Income Taxation Quick Notes

Function of income tax system

Income taxation – branch of taxation which provides for Madrigal vs. Rafferty Case
statutory and administrative system of imposing and  The Income Tax Law of the United States, extended
collecting tax on the yearly profits arising from property, to the Philippine Islands, is the result of an effect on the
professions, trades and offices. part of the legislators to put into statutory form this
canon of taxation and of social reform. The aim has
Nature of income taxation been to mitigate the evils arising from inequalities of
 Excise transaction system since it is a taxation on the wealth by a progressive scheme of taxation, which
exercise of a privilege to earn yearly profits from various places the burden on those best able to pay. To carry
sources. out this idea, public considerations have demanded an
exemption roughly equivalent to the minimum of
Basis in imposing income tax subsistence. With these exceptions, the income tax is
1. Partnership theory – theory based on the right supposed to reach the earnings of the entire non-
of a government to tax income emanates from governmental property of the country. Such is the
its partnership in the production of income, by background of the Income Tax Law.
providing the protection, resources, incentive,
and proper climate for such production. (CIR vs. Criteria in imposing Income Tax
Lednicky) 1. Citizenship or Nationality Theory – the country
2. Protection theory - The site of the source of where the income earner is a citizen because he
payments is the Philippines. The flow of wealth is given protection by his country no matter
proceeded from, and occurred within, where he earns his income. He is therefore
Philippine territory, enjoying the protection obliged to give support to his country.
accorded by the Philippine government. In
consideration of such protection, the flow of 2. Residence or Domiciliary Theory – the country
wealth should share the burden of supporting where the income earner resides for the reason
the government. that he is given protection in his place of
3. Favorable Business Climate Theory - Domestic residence.
corporations owe their corporate existence and
their privilege to do business to the
3. Source – the country where the source of
government. They also benefit from the efforts
income is where the activity that produced the
of the government to improve the financial
income took place. Not where the money
market and to ensure a favorable business
originated. So you should look into where the
climate. It is therefore fair for the government
activity took place that produced the income.
to require them to make a reasonable
contribution to the public expenses.
Features of Philippine Income Tax
Doctrine of Moral Neutrality of the Taxing Authority 
- These theories are the reason behind the law
The Establishment Clause principally prohibits the State
requirement payment of income taxes.
from sponsoring any religion, or favoring any religion as
against other religions. It mandates a strict neutrality in
Income tax systems:
affairs among religious groups. No tax in any amount,
1. As to manner of imposition:
large or small, can be levied to support any religious
a. Global tax system
activities or institutions, whatever they may be called,
b. Schedular tax system
or whatever form they may adopt to teach or practice
c. Semi global/schedular
religion.
2. As to applicable tax law
a. NIRC
This doctrine believes that the "wall of separation" does
b. Special laws
not require the state to be their adversary. Rather, the
3. As to tax rate
state must be neutral in its relations with groups of
a. Progressive
religious believers and nonbelievers." State power is no
b. Regressive
more to be used so as to handicap religious than it is to
c. Proportionate
favor them. The Strict Neutrality approach is not hostile
to religion, but it is strict in holding that religion may not Dividends – payment made by the company to
be used as a basis for classification for purposes of shareholders or owners of stocks, way to distribute back
governmental action, whether the action confers right to investors the revenue, ways that an investor earns.
or privileges or imposes duties or obligations. Only Also termed as cash dividend which is taxable.
secular criteria may be the basis of government action.
It does not permit, much less require, accommodation Stock Dividends – is the dividend payment made in the
of secular programs to religious belief. form of additional shares rather than a cash payout. The
company may decide to give this to the shareholders
Types of Philippine Income Tax instead of liquid cash, they are not taxable until they are
1. Gross income tax – occurs when the tax base is sold.
the total gross income of an individual or
corporation during the taxable year without
deductions whatsoever. Sources of income:
2. Net income tax – occurs when the tax base is 1. Services rendered or labor
the total gross income of an individual that has 2. Capital which is not limited to money or
claimed and was granted a deduction. property
3. Presumptive income tax – allowed in the 3. Gains from exchange of properties or gains
context of capital gains tax. It is a concept of from profit.
taxation according to which income tax is based
on "average" income instead of actual income. Related concepts
4. Composite tax – tax consisting of quasi-personal a. Return of Capital  Return of capital (ROC) is a
taxes, assessed on the particular source of payment, or return, received from an
income with a superimposed personal tax on investment that is not considered a taxable
the income as a whole. event and is not taxed as income. Capital is
5. Unitary tax returned, for example, on retirement accounts
and permanent life insurance policies; regular
investment accounts return gains first. is the
INCOME – means all wealth which flows into the return of the principal only, and it is not any
taxpayer other than as a mere return of capital. It gain or any loss as a result of the investment 
includes the form of income specifically described as NOT TAXABLE, reason: Because it is money
gains derives from sale or other disposition of capital being returned and not earned, it’s not
considered taxable income. Once returns exceed
 It is the amount of money coming to a person or the original initial investment, it counts as a
corporation within a specified time, whether as capital gain and is therefore taxable.
payment for services, interest, or profits from
investment. b. Return on capital  (ROC) is a ratio that
measures how well a company turns capital
Other terms: (e.g. debt, equity) into profits. In other words,
Capital – is the funds or property existing at one distinct ROC is an indication of whether a company is
point of time. It is the wealth. using its investments effectively to maintain and
protect their long-term profits and market share
Receipts – has reference to all wealth that flows into the against competitors. Return on capital is also
taxpayer which includes return of capital. It is broader in known as return on invested capital (ROIC). It is
scope than income. It does not necessarily mean an accounting measure. Return of capital refers
income, this is what is received and includes the income to a company returning original investment
in its definition (literally yots, receipt “kung unsay funds back to the investor or by liquidating
nadawat”) assets. Return on capital refers to a company’s
profitability.
Revenue – as applied to taxation, refers to all the funds
of income derived by the government, whether from
c. Revenue  Revenue is the income generated
tax or any other source.
from normal business operations and includes
discounts and deductions for returned
 merchandise. It is the top line or gross income absolutely, only that a taxpayer has at his
figure from which costs are subtracted to disposal the information necessary to compute
determine net income. the amount with reasonable accuracy. The all-
 As applied to taxation, it refers to all funds or events test is satisfied where computation
income derived by the government, whether remains uncertain, if its basis is unchangeable;
from tax or any other source. Revenue is to the the test is satisfied where a computation may
government, income is to person or be unknown, but is not as much as unknowable,
corporation. within the taxable year. The amount of liability
does not have to be determined exactly; it must
d. Receipts  Has reference to all wealth that be determined with "reasonable accuracy.
flows into the taxpayer which includes return of "Accordingly, the term "reasonable accuracy"
capital. It refers to amounts one has earned as implies something less than anex act or
the result of business activities such as selling completely accurate amount.
merchandise or performing services. Broader in
scope than income.
 The accrual of income and expense is permitted
e. Accounting income  Accounting income is the when the all-events test has been met. This test
profit a company retains after paying off all requires: (1) fixing of a right to income or liability to pay;
relevant expenses from sales revenue earned. It and (2) the availability of the reasonable accurate
is synonymous with net income, which is most determination of such income or liability.
often found at the end of the income
statement. The metric differs from gross income 4. Economic Benefit Principle  – Any economic
in that the latter accounts for only direct benefit to the employee that increases his net
expenses, whereas accounting income also worth, whatever may have been the mode by
takes into consideration all indirect expenses. which it is effect, is taxable.

Test of Taxable income 5. Severance test  – There is no taxable income

1. Flow of Wealth test  This test is based on the until there is a separation from capital of
definition of gross income under sec. 29, sec. 3 something of exchangeable value, thereby
particularly the term and income derived from supplying the realization or transmutation
any source whatever. which would result in the receipt of income.

 The site of the source of payments is the Philippines. 6. Substantial alteration test  – There is no
The flow of wealth proceeded from, and occurred taxable income until there is a separation from
within, Philippine territory, enjoying the protection capital of something of exchangeable value,
accorded by the Philippine government. In thereby supplying the realization or
consideration of such protection, the flow of wealth transmutation which would result in the receipt
should share the burden of supporting the government. of income.

2. Realization Test  Under the realization 7. Control test  Power to dispose; Assignment of
principle, revenue is generally recognized when income doctrine
both of the following conditions are met: (1) the
earning process is complete or virtually
complete; and, (2) an exchange has taken place.
This principle requires that revenue must be
earned before it is recorded.

3. All – event test  The all-events test requires

the right to income or liability be fixed, and the
amount of such income or liability be
determined with reasonable accuracy.1âwphi1
However, the test does not demand that the
amount of income or liability be known