CHAPTER 9 Regular Income Tax: Inclusion in 3.

Rank and file employees- those who

Gross Income hold neither managerial nor supervisory
functions
ITEMS OF GROSS INCOME SUBJECT TO
REGULAR TAX Types of employees as to Taxability

1. Compensation for services in whatever 1. Minimum wage earners- employees

form paid who are recipients of minimum wage.
2. Gross income from the conduct of They are exempt from income tax on
trade, business, or exercise of a their compensation (exempt from
profession income tax)
3. Gains derived from dealings in 2. Regular employees- employees who are
properties subject to regular progressive income
4. Interest tax
5. Rent
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions
11. Partner’s distributive share from the net
income of general professional
partnership
Taxable Compensation Income:

Compensation for Services in Whatever Form 1. Regular Compensation- this pertains to

Paid (1) the fixed remunerations received by the
employee every payroll period.
Compensation Income- pertains to types of 2. Supplemental Compensation- this
employee benefits that are subject to regular pertains to other performance-based
income tax pays to employees with or without
Types of employees as to function: regard to the payroll period

1. Managerial employees- those whose

given powers or prerogatives to lay Gross Income from the Conduct of Trade,
down and execute managerial policies Business, or Exercise of a Profession (2)
and/or hire, transfer, suspend, lay-off,
recall, discharge, assign or discipline - Income from any trade or business,
employees legal or illegal, and whether registered
2. Supervisory employees- those whose or unregistered.
effectively recommend such managerial - It can be determined as follows:
actions if the exercise of such authority Sales/Revenue/Receipt/Fees xxx
is not merely routinary or clerical in Less: Cost of Sales or Services xxx
nature but requires the use of Gross income from operations xxx
independent judgment
Not included:
 1. Business income exempt from income Interest Income (4)
tax:
- Interest income other than passive
a. Gross income from Barangay Micro-
income subject to final tax.
Business Enterprises (BMBE) under
- A taxable interest income must have
RA 9178
been actually paid out of an agreement
b. Gross income from enterprises
to pay interest. It cannot be imputed.
enjoying tax holiday incentives
- General Rule: Taxable Income
under the CREATE law which have
- Exceptions: Interest subject to final
not yet graduated to their income
taxes and exempt interest income
tax holiday
2. Business income subject to special tax:
a. PEZA- registered enterprises subject
to 5% gross income tax Examples of interest income subject to regular
b. Tourism Infrastructure and income tax:
Enterprise Zone Authority (TIEZA)- 1. Interest income from lending activities
registered enterprises subject to 5% to individuals and corporations by
gross income tax banks, finance companies, and other
c. Income of self-employed and or lenders
individuals who opted to be taxed 2. Interest income from corporate bonds
under the 8% income tax and promissory notes
3. Business income subject to final tax 3. Interest income from bank deposits
when not subjected to final tax by the abroad
payor
Exempt interest income:
Gains from Dealings in Properties (not subject
to CGT) (3) 1. Interest income earned by landowners
in disposing their lands to their tenants
- Dealings in capital assets other than pursuant to the Comprehensive
domestic stocks and real properties are Agrarian Reform Law.
subject to regular income tax 2. Imputed interest income
- Ordinary gains are included as items of
gross income. Ordinary losses are items
of deductions against gross income. Rent (5)
(Pertains to ordinary assets)
- The net capital gain from other capital - It is a passive income not subject to
assets after deducting capital losses is final tax under the NIRC
included as item of gross income. A net
Special Considerations on Rent:
capital loss is not an item of deduction
against gross income. (Pertains to - Obligations of the lessor that are
capital assets) assumed by the lessee are additional
rental income to the lessor (example:
real estate tax paid/ assumed by the
lease)
- Advance rentals are:
 a. Items of gross income upon receipt
if: unrestricted or restricted to be
applied in future years or upon the
termination of the lease
b. Not an item of gross income if: it
constitutes a loan; it is a security - These pertains to dividends declared by
deposit to guarantee payment or foreign corporations
rent subject to contingency which - Stock dividend: exempt from income
may or may not happen tax (but if converted to other form, the
- Leasehold improvement made by the fair market value of the stock dividends
lessee on the leased property which will received is taxable)
belong to the lessor upon termination - Liquidating dividends: only occur if the
of the lessee is included in the gross company is in a verge of bankruptcy
income of the lessor and therefore not considered as income
- Prepayments of rent must be reported
Conditional exemption on intercorporate
in full in the year of receipt regardless
dividend from NRFCs
of the accounting method used by the
lessor - Dividend received by domestic
corporations from non- resident foreign
corporations is generally subject to
Royalties (6) regular tax. However, they are exempt
if the following conditions are fulfilled:
- Royalties earned from sources within
1. The domestic corporate recipient
the Philippines are generally subject to
directly owns at least 20% in value of
final income tax except when they are
the outstanding shares of the NRFC.
active in nature.
2. The shareholdings in the NRFC must
- General rule: royalties derived from
have been held uninterruptedly for a
sources within the Philippines are
minimum of 2 years at the time of
subject to final tax
dividend distribution or throughout the
- Exception: active royalties and royalties
entire existence of the NRFC if it is
earned from sources outside the
operational for less than 2 years.
Philippines
3. The foreign-sourced dividend received
active income if it is the product or service they regularly provide
or remitted must be reinvested within
the next taxable year in business
Dividends (7) operations of the domestic corporation
- The term ‘dividends’ when used in this such as the following:
Title means any distribution made by a A. Working capital requirements
corporation to its shareholders out of B. Capital expenditures
its earnings or profits and payable to its C. Dividend payments
shareholders, whether in money or in D. Investments in domestic
other property subsidiaries
E. infrastructure projects
notes: Pensions (10)

- the law presupposes an inward These pertains to pension and retirement

remittance of foreign-source dividends benefits that fail to meet the exclusion criteria
and its actual use in business operations and hence subject to regular tax
here in the Philippines
- despite actual investment, the
exemption will not apply if the Partner’s distributive share from the net
ownership fails the 20% direct income of general professional partnership
ownership test (11)

- Partners are the ones subject to regular

tax on their share in the net income of
Annuities (8)
the general professional partnership
- the excess of annuity payments - The partners shall report as gross
received by the recipient over premium income their distributive share actually
paid is taxable income in the year of and constructively received from the
receipt net income of the partnership
- (Applies the concept of return on - This rule also applies to exempt joint
capital and return of premium) ventures and co-ownership

Prizes and Winnings (9) General Criteria for Items of Gross Income

Prizes- effort / Winnings- by chance Under the NIRC, the regular income tax has a
catch-all provision for all income derived from
Exempt prizes and winnings:
whatever sources that are:
1. Prizes received without effort to join a
1. Not subject to final tax, capital gains
contest/activity
tax, and special tax regime, and
2. Prizes in athletic competitions
2. Not excluded or exempted by law,
sanctioned by their respective national
treaty, or contract from taxation
sports association
3. Winnings from PCSO or lotto not Other Sources of Gross Income Subject to
exceeding 10,000 Regular Income Tax

1. Income distributions from taxable

estates or trust
2. Share from the net income of other
pass-through entities:
a. Exempt joint venture
b. Exempt co-ownership
3. Farming income
4. Recovery of past deductions
5. Reimbursement of expenses
6. Cancellation of indebtedness for a
consideration
Farming Income

1. Raise and sell operations: Rules under our tax laws:

- The proceeds on the sales of livestock
The excess of deductions over gross income in a
or farm products are included in gross
taxable year is carried over as a deduction
income subject to regular income tax.
against the net income of the next three years
- Animal raising expenses are presented
of operation also known as “Net Operating Loss
as items of deductions against gross
Carry-over” or NOLCO.
income
2. Purchase and sell operation: Hence, almost all prior year deductions have tax
- The gross profit from the sale (sale less benefits, thus their recovery will be taxable.
cost of purchase) is included in gross
income

It should be recalled that the proceeds of crop or

livestock insurance constitute a taxable item of
gross income because they are recovery of lost
profits.

Recovery of Past Deductions

Rules on Past Deductions Recovery:

a. Taxable- if the deduction resulted in an

income tax benefit to the taxpayer, the
recovered amount (UP TO THE EXTENT
OF TAX BENEFIT RECEIVED) is reported
as taxable income in the year of
recovery.
b. Not Taxable- if the deduction did not
result in an income tax benefit to the
taxpayer, the recovered amount is not Refund of Non-deductible expenses
taxable but is treated as a mere
recovery or return of capital. - Expenses or payments which are non-
deductible against gross income in the
computation of taxable net income will
Tax Benefit never create tax benefit to the
taxpayer. As such, their recovery should
There are two ways a taxpayer may benefit not be included in gross income.
from a deduction: - You cannot add what you have
1. Directly, through reduction of taxable deducted
income in the year of deduction
2. Indirectly, through reduction of future
taxable income through carry-over of
net operating loss
Reimbursement of Expenses

- Expenses of the taxpayer that are Effects of Value Added Tax on Reportable
reimbursed or paid by the customer or Gross Income
client constitute additional income to
the taxpayer.
- Example: 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.

Special Considerations in Reporting Gross

Income
Creditable Withholding Tax
1. Accounting Methods
2. Situs Rules
3. Effects of Value Added Tax
4. Creditable Withholding Tax
5. Power of the CIR to redistribute income
and expenses

- Advance payment of taxes that should

not be removed or excluded from the
gross income
- The CWTs are actually advances to the
annual income tax due of corporations
and individuals and are deductible
thereto.
- It must be noted that NRA-NETB and
NRFC are subject to Final Tax aside from
income subject to CGT.
- Inter-corporate dividends (DC to DC/
RFC to RFC) are exempt from final tax,
except when the recipient is an NRFC.
 associated enterprises will be controlled
in such a way to further the interests of
the associated enterprises in disregard
of their social responsibility on taxes

The Transfer Pricing Guideline

- To limit the unfair practices and to

properly reflect the income of
associated enterprises, the BIR and the
Department of Finance promulgated
Revenue Regulations No. 2 series of
2013 on transfer pricing.
- Under the regulation, two or more
enterprises are associated if one
participates directly or indirectly in the
management, control, or capital of the
other; or if the same persons
Creditable withholding tax and VAT participate directly or indirectly in the
management, control or capital of the
-VAT taxpayers shall revert to gross income
enterprises.
amounts of withholding tax but excludes
- Associated enterprises are also called
therefrom the amount of VAT charged to
“related parties”
customers or clients.

The arm’s length principle

Power of the CIR to Redistribute Income and
Deductions - An uncontrolled pricing method
determined by free market forces, also
- The commissioner is authorized to
called arm’s length pricing, is preferred.
distribute, apportion or allocate gross
- The failure to comply may expose the
income or deductions between or
taxpayer to a transfer pricing
among organizations, trade or business,
adjustment where the BIR re-computes
if he determined that such distribution,
the proper income of the associated
apportionment or allocation is
enterprises.
necessary in order to prevent evasion of
taxes, or clearly to reflect the income of The arm’s length principle shall be applied to:
any such organization, trade or
1. Cross-border transactions between
business.
associated enterprises
2. Domestic transactions between
associated enterprises
The Problem of Unfair Pricing between
Associated Enterprises

- There is a risk that the pricing of the Transfer Pricing Method

transfer of goods and services between
When the pricing methods between associated
enterprises do not reflect arm’s length pricing,
the BIR will adjust the controlled transactions to
their arm’s length values using the most
appropriate method considering the
circumstance of the taxpayer:

1. Comparable uncontrolled price (CUP)

method
- the transaction is valued in reference to
the amount charged in a comparable
uncontrolled transaction under
comparable circumstances.
- It does not apply to products containing
unique characteristics such as those
patented products or those containing
trade secrets
2. Resale price method (RPM)
- The transaction is valued based on the
functions performed by the reselling
party to the product.
3. Cost plus method (CPM)
- The transaction is measured by valuing
the function performed by the supplier
of the property or services
4. Profit split method (PSM)
- The P/L on the transaction is split based
on the division of profits or losses that
independent enterprises would have
expected to realize from engaging in
the transaction or transactions
5. Transactional net margin method
(TNMM)
- It uses the margin approach reference
to the operating profit earned in
comparable uncontrolled transaction.