Introduction to Income Taxation | Chapter 3 - Loss of Profits : Does not decrease net worth.

Thus, Recovery of Loss Profits increases net worth;

What is income for taxation purposes? taxable
- a taxable item of income is referred to as an
“item of gross income” less deductions and personal
exemptions allowable by law Taxable Recovery of Loss Profits
- gross income is broadly defined as any inflow of a. Proceeds of Crop of Livestock insurance
wealth to the taxpayer from whatever source, legal b. Guarantee payments
or illegal, that increases net worth. c. Indemnity (compensation for a loss or damage)
‣ includes income from employment, trade, received from patent infringement suit
business or exercise of profession, income from
properties, and other regular/casual transactions. Refer to the book for the illustrations and better
examples.
Elements of Gross Income
1. It is a return on capital that increases net Realized Benefit
worth - the term “benefit” means any form of advantage
2. It is a realized benefit derived by the taxpayer
3. It is not exempted by law, contract, or treaty - an increase in net worth; there is benefit
- increase in net worth occurs when one receives
Return on Capital income, donation, or inheritance
- capital means any wealth or property
- gross income is a return on wealth or property The following are not benefit, thus, not taxable
that increases the taxpayer’s net worth a. Receipt of a Loan – properties increase but
- e.g., the profit or earnings earned from the obligations also increase resulting in an offsetting
sale of goods effect in net worth
- increases net worth; thus, subject to income tax b. Discovery of Lost Properties – under the law, the
finder has an obligation to return the same to the
Return of Capital owner
- e.g., getting back the money you originally c. Receipt of money/property to be held in trust or
invested, without any profit to be remitted to another person
- merely maintains net worth; thus, not taxable ‣ If a taxpayer is entitled to keep for his
account a portion of a receipt, only that portion is
Capital items deemed with infinite value a benefit (taxable)
- capital items that have infinite value and are
incapable of pecuniary valuation (putting a money The “realized” concept
value on something) - realized means earned
- anything received as compensation for their loss - it requires that there is a degree of
is deemed a return of capital; not taxable undertaking or sacrifice from the taxpayer to be
- e.g., Life, Health, Human Reputation entitled of the benefit

Life Requisites of a realized benefit:

- proceeds of life insurance policies paid to the 1. There must be an exchange transaction
heirs/beneficiaries upon death of the insured are 2. The transaction involves another entity
exempt from income tax 3. It increases the net worth of the recipient
- proceeds of a life insurance contract collected
by an employer (company) as a beneficiary from the Types of Transfers
life insurance of an officer are likewise exempt 1. Bilateral Transfers or Exchanges (Onerous)
‣ Sale
However, the following are taxable return on capital ‣ Barter
from insurance policies: Benefits derived from these transactions are
a. Any excess amount received over premiums paid by “earned” or realized. Thus, subject to income tax
the insured upon surrender/maturity of the policy 2. Unilateral Transfers (Gratuitous)
b. Gain realized by the insured from the assignment ‣ Succession – transfer of property upon death
or sale of his insurance policy ‣ Donation
c. Interest income from the unpaid balance of the Benefits derived from these transactions are “not
proceeds of the policy realized” because of the absence of an earning
d. Any excess of the proceeds received over the process. Thus, they are only subject to transfer
acquisition costs and premium payments by an tax, not income tax.
assignee 3. Complex Transactions
- partly gratuitous and partly onerous
Health - commonly referred to as “transfers for less than
- any compensation received in consideration for full and adequate consideration”
the loss of health such as compensation for personal - gratuitous portion; subject to transfer tax
injuries or tortuous acts is deemed a return of - onerous portion; subject to income tax
capital; not taxable
What is meant by another entity?
Human Reputation - Every person, natural, or juridical, is an
- any indemnity received as compensation for its entity
impairment is deemed a return of capital; not - Items of gross income which arises from
taxable transactions that involves another natural or
- examples include moral damages received from: juridical entity are taxable
oral defamation or slander, alienation of affection, - the sales of one and the same entity, as well as
breach of promise to marry the income between business of a proprietor, are not
taxable
Recovery of Lost Capital vs. Recovery of Lost
Profits Benefits in the absence of transfers
- Loss of Capital : Decrease in net worth. Thus, - increase in wealth of the taxpayer in the form
Recovery of Capital merely maintains net worth; not of appreciation, increase in the value of his
taxable properties or decrease in the value of his
obligations in the absence of a sale transaction is a. Resident Foreign Corporation
not taxable b. Non-resident Foreign Corporation
- these are referred to as “unrealized gains” or
holding gains because they have not yet materialized
in an exchange transaction

Individual Income Taxpayers

Examples of Unrealized Gains or Holding Gains 1. Citizen
a. Increase in value of investments in equity/debt Under the constitution, citizens are:
securities a. Those who are citizens of the Philippines at the
b. Increase in value of real properties held time of adoption of the Constitution on February 2.
(revaluation increment) 1987
c. Increase in value of foreign currencies b. Those whose fathers or mothers are citizens of
held/receivable the Philippines
d. Decrease in value of foreign currency denominated c. Those born before January 17, 1973 of Filipino
debt by virtue of favorable fluctuation in exchange mothers who elected Filipino citizenship
rates d. Those who are naturalized in accordance with the
e. Birth of animal offspring law
f. Increase in value of land due to the discovery of
mineral reserves Classification of Citizens
A. Resident Citizen
Rendering of Services ‣ A Filipino citizen residing in the Philippines
- rendering of services for a consideration is an ‣ Filipinos working in Philippine Embassies or
exchange but does not cause a loss of capital; thus Consulate Offices
taxable B. Non-Resident Citizen
‣ Stayed abroad for at least 183 days
Basis of Exemption of Unrealized Income ‣ Citizen of PH with physical presence
- it does not mean that only income realized in abroad with a definite intention to reside therein
cash is subject to tax
‣ Leaves PH during taxable year to reside abroad
- income received in non-cash considerations is
(immigrant or employment on permanent basis)
taxable at the fair value of the property received
‣ Citizen of PH who works and derives income
from abroad and whose employment thereat requires
Taxable items of income may be realized by the
him to be physically present abroad most of the
taxpayer in two ways:
time during the taxable year
1. Actual Receipt – involves actual physical taking
of the income in the form of cash or property ‣ Citizen previously considered as Non-Resident
2. Constructive Receipt – involves no actual Citizen who arrives in the PH at anytime during the
physical taking of the income but the taxpayer is taxable year to reside permanently in PH shall be
effectively benefited treated as Non-Resident citizen for the taxable year
in which he arrives in the PH with respect to his
Inflow of Wealth without increase in net worth income derived from sources abroad until the date of
- the inflow of wealth to a person that does not his arrival in the PH.
increase his net worth is not income due to the This means: If a Filipino who was living abroad
total absence of benefit. Thus, not taxable. (and classified as a Non-Resident Citizen) comes
- e.g., receipt of property in trust, borrowing of back to the Philippines to live here permanently,
money under an obligation to return for tax purposes:
- the proceeds of embezzlement/swindling where - For the part of the year before they arrived,
money is taken without an original intention to any income they earned from abroad is not taxable in
return is an increase in net worth of the swindler. the Philippines.
Thus, taxable. - Once they arrive, they become a Resident
Citizen, and from that date onward, their worldwide
The following items of income are exempted by law income becomes taxable in the Philippines.
from taxation. Thus, they are not considered items Example:
of gross income. Juan lived and worked in Canada from January to June
a. Income of qualified employee trust fund 2025.He returned to the Philippines on July 1, 2025
b. Revenues of non-profit, non-stock educational to stay for good. Income from Canada (Jan–June) →
institutions Not taxed in PH. Income earned after July 1 (whether
in PH or abroad) → Taxed in PH.
c. SSS, GSIS, Pag-IBIG, or PhilHealth benefits‣
d. Salaries and Wages of minimum wage earners and
General Classification for Individuals
qualified senior citizen
1. Intention
e. Regular income of Barangay Micro-Business
- intention of the taxpayer regarding the nature
Enterprise
of his stay within or outside the Philippines shall
f. Income of foreign governments and foreign
be determined by appropriate residency
government-owned controlled operations
classification
g. Income of international missions/organizations
- documents purporting short-term stay : shall not
result in reclassification of the taxpayer’s normal
Types of Income Taxpayers
residency
A. Individuals
- documents purporting long-term stay : shall
1. Citizen
result in automatic reclassification of the
‣ Resident Citizen
taxpayer’s residency
‣ Non-resident Citizen 2. Length of Stay
2. Alien
‣ Resident Alien 2. Alien – an alien is normally non-resident
‣ Non-resident Alien A. Resident Alien – an individual who is residing in
a. engaged in trade or business the PH but is not a citizen thereof
b. not engaged in trade or business ‣ An alien who lives in the PH without definite
3. Taxable estates and trusts intention as to his stay
B. Corporations
1. Domestic Corporation
2. Foreign Corporation
 ‣ Comes to the PH for a definite purpose which Corporations
are subject to special tax
would require an extended stay even if his intention rules/preferential tax rates
Has a single-stockholder who may be a
at all times is to return abroad natural person, trust, or an estate
‣ Stayed in the PH for more than 1 year as of the Single stockholder may not be a:
end of the taxable year - bank and quasi-bank, trust, insurance,
‣ A resident alien retains his status until he One-Person public and publicly-listed company, and
Corporation non-chartered GOCC;
abandons the same or actually departs from the PH - Natural person who is licensed to
exercise a profession for the purpose of
exercising such profession.
B. Non-Resident Alien – an individual who is not
residing in the PH and who is not a citizen thereof
Types of Partnership:
‣ Engaged in Trade or Business (NRA-ETB) A. General Professional Partnership (GPP)
– aliens who stayed in the PH for an aggregate - formed by persons for the sole purpose
period of more than 180 days during the year of exercising a profession
- are income tax exempt, but, partners are
‣ Not engaged in Trade or Business (NRA-NETB) Partnership taxable in their individual capacity
– aliens who shall stay in the PH for an aggregate according to their share of partnership
period of not more than 180 days during the year income
- came to the PH for a definite purpose which in B. Business Partnership
its nature may be promptly accomplished - formed for profit
- taxable
Types of Joint Venture
C. Taxable Estates and Trust 1. Exempt Joint Ventures
‣ Estate – refers to properties, rights, and - Formed for the purpose of undertaking
obligations of deceased not extinguished by death construction projects or engaging in
petroleum, coal, geothermal and other
- Estates under Judicial Settlement : Income of energy operations pursuant to an operating
the properties left by the decedent is taxable to Joint
consortium agreement under a service
Venture
the estate (as individual taxpayer) contract w/ the gov’t
- Estates under Extrajudicial Settlement : Income - Ventures are taxable to their share in
net income of the joint venture
of the properties are taxable to the heirs
2. Taxable Joint Ventures
‣ Trust – an arrangement whereby one person - All other joint ventures are taxable as
transfers property to another person which will be corporations
under the management of a 3rd party Limited to property preservation or income
- Trust that is irrevocably designed by the collection is not a taxable entity and is
exempt , but, the owners are taxable on
Grantor : Income of properties are taxable to the their share on the income of the co-owned
trust (as individual taxpayer) property
Co-Ownership
- Trust that is designed as revocable by the A co-ownership that reinvests the income
Grantor : Income of properties are taxable to the of the co-owned property to other income
producing properties/ventures
grantor
- considered an unregistered partnership
- taxable as a corporation
B. Corporations
‣ Includes: OPCs, partnerships, profit-oriented The General Rules in Income Taxation
and non-profit institutions (charitable
institutions, cooperatives, gov’t agencies and Taxable on
instrumentalities, associations, leagues, civic or Income Earned
religious organizations), joint-stock companies, Individual Taxpayers Within Without
Resident Citizen ✓ ✓
joint accounts, association, or insurance companies Non-Resident Citizen ✓
‣ Excludes: GPPs; joint venture or consortium Resident Alien ✓
formed for the purpose of undertaking construction Non-Resident Alien ✓
projects or engaging in petroleum, coal, geothermal, Corporate Taxpayers
and other operations pursuant to an operating Domestic Corporation ✓ ✓
consortium agreement under a service contract w/ the Resident Foreign Corporation ✓
gov’t Non-Resident Foreign Corporation ✓

1. Domestic Corporation – organized in accordance Resident Citizen and Domestic Corporation enjoy
with PH laws privileges over aliens (e.g., full access to public
services). Their extraterritorial tax treatment is
‣ Includes OPCs owned and registered by resident
intended as a safety net to potential loss of tax
citizens in the PH
revenues, but may expose them to double taxation
- Individual that establishes OPC shall be taxable
(Minimization: credit for taxes paid abroad)
as a corporate taxpayer for the business
transactions of the OPC, but, he shall be subject to
Situs of Income vs. Source of Income
tax as an individual for his personal transactions
Situs of Income – it is the place of taxation of
‣ A corporation that incorporates in the PH is a
income. It is the jurisdiction that has the
domestic corporation under the Incorporation Test
authority to impose tax upon the income
even if the same is controlled by foreigners
Source of Income – it pertains to the activity or
2. Foreign Corporation – one that is organized under
property that produces the income
a foreign law
A. Resident Foreign Corporation (RFC)
Income Situs Rules
- Operates and conducts business in the PH through
a permanent establishment
Types of Income Place of Taxation (Situs)
- Taxable as an RFC on transactions with residents
Interest Income Debtor’s (borrower) residence
through its branch
Royalties Where the intangible is employed
B. Non-Resident Foreign Corporation (NRFC) Rent Income Location of the property
- Does not operate or conduct business in the PH Place where the service is
- Taxable as an NRFC on the direct transactions Service Income
rendered
with residents outside its branch
Other Income Situs Rules
Other Corporate Taxpayers A. Gain on Sale of Properties
1. Personal Property
Special Domestic and Foreign Corporations which
 ‣ Domestic Securities – presumed earned within the
PH
‣ Other Personal Securities – earned in the place
where the property is sold
2. Real Property – earned where the property is
located

B. Dividend Income from

1. Domestic Corporation – presumed earned within the
PH
2. Foreign Corporation – situs depends on pre-
dominance test

The pre-dominance test

If the ratio of the Philippines gross income over
the world gross income in the three-year period
preceding the year of dividend declaration is:
‣ At least 50%, the dividend portion on Philippine
gross income ratio is earned within
‣ Less than 50%, the entire dividend is earned
abroad

C. Merchandising Income – earned where the property

is sold

D. Manufacturing Income – earned where the goods are

manufactured and sold

Operations Remark
Production Distribution
Total income from production
Within Within and distribution is earned
within the PH
Total income from production
Without Without and distribution is earned
without the PH
Production income is earned
Within Without within, Distribution is
earned without
Distribution income is earned
Without Within within, production income is
without