INCOME TAXATION

Chapter 3: Introduction to Income Taxation

Item of gross income Taxable item of gross income

Taxable income Refers to the certain items of gross income less deductions and personal exemptions allowable
by law.

Taxable income = Gross Income

Gross Income Defined as any inflow of wealth to the taxpayer from whatever source, legal or illegal, that
increases net worth. It includes income from employment, trade, business or exercise of
profession, income from properties and other regular or casual transactions.
Elements of Gross Income  It is a return on capital that increases net worth
 It is a realized benefit.
 It is not exempted by law, contract, or treaty.

Gross Income = Selling Price – Cost of Goods Sold

Return on/ of Capital Return on Capital – means that the net worth increased. Thus, subject to income tax
Return of Capital – merely maintains net worth; hence, it is not taxable.
Capital items deemed with 1. Life
infinite value  proceeds of life insurance policies paid to the heirs/beneficiaries upon death of
the insured are EXEMPT from income tax.
 proceeds of a life insurance contract collected by an employer as a beneficiary
from the life insurance of an officer or any person directly interested with his
trade are likewise EXEMPT.
Taxable return on capital from insurance policies:
 excess amount received over premiums paid
 gain realized by the insured from the assignment/sale of his insurance policy.
 Interest income from unpaid balance of the proceeds.
 Excess of the proceeds received over the acquisition costs and premium payments by
an assignee of a life insurance policy.

2. Health – any compensation received in loss of health such as for injury/tortuous acts is
not taxable.
3. Human Reputation – any indemnity received a compensation for its impairment is a
return of capital exempt from income tax.
Taxable recovery of lost The recovery of lost profits through insurance, indemnity contracts, or legal suits constitute
profits. taxable return on capital.

Taxable recoveries of lost profits are the following:

a) Proceeds of crop or livestock insurance
b) Guarantee payments
c) Indemnity received from patent infringement suit.

Not benefits, not taxable a) Receipt of a loan

b) Discovery of lost property
c) Receipt of money or property to be held in trust for, or to be remitted to another
person.
Requisites of realized 1. There must be an exchange transaction.
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benefit 2. The transaction involves another entity.
3. It increases the net worth of the recipient.

Types of Transfer 1. Bilateral Exchanges (Onerous Transactions) – subject to income tax

 Sale
 Barter
2. Unilateral Transfers (Gratuitous Transactions) – subject to transfer tax
 Succession
 Donation
3. Complex Transaction – partly gratuitous and partly onerous
 Gratuitous portion – transfer tax
 Onerous portion – income tax

 Realized means earned which is taxable. Unrealized gains are not taxable.
 Increase in wealth of the taxpayer in the form of appreciation or increase in the value
of his properties or decrease in the value of his obligation IN THE ABSENCE OF SALE OR
BARTER TRANSACTION IS NOT TAXABLE.
Basis of exemption of Income received in non-cash considerations is taxable at the fair value of the property
Unrealized Income received.
 The proceed of embezzlement/swindling where money is taken without an original
intention to return are considered as income because it increases in net worth of the
swindler.
 An item of gross income is not exempted by Constitution, law, contracts or treaties
from taxation.
Items of income exempted 1. Income of qualified employee trust fund.
by law from taxation; 2. Revenue of non-profit not-stock educational institution.
hence, not considered as 3. SSS, GSIS, Pag-Ibig, or PhilHealth benefits
items of gross income 4. Salaries and wages of minimum wage earners and qualified senior citizen.
5. Regular income of BMBEs.
6. Income of foreign governments and foreign government-owned and controlled
corporation
7. Income of international missions and organized with income tax immunity.
Types of Income Taxpayers A. Individuals
1. Citizen
 Resident citizen
 Non-resident citizen
2. Alien
 Resident alien
 Non-resident alien
 Engaged in trade or business – stayed more than 180 days
 Not engaged in trade or business – stayed not more than 180 days
3. Taxable estate and trusts
 Trust that is irrevocably designated by the grantor is treated as an
individual taxpayer in which income of property held in trust is taxable to
the trust. (Treated as RESIDENT CITIZEN)
 Trust that is revocably designated by the grantor is not treated as an
individual taxpayer in which income of property held in trust is taxable to
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the grantor.
(Not a TAXPAYER)

B. Corporations
1. Domestic Corporation
2. Foreign Corporation
 Resident Foreign Corporation
 Non-resident foreign corporation
Income Situs Rule 1. Interest Income – Debtors residence
2. Royalties – Where the tangible is employed
3. Rent income – location of the property
4. Service income – place where the service is rendered.

Others:
A. Gain on sale of properties
1. Personal property
 Domestic securities – presumed earned within the Philippines.
 Other personal properties – earned in the place where property is sold.
2. Real Property – earned where property is located.
B. Dividend Income from:
1. Domestic corporation – presumed earned within.
2. Foreign corporation
 Resident Foreign Corporation – depends on the pre-dominance test where
if the ratio of the PH gross income over the world gross income of the RFC
in the 3-year period preceding the year of dividend declaration is:
 At least 50%, the portion of dividend corresponding to the
Philippine gross income ratio is earned within.
 Less than 50%, the entire dividend is earned abroad.
 Non-resident foreign corporation – earned abroad.
C. Merchandising Income – earned where the property is sold.
D. Manufacturing – earned where the goods are manufactured and sold.

Chapter 4: Income Tax Schemes, Accounting Periods, Accounting Methods, and Reporting
Income Taxation a. Final Income Taxation
Schemes b. Capital Gains Taxation
c. Regular Income Taxation

Tax schemes are mutually exclusive. An item of gross income that is subject to tax in on
one scheme will not be taxed by other schemes. Similarly, items of income that are
exempted in one scheme are not taxable by other schemes.
Final Income Taxation A. Characterized by final taxes wherein full taxes are withheld by the income payor
at source. The recipient income taxpayer receives the income net of taxes.
B. Applicable only on certain passive income listed by the law, but not all passive
income is subject to final tax.
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Passive vs. Active Passive income – earned with a very minimal or without active involvement of the
Income taxpayer in the earning process
 Interest income from banks
 Dividends from domestic corporations
 Royalties

Active income – arises from transactions requiring a considerable degree of effort or

undertaking from the taxpayer.
 Compensation income
 Business income
 Professional income
Capital Gains Taxation Imposed on the gain realized on the sale, exchange, and other dispositions certain
capital assets

Capital assets – not used in business, trade, or profession.

Ordinary assets – used in business trade or profession such as inventory, supplies or
property, plant, and equipment.

Note: Not all capital gains are subject to capital gains tax. Most of them are subject to
regular income tax.
Regular Income Regular income tax is the general rule in income taxation and covers all other income
Taxation such as:
1. Active Income
2. Other Income
 Gains from dealings in properties, not subject to capital gains tax.
 Other passive income not subject to final tax
Deadline of Filing the  Due for filing on the 15th day of 4th month following the close of taxable year.
Income Tax Returns  For dissolving corporation, they shall file their return within 30 days from the
cessation of activities or approval of merger by the SEC in the case of merger.
 For change of accounting period by corporate taxpayers, the accounting period
covers the start of the previous accounting period up to the designated year-
end of the new accounting period.
 For death of the taxpayer, the accounting period covers the start of the
calendar year until the death of the taxpayer.
 For the termination of the accounting period of the taxpayer by the CIR, the
accounting period covers the start of the current year until the date of the
termination of the accounting period.
Types of Accounting 1. General Method
Methods a) Accrual basis
b) Cash Basis
2. Installment and deferred payment method
3. Percentage of completion method
4. Outright and spread-out method
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5. Crop year basis
Accrual Basis Income is recognized when earned regardless of when received.
Expense is recognized when incurred regardless of when paid.

Tax Accrual Basis Income:

Cash Income xx
Accrued Income (earned but not yet received) xx
Advanced Income xx
Gross Income xx

Tax Accrual Basis Expense:

Cash expenses xx
Accrued Expenses (incurred but not yet paid) xx
Amortization of prepayments and
depreciation of capital expenditure xx
Deductions xx

Cash Basis Income is recognized when received and expense is recognized when paid.
Hybrid Basis Any combination of accrual basis, cash basis and other methods of accounting.

*Gross income determined by cash basis and accrual basis are combined.
Types of Returns to the 1. Income Tax Return
Government 2. Withholding Tax Returns
3. Information Returns

General Rule: Pay as you file

Capital gains tax and regular income tax are paid as the taxpayer files his return.
Penalties for Late Filing 1. Surcharge
or Payment of Tax a. 25% of the basic tax for failure to file or pay deficiency on time.
b. 50% for willful neglect to file and pay taxes.
2. Interest – 12% per annum effective Jan. 2018.
3. Compromise Penalty
Penalties for Non-Filing  P1000 for each such failure
or Late Return of  Provided that the amount imposed for all such failure during a calendar year
Information Return shall not exceed P25,000.

Chapter 5: Final Income Taxation

Features of Final Income 1. Final tax
Taxation 2. Tax withholding at source
3. Territorial imposition
4. Imposed on certain passive income earned from sources within the Philippines
5. Imposed on non- resident persons not engaged in business in the Philippines
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NOTE: FINAL INCOME TAX DOES NOT APPLY TO INCOME FROM SOURCES ABROAD.
Final Withholding  Inherently territorial
System  All items of income earned from sources abroad, passive, or active, are subject to
tax under the general scope of the regular income tax.

Non-resident person not engaged in trade or business General

Final Tax
Non-resident alien not engaged in trade/business (NR- 25%
NETB)
Non-resident foreign corporation (NRFC) 30%

Passive Income Subject

to Final Tax  LOCAL CURRENCY DEPOSITS
 Short term deposits – less than 5 years
 Long-term deposits – with a maturity of not less than 5 years.

Source of Income Individuals Corporations

Short term deposits 20% 20%
Long term deposits/Investment Cert. Exempt 20%
Interest or yield from
Note: Exemption does not include NRA-NETB
bank deposits or deposit
substitutes. Pre-termination concerns only individual taxpayers.
Tax On Pre-Termination of Long-Term Deposits of Individuals
Holding Period Final tax
Less than 3 years 20%
3 years to less than 4 years 12%
4 years to less than 5 years 5%
5 years or more 0%

Other applications of the final tax on interest:

a) Deposit substitutes
b) Government securities
c) Money market placement
d) Trust funds
e) Other investment evidence by certificates prescribed by BSP.

Note: Final tax is limited to banks and shall not be applied with time and savings deposit
maintained by members with cooperatives and by primary cooperatives with their
federation.

Interest Income Subject to Regular Tax

 Lending activities, whether or not in the course of business
 Investment Bonds
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 Promissory notes
 Foreign sources, whether bank or non-bank
 Penalty for legal delay or default

 FOREIGN CURRENCY DEPOSITS

Taxpayer Individuals Corporations

Residents 15% 15%
Non-Residents Exempt Exempt
Note: Rates and exemption also apply to NRA-NETB and NRFC

 JOINT ACCOUNTS ON FOREX DEPOSITS – if the bank account is jointly in the

name of a non-resident and a resident taxpayer, 50% of the interest shall be
exempt while other 50% shall be subject to the 15% final tax.

Domestic Dividends, in Types of dividends subject to tax

general a. Cash Dividends
b. Property Dividends
c. Scrip Dividends

Types of dividends not subject to tax

a. Stock dividends
 Distribution of stocks of another corporation as dividends is a taxable
property dividend and not a stock dividend

Stock dividends can be taxable if:

1. The corporation cancels or redeems stock issued as dividend.
Cancelling is equivalent declaration of cash dividends
2. Substantial alteration in ownership in the corporation like stock
dividends are given in lieu of cash dividends.

b. Liquidating Dividends
 Not viewed as income, but as exchange of properties
 When LD exceeds the cost of the investment, the excess is a taxable
capital gain, subject to RIT
c. Stock split – will never be subject to income tax

Source of dividends Individuals Corporations

Domestic corporation 10% final tax Exempt
Foreign Corporation Regular Tax Regular Tax
Note:
1. NRA-ETB – subject to 20% final tax
2. NRA – ETB – subject to 25% final tax
3. NRFC – subject to 30% final tax
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Exempt Dividends
1. Inter-corporate dividends (includes partnership since it’s a corporation)
2. Dividends from cooperative

Dividend Income from REIT – a publicly listed corporation established principally for the purpose of owning
Real Estate Investment income-generating real estate assets.
Trust (REIT)
The ff. recipients of REIT dividends are exempt from the final tax:
1. NRA or NRFC entitled to claim preferential tax pursuant to applicable tax treaty.
2. DC or RFC
3. Overseas Filipino investors
Share in net income of a  10% final tax applies at the determination of the income, not at the point of
business partnership, actual distribution.
taxable associations,  Share in net income includes share in the residual and.
joint venture, joint  Provisions for salaries, interest, and bonuses, if not expensed (Final
accounts, or co- Tax)
ownership  Provisions for salaries, interest, and bonuses, if expensed (RIT, which
means not included in the computation for FINAL Tax)
 If the corporation doesn’t declare dividends but the accumulated earnings is
beyond the reasonable needs of business, they will be imposed by 10%
Improperly Accumulated Earnings Tax (penalty tax)
Royalties Passive royalty income received from sources within the PH is subject to the following
final tax rates:

Source of passive royalties Individuals Corporations

Books, literary works, and musical compositions 10% 20%
Other sources 10% 20%

Notes:
1. Books and literary works that are being imposed by 10% pertains to printed
literatures. CDs/e-books are subject to 20% final tax.
2. Royalties on cinematographic films and similar works paid to NRAs and NRFCs is
subject to a final tax of 25%
3. When royalty is no longer passive, it is subject to RIT.
4. Royalties, active, or passive, earned abroad are subject to RIT.
Prizes Exempt Prize:
 Prizes received without effort.
 Prizes that are sanctioned by national sports organization

Amount of Taxable Prize Individuals Corporations

Prizes >P10,000 20% final tax Reg. Tax
Prizes <P10,000 (10k or less) Reg. Tax Reg. tax
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Note: Prizes from foreign passive income are subject to RIT.
Winnings
Types of winnings Individuals Corporations
PCSO/lotto winnings not exceeding P10,000 Exempt Exempt
PCSO/lotto winnings exceeding P10,000 20% Final Tax 20% Final Tax
Other winnings in general. 20% Final Tax Regular tax

Notes: PCSO/Lotto winnings for NRA-ETB & NRFCs, regardless of amount are
respectively subject to 25% or 30% final tax.
Tax Informer’s Reward  Tax informer’s reward is subject to 10% final tax.
 Amount of cash reward is whichever is lower
 10% revenues, surcharger, or fees recovered and or fine or penalty imposed
and collected
 P1,000,000
Tax-Free Corporate
Covenant Bonds Individuals Corporations
Tax on interest income on tax-free 30% final tax Regular
corporate covenant bonds. Income Tax

Petroleum Service  Every subcontractor, whether domestic or foreign, entering into a contract with a
Contractors service contractor engaged in petroleum operations in the PH shall be liable a
final income tax of 8% of its gross income
 Petroleum service contractors are subject to RIT.
 Persons or entities required by service contractor to supply goods and materials
are entitle to the preferential tax of 8%
Final Withholding Tax  BIR Firm 0619-F (Monthly Remittance Return of Final Income Taxes Withheld
Return  Shall be filed in triplicate by every withholding agent for the first 2 months of the
quarter.
Deadline of return  Shall be filed and the tax shall be paid on or before the 10th day of the month
following the month withholding was made.
Quarterly Filing  Shall file BIR form 1601-FQ, Quarterly Remittance Return of Final Income Taxes
Withheld, on or before the last day of the month of each quarter

Chapter 6: Capital Gains Taxation

Capital Gains Taxation Imposed on the gain realized on the sale, exchange, and other dispositions certain
capital assets

*Losses are not subject to CGT

Classification of 1. Ordinary assets – assets used and sold in ordinary course of business, such as
 INCOME TAXATION
Taxpayer’s Properties a. Stock in trade of a taxpayer or other real property of a kind which would be
properly included in the inventory of taxpayer if on hand at the close of the
taxable year. (Inventory)
b. Real property primarily for sale to customers in the ordinary course of his
trade or business. (Assets held for sale – inventory)
c. Real property used in trade/business of a character which is subject to the
allowance for depreciation. (Asset held for use – supplies & PPE)
d. Real property used in trade/business of the taxpayer. (Asset held for use –
PPE)

Notes: (ff. are ordinary assets)

 Real and other properties acquired (ROPA) by banks are classified as ordinary
assets even if banks are not actually engaged in the realty business. ROPA are
normally acquired and sold by banks in their normal course of business.
 Property purchased for future use in business
 Real property used, being used, or have been previously used in trade.

2. Capital Assets – any asset other than ordinary asset.

a. Personal (non-business) assets of individual taxpayer. (Almost everything you
own and use for personal or investment purposes, but never in business.)
b. Business assets of any taxpayers which are:
*Financial assets – cash, receivables, prepaid expenses, and investments.
*Intangible assets – patent, copyrights, leasehold rights, franchise rights.
Notes:
 ROPA in the form of stocks held by banks are capital assets. Those who have
stocks as ordinary assets are only dealers in securities.
 Properties classified as ordinary assets for being used in business by a taxpayer
not engaged in real estate business are automatically converted to capital assets
if there’s proof that the same have not been used for more than 2 years.
 Properties used by exempt corporation are capital assets. Exempt corporations
are not business.

Taxation of Gains on
Dealing in Properties Ordinary Gains Regular Income Tax
Capital Gains General rule: RIT
Exception rule: Capital gains tax
Capital Gains Subject to 1. Capital gains on the sale of domestic stocks sold directly to buyer.
Capital Gains Tax 2. Capital gains on the sale of real properties not used in business
Scope of Capital Gains Tax rates (TRAIN Law)
Taxation Gains on dealings in capital Individuals Foreign Corporations
assets
Gain on sale, exchange, and 15 % capital Net gains up to P100k – 5% CGT
other disposition of domestic gains tax Excess net gain above P100k – 10% CGT
 INCOME TAXATION
stocks directly to buyer
Sale, exchange, and other 6% capital
disposition of real property in gains tax of
the PH the SP or
FV,
whichever
is higher
Gains from other capital RIT
assets

NIRC Old Law:

Net gains up to P100k – 5%
Excess net gain above P100k – 10%

Capital gain on the sale, Domestic stocks

exchange, and other a) Preferred stock (cumulative, participative
disposition of domestic b) Common stock
stocks directly to buyer c) Stock rights
d) Stock options
e) Stock warrants
f) Unit of participation in any association, recreation, or amusement club.

The capital gains tax covers not only sales of domestic stocks for cash but also exchange
of domestic stocks in kind and other disposition:
a. Foreclosure of property in settlement of debt
b. Pacto de retro sales
c. Conditional sales
d. Voluntary buy back of shares
The term other disposition does not include:
a. Issuance of stock by a corporation – financing rather than a sale transaction
b. Exchange of stock for service – no gain or loss imputed
c. Redemption of shares in a mutual fund – exempted by NIRC from income taxation
d. Worthlessness of stocks – capital loss which is subject to the rules of RIT.
e. Redemption of stocks for cancellation by the issuing corp. – subject to RIT
f. Gratuitous transfer – subject to transfer tax
Modes of Disposing 1. Through PSE – not subject to capital gains tax, but to stock transaction tax of 60%
Capital Gains of 1% of the selling price effective Jan. 2018.
2. Directly buyer
Nature of Capital Gains 1. Universal tax – applies to all taxpayers regardless of classification. Applies even if
Tax the sale is executed outside the Philippines. But should be from domestic
corporation.
2. Annual tax – imposed on the annual net gain
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NET GAIN: In case of CASH SALE, total consideration received per deed
Selling price xx of sale.
Less: If TOTAL CONSIDERATION is paid partly in money and partly
Basis of stocks disposed xx in property, the sum of money and FV of property received.
In case of EXCHANGES, the value of the property received.
Selling expenses xx
Documentary stamp tax* xx
Net Capital Gain (Loss) xx

*Documentary stamp tax is deducted if paid by the seller.

Tax Basis of Stocks Tax Basis of Stocks
(COST OF STOCKS) Acquired by purchase Cost of the property which can be determined by
the following methods:
1. Specific identification – if shares can be
specifically identified.
2. Moving Average – books maintained by the
seller where transaction of stock is recorded.
3. FIFO – stocks cannot be specifically
identified.
Acquired by devise, FV at the time of death of the decedent
bequest, or inheritance
Acquired by gift Lower of the FV at the time of gift in the hands of
donor or the last preceding owner by whom it was
not acquired by gift
Acquired by inadequate Amount paid by the transferee for the property
consideration
Acquired under tax-free Substituted basis of the stocks.
exchanges

Stocks sold for inadequate consideration

 The excess of the FV of the stocks over the selling price is a gift (if there’s a
clear donative intent) subject to donor’s tax

Excess of FV over SP is subject to transfer tax

Fair Value xx
Selling Price xx
Gain is subject to capital gains tax
Less: Cost and Expenses xx
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Tax Compliance under 1. Transactional CGT – to be reported after each sale.

the old law 2. Annual CGT
Capital Gains Tax Rate Tax Rates
NIRC (Old Law) TRAIN LAW TRAIN Law
(FC)
Net gains up to P100,000 5% 5%
Excess net gain above P100,000 10% 15% 15%

Deadline of the  BIR Form 1707

Transactional Capital  Shall be file within 30 days after each sale, exchange, and other disposition of
Gains Tax Return stocks.
 If tax is qualified for installment, the tax is due within 30 days after each
installment.
Annualized CGT for  CGT is recomputed on the annual net gains then previously tax payments are
Foreign Corporation treated as tax credit thereto.
 After tax credit, the residual tax due is paid while excess transactional payment is
claimed as tax refund or tax credit.

Deadline of annual CGT returns:

 BIR Form 1707-A
 Shall be filed on or before the 15th day of the fourth month following the close of
taxable year of the taxpayer.
Installment Payment of When domestic stock is sold in installments, the capital gains tax may also be paid in
the CGT installments if the:
a. Selling price exceeds P1,000.
b. Initial payment does not exceed 25% of the selling price.

Net Capital Gains Tax Due shall be computed as:

Selling Price – Cost of shares sold = Net capital gain x NCG rate 15% = NCG Tax Due

Shall be computed as:

Collection/Contract Price x Whole Capital Gains Tax

With mortgage on stocks but not in excess cost

Selling Price – Mortgage assumed by the buyer = Contract Price

With excess mortgage over cost

Selling price – mortgage assumed + Constructive Receipt = Contract Price
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*Note: Constructive receipt is the excess of assumed mortgage over cost.

Special tax Rules in 1. Wash Sales of Stocks
Capital Gain or Loss 2. Tax-free exchanges
Measurement a. Exchange of stocks pursuant to a merger or consolidation
b. Transfer of stocks resulting in corporate control
Wash Sales Rule  Deemed to occur when within 30 days before and 30 days after the losing sale of
securities (also referred to as the 61-day period), the taxpayer acquired or
entered a contract or option to acquire the same or substantially identical
securities (stocks and bonds).
 Capital losses on wash sales by non-dealers in securities are not deductible
against capital gains because they are effectively unrealized.
 The loss on wash sale shall be deferred and added to the tax basis of the
replacement shares because the loss is a fake loss since the tax payer bought
back his original shares
A. Acquisition of identical shares before a losing sale/ after a losing sale
Selling Price – Cost of Shares Sold = Capital Loss
*If the shares sold is fully replaced within 61-day period, the capital loss shall not be
deductible in the computation of annual capital gains.
*Full replacement means when the quantity of the shares acquired in the 61-day period
is at least equal to the quantity sold.
*The adjusted basis of the replacement shares shall be:
(Basis of Replacement Shares = Purchase Price + Deferred Loss on Wash sales)

 Replacement shares are less than the shares sold (Only the portion covered with
replacement shares shall be disallowed. The portion without replacement cover is
deductible realized loss. Capital loss shall be split as follows:
Deferred loss = Replacement shares/Shares Sold x Capital Loss
Deductible Loss = Portion of shares sold without replacement cover/Shares Sold x Capital Loss

Tax Free Exchanges Merger or Consolidation

 Gains or loss on share-to-share swaps pursuant to a plan of merger or
consolidation will not be recognized for taxation purposes.
Initial Acquisition of Control
 No gain or loss shall be recognized if property is transferred to a corporation
by a person in exchange for stocks or units of participation in such a
corporation
Exchange Not Solely for Stocks
 If stocks are exchanged not solely for stocks but with other consideration such
as cash and other properties, the gains but not losses are recognized up to the
extent of cash and other properties
Regulatory Formula on
Tax Substitute Basis Tax basis of old shares exchanged xx
Add: Gain recognized on the transfer xx
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Less: Cash or other properties received xx
Tax basis of new shares received xx

Sale, Exchange, and  Subject to a tax of 6% of the selling price or the FV, whichever is higher.
Other Disposition of  FV of real property is whichever higher of the zonal value or fair market value
Real Property Classified  Normally, only land has zonal value but both land improvements have fair
as Capital Asset Located market value.
in the PH.  For lands, the capital gains tax is 6% of whichever is the highest of the SP (bid
price in case of foreclosure), zonal value, or provincial or city assessor’s FV.
Nature of the 6% Capital a. Presumption of capital gains – the 6% CGT applies even if the sale transaction
Gains Tax resulted to a loss.
b. Non-consideration to the involuntariness of the sale – CGT applies even if the
sale is involuntary or forced.
c. Final tax – CGT shall be withheld by the buyer against the selling price of the
seller and remit the same to the government.
Exceptions to the 6% 1. Alternative Taxation Rule
CGT An individual seller of real property capital assets has the option to be taxed at either:
(Permissible only when the taxpayer is individual and the buyer is the government, its
instrumentalities or agencies including gov’t owned and controlled corporation.)
a. 6% CGT
b. RIT
Documentary Stamp Tax 1. Domestic stock – P1.50 for every 200 par value.
2. Real Property – P15 for every P1000 higher of SP or FV

Chapter 7: Introduction to Regular Income Tax

Characteristics of the RIT 1. General in coverage – applies to all income except those that are subject to
final tax, CGT, and special tax regime.
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2. A net income tax – imposition on residual profits/gains after deductions for
expenses and personal exemptions allowable by law.
3. An annual tax
4. Creditable withholding tax
5. Progressive/Proportional

The Regular Income Tax Model:

Gross Income – Inclusions xx

Less: Allowable deductions xx
Taxable Income xx

Gross Income consists of 1. Exclusions of gross income – list of income exempt to RIT.
the major topics: 2. Inclusions of gross income – list of income subject to RIT.
3. Special topics – covers income that are either exclusion or inclusion
depending on certain circumstances, such as:
a. Fringe benefits
b. Dealings in properties
Allowable Deductions Deductions – expenses of the conduct of business or exercise of profession.
Commonly known as business expenses.

Individuals not engaged in business cannot claim deductions from gross income.
a. Pure compensation earner
b. Pure business or professional income earner
c. Mixed income earner – individual earning both compensation and
business/professional income.

Chapter 8: Regular Income Tax: Exclusions from Gross Income

Exclusions from Gross Income which will not be subject to income tax. They are not included in gross
Income income subject to regular tax, capital gains tax, or final tax.
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Not included in gross A. Proceeds of life insurance – return of capital, not taxable.
income and shall be B. Amount received by the insured as return of premium – return of capital
exempt from taxation: Note:
1. If the purchaser of the insurance sell or assign the policy to other person,
the insurance proceeds in excess of the cost received by the buyer shall be
taxable since he is not the original purchaser.
2. Proceeds of property insurance contract in excess of the tax basis of the
property lost or destroyed is TAXABLE RETURN ON CAPITAL
C. Gift, bequest, devise, or descent – subject to transfer tax
D. Compensation for injuries or sickness – return of capital
E. Income exempts under treaty.
F. Retirement benefits, pensions, gratuities, etc.
G. Miscellaneous items
Retirement Benefits, 1. Retirement benefit under RA. 7641 and those received by officials and
Pensions, Gratuities, and employees of private firms in accordance with a reasonable private benefit
other benefits plan maintained by employer.
Requisites of exemption: (can only be availed once)
a. First time availment of retirement benefit exemption
b. Retiring employee/official has been in the service of the same employer for
at least 10 years
c. Retiring employee is at least 50 years of age at the time of retirement.
d. Employer maintains a reasonable private benefit plan.

2. Separation or Termination
Requisites of exemption:
a. Separation/termination is due to job threatening sickness, deaths, or other
physical disability
b. Must be due to any cause beyond the control of the employee or official such
as:
 Redundancy
 Retrenchment
 Closure of employer’s business
 Employee lay off
 Downsizing of employer’s business
 Sickness or death of the employee
3. 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
4. United States Veterans Administration – administered benefits under the
laws of the U.S. received by any person residing in the Philippines.
5. SSS benefits
6. GSIS benefits
7. Miscellaneous items
 INCOME TAXATION

Miscellaneous items 1. Income derived on investments in the Philippines in loans, stocks, bonds, or
(exempt from income tax) other domestic securities, or from interest on deposits in banks in the
Philippines by:
a. Foreign gov’t
b. Financing institutions owned, controlled, or enjoying refinancing from
foreign government
c. International or regional financial institutions established by foreign
governments
2. Income derived by the gov’t and its political subdivisions from:
a. Any public utility
b. Exercise of essential gov’t function
Note: Exemption does not include gov’t-owned and controlled
corporations (GOCCs)
3. Prizes and awards made primarily in recognition of religious, charitable,
scientific, educational, artistic, literary, or civic achievements but only if:
a. Recipient is selected without action on his part
b. Recipient not required to render substantial future services as condition
to receiving the prize or award.
Examples:
- Nobel Prize Award
- Gawad Sining Award
- CNN Hero of the Year
- Most Outstanding Citizen
4. Prizes and awards in sports competitions granted to athletes:
a. Local and or international competition and tournaments
b. Whether held in PH or abroad
c. Sanctioned by their national sports association
5. Contributions for GSIS, SSS, PhilHealth, Pag-Ibig and Union dues of
individuals – pertains to employee share and their
MANDATORY/COMPULSORY monthly contribution
6. Contributions to Personal equity Retirement Account (PERA)
- PERA contributors are allowed to claim 5% of their PERA contributions as tax
credit against any internal revenue taxes.
7. Investment income and PERA distributions
8. 13th - month pay and other benefits received by officials and employees of
public or private entities not exceeding P90,000.
9. Gains from sale of bonds, debentures, or other certificate of indebtedness
with a maturity of more than 5 years – term gain does not include interests.
10. Gains realized from option of shares in a mutual fund company by the
investor

Other Exempt Income 1. Minimum Wage Earners

 INCOME TAXATION
Under the NIRC and Special 2. Income of Barangay Micro-Business Enterprises Act (RA 9178)
Laws 3. Income of Cooperatives
4. Income of non-stock, non-profit entities
5. Income of qualified employee trustfund
Requisites for exemption for Income of BMBE
a. Total assets exclusive of land should not exceed 3,000,000.
b. Service for BMBE excludes those rendered by licensed professionals and
partnership and corporations engaged in professional activities.
c. Must not be a branch or subsidiary of a large-scale enterprise.
Applicant must secure a certificate of authority from the Office of the Treasurer of
the city or municipality.

Chapter 9: Regular Income Tax: Inclusion in Gross Income

Items of Gross Income
a. Gross compensation  Compensation income pertains to the types of employee benefits that are
for service in subject to regular tax.
whatever form  Fringe benefit managerial/supervisory employees are not considered
compensation income and are subject to final tax. (Not subject to RIT)

b. Gross Income from  Includes income from trade or business, legal or illegal, and whether
conduct of trade, registered or unregistered.
business, or The following business income shall not be included in gross income subject to RIT.
exercise of a 1. Business income exempt from income tax
profession a. Gross income from a Barangay Micro-Business Enterprise (BMBE)
b. Gross income from enterprises enjoying tax holiday
2. Business income subject to special tax regime
a. PEZA registered enterprise subject to 5% gross income tax
b. TIEZA-registered enterprise 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
a. Subcontractors of petroleum service contractors subject to 8% final tax.
b. Business income of FCDUs and offshore banking units (OBUs) from
Philippine residents subject to 10% final tax.
c. Gains from  Gains and losses in dealing ordinary assets are subject to RIT
dealings in  Dealings in capital assets other than domestic stocks and real properties are
properties also subject to RIT.
d. Interest income  Refers to interest income other than passive interest income subject to final
tax.
Examples of interest income subject to RIT:
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1. Interest income from lending activities to individuals and corporations by
banks, finance company, and other lenders.
2. Interest income from bonds and promissory notes
3. Interest income from bank deposits abroad
e. Rents  Although this is a passive income, it is not subject to final tax under NIRC;
hence, it is subject to regular income tax
 Obligations of the lessor assumed by the lessee are additional income to the
lessor, subject to RIT.
 Advance rentals which can be items of gross income if unrestricted; and
restricted to be applied in future years or upon termination of the lease
 Not an item of gross income if it constitutes a loan or a security deposit to
guarantee payment.
f. Royalties  Royalties earned within PH are generally subject to final tax except when
they are active by nature where in that case it can be subjected to RIT
 Active royalty income and passive royalties earned from sources abroad are
subject to RIT
g. Dividends  Cash, property, and script dividends from foreign corporations are subject to
regular income tax.
 Normally, stock dividends are exempt from income tax, but when it is
subsequently redeemed such that, it amounts payment of cash dividend, the
FV of the stock dividends received is taxable.
h. Annuities Excess of annuity payment received by recipient over premium paid is taxable
income in the year od receipt.
i. Prizes and
Winnings Within Abroad
Prizes:
P10,000 and below Regular Tax Regular Tax
More than 10,000 Final tax Regular tax
PCSO and lotto, exceeding 20,000 Final Tax N/A
PCSO and lotto, not exceeding 20,000 Exempt N/A
Winnings from other sources Final Tax Regular Tax

j. Pensions  Pertains to pensions and retirement benefits fail to meet the exclusion
criteria and hence subject to regular tax.
k. Partner’s  Only partner’s share in net income is subject to regular income tax.
distributable
share from the
net income of
the general
 INCOME TAXATION
professional
partnership
Other Sources of Gross a. Income distribution from taxable estate or trusts
Income Subject to RIT b. Share from the net income of other pass-through entities.
 Exempt joint ventures
 Exempt co-ownership
c. Farming Income
d. Recovery of Past Deductions
e. Reimbursement of Expenses
f. Cancellation of indebtedness for a consideration

Chapter 10: Compensation Income

Not considered employees, 1. Consultants
thus the income or fees of 2. Directors without management functions
these individuals are not 3. Talents and artist on TV shows or radio broadcast
compensation, but
business or professional
income
Types of employees as to 1. Minimum wage earners – exempt from income tax on their compensation.
taxability 2. Regular employees – subject to regular progressive income tax.
Gross Compensation Tax Model on Compensation Income:
Generally, includes all
Income
Gross compensation income xx renumerations received under an
employer-employee relationship.
Less: Non-taxable compensation xx
Taxable compensation income xx
A. Mandatory deductions
- Mandatory contributions to GSIS, SSS, PhilHealth, HDMF, and
union dues
B. Exempt Benefits
- Benefits excluded and/or exempt under the NIRC and special laws
- Benefits exempt under treaty or international agreements
- Benefits necessary to the trade, business, or conduct of profession
of the employer
- Benefits for the convenience or advantage of the employer.
Exempt benefits under the 1. Renumeration received as incidents of employment
NIRC and special laws a. Exempt retirement benefits including retirement gratuities to
government officials and employees
(at least 50 yrs. old & has served 10 yrs. in that company)
b. Exempt termination benefits
c. Benefits from the United States Veterans Administration
d. Social security, retirement gratuities, pensions, and similar benefits from
 INCOME TAXATION
foreign government, agencies, and other institutions, private or public.
e. Benefits from SSS
f. Benefits from GSIS
2. De minimis benefits – privileges that are relatively small value and furnished
by employer merely as a means of promoting the health, goodwill,
contentment, or efficiency of his employees. (Petty fringe benefits)
3. 13th-month pay and other benefits not exceeding P90,000.
De minimis benefits (non- 1. Monetized unused vacation leave credits of private employees (10 days)
taxable compensation) 2. Monetized unused vacation and sick leave credits paid to gov’t officials and
employees. (No limit)
3. Medical cash allowance to dependents of employee (375/month)
4. Rice subsidy (P2000/month or 1 sack/month)
5. Uniform and clothing allowance (P6000)
6. Actual medical assistance (P10,000/year)
7. Laundry allowance (P300/month)
8. Employee achievement award in the form of tangible property (P10,000)
9. Gift given during Christmas and major anniversary celebrations (P5,000/year)
10. Daily meal allowance for overtime work and night/graveyard shift (25% of
the basic minimum wage on a per region basis
11. Benefits received of an employee by virtue of collective bargaining
agreement and productivity incentive schemes (P10,000)
12. Terminal leave pay accumulated due to involuntary separation (10 days)

Note: Terminal leave pay or the commutation of unused leave credits due to
involuntary separation from employment is now treated as de minimis benefits
subject to 10-day leave credit limit and is no longer exempt as part of exempt
termination benefits.
Taxable de minimis 1. Excess de minimis over their regulatory limit
benefits 2. Other benefits of relatively small value that are not included in the list of the
de minimis benefits.

Treatment of taxable de minimis benefits:

a. Rank and file employees – treated as compensation income under the
category 13th month pay and other benefits.
b. Managerial and Supervisory employees – fringe benefit subject to final fringe
benefit tax.
Exempt benefit under  Employee benefits of non-Filipino nationals and/or non-permanent residents
treaty or international of the Ph from foreign gov’t, embassies or diplomatic missions, and
agreements international organizations in the Philippines are exempt from income tax.
 It should be noted that only Filipino employees of foreign gov’t are not
exempt in the income tax exemption. Exemptions are only limit to non-
Filipino nationals and non-residents of the Philippines.
 Filipinos only included in the exemption under the following organizations.
1. UN
 INCOME TAXATION
2. Specialized Agencies pf the UN
3. AUSAID
4. FAO
5. WHO
6. UNDP
7. IOM
8. ISA
Note: There should be a confirmation of tax exemptions for Filipino
employees with the BIR’s International Affairs Division
Benefits necessary to the - Benefits/allowances furnished by the employer to the employees to enable
trade, business, or conduct them to execute their duties appropriately and effectively as required by
of profession of the necessary employment are exempt from income tax. (Necessity of the
employer employer rule)
- Those are considered as business expense.
Benefits for the - Benefits/allowance intended for the furtherance of the interest of the
convenience or advantage employer’s business is exempt from income tax. (Convenience of the
of the employer employer rule)
- If the given benefits/allowances are excessive such as when deliberately
granted to include a benefit for the employee, that portion would be
considered a taxable fringe benefit.
Composition of Taxable 1. Regular Compensation (BFP)– fixed renumerations received by the employee
Income every payroll period.
a. Basic salary
b. Fixed allowances (CFRT) – such as cost-of-living allowance, fixed housing
allowance, representation, transportation, and other allowances paid to
an employee every payroll period.
c. Paid vacation and sick leave
Non-compensation items:
1. Fees
2. Commissions
3. Tips and gratuities
4.
Not taxable fixed allowances:
 Ordinary and necessary allowances for travelling representation or
entertainment expense of employees incurred in the pursuit of the employer
trade and business
 Expense is subject to accounting or liquidation
 Any excess advances are returned to the employer.

Valuation of compensation paid in kind:

 Taxable at the FV of consideration received. If received in shares, the FV of
the shares at the date of services were provided is used.
 INCOME TAXATION
2. Supplementary Compensation – includes performance-based renumerations
to an employee in addition to the regular compensation with or without
regard to the payroll period.

The following are additional compensation under current tax rules:

a. Overtime, holiday, hazard, and night differential pay – constitute additional
compensation, except when derived by a minimum wage earner.
b. Commissions, emoluments, and honoraria
c. Living quarters or meals
d. Fees including director’s fees (if director is employee)
e. Taxable retirement and separation pay
f. Profit sharing and taxable bonuses
g. Gains on exercise of stock option –
(FV stocks – Exercise Price = Compensation Income)
13th Month Pay and Other Includes:
Benefits 1. 13th Month Pay
 Government employees – Christmas bonus + P5,000 cash gift
 Private employees – 1 month salary
2. Other benefits
a. Christmas Bonus
b. Cash gifts
c. Additional compensation allowance (ACA) for gov’t personnel
d. 14th - month pay, 15th month pay, etc.
e. Other fringe benefits of rank and file employees
1. Excess de minimis
2. Benefits not included in de minimis
3. Personal expenses reimbursed by employee
Other fringe benefits 1. Employee personal expenses shouldered by employer
2. Taxable de minimis benefits (excess de minimis & benefits not included in the
de minimis list.

CHAPTER 11 FRINGE BENEFIT TAX

Tax Treatment of Fringe a. Fringe benefits that are fixed every payroll period – regular compensation.
Benefit b. Fringe benefits that are variable and performance-based – supplemental.
c. Fringe benefits in terms of incentives – 13th month pay and other benefits.
d. Fringe benefits furnished for employer’s convenience or necessity – exempt
from income tax

Scope of Fringe Benefit Tax - Covers only the taxable fringe benefits of managerial/supervisory employees
General Categories of 1. Management perquisites benefits – management perks
Fringe Benefits Subject to 2. Employee personal expenses shoulder by employer
 INCOME TAXATION
FINAL TAX 3. Taxable de minimis benefits
a. Excess de minimis benefits
b. Benefits not included in the de minimis list’
Hybrid Expenses When the employer incurs expenses which is purported partly for business and
partly for employee’s incentive, only 50% of the expense representing the employee
incentive is subject to fringe benefit tax (which is a final tax)
Exempt Fringe Benefits 1. Fringe benefits which are authorized and exempted from under special
laws. (SSS, PhilHealth, HDMF, Group insurance)
2. Benefits required by nature, or necessary to the trade, business or
profession of employer.
3. Benefits given to the advantage of the employer
4. Contributions of the employer for the benefit of the employee to
retirement, insurance, hospitalization benefit plans.
5. Benefit given to rank and file employees
6. De minimis benefits within their legal limits.
The Fringe Benefit Tax - A final tax imposed on the fringe benefit furnished, granted, paid by the
employer (individual, professional partnership, corporation, government and
its instrumentalities), except rank and file employees

Characteristics of the Fringe Benefit Tax

1. Final tax
2. Tax upon the fringe benefits of managerial/supervisory employees
3. Paid by employer
4. Grossed up tax – the benefit taken home is net of the final tax thus the
monetary value (value taken home) needs to be grossed up by the
complement percentage of the applicable fringe tax.
5. Due quarterly – due on or before the last day of the month following the
quarter in which withholding is made
Procedures in computing 1. Determine the monetary value.
the fringe benefit tax *Monetary value – taxable amount of benefits taken home which is
presumed net of the final tax.

2. Determine the gross up rate (complement of the fringe benefit tax rate)
and the fringe benefit tax rate.
3. Gross up monetary value = monetary value/gross up rate
4. Determine the fringe benefit tax (FBT = Grossed-up MV x FBT rate)

Rules on Valuation of Monetary Value

Fringe Benefits 1. Benefits paid in Amount paid in cash
cash
2. Benefits paid in - Whichever higher of the FV of the
kind thing given or book value (cost –
depreciation)
- If ownership is transferred to the
 INCOME TAXATION
employee, the monetary value is
the entire FV.
3. Benefits that are - 50% of the rental value
furnished (free - If no rental value, the depreciation
use) value is used.
*Real property – 1/20 or 5%
*Movable – 1/5 or 20%

Fringe benefits, but not 1. Housing Benefits

limited to 2. Expense account
3. Vehicles of any kind
4. Household personnel, such as maid, driver or others
5. Interest for the difference between market rate (12%) and the actual interest
granted
6. Membership fees, dues, and other expenses borne by the employer for
employee in social and athletic clubs
7. Expense for foreign travel
8. Holiday and vacation expenses
9. Educational assistance to the employee family members
10. Life/health and other non-life insurance premiums similar accounts in excess
of what the law allows.
Taxable Housing Benefits 1. Employer leases a residential property for the use of his employee and the
said property is the usual residence of the employee. – monetary value is
50% of the rental
2. Employer owns a residential property and assign the same for use of
employee thus, annual value is 5% of whichever is higher of zonal or assessed
value – monetary value is 50% of the annual value.
3. Employer purchases a residential property on installment basis and allows
employee to use thus annual value is 5% of the acquisition cost, exclusive of
interest – monetary value is 50% of the annual value of benefit
4. Purchase by the employer of residential property and transfer ownership to
the employee – monetary value is 100% of whichever is higher of the
acquisition cost or zonal value
5. Purchase by the employer of residential property and transfer ownership to
the employee for less than adequate consideration – monetary value is the
higher between FV and zonal value less consideration paid by the
employee.
Exempt housing benefits:
a. Military officials of the AFP, PAF, Philippine Army, Phil Navy which are within
or accessible from the Military camp
b. Housing unit situated or adjacent to the premises of business/factory (within
 INCOME TAXATION
maximum 50 meters
c. Temporary housing for an employee in a housing unit for 3 months or less.
Taxable Expense Account Personal expenses incurred by an employee but are paid by the employer or
incurred and paid by employee but reimbursed by the employer are taxable fringe
benefits.
Taxable Motor Vehicles of 1. Purchase by employer in the name of the employee – monetary value is
Any Kind 100% of the cost of the motor vehicle.
2. Cash benefit to employee for the purchase of a vehicle, even if the vehicle is
partly used in the business of the employer – monetary value is 100% of the
cash benefit given
3. Purchase a car on installment basis by the employer with ownership placed in
the name of the employee – monetary value is 20% of the acquisition cost.
4. Employer shoulders a portion and is placed under in the name of the
employee – monetary value is portion shouldered by the employer
5. Fleet of motor vehicles owned for the use of business and the employees,
the value of the benefit is the cost of all motor vehicles not used for sales,
freight, delivery service, and other non-personal uses – monetary value is
50% of the value of benefit.
6. Fleet of motor vehicles leased for the use of business and the employees, the
value of the benefit is rental of all motor vehicles not used for sales, freight,
delivery service, and other non-personal uses – monetary value is 50% of the
value of benefits.
7. Yachts whether owned and maintained or leased by the employer are
presumed not for business use – the monetary value of benefit is 50% of the
5% of the cost or in case of lease, the whole rental payment.

Exempt vehicle from fringe benefit tax:

1. Aircrafts – deemed solely for business.
Taxable household Employee expenses borne by the employer for household personnel salaries, salaries
expenses of household help, personal driver, and personal expenses are taxable fringe
benefits. The monetary value is the amount paid.
Taxable interest loan at Taxable at the difference between the actual interest and market rate of 12%
less than the market rate
of 12%
Membership fees, dues in Monetary value is the amount paid.
social or athletic clubs
Expenses for foreign Taxable fringe benefits:
travels - Foreign travels not related to business of his/her employment that are borne
by the employer is taxable fringe benefit. Monetary value is the amount paid.
- Lodging cost excess of $300/day
- Expenses for the family members of the employee shouldered by the
employer is taxable in full.

Exempt from fringe benefits

 INCOME TAXATION
- Reasonable business expenses for foreign travel for attending business is
exempt, such as the ff:
a. Inland travel expenses such as food, beverage and local transportation
cost.
b. Lodging cost amounting to $300/day or less
c. Economy and business class airplane tickets
d. 70% of the cost of the first-class ticket
Holiday and Vacation If paid by the employer, it is a taxable fringe benefit. Monetary value is the amount
expenses paid.
Educational Assistance to - Generally educational assistance is taxable, however if it the education or
the employee or his study is directly related with the employer’s trade/business and there’s a
dependents. contract that the employee to remain employed for a period of time they
agreed upon.
Life/health and other non- These are taxable fringe benefits except:
life insurance premiums 1. Contributions of employee for SSS, PhilHealth, GSIS, and HDMF
similar accounts in excess 2. Cost of premium for group insurance of employees.
of what the law allows.

Fringe benefit tax rate

Employees Tax rates
RC, Non-resident citizens, resident aliens 35%
NRA - NETB 25%
NRA -ETB 25%

CHAPTER 12: DEALINGS IN PROPERTIES

Dealings in properties - Dealings in ordinary assets are subject to RIT.
- Dealings in capital assets other than gain on sale of domestic stock directly to
buyer and gain on sale of real properties located in Philippines, are also
subject to RIT.
Determination of Gains or Includes:
Losses in Dealings of Selling price xx
Property Less: Tax Base/adjusted basis of the asset disposed xx 1. Sum of money
received
Gain or loss xx
2. FV of non-cash
properties
received

Special Rules in the A. For assets acquired by purchase, the tax basis is the:
Determination of Tax Basis 1. Acquisition cost for: (CAN)
 Capital assets
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 Non-depreciable ordinary asset such as land
 Any asset purchased for an inadequate consideration or those
acquired at less than their FV at the date of acquisition
2. Depreciated cost for any depreciable ordinary assets.
*Acquisition costs – include the purchase price, tax assumed, and
acquisition-related costs such as commissions paid in acquiring the
assets.

B. Other assets received by exchange – tax basis is FV of asset recived

C. For assets received by way of gratuitos title:

1. Donation – whichever is lower of:
 Tax basis on the hand of the donor or the last preceding
owner by whom it was not acquired by donation
 FV at the date of the gift
2. Inheritance – FV of the property on the date of death of the decedent.

D. For shares received by way of tax-free exchanges.

1. For pure share-for-share swap, the tax basis of the shares exchanged or
given is the tax basis of the shares received.
2. For share-swap with non-cash consideration, the tax basis shall be the
substituted basis computed as follows

Transferor:

Tax basis of shares exchanged xx

Add: Gain recognized xx
Amounts treated as dividends of the shareholder xx
Less: Cash and FV of other properties received xx
Tax basis of new shares received by the transferor xx

Transferee:

Original basis in the hands of the transferor xx

Add: Gain recognized to the transferor xx
Tax basis of the shares received by the transferee xx

Tax Treatment of Ordinary A. Ordinary gains

Gains and Losses  Separate items of gross income subject to RIT
 Taxable in full
B. Ordinary Losses
 INCOME TAXATION
 Items of deductions from gross income in the determination of net
income from business/profession
 Deductible in full
Tax Treatment of Capital  Capital losses are only deductible only up to the extent of capital gains from
Gains and Losses dealings of capital assets not subject to CGT.
 Capital gains and losses are offset.
 Net capital gain is an item of gross income subject to RIT
 Net capital loss is not an item of deduction against gross income

Determination of net capital gain/loss thru holding period rule:

INDIVIDUAL
1. 1 year or less (short-term holding period) – 100% of the capital gain or loss is
recognized.
2. More than 1 year (long-term holding period) – 50% of the capital gain or loss
is recognized.

CORPORATION
 Regardless of the holding period, 100% of the capital gains or loss is
recognized.
Effects of Situs on Dealings - If taxpayer is taxable on world income (Resident Citizen & Domestic Corp) the
in Properties rules on dealings of properties apply to all properties regardless of location.
- If taxpayer is taxable only in Ph, the rules only apply to properties in Ph.
Net Capital Loss Carry Over Individual taxpayers are allowed to carry-over bet capital loss as a deduction agains
net capital gain of the ff. year subject to ff. limit: (the net capital loss carry over is
whichever the lowest of the actual net capital loss, limit 1, and limit 2.
1. Limit 1 – the amount of net income in the year the net capital loss was
sustained.
2. Limit 2 – the available net capital gain in the following year.

*net capital loss is carry-over strictly for 1 year only and applicable only to individual
taxpayers.
Merger or Consolidation No gain or loss shall be recognized if in pursuant to a merger or consolidation
1. A corporation exchanges property solely for stock of another corporation
2. A shareholder exchanges his stock in a corporation solely for the stock of
another corporation
3. A security holder of a corporation exchanges his securities in such
corporation solely for the stocks of another corporation.

CHAPTER 13 – PRINCIPLES OF DEDUCTION

Special Considerations with 1. Property repairs and improvements

Deductions  Repairs that significantly increase the value or prolong the useful life
 INCOME TAXATION
of properties are capital expenditures which are capitalized and
included in the subsequent annual provision for depreciation.
 Repairs that merely restore the value/functionality of the property
without causing increase in FV/useful life of the property shall be
deducted as outright expense
 If the FV increased due to repairs improvements or additions, the
actual cost of the repairs, improvements/additions, the actual cost of
the repairs should be capitalized not to exceed the appreciation in FV.
However, if the increase in FV is lower than the cost of repairs, the
excess cost over increase in FV is an outright expense.
 If FV is not determinable, the excess of actual repair over the tax basis
of property is presumed a capitalizable the increase in FV.
 Replacement of old or destroyed properties – the tax basis of the
property is deductible as a loss.
 Cost of demolishing old building
a. When the land is acquired with an old building but was not
intended to be used by the buyer, the entire amount paid is
assigned only the land.
b. The cost of demolishing the old building net of any salvage scrap,
are treated as additional cost of acquisition of the land.
c. The cost of razing or removing old building to give way for the
erection of new building is capitalized as part of the cost of
replacement building.

2. Asset Acquisition-Related Cost

a. All cost directly related to the acquisition of an item of PPE are capitalized
as part of the cost of the property subject to depreciation.
b. Expenses incurred which are directly related to the acquisition of goods
are capitalized to the cost of goods sold and expensed through cost of
goods sold when sold
3. Security Issue Cost – expenses of issuing securities directly related are not
deductible expense against gross income. They are deducted against the
proceeds of such securities.
4. Manufacturing expenses – Overhead costs are capitalized as part of the cost
of goods being processed and are expensed through cost of sales when sold.
5. Effects of Accounting Method
Cash basis deductions: Accrual basis deductions
Cash expenses (paid) xx Accrued expenses (paid/unpaid) xx
Amortization of prepayments xx Amortization of depreciation xx
Depreciation of properties xx Depreciation of properties xx
Cash basis deduction xx Accrual basis deductions xx
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6. Effect of VAT on Deductions

Treatment of Input Vat
1. For VAT taxpayers – the input VAT is tax credit thus, not an item of
deduction.
2. For Non-VAT taxpayers – the input vat is part of the cost of the purchase;
hence, claimable as deduction

General Principles of 1. Expenses must be legitimate, ordinary, actual, and necessary (LOAN)
Deductions from Gross 2. The Matching Principle – only business expenses which contribute to in
Income connection with the generation of income are deductible.
3. 1elated Party Rule – in case of transaction between related parties, gains are
taxable but losses are not deductible.
4. The Withholding Rule -
Deductible Expenses 1. Salaries and Wages Expenses
2. Utilities Expense such as electricity, telephone, internet, gas and water
3. Selling expenses such as delivery and commission expense
4. Rent Expense
5. Local taxes and permits
6. Immaterial capital expenditures.
7. Repairs that merely restore the value or functionality of the property without
causing increase in FV or useful life
8. Excess of repair cost against increase in FV
9. Tax basis of old property or destroyed
Capital Expenditure 1. PPE
(Deductible against future 2. Inventory
gross income) 3. Investments like land held for appreciation in value; stock/bonds of another
corporation
4. Prepayments
5. Acquisition of intangible asses such as patent, franchise, including costs of
defending the same in court
6. Expenses to promote business goodwill
7. Rentals on capital lease or finance lease that transfers ownership
8. Repairs that significantly increase the value or prolong the useful life of
properties
9. Cost of replacement of the replacement property
10. Cost of demolishing old building to give way for erection of the new building
that forms part of the cost of the replacement building
Non-deductible 1. Decrease in value of properties or investment such as stock/bonds, foreign
currencies, foreign currency denominated receivables, machineries,
equipment, building brought by obsolescence
2. Estimated future loss on bad debts or uncollectible receivables
3. Estimated loss on lawsuit not yet confirmed by a final judgment
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4. Loss on properties covered by insurance or indemnity contracts

Itemized deduction from 1. Interest Expenses

gross income 2. Taxes
3. Losses
4. Bad Debts
5. Depreciation
6. Depletion
7. Charitable and other contributions
8. Contributions to pension and trust
9. Research and development cost
10. Other ordinary and necessary trade, business, or professional expenses

If not directly connected in selling of goods or rending of services, these items are
classified as Regular Allowable Itemized Deductions
1. Interest Expense a. Valid indebtedness
b. Indebtedness of the taxpayer
c. Indebtedness must relate to the taxpayer’s trade/business/profession
d. Interest expense must have been paid or incurred during the taxable year.
e. Interest must have been stipulated in writing
f. Interest must be legally due
g. Interest payments must not be between related parties
h. Interest must not be incurred to finance petroleum operations
i. Interest is not expressly disallowed by law to be deducted from gross income
j. Interest incurred in acquisition of property for business, the same is not
treated as capital expenditure

Percentage of interest rate deductible – 33%

Deductible interest expense; Tax Savings from Allowable IE

Gross interest expense xx

Less: Interest income x Arbitrage limit xx
Deductible interest expense xx
Multiply: Reg. Corporate Tax Rate xx
Tax savings from allowable IE xx

Optional Treatment of Interest Expense at the option of the taxpayer

a) An outright deduction from gross income
b) A capital expenditure claimable thru depreciation

Other deductible interest expense

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a) Interest from tax delinquency
b) Interest from scrip dividends

Example of non-deductible interest expense

a) Interest on personal loans
b) Interest incurred with related party
c) Discount or pre-deducted interest applicable for future period for individual
taxpayers
d) Interest expense incurred to finance a petroleum operation
e) Interest in redeemable preferred shares
f) Imputed interest
2. Taxes Taxes paid or incurred within the taxable year in connection with the taxpayer’s
trade or business shall be allowed as deduction except:
a. Philippine income taxes except fringe benefit tax
 Final income tax
 Capital gains tax
 Regular income tax
3. Foreign income tax, claimed as tax credit
4. Estate and donor’s tax
5. Special assessment
6. Business taxes, VAT
7. Surcharges or penalties on delinquent taxes

Example of deductible taxes

a. Percentage
b. Excise
c. Documentary stamp
d. Occupational
e. License
f. Fringe benefit
g. Local taxes except special assessment
h. Community
i. Municipal
j. Foreign income tax if not claimed as tax credit

Foreign income tax can either be claimed as: (can only be claimed by RC and DC)
a. Deduction
b. Tax credit – foreign taxes paid are not deducted against gross income, but
are credited against income tax due on world taxable income.

Determination of foreign tax credit:

Shall be the lower of the actual foreign income tax paid and the following limit
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(Foreign taxable income/World taxable income) x Philippine income tax due

3. Losses Losses actually sustained during taxable year and not compensated by insurance or
other indemnity shall be allowed as deduction.

Requisites for deduction of losses

a. Must be incurred in trade/business/profession
b. Must pertain to property connected to trade/business/profession (must be
ordinary losses)
c. Must not be compensated by insurance
d. Must file a declaration of loss within 45 days from discovery
e. Loss must not be claimed as deduction for estate tax purpose in the estate
tax return

Examples of ordinary losses

a. Loss on disposal or destruction of any ordinary asset
b. Loss due to voluntary removal of building incident to renewal or replacement
 Tax basis of the old property if it is total replacement shall be claimed
as loss while total replacement cost is capitalized subject for
allowance of depreciation.
 If partial replacement, the restoration shall be expensed up to the
extent of tax basis of property immediately before the casualty. Any
excess is capitalized subject for allowance of depreciation
c. Permanent or irreversible loss in value of assets due to change in business
conditions, only to the extent realized
d. Abandonment loss
 Abandonment must be filed with the Commissioner on Internal
Revenue
 If the operation resumed, the amount of abandonment loss
previously claimed shall be reversed and included in gross income in
the year of resumption or restoration and shall be amortized of
depreciated as the case maybe

Others:
- 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.
4. Bad Debts Bad debts refer to debts due to the taxpayer which were ascertained to be worthless
and were charged off within taxable year. The deductible bad debt expense pertains
to the write off of uncollectible receivables.
- Subsequent recovery of bad debts previously allowed as deduction shall be
included as part of gross income in the year of recovery
- Bad debt expense sustained by taxpayer under cash basis should not be
deducted even they changed its accounting method.
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Requisites of claim for deduction of bad debt:

a) Debt must be ascertained to be worthless
b) Must be charged off within the taxable year
c) Must be connected with taxpayer’s profession/trade/business
d) Taxpayer must be under the accrual basis of accounting
e) Should be a loss on capital
f) Loss of capital can be deducted by both cash and accrual basis
g) It must not be incurred from related party.

Securities becoming worthless

- Bad debt expense
- Covers evidence of indebtedness
5. Depreciation Special Rules on Depreciation
1. 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
2. Properties held in trust
 Allowable deduction shall be apportioned between income
benefeciaries and the trustees
3. Revaluation on properties
 Depreciation must be on its acquisition cost and not on appraised
value.
 Impairment on PPE are not deductible
4. Rules on deductibility of Depreciation on Passenger Vehicles
 Only vehicle for land transport is allowed for an official or employee,
and the value shall not exceed 2.4m
 No depreciation shall be allowed for yachts, helicopters, airplanes or
aircrafts, and land vehicles that exceed the threshold

Notes:
- Under NIRC, private educational institutions are granted the option to treat
capital expenditure as outright expense or deduction through allowance for
depreciation
5. Depletion Depletion expense is a provision for the periodic return of capital investment
wasting asset s such as minerals, gas, and oil

Treatment of Tangible Development Cost

1. Petroleum operations
Properties used in petroleum operations:
 Can be depreciated using straight line or declining balance method
 Shifting from one method to another is permitted.
Properties not used in operations
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 Straight line method on the basis of useful life of 5 years.
2. Mining Operations
 Expected life is 10 years or less, use the normal rate of depreciation.
 Expected life is more than 10 years, can be depreciated over any
number of years between 5 years and 10 years.

Tax Treatment of Intangible Exploration and Development Cost

a. Before commercial production – capitalized as cost of the wasting asset
b. After commencement of commercial production, if incurred with
 Non-producing wells or mines, deducted in the period paid or
incurred.
 Producing wells or mines, at the option of taxpayer, either:
a. Capitalized and amortized using the cost-depletion method
b. Deducted in the year paid or incurred

Treatment of exploration and development costs:

Cost-depletion formula:

Tax basis of wasting asset x Units extracted/total estimated units = capitalized cost
Units extracted for the year + Estimated remaining units = total est. units

6. Charitable and Contributions or gifts made to the government or NGO may be deducted against
other operation gross income.

Requisites: (donations that fail any requisites is non-deductible)

1. Donee institution must be a domestic institution
2. No income to the donee institution must inure to the benefit of any private
stockholder or individual.
3. Contribution must be valued at the tax basis of the property donated.
4. Taxpayer must engage in trade or business
5. Done must issue certificate of donation which includes donor’s statement of
values
6. If the amount of donation is at least 50,000 the donor shall file a Notice of
Donation to the RDO where he is registered within 30 days upon receipt of
the Certificate of Donation

Classification of Contributions
A. Fully Deductible contributions (PTA)
1. Donations to the government or political subdivisions used in priority
activities, CHHEEY
2. Donation to foreign institution or int’l organization in pursuance with
agreements, treaties, or special laws.
 INCOME TAXATION
3. Donations to accredited domestic NGO
Requisites for full deductibility:
a. NGO must operate and operated exclusively for the above purpose
b. Makes utilization of the contribution not later than 15th of the third
month after the close of its taxable year
c. Admin expenses do not exceed 30% of its total expenses
d. Members of BOT must not receive renumerations
e. In liquidation, the asset of NGO will be distributed to another
nonprofit domestic corporation organized for similar purpose
f. Amount of contribution other than money must be valued at
acquisition cost.
4. Contributions subject to limit
a. Donations to government exclusively for public purpose not in
accordance with priority activity.
b. Donations to non-accredited NGO for the purposes of CCRRESSY

Limit of deduction for contributions: (Limit on deduction or the actual partially

deductible, whichever is lower)
Based on the taxable income derived from TBP before deduction of any
contributions
a. 10% for individuals
b. 5% for corporations
Deduction limit = Net income x Individual limit percentage

7. Contributions to Types of employee pension plans:

pension trusts 1. Defined contribution plan – employer is merely obligated to make certain
amount of contribution to the pension plan on reg. basis. The employer does
not guarantee the amounts of benefits to the employees.
2. Defined benefit plan – the employer guarantees the amount of benefits to
the employee
8. Research and Research activities – geared towards discovered of new knowledge.
Development Cost Development activities – geared towards determining application of research
knowledge which could provide income and benefits for the business.

Tax Treatment of R&D Costs

a. R&D related to capital accounts such as property used in business are
capitalized as part of cost of property and deducted through depreciation
expense
b. R&D costs not related to capital accounts are treated as follows at the option
of taxpayer:
 Outright expense
 Deferred expense amortized over a period not less than 60 months
beginning from the montht he taxpayer realize benefits from the R&D
expenditures.
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9. Expenses, in general Other legal, ordinary, actual and necessary expenses of business can be claimed by
the taxpayers as long as supported with officials receipts or other pertinent record.
10. Entertainment, EAR expense includes representation expense and/or depreciation or rental expense
Amusement, and relating to entertainment facilities
Recreation (EAR)
Expenses Ceiling on Deduction:
- Taxpayers engaged in sales of goods or properties – 0.5% of net sales.
- Taxpayers engaged in the sales of service – 1% of net revenues
- Taxpayers engaged in both goods/properties and services, shall be
determined in the ff. formula

((Net Sales or Net Revenue)/Total Net Sales and Net Revenue ) x Actual EAR