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Chapter 3 - Notes from Income Taxation

Income Taxation (Ateneo de Davao University)

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CHAPTER 3 Taxable return on capital from insurance policies

 Excess amount received over premiums
INTRODUCTION TO INCOME TAXATION
paid by the insured upon surrender or
Why is income subject to tax? maturity of the policy
 Gain realized by the insured from the
 Income is regarded as the best measure of assignment or sale of his insurance policy
taxpayer’s ability to pay tax.  Interest income from the unpaid balance of
 It is an excellent object of taxation in the the proceeds of the policy
allocation of government costs  Any excess of the proceeds received over
INCOME FOR TAXATION PURPOSES the acquisition costs and premium
payments by an assignee of a life insurance
“GROSS INCOME” – taxable income in layman’s policy
term. Tax concept of income under NIRC
 Health – compensation received in
Taxable income in NIRC refers to certain items of
consideration for the loss of health such as
gross income less deductions and personal
compensation for personal injuries or tortuous
exemptions allowable by law
acts is deemed a return of capital
Taxable item of income – “item of gross income” or
“inclusion in gross income”  Human Reputation – any indemnity received as
compensation for its impairment is deemed a
GROSS INCOME – any inflow of wealth to the return of capital exempt from income tax
taxpayer (legal or illegal) that increases net worth.
Ex. income for employment, trade, Ex. moral damages from oral defamation or
business/exercise of profession, income from slander, alienation of affection, breach of
properties promise to marry.
ELEMENTS OF GROSS INCOME
Recovery of lost capital vs. Recovery of lost
1. RETURN ON CAPITAL THAT INCREASES NET profit
WORTH
Loss of Capital Decrease in net worth
CAPITAL – any wealth or property. Gross income is
Recover of Lost Capital Merely maintains net
a return or wealth or property
worth
Ex. purchased goods at 300, sold for 500 Los of Profits DO NOT decrease net
worth
SP 500 Total Return Recover of Lost Profits Return on capital
Cost (300) Return OF Capital
Mark-up 200 Return ON Capital Taxable recovery of lost profits
- recovery of lost profits through insurance,
RETURN ON CAPITAL – increases net worth. indemnity contracts, or legal suits (taxable return on
Subject to income tax capital)
RETURN OF CAPITAL – merely maintains net
worth, not taxable. Taxable recoveries of lost profits
*Improvement in net worth indicates ability to pay a) proceeds of crop or livestock insurance
tax b) guarantee payments
c) indemnity received from patent infringement
Capital Items with INFINITE VALUE suit
 Life – proceeds from life insurance policies paid
to heirs/beneficiaries upon death of insured, 2. REALIZED BENEFIT
proceeds of life insurance contract collected by
an employer as beneficiary from the life “BENEFIT CONCEPT” – benefit means advantage
insurance of an officer are exempt from income derived by taxpayer. There is benefit when net
tax. (viewed as advance recovery of future loss)

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worth of taxpayer is increased (increase when BENEFITS IN THE ABSENCE OF TRANSFERS

receives income, donation, or inheritance)
- increase in wealth through appreciation or
NOT BENEFITS (NOT taxable) decrease in obligation in the absence of a sale or
barter transaction is NOT TAXABLE. Referred to as
a) Receipt of a Loan – properties and obligation
UNREALIZED GAINS OR HOLDING GAINS as
increase (off set)
they have NOT yet materialized in an exchange
b) Discovery of lost properties – finder has an
transaction. Examples
obligation to return to owner
c) Receipt of money property – to be held in trust a. Increase in value of investments in equity or
for or to be remitted to another person debt securities
b. Increase in value of real properties held
*if taxpayer is entitled to keep for his account
(revaluation increment)
portion of a receipt, only that portion is a benefit.
c. Increase in value of foreign currencies held or
“REALIZED CONCEPT” – realized means earned. receivable
Requires a degree of undertaking/sacrifice from the d. Decrease in value of foreign currency
taxpayer to be entitled of the benefit. denominated debt by virtue of favorable
fluctuation in exchange rates
Requisites of a realized benefit e. Birth of animal offspring, accruals of fruits in an
1. there must be an exchange of transaction orchard or growth of farm vegetables
2. transaction involves another entity f. Increase in value of land due to the discovery of
3. increases the net worth of the recipient mineral reserves

TYPES OF TRANSFERS Rendering of Services – considered an exchange

but does NOT cause a loss of capital. Hence, entire
1. Bilateral Transfers or Exchanges – onerous consideration received (compensation income,
transactions; benefits are “earned or realized” services fee) is an item of gross income.
thus subject to income tax
a. Sale Ex. debt cancelled in consideration for services
b. Barter rendered. This is considered realized gains from
2. Unilateral Transfers or Transfers – gratuitous exchanges thus an item of gross income.
transactions; benefits are NOT realized BASIS OF EXEMPTION OF UNREALIZED
because of the absence of an earning process. INCOME
Subject to TRANSFER TAX, NOT income tax
a. Succession – transfer of property upon - income received in NON-cash consideration is
death taxable at the FV of property received.
b. Donation
MODE OF RECEIPT/REALIZATION BENEFITS
3. Complex Transactions – partly gratuitous and
taxable income may be realized by taxpayer in:
partly onerous; “transfers for less than full and
adequate consideration”. Gratuitous portion 1. Actual Receipt – actual physical taking of
subject to TRANSFER TAX, while Onerous income in form of cash or property
portion is subject to INCOME TAX. 2. Constructive Receipt – NO actual physical
taking of income, but the taxpayer is effectively
Ex. excess of FV over selling price is gratuity,
benefited (ex. offset of debt, deposit of income
excess of SP over cost is item of gross income.
in checking account)
NOTES:
Inflow of wealth without increase in net worth
- sales of a home office to its branch office are NOT
- inflow that does NOT increase net worth is income
taxable as they pertain to one and the same
due to total absence of benefit
taxable entity.
Examples: receipt of property in trust, borrowing
- income between businesses of proprietor should
money under an obligation to return (LOAN)
NOT be taxed since proprietorship business are
taxable upon the same owner.

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*proceeds of embezzlement or swindling where  Born before Jan. 17, 1973 of Filipino Mothers
money is taken without original intention to return is who elected Filipino citizenship upon reaching
considered income because of the increase in net the age of majority
worth of the swindler.  Naturalized in accordance with the law
3. NOT EXEMPTED BY LAW, CONTRACT, OR Classification of Citizens
TREATY
A. Resident Citizen – filipino citizen residing in PH
- item of gross income is NOT exempted by the B. Non-resident Citizen
Constitution, law, contracts of treaties from taxation.  Citizen of PH with physical presence
abroad with a definite intention to reside
Following items are exempted by LAW from
therein
taxation (NOT considered items of gross income):
 Leaves PH during taxable year to reside
1. Income of qualified employee trust fund abroad (immigrant or employment on
2. Revenues on non-profit, non-stock educational permanent basis)
institutions (ex. AdDU)  Citizen of PH who works and derives
3. SSS, GSIS, Pag-IBIG, or PhilHealth benefits income from abroad and whose
4. Salaries and Wages of Minimum Wage earners employment threat requires him to be
and qualified senior citizen physically present abroad most of the
5. Regular income of barangay Micro-business time during the taxable year
enterprise (BMBEs)  Citizen previously considered as NON-
6. Income of foreign governments and foreign resident citizen who arrives in the PH at
Government owned controlled corporations anytime during the taxable year to
(GOCC) reside permanently in PH shall be
7. Income form international missions and treated as NON-resident citizen for the
organizations with income tax immunity taxable year in which he arrives in the
PH with respect to his income derived
TYPES OF INCOME TAXPAYERS from sources abroad until the date of his
A. INDIVIDUALS arrival in the PH
1. Citizen *Filipinos working in PH embassies or PH
a. Resident Citizen consulate offices are NOT considered non-resident
b. Non-Resident Citizen citizens.
2. Alien
a. Resident Alien Alien
b. Non-Resident Alien
1. Resident Alien – residing in the PH but is NOT
i. Engaged in trade or business
citizen
ii. NOT engaged in trade or
 Lives in the PH without definite intention
business
as to his intention
3. Taxable estates and trust
 Comes to PH for a definite purpose
B. CORPORATIONS
which in its nature would require an
1. Domestic Corporation
extended stay and to that end makes his
2. Foreign Corporation
home temporarily in the PH although
a. Resident foreign Corporation
intention at all times is to return to his
b. Non-Resident Foreign Corporation
domicile abroad
INDIVIDUAL INCOME TAXPAYERS
*if acquired residence in PH retains his
Citizens status as such until he abandons the same
or actually departs from the PH
 Citizens of PH at time of adoption of
Constitution on Feb. 2, 1987 2. Non-Resident Alien – NOT residing in PH
 Father and mother are citizen of PH retains his status as such until he abandons the
same or actually departs from PH

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a. Non-Resident Aliens Engaged in - Estates under judicial settlement are treated as

Business (NRA-ETB) – aliens who individual taxpayers. Estate is taxable on
stayed in PH for an aggregate period of income of properties left.
MORE THAN 180 days during the year - Estates under extrajudicial settlement are
b. Non-Resident Aliens NOT Engaged in exempt entities. Income under these properties
Business (NRA-NETB) is taxable to the heirs
i. Comes to PH for a definite 2. TRUST
purpose which in its nature may - An arrangement where one person
be promptly accomplished (grantor/trustor) transfers (donates) property to
ii. Comes to PH and stay therein another person (beneficiary), which will be held
for aggregated period for NOT under the management of a third party
more than 180 days during the (trustee/fiduciary)
year - Trust irrevocably designated by the grantor is
treated as if it’s an individual taxpayer
- Income of property held in trust is taxable to the
THE GENERAL CLASSIFICATION RULE FOR trust
INDIVIDUALS - Trust designated as revocable by grantor are
NOT taxable entities and NOT considered as
1. Intention – the intention shall determine his individual taxpayers. Income is taxable to the
appropriate residential classification. Taxpayers grantor
submit to the CIR of the BIR documentary - When trust agreement is silent as to
proofs (visas, work contracts, etc.) indicating revocability, presumed to be revocable
intention. Documents with short term stay
(tourist visa) shall NOT result in reclassification CORPORATE INCOME TAXPAYERS
of normal residency. If long-term stay
Term ‘corporation’ includes OPC (One Person
documents (immigration visa, working visa) for
Corporation), partnerships, joint-stock companies,
an extended period would result to automatic
joint accounts, associations, insurance companies
reclassification of residency
(EXCEPT: general professional partnerships, joint
venture in consortium formed for undertaking
2. Length of Stay – in default of such
construction project or engaging petroleum, coal,
documentary proof, the length of stay is
geothermal and other energy operations pursuant
considered:
to an operating consortium agreement under
a. Citizens staying abroad for a period of at
service contract with the govt). hence, corporation
least 183 days are considered non-
includes profit-oriented and non-profit institution
resident.
(charitable institutions, cooperatives, government
b. Aliens who stayed in PH for more than 1
agencies and instrumentalities, associations,
year as of the end of taxable year are
leagues, civic or religious and other organizations.
considered resident
c. Aliens who are staying in PH for not DOMESTIC CORPORATION – organized in
more than 1 year, but more than 180 accordance with PH laws. Includes OPC owned
days are deemed non-resident aliens and registered by resident citizens in PH. Still a
engaged in business domestic corporation if controlled by foreigners but
d. Aliens who stayed in PH for NOT more incorporated in PH
than 180 days are considered non-
FOREIGN CORPORATION – organized under
resident aliens NOT engaged in trade or
foreign law
business
TYPES OF FOREIGN CORPORATION
TAXABLE ESTATES AND TRUSTS
1. RESIDENT FOREIGN CORPORATION (RFC)
1. ESTATE
– operates and conducts business in PH
- Refers to properties, rights, and obligation of
through permanent establishment (ex. branch).
deceased person NOT extinguished by his
taxable on transaction through branch
death.

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2. NONRESIDENT FOREIGN CORPORATION –

does NOT operate or conduct business in PH.
Transacts directly to residents outside its
branch, taxable on the direct transactions.
SPECIAL CORPORATIONS – domestic or foreign
corporation subject to special tax rules or
preferential tax rates.
OTHER CORPOARATE TAXPAYERS THE GENERAL RULES IN INCOME TAXATION

1. One Person Corporation (OPC) – single Taxable On Income Earned

stockholder (can be natural, trust, or estate). INDIVIDUAL WITHI WITHOUT
Banks etc. and practice for procession cannot TAXPAYERS N (outside
incorporate as OPC. PH)
2. Partnership Resident Citizen / /
Non-Resident Citizen /
a. General Professional Partnership
Resident Alien /
(GPP) – sole purpose of exercising
Non-Resident Alien /
profession (NO part of income can
CORPORATE
be derived from trade or business). TAXPAYERS
NOT treated as corporation and is Domestic Corporation / /
NOT a taxable entity. Exempt from Resident Foreign /
income tax but partners are taxable Corporation
individually with respect to share in Non-Resident Foreign /
income of the partnership. (ex. Corporation
practice in same professions – both Note: “territoriality rule” – ALL taxpayers (except
accountants) resident citizens and domestic corporations) are
b. Business Partnership – formed for taxable only on income earned within the PH
profit. Taxable as corporation. (ex.
practice of two different profession – THE RESIDENCY AND CITIZENSHIP RULE
atty and accountant) Resident Citizens of PH and Domestic
3. Joint Venture Corporations – taxable on ALL income from
a. Exempt Joint Ventures – for purpose sources WITHIN and WITHOUT
of undertaking construction projects
or engaging petroleum, coal, *corporation is a citizen of the country where it
geothermal and other energy incorporated.
operations. NOT treated as
BASIS OF THE EXTRATERRITORIAL TAXATION
corporation thus tax-exempt on
regular income, but venturers are Resident citizens and domestic corporation have
taxable on share on net income of full access on benefits from government. The
JV taxation on their foreign income properly reflects
b. Taxable Joint Ventures – other than this difference in benefits consistent with the
JV (residual) Benefit Received Theory. The extraterritorial
4. Co-Ownership treatment is intended as a safety net to the
- joint ownership of property formed for potential loss of tax revenues brought by situs
preserving the same and/or dividing its income. relocation or practice of executing or structuring
- If limited to property preservation or income transaction transactions such that income will be
collection, NOT taxable entity but co-owners are realized abroad to avoid PH income taxes.
taxable on their share on income of co-owned
property. ISSUE OF INTERNATIONAL DOUBLE TAXATION
- If reinvests income of co-owned property to Rule on extraterritorial taxation exposes resident
other income producing properties/ventures, it citizens and domestic corporation to DOUBLE
will be considered an unregistered partnership TAXATION. However, NIRC allows a tax credit for
taxable as corporation

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taxes paid in foreign countries. They also pay  Less than 50%, the entire dividends are
minimal taxes in PH on their foreign income earned abroad
because of tax credit.
NOTE: If ratio is less than 50% then the gross
SITUS OF INCOME – place of taxation of income. income from abroad will be deemed earned outside
It is the jurisdiction that has the authority to impose the PH, thus dividends will NOT be split to
tax upon the income. Determines whether or not an Within/Without PH (Refer to page 80)
income is taxable in the PH. Particularly important
C. Merchandising Income – earned where the
to taxpayers taxable only on income WITHIN but
property is sold
also important on global income for computation of
D. Manufacturing Income – earned where the
foreign tax credit.
goods are manufactured and sold
SOURCE OF INCOME – pertains to
OPERATIONS REMARK
activity/property that produces the income
PRODUCTION DISTRIBUTION
(different with SITUS OF INCOME) Within Within Total Income from
INCOME SITUS RULES production and
distribution earned
Types of Income Place of Taxation (situs) WITHIN the PH
1. Interest Income Debtor’s Residence Without Without Total Income from
2. Royalties Where the intangible is the production and
employed distribution is earned
3. Rent Income Location of Property WITHOUT the PH
4. Service Income Place where service is Within Without Production Income
rendered is earned within,
Distribution Income
is earned WITHOUT
OTHER INCOME SITUS RULES Without Within Distribution Income
is earned within,
A. Gain on Sale of Properties Production Income
a. Personal Property – is earned WITHOUT
i. Domestic Securities – presumed
earned within PH
ii. Other Personal Properties – NOTE: page 82
earned where property is sold
 Home Office and Branch – NOT separate
b. Real Property – earned where the
 Parent and Subsidiary - Separate
property is located

B. Dividend Income
a. Domestic Corporation – presumed
earned within
b. Foreign Corporation
i. Resident Foreign Corporation –
depends on predominance test
ii. Non-Resident Foreign
Corporation – earned abroad
*PRE-DOMINANCE TEST – if ratio of PH gross
income over world gross income of the resident
foreign corporation in the three-year period
preceding the year of dividend declaration is:
 At least 50% the portion of the dividend
corresponding to the PH gross income ratio
is earned within

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