INTRODUCTION TO

INCOME TAXATION
 TOPICS COVERED:
 CHARACTERISTICS OF “GROSS INCOME”
 KINDS OF TAXPAYERS
 SITUS OF TAXATION
 WHY IS INCOME TAXED?
Income is the best measure of a taxpayer’s ability to pay
 BASIC DEFINITIONS
Gross income – Refers to what is income for taxation purposes
Taxable income – as the pertinent items of gross income that are subject
to tax after allowable deductions
GROSS INCOME
(DEDUCTIONS)
TAXABLE INCOME
Tax Base – the value of a certain goods, or property for taxation purposes
CHARACTERISTICS OF GROSS INCOME

 Return on Capital
 Realized Benefit
 Not exempted by law, contract, constitution, and treaty
 RETURN ON CAPITAL
PROCEEDS/TOTAL RETURN
(RETURN OF CAPITAL)
RETURN ON CAPITAL
- For accounting purposes we are merely referring to gain on sale (Goods)

Reminder:
Provider of Services: Income is the revenue/proceeds itself
 TYPES OF CAPITAL

With Finite Value

- Return of Capital
- Return on Capital
With Infinite Value
- Return Of Capital
- Severance/Separation test of income – separation from capital of something
which is of exchangeable value
 CAPITAL WITH INFINITE VALUE
 LIFE
 HEALTH
 HUMAN REPUTATION
 LIFE
- Death/Lost of Life – Compensation

Life Insurance policy – Death – Proceeds – All Return of Capital

Example: Becky purchased a 1,500,000 life insurance policy paying a
total of 100,000 before his death. His beneficiaries collected the entire
proceeds. How much is return on capital?
Answer: None
Blood Money
 LIFE
EXCEPTIONS:

The Insured Person Outliving the Life Insurance Policy

Example: Carlos entered into a Life insurance policy paying 20,000 annual
premium for 1,000,000 in case of death for a term of 7 years. Carlos surrendered
the policy after 7 years and was paid by the insurance company 200,000
representing the cash surrender value. How much is the return on capital

Answer: 60,000 (200,000 – 140,000 (20,000*7))

 LIFE
 Assignment of the Insured Person to other person

Example: Betty is paying 20,000 annual premium on life insurance contract which
would pay her 1,000,000 in case of death. After paying for 4 years, Betty assigned
the policy to Carlos for 120,000. Carlos paid 20,000 annual premiums for another 4
years before the death of Betty. How much is the return on capital for Betty and
Carlos, respectively?
Answer:
Betty: 40,000 (120,000-80,000(20,000*4))
Carlos: 800,000 (1,000,000 – 120,000(Payment to Betty)-80,000(20,000*4))
 LIFE
 Interest income on Life Insurance
Example: Carlos entered into a life insurance paying 20,000 annual
premiums during the term of the policy and his beneficiaries is to receive
1,000,000 proceeds but the insurance company cannot immediately cover
the 1,000,000 amount, so the they only issued first 400,000 to the
beneficiaries of Carlos. The remaining 600,000 earned an interest of
60,000. How much is the return on capital?
Answer: 60,000
 HEALTH
Example: Henson was one of the passengers of a van that fell off. Henson sued
the bus company and was awarded indemnity of 800,000 for the following
 500,000 for the impairment of his health resulting to the amputation of his legs
200,000 for his loss salaries during his hospitalization
 100,000 for his attorney’s fees
- How much is the return on capital?

Answer: 200,000 (Return of lost profit)

 RETURN OF LOST CAPITAL VS RETURN OF LOST PROFIT

RETURN OF LOST CAPITAL

- Return of Capital
- Write off of Bad debt expense (Recovery)
RETURN OF LOST PROFIT
- Return on Capital
 RETURN OF LOST PROFIT
 CROP/LIVESTOCK INSURANCE
 DAMAGES UNDER PATENT INFRINGEMENT SUIT
 GUARANTEE INCOME PAYMENTS
CROP/LIVESTOCK
 PATENT INFRINGEMENT SUIT
Example: Felix sells hot chili – flavored pancakes using a secret formula
he patented. He sued a competing pancake house for alleged patent
infringement and claimed a total indemnity of 1,200,000 composed of the
following
 1,000,000 for loss profit from loss of sales
200,000 as Attorney’s fees
- How much is the return on capital
Answer: 1,000,0000
 GUARANTEE INCOME PAYMENTS
Example: Jems invited Jebs to invest on his business with an initial
agreement of 50/50 sharing but Jebs refused so as a return Jems
guaranteed Jebs for a share in the income amounting 1,000,000 yearly.
During the current year the Actual income of Jem’s business is 1,800,000.
How much is the recovery of lost profit for Jebs/ Guarantee Income
Payment?
Answer: 100,000
 Sharing is 50/50, 1,800,000/2 = 900,000 but he is guaranteed with a share
of 1,000,000.
 HUMAN REPUTATION
 Breach of Promise to Marry
 Alienation of Affection
 REALIZED BENEFIT
Benefit = Increase in net worth – Equity

Section 36, Revenue Regulation No.2 -1940 – defined –Gross income as all wealth
which flows into the taxpayer other than a mere return of capital and includes gains

Realization Test – revenue is generally recognized when the earning process is

complete or virtually complete and exchange has taken place

Realized – includes exchange (Sale or Barter) and Other Parties( Natural and
Juridical Persons)
 EXERCISE:
1. Appreciation of Land - + Net worth but not realized (No Exchange)
2. Increase of investment in equity securities - + Net Worth but not realized (No Exchange)
3. Increase in the fair value of biological assets either due to price or physical change - + Net
Worth but not realized
4. Gain on Sale - + Net Worth and realized
5. Borrowing of money – No effect in net worth
6. Donation - + Net worth but not realized (No Exchange)
7. Inheritance - + Net worth but not realized (No Exchange)
 EXERCISE

8. A sole proprietor sold goods to the sole proprietorship above cost

(Without Exchange)
9. The Home office sold goods to the branch above cost (Without Exchange)
10. A parent company sold goods to its subsidiary above cost (With
Exchange)
11. A Shareholder sold goods to the corporation above cost (With Exchange)
COMPLEX TRANSACTION

FAIR VALUE
COST PROCEEDS
3M
1M 2M

INCOME/G
AIN
DONATION
 SALE/BARTER
Income Tax Principle – Ability to pay theory

Why does Barter is included? It creates room for tax evasion

 NOT EXEMPTED BY LAW, CONTRACT,
CONSTITUTION, TREATY

1.Income of the Government

2. Income of Non – Profit , Non Stock Educational Institutions
 TYPES OF TAXPAYER
Natural Person – Individual Taxpayer
 Juridical Person – Corporate Taxpayer
 Corporation

DC
RFC BRANCH

FC

NRFC
 EXERCISE
1. A Corporation abroad has a branch in the Philippines
2. A corporation is incorporated in the Philippines with 30% ownership of
Chinese Citizens
3. A foreign parent corporation has a subsidiary in the Philippines
 INDIVIDUAL TAXPAYER
Classification Rules

RC NORMAL
1. Intention
C
NRC
A 2. Actual Length of Stay
RA
1. RC – NRC – Atleast
183 days
ETB 2. NRA – RA - > 1 year
NORMAL NRA 3. ETB - > 180 days
NETB
 SPECIAL CONSIDERATIONS

 PARTNERSHIP
 JOINT VENTURE
 ESTATE
TRUST
 CO - OWNERSHIP
 PARTNERSHIP

GPP In Exercise of Common Profession

GCP/BP

Taxable like a
Corporation
 EXERCISE
1. Kc Sia, CPA , Nicole Baccay, CPA, and Joyce Guspid, CPA agreed to
make a partnership accounting office to render tax services
2. Atty. Jerome Banera and John Michael Parales, CPA formed a
partnership to provide tax services.
3. Ronalyn Bajo, CPA, Mae Ann Supangan, CPA, and Kate Taguba, CPA
formed a partnership on a Fitness Gym and to serve as gym instructors
 JOINT VENTURE

OIL
EXPLORATION
EJV

CONSTRUCTION

TJV PARTNERSHIP
NORMAL
 ESTATE
- Property left by a decedent
JAN AUG DEC
1 1 ESTA
31 JUDICIAL TE

800K 500K
DEA
TH

EXTRA HEIR
PROP JUDICIAL S
INDUST PROPE
RY ERTY
RTY
 TRUST
- Designation of something to another person but in management of another
person
Example: Vic Sotto is to give Pauleen Luna Birds, but because Pauleen is
not of legal age Vic needs the trust of Joey to manage the Birds as trustee.
BIRD
S 300K
TRUST
VIC
JOEY

PAU IRREV
LEE OCAB
N LE
REVOC
ABLE
VIC
 CONTROL TEST
- Power to procure the payment of income and enjoy the benefit thereof.
CO - OWNERSHIP

PRESERVATION EXEMPT

RE INVESTMENT
OF INCOME PARTNERSHIP
 SITUS OF TAXATION
PLACE OF INCOME
Importance: Territoriality rule of Taxation - Initially all taxpayers are
taxable on their Philippine Income only with the exception of Resident
Citizen and Domestic Corporation
To determine what taxing authority has the right to tax the income
 INTEREST INCOME
- Debtor’s Residence
Example: A, a Chinese residing in Korea, lent to B residing in Japan,
1,000,000 with a stipulation to pay 10% interest. The loan was secured by
a property which is situated in the Philippines. Where is the situs of the
interest income of 100,000?
Answer: Japan
 DIVIDEND
DC – All income earned in the Philippines
FC – Pre Dominance Test
- If the ratio of the Philippine gross income over the world gross income of
the resident foreign corporation in the 3 year period preceding the year of
dividend declaration
If % is at least 50% - the percentage * dividend received is earned in the
Philippines, the rest is outside the Philippines
If % is less that 50% - the dividends are earned abroad
 DIVIDENDS
EXAMPLE:
Mr Ching a resident alien received 100,000 dividends from DLH
Company. DLH Company earned 11,200,000 income earned in
Philippines and 8,800,000 Abroad for the last 3 years.Compute for the
dividend income earned in the Philippines if DLH is a domestic
Corporation and a resident foreign cAnswer:
DC – 100,000
RFC – 56,000 = 11,200,000/20,000,000= 56%, atleast 50% so the
percentage * dividend (56%*100,000) is earned in the Philippines, 44,000
is earned abroad
orporation respectively
 SERVICE
- Where rendered
Examples:
I asked a foreign corporation to make me a website. Where is the situs of
fee that I will to the corporation?
Answer: Foreign/Abroad
I asked a foreign corporation to make me a advertising/marketing video to
be provided to my customers in the Philippines. Where is the situs of fee
that I will to the corporation
Answer: Philippines
 RENT
- Location of the Property (Real)
- It is like service, where service is rendered
 ROYALTY
- Where the intangible is employed
 GAIN ON SALE
- Place of sale - agreement
IP/RP Location

MP/PP Place of
Sale
Exception: Domestic Securities – Always in the Philippines
 MINING INCOME
- Location of the Mine
 FARMING INCOME
- Location of the Farm
Example: A Filipino Farmer produced Watermelon from his farm in the
Philippines which he subsequent sell in the market Abroad. Where is the
income earned?
Answer: Philippines
It is like manufacturing without industrial equipment/ natural process of
manufacturing
 MERCHANDISING
- Place of Sale
 MANUFACTURING
Place of Production Place of Sale Situs

Within the Philippines Within the Philippines Within the Philippines

Without/Outside the Philippines Without/Outside the Philippines Without/Outside the Philippines

Within the Philippines Without/Outside the Philippines Within and Outside the Philippine

Without the Philippines Within the Philippines Within and Outside the Philippine
 Exercise: Pines Company, a domestic Corporation, produces Product X which it sell here and
abroad. Pines has a branch in Japan. Considering that Japan has a lower tax rates. Pines
Company transfers Product X the Japanese branch at cost. The following shows a brief
summary of the Philippine and Japanese Operation

  Philippine Head Office Japanese branch

Domestic and Export Sales 20,000,000 12,000,000

Cost of sales 10,000,000 6,000,000

A closely similar domestic product would sell at 50% mark up. However, The CIR and Pines company
set an advanced pricing agreement of 20% Margin of Product X. Determine the total income earned
within and what there is no APA what is the total income earned within
 SOLUTION:
 APA
- 20% profit margin = income and it is based on sale, cost = 80% - 6,000,000
6,000,000/.8 = 7,500,000. 7,500,000 (Sales) – 6,000,000 (Cost) = 1,500,000
income within
 Transfer Pricing Concept
- 50% Mark Up, based on cost of 6,000,000
 6,000,000* 50%= 3,000,000 mark up + 6,000,000 = 9,000,000 Sale
 9,000,000 Sales – 6,000,000 Cost= 3,000,000 income within the Philippines
 TO ILLUSTRATE
 APA 1,500,000
within
- Income on Japan Sales (6,000,000)
4,500,000
without

3,000,000
 Transfer Pricing within
- Income on Japan Sales
3,000,00
0
without