should be excluded from gross income?
Basic Pay 96,0 PhilHealth Contribution 2,000

00
Overtime Pay 5,000 HDMF Contribution 1,500
13th Month Pay 8,000 Cellphone Repair Revenue 200,000
SSS Contributions 3,000 Operating Expenses 80,000
Problem 8.2 NON-STOCK, NON-PROFIT ENTITY
A non-stock, non-profit charitable entity received the following during the taxable
year.
Contributions from the public 1,400,000
Income from sale of merchandise 500,000
Gain on the sale of properties 300,000
How much is the total exclusion from gross income subject to regular tax?
Problem 8. 3 COOPERATIVE
Koop Eratiba, a multi -purpose credit cooperative, had the following income
during the taxable year.
Income from related activities 400,000
Income from unrelated activities:
Dividends from stocks 20,000
Income from time deposits 18,000
Rent Income 60,000
Answer the following questions.

1. How much of the income is taxable?
2. How much of the income is non-taxable?
❖ Bureau of Internal Revenue Memorandum Circulars
❖ Supreme Court Jurisprudence on Tax Cases
Lesson Number : 9
Topic : Inclusions in Gross Income

LEARNING OBJECTIVES
At the end of this module, you are expected to:
1. Identify the different sources of reportable gross income; and
2. Explain the different principles to be considered in reporting items of income

under gross income; and
3. Eliminate the effects of value-added tax and creditable withholding tax in

computing the gross income
PRE-ASSESSMENT
1. Remembering what you learned from Module No. 5, what is the difference
between prizes and winnings?
2. Get a copy of a receipt from your recent purchase, what are the taxes that you can
see on the document?
For purposes of the discussions in this module, when the phrase “inclusion in gross income” is
used, it would mean the items of income which are reportable under gross income in the
income tax return for the regular income taxation scheme.
LESSON PRESENTATION
GENERAL CRITERIA
Items of gross income subject to regular income tax are not limited to those
mentioned under the NIRC. The regular income taxation scheme is a catch-all
provisions for all income derived from whatever sources that are:
a. Not subject to final tax, capital gains tax and special tax regimes, and
b. Not excluded or exempted by law, treaty, or contract from taxation.
COMPENSATION FOR SERVICES

Under current tax rules, the term "compensation income" technically pertains to the
types of employee benefits that are subject to regular tax. The fringe benefits of
managerial or supervisory employees are not considered compensation income and
are subject to final tax. This will be extensively discussed in the next module.
BUSINESS INCOME
This includes income from any trade or business, legal or illegal, and whether registered or
unregistered. This has been discussed mostly on Module 7.
The following business income shall not be included in gross income subject to regular
income tax:
1. Business income exempt from income tax such as:

a. Gross income from a Barangay Micro-Business Enterprise (BMBE)
under RA 9178
b. Gross income from enterprises enjoying tax holiday incentives
under E0 226 which have not yet graduated to their income tax holiday
incentives
2. Business income subject to special tax regime such as:
a. Philippine Economic Zone Authority (PEZA)-registered
enterprises subject to 5% gross income tax
b. Tourism Infrastructure and Enterprise Zone Authority
(TIEZA)registered enterprises subject to 5% gross income tax
c. Income of self-employed and or individuals (SE/P) who opted to
be taxed under the 8% income tax
3. Business income subject to final tax when not subjected to final tax by the
payor
a. Subcontractors of petroleum service contractors subject to 8% final
tax
b. Business income of foreign currency deposit units (FCDUs) and
offshore banking units (OBUs) from Philippine residents subject to 10%
final tax
GAINS FROM DEALINGS IN PROPERTIES

This will be extensively in Module No. 12.
INTEREST INCOME
This particularly refers to interest income other than passive interest income subject to
final tax. A taxable interest income must have been actually paid out of an agreement to
pay interest. It cannot be imputed.
The following are exempt from regular income taxation:
1. Interest income earned by landowners in disposing their lands to their tenants

pursuant to the Comprehensive Agrarian Reform Law
2. Imputed interestincome
Illustration 9.1
EGA Finance reported the following interest income during the year:
From loans 3,000,000
From deposits with banks 400,000
Notes rediscounting 100,000
Treasury notes 50,000
The interest income from deposits and-notes

T are subject to final tax,
therefore, not inclusions as gross
income under regular taxation.
RENT INCOME
Rent income arises from leasing properties of any kind. It is a passive income but is
not subject to final tax under the NIRC; hence, it is subject to regular income tax. Aside
from the periodic receipts of such, the following should be considered.
1. Obligations of the lessor that are assumed by the lessee are additional
rental income to the lessor.
2. Leasehold improvements made by the lessee on the leased property are
recognized by the lessor as income using the spread-out method or outright
method.
3. On advance rentals,
Inclusion Exclusion
• Unrestricted • It constitutes a loan
• Restricted to be applied in future years or • It is a security deposit to guarantee
upon the termination of the lease payment or rent subject to contingency
which may or may not happen
ROYALTIES
Royalties earned from sources within the Philippines are generally subject to final income
tax except when they are active by nature. Active royalty income and royalties earned
from sources outside the Philippines are subject to regular income tax.
Type/Source Within Abroad

Passive X ✓
Active ✓ ✓
Illustration 9.2
Maestra Rihanna has the following royalties during the year.
From mining properties in the Philippines 550,000
From musical compositions in the Philippines 450,000
From books published abroad 250,000
From licensing earned by her domestic business 800,000
All but the royalty from musical compositions is inclusions in gross income since it is subject to final
tax.
DIVIDENDS
These pertain to dividends declared by foreign corporations. It should be recalled that
dividends declared by domestic corporations are generally subject to 10% final tax if the
recipient is an individual taxpayer and exempt if the recipient is a domestic or a
resident foreign corporation. Cash, property, and script dividends from foreign
corporations are items of gross income subject to regular income tax.
Source (right) / Non-Resident

Recipient (below) Domestic Resident Foreign
Foreign
RC, DC X ✓ ✓
NRC, RA, NRA-ETB,
X Pre-dominance test X
RFC, NRFC
Illustration 9.3
A portfolio of equity investments held by a taxpayer received cash dividends from the
following during the year.
Domestic Corporation 400,000
Resident Foreign Corporation 300,000
Non-Resident Foreign Corporation 200,000
The pre-dominance test on the RFC revealed a 60% rate.
The P400,000 dividend from domestic corporation is excluded regardless of the recipient. If the taxpayer
is a resident citizen or domestic corporation, the gross income of P500,000 should be included,
otherwise, only the P180,000 relating from the pre-dominance test is an item of gross income.
ANNUITIES
The excess of annuity payments received by the recipient over premium paid is taxable
income in the year of receipt.
Illustration 9.4
Andrew purchased an annuity contract for P100,000 which shall pay him P10,000
annually until he dies.
The receipt of the first 10 annual annuity payments is a return of capital. Any further receipt from
year 11 onwards is an item of gross income subject to regular income tax.
PRIZES AND WINNINGS
Prizes and winnings that are exempted from final tax are not items of gross income subject
to regular income tax.
Earned within by Earned within by

Nature individuals corporations Earned abroad
Prizes and PCSO

winnings at most P10,000 ✓ ✓ ✓
Prizes and PCSO

winnings more than X ✓ ✓
P10,000
Winnings from other
X ✓ ✓
Sources
PENSIONS
These pertain to pensions and retirement benefits that fail to meet the exclusion criteria
and hence subject to regular tax.
SHARE IN NET INCOME OF SPECIAL CORPORATIONS
Shares in the net income of pass-through entities are subject to the regular income
tax. These would include income earned from exempt partnerships, joint ventures
and co-ownerships.
Taxability of Entity Organized Within Organized Abroad

Taxable X ✓
Exempt ✓ ✓
INCOME DISTRIBUTIONS FROM TAXABLE ESTATES AND TRUSTS
Recall that income earned by estates and trusts which are distributed to the
heirs/beneficiaries are deemed deductions against the gross income of the estate or
trust.
These, however, are taxable to the beneficiary.
Illustration 9.5
Continuing Illustration 7.7, The P1,250,000 income distributed to the heirs is taxable to the
heirs. The same goes with the P300,000 received by Mr. Salamat in Illustration 7.8.
RECOVERIES OF PAST DEDUCTIONS

Tax benefit rule is a general principle in taxation which states that if a taxpayer
deducted an item on his income tax return and enjoyed a tax benefit (reduced his
income tax) thereby, and in a subsequent year recovers all or part of that item, he will
recognize gross income in the year the deducted item is recovered to the extent of the
benefit realized.
Past deductions that created tax benefits to the taxpayers must be reverted back to gross
income in the year of recovery so that the government will recover the tax lost from the
deduction.
The rule has both an inclusionary and an exclusionary component, i.e., the recovery is
included in the taxpayer's gross income to the extent that the taxpayer obtained a tax
benefit from the prior year's deduction, and the recovery is excluded to the extent that
the prior year's deduction did not provide a tax benefit .
Illustration 9.6
A taxpayer incurred P60,000 bad debt expense in 2018 out of which P35,000 was recovered in
2020:
2018 2019 2020

Net income before bad debts expense 100,000 80,000 120,000
(Bad Debts Expense)/Recoveries (60,000) - 35,000 Net Income after bad debts expense 40,000
80,000 ???
The entire P60,000 deduction in 2018 is a tax benefit to the taxpayer. Hence, the P35,000 recovery
from this deduction is a tax benefit which must be reverted back to gross income in 2020. The taxable
net income in 2020 shall be P155,000.
His tax payable will be:
Expenses of the taxpayer that are reimbursed or paid by the customer or client
constitute additional income to the taxpayer.
Examples:
1. When the lessee pays the ownership costs of the lessor such as real
property tax and insurance on the property, the payment constitutes income to
the lessor.
2. When a client reimburses the out-of-pocket expenses of a professional
Let us check the amount of the professional fee.
practitioner, the reimbursements are income to the practitioner.
CANCELLATION OF INDEBTEDNESS
The cancellation of indebtedness may amount to gratuity or payment of income. The
cancellation of debt:
a. In consideration of service or goods - treated as income

b. As an act of gratuity - treated as gift; not as income
c. As capital transaction such as forfeiting the right to receive dividends in
exchange of the debt - treated as dividend income
ACTIVITY/ EVALUATION
TRUE OR FALSE
1. Income that is not realized is not taxable, but illegal income is taxable.
2. Income received under a mistake of fact or law is to be included as part of
gross taxable income.
3. If the advance rental is received as a security deposit without restriction,
then such amount should be excluded in the determination of rental income.
4. The amount of bad debts which resulted to reduction of taxable income
will become a taxable income in the subsequent year when such is eventually
recovered.
5. The cancellation of a taxpayer’s indebtedness is an income unless such
cancellation is intended as a gift.
6. If debt is cancelled due to services rendered by the debtor, the basis of tax
is the value of the services rendered.
7. Gross income includes all income from whatever sources whether
legal or illegal.
8. Income that is not realized is taxable.
9. When stock dividends received are of a different class from shares
previously acquired, the stock dividends are taxable income.
10. Passive income earned abroad by a resident citizen that has been subjected
to foreign final tax shall not anymore be taxed in the Philippines.
MULTIPLE CHOICE
Choose the best answer from the choices provided.
1. Which of the following is not an inclusion?
a. Prize received by a resident individual from a foreign source
b. Prize received by a domestic corporation from a foreign source
c. Winnings received by a non-resident foreigner from a foreign source
d. Winnings received by a resident corporation from a domestic source
2. Which of the following dividends should be reported as an item of gross income?

a. From domestic corporation to resident citizen
b. From non-resident foreign corporation to resident citizen
c. From domestic corporation to resident alien
d. From non-resident foreign corporation to resident alien
3. Which of the following will not be reported in gross income?

a. Receipt of inheritance
b. Share in the net income of a foreign partnership
c. Royalties from foreign sources
d. Income distribution from a taxable estate
4. Interest income from which of the following sources is an exclusion

from gross income? a. Notes
b. Bonds
c. Lending
d. Deposits
5. Which is subject to regular tax to a resident foreign corporation?

a. Service fee abroad
b. Gain from sale of real property capital assets in the Philippines
c. Dividends from a domestic corporation
d. Gain from dealings in properties abroad
REINFORCEMENT/ ASSIGNMENT Problem
9.1 COMPREHENSIVE
Valkyrie reported the following income during the
year. Within Abroad
Service Fees 400,00 300,000
0
Interest Income from bank deposits 40,000 70,000
Royalties from franchise 80,000 30,000
Gains on property dealings 10,000 100,000
Winnings 60,000 50,000
Prizes 5,000 -
Determine the total amount of gross income if Valkyrie is a:
1. Domestic corporation
2. Resident Citizen
3. Resident Alien
4. Resident Foreign Corporation
Problem 9.2 CONCURRENT TAXES

Problem 9.2
Dr. Ken Jeong is a famous celebrity doctor. He is a VAT taxpayer and is subject to 10%
expanded withholding tax. The following are his items of income and expenses during the year.
Professional medical fees from a hospital (gross of VAT and EWT) 2,016,000
Professional medical fees from his clinic (net of VAT and EWT) 432,000
Talent fees from TV guesting (gross of VAT, net of EWT) 2,040,000
Talent fees from endorsements (net of VAT, gross of EWT) 1,450,000
Allowable Deductions 650,000
Compute for his tax due.
Problem 9.3 COMPREHENSIVE

Mang Jose has several interests in various businesses and partnerships. He received the following income
during the year.
Dividends from a domestic corporation 120,000
Dividends from a resident foreign corporation 80,000
Share in net income of a business partnership 200,000
Share in net income of a professional partnership 100,000
Share in net income of a joint venture 50,000
Share in net income of a co-ownership 20,000
How much is the total income to be reported in gross income?
REFERENCES:
❖ Income Taxation with Special Topics and Properly Filled BIR Forms, 2020
Edition - Enrico D. Tabag, CPA, MBA & Earl Jimson R. Garcia, CPA, MBA
❖ Reviewer in Taxation Updated TRAIN-Book 1 2018 Edition- Asser S.

Tamayo, CPA, MBA
❖ Income Taxation-Laws, Principles and Applications- Rex B. Banggawan,

CPA, MBA
Lesson Number : 10
Topic : Compensation Income
LEARNING OBJECTIVES
At the end of this module, you are expected to:
1. Classify employees as to function and taxability;
2. Identify the non-taxable compensation income;
3. Apply the limits on de minimis benefits and determining the tax treatment
for the excess;
4. Identify the components of 13th month pay and other benefits and determine
taxability by applying the exemption threshold;
5. Identify the components of regular and supplementary compensation; and
6. Identify the relevant returns for compensation income on both parts of the
employer and employee.
PRE-ASSESSMENT

1. Remembering from your BAINTE1X class, what are the items of
compensation income?
2. How did you compute for the monthly withholding tax on compensation
when you studied payroll accounting?
3. What differentiates regular and supplementary compensation?
4. What do you think does the term ‘de minimis’ mean?
LESSON PRESENTATION
TYPES OF EMPLOYEES
It is to be noted that one should know where an employee is classified as there are
different tax rules for each classification.
As to Function
1. Managerial employees - Those who are given powers or prerogatives to
lay down and execute managerial policies and/or to hire, transfer, suspend,
lay-off, recall, discharge, assign or discipline employees
2. Supervisory employees - Those who effectively recommend such
managerial actions if the exercise of such authority is not merely routinary or
clerical in nature but requires the use of independent judgment
3. Rank-and-file employees - Those who hold neither managerial nor
supervisory functions
As to Taxability
1. Minimum wage earners - Employees who are recipients of minimum wage.
They are exempt from income tax on their compensation.
2. Regular employees - Employees who are subject to the regular progressive
income tax
As to Employer
1. Private Employee – one that is employed in the private sector. This employee
normally pays the SSS Contributions.
2. Government Employee – one that is employed by any government body
including its political subdivisions. This employee normally pays the GSIS
Contributions. Its basic pay is normally based on salary grades.
TAX MODEL ON COMPENSATION INCOME
Let us look at a portion of BIR Form 2316 to see the tax model on compensation income .
Let us assume that there is only one employer connected with employee and no other
sources income on his part during the taxable year. We can further simplify the tax model
as:
Gross Compensation Income xx
Non-Taxable Compensation Income (xx)
xx
Taxable Compensation Income
xx
Tax Due (xx)
Tax Withheld
Tax Payable xx
Remember that purely employed individuals may qualify for the substituted filing of
income tax return. This is because normally, its employer annualizes all its taxable
compensation income and this would result to a nil amount of tax still due.
To illustrate the flow of the topics in this module and how it relates to the tax model. You
may look at the diagram below.
Firstly, we will determine those items which are non-taxable for us to only consider those
taxable items later on. We will then work our way up to compute for the taxable
compensation income.
EXEMPT COMPENSATION INCOME

Let us again look at Form 2316 to identify the items of exempt compensation income.
Basic Salary
This includes the P250,000 exemption threshold which is the first bracket in the progressive tax
table. This should also include the Statutory Minimum Wage of a minimum wage earner.
It should be noted, however, that if the taxable regular and supplementary compensation is less than P250,000, the
actual amount will be added in lieu of the P250,000.
Supplementary Compensation of MWE

This would include Holiday Pay, Overtime Pay, Night Shift Differential pay and Hazard Pay.
13th Month Pay and Other Benefits

As provided by the tax code, the first P90,000 is exempt, any excess over this amount is part of Supplementary
Compensation. The composition of this item will be discussed later.
De Minimis Benefits
This would include petty benefits which are within the limits provided by RR 5-2011. This is further
discussed in this module.
Mandatory Contributions
Employee Share on the mandatory contributions to SSS, GSIS, PHIC and HDMF are non- taxable. The
same goes to union dues.
Salaries and Other Forms of Compensation

This is the catch-all basin for all other exempt benefits as provided by tax and special laws.
These are, but not limited to, the following:
a. Exempt retirement benefits under RA 7641 including exempt retirement

gratuities to government officials and employees
b. Exempt termination benefits
c. Benefits from the United States Veterans Administration
d. Social security, retirement gratuities, pensions, and similar benefits from foreign
government agencies and other institutions, private or public
e. Benefits from SSS, under the SSS Act of 1954, as amended f. Benefits from GSIS
under the GSIS Act of 1937, as amended
f. Personal Economic Relief Allowance of government employees
g. Benefits exempt under treaty or international agreements
h. Benefits necessary to the trade, business, or conduct of profession of the
employer
i. Benefits for the convenience or advantage of the employer
DE MINIMIS BENEFITS
De minimis benefits are facilities or privileges such as entertainment, medical services, or courtesy
discounts on purchases that are of relatively small value and are furnished by the employer merely as a
means of promoting the health, goodwill, contentment, or efficiency of his employees. De minimis
benefits are petty fringe benefits exempt from income tax. As originally conceived, other petty fringe
benefits which fall within the purview of de minimis even if not part of the de minimis list are normally
treated as de minimis and are also exempt from income tax. However, the BIR and the Department of
Finance changed the rule wherein the term "de minimis benefits" was restricted to mean only the
following:
De Minimis Benefit Limit

Monetized unused vacation leave credits of private employees 10 days per year
Monetized unused vacation and sick leave credits of government
employees -no limit-
Medical Cash allowance to dependents P1,500 per semester
Rice subsidy P2,000 per month
Uniform and Clothing Allowance P6,000 per year
Actual Medical Assistance P10,000 per year

Laundry Allowance P300 per month
Employee Achievement Award, in the form of non-cash tangible
P10,000 per year
Property
Christmas and Anniversary gifts P5,000 per year
Daily meal allowance for overtime work and night or graveyard
25% of minimum wage
Shift
Benefits received under CNA/CBA and PEI schemes P10,000 per year
Excess De Minimis Benefits
Amounts in excess of these regulatory limits are called excess de minimis benefits.
Taxable De Minimis Benefits

This includes the excess de minimis benefits and other benefits of relatively small value that not
included in the list of de minimis benefits under RR 5-2011.
T reatment
The table below summarizes the treatment for the taxable de minimis benefits basing on the
type of employee as to their function.
Function Treatment
Managerial or Supervisory Subject to Fringe Benefit Tax (Final Tax)
Rank-and-File Part of 13th Month Pay and Other Benefits
Since those taxable de minimis benefits earned by employees occupying managerial or
supervisory functions is subject to FBT which is a form of final tax, such is not reported in the
Form 2316.
Illustration 10.1
Lula is paid at a P750 daily rate. In addition to the basic pay, she received the following
during the year.
Monetized unused vacation days 11 days
Monetized unused sick days 8 days
Medical cash allowance to dependents P1,000 per quarter
Rice subsidy P2,200 per month
Uniform allowance P5,000
Medical allowance for healthcare needs of Lula P8,500
Laundry allowance P350 per month
Cash Achievement Award P5,000
Anniversary Gift P6,000
Collective bargaining agreement benefits P10,000
Scenario 1: Lula is a private employee.
Actual Limit Excess
Monetized unused vacation days 8,250 7,500 750
Monetized unused sick days 6,000 - 6,000
Medical cash allowance to dependents 4,000 4,500 -
Rice subsidy 26,400 24,000 2,400
Uniform allowance 5,000 6,000 -
Medical allowance 8,500 10,000 -
Laundry allowance 4,200 3,600 600
Cash Achievement Award 5,000 - 5,000
Anniversary Gift 6,000 5,000 1,000
Collective bargaining agreement benefits 10,000 10,000 -
Total 83,350 15,750

The amount of P67,600 (P83,350-P15,750) will be exempt as these are within the limits. It
will be reflected on item 33 on Form 2316. The taxable de minimis benefits amounting to
P15,750 will be part of 13th Month Pay and Other Benefits if Lula is a rank-and-file
employee or subject to Fringe Benefit Tax if she holds either managerial or supervisory
position.
Scenario 2: Lula is a government employee.

Actual Limit Excess
Monetized unused vacation days 8,250 Unlimited -
Monetized unused sick days 6,000 Unlimited -
Medical cash allowance to dependents 4,000 4,500 -
Rice subsidy 26,400 24,000 2,400
Uniform allowance 5,000 6,000 -
Medical allowance 8,500 10,000 -
Laundry allowance 4,200 3,600 600
Cash Achievement Award 5,000 - 5,000
Anniversary Gift 6,000 5,000 1,000
Collective bargaining agreement benefits 10,000 10,000 -
Total 83,350 9,000

The amount of P74,350 (P83,350-P9,000) will be exempt as these are within the limits. It will
be reflected on item 33 on Form 2316. The taxable de minimis benefits amounting to P9,000
will be part of 13th Month Pay and Other Benefits if Lula is a rank-and-file employee or
subject to Fringe Benefit Tax if she holds either managerial or supervisory position .
th
13 MONTH PAY AND OTHER BENEFITS
The following are the items of this category.
1. 13th month pay, 14th month pay, 15th month pay, etc.
2. Christmas bonus of p rivate employees
3. Cash gifts other than Christmas or Anniversary gifts of private employees
4. Additional Compensation Allowance (ACA) of government employees
5. Other fringe benefits of r ank-and-file employees
a. Taxable de minimis benefits
b. Personal expenses shouldered by the employer
The exemption threshold of the aggregate amount of these items is P90,000. This means that
that first P90,000 is exempt and any excess is added as part of Supplementary Compensation
reported in item 46 under Form 2316.
Illustration 10.2
Luna received the following benefits during the year:
13th Month Pay 30,000
Excess de minimis benefits 25,000
Personal expenses reimbursed by the company 10,000
Christmas Gift 5,000
Scenario 1: Luna is a private rank-and-file employee

The Christmas gift is part of de minimis benefits which was within the limits, therefore, the 13th Month
Pay and Other Benefits is:
13th and 14th Month Pay 60,000
13th Month Pay and Other Benefits 95,000

The first P90,000 is non-taxable to be reported under item 32 in Form 2316. The excess of
P5,000 is taxable to be reported under item 46 un Form 2316.
Scenario 2: Luna is a private supervisory employee

The Christmas gift has the same treatment as Scenario 1. The excess de minimis and personal expenses
are subject to Fringe Benefit Tax, thus, the sum of 13th and 14th Month Pay is the total 13th Month Pay
and Other Benefits.
The whole amount of P60,000 is exempt to be reported under item 32 in Form 2316
Scenario 3: Luna is a government rank-and-file employee
The Christmas gift is part of 13th MP&OB, therefore, the 13th Month Pay and Other Benefits is:
The first P90,000 is non-taxable to be reported under item 32 in Form 2316. The excess of P10,000 is
taxable to be reported under item 46 un Form 2316.
Scenario 2: Luna is a government supervisory employee

The Christmas gift has the same treatment as Scenario 1. The excess de minimis and personal expenses are
subject to Fringe Benefit Tax, therefore, the 13th Month Pay and Other Benefits is:

The whole amount of P65,000 is exempt to be reported under item 32 in Form 2316.
SUPPLEMENTARY COMPENSATION
These are additional compensation which are performance-based remunerations. These are
given with or without regard to the payroll period. The following are the items of
supplementary compensation.
Overtime, Holiday, Hazard, and Night Differential Pay

These constitute additional compensation, except when derived by a minimum earner.
Taxable 13th Month Pay and Other Benefits

This is the excess of the 13th MP&OB over the P90,000 exemption threshold.
Commissions, Emoluments, Honoraria

Commissions are incentives intended to stimulate sales. These may be given as a profit sharing
or performance bonus. Emoluments pertain to any pay in general while honoraria are
additional payments for attending to special tasks or assignments.
Living Quarters or Meals

If an employee receives free living quarters or meals in addition to salary for services rendered,
the value to the employee of such living quarters or meals is included in compensation income.
However, when the same was furnished to an employee for the convenience of the employer or out of
necessity of the employer's business, the value thereof is not compensation income, but a business
expense.
Stock Option Plans

Under various stock option plans, employees are given the privilege to buy shares at an agreed exercise
price after meeting stipulated vesting conditions. The option will have value when the stock of the
employer increases in value above the exercise price at exercise date. The value of the option is the
10
discount at exercise date. In the past, stock options were not taxed at exercise date under the view that
the discount becomes realized only when the stocks are disposed.
Under current tax rules, the discount (i.e. market price - exercise price) at exercise date is viewed as
compensation in kind. The gains from the exercise of stock options constitute a taxable compensation
income, unless they qualify as fringe benefits subject to final tax.
Fees
Fees are received by an employee for the services rendered to the employer including a director's fee of
the company; fees paid to the public officials, such as clerks of court or sheriffs for services rendered in
the performance of their official duty over and above their regular salaries. •
Legal fees paid by a union on behalf of its president constitute compensation. Marriage fees, baptismal
offerings, sums paid for conducting masses for the dead, and other contributions received by a
clergyman, evangelist, or religious worker for services rendered are considered compensation.
Taxable Retirement and Separation Pay

Those which did not meet requisites for exemption are taxable as supplementary compensation.
Profit Sharing or Taxable Bonus

Profit sharing is a reward for churning the business to post a profit. It is a compensation for controlling
all the factors that influence profit such as marketing and sales, productivity, and administrative factors.
It is a reward which can be enjoyed by individual employees such as salesmen, division heads, key
officers, or by all employees collectively. Bonuses are supplemental or additional compensation.
However, if they are linked solely to productivity under the productivity incentive plan of the employer
pursuant to RA 6971, they should be considered as de minimis benefits.
Let us look at its designated portion in the Form 2316 on how they are reported.
Those which are not specifically identified in the return can be specified under item 49.
REGULAR COMPENSATION
The regular compensation includes fixed remunerations due to be received by an employee
every period such as:
1. Basic salary
2. Fixed allowances such as cost-of-living allowance, fixed housing allowance,
representation, transportation, and other allowances paid to an employee every payroll
period
Fixed Allowances are those which are fixed in amounts and regularly received as part of the basic
monthly, bi-weekly, weekly or daily salaries or wages are part of regular compensation.
This applies even if a portion of the allowances are actually used in the employer's business.
Exception Rule
a. Ordinary and necessary allowances for travelling, representation or
entertainment expense of employees incurred in the pursuit of the employer' trade,
business or profession.
b. The expense is subject to accounting or liquidation.
c. Any excess advances are returned to the employer.
Hence, variable and liquidated allowances are not subject to tax. However, amounts of
allowances that are retained by the employee for himself shall be considered compensation.
Paid Absences
The paid absences of an employee applied against his vacation or sick leave credits which are
normally received as part of the regular salary is part of the regular compensation.
Let us look at the portion designated for Regular Compensation on Form 2316.
Similar to supplementary compensation, those items which are not specifically identified
as regular compensation income in the form can be specified under item
42.
FLOWCHART OF TAX TREATMENTS

Following is a flowchart of the tax treatments to guide you. When using this flowchart, it
is imperative that you know where a certain item of compensation is classified.
Illustration 10.3
Jackie earned the following during the taxable year.
Monthly Basic Pay, net of P3,500 mandatory deductions 26,500
Overtime Pay 12,000
Collective Negotiation Agreement 25,000
Midyear Bonus (13 th Month Pay) 30,000
Yearend Bonus (14th Month Pay) 30,000
Cash Gift 5,000
Clothing Allowance 6,000
Monetized Unused Vacation Days (five days) 7,500
Monetized Unused Sick Days (three days) 4,500
Anniversary Gift 5,000
Additional Compensation Allowance 6,000
Personal Economic Relief Allowance 18,000
Scenario 1: Jackie is a government rank-and-file employee.
Actual Limit Taxable
Monetized Unused Vacation Days 7,500 Unlimited -
Monetized Unused Sick Days 4,500 Unlimited -
Anniversary Gift 5,000 5,000 -
Collective Negotiation Agreement 25,000 10,000 15,000
Clothing Allowance 6,000 6,000 -
Taxable De Minimis 15,000

Midyear Bonus 30,000
Yearend Bonus 30,000
Cash Gift 5,000
Additional Compensation Allowance 6,000

Exemption Threshold 90,000
Taxable 13th Month Pay and Other Benefits -

Overtime Pay 12,000
Supplementary Compensation 12,000

Regular Compensation (Basic Pay) (26,500 x 12) 318,000
Total Taxable Compensation Income before P250,000 threshold 330,000

To conform with the format of the Form 2316, it shall be reported as
Gross Compensation Income 509,000
Less: Non-Taxable/Exempt Income (179,000 + 250,000) 429,000
Gross Taxable Compensation Income 80,000
Tax Due 16,000

Less: Tax Withheld (assuming taxes were properly withheld) 16,000
Tax Payable -
Scenario 2: Jackie is a government supervisory employee.

The same taxable income and tax due will be computed as the only difference would be the treatment of
the P15,000 taxable de minimis which would be subject to Fringe Benefits Tax. Since the remaining
P71,000 13th MP&OB is below the exemption threshold, there is no effect on the taxable income. This
amount, however, will not be reported in Form 2316. As such,
Scenario 3: Jackie is a private rank-and-file employee.
The same taxable income and tax due will be computed. The only difference with Scenario 1 is that the Cash
Gift will be added with the anniversary gift which will then create a P5,000 excess de minimis on top of the
previous amount of P20,000. Since the total 13th MP&OB is still below the exemption threshold, there would
be no effect on the taxable income. The same presentation for Form 2316 is expected.
Scenario 4: Jackie is a private supervisory employee.
The same taxable income and tax due will be computed. As discussed in Scenario 3, the cash
gift will turn into an excess de minimis benefit which will be subject to Fringe Benefit Tax. The remaining
13th MP&OB of P66,000 is still below the exemption threshold, leading to no effect
on the taxable income. The summary in Form 2316 would look like this:
MINIMUM WAGE EARNER

A minimum wage earner refers to a worker in the private sector who is paid the minimum
wage or to an employee in the public sector with compensation income of not more than the
statutory minimum wage (i.e., those with salary grade 1 to 3) in the nonagricultural sector
where he or she is assigned. The statutory minimum wage refers to rate fixed by the Regional
Tripartite Wage and Productivity Board of the Department of Labor and Employment or
P5,000/month or P60,000/year, whichever is higher.
As discussed previously, their Basic, Holiday, Hazard, Overtime and Night Differential Pays
are non-taxable despite presence of other forms of income.
Rules on Change in Status

1. When an employee becomes a minimum wage earner during the year, he/she
shall be subject to income tax only on compensation earned before becoming a
minimum wage earner.
2. When an employee ceases to be a minimum wage earner during the year, due
to increase in salary, only the income for the rest of the year is taxable.
COLA Treatment
COLA forms part of statutory minimum wage, thereby, it is exempt.
Illustration 10.4
Tiana was a minimum wage earner from January 1 to June 30 of the taxable year. She was
promoted effective July 1 and was given a salary rate higher than the statutory minimum
wage. The following are the benefits she received during the year.
Jan 1 – Jun 30 Jul 1 – Dec 31
Monthly Basic Pay 9,000 15,000
13th Month Pay - 12,000
Rice Subsidy 6,000 6,000
Medical Allowance to Dependent 1,000 2,500
Holiday Pay 2,000 4,000
Overtime Pay 5,000 7,000
Commission 45,000 78,000
Monthly Mandatory Deductions 3,000 4,000
Her taxable income for the year would be computed as follows:

Actual Limit Excess
Rice Subsidy 12,000 24,000 -
Medical Cash Allowance (Jan-Jun) 1,000 1,500 -
Medical Cash Allowance (Jul-Dec) 2,500 1,500 1,000
Total Taxable de minimis 1,000


Exemption Threshold 90,000
Taxable 13th Month Pay and Other Benefits -

Holiday Pay 4,000
Overtime Pay 7,000
Commission 123,000
Supplementary Compensation 134,000

Regular Compensation (90,000-4,000) 86,000
Taxable Compensation Income before P250,000 threshold 220,000

To conform with the format of the Form 2316, it shall be reported as:
Less: Non-Taxable/Exempt Income (92,500 + 220,000*) 312,500
Gross Taxable Compensation Income -
Since the taxable compensation income before the P250,000 threshold of P220,000 is lower
than the exemption threshold, this is the amount added to the P92,500 non-taxable income.
ACTIVITY / EVALUATION:
TRUE OR FALSE:

1. A regular employee is subject to regular income tax only.
2. The overtime pay of MWEs is exempt from income tax. 3.
An employee who became a MWE during the year is exempt from
tax for the entire year.
4. The excess of 13th MP&OB over P90,000 is considered as compensation
income.
5. The Christmas gift of private employees forms part of “other benefits”
while that of government employees is considered as a de minimis benefit.
6. Fixed allowances are supplemental compensation.
7. Benefits from productivity incentive schemes are treated as a de minimis
benefit.
8. Benefits for the advantage of the employee are exempt from income
tax.
9. The excess of the 13th MP&OB over the P90,000 is subject to Fringe Benefit Tax
if the employee holds either a managerial or supervisory function.
10. The sick leave credit of government employees up to 10 days is exempt de
minimis.
MULTIPLE CHOICE
1. Which of the following is a taxable compensation income?

a. Separation pay die to resignation
b. Retirement pay under BIR approved retirement plan
c. Separation pay due to disability
d. Terminal pay due to death
2. Which of the following is a taxable compensation income?

a. Employee share in social security contributions
b. Cost of living allowance
c. De minimis benefits within their limits
d. Separation pay due to closure of employer’s business
3. Meal allowance is taxable when given

a. For overtime duty
b. In cash
c. For night shift assignment
d. As incentive to all employees
4. The term ‘de minimis’ does not include

a. Christmas bonus
b. Christmas gift
c. Rice subsidy
d. Monetized unused vacation leave
5. The P90,000 exemption threshold is applicable for every every .

a. employer; annually
b. employee; annually
c. employer; quarterly
d. employee; quarterly
REINFORCEMENT/ ASSIGNMENT
Problem 10.1 13TH MONTH PAY AND OTHER BENEFITS
Jonathan, a purely employed taxpayer, received the following during the taxable year.
13th Month Pay (Midyear Bonus) 48,000
14th Month Pay (Yearend Bonus) 48,000
Taxable de Minimis Benefits 20,000
Determine the taxable 13th Month Pay and Other Benefits given that Jonathan is:
Problem 10.2 COMPREHENSIVE
Miss Ma. Dolly Rigat, a private employee, obtained the following from
benefits her
employment during the year.
Basic Pay, gross of P74,000 mandatory P 780,000
deductions
Monetized Unused Vacation Leave Credits (8 26,000
days)
Monetized Unused Sick Leave Credits (2 days) 6,500
Uniform Allowance 15,000
Christmas Cash Gift 10,000
Benefits under a Productivity Incentive Scheme 20,000
Rice Subsidy 35,000
Laundry Allowance 5,000
Medical Assistance 10,000
Overtime Pay 16,000
Cost of Living Allowance 30,000
Holiday Pay 10,000
Determine her taxable compensation income before the P250,000 exemption assuming she is a:
1. Supervisory employee
2. Rank-and-File employee
COURSE CODE AND TITLE: BCAR 5 – INCOME TAXATION
LESSON NUMBER : 11
TOPIC : FRINGE BENEFIT TAX
INSTRUCTOR : Rosario A. Calamba, CPA, PhD
LEARNING OBJECTIVES:
1. Define fringe benefit tax and de minimis benefits;
2. Identify the tax base, tax rate, and valuation of fringe benefit tax;
3. Compute the fringe benefit tax;
4. Discuss the special rule in computing monetary value of items subject to fringe
benefit tax; and
5. Identify the relevant returns and their deadline for filing.

PRE-ASSESSMENT
Final Tax
Recoveries
Indirect Cost
Net Income
Gross Income
Excise Tax
Business Income
Earned Income
Nominal Value
Estate Tax
Fiscal Policy
Internal Revenue Code
Transfer Tax
Shifting
LESSON PRESENTATION
FRINGE BENEFIT
Section 33 (B) of the NIRC defines Fringe Benefits as "any good, service, or other benefit furnished or
granted by an employer, in cash or in kind, in additon to basic salaries, to an individual employee such
as, but are not limited to, the following:
a. Housing;
b. Expense account;
c. Vehicle of any kind;
d. Household personnel, such as maid, driver and others;
e. Interest on loan at less than market rate to the extent of the difference between the market
rate and actual rate granted;
f. Membership fees, dues and other expenses borne by the employer for the employee in
social and athletic clubs or other similar organizations;
g. Expenses for foreign travel;
h. Holiday and vacation expenses;
i. Educational assistance to the employee or his dependents; and
j. Life or health insurance and other non-life insurance premiums or similar amounts in
excess of what the law allows."
Rationale of Granting Fringe Benefits

The following reasons may justify the granting of fringe benefits:
1. A fringe benefit, given to employees is a form of incentive to encourage employees'

productivity and loyalty to employer;
2. During financial difficulties, the employer may decrease or discontinue previously given
fringe benefits, but cannot reduce the wage or salary of a specified amount once it is given to
employees; and
3. Additional remunerations for overtime and separation pay do not include fringe benefits.
FRINGE BENEFIT TAX

The fringe benefit tax is a final tax imposed on the fringe benefit furnished, granted or paid by the
employer to the employee, except rank and file employees, whether such employer is an individual, a
professional partnership or a corporation, regardless of whether the corporation is taxable or not, or the
government and its instrumentalities.
Scope
The fringe benefit tax covers only the taxable fringe benefits of managerial or supervisory employees.
For purposes of the fringe benefit tax, RR3-98 clarifies that taxable fringe benefits exclude those items
considered as compensation income. Hence, an excellent understanding of the items of compensation
income is extremely important in highlighting the bounds between compensation income and the fringe
benefits subject to fringe benefit tax.
General Categories
The following are the general categories of fringe benefits subject to final tax.
1. Management perquisite benefits

2. Employee personal expenses shouldered by the employer
3. Taxable de minimis benefits
a. Excess de minimis over their limits
b. Benefits not included in the de minimis list
Exemption
The following fringe benefits are exempt from the fringe benefit tax:
1. Fringe benefits which are authorized and exempted from tax under special laws
2. Benefits required by the nature of, or necessary to the trade, business or profession of the
employer
3. Benefit given for the convenience or advantage of the employer
4. Contributions of the employer for the benefit of the employee to retirement, insurance
and hospitalization benefit plans
5. Benefit given to rank and file employees whether or not granted under a collective
bargaining agreement
6. De minimis benefits within their legal limits
Characteristics:
Final tax
The fringe benefit tax is a final tax which is withheld by the employer at source. Thus, the employee need
not report the fringe benefits in his income tax return.
Tax upon the fringe benefits of managerial or supervisory employees

The fringe benefit tax is not a tax to the employer. It is a tax upon the fringe benefit realized by the
managerial or supervisory employee. It is a tax to the employee; hence, it applies regardless of the
identity of the employer. Therefore, it applies even if the employer is a sole proprietor, partnership,
corporation whether taxable or exempt, or the government.
Paid by the employer

As a final tax, the tax is presumed withheld at source and remitted by the employer to the government.
Grossed-up tax
The monetary value or the amount of fringe benefit realized or taken home by the employee is
effectively net of the final tax which is to be withheld at source Hence, the monetary value is first
grossed-up by the complement percentage of the applicable fringe benefit tax rate before the fringe
benefit tax rate is applied.
Due quarterly
The fringe benefit tax is due for remittance quarterly based on the accounting period (fiscal or calendar)
selected by the employer. The monetary value of each taxable fringe benefit is determined and reported
quarterly through RIR Form 1603Q. The quarterly fringe benefit tax is due on or before the last day of
the month following the quarter in which withholding was made.
Procedures for Computation

The following are the general steps in the computation of the fringe benefit tax.
Step 1: Determine the monetary value.

Monetary value refers to the taxable amount of benefits taken home or realized by the managerial or
supervisory employee. The monetary value is presumed net of the final tax.
Step 2: Determine the fringe benefit tax rate applicable for the taxpayer.
The fringe benefit tax rate for non-resident aliens not engaged in trade or business is 25% and 35% for
other cases.
Step 3: Determine the gross-up rate.

The gross up rate is computed by deducting the fringe benefit tax rate from 100%.
Step 4: Determine the grossed-up monetary value.

The monetary value is computed by dividing the monetary value by the gross-up rate.
Step 5: Determine the fringe benefit tax.

This is done by multiplying the fringe benefit tax rate to the grossed-up monetary value.
Illustration 11.1
A manager of IP Company received a fringe benefit with a value of
The fringe benefit tax is computed as:

Step Particular Amount
1 Monetary Value 52,000
2-3 Grossed -up Rate (100% -35% ) 65%
4 Grossed -up Monetary Value 80,000
2 Fringe Benefit Tax Rate 35%
5 Fringe Benefit Tax 28,000
Rules on Valuation
The following shall be considered in determining the monetary value of the fringe benefit.
Benefits paid in cash

When benefit is given in cash or paid for in cash, the monetary value is the amount paid for in cash.
Note: The only exception here is when the employer pays for the rent of the residence of the employee.
Monetary value is 50% of the rental payment.
Benefits paid in kind

When benefit is given in kind, the monetary value is the fair value of the thing given unless its book
value is higher. Book value is the cost less any provision for depreciation for depreciable properties.
Simply stated, the monetary value is the fair value or the book value of the thing given, whichever is
higher. When ownership over the property is transferred to the employee, the monetary value is the
entire fair value of the property even if the property is partially used in the business of the employer.
Benefits that are furnished

When the benefit is given in the form of free use of the employer's property, the monetary value is 50%
of the rental value of the property. If the property has no available rental value, the depreciation value is
used. For purposes of the depreciation value, the presumptive useful lives of the property are:
Pro
per Presumptive Annual Depreciation Quarterly Depreciation
ty Useful Life Value Value
Re 20 years 1/20 or 5% 1/80 or 1.25%
al
Pr
op
er
ty
M 5 years 1/5 or 20% 1/20 or 5%
ov
ab
le
Pr
op
er
ty
Illustration 11.2
A partnership transferred the use of a property with a fair value of P2,000,000 to its
supervisor.
The monetary value would be:

Real Property Movable Property
Fair Value 2,000,000 2,000,000
Presumptive Useful Life 20 5
Annual Depreciation Value 100,000 400,000
Quarters 4 4
Quarterly Depreciation Value 50,000 100,000
HOUSING PRIVILEGES
The housing fringe benefits shall use the following formula for the monetary values.
Housing Privilege Monetary Value

Lease of residential property for residential use of
Employees 50% of rental payments
Assignment of residential property for use of 5% x 50% x higher between Assessed

Employees Value and Zonal Value
Purchase of residential property on instalment basis

for the use of employees 5% x 50% x Acquisition Cost
Purchase of residential property and ownership is Higher between Acquisition Cost

transferred in the name of employee and Zonal Value
Purchase of residential property and ownership is
transferred in the name of employee for less than Higher between Fair Value and
adequate consideration Zonal Value less Consideration Paid
Illustration 11.3
Vacation Company purchased a residential property for P5,500,000. The zonal and assessed
value of the property are P6,000,000 and P5,000,000, respectively.
Compute for the fringe benefit tax under the following independent scenario.
1. Assigned for use of employees
2. Purchased on instalment for use of employees
3. Purchased for transfer of ownership to employees
4. Purchased for transfer of ownership to employees for a payment of P2,000,000
The fringe benefit tax for the year would be:

Scenario 1 Scenario 2 Scenario 3 Scenario 4
Monetary Value 150,000 137,500 6,000,000 4,000,000
Grossed-up Rate 65% 65% 65% 65%
Grossed-up Monetary Value 230,769 211,538 9,230,769 6,153,846
Fringe Benefit Tax Rate 35% 35% 35% 35%
Fringe Benefit Tax 80,769 74,038 3,230,769 2,153,846
Nontaxable Housing Fringe Benefit

The following housing benefits are not subject to fringe benefit tax:
1. Housing privilege of the Armed Forces of the Philippines (AFP) officials - i.e., those of the
Philippine Army (PA), Philippine Navy (PN) or Philippine Air Force (PAF);
2. A housing unit, which is situated inside or adjacent to the premises of a business or
factory. A housing unit is considered adjacent to the premises of the business if it is located
within the maximum of fifty (50) meters away from the perimeter of the business premises; and
3. Temporary housing for an employee who stays in a housing unit for three (3) months or
less.
EXPENSE ACCOUNT
The following are treated as taxable fringe benefits:
1. Expenses incurred by the employee but paid by his employer;

2. Expenses paid by the employee but reimbursed by his employer. However, if the above
expenditures are duly receipted for and in the name of the employer and these do not partake the
nature of a personal expense attributable to the employee, the same shall not be subject to fringe
benefit tax; and
3. Personal expenses of the employee (like purchases of groceries for the personal
consumption of the employee and his family members) paid for or reimbursed by the employer
to the employee whether or not the same are duly receipted for in the name of the employer.
Representation and transportation allowances that are fixed in amounts and regularly received by the
employees as part of their monthly compensation income shall be considered as taxable compensation
income subject to Withholding Tax on Wages.
Illustration 11.4
Mushroom. Corporation allows its Chief Operation Officer, Mr. Candido Perez, to incur
expenses subject to reimbursement. Mr. Perez presents
following
the itemized receipts:
Light and Power (75% in the name of the company) 8,000
Grocery items 15,000
Clothing 5,000
Gasoline of company car 3,000
Transportation for business trip 12,000
The following are the items subject to FBT and the resulting amount of FBT.
Light and Power 2,000
Grocery items 15,000
Clothing 5,000
Total Fringe Benefits 22,000
Grossed-up rate 65%
Grossed-up Monetary Value 33,846
FBT Rate 35%
Fringe Benefit Tax 11,846
MOTOR VEHICLES
The housing fringe benefits shall use the following formula for the monetary values.
Motor Vehicle Privilege Monetary Value

Purchase of motor vehicle in the name of employee Acquisition Cost
Cash is given to employee for the purchase of vehicle, Cash received by the employee
However, if the cash given is subjected to WTC, it ownership
is placed in the name of the employee
shall not be subject to FBT anymore.
Purchase of car on instalment basis the ownership of

Acquisition Cost ÷ 5
which is placed in the employee
Employer shoulders a portion of the purchase price,
Portion shouldered by the employer
the ownership is placed in the name of employee
Employer owns and maintains a fleet of motor
Acquisition Cost x 20% x 50%
vehicles for the use of the business and the employees
Employer leases and maintains a fleet of motor
50% x Rental Payments
vehicles for the use of the business and the employees
Aircrafts Not applicable
Yachts Acquisition Cost x 5%
HOUSEHOLD EXPENSES
Expenses of the employee which are borne by the employer for household personnel, such as salaries
of household help, personal driver of the employee, or other similar personal expenses (like payment
for homeowners ‘association dues, garbage dues, etc.) shall be treated as taxable fringe benefits.
INTEREST ON LOAN AT LESS THAN MARKET RATE

The interest forgone by the employer representing the difference between 12% and the actual interest
charged is a taxable fringe benefit.
MEMBERSHIP FEES, DUES AND OTHER EXPENSES

Membership fees, dues and other expenses borne by the employer for the employee in social and athletic
clubs or other similar organizations.
The entire expenditures shall be treated as taxable fringe benefits of the employee.
EXPENSES FOR FOREIGN TRAVEL

Reasonable business expenses for foreign travel for attending business meetings and conventions are
exempt, such as the following:
1. Inland travel expenses such as food, beverage and local transportation costs
2. Lodging costs in hotel or similar establishment amounting to an average of $300/day or
less.
3. Economy and business class airplane tickets
4. 70% of the cost of first-class ticket
Note that 30% of the cost of first-class ticket in foreign travels is considered de-minimis. Note also that
the foregoing rules apply only on foreign travels. The cost of domestic travel is generally considered as
reasonable and hence deductible.
Expenses in excess of the aforementioned limits and for the family members of the employee shouldered
by the employer are taxable fringe benefits.
Illustration 11.5
Payaman Company allowed its President, Mr. Cong, to attend a convention abroad for five
days and nights with the privilege to bring his wife, Viy. The company shouldered the
following expenses for their foreign travel: P70,000 each for their first class plane ticket, $350 each for
their daily lodging cost and P50,000 each for their foods and inland transportation.
The exchange rate is $1:P50.
All expenses related to Viy are taxable.
Taxable Exempt
Plane Ticket 91,000 49,000
Lodging Costs 100,000 75,000
Foods and Local Transportation 50,000 50,000
Total 241,000 174,000
HOLIDAY AND VACATION EXPENSES

Holiday and vacation expenses are taxable fringe benefits if shouldered by the employer. The monetary
value is the amount paid or shouldered by the employer.
EDUCATIONAL ASSISTANCE
Educational assistance to the employee is generally taxable except when it is incurred for the
convenience or furtherance of the employer's business, such as:
1. the education or study is directly connected with the employer's business or profession: and
2. there is a written contract (i.e., employee bond) that the employee is under obligation to remain
at the employ of the employer fora period if time ther mutually agreed upon.
Educational assistance granted to dependents of the employee is generally taxable except when the
assistance was provided through a competitive scheme under a scholarship program of the company.
Illustration 11.6
E-Low Cost is a travel and tours company which provides educational assistance to the following employees
under an employment bond:
Position Degree Program Monthly Stipend
VP for Management Doctor in Business Administration P 10,000
VP for Marketing Master in Marketing Management 8,000
Operations Manager BS in Tourism Management 5,000
Accounting Supervisor BS in Architecture 3,000
Accounting Staff BS in Accounting Information System 3,000
Only the tuition fee of the accounting supervisor is subject to fringe benefit tax and shall be reported in
the quarters it is paid. Even if covered by an employee bond, his field of study is neither related to the
nature of his job nor to the employer's business. The fringe benefit of all the other employees will neither be subject
to the fringe benefit tax nor the regular income tax under the "convenience of the employer" rule.
INSURANCE PREMIUMS
This includes life or health insurance and other non-life insurance premiums or similar amounts in
excess of what the law allows. These are taxable fringe benefits except the following insurance or
premium contributions allowed or required by law:
1. Contributions of the employer for the benefit of the employee pursuant to the provisions
of existing law such as contributions to SSS, GSIS, PhilHealth, and HDMF
2. Cost of premium for group insurance of employees
Illustration 11.7
Kingsdale Company made the following insurance premium payments during a calendar quarter:
P30,000 premium for the life insurance of the Chief Executive Officer (CEO) with Kingsdale
Company as the beneficiary of the policy
P20,000 premium for the life insurance of the Company Chief Operating Officer (COO) with his wife as
the beneficiary
P15,000 insurance premium of the personal car of the company manager - P40,000 premium for group
insurance of employees
P80,000 premium share in SSS, PhilHealth, and Pag-Ibig dues of employees
P10,000 fire insurance premium for the company building
The quarterly monetary value of fringe benefits shall be computed as follows:

Life insurance premium of COO where his wife is the beneficiary 20,000
Car insurance of company manager 15,000
Quarterly monetary value 35,000
The insurance premium on the life of the CEO where the company itself is the beneficiary is not a fringe
benefit to the executive employee but a business expense. Group insurance premiums and those required by
special laws are not taxable. The premium for fire insurance on company building is a business expense.
ACCOUNTING
The following are the pro-forma accounting entries in recording in the books of the employer. MV means
that this is usually the monetary value
Fringe Benefit Expense [mv]

Benefits paid for in cash or in Fringe Benefit Tax Expense xx
kind Cash/Property Xx
Fringe Benefit Tax Payable Xx
Benefits which do not involve Fringe Benefit Tax Expense [mv]

payment of cash or properties Fringe Benefit Tax Payable Xx
Exempt benefits paid for in cash Fringe Benefit Expense [mv]

or in kind Cash/Property Xx
Tax Treatment
The total fringe benefit expense including the fringe benefit tax expense is a deductible expense of the
employer against his gross income in the computation of his taxable income. It must be noted that a
deductible fringe benefit expense exists only when the benefit is paid in cash or in kind. The expense is
measured at the actual cost or tax basis of consideration given as fringe benefits.
FILING AND DEADLINE OF FORMS

There is only one form relevant to fringe benefit taxes. The quarterly withholding tax remittance return
shall be filed in triplicate by every Withholding Agent (WA / payor) required to deduct and withhold
taxes on fringe benefits furnished or granted to employees other than rank and file employees subject to
Final Withholding Taxes. [You may click the form code to access the link to the pdf file of said form.]
Deadlin e
Form Name Manual Filing eFPS Filing
Quarterly Remittance Return of last day of the month following the close of
Final Income Taxes Withheld the quarter during which withholding was
1603Q on Fringe Benefits Paid to made
Employees Other than Rank
and File)
ACTIVITY/ EVALUATION
TRUE OR FALSE

1. The fringe benefit tax is a final tax.
2. The fringe benefit tax is a tax on the employer.
3. Only managerial and supervisory employees working in the
private sector is subject to fringe benefit tax.
4. Lodging costs on foreign travel is a taxable fringe benefit regardless of
amount.
5. 30% of first-class tickets in foreign travel is an exempt fringe benefit.
6. The annual depreciation value of a real property is 20% of the value of the
property.
7. The monetary value of use of leased property is the full amount of rental
payments.
8. When a residential property is purchased to be transferred in the name of
employee for inadequate consideration, the monetary value is the excess of the
zonal value over the acquisition cost.
9. The grossed-up monetary value is the benefit expense of the employer.
10. The liability of the employer is to withhold the corresponding income
tax from the fringe benefit earned by the employee.
MULTIPLE CHOICE
A 1. Which value should be used as tax base to compute the fringe benefit on property
assigned for the use of employees? a. FMV of the property
b. Cost of the property
c. Equivalent rental value of the property
d. Fringe benefit value
D 2. The following are nontaxable housing fringe benefit, except

a. Housing for military officials of the AFP
b. Housing within 50 meters of business premises
c. Temporary housing within three months or more
d. Free housing privileges to a corporate officer
D 3. Interest on loans granted by the employer to employee are taxable fringe benefit
when the interest rate is a. More than 12%
b. At least 12%
c. At most 12%
d. Less than 12%
D 4. Which of the following business travel expenses is not subject to fringe benefit tax?
a. Hotel accommodation for $300 per day.
b. Cost of economy airplane ticket
c. Inland travel expense
d. All of the above
A 5. Education grant to the employee or his dependent by the employer is not subject to fringe
benefit tax, except when
a. The study grant involved is connected with the trade
b. There is a written contract that the employee will remain to work for a period of
time.
c. The assistance was through competitive scholarship program.
d. The study grant is not connected with the trade.
REINFORCEMENT/ ASSIGNMENT
RE
Problem 11.1 MONETARY VALUE
An employer remitted P196,700 pertaining to amount withheld from the cash benefit granted
to its managerial employee.
1. How much is the monetary value of fringe benefit paid?

2. How much is the total deductible expense of the employer?
Problem 11.2 PERSONAL EXPENSES
Gecko Company paid the following fringe benefits during the calendar quarter of its managerial
employee.
Salaries of household help 8,000/month
Salary of personal guard 18,000/month
Personal driver 9,000/month Annual association dues 6,000
Garbage dues 100/week
Compute for the quarter’s fringe benefit tax assuming the employee is:
1. A resident alien
2. Non-resident alien not engaged in trade or business
Problem 11.3 MOTOR VEHICLES

Violette Company maintains a fleet of motor vehicles for business use and employee use. The
following related to the calendar quarter just ended.
Cost of three motor vehicles used exclusively for sales and 4,500,000
delivery services
Cost of motor vehicles from employee’s business use and 500,000
employee use
Rental payments for additional motor vehicle for employee’s 30,000
personal use
Compute for the fringe benefit tax.

REFERENCES:

Tamayo, CPA, MBA

CPA, MBA
❖ National Internal Revenue Code of 1997
❖ Bureau of Internal Revenue Regulations

COURSE CODE AND TITLE : BCAR 5 - INCOME TAXATION
LESSON NUMBER : 12
TOPIC : Dealings in Properties
___________________________________________________
LEARNING OBJECTIVES
1. Explain dealings in properties transaction;
2. Compute capital gains and losses; and
3. Discuss the rules in capital gains and losses as to the valuation, the holding
period and the corresponding rates to be used.
PRE-ASSESSMENT
1. Which statement is correct?

a. Capital loss is deductible from capital gain.
b. Capital loss is deductible from ordinary gain.
c. Ordinary loss is deductible from capital gain.
d. Ordinary loss is deductible from ordinary gain.
2. A long-term holding means

a. More than 12 months
b. Less than 12 month
c. At least 12 months
d. At most 12 months
3. The holding period rule applies to

a. Domestic corporations
b. Taxable trusts
c. General professional partnerships
d. Resident foreign corporations
4. Which if the following results to a regular income tax due?

a. Sale of real properties held as capital asset
b. Sale of domestic stocks directly to buyer
c. Excess of capital gains over capital losses
d. Excess of capital losses over capital gains
5. Which is incorrect regarding net capital loss carryover?

a. Applicable only for a period of one year
b. Applicable to individual taxpayers engaged in business
c. Applicable to individual taxpayers not in business
d. Applicable to corporate taxpayers
LESSON PRESENTATION
DEALINGS IN PROPERTIES
INTRODUCTION
Dealings in properties involve the sale, exchanges, and other disposition of properties such as
ordinary assets or capital assets. It should be recalled that ordinary assets are assets used in the
business of the taxpayer such as inventories, supplies and property, plant and equipment.
Capital assets are assets other than ordinary assets. Dealings in ordinary assets are subject to
regular income tax. Dealings in capital assets, other than domestic stocks and real properties,
are also subject to regular income tax.
Dealings in ordinary assets may result in an ordinary gain or an ordinary loss. Dealings in capital
assets may likewise result in a capital gain or a capital loss.
Determination of Gains or Losses

Selling Price xx
Tax Basis (xx)
Gains/(Losses) xx
Selling Price
Selling price includes the amount realized from the sale and other disposition of property which
shall include:
1. The sum of money received and
2. Fair value of non-cash properties received
Tax Basis
Tax basis refers to the cost, carrying amount, or depreciated cost of an asset. The cost of an
asset is the value forgone to acquire it. Generally, it is the purchase price or the fair value of
consideration paid in acquiring the property disposed of.
Classifying Gains and Losses

As you have learned from previous modules how to classify assets on whether they are ordinary
and capital. Capital gains and losses arise from disposition of capital assets. Ordinary gains and
losses arise from disposition of ordinary assets.
Tax Treatment of Ordinary Gains and Losses

Ordinary gains are separate items of gross income subject to regular income tax. Ordinary losses
are items of deductions from gross income in the determination of net income from business or
profession. Ordinary gain is taxable in full. Ordinary loss is deductible in full. The gain or loss on
sale by dealers of properties is an ordinary gain or loss.
Tax Treatment of Capital Gains and Losses

Under the NIRC, capital losses are deductible only up to the extent of capital gains from dealings
in capital assets other than domestic stocks and real properties. Hence, capital gains and capital
losses are offset. A net capital gain is an item of gross income subject to regular income tax. A
net capital loss is not an item of deduction against gross income. The law views net capital losses
as unnecessary expenses since capital assets are not used in the business or trade of the
taxpayer. Determination of net capital gain or net capital loss. The determination of net capital
gains or net capital loss on capital assets, other than domestic stocks and real properties,
depends upon whether the taxpayer is an individual or a corporation.
CORPORATE TAXPAYERS
Capital gains are fully recognized by corporate taxpayers whilst capital losses are recognized
only to the extent of capital gains. In short, only net capital gains are recognized, net capital
losses are not deductible.
Illustration 12.1
Eagle Company had the following during the year.
Ordinary Capital
100,000 35,000
Gains 60,000 20,000
Losses
The taxable income is:

100,000
Ordinary Gains 60,000
Less: Ordinary Losses 40,000
Net Ordinary Gains 35,000

Net Capital Gains 20,000
15,000
Capital Gains
Less: Capital Losses
Taxable Income 55,000

Illustration 12.2
Assume the same facts as Illustration 12.1, except that the capital gain is P20,000 and capital loss
is P35,000.
The taxable income would be the net ordinary gain of P40,000. Since the capital loss is higher than the capital
gain, the net amount cannot be deducted.
INDIVIDUAL TAXPAYERS
The same is applicable to individual taxpayers except that there is a holding period rule and net
capital losses can be carried over.
Holding Period
If the capital gains or losses arose from capital assets which were held for more than one year,
the amount for the capital gain or loss is reduced by half.
Illustration 12.3
Steve Company had the following during the year.
Ordinary Long-term Capital Short-Term Capital
Gains 350,000 100,000 50,000
Losses 170,000 70,000 40,000
The taxable income is:
Ordinary Gains 350,000

Less: Ordinary Losses 170,000
Net Ordinary Gains 180,000

Net Capital Gains
Short-Term Capital Gain 50,000
Long-Term Capital Gain (100,000 / 2) 50,000
Less: Short-Term Capital Loss 40,000
Less: Long-Term Capital Loss (80,000 /2) 35,000 25,000
Taxable Income 205,000
Rationale of the holding period rule

Capital gains normally build up over time. However, the annual capital gains build up is not
taxed because they are unrealized gains. In accordance with the ability to pay theory, these
gains are taxable only when realized or severed from the capital through disposal by sale or
exchange.
Individual taxpayers are subject to progressive tax where higher income is subject to higher
tax and lower income to lower tax. The one-time or lump sum taxation of the capital gains
upon realization on disposal results to higher income tax compared to the total of taxes
assuming the annual build-up of capital gains is taxed annually. As a legislative
compromise, only 50% of long-term capital gains and losses upon disposal are recognized
for taxation purposes.
Corporate taxpayers are subject to proportional tax wherein the same income tax rate applies
regardless of the level of income. The one-time taxation of the gain on disposal and the annual
taxation of the capital gain as it builds up over time will yield the same amount of tax. Thus, the
holding period rule is held not to apply to corporate taxpayers.
Net Capital Loss Carryover
When a net capital loss is incurred in a period, said amount is still not deductible against ordinary
gains/losses. Instead, such amount can be carried over as a deduction for the next taxable year
if there is a net capital gain. The amount which can be carried over is the lowest of:
1. Net Capital Loss;

2. Net Income in the year the net capital loss is sustained; and
3. Net capital gain in the following year.
2019 Net Income before property dealings 180,000
2019 Net Capital Gains
2019 Capital Gains 50,000
Less: 2019 Capital Losses 10,000
Less: Net Capital Loss Carryover 30,000 10,000
2019 Taxable Income 190,000

The net capital loss carryover is the lowest of P80,000, P30,000 (P90,000-P60,000) and P40,000
(P50,000-P10,000).
Scenario 2: The capital losses in 2019 is P80,000.

Less: 2018 Capital Losses 80,000 -

Less: 2019 Capital Losses 10,000
Less: Net Capital Loss Carryover 20,000 10,000
Illustration 12.4
Sonny Cresencio reported the following in 2019 and 2020.
2019 2020
Net Income before property dealings 80,000 180,000
Capital Gains 60,000 50,000
Capital Losses ??? 10,000
Scenario 1: The capital losses in 2019 is P90,000.

Less: 2018 Capital Losses 90,000 -
2018 Taxable Income
The net capital loss carryover is the lowest of P80,000, P20,000 (P80,000-P60,000) and P40,000 (P50,000P10,000).
Rationale of the first limit: Net income at incurrence of capital loss

The amount of capital loss carry-over shall not exceed the net income before dealings in
capital assets in the year the net capital loss was sustained. This rule is anchored on the tax
benefit rule. If the law allowed full deductibility of capital loss, the taxpayer would be
benefited only up to the amount of the net income which the capital loss will erase and save
from taxation. The excess of the capital loss above this amount will not have a tax benefit.
To be fair, the carry over shall not result in allowing the taxpayer more than what he could
have claimed assuming full deductibility of capital loss is allowed by the law. In other words,
the carry-over should not result in undue enrichment to the taxpayer.
Rationale of the second limit: Net capital gain in the following year
The amount of capital loss carry-over shall not exceed the net capital gain in the following
year. Allowing capital loss carry-over in excess of the net capital gain in the following year
will create another net capital loss in the following year which will breach the one-year carry-
over rule under the NIRC.
FLOWCHART GUIDE
The flowchart below will guide you on the tax treatments assuming there is no net capital loss
sustained from previous years.
ACTIVITY/EVALUATION

1. The gain is said to be short-term if the sale of the asset is made in less than one year
from its acquisition.
2. Ordinary gains or losses are subject to the holding period rule if the taxpayer is
an individual taxpayer.
3. Ordinary losses are deductible to the extent of ordinary gains.
4. A net ordinary loss is deductible against gross income while a net capital loss is
not.
5. The holding period rule is relevant to all taxpayers.
6. Banks are dealers in securities.
7. Capital losses are deductible only to the extent of the capital gains.
8. The NCLCO is applicable for the next three years from the year of operating
loss and can be deducted from ordinary income and net capital gain.
9. Tax basis means the cost or depreciated cost of the property.
10. If the holding period is less than one year, the capital gain or loss is reduced by
half.
REFERENCES:
Tamayo, CPA, MBA
CPA, MBA
❖ National Internal Revenue Code of 1997 ❖ Bureau of Internal Revenue
Regulations
❖ Bureau of Internal Revenue Memorandum Circulars ❖ Supreme Court
Jurisprudence on Tax Cases
COURSE CODE AND TITLE: BCAR 5 - INCOME TAXATION
LESSON NUMBER : 13
TOPIC : Regular Deductions
INSTRUCTOR : Prof. Rosario A. Calamba, CPA, PhD
_________________________________________________________
LEARNING OBJECTIVES
1. Demonstrate mastery of the accounting rules of deductions;
2. Understand the different principles in claiming deductions; and
3. Identify the regular items under itemized deductions and requisites for deductibility.
PRE-ASSESSMENT
1. Which is a deductible tax expense?

a. Surcharges and penalties
b. Stock transaction tax
c. Real property tax on business properties
d. Special assessment
2. Which is not deductible against gross income?

a. Depreciation value of fringe benefits given to managerial employee
b. Fringe benefits to rank and file employees
c. Compensation of minimum wage earners
d. Salaries of managerial or supervisory employees
3. R&D costs that are not chargeable to capital account can be claimed as
a. Deductible expense
b. Deferred expense subject to amortization
c. Both a and b
d. Either a or b
4. Which of the following taxpayers cannot claim deductions from gross income?
a. General professional partnerships
b. Domestic corporation
c. Resident foreign corporation
d. Non-resident foreign corporation
5. Deductions can be claimed against

a. Talent fees
b. Fixed allowances
c. Fringe benefits
d. Salaries
LESSON PRESENTATION
REGULAR DEDUCTIONS
ALLOWABLE DEDUCTIONS
Deductions from gross income pertain to business expenses incurred by a taxpayer engaged in
business or engaged in the practice of profession.
Business means habitual engagement in a commercial activity involving the regular sale of
goods and services to customers or clients. In taxation, the term business is generally used to
include the exercise of a profession self-employment is a business but employment is not a
business.
Business Expense vs. Personal Expense

Business expenses are costs of doing trade, business or practice of profession such as
employee salaries, office utilities, supplies and rent, taxes, losses, bad debts, depreciation on
business properties, research and development and the like.
Personal expenses include the living and family expenses of individual taxpayers such as family
food, personal recreation and transportation, medication, home rentals and utilities, tuition fees
of dependents, and other similar expenses.
Allocation of Common Expenses

Expenses that are intended for both the business and for personal use of the taxpayer are
allocated between the two. Only those that pertain to the business are deductible
Business Expense vs. Business Capital Expenditure

Business expenses benefit only the current. They are costs of generating income or gains for the
current period. Hence, they are deductible against gross income in the current period. Capital
expenditures are expenses that benefit future accounting periods. They are initially recorded as
assets upon acquisition then later deducted against future gross income when used in the trade,
business or profession of the taxpayer. The advanced deduction of capital expenditures is not
warranted as it contradicts the Lifeblood Doctrine.
Expenses to Promote Business Goodwill

Expenses incurred to create or maintain some form of goodwill for the taxpayer's trade or
business or for the industry or profession of which the taxpayer is a member are non- deductible.
Non-Depreciable Asset
The cost of assets that do not depreciate by usage or by passage of time such as land is
deducted against the selling price when sold.
Depreciable Properties
The "depreciable cost" or the acquisition cost, net of expected salvage value, is allocated as
deduction over the useful life the property. The useful life of the property is the length of time it is
expected to be serviceable or its legal life, if applicable, whichever is lower. Note that the law
requires maximum usage life on certain items of properties such as vessels or aircrafts after
which they must be de-commissioned from use. The depreciation method is similar to the ones
you learned in Intermediate Accounting.
Intangible Assets
Amortizable intangible assets are those that lose their value over time should be expensed over
their legal life or expected usage life whichever is lower. Intangible assets that do not lose their
value such as franchise of public utility vehicles shall not be amortized.
Inventory
For goods inventory and supplies, their costs are deducted when sold or used in the business
using the inventory method or the specific identification method with the aid of a Point-of-Sale
(POS) machine.
Immaterial Capital Expenditures

The acquisition of items of property, plant and equipment, inventories or prepayments of
expenses which are relatively immaterial in amount may be deducted outright as expense upon
acquisition as this will not materially distort net income.
Repairs and Improvements

If the fair value of the property increases due to repairs, improvements or additions, the actual
cost of the repairs, improvements or additions that should be capitalized should not exceed the
appreciation in fair value. If the fair value of the property is not determinable, the excess of the
actual repair cost over the tax basis of the property is presumed a capitalizable increase in fair
value. Improvements and additions to properties normally increase the value or useful life of
properties; hence, these are capitalized and depreciated.
Replacements and Demolition
The tax treatments for these are the same with what you learned in Intermediate Accounting.
Asset Acquisition-Related Costs

All costs directly related to the acquisition of an item of property, plant and equipment such as in-
transit insurance, title guarantee insurance, freight, finder's fee or commissions, import duties,
and other taxes (excluding VAT for a VAT taxpayer) are capitalized as part of the cost of the
property subject to depreciation.
Security Issue Costs

Expenses of issuing equity or debt securities (i.e., stock or bonds) such as cost of registering
shares of stock to the Securities and Exchange Commission (SEC), cost of printing bond or
stock certificates, or brokers' commission on selling stocks or bonds, are not deductible expense
against gross income. They are deducted against the proceeds of such securities.
Manufacturing Expenses
The same computations you learned from your Intermediate and Cost Accounting classes are
applicable for manufacturing expenses.
Effect of Concurrent Taxes

Similar to items of gross income, the effect of value-added tax and expanded withholding taxes
are applicable to the allowable deductions.
LOAN PRINCIPLE
A deductible business expense is legitimate, ordinary, actual and necessary.
1. It is incurred in and for the current taxable period.
L 2. It is not a capital expenditure.
Legitimate 3. It pertains to the business or profession of the taxpayer.
4. It is not contrary to law, public policy or morals.
5. It is adequately substantiated with receipts or other documents.
It is "ordinary" when it is normal in relation to the business of the ta,payer
O Ordinary
and the surrounding circumstances.
An expense is actual if it is paid or resulted to an incurrence of an
A Actual obligation to the taxpayer. In case of a loss, it must be sustained or realized
by the taxpayer in a closed and completed transaction.
An expense is necessary if reasonable and essential to the development,

N Necessary management, operation, or conduct of the trade, business or exercise of
profession of the taxpayer.
MATCHING PRINCIPLE
It is a well-established rule in income taxation that only business expenses that are incurred for
the generation of items of gross income subject to regular tax are deductible. This is a pervasive
criterion that is consistently observed by the NIRC, revenue regulations, and BIR rulings.
Business expenses incurred to generate items of gross income that are either exempt or
excluded from taxation, subject to final tax or capital gains tax or to a special tax regime, must
not be matched or deducted against gross income subject to regular tax.
THE RELATED PARTY RULE

Gains realized between related parties are taxable, but losses are non-deductible. The rule is
intended as a control measure due to the fact that related party transactions can be easily
tailored in a way to evade taxes. This rule is particularly relevant in the claim of losses, bad
debts, and interest expenses.
The following are considered as related parties.
1. Members of a family
2. Except in cases of distribution in liquidation, the direct or indirect controlling
individual of a corporation
3. Except in cases of distribution in liquidation, corporations under direct or indirect
common control by or for the same individual
4. Grantor and fiduciary of any trust
5. Fiduciaries of trusts with the same grantor
6. Fiduciary of a trust and the beneficiary of such trust
Members of a family includes brothers and sisters (whether half-blood or full-blood), spouse,
lineal ascendants and descendants. Control means ownership of more than one half (½) of the
voting stocks of a corporation.
WITHHOLDING RULE
Payors of income are required to withhold income taxes on their payments. The failure to comply
with this requirement shall result in the disallowance of the expense as deduction.
The rule is “No Withholding, No Deduction.”
TAX REPORTING CLASSIFICATION OF DEDUCTIONS
Cost of Sales or Cost of Services

Cost of sales or cost of services is deducted outright against sales, revenues, receipts or fees of
individual taxpayers in the measurement of gross income from operations. It must be noted that
expenses that are directly related to the rendering of services or in the acquisition of goods are
excluded from the regular allowable itemized deductions and are included in "cost of sales" or
"cost of services" as the case may be.
Regular Allowable Itemized Deductions

Regular allowable itemized deductions pertain to all necessary and ordinary expenses paid or
incurred during the taxable year including directly attributable costs in carrying on the
development, management, operation and/or conduct of the trade, business or exercise of
profession. Expenses which are not directly related to the acquisition of goods or provision 01
services are included in regular allowable itemized deductions.
Special Allowable Itemized Deductions

Special allowable itemized deductions are additional deductions as provided under the NIRC or
special laws.
Net Operating Loss Carry Over (NOLCO)

This pertains to the excess of expense deduction over gross income during a taxable year which
is allowed by the law to be deducted against the net income of the following three years.
Technically, NOLCO is not an expense. It is a special deduction incentive allowed by law.
Technically, deduction incentives are deductible only in the year they are availed of but NOLCO
is exceptionally allowed to be carried over three years.
MODE OF CLAIMING DEDUCTIONS

Itemized Deductions
Under the itemized deductions, taxpayers list every item of business expense they claim as
deductions. Deductions are strictly construed against the taxpayer. The taxpayer has to point to
the provision of the law authorizing the deduction, substantiate his claim by supporting the
deduction with official receipts, payment vouchers, cancelled checks or other adequate records
and documentations, and comply with any withholding tax requirements on expenses.
Deductions claimed must also comply with any applicable deduction ceilings set by law.
Optional Standard Deductions

The optional standard deduction is in lieu of the itemized deductions, regular or special,
including NOLCO. The deduction is merely presumed as a fixed percentage of gross income for
corporations and gross sales or gross receipts for individuals.
INTEREST EXPENSE
Requisites for Deductibility:
1. There must be a valid indebtedness.

2. The indebtedness must be that of the taxpayer.
3. The indebtedness must be connected with the taxpayer's trade, business or
exercise of profession.
4. Interest expense must have been paid or incurred during the taxable year.
5. Interest must have been stipulated in writing.
6. Interest must be legally due.
7. Interest payments must not be between related taxpayers.
8. Interest must not be incurred to finance petroleum operations.
9. In case of interest incurred in the acquisition of property, used in trade, business or
profession, the same is not treated as a capital expenditure.
10. The interest is not expressly disallowed by law to be deducted from gross income
of the taxpayer.
Arbitrage Limit
The deductible amount of interest expense is the gross interest expense reduced by onethird (
1/3) of the gross amount of interest income which was subjected to the 20% final tax.
Deductibility of Discount
Discount or pre-deducted interest is a prepayment. Hence, it is not deductible upon release of
the loan but upon payment of the same or as it accrues as expense. If the loan is due on
installments, the interest pertaining to each installment shall be deductible.
Optional Treatment
Interest incurred in financing the acquisition of property used in trade or business may, at the
option of the taxpayer, be claimed as either: (a) an outright deduction from gross income or (b) a
capital expenditure claimable through depreciation.
Other Deductible Interest Expense

The following may be claimed as deductions
1. Interest from tax delinquency
2. Interest from scrip dividends
Non-Deductible Interest
The following cannot be claimed as deductions.
1. Interest on personal loans
2. Interest incurred with a related party
3. Discount or pre-deducted interest applicable to future periods for individual
taxpayers
4. Interest expense incurred to finance petroleum operations
5. Interest on redeemable preferred shares
6. Imputed interest
Illustration 13.1
For the year 2020, Jackie company had the following items of interests.
Interest expense on bank loans 80,000

Interest expense on bonds 63,000
Interest income from bank deposits, gross of final tax 27,000
Interest income from promissory notes 12,000
The deductible interest expense would be:
Interest expense on bank loans 80,000

Interest expense on bonds 63,000
Arbitrage on the interest income from bank deposit (27,000/3) (9,000)
Deductible interest expense 134,000

TAXES
The following taxes are classified as to their deductibility against gross income.
Deductibl Non-
e Deductible
1. Fringe Benefit Tax 1. Final Income Tax
2. Excise 2. Capital Gains Tax
3. Tax 3. Regular Income Tax
4. Percentage Tax 4. Foreign Income Tax, is claimed as
5. Documentary Stamp Tax tax credit
6. Occupational Tax 5. Value-Added Tax
7. License Tax
8. Local Taxes
9. Community Tax
10. Municipal Tax
11. Foreign Income Tax, if claimed as tax
deduction
Who can claim tax credit or deduction for foreign taxes paid?
Consistent with the matching rule, only taxpayers taxable on world income such as domestic
corporations and resident citizens can claim deduction or tax credit for foreign income taxes
paid.
Tax treatment of refunds or credit of taxes

The refund or credit of deductible taxes must be reverted to gross income to the extent of their
tax benefit. Incidentally, the refund of non-deductible taxes is exempt from income tax.
LOSSES
Losses actually sustained during the taxable year and not compensated by insurance or other
indemnity shall be allowed as deductions.
Requisites for Deductibility

1. It must be incurred in trade, profession or business of the taxpayer. (The loss must
be a business loss, not a personal loss.)
2. It must pertain to property connected with the trade, business or profession, if the
loss arises from fires, storms, shipwrecks, or other casualties, or from robbery,
theft, or embezzlement. (The loss must be an ordinary loss.)
3. The loss must not be compensated by insurance or indemnity contract. (The loss
must be actually sustained, not temporary.)
4. A declaration of loss must have been filed by the taxpayer within 45 days from the
date of discovery of the casualty or robbery, theft or embezzlement giving rise to
the loss.
5. The loss must not have been claimed as a deduction for estate tax purposes in the
estate tax return. (Double deduction is not allowed.)
Losses from ordinary assets are deemed normal to the taxpayer's trade, business or profession;
hence, these are deductible in full. Losses on capital assets are deemed by law unnecessary
expenses; hence, these are deductible only up to the extent of capital gains.
Total Destruction of Properties
If the restoration involves total replacement of the previous property, the tax basis of the old
property shall be claimed as a loss while the entire replacement cost is capitalized as cost of the
replacement property subject to allowance for depreciation.
Partial Destruction of Properties

If the restoration involves partial replacement of the previous property, the restoration cost shall
be expensed up to the extent of the tax basis of the property immediately before the casualty.
Any excess is capitalized subject to allowance for depreciation.
Loss of Value of Assets
The loss of value of assets, as a rule, is not deductible due to their temporary and reversible
nature. However, impairment losses that became actually sustained can be deducted.
Loss on Insured Property

The excess of the tax basis of the property over the insurance reimbursement is a deductible
loss in the year of insurance settlement.
Abandonment Losses
In the event a contract area where petroleum operations are undertaken is abandoned, the
accumulated exploration and development expenditures pertaining thereto, including the
adjusted tax basis of equipment directly used in the abandoned contract area, shall be allowed
as a deduction.
Losses from Wagering Transactions

Losses from wagering transactions such as gambling and other passive activities shall be
allowed only up to the extent of the gains from the same transaction.
Application of the Matching Rule

Taxpayers taxable on global income can deduct losses on properties wherever situated, but
taxpayers taxable only on Philippine income can only deduct losses on properties situated in the
Philippines.
BAD DEBTS
Bad debts refer to debts due to the taxpayer which were actually ascertained to be worthless
and were charged off within the taxable year. The following requisites must be met for the
deductibility.
1. The debt must have been ascertained to be worthless.
2. It must be charged off within the taxable yea
3. It must be connected with the taxpayer's profession, trade or business (i.e.,
uncollectible personal credits are non-deductible).
4. The taxpayer must be under the accrual basis of accounting.
5. It must not be incurred from a related party.
Non-Deductible Bad Debts

1. Bad Debts from personal receivables
2. Securities becoming worthless of taxpayers other than domestic banks and trust
companies
3. Loss on capital investment in partnerships, joint ventures or corporations
DEPRECIATION
Depreciation refers to the gradual exhaustion in the value of tangible business properties
brought by ordinary wear and tear through usage or obsolescence by the passage of time. It is a
provision for the periodic return of the invested capita] on the property throughout its useful life.
Depreciation Methods
1. Straight-line method
2. Declining-balance method
3. Sum-of-the-year-digit method
4. Any other method which may be prescribed by the Secretary of Finance upon
recommendation of the CIR
Life Tenancy to a Property

In the case of property held by one person for life with remainder to another person, the
deduction shall be computed as if the life tenant were the absolute owner of the property and
shall be allowed to the life tenant.
Properties Held in Trust

In the case of property held in trust, the allowable deduction shall be apportioned between the
income beneficiaries and the trustees in accordance with the pertinent provisions of the
instrument creating the trust, or in the absence of such provisions, on the basis of the trust
income allowable to each.
Depreciation on Revalued Property
The depreciation of an asset must be premised on its acquisition cost and not on its reappraised
value. Taxpayers using the revaluation model in accounting for items of property. plant, and
equipment are not allowed to deduct the depreciation of the revaluation surplus on the value of
property as this is not an actual cost. Rules on Deductibility of Depreciation on Passenger
Vehicles
1. Substantiation of the purchase with sufficient evidence such as official receipts and
other documents bearing the total purchase price including specific motor vehicle
identification numbers of the vehicles 2
2. Substantiation of the direct connection or relation of the vehicle to the
development, operation, and/or conduct of the trade, business, or profession of the
taxpayer
3. Only one vehicle for land transport is allowed for an official and employee, and the
value of which shall not exceed P2,400,000.
4. No depreciation shall be allowed for yachts, helicopters, airplanes or aircrafts, and
land vehicles which exceeded the threshold unless the main line of business is
transport operation or lease of transportation equipment and the vehicles
purchased are used in said operations.
AMORTIZATION
The same concepts from depreciation is also applicable to intangible assets.
DEPLETION
This is a provision for the periodic return of capital investments in wasting assets such as
minerals, gas and oil.
Illustration 13.2
At the start of the year, Minas Company capitalized P8,000,000 as cost of its wasting assets. During the year, it
extracted 6,000,000 tons of ores and an estimated remaining extractables of 14,000,000 tons.
For the year, Minas should recognize depletion expense of P2,400,000 (8,000,000 x 6,000,000 /
20,000,000).
Expense Option on Non-Producing Mines

After commercial production has commenced, exploration and development drilling expenses
incurred on non-producing mines may be deducted outright but the deductible amount shall not
exceed 25% of the net income from mining operations without the benefit of any tax incentives
under existing laws. The unclaimed balance of the expense shall be carried forward to the
succeeding years until fully deducted.
Illustration 13.3
Sanim Company had the following net income before the depletion expenses.
2018 2019 2020
Net income before depletion expense 8,000,000 6,000,000 7,500,000
Explorations Costs 2,500,000 1,500,000 1,000,000
The limits would be computed as:
2018 2019 2020
Net income before depletion expense 8,000,000 6,000,000 7,500,000
Limit 25% 25% 25%
Deduction Limit 2,000,000 1,500,000 1,875,000
The deductible depletion expense shall be the lower of the accumulated expenses and the limit, thus,
2018 2019 2020 Actual
Depletion Expense Carryover, beginning - 500,000 500,000

Depletion Expense, this year 2,500,000 1,500,000 1,000,000
Total Accumulated Depletion Expense 2,500,000 2,000,000 1,500,000
Less: Deductible Depletion Expense 2,000,000 1,500,000 1,500,000

Depletion Expense Carryover, ending 500,000 500,000 -
CHARITABLE AND OTHER CONTRIBUTIONS

Contributions or gifts made to the government or non-government organizations (NGOs) may be
deducted against gross income.
Fully Deductible contributions

1. Donations to the government or political subdivisions including fully owned
government and controlled corporations to be used exclusively in undertaking
priority activities as determined by the National Economic Development Authority
(NEDA) in Education, Human settlements, Health, Culture and sports, Youth and
sports development and Economic developments.
2. Donation to foreign institution or international organization in pursuance of or in
compliance with agreements, treaties or special laws
3. Donations to accredited domestic non-government organizations. The NGO must
be an accredited donee institution with certifications issued by the following
designated accrediting entities:
a. Department of Social Welfare and Development - for charitable and or social
welfare organizations, foundations and associations
b. Department of Science and Technology - for research and other scientific
activities
c. Philippine Sports Commission - for sports development
d. National Council for Culture and Arts - for cultural activities
e. Commission on Higher Education - for educational activities
Requisites
1. The NGO must be organized and operated exclusively for the above purposes, and
no income inures to the benefit of any private individuals.
2. The non-profit organization makes utilization of the contribution not later than the
15th day of the third month after the close of its taxable period.
3. The administrative expenses of the NGO do not exceed 30% of its total expenses.
4. Members of the Board of Trustees must not receive remunerations.
5. In the event of liquidation, the asset of the NGO will be distributed to another
nonprofit domestic corporation organized for similar purpose.
6. The amount of contribution of property other than money must be valued at
acquisition cost.
Contributions Subject to Limit

1. Donations to the Government of the Philippines or political subdivisions exclusively
for public purposes not in accordance with priority activities
2. Donation to non-accredited non-government organizations or to domestic
corporations organized exclusively for the following purposes: Religious, Cultural,
Charitable, Educational, Scientific, Rehabilitation of veterans, Youth and sports
development and Social welfare
Limit of Deduction for Contributions

Based on the taxable income derived from trade, business or profession (i.e., net income) before
the deduction of any contributions.
Individual Corporation
s
10% 5%
Illustration 13.4
Janie Bolido, a practicing architect had the following income and donations during the year:
Professional fees 1,100,000
Donations to government priority activities 100,000
Donations pursuant to treaties 30,000
Donations to accredited charitable institutions 50,000
Donations to the government for public purpose 80,000
Donations to non-accredited charitable institutions 60,000
Donations to a foreign charitable institution 40,000
Donations to street beggars 50,000
Other deductible business expenses 600,000
The taxable income would be computed as:
Professional fees 1,100,000

Other deductible business expenses 600,000
Net Income before donations 500,000

Deductible Contributions
Full: Government priority activities
100,000
Accredited charitable institutions 50,000
Treaty-Covered entities 30,000 180,000
Partial: Government non-priority activities 80,000

Non-accredited charitable institutions 60,000 140,000
Limit 50,000
Taxable Income 270,000 50,000
PENSION EXPENSE
Defined Contribution Plans

The deductible amount is the amount contributed.
Defined Benefit Plan

1. The contribution to the fund is first attributed to current service cost. The funding of
current service cost is deductible in full.
2. The excess funding is attributed to any unfunded past service cost. The funding of
past service cost is amortized over 10 years regardless of the actual vesting period
of covered employees.
3. Overfunding of the fund is a prepaid pension expense deductible in the future as
funding of future current service cost.
Illustration 13.5
Following are transactions of Unlonely Company on its defined benefit plan.
2018 2019 2020
Past Service Cost 650,000 - -
Current Service Cost 550,000 560,000 520,000
Annual Contribution 400,000 1,500,000 450,000
The deductible pension expense would be for 2018 is the annual contribution of P400,000 since it is
only attributable to the current service cost.
For 2019, the deductible expense is:
Contribution 1,500,000
Unfunded 2018 Current Service Cost 100,000 100,000
2019 Current Service Cost 560,000 560,000
Excess 840,000
Funding of Past Service Cost 650,000 65,000
Overfunding 190,000 670,000

Deductible Pension Expense
For 2020, the deductible expense is:

Contribution 400,000
2019 Prepaid Pension Expense 190,000
Total Funding for 2020 590,000

2020 Current Service Cost 520,000 520,000
Overfunding 70,000
Amortization of 2019 past service cost funding 65,000
Deductible Pension Expense 585,000
RESEARCH AND DEVELOPMENT COSTS

Research activities are geared towards discovery of new knowledge. Development activities are
geared towards determining application of research knowledge which could provide income and
benefits for the business.
Tax Treatment
1. Research and development costs related to capital accounts such as property used
in business are capitalized as part of the cost of the property and deducted through
depreciation expense.
2. Research and development costs not related to capital accounts are treated as
follows at the option of the taxpayer:
a. Outright expense; or
b. Deferred expense amortized over a period not less than 60 months
beginning from the month the taxpayer realizes benefits from the R&D
expenditures EXPENSES, IN GENERAL
Other legal, ordinary, actual and necessary expenses of business can be claimed by the
taxpayers as long as these are substantiated with official receipts or other pertinent records.
Examples of other deductible expenses:
1. Salaries and allowances
2. Fringe benefits
3. SSS, GSIS, PhilHealth, HDMF, and other contributions
4. Commissions
5. Outside services
6. Advertising
7. Rental
8. Insurance
9. Royalties
10. Repairs and maintenance
11. Entertainment, amusement, and recreation expenses
12. Transportation and travel
13. Fuel and oil
14. Communication, light, and water
15. Supplies
16. Miscellaneous expenses
ENTERTAINMENT, AMUSEMENT, AND RECREATION (EAR) EXPENSE

EAR expense includes representation expense and/or depreciation or rental expense relating to
entertainment facilities.
Limit
The maximum amounts of deductible EAR expense are the following:
Taxpayers Selling
Taxpayers Selling Goods or Services
Propertie
s
0.5% of net sales 1% of net revenues
For taxpayers engaged in the sales of both goods or properties and services, the actual EAR to be
compared on the limits shall be based on the allocation via the net sales and revenue.
Illustration 13.6
Johnny Moon is engaged ngaged in both sales of goods and sales of services. He incurred a total
of P9,000 entertainment, amusement, and recreation expenses in 2020. He reported P300,000 in
net sales and P700,000 in net revenues.
The deductible EAR shall be computed as follows:

Sales Limit Rate Limit Actual Deductible
Goods 300,000 0.5% 1,500 2,700 1,500
Services 700,000 1% 7,000 6,300 6,300
Total 1,000,000 9,000 7,800
ACTIVITY/EVALUATION: TRUE OR FALSE:

______1. The arbitrage limit applies to all taxpayers including individuals.
______2. Depreciation on revaluation surplus of properties can be deducted as part of depreciation
expense.
______3. Losses on wagering transactions are deductible in full.
______4. The depreciation expense on properties eld under life tenancy is computed as if the life
tenant were the absolute owner of the property.
______5. Donations to foreign institutions covered by treaty exemptions are fully deductible.
______6. Purely employed individuals can claim deductions for donations made.
______7. All business expenses are allowable deductions from gross business income.
______8. Repaired that increase property useful life are capitalized.
______9. Foreign taxes can be claimed as a deduction or tax credit.
______10. Bad debt expenses between related parties can be deducted as long as these are
adequately supported with documentary evidence.
REFERENCES:

Tamayo, CPA, MBA

CPA, MBA

COURSE CODE AND TITLE: BCAR 5 - INCOME TAXATION
LESSON NUMBER : 14
TOPIC : SPECIAL ITEMIZED DEDUCTIONS
_________________________________________________________
LEARNING OBJECTIVES
1. Identify the special items under itemized deductions and requisites for deductibility;
2. Illustrate how net operating losses can be carried forward to offset future operating
income; and
3. Explain the effects of choosing the optional standard deduction, including computing the
deductible amount and its basis.
PRE-ASSESSMENT:
1. NOLCO can be carried over in the next five years for these circumstances, except
a. Incurred in the first ten years of a mining company
b. Incurred during 2020
c. Incurred during 2021
d. Continuous net operating loss for three years
2. Which is not a deduction incentive from a special law?
a. Discounts to PWDs under RA 9442
b. Additional compensation expense under RA9257
c. Additional training expense under RA 8502
d. Additional free legal assistance expense under RA 9999
3. Which is not included in corporate OSD?

a. Cost of sales
b. Selling expenses
c. Administrative expenses
d. Creditable withholding tax
4. Non-operating income subject to regular tax is excluded in the OSD base of a. Individuals only
b. Corporations only
c. Both individuals and corporations
d. Neither individuals nor corporations
5.The option to elect OSD is irrevocable

a. In the year it was made
b. Over the next three years
c. In the quarter it was made
d. Effective the quarter in the year the option was made
LESSON PRESENTATION
SPECIAL ITEMIZED DEDUCTIONS

Tax incentives are given by special laws in the form of an additional deduction aside from the
actual expense incurred by a taxpayer. It is good to take note that these are deductible up to the
extent of taxable income before special deductions and NOLCO.
Income Distributions made by Taxable Estates and Trusts
Distribution of income of taxable estates or trusts to the heirs or beneficiaries are deductible against the
gross income of the estate or trust. This has been discussed in Module 7.
Transfer to Reserve Funds of Insurance Companies

Under the Insurance Code, non-life insurance companies are required to maintain a reserve
equivalent to 40% of their gross premium, less returns and cancellations for risks expiring within
one year. For marine cargo risks, the reserve is equivalent to the amount of premium on
insurance during the last two months of the calendar year.
The net additions, if any, required by law to be made within the year to the reserve funds and the
sums, other than dividends, paid within the year on policy and annuity contracts may be
deducted from the gross income of insurance companies.
Under current regulations, the transfer to the reserve fund shall be deductible in the year it was
actually paid and not in the year it was determined. Also in consonance with the tax benefit rule,
the release of the reserve is treated as an income in the year of release.
Illustration 14.1
On December 31, 2019, the reserve fund of Insurascore Company had a balance of P850,000.
On December 31, 2020, the minimum required level of the reserve fund is P1,200,000.
The increase in the required reserve fund of P350,000 (P1,200,000 – P850,000) is a special
item of deduction against the gross income of the company. Once this reserve is released, it
shall form part of the gross income.
Dividend Distribution of a Real Estate Investment Trust

An REIT is a publicly listed corporation established principally for the purpose of owning income-
generating real estate assets. An REIT is legally mandated to distribute 90% of its distributable
income as dividends to shareholders.
Under RA 9856, the dividend distributions of REITs are treated as special deductions against
gross income. For purposes of computing the taxable net income of REITs, dividends distributed
by them from their distributable income after the close of a taxable year and on or before the
last day of the fifth month following the close of the taxable year shall be considered as paid on
the last day of such taxable year.
Transfer to Reserve Fund of Cooperatives

Under RA 9520, cooperatives are required to maintain reserves for their protection and stability.
Cooperatives are exempt from income tax but are subject to tax on their income from unrelated
activities. The amount transferred by the cooperative to the reserve fund out of the net surplus
from unrelated activities is an item of deduction in the computation of the taxable net income of
the cooperative. Normally, this is 10% of the net income from unrelated activities.
Special Deductions Related to Senior Citizens and Persons with Disability The
following are the rates and requisites for the following special deductions.
Special
Deduction Rate Requisites
Discounts to 20% of the 1. Only that portion of the gross sales exclusively used,
Senior Citizens gross selling consumed, or enjoyed by the senior citizen or PWD
and Persons price shall be eligible for the deductible sales discount. The
with Disability 2. gross selling price and the sales discount must be
separately indicated in the official receipt or sales
invoice issued by the establishment for the sale of
goods or services to the senior citizen or PWD.
3. Only the actual amount of the discount granted or

sales discount not exceeding 20% of the gross selling
price can be deducted from gross income, net of VAT,
if applicable.
4. The discount can only be allowed as deduction from
gross income for the same taxable year that the
discount is granted.
Additional 15% of the 1. Employment shall have to continue for at least 6

Claimable salaries and months.
Compensation wages given 2. The annual taxable income of the senior citizen does
Expense for not exceed the poverty level as determined by NEDA.
Senior Citizen
Employees
Additional 25% of the 1. The entity must present proof as certified by DOLE that
Claimable salaries and disabled persons are under their employ.
Compensation wages given 2. The disabled employee is accredited with DOLE and
Expense for DOH as to his disability, skills and qualifications.
Persons with
Disability
Cost of 50% of the Entity must have improved or modified their physical
Facilities direct costs of facilities in order to provide reasonable accommodation for
Improvement for improvement disabled persons.
Disabled
Persons
Illustration 14.2
Compassion Company gives a 25% discount on sales made to senior citizens and disabled persons.
Sales made for goods costing P5,600,000 are the following:
To regular customers 8,900,000 To senior citizens 2,100,000

To disabled persons 1,400,000
It also had the following expenses.

Regular Expenses 1,750,000
Salaries of employed senior citizens 90,000
Salaries of employed disabled persons 50,000
The company also had an expenditure included in the regular expenses for a facility
improvement amounting to P100,000 which was for the convenience of its disabled persons as
clients.
The taxable income would be computed as follows:

Gross Sales (8,900,000+2,100,000+1,400,000) 12,400,000
Cost of Sales 5,600,000
Gross Income 6,800,000

Less: Allowable Deductions
Regular Deductions 1,750,000
Special Deductions
SC Discounts (2,100,000 x 20%) 420,000
PWD Discounts (1,400,000 x 20%) 280,000
SC Salaries (90,000 x 15%) 13,500
PWD Salaries (50,000 x 25%) 12,500
PWD Facility Improvements (100,000 x 50%) 50,000 776,000
Taxable Income 4,274,000
Jewelry Industry Development Act of 1998

Under RA 8502 and its implementing rules and regulations, a qualified jewelry enterprise duly
registered and accredited with the Board of Investments (BOI) is entitled to an additional
deduction to the following:
Special
Rate Requisites
Deduction
Expenses 50% of the 1. A qualified jewelry enterprise must submit to the BIR a
incurred in actual certified true copy of its Certificate of Accreditation
TESDA- expenses issued by the BOI.
approved 2. The training scheme must be approved and certified
training by TESDA.
schemes
Adopt-A-School Act of 1998

Under the Adopt-a-School Program, private entities are allowed to assist a public school in particular
aspects of their educational program within an agreed period of time.
Special
Rate Requisites
Deduction
Contributions 50% of the 1. The deduction shall be availed of in the taxable year in
made to a contribution which the expense is paid or incurred.
participating made 2. The expense is substantiated with sufficient evidence
school such as official receipts, delivery receipts and other
adequate records.
3. The application together with the approved MOA
endorsed by the National Secretariat shall be filed with the

RDO having jurisdiction over the place of business of the
adopting private entity
Expanded Breastfeeding Promotion Act of 2009
The purpose of RA10028 is to encourage, protect, and support the practice of breastfeeding
which is believed to provide distinct benefits to the mother and the infant aside from saving the
country's valuable foreign exchange that may otherwise be used for milk importation.
Special
Rate Requisites
Deduction
Expenses 100% of the 1. The deduction shall apply for the taxable period when
for expenses the expenses were incurred.
Compliance to 2. All health or non-health facilities, establishments and
Rooming-in institutions shall comply with the IRR of RA 10028
and Breast- within 6 months after its approval.
Feeding 3. The facility, establishment or institution shall secure a
Practices "Working Mother-Baby-Friendly Certificate" from the
Department of Health to be filed with the BIR.
Free Legal Assistance

Lawyers or professional partnerships providing pro-bono legal services are given deduction incentives
for their free legal services.
Special
Rate Requisites
Deduction
Free Legal Lower of The free legal services must be exclusive of the 60-hour
Assistance supposed mandatory free legal assistance rendered to indigent
income and 10% clients as mandatorily required under the Rule on
of the gross Mandatory Legal Aid Services for Practicing Lawyers.
income from
practice of legal
profession
Productivity Incentive Act of 1990

A business enterprise can avail of the following:
Special
Rate Requisites
Deduction
Productivity 50% of the None
Incentive Bonus bonuses
given
TESDA- 50% of the 1. Must have been provided to rank-and-file employees

accredited grant given 2. Must not have been given during the pendency of a
trainings and strike or lockout arising from any violation of the
special studies productivity incentive program.
NET OPERATING LOSS CARRYOVER

Aside from special laws, the tax code also allows for the deduction of Net Operating Loss
Carryover. This pertains to the amount of net operating loss that is allowed by the law to be
carried over as deduction.
Rationale
NOLCO is intended to allow the taxpayer to recoup his losses before taxation go full swing. Without it,
income taxation would result in taxation of recoveries of lost capital.
Applicability
All taxpayers subject to tax on taxable income whether at the regular income tax or at
preferential tax rate can deduct NOLCO. Taxpayers who are exempt, enjoying a tax holiday,
subject to tax on gross income, or those subject to final income tax, cannot deduct NOLCO.
Computation
NOLCO will be computed as follows:
Gross Income xx
Regular Itemized Deductions (xx)
Special Itemized Deductions from NIRC (xx)
Net Operating Loss Carryover (xx)

Deduction incentives are not actual operating expenses. They are not actual costs. Hence, they
must be excluded in the amount of net operating loss carry over. That is why deduction
incentives are legally allowed only as deduction in the period they are availed of. The carryover
of deduction incentives is not legally warranted. Prior year NOLCO, which is also a deduction
incentive, cannot be deducted in the measurement of the current year NOLCO
To emphasize the rules in the measurement of taxable net income or NOLCO:
1. Cost of sales or cost of services and regular allowable itemized deductions are fully
deductible against gross income.
2. Special incentive deductions are deductible only to the extent of net income before
special incentive deductions.
3. NOLCO prior years are deductible only to the extent of net income after special
incentive deductions but before NOLCO.
Carryover Period
General Rule
Generally, net operating losses can be carried over for the next three years provided that the
business has a taxable income from business on these years.
Bayanihan to Recover as One Act

Unless otherwise disqualified from claiming the deduction, the business or enterprise which
incurred net operating loss for taxable years 2020 and 2021 shall be allowed to carry over the
same as a deduction from its gross income for the next five (5) consecutive taxable years
immediately following the year of such loss.
Mining Companies
The net operating loss sustained by mining companies without the benefit of incentives under the
Omnibus Investment Code of 2007 in any of their first 10 years of operation is allowed to be
carried over a period of five years following the year the net operating loss was sustained.
Illustration 14.3
Divoc Company obtained the following for the specified years (in thousands):
2019 2020 2021 2022 2023 2024 2025
Gross Income 1,000 500 600 900 900 1,100 1,200
Allowable Deductions 1,100 1,000 The 1,000 900 700 700 900
NOLCO will be applied as follows:
2019 2020 2021 2022 2023 2024 2025
Income before NOLCO (100) (500) (400) - 200 400 300
NOLCO (200) (400) (300)
Taxable Income - - - - - - -
The first P100 NOLCO applied in 2023 came from 2019 and the balance from 2020. The
remaining balance of NOLCO for 2020 is applied in 2024. The NOLCO applied in 2025 came from
2021, the balance of P100 of which is still deductible until 2026.
Requisites for Deductibility

1. The taxpayer must no be exempt from income tax during the taxable year when the
NOLCO was incurred.
2. There has been no substantial change on the ownership of the business or
enterprise.
OPTIONAL STANDARD DEDUCTION

The OSD is in lieu of the itemized deductions including NOLCO allowable under the NIRC and
special laws. Under the OSD, the allowable deduction of the taxpayer is simply presumed as a
percentage of gross sales or receipt for individuals and gross income for corporations. There is no
need to support every item of expense. The OSD, however, does not relieve the taxpayer of the
responsibility to deduct withholding tax on certain income payments as required by the NIRC.
Applicability
OSD is a proxy for itemized deductions. As a rule, all taxpayers who are subject to tax on taxable
net income can claim deductions except the following:
1. Non-resident alien engaged in trade or business (NRA-ETB)
2. Taxpayers mandated to use itemized deductions
a. Exempt GOCCs and non-stock, non-profit corporations with no taxable income
b. Corporations with income subject to special/preferential tax rates
c. Corporations with income subject to regular corporate income tax and
special/preferential tax
d. Exempt individuals under the NIRC and special laws with no other taxable income
e. Individuals with income subject to special/preferential tax rates
Rate and Base
The rate for the deduction is 40% of the following bases:
Gross Sales/Receipts/Revenues xx xx
Cost of Sales/Services - (xx)
Primary Income - xx xx xx xx
Other Operating Income not subject to final tax xx
Non-Operating Income not subject to final tax
Base xx xx
The gross sales/ receipts/ revenues should be net of any discounts, allowances and returns. These
terms are further differentiated on their usage on the table below.
Accrual Basis Cash Basis
Seller of Goods Gross Sales Gross Sales
Seller of Services Gross Revenues Gross Receipts
Replacement
The optional standard deduction replaces the following depending on the type of the taxpayer.
Cost of Sales ✓ X
Regular Allowable Itemized Deductions ✓ ✓
Special Allowable Itemized Deductions ✓ ✓
Net Operating Loss Carryover ✓ ✓
Net Capital Loss Carryover X X
Illustration 14.4
A business enterprise elects the use of the optional standard deduction for the year. Following are
the two accounts connected with its primary income.
Unearned Revenue
Earnings 1,800,000 Beginning Balance 250,000
Cash Receipts 1,730,000
Ending Balance 180,000
Accrued Revenue
Beginning Balance 60,000 Cash Receipts 220,000
Accruals 280,000
Ending Balance 120,000

It also had other operating income of P20,000, half of which is subjected to final tax. Nonoperating
income during the year was P5,000. The cost of sales/services is P980,000, regular deductions is
P480,000, special deductions is P50,000 and available NOLCO is P100,000.
The optional standard deduction would be computed as follows depending on the classification and
operation of the taxpayer. [Amounts are in thousands]
Individual Corporate
Services – Services Services – Services
Goods Accrual Goods Accrual
- Cash - Cash
Gross Item 2,080 2,080 1,950 2,080 2,080 1,950
Other Operating Income 10 10 10 10 10 10
Non-Operating Income - - - 5 5 5
Cost of Sales/Services - - - (980) (980) (980)
Base 2,090 2,090 1,960 1,115 1,115 985
Rate 40% 40% 40% 40% 40% 40%
OSD 836 836 784 446 446 394
The taxable income would be computed as follows depending on the classification and operation of the
taxpayer. [Amounts are in thousands]
Individual Corporate
Services – Services Services – Services
Goods Accrual Goods Accrual
- Cash - Cash
Gross Item 2,080 2,080 1,950 2,080 2,080 1,950
Other Operating Income 10 10 10 10 10 10
Non-Operating Income 5 5 5 5 5 5
Cost of Sales/Services - - - (980) (980) (980)
OSD (836) (836) (784) (446) (446) (394)
Taxable Income 1,259 1,259 1,181 669 669 591
OSD for General Professional Partnerships

A general professional partnership (GPP) is not a taxable entity. It is merely viewed as a "pass-
through" entity where income is ultimately taxed to the partners. Each partner shall report as gross
income his distributive share, actually or constructively received, in the net income of the GPP.
Thus, a GPP can choose either the itemized deduction or the optional standard deduction in
computing its distributable net income. Partners in GPP cannot claim OSD against their share in
net income.
ACTIVITY/EVALUATION:
1. The transfers to all reserve funds of the cooperative including mandatory and
discretionary funds are deductible from the gross income of cooperatives.
2. NOLCO always exist when there is a net operating loss.
3. There is an additional 15% deductible salary expense for those senior citizen and
disabled person employees.
4. Dividends are non-deductible by any taxpayer except real estate investment trusts.
5. The taxable net income of individuals is 60% of their gross sales or
receipts.
6. Administrative and selling expenses are included as cost of services.
7. The option to elect OSD ay result into a net operating loss carryover.
8. The gross sales figure in terms of computing OSD should be exclusive of discounts,
allowances and returns.
9. The discounts given to senior citizens and disabled persons decreases the gross
income.
10. Corporations opting for OSD can claim deduction for cost of goods sold or cost of
services.
REFERENCES:

Tamayo, CPA, MBA
CPA, MBA

Income Taxation Module Compilation Finals

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Course Code and Title: BACR 5 – INCOME TAXATION

Topic : Exclusions from Gross Income

Instructor : Prof. Rosario A. Calamba, CPA, PhD

At the end of this lesson, the student should be able to:

2. Understand the limitations of exemption of certain income items;

Try to answer the following questions.

PROCEEDS OF INSURANCE POLICIES

GIFTS, BEQUESTS AND DEVISES

COMPENSATION FOR DAMAGES

Nontaxable, if the compensation for damages is on account of

a. Personal physical injuries or sickness;

Taxable, if the compensation for damages is a payment for

a. Actual damages for loss of anticipated profits;

INCOME EXEMPT UNDER TREATY

a. This is the first time availment of retirement benefit exemption.

SEPARATION AND TERMINATION BENEFIT

1. The separation or termination must be due to job-threatening sickness, deaths, or other

1. Backwages or illegal deductions repaid by the employer upon termination

paycheck shows the following details:

Scenario 3: Kala chose to resign first.

SOCIAL SECURITY BENEFITS

Received from Foreign Income

These are exempt under the exemption doctrine of international comity.

a. Any public utility; or

b. Exercise of essential government function Government agencies and instrumentalities

Mandatory Payroll Deductions

Personal Equity and Retirement Account

Contributions to PERA accounts are exclusions in gross income. This is an additional

13th Month Pay and Other Benefits

Gains on Sale of Long-Term Indebtedness

Gain on Redemption of Shares in a Mutual Fund Company

MINIMUM WAGE EARNERS

To qualify as a BMBE, an enterprise must not be a branch or a subsidiary of a large scale

Tax Exemption on Income from Operations

NON-STOCK AND NON-PROFIT ENTITIES

Conditions for exemptions of employee trust funds:

Problem 8.1 NON-RESIDENT TAXPAYER

How much of the P1,000,000 should be excluded from gross income?

Basic Pay 96,0 PhilHealth Contribution 2,000

Answer the following questions.

❖ Bureau of Internal Revenue Memorandum Circulars

❖ Supreme Court Jurisprudence on Tax Cases

Course Code and Title: BACR 5 – INCOME TAXATION

Topic : Inclusions in Gross Income

At the end of this module, you are expected to:

1. Identify the different sources of reportable gross income; and

2. Explain the different principles to be considered in reporting items of income

3. Eliminate the effects of value-added tax and creditable withholding tax in

COMPENSATION FOR SERVICES

1. Business income exempt from income tax such as:

GAINS FROM DEALINGS IN PROPERTIES

The following are exempt from regular income taxation:

1. Interest income earned by landowners in disposing their lands to their tenants

The interest income from deposits and-notes

Type/Source Within Abroad

Source (right) / Non-Resident

Earned within by Earned within by

Prizes and PCSO

Prizes and PCSO

Taxability of Entity Organized Within Organized Abroad