Module in

INCOME AND
BUSINESS
TAXATION

(FOR CLASSROOM DISCUSSION ONLY)

By:
JEFFEL RYAN Z. BULANDOS, CPA, MBA

Contributors:
ALVIN GINO M. BAUTISTA, MBA
CAMILLE D. BINAJBAJ, MBA
KATHLEEN ROSE Y. JOSE, CPA, MBA
MERCY V. TORRES, MM-BM
 LESSON 1
GENERAL PRINCIPLES OF TAXATION
Learning Objectives:

At the end of the chapter, the student should be able to:

 Define Taxation.
 Know the scope, nature, bases, purpose, stages, and limitations of Taxation.
 Define Taxes.
 Determine the characteristics and classification of taxes.
 Know the different tax laws

Definition of Taxation

It is an inherent power of the State vested in the legislative body of the government to enforce
proportional contribution upon persons, properties or rights to generate revenues which defray the
necessary expenses of the government.

1. Scope of power of taxation – The power of taxation is comprehensive, plenary, unlimited, and
supreme. This power is however subject to inherent and constitutional limitations.

2. Nature of power of taxation

a. The power is inherent because it is inseparable from the State.
b. It is essentially a legislative function.
c. The primary objective of taxation is to collect tax and to raise revenues for support to the
government in exercising its function.

3. Bases of taxation
a. Taxation is based on necessity.
b. Reciprocal duties of protection and support between the state and its inhabitants.

4. Purposes of taxation
a. Principal purpose – To raise revenue for government needs.
b. Secondary purposes
i. To reduce excessive inequalities of wealth.
ii. Protective tariff on imported goods may be imposed to protect local producers against
foreign competitors.
iii. To encourage the growth of home industries through the proper use of tax exemptions
and tax incentives, and
iv. To implement the police power of the state in promoting the general welfare.

6. Aspects, Phases, Stages of Taxation

a. Levying or imposition of the tax
b. Collection of the tax

1
7. Basic principles of a sound tax system.
a. Fiscal adequacy – Means sufficiency of source of revenue to meet expenditures of government
regardless of business conditions.
b. Equality or theoretical justice – The tax imposed must be proportionate to taxpayer’s ability to
pay the same.
c. Administrative feasibility – The law must be capable of convenient, just and effective
administration.

8. Taxation, Eminent Domain, Police Power defined.

a. Taxation – the power by which the sovereign raises revenue to defray the necessary expenses
of government.
b. Eminent Domain – the power of the state to take private property for public use upon
payment of just compensation. It is sometimes called expropriation.
c. Public Power – the power of the state to enact laws to promote public health, public morals,
public safety and the general welfare of the people.

9. Limitation of the power of taxation

a) Inherent Limitations: (those restrictions not embodied in the constitution)
1) Taxes may be levied only for public purpose.
2) Power to tax is limited to territorial jurisdiction of the state.
3) Power to tax, being inherently legislatives, may not be delegated.
4) International Comity.
5) Exemption from taxation of government entities.
b) Constitutional limitations: (Those restrictions expressly provided in the constitution)
1) Observance of due process of law and equal protection of the laws
2) No imprisonment for non-payment of poll tax
3) Equal protection of the law
4) Rule of uniformity and equity in taxation
5) Non-impairment of the Supreme Court jurisdiction of tax cases
6) Concurrence by a majority of all members of Congress in the passage of law granting tax
exemption
c) Contractual Limitations: Restrictions on the taxing power as a result of contracts entered into by
the government with another party who maybe its own citizen or another government

10. Situs of Taxation –

a) Meaning – Situs means place of taxation, that is, the country which has jurisdiction to
impose a particular tax upon persons, property or business transactions.
b) Situs of persons or individuals
1) Community tax – residence of the person
2) Income tax: a. legal residence
b. Place where the income is derived
c. Office of the commissioner
3) Estate tax – residence of the decedent upon his death
4) Donors tax – residence of the donor at the time of donation
c) Situs of Taxation of Property
1) Real property – location of property
2) Tangible personal property – location of property

2
 3) Intangible personal property (royalties, copyright and other intangible) – domicile or
residence of the owner.
d) Situs of taxation for business and occupation
It is the place where the act is performed or where the occupation engaged in.
e) Specifically, where national taxes should be paid:
Except if it is to be paid to the municipal or city treasurer’s office (local taxation), the
Bureau of Internal Revenue gives us the venue for the taxes that they administer (National
Taxes) namely:
1) Authorized agent bank (where Taxpayer Record update was submitted by the
taxpayer)
2) Revenue District Officer; Collection officer or duly authorized treasurer of the city or
municipality in which such person has his legal residence or principal place of
business in the Philippines.
3) If there be no legal residence in the Philippines, then it should be with the office of
the Commissioner of Internal Revenue.

11. Double Taxation –

a) Definition – When the same property is taxed twice when it should be taxed but once;
both taxes must be imposed on the same property or subject matter; for the same
purpose, by the same state, government or taxing authority, within the same jurisdiction
or taxing district, during the same taxable period, and the same kind of character of tax.
b) Kinds:
1) Direct double taxation – Taxing twice by the same authority, for the same
purpose, in the same year, some of the property in a given territory in which the
tax is laid without taxing all of them a second time. This type of double taxation is
prohibited by the constitution as it violates the rule of uniformity
2) Indirect double taxation – This type of double taxation is not prohibited. Thus, a
lessor who derives rental income from his land may be required to pay income tax
on the net rentals, real estate tax on assessed value of the land, and community
tax, also on the assessed value of the land.

12. Exemption from taxation –

a) Meaning – Grant of immunity, express or implied, to particular persons, corporations, or
to persons or corporations of a particular class, from a tax upon property, or an excise
which persons and corporations generally within the same taxing district, are obliged to
pay. Briefly, it is the privilege of not being imposed a financial burden to which others
are subject.
b) Power of legislature to grant exemption – In the exercise of its inherent power to tax,
the state through its legislature has full power to exempt any person, corporation or
class of property from taxation as its views of public policy and expediency may dictate.

13. Forms of Escape from Taxation

a) Shifting – Transfer of the tax burden by the person on whom it is imposed by law to
another who bears it.
b) Capitalization – Form of backward shifting whereby future taxes on property sold are
capitalized.
c) Transformation – Effected through the process of production. The producer on whom
the tax is imposed, fearing the loss of his market if he adds the tax to the price, pays the

3
 tax and recovers his additional expense by improving his method of production thereby
turning out units of lesser cost. Here, the tax is transformed into a gain through the
medium of production.
d) Evasion – Use by the taxpayer of illegal means to defeat or lessen the payment of tax
otherwise known as Tax Dodging and punishable by law.
e) Avoidance – Use by the taxpayer of legally permissible methods in order to reduce tax
liability; otherwise called Tax Minimization.
f) Exemption – Privilege of not being levied with a particular tax wherein other individuals
are obligated to pay.

T A X E S - Enforced contribution levied by the state by virtue of its sovereignty on persons and property
within its jurisdiction for the support of the government and all public needs.

1. Essential characteristics of tax

a) Enforced contribution
b) Levied pursuant to a legislative authority
c) Proportionate in character
d) Generally payable in money
e) Levied on persons and property within the jurisdiction of the state.
f) Levied and collected for public purposes.
g) Commonly required to be paid at regular intervals.

2. Nature and classification

a) As to subject matter or object:
1) Personal, poll or capitation – tax of a fixed amount on individuals residing within a
specified territory without regard to their property or occupation.
2) Property – imposed on property, whether real or personal, in proportion either to its
value or in accordance with some other reasonable method of apportionment.
3) Excise – imposed upon the performance of an act, the enjoyment of a privilege or
engaging in an occupation.
b) As to who bears the burden:
1) Direct – demand from persons who are intended or bound by law to pay the tax.
2) Indirect – one which the taxpayer can shift to another.
c) As to determination of amount:
1) Specific – one imposed and based on a physical unit of measurement, as by head or
number, weight, or length or volume.
2) Ad valorem – of a fixed proportion of the value of property with respect to which
the tax is assessed. Needs an independent appraiser to determine its value.
d) As to purpose:
1) General, fiscal or revenue – no particular purpose or object for which the revenue is
raised, but is simply raised for whatever need may arise.
2) Special or regulatory – imposed for a special purpose regardless of whether revenue
is raised or not, and is intended to achieve some social or economic end.
e) As to authority imposing the tax or scope:
1) National – imposed by the national government.
2) Municipal or local – imposed by municipal government.

4
 f) As to graduation or rate:
1) Proportional – based on a fixed percentage of the amount of property income or
other basis to be taxed.
2) Progressive – the rate increases as the tax base increases.
3) Regressive – the tax rate decreases as the tax base increases.
4) Digressive – increase of rates is not proportionate to the increase of tax base.

3. Distinguished from other charges or fees

a) From license fee:
Tax – imposed for revenue purposes, involve exercise of taxing power, has maximum
limit; imposed on persons, property and right to exercise privilege; its non-payment does not
make a business or act illegal.
License – imposed for regulatory purposes; involves exercise of police power; limited to
cost of regulation; imposed only on right to exercise privilege; its non-payment makes the act or
business illegal.
b) From toll:
Tax – a demand of sovereignty; is for the support of government; its amount is
regulated by necessities to government, imposed only by the government.
Toll – a demand of proprietorship; is a compensation for use of another’s property; its
amount is determined by cost of property; is collected by the government or
private entity.
c) From penalty:
Tax – aimed at raising revenue, imposed only by the government.
Penalty – designated to regulate conduct; imposed by the government and also by
private entities.
d) From special assessment:
Tax – levied on persons, property, or exercise of privilege; can be made a personal
liability of the person assessed; is based on government’s necessity without any
special benefit accruing to taxpayer; is of general application.
Special assessment – levied only on land; not a personal liability of person assessed; is
based on special benefits resulting to property assessed; is exceptional as to
time and place (not of general application)
e) From revenue:
Revenue is broader and includes all funds or income derived from taxes or otherwise,
such as financial assistance from another government, donations from private
individuals, commercial revenue like tolls, postage, price paid for goods and
services produced by government owned enterprises; and administrative
revenues like fines, penalties and forfeitures.
f) From customs duties:
Tax – broader than customs duties and include the latter.
Customs duties –taxes levied upon commodities imported into or exported out of the
country.
g) From debt:
Tax – is imposed by law; cannot be assigned; generally payable in money; not subject to
set-off; liable for imprisonment if not paid; is governed by special prescriptive
periods under the tax code.

5
 Debt – arises from contact; can be assigned; subject to set-off; no imprisonment in case
of non-payment thereof; is governed by prescriptive periods under the civil code
and other special laws

TAX LAWS – Any law which provides for the assessment and collection of taxes to defray the expenses
of government.

1. Sources of Tax Laws

a) Constitution
b) Statutes (enactment by the legislative body)
c) Presidential decrees
d) Rules and regulation (as those issued by the Secretary of Finance implementing tax laws).
e) Administrative rulings, opinions, and circulars (as those rendered or issued by the
commissioner of Internal Revenue or the Secretary of Finance).
f) Judicial decisions (as those rendered by the Supreme Court and court of Tax Appeals)
g) Provincial, city, municipal and barrio ordinances
h) Treaties
i) Legislative materials

2. Interpretation or construction
a) Liberal – in favor of taxpayer and against the government where the intent or meaning of
the tax law is doubtful.

3. Existing tax laws in the Philippines

a) National:
1) The National Internal Revenue Code or C.A 466
2) The Tariff and Customs Code
3) Special laws, like the
a. Special Science Fund Law
b. Narcotic Drug Law
c. Special Education Fund law
d. Sugar adjustment Act
e. Peace and Order Fund Law
b) Local:
1) Municipal Autonomy Act
2) Barrio Charter
3) Assessment Law
4) Charter of Cities
5) Local Tax Code

4. National Internal Revenue taxed under the administration of the Bureau of Internal Revenue.
a) Income Tax
b) Transfer Taxes (Estate and Donors)
c) Value Added Tax
d) Other Percentage Taxes
e) Excise taxes (Specific and ad valorem on certain goods)
f) Documentary stamp taxes
g) Such other taxes as are or thereafter maybe imposed and collected by the B.I.R

6
5. National Taxes and Fees transferred to the Provinces, Cities and Municipalities.
The power to levy and collect the following taxes and fees has been transferred from the
National Government to the provinces, cities and municipalities.
a) Occupation tax on all persons engaged in the exercise or practice of their profession or
calling;
b) Amusement tax on Admission Fees – to be collected from the proprietors, lessees,
operators of theaters, cinematography, concert halls, circuses and other places of
amusement;
c) Fees for sealing and licensing of weights and measures. To be collected from store
owners who use weighing scale or meter stick in their business.
d) Community tax – This was formerly known as residence tax.

6. Powers and Duties of the Bureau of Internal Revenue in General (under the supervision and
control of the Department of Finance):
a) To assess and collect all national internal revenue taxes, fees and charges;
b) To enforce all forfeitures, penalties and fines connected therewith;
c) To give effect to and administer the police power conferred to it by law;
d) To recommend to the Secretary of Finance all needful rules and regulations for the
effective enforcement of the provisions of the National Internal Revenue Code.

7. Chief Officials of the Bureau of Internal Revenue

a) Commissioner of Internal Revenue – the chief
b) Four (4) deputy commissioners – assistant chiefs

8. Powers of the Commissioner of Internal Revenue

a) Interpret tax laws and to decide tax cases
b) Obtain information and to summon, examine, and take testimony of persons, with
additional provision introduced by RA 10963 that the Cooperative Development
Authority shall submit a report on tax incentives availed by cooperatives to the BIR and
DOF.
c) Make assessments and prescribe additional requirements for tax administration and
enforcement. This authority is not withstanding any law requiring the prior
authorization of any government agency or instrumentality.

7
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

Exercise 1.1

MULTIPLE CHOICE. Encircle the letter of the correct answer.

1. The process by which the sovereign raises income to defray the expenses of the government is
called:
a. subsidy c. taxation
b. tariff d. tribute

2. One of the following is a primary purpose of taxation

a. Protection of local industries against foreign competition through imposition of high
customs duties on imported goods;
b. Reduction of inequalities in wealth and income by imposing progressively higher tax rates;
c. To secure revenue for the support of the government;
d. Strengthening of anemic enterprises by giving tax exemptions.

3. All of the following, except one, are basic principles of the sound tax system
a. Fiscal adequacy c. Administrative feasibility
b. Theoretical justice d. Inherent in sovereignty

4. The power of taxation can only be exercised by the lawmaking body

a. Subject to constitutional and inherent limitations
b. Equality or theoretical justice
c. Legislative in character
d. Inherent in sovereignty

5. Those restriction on the exercise of the power of taxation that are found in the constitution or
implied from its provisions
a. Theoretical justice c. Inherent limitations
b. Legislative character d. Constitutional limitations

6. Treating persons who are similarly situated in the same manner –

a. Uniformity of taxation c. Equality of taxation
b. Due process of law d. Non-delegation of legislative power

7. No law granting any tax exemption shall be passed without the concurrence of –
a. Majority of all members of the Congress
b. 2/3 vote of all members of the Congress
c. ¾ vote of all members of the Congress
d. Unanimous vote of all members of the Congress

8. A fundamental rule in taxation that “the property of one country may not be taxed by another
country.” This is known as
a. International law c. Reciprocity
b. International comity d. International inhibition

8
9. The amount required is dictated by the needs of the government in –
a. License fee c. Toll
b. Tax d. Tariff

10. All of the following, except one, are essential characteristics of a tax.
a. It is based on ability to pay
b. It is an enforced contribution
c. It is generally payable in money
d. It is proportionate in character

11. All of the following except one, are kinds of taxes as to rates, what is it?
a. Proportional c. Progressive
b. Digressive d. Constructive

12. No person shall be imprisoned for non-payment of

a. Property tax c. Poll tax
b. Excise tax d. Income tax

13. A tax that is imposed upon a person who is directly bound to pay it –
a. Direct tax c. Excise tax
b. Indirect tax d. Poll tax

14. Tax imposed by the national government and is effective within the entire jurisdiction thereof
a. National tax c. Proportional tax
b. Local tax d. General tax

15. In taxation, it is a compensation for the use of another’s property.

a. License fee c. Toll fee
b. Special assessment d. None of the above

16. In taxation, requisites for validity call that they must be published in the official gazettes and not
contrary to law. They are:
a. Treaties c. Judicial decisions
b. Statutes d. Revenue regulations
17. It is one of the basis principles of a sound tax system which means that taxes must be
proportionate in characters.
a. Fiscal adequacy c. Administration feasibility
b. Equality of theoretical justice d. Uniformity

18. The taxpayer gives the following reasons in refusing to pay a tax. Which is not legally
acceptable?
a. That he has been deprived of due process of the law.
b. That there is lack of territorial jurisdiction.
c. That the prescriptive period for the tax has lapsed.
d. That he will derive no personal benefit from the tax.

9
19. An enforced proportional contribution from owners of lands for special benefits resulting from
public improvements is called:
a. Toll fee c. Special contribution
b. Special assessment d. Real property tax

20. Special assessment is an enforced proportional contribution from owners of land specially
benefited by public improvements. One of the following is not considered as one of its
characteristics, what is it?
a. It is levied only on land
b. It is based wholly on benefits
c. It is not a personal liability of the persons assessed.
d. It is based also on necessity

21. The power to levy and collect this tax has been transferred to the province and cities under the
local tax code (PD 231)
a. Estate tax
b. Privilege tax
c. Fees for sealing and licensing of weights and measures
d. Donors tax

22. Direct double taxation violates

a. Rule of equality
b. Rule of ability to pay
c. Rule of reciprocity
d. None of the above

23. Also known as tax minimization

a. Tax exemption c. Tax avoidance
b. Tax evasion d. Transformation

24. All of the following, except one, are sources of tax laws –
a. Legislations, tax treaties and tax ordinances
b. Judicial decisions
c. Opinions of authors
d. Administrative rules and regulations

25. With special reference to internal revenue taxes, it is merely a notice to the effect that the
amount stated therein is due as tax and a demand for the payment thereof. It is:
a. Subpoena duces tecum
b. Warrant of arrest
c. Assessment
d. Letter of authority to examine

10
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

Exercise 1.2

MATCHING TYPE- From the words or terms enumerated below (Column A), choose the answer that
corresponds to the definitions or statements given in the following numbers (Column B). Write the letter
of your answer on the space provided

Column A

A. Toll fees P. Territorial Jurisdiction

B. Taxes Q. Interpretation of tax laws
C. Public Purpose R. Nature of Taxation
D. Taxation S. Compensation for police power
E. Tax Dodging T. Administrative feasibility
F. Double Taxation U. Indirect tax
G. Capitalization V. Transformation
H. Ability to Pay W. Local autonomy Act
I. Express or Affirmative X. International Committee
J. Basis of Taxation Y. Uniformity of Taxes
K. License Fee Z. Incidence
L. Tax minimization AA. Police Power and Taxation
M. Excise Tax BB. Shifting
N. Three inherent powers CC. Legislative
O. Advalorem Tax DD. Special or Regulatory

Column B

1. Property of one country, located in another may not be taxed by the latter. _____
2. It is a scheme wherein a taxpayer makes use of the loopholes of the law to his own advantage.
_____
3. It is construed to be in favor of the taxpayer and against the government. _____
4. It is only illegal escape from taxation. _____
5. The burden for the tax is ultimately passed on and borne by the buyer or consumers. _____
6. Reciprocal duties of protection and support between the state and the taxpayer. _____
7. A compensation for the use of somebody else’s property. _____
8. It is the purpose of this tax to achieve economic ends. _____
9. It means that taxpayers must share with the government correspondingly what he enjoys. _____
10. The official in-charged of enforcing the law must have a thorough knowledge of the law. _____
11. They are considered to be inherently legislative. _____
12. These inherent powers are directed to the whole citizenry. _____
13. It means that it will benefit majority of the taxpayers and majority does not always mean
100%._____
14. Tax laws are enforceable only within their limits or boundaries. _____
15. It is the maintenance of a healthy society in terms of economic standard. _____
16. It empowers the municipal or city government to enact its own laws. _____

11
17. In this case, the selling price is decreased by deducting future taxes and expenses. _____
18. Non-payment of such makes the act of business illegal. _____
19. This body has the sole power to grant tax exemption. _____
20. It is known to be statutory exemption. _____

12
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

Exercise 1.3

TRUE OR FALSE. State whether the statement is TRUE or FALSE. Write your answer on the space
provided after each number.

1. The value-added tax is a property tax. _____

2. Our Constitution does not prohibit double taxation. _____
3. The power of taxation is always a legislative function. _____
4. Income tax is an indirect tax. _____
5. Under the present constitution, the president is authorized to increase or decrease national
internal revenue tax rates. _____
6. Due process of law means, a law which hears before it condemns and renders justice before it
proceeds upon inquiry. _____
7. Every sovereign government has the inherent power to tax. _____
8. One nature of taxation is the reciprocal duties of protection and support between the state and
subjects thereof. _____
9. The community tax (residence tax) is now a local tax. _____
10. Taxes are debts and therefore no person may be imprisoned for non-payment of the same.
_____
11. The poll tax provided for in the constitution refers to the community tax. _____
12. Tax laws should be construed most strongly against the government and in favor of the taxpayer
if the meaning of the tax statute is doubtful. _____
13. A regressive tax is one the rate of which decreases as the tax base increases. _____
14. Complete and perfect uniformity in taxation is attainable. _____
15. Generally, laws granting tax exemption are interpreted as strictly against the government and in
favor of taxpayers. _____
16. The constitution does not authorize the use of public money derived from taxation in favor of
any religious order. _____
17. Local government are now authorized under the constitution to levy taxes and create its own
laws. _____
18. Public purpose means equal distribution of benefits to the taxpayers. _____
19. Tax laws are superior to laws covering obligation and contracts. _____
20. The tax courts cannot question the wisdom of the imposition of a tax. _____

13
 LESSON 2
INCOME CONCEPTS AND EXCLUSIONS
Learning Objectives:

At the end of the chapter, the student should be able to:

 Know the legal concept of income.
 Explain the bases and nature of income.
 Know the different kind of income in taxation.
 Know the exclusions from gross income.

Sec. 32 of National Internal Revenue Code (NIRC) states that Gross income means all income derived
from whatever source, including the following:
1. Compensation for services in whatever form paid
2. Income derived from the conduct of trade or business or the exercise of a profession
3. Gains derived from dealings in property
4. Interest
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions
11. Partner’s distributive shape from the net income of the general professional partnership

GENERAL CLASSIFICATION OF INCOME

For taxation purposes, the income of a taxpayer may be broadly classified as taxable income and
non-taxable income.
Taxable income refers to the earnings of a taxpayer subject to the basic or normal income tax, rates
ranging from 20% to 35% for the taxable year 2018-2022 and 15% to 35% for the taxable year 2023
onwards, on the amount in excess of ₱250,000.00, or to final tax.
Non-taxable income refers to earning of the taxpayers that are excluded from gross
income as provided in the NIRC, as amended, and other tax laws. Non-taxable income should never be
included in the computation of the gross taxable income.

INCOME
INCOME

Taxable Non-taxable

1. Compensation 1. Life insurance proceeds

2. Business income 2. Return of premium
3. Gains from property 3. Gifts, bequest, devices
4. Passive income 4. Compensation for injuries
5. Other taxable income 5. Retirement benefits
6. Other non-taxable income 14
CLASSIFICATION OF TAXABLE INCOME

The Tax Code does not expressly classify taxable income. However, to facilitate discussion, the
following broad classification is made:
1. Compensation income
2. Business income from exercise of profession
3. Gains from dealings in property
4. Passive income
5. Other taxable income

COMPENSATION INCOME

Compensation income means all remuneration for services performed by an employee for
his/her employer under the employer-employee relationship, unless clearly excluded by the Tax Code.

Composition of Gross Compensation Income

The following are included as part of gross compensation income;
1. Salaries, wages or frees
2. Commission
3. Honoraria
4. Allowances
5. Thirteenth month pay and other benefits
6. Holiday pay, overtime pay, night shift differential pay, and hazard/emergency pay
7. Separation pay
8. Retirement pay
9. Sick leave pay/vacation leave pay
10. Fringe benefits

Salaries, Wages or Fees

Salaries are generally an earning paid on regular interval; wages are paid on an hourly or daily
basis; and fees implies payment to an individual who is of authority like director’s fees, legal fees,
account’s fees or fees for conduct of religious ceremony (e.g., marriage, baptismal or masses.

Commission

Payment made based on certain percentage of output like salesman commission or

underwriter’s commission. Commission is taxable even if the employee receiving the compensation is a
minimum wage earner.

Honoraria

Honoraria are earnings derived from services usually undertaken by an individual who rendered
his/her expertise in a particular field. An example is the honoraria given to a special lecturer.

15
Allowances
An allowance may either be fixed or variable. Allowance may be fixed when it is attached to the
position or office, and variable when it changes consequently as influenced by certain factors such as
number of visitors, distance of travels, or frequencies of seminar.

The most common types of allowances received by an employee are:

1. Cost of living allowance (COLA).
2. Representation and traveling allowance (RATA).
3. Personnel economic relief allowance (PERA).

Thirteenth Month Pay and Other Benefits

The thirteenth (13th) month pay of an employee is tantamount to one-month basic salary of
officials and employees of the government, national or local, including government-owned or controlled
corporations, and/or private offices, it is received after the 12th month pay.
The 13th month pay is equals to the total basic salary during the year divided by 12 months.
Other benefits include Christmas bonus, productivity incentive bonus, performance-based
bonus, loyalty award, gifts in cash or in kind, and other benefits of similar nature actually received by
officials and employees of both government and private offices.
The 13th month pay shall cover benefits paid or accrued during the year, provided that the total
amount shall not exceed ₱90,000.
Otherwise stated, any amount in excess of ₱90,000 is taxable. Thus, 13th month pay, cash gift,
and bonus not exceeding ₱90,000 is neither taxable nor subject to withholding tax.

Holiday, Overtime, Night Shift Differential, and Hazard/Emergency Pay

Hazard pay refers to the amount paid by the employer to employees who were actually
assigned to work to danger or strife-torn areas, disease-infested places, or in distressed or isolated
stations and camps, which expose them to great danger of contagion or peril to life. Holiday pay,
overtime pay, night shift differential pay, and hazard pay is generally taxable.

Separation Pay

Separation pay may be taxable or non-taxable. It is taxable if the separation is voluntarily made
by the employee. Separation pay is not taxable on account of:
1. Sickness
2. Disability
3. Death
4. Reorganization of the company
5. Bankruptcy of the company

Retirement Pay

As a general rule, retirement pay is taxable. The exceptions are the following:
1. Retirement pay from SSS or GSIS
2. Retirement pay from employer, provided the following requirements are compiled:
a. The retirement plan of the company has been approved by the BIR Commissioner.
b. The retiree should have been connected with the company for 10 years.

16
 c. The retiree should be at least 50 years old.
d. The retiree availed the retirement for the first time.
e. The retirement plan is fair and equitable to all employees, regardless of position.

Sick Leave and Vacation Leave

The salary of an employee on vacation or sick leave, which is paid to him/her notwithstanding
his/her absence from work, constitutes taxable compensation income.

Fringe Benefits

Fringe benefits means any good, service or other benefit granted in cash or in kind by an
employer to an individual employee in addition to his/her basic salary.

Fringe benefits may be subject to final or basic tax. The guidelines are:
1. If the recipient of the fringe benefit is a rank-and-file employee, the amount is subject to basic tax;
hence, it becomes part of gross compensation income.
2. If the recipient is occupying supervisory or managerial position, the fringe benefit is subject to final
tax.

BUSINESS/PROFESSIONAL INCOME

Business income represents gain or profit derived from the investment of money, goods, services or
its equivalent.
Professional income refers to the earnings of individuals who exercise their profession to the public.
For example, a physician that provides medical services in his/her clinic, a certified public accountant
who offers accounting bookkeeping, tax consultancy and auditing services, and a lawyer who provides
legal services are all professionals with income obtained from the exercise of their profession.
Gross income derived from doing business shall be equivalent to gross sales less sales returns,
discounts and allowances, and cost of goods sold.
In the case of taxpayers engaged in the sale of services, gross income means gross receipts sales
returns, discounts, allowances and cost of services
Cost of services shall mean all direct costs and expenses necessarily incurred to provide the services
required by the customers and clients.
Cost of goods sold shall include all business expenses directly incurred to produce the
merchandise to bring them to their present location and use.
For trading or merchandising concerns, cost of goods sold shall include the invoice cost of the
goods sold, plus import duties, freight in transporting goods to the place where the goods are actually
sold, including insurance while the goods are in transit.
For manufacturing concerns, cost of goods manufactured and sold shall include all costs of
production of finished goods, such as raw materials used, direct labor and manufacturing overhead,
freight cost, insurance premiums, and other costs incurred to bring raw materials to the factory or
warehouse.

17
Accounting Methods of Reporting Business Income

There is no prescribed method of reporting business income. It is the discretion of the taxpayer,
he/she shall adopt an accounting method or system of recording the business income that is best suited
to his/her purpose and will to reflect the true results of operation.
The accounting methods of recognizing business income are as follows, but are not
limited thereto:
1. Accrual basis
2. Cash basis
3. Hybrid method
4. Crop-year basis
5. Installment method
6. Deferred payment method
7. Percentage of completion method and completed contract method
8. Spread out and outright methods

Accrual Basis

The income, profits, and gains are included in the gross taxable income when earned, whether
received or not, and expenses are included in the allowable deductions when incurred whether pair or
not.

Cash Basis

The income, profits, and gains are reported as gross income when received, and expenses are
deductible when paid.

Hybrid Method

The hybrid method is the combination of the accrual and cash basis or reporting income and
expenses. This is a practice of reporting income on the cash basis and recording expenses on accrual
basis, or the other way around.

Crop-year Basis

Farmers adopt the crop year basis of computing gross income when the gestation period of the
crop is more than one year. Gestation period refers to the span of time from planting to harvesting.
All operating and production expenses incurred are deducted when an income is
realized.

Installment Method

The amount of income to be reported under installment method is a portion of the collection
received during the year. The following may report their income under installment method;
1. A taxpayer who regularly sells a personal property on installment;
2. A taxpayer who makes a casual sale of personal property, other than inventory, on installment
basis; provided the selling price exceeds ₱1,000, and the initial payments do not exceed 25% of
the selling price;

18
 3. A taxpayer who sells or dispose real property on installment basis, provided the initial payments
do not exceed 25% of the selling price.

Deferred Payment Method

The deferred payment method of recognizing income is a variation of installment method, since
property are sold also on installment basis, but the initial payment exceeds 25% of the selling price. If
the initial payment, therefore, is not more than 25% of the selling price, then the installment method
shall be used. Usually, the amount of income recognized in deferred payments method is the difference
between the selling price and the cost of the property.

Percentage of Completion Method and Completed Contract Method

There are the two methods used in long-term construction contract.

1. The percentage of completion method reports income based on the progress of work.
2. The completed contract method, on the other hand, reports income only upon the completion
of the project.

Computation of Gross Business Income

The basic rule is that the taxpayer shall adopt a method of computing income that the best suits
his/her purpose, provided the method employed reflects the true results of operation.
One factor that determines the mode of computing the gross income of the business or
professions is the nature of the business. Business entities are classified according to their nature as
follows:
1. Merchandising. Business entity engaged in buying and selling goods or products without
changing the form or appearance of the product. An example is Shoe Mart.
2. Manufacturing. Business engaged in buying and selling goods by changing the form of the
product through a certain process. An example is the Coca-Cola Company.
3. Service. Business establishment engaged in providing services. An example is the Philippine
National Bank.
4. Farming or agriculture. Business entities engaged in agriculture farm operation or production of
farm animals. An example is Dole Philippines.
5. Construction. Business engaged in the construction of roads, bridges, buildings, and other
permanent structures. An example is the JRS Construction Company.

Farming or Agriculture

A business entity engaged in farming may determine the gross income using the following methods:
1. Cash basis
The cash basis of computing gross income shall be used if the business entity does not
maintain inventory or does not take into account the value of the inventory.
2. Accrual basis
Under the accrual basis, the gross income is computed by considering the value of the
inventory.

19
 3. Crop year basis
The crop year basis of computing gross income is usually adopted when the time to
produce the crop or its gestation period is more than one year. Farming engaged in rubber
production has five to eight years’ gestation period.

Construction Business
The gross income of a business entity engaged in the construction of permanent structures, such
as buildings, roads or bridges, is computed using:
1. Completed contract method. This method will only recognize income once the project is fully
completed.
2. Percentage of completion method. The percentage of completion, as the title suggests, will
recognize income based on the progress of the work completed.

GAINS FROM DEALINGS IN PROPERTY

Gains from dealings in property arise from sale or exchange of property, real or personal
property. Gains from dealings in property are income derived from the sale or exchange of assets, either
ordinary or capital. Gains represent the excess of the selling price over costs or other determinable
value. Losses, meanwhile, are the excess of costs and related expenses over selling price. Gains from
dealings in property are one of the major items comprising the gross taxable income.

MEASUREMENT OF GAINS AND LOSSES

Notwithstanding the basic rule, the gain or loss in property is computed by considering the very
nature of the transaction.
The transaction may be:
1. A sale of property; or
2. An exchange of property.

Sale of Property

The amount of gain or loss from a sale transaction is equal to the difference between the selling
price and the cost.
Exchange of Property

The amount of gain or loss from an exchange transaction is the difference between the fair
market value of the asset received and the cost of the asset given.

In determining gain or loss on disposal or exchange of asset, the cost of the property is deduced
either from the selling price or from the fair market value.

DETERMINATION OF GAIN (LOSS)

Sale of Property Exchange of Property
Selling price xxxxx Fair market value xxxxx
Less: Cost xxxxx Less: Cost xxxxx
Gain (loss) xxxxx Gain (loss) xxxxx

20
ORDINARY ASSETS AND CAPITAL ASSETS

Another important factor in determining gains or losses from dealings in property is the
classification of property.

Capital Assets

Section 39 (A1) of the Tax Code defines “capital assets” as properties held by the taxpayer
(whether or not connected with his/her trade or business), but do not include stock in trade of the
taxpayer or other properties of kind, which would properly be included in the inventory of the taxpayer
if on hand at the close of taxable year, or properties held by the taxpayer if on hand at the close of
taxable year, or properties held by the taxpayer primarily for sale to customers in the ordinary course of
his/her trade or business, or properties used in trade or business, of a character which is subject to the
allowance for depreciation or real properties used in trade or business of the taxpayer.
By the process of elimination, the term “capital assets” will embrace all properties, whether
connected or not with the business, which are not classified as ordinary assets.

Ordinary Assets

By the process of exclusion, ordinary assets refer to any property enumerated as follows:
1. Stock in trade of the taxpayer or other property of a kind that would properly be included in the
inventory of the taxpayer if on hand at the end of the taxable year
2. Property used in trade or business of a character which is subject to the allowance for
depreciation
3. Real property used in trade or business of the taxpayer

ORDINARY AND CAPITAL GAIN (LOSS)

In the disposition of ordinary assets, there arises ordinary gain or ordinary loss. Likewise, in the
sale of capital assets, there will be capital gain or capital loss.
Ordinary gain refers to the excess of the selling price over the cost of an ordinary asset. Ordinary
loss is the excess of the costs over the selling price of an ordinary asset being sold or exchanged.
Capital gain refers to excess of selling price over costs/other determined value of a capital asset.
Capital loss is the excess of cost over the selling price of capital asset.
Net capital gain is the excess of capital gains from capital losses in the disposition or exchange
of capital assets.
Net capital loss is the excess of capital losses over capital gains in the sale or exchange of capital
assets.

PASSIVE INCOME

The income is termed passive when the taxpayer earned the profit or gains without effort or
labor exerted. Passive income is subject to a separate and final tax at fixed rates ranging from 5% to
25%; hence, it shall not be included as part of the gross taxable income subject to basic or normal tax.
The final tax on passive income shall be withheld by the payor who acts as the withholding
agent and remits the same to the BIR.
The following income tax is considered passive income subject to final tax:

21
  Resident Citizen Non-resident Alien Non-resident Alien
Types of Income  Non-resident Engaged in Business or NOT Engaged in
Citizen Trade in the Philippines Business or Trade
 Resident Alien in the Philippines
A. Interest income
Interest income in the Philippines 20% 20% 25%
Yields or any other monetary
benefits from deposit substitutes, 20% 20% 25%
trust funds, and similar
arrangement in the Philippines
Interest income from long-term
deposits or investments evidenced Exempted Exempted 25%
by certificates prescribed by the
BSP with maturity of five years or
more
If long-term deposit is
pre-terminated before the 5th year,
the final tax shall be: 5% 5% 25%
4 years – less than 5 12% 12% 25%
years 20% 20% 25%
3 years – less than 4
years
Less than 3 years
Interest income under the
Expanded Foreign Currency Deposit *15% Exempted Exempted
System (FCDS) Non-resident citizen –
Exempted
B. Royalty income
In general 20% 20% 25%
On books, literary works, musical
works in the Philippines 10% 10% 25%

C. Prizes and winnings

In general 20% 20% 25%
Prizes less than ₱10,000 Subject to basic tax Subject to basic tax
From the Philippine Charity
Sweepstake Office (PCSO) and Lotto In excess of ₱10,000 is In excess of ₱10,000 is 25%
subject to 20% final tax subject to 20% final tax

D. Cash and/or Property Dividends

a. Cash and/or property dividends
actually or constructively
received from a domestic
corporation or from joint stock
corporation, insurance or 10% 20% 25%
mutual fund companies and
regional operating
headquarters of multinationals
(beginning January 1, 2000)

22
b. Share of an individual in the
distributive net income after
tax of a partnership (other than
a general professional 10% 20% 25%
partnership) of which he is a
partner (beginning January 1,
2000)
c. Share of an individual in the net
income after tax of an
association, a joint account, or
a joint venture or consortium 10% 20% 25%
taxable as a corporation of
which he is a member or
co-venturer (beginning January
1, 2000)

OTHER TAXABLE INCOME

Income earned that cannot be classified as compensation, business income, earnings from
dealings f properties or passive income shall be classified under this category
Other income includes the following:
1. Interest income
2. Rent income
3. Dividend income
4. Annuities
5. Prizes and winnings
6. Pensions

INTERST INCOME

Interest income on bank deposit in the Philippines is subject to final tax 20%. However, interest
income on bank deposit earned outside the Philippines shall be part of the gross taxable income subject
to basic tax.
Interest income other than those subject to final tax is included as part of the gross income
subject to basic normal tax. Unless exempted by law, interest received by a taxpayer is taxable. Interest
includes those arising from indebtedness, whether business or non-business.

RENT INCOME

Rent income arises from leasing out of property, either real or personal. The amount of taxable
rent income shall be the sum of the following:
1. Current rent lease payment
2. Advance rent payment or security deposit without restriction
3. Payment of the lessee to third parties like interest, taxes, and loans insurance premium in
behalf of the lessor
4. Uncollected rent income earned already (accruals) at the end of the period
5. Income from leasehold improvements

23
 Advanced rent or security deposit without restriction shall be reported as income in the period
actually received, regardless if the taxpayer uses an accrual or cash basis of accounting.

Income from Leasehold Improvements

Leasehold improvements are additions, improvements, major renovation or complete new

structure to the existing property to improve the present condition, appearance or working capacity.

Method of Computing Income from Leasehold Improvements

1. Outright method. The basis of tax using the outright method is the fair market value of the
improvement on the date such improvement has been completed notwithstanding the effective
date of the contract. No income on leasehold improvement shall be recognized, therefore,
unless the improvement has been completed notwithstanding the consummation of lease
contract.
2. Spread-out Method. The amount of income that shall be recognized under the spread-out
method shall be the allocated portion pertaining to each period or term realized. The allocated
portion pertaining to each period is equal to the book value of the improvement at the end of
the lease term of the leaser.

DIVIDEND INCOME

This is an income earned by a taxpayer from the distribution of earnings or profits of a

corporation. The dividends are payable in money or in property. The dividends that are not subject to
final tax or not expressly exempted from taxation shall be included in the gross income of individual or
corporate taxpayers.

Basic Guidelines on Dividends

To facilitate easy understanding of dividends, the following categories are suggested:

1. Dividend received from a domestic corporation. A domestic corporation subject to tax declares
and distributes dividends, and the recipient of dividends is:
a. A domestic or resident corporation. The dividend is tax-exempt.
b. A resident foreign corporation. The dividend received is exempt from tax.
c. A non-resident foreign corporation. Generally, the dividend is subject to a final tax rate of
30% effective January 1, 2009. However, under the rule f reciprocity, it is subject to a final
tax of 15%.
d. A resident citizen, non-resident citizen, or resident alien. The dividend is subject to 10% final
tax.
e. A non-resident alien engaged in business or trade in the Philippines. The dividend earned is
subject to final tax of 20%.
f. A non-resident alien not engaged in business or trade in the Philippines. The dividend is
subject to 25% final tax.

The dividend income from a domestic corporation deemed 100% from within the
Philippines.

24
 2. Dividend earned from a resident foreign corporation. The following tax procedures may be
followed.
a. Dividend received by individual taxpayers from resident foreign corporation shall be
included in the computation of gross taxable income subject to the scheduler income tax
rate.
b. Dividends received by corporate entity subject to tax from resident foreign corporation are
included in computing gross taxable income subject to 30% tax rate effective January 1,
2009.
c. Resident foreign corporation is taxable on its income from within the Philippines. In case the
gross income of a resident foreign corporation derived from the Philippines for three-year
period preceding the declaration of dividend is:
 Less than 50% of the total gross income (within and without) – the dividend is
deemed earned from outside the Philippines. The dividend shall not be included
as part of the gross taxable income.
 More than 50% but not more than 85% of the total gross income (within and
without) – the dividend income is deemed earned partly within and partly
outside the Philippines. The dividends shall be prorated, and the amount
realized from within the Philippines shall be included in computing gross taxable
income.
 More than 85% of the total gross income (within and without) – the dividend is
deemed earned from within the Philippines; hence, the total amount of
dividend is included in the computation of gross taxable income.
d. In case the problem is silent, dividend income earned is deemed 100% earned from within
the Philippines.

3. Dividend earned from a non-resident foreign corporation. The following guidelines may be
observed if dividends are declared and distributed by a non-resident foreign corporation:
a. In case the recipient is an individual taxpayer, the amount of dividends shall be included
in computing gross taxable income subject to the scheduler income tax rate.
b. If the recipient is a domestic corporate entity, the inter-corporate dividends shall be
included in the computation of gross taxable income subject to 30% income tax rate
effective January 1, 2009.

Forms of Dividends

A corporate entity may distribute part of its earnings as dividends in the following forms:
1. Cash dividend. Cash dividend, if received by an individual taxpayer – regardless of classification
– and a non-resident foreign corporation, is subject to final tax based on the cash received.
However, if received by a domestic or resident foreign corporation, the cash dividend is
tax-exempt.
2. Property dividend. Property dividend is subject to final tax at the same rate of cash dividend
based on the fair market value of the property at the time of dividend declaration, if the
recipient is classified as an individual taxpayer or non-resident foreign corporation.
Again, inter-corporate property dividends received from domestic corporations by other
domestic corporations and resident foreign corporations are tax exempt.
3. Stock dividend. The basic rule is that stock dividend is not taxable. A company simply capitalizes
its earnings by merely transferring part of its retained earnings to capital stock.
The following procedures may be followed:

25
 a. Pure stock dividend is tax-exempt. Stock dividend is said to be pure stock when the
dividend declaration and payment is in the form of shares of stock.
b. Stock dividend representing distribution of earnings is taxable. Distribution of earnings
occurs if the following elements are present:
 The stockholders have the option to receive cash or property dividend, instead
of stock dividend and some stockholders exercise that option.
 The option, when exercised, results to change in the old proportionate interest
of stockholders in the corporation.
4. Liquidating dividend. Liquidating dividend represents return of capital to the stockholders and is
not taxable. However, in case the amount returned exceeded the cost of investment, the excess
is subject to capital gains tax.
When the company is already distributing all its assets because it is undergoing
dissolution, the difference between the amount received and the cost of investment is treated
as either capital gain or capital loss.
5. Scrip dividend. Scrip dividend is a form of dividend payment made through the issuance of a
promissory note. Scrip dividend is subject to final tax based on the fair market value of the note.

ANNUITIES

Annuity refers to the installment amount paid for life insurance coverage returned by an
insurance company. The annuity received that represents interest is taxable, and shall be included in the
gross taxable income, while the amounts that represent return of premium are not taxable.

PRIZES AND WINNINGS

The guidelines to be observed are:

1. Prizes, winnings, and awards shall be included in the computation of gross income if:
a. Received by an individual taxpayer from Philippines sources, and the amount of prizes
or winnings is ₱10,000 or less;
b. Received by an individual taxpayer from foreign sources regardless of the amount; and
c. Received by corporations from Philippines or foreign sources regardless of the amount.
2. Prizes, winnings, and awards received by an individual taxpayer from Philippines sources are
subject to 20% final tax.
3. The following prizes, winnings, ad awards are tax-exempt; hence, they are to be excluded from
gross taxable income, whether the taxpayer is an individual or corporate entity:
a. Prizes or awards to athletes in national and international sports competition held in the
Philippines and abroad and governed by recognized sports associations
b. Prizes and awards in recognition of religious, charitable, educational, scientific, artistic
or literary performance or achievement, provided the recipient was selected without
action on his/her part, and he/she is not required to render substantial future service in
view of the award

PENSIONS

Amount of money received in lump sum or on staggered basis in consideration of services

rendered. Pensions are being given after the individual reaches the age of retirement. It is taxable to the
extent of the amount received except if there is as approved pension plan by the Bureau of Internal
Revenue.

26
EXCLUSION FROM GROSS INCOME

Section 32(B) of the NIRC lists the items for exclusion from gross income.
1. Proceeds of life insurance policy payable upon the death of the insured. However, it is taxable if
the insured outlives the policy.
2. Return of premiums either during the term, at the maturity, or upon surrender of the contract.
3. The value of the property acquired by gift, bequest, devise or descent.
4. Compensation for personal injuries or sickness received from insurance plus damages.
5. Income of any kind which are contained in a treaty binding upon the Philippine government.
6. Retirement benefits, pension, etc.
a. Retirement benefits – requisites
i. The employer must maintain a private pension plan which is approved by the BIR;
ii. The employee has been in the service of the same employer for at least 10 years;
iii. The retiring employee must not be less than 50 years old upon retirement;
iv. The benefit of exemption can be availed of only once.
b. Separation pay – separation of employee from service must be due to:
i. Death, sickness, physical disability, or
ii. Any cause beyond the control of the employee.
7. Prizes and awards – given to religious, charitable, scientific, educational, artistic, literary, or civic
achievement, provided that:
a. The recipient did not join the contest; and
b. He is not required to render substantial future services.
8. Benefits received by persons residing in the Philippines under U.S. laws administered by U.S.
Veterans Administration;
9. Benefits received from SSS, GSIS including retirement gratuity received by government officials
and employees;
10. Income derived by foreign governments;
11. Income derived by the government or its political subdivisions from public utility or any essential
government function;
12. Prizes and awards granted to athletes in –
a. Local and international sports competitions,
b. In the Philippines or abroad,
c. Sanctioned by their national sports associations,
d. And the sports association must be recognized by the Philippine Olympic Committee
13. 13th month pay and other benefits up to ₱90,000;
14. GSIS, SSS, Medicare and Pag-Ibig and Union dues of individuals;
15. Gains from sale of bonds, debentures and other certificate of indebtedness with a maturity
period of more than 5 years;
16. Gains realized by investors upon redemption of shares in a mutual fund company;
17. Compensation Income of Minimum Wage Earners (MWEs) who work in the private sector (and
public sector not exceeding the minimum in the non-agricultural sector) and being paid the
Statutory Minimum Wage (SMW), as fixed by the Regional Tripartite Wage and Productivity
Board (RTWPB)/National Wages and Productivity Commission (NWPC), applicable to the place
where he/she is assigned including their holiday pay, overtime pay, night shift differential pay
and hazard pay.

27
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 2.1
TRUE OR FALSE. State whether the statement is TRUE or FALSE.
1. Income represents inflow of money or benefits even coming from illegal source, such as gambling,
extortion, theft, bribes, and smuggling.
2. Compensation income is an earning from services rendered by an employee under an
employer-employee relationship.
3. Compensation means all remuneration for services performed by an employee for his/her employer
under an employer-employee relationship.
4. All the payments received by the employee from the employer are treated as taxable compensation
income.
5. The employer-employee relationship shall be present at the time the payment is made for remuneration
to be classified as compensation income.
6. Employer is an individual performing services under an employer-employee relationship.
7. There is employer-employee relationship when the person for whom services are performed has the
right to control and direct the individual who performs the services.
8. Fixed allowances received by an employee are taxable, while the variable allowances are tax-exempt.
9. When the allowance received by an employee is intended for the benefit of the employer, the amount is
not included in the employee’s gross taxable income.
10. Benefits like Christmas bonus, 13th month pay, and productivity incentive bonus of the government
officials and employees are non-taxable because of the concept that government officials and employees
render service to the public.
11. Hazard pays provided to employees, either in private sector or government agencies, who are regularly
exposed to dangerous or hazardous chemicals, are not taxable.
12. Retirement pay or benefits from SSS or GSIS are non-taxable.
13. Retirement pay is basically non-taxable because the pay serves as a gift of the government to aged
individuals.
14. Premium paid by an employer to cover the life insurance of an employee is not taxable if the beneficiary
of the life insurance policy is the company.
15. Crop year basis is used by farmers whose crop take more than one year from planting up to harvesting
and disposing – the entire cost of production under which is deducted from the gross income in the year
it was realized.
16. The percentage of completion method used by a business entity in long-term construction project
implies that recognition of income is based on the progress of work performed.
17. Passive income refers to income that is expressly exempted by law from taxation.
18. Passive income subject to final tax shall form part of the gross income for purposes of computing the
normal income tax liability of individuals and corporations.
19. Interest income on deposit earned in the Philippines is an example of a passive income.
20. Gifts, bequests, and devices are subject to final tax.
21. Prizes and winnings with value less than ₱10,000 are normally subject to final tax.
22. Prizes and awards received in recognition of religious, charitable, scientific, educational, artistic, literary
or civic achievement are not taxable if the recipient was selected without any action on his/her part to
enter the contest and he/she is not required to render substantial future services as a condition to
receiving the prize or award.
23. Proceeds of the life insurance policy received by the heirs or beneficiary of the insured are not taxable.
24. Fringe, benefits received by rank-and-file, other than de minimis, are included in the gross taxable
income.
25. The 13th month pay of government officials and employees is taxable in excess of the ₱90,000 threshold.

28
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 2.2
Problem
Mr. Ricardo Dalisay, a chemical engineer at Probinsyano Company, recently tendered his
resignation from the company because he got a favorable financial offer from the Manilenyo Company.
Bearing a monthly rate ₱20,000, his total basic salary for his 10 months stay at Probinsyano amounted
to ₱200,000. Because of his exposure to chemicals at Probinsyano, he has given a hazard pay equivalent
to 100% of his one-month basic salary and an overtime pay of 5% of his total salary for 10 months. Mr.
Ricardo Dalisay also received a separation pay of ₱15,000 upon his resignation.

Required: Determine the gross compensation income of Mr. Ricardo Dalisay from Probinsyano
Company.

29
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 2.3
Problem
Eat Bulaga Company provided benefits to the following employees in addition to their basic salary:
 Mr. Vic Sotto, controller, with a monthly salary of ₱50,000, is housed by the company in a
penthouse located outside the business premises. The prevailing rental value of the penthouse
is ₱18,000 per month.
 Mr. Joey De Leon, with a monthly salary of ₱10,000 as receivable clerk, is likewise housed by the
company in an ordinary dormitory with monthly rental payment of ₱3,000.

Required: Determine the compensation income of Mr. Vic Sotto and Mr. Joey De Leon for the taxable
year.

30
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 2.4
Problem
At the end of 2018, Showtime Company reported the following:

Sales on account ₱ 3,700,000

Cash sales 1,800,000
Cost of sales 1,500,000
Salaries and wage paid during the year 250,000

During 2018, the company collected 40% of the sales on account, and has unpaid
salaries to employees of ₱30,000.

Required: Determine the gross income and salaries expenses using the:
1. accrual method
2. cash basis method

31
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 2.5
Problem
Mr. Albert, a self-employed individual, presented the following data showing his business the
business operation in 2018:

Sales ₱5,800,000
Sales returns and allowances 150,000
Merchandise inventory, January 1, 2018 1,200,000
Merchandise inventory, December 31, 2018 1,800,000
Freight-in 80,000
Purchase 4,100,000
Purchase returns and allowances 110,000
Freight-out 90,000

Required: Compute the gross taxable income during the current year.

32
 LESSON 3
ALLOWABLE DEDUCTIONS
Learning Objectives:

At the end of the chapter, the student should be able to:

 Discuss the nature of deductions.
 Discuss the different kinds of deductions.
 Know the different business expenses.

Deductions refer to the amounts that are subtracted from the gross income to arrive at the taxable
income. The amounts are deductible if allowed by the National Internal Revenue Code (NIRC) or by the
Revenue Regulations issued by the Secretary of Finance.
The concept of allowable deductions discussed in this chapter applies to both individual and
corporate taxpayers.

KINDS OF DEDUCTION
Generally, the types of deduction are:
1. Optional standard deduction;
2. Itemized deductions; and
3. Special deductions.

OPTIONAL STANDARD DEDUCTION

Optional standard deduction is a deduction that the individual taxpayer may elect to use instead of
using the itemized deduction.
The following guidelines shall be observed in applying the optional standard deduction:
1. The maximum allowable amount for individual taxpayers is 40% of gross sales or gross receipts
effective July 6, 2008, (Rev. Reg. No. 16-2008).
2. For corporate taxpayers, the total optional deductions shall not exceed 40% of gross income
effective July 6, 2008.
3. The following taxpayers are allowed to adopt the optional standard deduction:
a. Resident citizen
b. Non-resident citizen
c. Resident alien
d. Taxable estate
e. Trusts
f. Domestic corporation
g. Resident foreign corporation
4. Non-resident aliens and non-resident foreign corporations cannot adopt the optional standard
deduction.
5. The 40% optional standard deduction shall not be allowed for taxpayers earning compensation
income arising from an employer-employee relationship.
6. An individual taxpayer who is entitled to and claims the optional standard deduction shall not be
required to submit with his/her return financial statements required by the Tax Code.

33
 7. Taxpayers who select optional standard deduction should signify so in his/her return, and such
election shall be irrevocable during the taxable year.
Unless the taxpayer signifies in his/her return his/her intention to elect the optional standard
deduction, he/she shall be considered as having availed himself/herself of the itemized deduction.

DEDUCTIONS FROM GROSS INCOME

Itemized deduction Optional standard deduction

1. Business expenses 1. Individual taxpayers – 40% of
2. Interest gross sales or receipts
3. Taxes 2. Corporation – 40% of gross
4. Losses income
5. Bad debts The election is irrevocable.
6. Depreciation and depletion Individual taxpayers shall not be required
7. Charitable & other contributions to submit financial statement with their
8. Research and development cost tax return.
9. Pension trust

Special deduction
1. Special deductions allowed to insurance companies

Individual taxpayers who opted for the optional standard deduction shall keep the records
pertaining to their gross sales or gross receipts, and for the corporation, such records pertaining to its
gross income as defined in Section 32 of the Tax Code during the taxable year as may be required by the
rules and regulations promulgated by the Secretary of Finance, upon the recommendation of the BIR
Commissioner.

ITEMIZED DEDUCTIONS

Itemized deduction is a listing of specific expenses enumerated and allowed under Sec. 34 of the
Tax Code and related tax regulations to be deducted from gross taxable income to arrive at the taxable
income.
Usually, the specific items allowed in the itemized deductions are the items that appear in the
income statement of the business entity.

Taxpayers Entitled to Itemized Deductions

The following taxpayers may use the itemized deduction:
1. General professional partnership
2. Corporations, either domestic or foreign
3. Estates and trusts engaged in business
4. Individual taxpayers who are engaged in trade, business or exercise of professions, except
non-resident alien

34
Composition of Itemized Deduction

Section 34 of the NIRC, as amended, enumerates the following items as allowable deductions
against the gross taxable income:
1. Business expenses
2. Interest
3. Taxes
4. Losses
5. Bad debts
6. Depreciation
7. Depletion of oil and gas wells and mines
8. Charitable and other contributions
9. Research and development costs
10. Pension trusts

Business Expenses

In general, there shall be allowed as deduction from gross income all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the
development, management, and operation and/or conduct of the trade, or exercise of a profession,
including:
1. Reasonable allowance for salaries, wages, and other forms of compensation for personal
services actually rendered, including the grossed-up monetary value of fringe benefits provided
or granted by the employer to the employee, provided that the final tax imposed has been paid.
2. A reasonable allowance for travel expenses, locally and abroad, while away from home in the
pursuit of trade, business or profession
3. A reasonable allowance for rentals and/or other payments which are required as a condition for
the continued use or possession of property to which the taxpayer has not taken the title or
which he/she has no equity other than that of a lessee, user or possessor
4. A reasonable allowance for entertainment, amusement, and recreation expenses during the
taxable year that are directly connected to the development, management, and operation of the
trade, business or profession of the taxpayer, provided that any expenses incurred are not
contrary to law, morals, public policy or public order

Otherwise stated, business expenses are ordinary, necessary, and reasonable expenses incurred
in running the affairs and operation of the business entity to achieve its goals and objectives. The
business expenses may include the following:
1. Salaries, wages, and other forms of compensation
2. Grossed-up monetary value of fringe benefits granted by the employer to the employee
3. Travel allowance and expenses in the pursuit of trade, business or profession
4. Representation, entertainment, amusement, and recreation expenses that are directly related
to the development of the taxpayer’s trade, business or profession
5. Rental expenses for the use of property
6. Commissions
7. Supplies used
8. Advertising and other selling expenses
9. Other similar business expenses

35
Requisites for Business Expenses to be Deductible
The following requisites shall be met for business expenses to be deductible:
1. Expenses must be both ordinary and necessary.
2. The amount must be reasonable.
3. Expenses must be connected with the taxpayer’s trade, business or profession.
4. Expenses must be incurred or paid during the taxable year.
5. Expenses are not contrary to law, morals, public policy or public order.
6. Expenses must be supported with receipts or other forms of business documents.

The following business expenses, however, are discussed for greater emphasis:
a. Salaries
The term “salaries” includes wages and other forms of compensation for personal
services actually rendered, including the grossed-up monetary value of fringe benefits
provided or granted by the employer to the employee, provided that the final tax has been
paid.
Normally, salary expenses are supported by a payroll. The gross amount is the
deductible figure and not the net mount or take home pay of the employees.

b. Travel expenses
Expenses for travel or transportation in the pursuit of trade, business or profession
within the country or abroad are deductible.
Travel expenses include money spent for meals and lodging while on travel;
provided that the expenses are connected with the business and the amounts are
reasonable.

c. Rental expenses
Rental expenses include rents and other payments which are required as a condition for
the continued use of possession, for the purpose of trade, business or profession, of
property to which the taxpayer has not taken or is not taking title or which he/she has no
equity other than that of a lessee, user or possessor.
Other payments related to rent include taxes and insurance paid by the lessee for the
business property of the lessor being used by the lessee related to his/her business or
profession.

d. Representation and entertainment expense

Representation and entertainment expenses include expenses paid for amusement and
recreation during the taxable year, which are directly connected with the business activities
or profession of the taxpayer.
The allowable amount is subject to the following limitation:
 Taxpayers engaged in – 1/2 % of net sales
Sale of goods (inventories)
 Taxpayer engaged – 1% of net revenue
sale of services, exercise of
profession, and rental of
properties

The allowable amount shall be the actual amount incurred or paid or the limitation,
whichever is lower.

36
Interest Expense

Sec. 2(a) of RR 13-2000 defined “Interest Expense” or payment for the use or forbearance
or detention of money, regardless of the name it is called or denominated. Interest expense arises when
an individual borrows money from a bank or financial institutions or when a penalty is imposed in view
of delinquent payment of financial obligations.

Requisites for Interest Expenses to be Deductible

1. There is indebtedness as evidenced by a document.
2. The indebtedness must be that of the taxpayer.
3. The indebtedness must be connected with the taxpayer’s trade, business or profession.
4. The interest must have been paid or accrued during the taxable year.

Classification of Interest Expense

Although the Tax Code does not categorically classify interest expense, it is suggested, to facilitate
easy discussion, that it shall be classified as follows:

1. Deductible interest expense subject to limitation.

Basically, the amount of interest expense incurred or paid is deductible in full.
However, Section 34 (B) of the Tax Code, as amended, mentions that the amount of
interest paid or incurred within a taxable year on indebtedness in connection with the
taxpayer’s profession, trade or business shall be allowed as deduction from gross income;
provided, that the taxpayer’s allowable deduction for interest expense shall be reduced by an
amount equal to 33% of the interest income subject to final tax effective January 1, 2009.
Simply stated, if a taxpayer incurs interest expense in connection with business and, at
the same time, earns interest income subject to 20% final tax, the allowable interest expense
shall be reduced by an amount equivalent to the interest income multiplied by 33%.

2. Deductible interest expense in full amount

a. Interest for tax delinquency.
b. Interest payment on scrip dividends.
c. Interest payment on deposits.
d. Interest payment on bonds.

3. Non-deductible interest expense

a. Interest paid in advance by a taxpayer using the cash basis method of accounting
b. Interest expense arising between related taxpayers
c. Interest expense if the indebtedness is incurred to finance petroleum exploration
d. Interest on preferred stock
e. Interest agreed on orally
f. Interest on indebtedness that has prescribed

4. Optional treatment of interest expense

At the option of the taxpayer, interest incurred to acquire property used in trade,
business or exercise of a profession may be allowed as a deduction or treated as a capital
expenditure.
The optional treatment of interest expense is only applicable if the taxpayer borrows
money for the acquisition of property for the use of the business or exercise of profession.

37
 The two alternative procedures are:
a. Outright expense
b. Capital expenditure

Taxes

Taxes paid or incurred within the taxable year in connection with the taxpayer’s profession,
trade or business shall be allowed as deduction, except those expressly not allowed by the Tax Code, as
amended.

Requisites for Taxes to be Deductible

1. They must be paid or incurred during the taxable year.
2. They must be connected with the taxpayer’s trade business or profession.
3. They must be imposed directly upon the taxpayer.

Classification of Taxes
To simplify, taxes are classified as
1. Non-deductible taxes
a. Philippine income tax
b. Estate tax
c. Donor’s tax
d. Value-added Tax
e. Special assessment
f. Stock transaction tax
g. Income taxes paid in foreign country treated as tax credit
2. Deductible taxes
a. Import duties
b. Excise taxes
c. Occupation taxes
d. Documentary stamp taxes
e. Privilege and license taxes
f. Business taxes except taxes on the sale of shares of stock through the local stock
exchange
g. Local business and municipal
h. Automobile registration fees

It should be noted, however, that interests and surcharges on tax delinquency are not
deductible as taxes, but as interest expense. The deductible taxes are equal only to the amount of taxes
due before any interest and surcharges.

Limitations on Taxes as Deduction

1. For non-resident alien engaged in trade or business in the Philippines and a resident foreign
corporation, the deductible amount is limited to the extent of income from within the
Philippines.
2. For a citizen of a foreign country residing in the Philippines, whose income from sources within
such foreign country, is not subject to Philippines income tax paid such foreign country, which
corresponds to his/her net income subject to Philippine income tax, shall be allowed as a
deduction.

38
 The portion of taxes paid to the foreign country, which is deductible, is computed as
follows:

Net income from within

Deductible the Philippines Taxes paid to
Foreign taxes Net income – World foreign country

Losses

Losses actually sustained during the taxable year and not compensated by insurance or other
forms of indemnity shall be allowed as deductions if incurred in the pursuit of trade, business, or
profession.
Losses may arise from fire, storm, shipwreck or other casualties, or from robbery, theft or
embezzlement.
The taxpayer shall submit a declaration of loss sustained from casualty or robbery, theft or
embezzlement during the taxable year in no less than 30 days nor more than 90 days from the date of
discovery of such losses.
No loss shall be allowed as a deduction if at the time of the filing of the return, such loss has
been claimed as a deduction for estate tax purposes in the estate tax return.

Requisites for Losses to be Deductible

1. The loss must be actually sustained in a closed and completed transaction.
2. The loss must be that of the taxpayer and incurred in connection with trade, business or
profession.
3. The loss must not be compensated by insurance or other forms of indemnity.
4. The loss must be reported to the BIR within the period of 30 days up to 90 days from the date of
the discovery of the loss.

Classification of Losses
Losses are classified as:
1. Deductible losses. The following losses are deductible subject to some requirements:
a. Business losses and losses from theft, robbery or embezzlement
b. Casualty losses arising from storm, fire or shipwreck
c. Net operating loss carry-over (NOLCO)
d. Other types of losses

2. Non-deductible losses. In the computation of taxable income, losses arising from sales or
exchanges of properties under the following cases are not deductible:
a. Losses incurred between members of the family. The family or individual shall include
only his/her brothers and sisters (whether by whole or half-blood), spouse, ancestors,
and lineal descendants.
b. Losses arising between an individual and a corporation where more than 50% in value of
the outstanding stock of which is owned, directly or indirectly, by or for such individual,
except in case of distributions in liquidation
c. Losses on sale or exchange between two corporations where more than 50% in value of
the outstanding stock of which is owned, directly or indirectly, by or for the same
individual, if either one of such corporations, with respect to the taxable year of the

39
 corporation preceding the date of the sale or exchange was, under the law applicable to
such taxable year, a personal the law applicable to such taxable year, a personal holding
company or a foreign personal holding company, except in case of distributions in
liquidation
d. Losses between the grantor and a fiduciary of any trust
e. Losses between the fiduciary of a trust and the fiduciary of another trust, if the same
person is a grantor with respect to each trust
f. Losses incurred between fiduciary of a trust and a beneficiary of such trust

Business Losses
Ordinarily, business entities sell goods and/or render services to customers on credit. Also,
business concerns use either the accrual or cash basis of accounting. Credits extended to customers
sometimes, if not often, are not paid; hence, business losses are incurred.
Losses of income due to worthless debts are either deductible or not.

Casualty Losses
Casualty losses arise from accidents, natural calamities or man-made events resulting in
destruction, deprivation or deterioration of the value of the property. The casualty losses should be on
account of fires, storms, flood, earthquakes, shipwrecks, car accidents, or other similar forms of
casualty.

Net Operating Loss Carry-over (NOLCO)

Net operating loss means the excess of allowable deduction over gross taxable income in a
particular taxable year.
The net operating loss of the business or enterprise for any taxable year immediately preceding
the current taxable year, which had not been previously offset as deduction from gross income, shall be
carried over as a deduction from gross income for the nest three consecutive taxable years immediately
following the year of such loss.

Limitations of NOLCO
The following are the limitations in applying NOLCO:
1. The operating loss had not been previously offset as deduction from gross income.
2. Any net loss incurred in a taxable year that the taxpayer was exempt from income tax
should not be allowed as a deduction.
For instance, if the government granted Mr. Frederick a tax-exempt status during
2011 and his business incurred a net loss, he could not carry forward and deduct the net loss
against the next year’s taxable net income.
3. The NOLCO shall be allowed only if there has been no substantial change in the ownership
of the business or enterprise in that:
a. Not less than 75% in nominal value of outstanding issued shares, if the business is in the
name of a corporation, is held by or on behalf of the same persons; or,
b. Not less than 75% of the paid-up capital of the corporation, if the business is in the
name of a corporation, is held by or on behalf of the same persons.

Nominal value of outstanding issued shares refers to the par value or stated value of the
shares of stock issued and in the possession of the stockholders of the corporation.
Simply stated, this refers to the total outstanding capital of the corporation.

40
 4. The net operating loss can be carried over only for the next three consecutive taxable years
immediately following the year of the incurrence of the loss.
5. For mines other than oil and gas wells, net operating loss incurred in any of the first 10 years
of operation may be carried over as a deduction from taxable income may be carried over as
a deduction from taxable income for the next five years immediately following the year of
such loss.
The entire amount of such loss shall be carried over to the first of the five taxable
years following the loss, and any portion of such loss which exceeds the taxable income of
such first year shall be deducted in like manner from the taxable income of the next
remaining four years.

Taxpayers Entitled to NOLCO

1. Self-employed individual taxpayers
2. Estates and trusts
3. Domestic and resident foreign corporations covered by the normal basic tax
4. Domestic and resident foreign corporations (special corporation) subject to preferential tax rate
like hospitals and private educational institutions

Taxpayers Not Entitled to Carry Forward Net Operating Loss

1. Individual taxpayers earning income purely from compensation. Also, net operating loss cannot
be deducted from compensation income.
2. Offshore banking unit of foreign banks as duly authorized by the Bangko Sentral ng Pilipinas
3. Foreign currency deposit units of both domestic and foreign bank duly authorized by the Bangko
Sentral ng Pilipinas
4. Taxpayers who are exempt by law from income taxation

Other Types of Losses

The types of losses are:
1. Capital losses. The concepts and principles on losses arising from sale or exchange of capital
assets have been lengthily discussed in Chapter 5 – Gains and from Dealings in Property.
2. Loss from wash sales of stock or securities. Similarly, the proper tax procedures and treatment
on losses sustained or incurred relative to wash sales on shares of stock have been deeply
discussed in Chapter 5.
3. Wage losses. Wagering gains or losses refer to earnings or losses derived from gambling,
whether legal or illegal. The basic procedures are:
a. If there is only a wagering gain, the gain is included in the gross taxable income.
b. If there is only a wagering loss, the loss is a non-deductible item.
c. If there is both a wagering gain and a wagering loss, the wagering loss is deducted from
wagering gain, and the result is treated as follows:
 Net wagering gain is included in the gross taxable income.
 Net wagering loss is non-deductible item.
4. Losses from diminished value of shares of stock. When the market value of shares of stock,
classified as ordinary assets decreased below their acquisition cost or unit cost, the loss is not
deductible unless the shares of stock are actually sold or exchanged.
5. Losses from securities becoming worthless. If securities become worthless during the taxable
year and are capital assets, the loss resulting therefrom shall be considered as a loss from the
sale or exchange of capital assets on the last day of such taxable year.

41
 6. Abandonment losses. In the event a contract area where petroleum operations are undertaken
is partially or wholly abandoned, all accumulated exploration and development expenditures
pertaining thereto shall be allowed as a deduction; provided that accumulated expenditures
incurred in that area prior to January 1, 1979 shall be allowed as a deduction only from any
income derived from the same contract area. In all cases, notices of abandonment shall be filed
with the BIR Commissioner.

Bad Debts

Bad debts refers to worthless or uncollectible amounts, in whole or in part, which is due to a
taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or
services rendered.

Requisites for Bad Debts to be Deductible

1. There must be an existing debt, which is valid, subsisting, and demandable.
2. The existing debts must be ascertained to be worthless.
3. The debts must be charged off within the taxable year.
4. The existing indebtedness must be connected with trade, business or exercise of profession.
5. The debts must not be sustained or incurred between related parties.

Depreciation

There shall be allowed as a deduction a reasonable allowance for the wear, tear, and
obsolescence of property used in trade or business.
Depreciation is the reduction in the value of intangible assets brought about by wear, tear, and
obsolescence. Otherwise stated, depreciation is the allocated costs of the intangible assets used in trade
or business over its useful life.
At the time the assets are acquired, the whole acquisition costs is capitalized and not treated as
outright expense. Expenses start to be recognized once the asset is used in the operating activities of
the business. Such expense is termed as “depreciation” or “amortization”.
Depreciation is applicable when the assets are tangible. Examples of tangible assets subject to
depreciation are building, machinery, equipment, furniture and fixtures, and tools.
However, when the asset is intangible, that is, without physical appearance, the appropriate
term to denote reduction in its value is amortization. Intangible assets include franchise, patents,
trademark, goodwill or copy rights.

Requisites for Depreciation to be Deductible

1. The assets must be connected with trade, business or profession.
2. The amount of allowance to be provided shall be reasonable. The term “reasonable allowance”
shall include an allowance computed in accordance with rules and regulations prescribed by the
Secretary of Finance upon the recommendation of the BIR Commissioner using the straight-line
method, declining balance method or sum-of-the-years-digit method.
3. The amount of depreciation should be charged off during the year.

Methods Used in Computing Depreciation

The various methods of computing depreciation shall be, but not limited, to the following:
1. Straight-line method. The straight-line method allocates the depreciable amount of the asset
equally over the estimated life.

42
 Depreciable amount is computed by deducting the residual value or scrap value of the
asset at the end of its useful life from acquisition costs. Residual or scrap value refers to the
estimated realizable amount at the end of the life of the asset. Estimated useful life refers to the
period when the asset is productively used in the operation of the business.

The formulas to compute annual depreciation using straight line are:

Cost minus residual value
a. Depreciation =
Estimated life in years

b. Depreciation = Depreciable cost x Annual straight-line rate

The straight-line rate is computed as follows:

100%
Annual straight line rate =
Estimated life in years

2. Declining balance method. The Tax Code, as amended, provides that under the declining balance
method, the depreciation rate shall not exceed twice the rate that would have been used had
the annual depreciation allowance been computed under the straight-line method.
Simply stated, using the double declining balance method would just double the annual
depreciation rate under the straight-line method.
In computing the depreciation using the double declining balance method, the following
points should be remembered:
a. The residual value or scrap value is disregarded.
b. A uniform rate is applied (straight line depreciation rate times two).
c. At the end of the asset’s life, any scrap value may be simply deducted from the
remaining book value.

3. Sum-of-the-years digit (SYD) method. Under this method, the depreciable cost of the assets is
multiplied by a certain fraction; the numerator is equal to the life of the asset, and the
denominator is equal to the sum of the remaining useful life of the asset.
The formula to compute the denominator is as follows:

Estimated life + 1
SYD factor = Estimated life ( )
2

Applying the given formula, if the estimated useful life of the assets is six years, the SYD factor
will be 21 (6[(6 + 1)/2]).
In computing the depreciation using SYD method, the residual value is deducted from the cost
of the asset.

4. Miscellaneous provisions on depreciation

a. Agreement as to useful life on which depreciation rate is based

43
 Where under rules and regulation, the taxpayer and the BIR Commissioner have
entered into agreement in writing specifically dealing with the useful life and rate of
depreciation of any property, the rate so agreed upon shall be binding on both the taxpayer
and the national government in the absence of facts and circumstances not taken into
consideration during the adoption of such agreement. The responsibility of establishing the
existence of such facts and circumstances shall rest with the party initiating the
modification. Any change in the agreed rate and useful life of the depreciable property as
specified in the agreement shall not be effective for taxable years prior to the taxable year,
in which notice in writing by certified mail or registered mail is served by the party initiating
such change to the other party to the agreement.

b. Depreciation of properties used in petroleum operations

The following guidelines shall be observed in handling depreciation of properties
used in petroleum operation:
 An allowance for depreciation in respect of all properties directly related to production
of petroleum initially placed in service in a taxable year shall be allowed under the
straight-line or declining balance method of depreciation at the option of the service
contractor.
 However, if the service contractor initially elects the declining balance method, it may at
any subsequent date, shift to the straight-line method.
 The useful life of properties used in or related to production of petroleum shall be 10
years or shorter as may be permitted by the BIR Commissioner.
 Properties not used directly in the production of petroleum shall be depreciated under
the straight-line method based on an estimated useful life of five years.

c. Depreciated of properties used in mining operations

An allowance for depreciation in respect of all properties used in mining
operations shall be computed as follows:
 At the normal rate of depreciation if the expected life is 10 years or shorter.
 Depreciated over any number of years between five years and the expected life if
the latter is more than 10 years, and the depreciation thereon allowed as deduction
from taxable income, provided that the contractor notifies the BIR Commissioner at
the beginning of the depreciation period as to which depreciation rate allowed will
be used.

d. Depreciation deductible by non-resident alien engaged in trade or business or resident

foreign corporations
In the case of a non-resident alien individual engaged in trade or business or a
resident foreign corporation, a reasonable allowance for the deterioration of property
resulting in its use or non-use in the business, trade or profession shall be permitted only
when such property is located in the Philippines.

e. Options of private educational institutions

A private educational institution has the following options relative to properties
acquired and subject to allowance for depreciation:
 Expenses incurred in the acquisition of property that has been capitalized can be
deducted in full during the taxable year when the property was acquired.

44
  Allocate the acquisition costs over the estimated useful life of the asset by providing
regularly the annual allowance for depreciation.

Depreciation of Oil and Gas Wells and Mines

The term “depletion” is synonyms with depreciation and amortization, since it connotes
reduction in the carrying value of the asset. Technically, however, it is appropriately used to refer to
reduction of value of wasting assets. The term ‘wasting assets” generally refers to assets which are
natural resources physically consumed and not replaceable, such as oil, ore, coal, timber, and precious
metals like gold and silver.

General Guidelines in Handling Depletion of Oil and Gas Wells and Mines
1. A reasonable allowance for depletion computed in accordance with the cost-depletion method
shall be allowed or granted as deductible item.
Basically, there are three methods of determining depletion, namely:
a. Cost-depletion method.
b. Percentage depletion method.
c. Discovery depletion method.
2. When the allowance for depletion equals the capital invested, no further allowance shall be
granted. In short, the amount of allowance for depletion is limited only to the capital invested.
3. After production in commercial quantities has commenced, certain intangible exploration and
development drilling cost:
a. Shall be deducted in the year incurred if such expenditures are incurred for
non-producing wells and/or mines, or
b. Shall be deductible in full in the year paid or incurred or, at the election of the taxpayer,
may be capitalized and amortized if such expenditures incurred are for producing wells
and/or mines in the same contract area.
4. Any intangible exploration, drilling, or development expenses may be handled in the following
manner:
a. If incurred for non-producing wells and/or mines, which means efforts are not
successful, the expenditures are deductible in the year incurred.
b. If incurred for producing wells and/or mines, which means efforts are successful, the
expenditures are deductible in full in the year incurred or may be capitalized and
amortized.
5. Any intangible exploration, drilling, and development expenses allowed as a deduction in
computing taxable income during the year shall not be considered in computing the adjusted
cost basis for the purpose of computing allowable cost depletion.

Guidelines in Deducting Exploration and Development Expenditures

1. In computing taxable income from mining operations, the taxpayers may deduct exploration
and development expenditures accumulated as cost or adjusted basis for depletion as of date of
prospecting, as well as exploration and development expenditures paid or incurred during the
taxable year.
2. The total amount deductible for exploration and development expenditures shall not exceed
25% of the net income from mining operations computed without the benefit of any tax
incentives under existing laws.
3. The actual exploration and development expenditures minus 25% of the net income from
mining shall be carried forward to the succeeding years until fully deducted.

45
 4. The election by the taxpayer to deduct the exploration and development expenditures is
irrevocable and shall be binding in succeeding taxable years.

Guidelines in Deducting Depletion by a Non-resident Alien Individual or a Foreign Corporation

In the case of non-resident alien individual engaged in trade or business in the Philippines or a
resident foreign corporation, allowance for depletion of oil and gas wells or mines shall be authorized
only in respect to oil and gas wells or mines located in the Philippines.
Net income from mining operation shall mean gross income from mining operations less
allowable deductions that are necessary or related to the operations.
Allowable deduction shall include mining, milling, and marketing expenses, and depreciation of
properties directly used in the mining operations. It does not apply to expenditures for the acquisition or
improvement of property of a character which is subject to the allowance for depreciation. Similarly, it
does not apply to amounts paid or incurred for the exploration and development of oil and gas.
Exploration expenditures mean expenditures paid or incurred for ascertaining the existence,
location, extent, or quality of any deposit of ore or other minerals, and paid or incurred before the
beginning of the development stage of the mine or deposit.
Development expenditures mean expenditures paid or incurred during the development stage of
the mine or other natural deposits. The development stage of the mine or other natural deposit shall
begin at the time when deposits of ore or other minerals are shown in sufficient commercial quantity
and quality and shall end upon commencement of actual commercial exploration.

Charitable and Other Contributions

In general, contributions or gifts actually paid or made within the taxable year to, or for the use
of, the government of the Philippines or any of its agencies or any political subdivisions exclusively for
public purpose shall be deductible from the gross taxable income of the taxpayer.

Requisites for Charitable Contributions to be Deductible

1. There must be an actual contribution made.
2. The taxpayer giving charitable donations must be engaged in business, trade or exercise of
profession.
3. The entity receiving the donations is among those specified by law.
4. The net income of the institution must not insure to the benefit of any individual or private
stockholder.

Classification of charitable contributions

Charitable and other contributions are classified as follows:
1. Deductible charitable contributions
Deductible charitable and other contribution is further classified into:
a. Charitable contributions deductible in full donations to the following entities or
institutions are deductible in full:
 Government of the Philippines or to any of its agencies or political subdivisions,
including fully-owned government corporations exclusively to finance, to
provide for or to be used in undertaking priority activities in:
- Education
- Health
- Youth and sports development
- Human settlement

46
 - Science and culture
- Economic development
 Donations for economic development shall be in accordance with the National
Priority Plan determined by the National Economic Development Authority
(NEDA), in consultation with appropriate government agencies, including its
regional development councils and private philanthropic persons and
institutions; otherwise, any donation made to the government or any of its
political subdivision shall be subject to limitations.
b. Foreign institutions or international organizations in compliance with agreements,
treaties or commitments entered into by the government and the foreign
institutions or international organizations or in pursuance of special laws
c. Accredited non-government organizations organized and operated exclusively for
scientific, research, educational, character-building, youth and sport development,
health, social welfare, cultural and charitable purposes; provided, the following
conditions or requirements are fully complied with, otherwise, deduction will be
subject to limitations:
 The donations or contributions must be utilized directly for the active for which
it was organized not later than the 15th day of the third month after the close of
the taxable year.
 The amount of administrative expenses shall in no case exceed 30% of the total
expenses.
 In case of dissolution, the assets would be transferred to another non-profit
domestic corporation organized for a similar purpose.

The following are some of non-profit organizations recognized by the

government where donations are fully deductible:
 Cultural Center of the Philippines (CCP)
 Ramon Magsaysay Award Foundation (RMAP)
 Boy Scout of the Philippines (BSP)
 Girl Scout of the Philippines (GSP)
 Integrated Bar of the Philippines (IBP)
 Roxas Educational and Welfare Committee
 National Social Action Council (NASAC)
 International Rice Research Foundation
 Development Academy of the Philippines (DAP)
 State colleges and Universities (SUCs)
 School of Deaf and Blind (SDB)
 Philippine Amateur Athletic Association (PAAF)
 Artesin Well Fund
 National Museum, Library, and Archives

2. Charitable contributions subject to limitation

Charitable or other contributions to the following entities are subject to limitations;
hence the amount donated or contributed cannot be deducted totally:
a. Government of the Philippines or any of its political subdivisions exclusively for
public purpose

47
 b. Domestic corporations, associations or institutions organized and are operating
exclusive for the following purpose:
 Religious
 Charitable
 Scientific
 Youth and sports development
 Cultural or educational
 Rehabilitations of veterans
c. Social welfare institutions
d. Non-governmental organizations (NGOs)

Amount of Limitation
The ceilings of charitable contribution subject to limitation are:
1. 10% if the donor is an individual taxpayer; and
2. 5% if the donor is a corporation.

The basis of the 10% or 5% is the taxable business income before the contribution. Similarly, the
deductible amount is the limitation or the actual contribution, whichever is lower.

Taxable income relative to the computation of the limitation means gross taxable income from
trade, business or exercise of profession minus the allowable deductions. The basic and additional
personal exemptions shall not be deducted to determine such taxable income.

Non-deductible Charitable Contribution

Charitable and other contributions not expressly covered by taxation law or any special law or
contributions that did not meet the requirements of the law are non-deductible contributions.

Basic Procedures in Computing the Deductible Amount

1. Determine whether contributions are deductible or non-deductible. Non-deductible
contributions are excluded.
2. If the contribution is deductible, determine whether donation is deductible in full or subject to
limitation.
3. If the contribution is subject to limitation, compute the taxable income before personal
exemptions.
Taxable income is computed by subtracting allowable deductions except charitable
contributions from gross taxable income. The computation of gross taxable income is lengthily
discussed in Chapter 4 – Concept of Income
4. Multiply the taxable income before contribution by the following percentages:
a. 5% if the donor is a corporation
b. 10% if the donor is an individual taxpayer
5. Compare the actual contributions and the results obtained in Step 4 and use the lower amount
as deductible contribution.

Valuation of Property Donated Other than Money

The amount of any charitable contribution of property other than money shall be based on the
acquisition cost of said property.

48
Research and Development Costs
Research and development costs refer to expenses incurred by taxpayers relative to scientific or
technical evaluation and findings of improving, formulating, and testing products or processes prior to
full-scale commercial production.

Requisites for Research and Development Costs to be Deductible

1. They must be paid or incurred by the taxpayer in connection with his/her trade, business or
profession.
2. They must not be treated as an expense.
3. The costs are chargeable to capital account, and not chargeable to property of a character which
is subject to depreciation or depletion.
4. They must be ordinary and necessary.

Tax Treatment of Research and Development Costs

Business expenses that are properly classified as research and development costs are handled
either as:
1. Ordinary and necessary expenses recognized in the period incurred or paid
2. Capitalized and then amortized over a period of not less than five years

Limitations on Deduction
Deduction on search and development shall not apply to:
1. Any expenditures for the acquisition or improvement of land, or for the improvement of
property to be used in connection with research and development of a character which is
subject to depreciation and depletion
2. Any expenditure paid or incurred for the purpose of ascertaining the existence, location, extent
or quality of any deposit of ore or other mineral, including oil or gas

Pension Trusts
An employer establishing or maintaining a pension trust to provide for payment of reasonable
pensions to his/her employees shall be allowed a deduction in addition to the contributions to such
trust fund during the taxable year to cover the pension liability accruing during the year.
Requisites for Pension Trusts to be Deductible
1. They must be ordinary and necessary business expenses.
2. The contribution must be reasonable.
3. The amount is intended for the payment of pensions to employees.
4. The tax required to be deducted and withheld therefrom has been paid to the BIR.
5. The pension trust must be established and maintained by the employer.

Deductible Pension Trust

The following contributions or payments to pension trust are deductible with their
corresponding tax treatment:
Deductible pension trust contributions Proper tax treatment
1. Contributions or payments to cover pension Deduct the full amount
liabilities accruing during the taxable year
2. Contributions or payments to cover pension Prorated in equal period
trust in excess of the contributions or of ten 10 years beginning
contributions for past pensions in the year in which payment

49
SPECIAL DEDUCTIONS

Insurance Companies
For insurance companies, whether domestic or foreign doing business in the Philippines, the
following may be deducted from their gross income:
1. Net additions, if any, required by law to be made within the year to reserve funds.
2. Sums other than dividends paid within the year on policy and annual contracts

NON-DEDUCTIBLE ITEMS

In computing net income, no deduction shall, in any case, be allowed in respect to:
1. Personal, living, or family expenses
2. Any amount paid out for news buildings or for permanent improvements, or betterments made
to increase the value of any property or estate
3. Any amount expensed in restoring property or in making good the exhaustion thereof for which
an allowance is or has been made
4. Premiums paid on any life insurance policy covering the life of any officer or employee, or of any
person financially interested in any trade or business carried on by the taxpayer, individual or
corporate, when the taxpayer is directly or indirectly a beneficiary under such policy
5. Losses from sale or exchange or property:
a. Between members of a family. The family of an individual shall include only his/her
brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal
descendants
b. Except in the case of distributions in liquidation, between an individual and a
corporation more than 50% in value of the outstanding stock of which is owned, directly
or indirectly, by or for such individual
c. Except in the case distributions in liquidation, between two corporations more than 50%
in value of the outstanding stock of which is owned, directly or indirectly, by or the same
individual
d. Between the grantor and a fiduciary of any trust
e. Between the fiduciary of a trust and the fiduciary of another trust, if the same person is
a grantor with respect to each trust
f. Between fiduciary of a trust and beneficiary of such trust

50
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

Exercise 3.1

MULTIPLE CHOICE. Encircle the letter of the correct answer.

1. The optional standard deduction on individual is –

a. 40% of taxable income.
b. 40% of business and/or professional including compensation income.
c. 40% of business and/or professional income.
d. 10% of business and/or professional excluding compensation income.

2. Optional standard deduction is allowed to

a. Resident alien
b. Nonresident alien engaged in trade or business
c. Nonresident alien not engaged in trade or business
d. Nonresident foreign corporation

3. One is not a deductible tax

a. Local business tax c. Privilege tax
b. Value-added tax d. Occupation tax

4. Which of the following items is correct?

a. Interest incurred on loan from a brother is deductible.
b. Interest expense incurred on unpaid value-added tax is reduced by 42% of interest income
subjected to final tax.
c. Interest payable which had already prescribed is deductible if paid voluntarily by the
taxpayer.
d. Interest incurred to acquire a business asset may be added to the cost of the property.

5. Which of the following statements is correct?

a. All compensation payments made by an employer to an employee are deductible to the
employer.
b. All compensation payments made by an employer to an employee are taxable to the
employee.
c. All travelling expenses incurred by an employee which are in accordance with the itinerary
of travel approved by the employer are not taxable to the employee.
d. Transportation expenses incurred by an employee are nevertheless deductible to the
employer even if they are not incurred while “away from home”.

51
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 3.2

TRUE OR FALSE. State whether the statement is TRUE or FALSE.

1. All expenses related to business activities that are reasonable and duly supported with
documents are deductible.
2. Business expenses are deductible if so provided in the Tax Code or related BIR issuances.
3. The 40% optional standard deduction is computed based on gross taxable income from
business, compensation, and exercise of profession.
4. Corporate taxpayers may opt to use the 40% optional standard deduction.
5. Non-resident citizens can adopt the 40% optional standard deduction.
6. Business expenses that are necessary but not ordinary in the operating activities are allowable
deductions.
7. Estimated expenses are deductible from gross taxable business income, provided they are
necessary and ordinary.
8. Unreasonable business expenses, though necessary and ordinary, are non-deductible.
9. Expenses paid to the officials of the national government, that constitute kickbacks, are
deductible subject to certain conditions.
10. Travel expense of employees, whether connected or not with the business, provided they are
supported with documents, are deductible.
11. Rental expenses include taxes and insurance paid by the lessee on the property of the lessor.
12. Advance rent payment is deductible in full during the time of payment.
13. Improvements on the leased property are deductible expenses apportioned over the term of
the lease.
14. Accrued interest expenses are non-deductible; but interest expenses paid during the taxable
year are deductible.
15. The 12% interests on late filing and late payment of tax return are deductible.
16. Interest paid in advance is deductible currently if the taxpayer employs the cash basis of
recording.
17. If the taxpayer is using the cash basis, interest discounted on loan borrowings is deductible at
the time of the full payment of indebtedness.
18. Interest expenses duly supported by necessary documents incurred between members of the
family are allowable deductions.
19. The interest expense may be added to the cost of the property and apportioned over its
estimated useful life.
20. All taxes incurred and paid are deductible business expense.
21. Taxes deductible from gross income are taxes proper, interests, and penalties incident to tax
delinquency.
22. If there is a 100% loss, the amount of deductible loss is equal to the value of the property.
23. The tax principle on net operating loss carry-over is applicable only to individual taxpayers.
24. Generally, net operating loss can be carried forward over a period of five years following the
period of loss.

52
25. Estimated uncollectible bad debts are allowable deduction from the gross taxable income.
26. Partial recognition of debts is deductible, provided it is supported by necessary required
documents.
27. Bad debts previously written off and later collected in succeeding year are included in the gross
taxable income.
28. Under the straight-line method of depreciation, the amount of depreciation is equal to
depreciable costs apportioned over the useful life of the property.
29. The scrap value of depreciable assets is disregarded in the computation of depreciation using
the declining balance method.
30. The depreciation rate adopted by the taxpayers shall be approved by the BIR Commissioner.
31. Properties directly used in petroleum operations are depreciated over a period of five years or
shorter as may be allowed by the BIR Commissioner.
32. Charitable contributions are deductible from compensation income.
33. Charitable contributions extended to government entities for health and human settlement are
deductible in full.
34. Donations to accredited non-governmental organizations are deductible in full subject to certain
conditions.
35. Donations of individual taxpayers to the national or local government units are deductible in full
amount.

53
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 3.3

Problem

Assume that Mr. Bong acquired a machine at a cost of ₱ 7,600,000 with no salvage
value. The useful life of the machine is estimated to be 25 years.

Required:
1. Assuming the straight-line method was used, the annual depreciation on the machine is?
2. Assuming that at the end of the 20 th year, it was determined that the machine has 10 more years of
useful life, how much shall be the depreciation expense from the 21 st year to 30th year?
3. Assume further that instead of the machine having 10 more years of useful life, it only has 2 years,
what is the depreciation expense for the remaining two years?

54
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 3.4

Problem

BA Company presented the following data on an asset acquired on January 1, 2017:

Acquisition cost ₱ 2,000,000

Residual value 200,000
Estimated useful life 20 years

Required: Compute the depreciation using the double declining balance method.

55
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 3.5

Problem

On January 1, 2018, KMJS Company acquired an additional office equipment costing

₱830,000. The asset has an estimated useful life of four years with a residual value of ₱30,000.

Required: Compute the depreciation using the SYD method.

56
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 3.6

Problem

Mr. Jong practicing his profession donated gifts worth ₱ 60,000 to Home for the Homeless, an
accredited non-governmental organization. The taxpayer’s gross income for the taxable year is ₱
2,000,000 while the deductions, ₱ 1,500,000 the donation excluded.

Required: Determine how much of his donation shall be allowed as deduction.

57
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 3.7

Problem

Assume the following data of a taxpayer:

Building construction cost ₱ 4,000,000

Additions 2,000,000
Accumulated depreciation 3,200,000
Insurance recovered 2,400,000

Required: Compute the deductible loss from fire.

58
 LESSON 4
TAXATION OF INDIVIDUAL TAXPAYERS
Learning Objectives:

At the end of the chapter, the student should be able to:

 Discuss the classification of individual taxpayers.
 Explain what the sources of income are.
 Compute for the income tax on an individual taxpayer

From the concept of taxation, individual taxpayer means any person who derives income from
their practice of profession, of having trade or business, or that receiving compensation as an employee.
Therefore, individual taxpayer is a natural person. The term does not include judicial entity created by
the operation of law and having personality separate and distinct from the owner or owners, these are
business entities in the form of sole proprietorship, partnership or corporation.

Person in Taxation Means

 Individual – refers to a person deriving income from his/her practice of profession, trade or
business or earning compensation as an employee.
 Corporation – shall include partnerships, no matter how created or organized, joint stock companies,
joint accounts (cuentas en participacion), associations, or insurance companies, but does
not include general professional partnerships and a joint venture or consortium formed
for the purpose of undertaking construction projects or engaging in petroleum, coal,
geothermal and other energy operations pursuant to an operating or consortium
agreement under a service contract with the Government (Tax Code).
 Estate – refers to the mass of all property, rights and obligations of a person which are not
extinguished by his death.
 Trust – a right on property, real or personal, held by one party for the benefit of another.

CLASSIFICATION OF INDIVIDUAL TAXPAYERS

CLASSIFICATION OF INDIVIDUAL TAXPAYERS

Based on citizenship *Based on filing status

Citizen of the Philippines

1. Single
1. Resident citizen
2. Head of the family
1 2. Non-resident citizen
3. Married

Alien
1. Resident alien
2
2. Non-resident alien
a. Engaged in business
b. Not engaged in

59
*The classification of individual taxpayers based on filing status is no longer applicable under the new tax law, the
Tax Reform for Acceleration and Inclusion (TRAIN) Act also known as Republic Act 10963.

Taxpayers According to Citizenship

1. Citizens of the Philippines. The following individuals are citizens of the Philippines:
a. Those who are citizens of the Philippines at the time of the adoption of the 1987
Constitution (on February 2, 1987);
b. Those whose fathers or mothers are citizens of the Philippines;
c. Those born before January 17, 1973 of Filipino mothers who elect Philippine citizenship
upon reaching the age of majority;
d. Those who are naturalized in accordance with law.

Sub-classification of Citizen Taxpayer

For income tax purposes, a citizen is further classified into:
1) A resident citizen is a Filipino citizen who:
a. resides or stay in the Philippines permanently; or
b. stays outside the Philippines for less than 183 days during a particular taxable year.
2) A non-resident citizen is a Filipino citizen who may be:
a. A citizen of the Philippines who establishes to the satisfaction of the BIR Commissioner
the fact of his/her physical presence abroad with a definite intention to reside therein;
b. A citizen of the Philippines who leaves the Philippines during the taxable year to reside
abroad, either as an immigrant or for employment on a permanent basis;
c. A citizen of the Philippines who works and derives income from abroad and whose
employment thereat requires him/her to be physically present abroad most of the time
during the taxable year;
d. A citizen who has been previously considered as a non-resident citizen and who arrives
in the Philippines at any time during the taxable year to reside permanently therein shall
likewise be treated as a non-resident citizen for the taxable year in which he arrives with
respect to his income derived from sources abroad until the date of his/her arrival in the
Philippines;
e. The taxpayer shall submit proof to the commissioner to show his intention of leaving the
Philippines to reside permanently abroad or to return to and reside in the Philippines as
the case maybe.

2. Aliens. Individuals who are not Filipinos:

Sub-classification of Aliens
For income tax purposes, aliens are further classified as follows;
1) Resident alien refers to an individual whose residence is within the Philippines, but is not a
citizen thereof.
2) Non-resident alien means an individual who does not reside in the Philippines and who is
not a citizen thereon.
A non-resident alien is further classified as follows:
a. A non-resident alien engaged in trade or business refers to:
i. An individual who is not a citizen and who is not a resident of the
Philippines, but has a business, particularly a sole proprietorship,
established and operating in the Philippines; or

60
 ii. A non-resident alien who comes to the Philippines and stays for an
aggregate period of more than 180 days during the taxable year.
b. A non-resident alien not engaged in trade or business refers to:
i. One who comes to the Philippines for a definite purpose which in its nature
may be promptly accomplished.
c. Special aliens are individuals with source of income under special employment
contracts, in offshore banking units, petroleum contractors, and regional or area
headquarters of multinational corporations operating in the Philippines.

Taxpayers According to Filing Status

The classifications of individual taxpayers according to filing status are as follows:
1. Single - A single individual taxpayer is unmarried, widowed, divorced, or married but legally
separated, without any qualified dependent.
2. Head of the family - refers to an unmarried or legally separated man or woman with one or both
parents, or with one or more legitimate, recognized or legally adopted children, living with and
dependent upon him/her for their chief support, where such brothers or sisters or children are
not more than 21 years of age, unmarried, and not gainfully employed; or where such brothers,
sisters or children, regardless of age are incapable of supporting themselves because of mental
or physical defect. For taxation purposes, benefactors of senior citizen are also considered heads
of the family.
3. Married - refers to a person who is legally married including one who is separated from his/her
spouse neither by way of divorce nor by way of legal separation, with or without qualified
dependent children.

*ALLOWABLE PERSONAL EXEMPTION

Personal exemption is an arbitrary amount granted by law to the individual taxpayer as an
allowable deduction from gross income. It represents an amount intended to cover the taxpayer’s
personal, family, and living expenses or minimum subsistence for himself/herself and his/her
dependents.
The two types of personal exemptions allowed to an individual taxpayer are:
1. Basic personal exemption - an arbitrary amount based on the civil or filing status of the taxpayers.
2. Additional personal exemption - an amount allowed based on the number of qualified dependent
children of a taxpayer.
*The allowable personal exemption is no longer applicable because it was removed in the Tax Reform for
Acceleration and Inclusion (TRAIN) Act also known as Republic Act 10963.

The table presents the then and now basic and additional personal exemption allowed by tax laws.

R.A. No. 8424 R.A. No. 9504 R.A. No. 10963

(January 1, 1998 – (July 6, 2008 – (January 1, 2018
July 5, 2008) December 31, 2017) thereafter)
Basic

Single ₱20,000 ₱50,000 -

Head of the family 25,000 50,000 -

Married 32,000 50,000 -

61
Additional

For each qualified dependent child not to exceed four 8,000 25,000 -

SOURCES OF INCOME

Source of income only refers on how you earned the income, from property, activity or by way of
service. It is important to know the source of income of individual taxpayers, whether it was earned
from within the Philippines or outside, because not all individual taxpayers are taxed on all of their
income.

TAXABLE INCOME BASED ON CLASSIFICATION OF INDIVIDUAL TAXPAYERS

Taxable income is defined as the pertinent items of gross income less the deductions, if any,
authorized for such types of income by the Tax Code or other special laws. The taxable income is also
known as the tax base upon which tax rate is to be applied to arrive at the tax due/payable by a
taxpayer.
The following guidelines will help to determine the taxable income of individual taxpayers based on
the sources of income:
1. Resident citizen (RC). Resident citizens are taxable on all income derived from sources within
and outside the Philippines.
2. Non-Resident citizen (NRC). These type of individual taxpayers are taxable on their income from
within the Philippines only.
3. Resident Alien (RA). The resident aliens are taxable on their income from within the Philippines
only.
4. Non-resident alien engaged in trade or business in the Philippines (NRAETBP). These taxpayers
are taxable on their income from within the Philippines only.
5. Non-resident alien not engaged in trade or business in the Philippines (NRANETBP). These
taxpayers are taxable on their gross income from within the Philippines at 25%. The taxpayer
cannot claim personal exemptions and expenses as deductions.
6. Special individuals/alien (SI/A). These type of taxpayers are taxable on their income from
within the Philippines at 15% based on gross income. (The 15% shall not be applicable to RHQs
registering with the SEC after January 1, 2018)

Basic Formula in Computing Net Taxable Income

Gross taxable income xxxxxx

Less: Allowable deduction xxxxxx
Taxable net income xxxxxx

RC NCR RA NRAETBP NRANETBP SI/A

Taxable Income
Within Yes Yes Yes Yes Yes Yes
Without Yes No No No No No

Tax base NI1 NI NI NI GI2 GI

1
NI- Net Income
2
GI- Gross 62
 Illustration

Required: Compute the net taxable income for the taxable year 2018, if the taxpayer is:
1. Resident citizen
2. Non-resident citizen
3. Resident alien
4. Non-resident alien engaged in trade of business in the Philippines.
5. Non-resident alien not engaged in business or trade in the Philippines.
6. Special individual employed in a regional headquarters of a multinational corporation.

Answer 1 – Resident citizen is taxable within and outside the Philippines.

Remark: In computing the amount of tax due, a schedular tax rate is used. The computation
of the tax due and payable using the schedular tax table is discussed in the latter part of this
chapter.

Answer 2&3 – Non-resident citizen and resident alien are taxable within the Philippines only.

Answer 4 – Non-resident alien engaged in trade or business in the Philippines is taxable on

income within the Philippines only.

63
 Answer 5 – Non-resident alien not engaged in trade or business in the Philippines is taxable on
gross income within the Philippines only.

Remarks: A non-resident alien not engaged in business o trade in the Philippines is taxable
on gross income at 25% (no changes as to TRAIN Law). Accordingly, the tax due will be ₱
240,000 (₱ 960,000 x 25%).

Answer 6 – Special individual employed in a regional headquarters of a multinational corporation.

Remarks: Special individual is taxable on gross income within the Philippines only at 15%.
Accordingly, the gross taxable income of the taxpayer will be ₱ 960,000, and the amount of
tax due and payable will be ₱ 144,000 (₱ 960,000 x 15%). It is to be noted that under the
TRAIN Law where there was additional provision [Subsection (F)] that the 15% preferential
tax rate provided in Subsection (C), (D) and (E) of the NIRC shall not be applicable to RHQs,
ROHQs, OBUs or Petroleum service contractor and subcontractor registering with the SEC
after January 1, 2018.Therefore, there will be no tax consequences on the part of special
individual if its employer on registered with the SEC after the said date.

Types of Income Taxes

1. A. Graduated/Schedular or basic normal tax. The basic normal tax for citizen, resident alien and
non-resident alien engaged in trade or business shall be computed in accordance with and at
the rates established in the following schedule:

Section 24 (A) of National Internal Revenue Code of 1997

If the taxable income is:
Income Tax Table
Not over ₱ 10,000 5%
Over ₱ 10,000 but not over ₱ 30,000 ₱ 500 + 10% of the excess over ₱ 10,000
Over ₱ 30,000 but not over ₱ 70,000 ₱ 2,500 + 15% of the excess over ₱ 30,000
Over ₱ 70,000 not over ₱ 140,000 ₱ 8,500+ 20% of the excess over ₱ 70,000
Over ₱ 140,000 but not over ₱ 250,000 ₱ 22,500 +25% of the excess over ₱ 140,000
Over ₱ 250,000 but not over ₱ 500,000 ₱ 50,000 + 30% of the excess over ₱ 250,000
Over ₱ 500,000 ₱ 125,000+ 32% of the excess over ₱ 500,000

64
Effective January 1, 2018
If the taxable income is:
Income Tax Table
Not over ₱ 250,000 0%
Over ₱ 250,000 but not over ₱ 400,000 20% of the excess over ₱ 250,000
Over ₱ 400,000 but not over ₱ 800,000 ₱ 30,000 + 25% of the excess over ₱ 400,000
Over ₱ 800,000 not over ₱ 2,000,000 ₱ 130,000+ 30% of the excess over ₱ 800,000
Over ₱ 2,000,000 but not over ₱ 8,000,000 ₱ 490,000 +32% of the excess over ₱ 2,000,000
Over ₱ 8,000,000 ₱ 2,419,000 + 35% of the excess over ₱ 8,000,000

Effective January 1, 2023

If the taxable income is:
Income Tax Table
Not over ₱ 250,000 0%
Over ₱ 250,000 but not over ₱ 400,000 15% of the excess over ₱ 250,000
Over ₱ 400,000 but not over ₱ 800,000 ₱ 22,500 + 20% of the excess over ₱ 400,000
Over ₱ 800,000 not over ₱ 2,000,000 ₱ 102,500+ 25% of the excess over ₱ 800,000
Over ₱ 2,000,000 but not over ₱ 8,000,000 ₱ 402,500 +30% of the excess over ₱ 2,000,000
Over ₱ 8,000,000 ₱ 2,202,500 + 35% of the excess over ₱ 8,000,000

*Non-resident alien not engaged in trade or business in the Philippines earning business and
professional income, compensation income or combination of both is subject to a final rate of 25%.

Illustration

Mr. Bulandos, a resident citizen, married with three qualified dependent children, had a gross
compensation income of ₱ 875,000.

Required: Compute the income tax due of the taxpayer for the following taxable year 2018
Answer: The income tax due is computed as follows:

For Taxable Year 2018

Gross Compensation Income ₱ 875,000
Net Compensation Income 875,000
Tax Due:
On ₱ 400,000 ₱ 30,000
On the excess [(₱ 875,000- ₱ 400,000) ₱ 475,000 x 25%] 118,750
Tax due ₱ 148,750

65
 The format to compute for taxable income self- employed individuals is as follows:

a. Self- employed without compensation income

Gross sales/ receipts xxxxxx
Less: Sales returns and allowances xxxxxx
Net sales/receipts xxxxxx
Less: Cost of sales/ services xxxxxx
Gross taxable income xxxxxx
Less: Allowable deductions xxxxxx
Taxable income xxxxxx
b. Self- employed with compensation income
Gross taxable compensation income xxxxxx
Add: Taxable business income
Gross sales/receipts xxxxxx
Less: Sales returns and allowances xxxxxx
Net Sales/ receipts xxxxxx
Less: Cost of sales/ services xxxxxx
Gross taxable income xxxxxx
Less: Allowable deductions xxxxxx xxxxxx
Taxable income xxxxxx

In case there are other incomes, the same shall be added in order to arrive at the total
taxable income.

1. B. 8% Income Tax Option

For Purely Self-employed Individuals and/or Professionals whose gross sales/receipts and
other non-operating income do not exceed the VAT threshold of P3,000,000, the tax shall be of
the taxpayers option (www.bir.gov.ph)
a. Income tax based on the Graduated/Schedular Income Tax Rates; or
b. 8% Income tax on Gross Sales or Gross Receipts in excess of P250,000 in lieu of the
Graduated/Schedular Income Tax Rates and the percentage tax.
2. Passive or final income tax. Passive income is an income earned by the taxpayers without any
effort or labor exerted. Passive income from sources within the Philippine is subject to final Tax.
The final tax imposed on passive income is being withheld by the payor who acts as the
withholding agent and remits the final tax to the BIR or an authorized collecting agent.
The different incomes subject to final tax including the corresponding the final tax rated
are already discussed in Chapter 2- Income Concepts and Exclusions.

3. Capital gains tax. Capital gains are usually subject to final capital gains tax. When the capital
gains are not subject to final tax, they shall be included as part of the gross taxable income
subject to the scheduler or basic normal tax.
This topic has been thoroughly discussed in Chapter 2- Income Concepts and Exclusions.

INDIVIDUALS EXEMPT FROM INCOME TAX

A. Non-resident citizen who is:

1. A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of
his/her physical presence abroad with a definite intention to reside therein.

66
 2. A citizen of the Philippines who leaves the country during the taxable year to reside abroad,
either as an immigrant or for employment on a permanent basis.
3. A citizen of the Philippines who works and derives income from abroad and whose employment
thereat requires him/her to be physically present abroad most of the time during the taxable
year.
4. A citizen who has been previously considered as a non-resident citizen and who arrives in the
Philippines at any time during the year to reside permanently in the Philippines will likewise be
treated as a non-resident citizen during the taxable year in which he/she arrives in the
Philippines, with respect to his/her income derived from sources abroad until the date of his/her
arrival in the Philippines.

B. Overseas Contract Worker, Including Overseas Seaman

An individual citizen of the Philippines who is working and deriving income from abroad as
an overseas contract worker is taxable only on income from sources within the Philippines. A
seaman who is a citizen of the Philippines and who receives compensation for services rendered
abroad as a member of the complement of a vessel engaged exclusively in international trade will be
treated as an overseas contract worker.
C. Barangay Micro Business Enterprises (Republic Act 9178 or BMBE Law)
BMBEs refer to any business enterprise engaged in the production, processing or
manufacturing of products or commodities, including agro-processing, trading and services, whose
total assets including those arising from loans but exclusive of the land on which the particular
business entity’s office, plant and equipment are situated, should not be more than ₱ 3,000,000.
Services shall exclude the practice of a licensed profession.

D. Expanded Senior Citizens Act of 2010

The exemption from the payment of individual income taxes is available to senior citizens
who are considered to be minimum wage earners in accordance with Republic Act 9504. Senior
citizens are also exempted from value-added tax (VAT) on certain good and services as discussed in
Chapter 8 Value-Added Tax.

67
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 4.1

TRUE OR FALSE. State whether the statement is TRUE or FALSE.

1. An overseas contract worker in Japan is classified as non- resident citizen in the Philippines.
2. A foreign who stays in the Philippines for 250 days is deemed engaged in business or trade in
the Philippines.
3. An individual taxpayer may either be a natural or a judicial person.
4. A natural-born citizen may either of the Philippines from birth and has to perform any act to
perfect his/her citizenship.
5. Resident citizen may include a Filipino citizen who stays outside the Philippines for more than
183 days.
6. Non-resident citizens may include Filipino employed by an offshore banking unit in the
Philippines.
7. A special alien does not include Filipino citizen employed by an offshore banking unit in the
Philippines.
8. A seaman on international vessel is taxable only on his income within the Philippines.
9. A non-resident citizen is taxable on his/her income from within and outside the Philippines.
10. A Filipino citizen who earns income abroad and stays in foreign country most of the time is a
non-resident citizen.

68
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 4.2

Classify properly the following individual taxpayers whether they are resident citizen (RC),
non-resident citizen (NRC), resident alien (RA), non-resident alien engaged in trade or business in the
Philippines (NRAETBP), non-resident alien not engaged in trade or business in the Philippines
(NRANETBP), and special individual (SI).

1. Mr. Jeff Bulandos, Filipino, employed as a seaman abroad, returned to the Philippines for a
15-day vacation.
2. Ms. Camille Binajbaj left from the Philippines to work as a nurse in California, U.S.A.
3. Mr. Christopher Vergara, alien, stayed in the Philippines for 10 months.
4. Ms. Kathleen Jose, a Filipino overseas contract worker, returned to the Philippines to attend the
wedding of her older sister.
5. Mr. Rey Blas, a non-resident alien, has been in the Philippines for more than one year as a
tourist enjoying the weather and beauty of the various places.
6. Ms. Lady Anne Murillo, Filipino citizen, has her residence in Singapore.
7. Ms. Irene Diaz, Filipino citizen, left Philippines for a surgical operation in U.S.A.
8. Mr. Walter Salva, non-resident alien, stayed in the Philippines as manager of a domestic
telecommunication company from February to November of the current taxable year.
9. Mr. Alvin Bautista, Filipino, is engaged by a foreign petroleum service contractor in petroleum
operations at Palawan.
10. Ms. Mary Chris Autria, non-resident citizen, returned to the Philippines during the taxable year
to reside therein after working for three years in Singapore as an entertainer.
11. Ms. Germina Santos, a British, left Manila for Europe for vacation. He has a re-entry permit.
12. Ms. Grace Taruc, a non-resident alien, stayed in the Philippines as manager of a domestic airline
from January to September.
13. Ms. Mercy Torres, a non-resident alien, finding the beauty of the Philippines, stayed therein for
more than one hundred eighty days.
14. Ms. Hazel Mina, an alien, stayed in the Philippines for more than one year.
15. Ms. Adel Crisolo, citizen, maintained her residence in Australia.

69
 NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 4.3

Identify whether the following are subject to final tax or not (year 2018). Taxpayer is a RESIDENT
CITIZEN unless otherwise stated (Y/N).

Final Tax? Rate

1) Interest from peso bank deposit, Equitable – PCIB Makati
2) Interest from Japanese yen bank deposit, Sumitomo Bank, Japan
3) Interest from USA dollar bank deposit, First USA Bank, New York
4) Interest income from a debt instrument not within the coverage of deposit substitute, Philippines
5) Interest income from a debt instrument within the coverage of a deposit substitute, Philippines
6) Interest on government debt instrument and securities (regardless of number of lenders at the
time of the origination)
7) Interest from overdue accounts receivable, Philippines
8) Royalties, in general, Manila
9) Royalties, books published in Manila
10) Prize amounting to ₱ 30,000, Philippines
11) Prize amounting to ₱ 10,000, Philippines
12) Prize amounting to ₱ 40,000, USA
13) Winnings amounting to ₱ 30,000, Philippines
14) Winnings amounting to ₱ 10,000, Philippines
15) USA Sweepstakes winnings
16) Philippine Lotto winnings
17) Interest received from depository bank under expanded foreign currency deposit system (jointly in
the name of a non-resident citizen and his spouse who is a resident citizen)
18) Interest income from long-term deposit or investment evidenced by certificates issued by BSP
(issued by a financial institution other than a bank in denomination of ₱ 10,000)
19) Interest income from long-term deposit or investment evidenced by certificates issued by BSP
(issued by a bank to an individual in denomination of ₱ 10,000)
20) Dividend from a domestic corporation received on April 15, 2006
21) Share in distributive net income of local business partnership received on May 15, 2006
22) Share in net income after tax of an association, a joint account, or a joint venture or consortium
received on August 15, 2006
23) Share in the net income of a general professional partnership
24) Dividend from a foreign corporation
25) Interest income from long-term deposit or investment evidenced by certificates issued by BSP
received by a NONRESIDENT ALIEN NOT ENGAGED IN TRADE OR BUSINESS
26) Interest income from long-term deposit or investment evidenced by certificates issued by BSP
received by a NONRESIDENT ALIEN ENGAGED IN TRADE OR BUSINESS
27) Interest income received by NON-RESIDENT ALIEN individual from a depository bank under
expanded foreign currency deposit system
28) Interest income received by NON-RESIDENT CITIZEN individual from a depository bank under
expanded foreign currency deposit system
29) Dividend received by a NON-RESIDENT ALIEN not engaged in business in the Philippines from a
domestic corporation
30) Dividend received by a NON-RESIDENT ALIEN engaged in business in the Philippines from a
domestic corporation

70
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 4.4

Problem

A married resident citizen supports three (3) qualified dependent children and a
brother-in-law who is PWD, unmarried and not gainfully employed. He has the following data on income
and expenses for the year 2018:
Salary, Philippines ₱ 560,000
Gross business income, Philippines (gross sales, ₱1,200,000) 500,000
Business expenses, Philippines 180,000
Gross business income, USA (gross sales, ₱ 1,500,000) 900,000
Business expenses, USA 300,000
Interest income from bank deposit, Philippines 50,000
Interest income from bank deposit, USA 70,000
Interest income from domestic depository bank under EFCDS 80,000
Interest income from a debt instrument not within the coverage
of deposit substitute, Philippines, gross of 20% creditable
withholding tax 50,000
Interest income from a debt instrument within the coverage
of a deposit substitute, Philippines 60,000
Royalty on book published in the Philippines 100,000
Prize in a contest he joined in the Philippines 5,000
Philippine Charity Sweepstakes winnings 1,000,000
Gain from sale of shares of stock not traded through the
local stock exchange 150,000
Dividend received from a domestic corporation 40,000
Tax payments, first three (3) quarters 100,000

Required: Compute for the following questions:

1. How much is the total final tax on certain passive income?
2. How much is the capital gains tax?
3. How much is the taxable net income and income tax due if the taxpayer failed to avail of the 8%
tax option?

71
 LESSON 5
TAXATION OF PARTNERSHIPS, ESTATES AND TRUSTS
Learning Objectives:

At the end of the chapter, the student should be able to:

 Discuss what partnership is.
 Explain the different classification of partnership.
 Discuss what is estate and trust.
 Determine the taxable income and allowable deductions for partnership

Definition of Partnership
By the contract of partnership, two or more persons bind themselves together to contribute
money, property or industry to a common fund with the intention of dividing profits among themselves
(Article 1767 of the Civil Code of the Philippines). Two or more persons may also form a partnership for
the exercise profession.

CLASSIFICATION OF PARTNERSHIPS

Based on Liability of Partners

1. General partnership is a partnership created and operating with a general partner is one whose
liabilities or obligations are not limited only to his/her capital contributions. Creditors have the
right to go after the personal properties of the general partner in the event of the partnership’s
bankruptcy.
2. Limited partnership is a partnership consisting of a general partner and a limited partner. A
partner is his/her liability is limited only to his/her capital contributions. In the event of the
partnership’s dissolution and partnership is insolvent, the creditors cannot go after the personal
properties of a limited partner.

Based on Taxation
1. General professional partnership is a partnership formed for the purpose of exercising the
partner’s common profession, and no part income of which is derived from engaging in any
trade or business.
2. General co-partnership is a partnership created for the purpose of obtaining profits from the
conduct of trade or business.

GENERAL PROFESSIONAL PARTNERSHIP

A general professional partnership (GPP) is formed by persons for the purpose of exercising
their profession. For income tax purposes, GPP is not taxable entity since it acts only as a “pass through”
entity where its income is finally taxed to the partners comprising it.
The net income of GPP, for purposes of computing the distributive share of the partners, shall
be computed in the same manner as a corporation.
In computing allowable deductions, a GPP may use either the itemized deduction allowable
under Sections 34 (A) to (J) of the Tax Code or, in lieu thereof, it can opt for the optional standard
deduction(OSD) in an amount not exceeding 40% of its gross income.

72
 The net income determined by either using the itemized deductions or OSD represents the
distributive net income from which share of each partner is to be determined.

Tax Liability of Parents in a General Professional Partnership

The following guidelines determine the tax liability of a partner in a general professional
partnership:
1. Each partner shall report as gross income his/her distributive share, actually or constructively
received, in the net income of the partnership. Stated otherwise, the share of each partner in
the net profits regardless of whether it is distributive or not.
2. The partners in a GPP shall be liable for income tax only in their separate and individual
capacities.
3. On the partner’s distributive share in GPP, the individual partner can still claim deductions
incurred or paid by him/her subject to the following conditions:
a. If the GPP uses the itemized deductions, the partners may still claim itemized
deductions from partnership’s share. However, they are precluded from claiming the
same expenses already claimed by the GPP.
b. If the GPP avails itemized deductions, the partners are not allowed to claim the OSD
from their share in the net income of GPP. This means that the OSD is in lieu of the
items of deductions claimed both by GPP and the partners.
c. If the GPP avails the OSD in computing its net income , the partners can no longer claim
further deduction from their share in the net income of the GPP.
4. The method of deductions on other gross income of the partner derived from trade, business or
practice of profession would follow the same deduction availed of from GGP’s distributive
income.
If the GPP opts for the OSD , a partner may also use the OSD on the other gross income
from trade , business or exercise of profession , but not to include his/her share from the net
income on the GPP.
5. The distributive share of the partners in a GPP shall be subject to creditable withholding tax
based on the following rates.
10% - Share in the net income is ₱ 720,000 or less.
15%- Share in the net income exceeds ₱ 720,000.
The amount of creditable withholding tax shall be withheld by the GPP and deducted by
each partner in his/her income tax due upon filling his/her return.

Illustration
Mercy and Mina were partners in CD & Co., a general professional partnership, and shared
profit and losses in the ratio of 40% and 60% respectively. The GPP presented in the following data for
the year:
Gross income ₱ 1,000,000
Operating expenses 600,000
Charitable contributions subject to limitation 50,000
Required: Determine the following:
1. Tax liability of the partnership
2. Distributive share of each partner under the following assumptions:
a. The GPP avails itemized deductions.
b. The GPP and avails the OSD.

73
Answer and analysis 1: The partnership is not subject to tax, being a general professional partnership.
However, the distributive share of the partners shall be subject to 10% creditable withholding tax if it is
₱ 720,000 or less, and 15% if more than ₱ 720,000.

Answer and analysis 2a: The distributive share of Mercy and Mina, if the GPP is using the itemized
deductions, would be:

Gross income ₱ 1,000,000

Less: Operating expenses 600,000
Net income before charitable contribution ₱ 400,000
Less: Charitable contribution
Actual ₱ 50,000
Limit (₱ 400,000 x 5%) 20,000
Lower 20,000
Net income ₱ 380,000

The limit on charitable contribution is computed using the prescribed 5% , since the tat
law directs that the net income of the partnership shall be computed in the same manner as
that of a corporation.

The distributive share of each partner appears as follows:

Carlos (₱ 380,000 x 40%) ₱ 152,000
Dante ( ₱ 380,000 x 60 %) 228,000
Total income of partnership ₱ 380,000

The distributive share of each partner is subject to creditable withholding tax of 10% if
the share in the neat income is ₱ 720,000 and below, and 15% if the share is more than ₱
720,000.

The creditable withholding tax of each partner would be:

Carlos ( ₱ 152,000 x 10%) ₱ 15,200
Dante (₱ 228,000 x 10%) ₱ 22,800

In other words, Mercy will received only ₱ 136,800(₱ 152,000- ₱ 152,000) from the net
income of the GPP, but still will report a taxable income of ₱ 152,000 . The same tax principles
will also apply the distributive share of Mina.

Answer and analysis 2b. The distributive share of each partner if the GPP adopts the OSD, is computed
as follows:
Gross income ₱ 1,000,000
Less: Deductions under OSD (₱ 1,000,000 X 40%) 400,000
Net income ₱ 600,000

The distributive share, net of creditable withholding tax, of each partner is

computed as follows;

74
 Mercy Mina
Share in the net income
Mercy (₱ 6,000,000 x 40%) ₱ 240,000
Mina (₱ 6,000,000x 60%) ₱360,000
Less: Creditable withholding tax
Mercy (₱ 240,000 x 10%) 24,000
Mina (₱ 360,000 x 10%) _______ 36,000
Distributive share, net of tax ₱ 216,000 ₱324,000

GENERAL CO-PARTNERSHIP

A general co- partnership, unlike a general professional partnership, is a taxable entity. It is

created primarily to accumulate profits and treated as a corporation for income t ax purposes.

Tax Liability of a Partner in Co – Partnership

The following guidelines shall be observed in determining the tax liability of a partner in a
general co- partnership:
1. A general co-partnership is taxable on its income like a corporation. Having the juridical
personality of a corporation, the partnership is required to file the quarterly and annual income
tax returns. It is subject to 30% corporate tax rate effective January 1, 2009, and also subject to
the principle of minimum corporate income tax (MCIT) of 2% based on gross income.
The proper application of the minimum corporate income tax is illustrated in Chapter 6-
Taxation of Corporations.
2. The share of a partner in a general co-partnership subject to tax is treated like a dividend, that is
the share is also subject to 10% final tax.

Illustration
Mr. Danilo and Mr. Norman, both self-employed and married, decided to form a partnership for
the purpose of buying and selling fresh mangoes. During the 2017 taxable year they presented
operation as follows
Gross income ₱ 1,800,000
Less: Itemized allowable deductions 1,450,000
Net income ₱ 350,000

The results of their individual business operations are as follows:

Mr. Danilo Mr. Norman
Gross income ₱ 800,000 ₱ 1,200,000
Less: Allowable expenses 550,000 970,000
Net income ₱ 250,000 ₱ 230,000

Mr. Danilo and Mr. Norman have six and two qualified children, respectively. In their
partnership, they divide profits and losses in the ratio of: Mr. Danilo 45%; and Mr. Norman 55%.

Required: Compute the net taxable income of both taxpayers’ subject to basic tax and final tax.

Answer: The net taxable income subject to basic tax of both partners are computed as follows:

75
 Mr. Danilo Mr. Norman
Gross income ₱ 800,000 ₱ 1,200,000
Less: Allowable expenses 550,000 970,000
Net taxable income ₱ 250,000 ₱ 230,000

The income subject to final tax is computed as follows:

Gross income ₱ 1,800,000
Less: Itemized allowable deductions 1,450,000
Net income ₱ 350,000

The share of each partner on the income of the partnership shall be subject to final tax
based on the net income after deducting the 30% income tax computed as follows:

Net income ₱ 350,000

Less: Income tax (₱ 350,000x30%) 105,000
Net income after tax ₱ 245,000

The amount of final tax for each partner is determined as follows.

Mr. Danilo Mr. Norman
Share in the net income of the partnership
(₱ 245,000x 45%) ₱ 110,250
(₱ 245,000x55%) ₱ 134,750
Multiply by final tax rate 10% 10%
Final tax ₱ 11,025 ₱ 13,475

The share of each partner in a general co-partnership is noticeably not included in the
gross taxable income subject to basic tax.

CO- OWNERSHIP

Co-ownership means that there are two or more owners of a property or properties. Usually,
co-ownerships exist when there are two or more beneficiaries that inherit a property; or a donation is
made to two or more donees.
The general rule, co-ownership is not subject to tax. However, co-ownership shall be subject to
tax using the corporate tax rate under the following cases:
1. Co-ownership is voluntarily created through agreement.
2. Shares of co-owners are invested in the co-ownership with the intention of producing
income.
3. Inherited property remained undivided for more than 10 years.

Illustration
During the current taxable year, Adel and Jenny, both married without qualified dependents,
inherited an income producing property from their deceased widowed father. At the end of the year,
the income generated from the property amounted to ₱ 800,000 which will be divided equally between
them. On their individual capacity, Adel and Jenny have compensation income of ₱ 600,000 and ₱
750,000, respectively, during the year.

Required: Determine the income tax due from Adel and Jenny.

76
Answer and analysis: The law on taxation is silent as to whether the individual shares of the co-owners
on the income of the co-ownership property are subject to creditable withholding tax or not. In this
regard, based on the principle that taxation law shall be constructed in favor of the taxpayer, the shares
shall not be subject to creditable withholding tax.
The income tax liability of Adel and Jenny is computed as follows:
Adel Jenny
Compensation income ₱ 600,000 ₱ 750,000
Share in co- ownership (₱ 800,000/2) 400,000 400,000
Total income ₱ 1,000,000 ₱ 1,150,000
Less: Optional standard deduction
(₱ 400,000 x 40%) ₱ 160,000 ₱ 160,000
Total deduction ₱ 160,000 ₱ 160,000
Net taxable income ₱ 840,000 ₱ 990,000

Tax on ₱ 800,000 ₱ 130,000 ₱ 130,000

Tax on excess
Adel (₱ 840,000-₱ 800,000) x 30% 12,000
Jenny (₱ 990,000-₱ 800,000) x 30% 57,000
Tax due and payable ₱ 142,000 ₱ 187,000

ESTATE

Estate refers to the total value of all assets and liabilities left by an individual at death. Upon the
death of an individual, the properties are ordinarily transferred to the heirs. However, the income
accruing to the inherited property becomes taxable only to the heirs once he/she receives the property,
although the basic principle is that an income is taxable to the person earning it. In taxation, the term
person refers to an individual, a trust, an estate, a partnership or a corporation.

Classification of Income-producing Estate

An estate may be income producing or non-income producing. An income producing estate may
either be a non-taxable or taxable estate.

Non-taxable Income producing Income

When the estate is not under court or judicial proceedings, its income shall not be subject to
income tax. In this case, the heirs are treated as co-owners of the property and are required to include
the income in their individual gross taxable income.

Taxable income – producing Estate

If the estate is under or judicial proceedings, its income during the period of settlement shall be
taxable. In this case, the estate is treated as a judicial person subject to income tax computed based on
the same manner and on the same basis as in the case of an individual taxpayer.

TRUST

Trust or contract of trust is an agreement created by will or otherwise where the property of a
grantor is being transferred to the trustee or administrator for purposes of management or conservation

77
of the property. Ultimately, the income of and the title to the property will be transferred to the
beneficiary as expressed by the grantor.
Trustee refers to the person who manages and preserves the property in trust. The trustee is
also known as the fiduciary, administrator or executor.
Grantor refers to the owner of the property who establishes the trust. The other terms for
grantor are creator, benefactor or trustor.
Beneficiary refers to the person who will succeed to or receive the property in trust.

Classification of Income-producing Trust

A trust may be income producing or non- income producing. When the trust is income
producing, it may either be non- taxable or taxable.

Non- taxable Income –producing Trust

The income of the trust is not taxable to the trust if:
1. The trust is a revocable trust; and
2. The income of the trust is for the benefit of the grantor.

When the contract is revocable or when the income of the trust is for the benefit of the grantor,
the income shall be included in the gross taxable income of the grantor.

Taxable Income- producing Trust

A trust is considered a separate juridical entity if under the contract of trust, the title of the
property in trust shall be transferred later to the beneficiary. The contract is revocable, and the income
of the trust is partially or fully credited for the benefit of the beneficiary.
The following trusts are deemed separate taxable persons or entities:
1. The following accumulated in trust for the benefit of an unborn or unascertained person
with contingent interest, and the income accumulated or held for future distributions under
the terms of the will or trust.
2. The income which is to be distributed currently by the fiduciary to the beneficiaries, and the
income collected by a guardian of an infant which is to be held or distributed as the country
may direct.
3. The income which, in the direction of the fiduciary, may be either distributed to the
beneficiaries or accumulated.

78
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 5.1

TRUE OR FALSE. State whether the statement is TRUE or FALSE.

1. Partnership is created by mere agreement of partners.

2. The partners are liable to their capital contributions in a general partnership.
3. A creditor can go after the personal properties of a limited partner.
4. A general professional partnership is not subject to income tax.
5. A partner in a genera professional partnership is not subject to tax on his/her share in the
profits.
6. A partner in a general professional partnership may compute his/her share of the distributive
profit as gross or net amount of income.
7. Profits and losses of a partnership shall be divided among partners based on their agreement.
8. A general professional partnership is not subject to tax; however, the partners composing such
partnership are subject to tax based on their distributive share.
9. A general co- partnership is subject to final tax of 10% or 20% as the case may be.
10. A general co-partnership is not subject to tax, but the partners comprising such partnership are
subject to income tax based on their distributive share.
11. Estates and trusts are allowed a personal exemption of ₱ 20,000 regardless of the number of
trusts a beneficiary may receive income from.
12. The gross taxable income of an estate is computed in the same manner and basis as in the case
of an individual taxpayer.
13. The income of a revocable trust is taxable to the trust.
14. A pension trust created for the benefit of the employees is not subject to income tax.
15. A trust is allowed to deduct a personal exemption of ₱ 20,000.
16. The portion of the estate transferred to the beneficiary is deductible from the income of the
estate.
17. Taxable estates are estates of deceased persons judicially settled.
18. For a trust to be taxable, it must be revocable both as to corpus and income.
19. The amount of estate transferred to the beneficiaries is an allowable deduction from the gross
income of the estate.
20. When there are several created by the grantor, each trust shall not file a separate income tax
return, but only a consolidated return shall be made.

79
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 5.2

Problem

Mr. Renato and Mr. Walter, both married and are certified public accountants, formed general
professional partnership during the current taxable year to render consultancy services to the public.
The partners share profits and losses equally.

The result of the partnership’s operation showed the following data:

Gross receipt from clients ₱ 1,000,000
Costs of services 300,000
Business expenses 240,000

Additional information provided:

a. Mr. Renato, married with three qualified dependent children, has other income derived
from business as follows:
Gross sales ₱ 400,000
Costs of expenses 120,000
Operating taxes 80,000

b. Travelling expenses incurred by the partners related to GPP’s operation, which were neither
claimed by the GPP as deduction income nor liquidated by the partnership:
Mr. Renato ₱ 15,000
Mr. Walter 10,000

c. Mr. Walter, married with five qualified dependents, received compensation income of ₱
250,000 as part –time college professor.

Required: Determine the net taxable income and the tax due and payable of Mr. Renato under the
following cases:
1. The GPP avails itemized deductions.
2. The GPP avails the OSD.

80
 LESSON 6
TAXATION OF CORPORATIONS
Learning Objectives:

At the end of the chapter, the student should be able to:

 Discuss what corporate taxation is.
 Explain the taxable income and tax due for a corporation.
 Explain the allowable deduction for corporate tax purposes, as well as the exemptions.

Definition of Corporation

A corporation is an artificial being created by operation of law, having the right of succession
and the powers, attributes, and properties expressly authorized by law or incident to its existence.

Gross Income and Allowable Deductions of Corporations

The following is the basic formula for determining the tax liability of a corporation:

Gross income (discussed in Chapter 2) xxxxxx

Less: Allowable expenses (discussed in Chapter 3) xxxxxx
Net taxable income xxxxxx
Multiply by basic tax rate 30%
Income tax due xxxxxx

The following shall compose the gross income of a corporation:

1. Business income
2. Gains from dealings in property
3. Passive income not subject to final tax
4. Other incomes like rent

CLASSIFICATIONS OF CORPORATION

Domestic or Foreign Corporations

A domestic corporation is one organized under the existing laws of the Philippines, while a
foreign corporation is one organized under the laws of a foreign country.
Domestic corporation include those owned and controlled by the government to undertake an
activity classified as business or commercial. An activity is considered business or commercial when it is
regularly undertaken, and its primary objective is to gain profit.
Foreign corporations are further classified as follows:
1. Resident foreign corporations
2. Non- resident corporations

Subject or Not Subject to Taxation

A corporation is subject to income taxation when the earning is covered by income tax. On the
other hand, a corporation is not subject to taxation when the income is exempted from tax.
For corporations’ subject to tax, the following guiding procedures may be observed:

81
 1. A domestic corporation is taxable on all income from within and outside the Philippines.
2. A foreign corporation, whether resident or non-resident, is taxable on all income from within
the Philippines only. The income from within the Philippines must be computed in case it
cannot be identified if it is sourced from within or outside the Philippines.
3. The tax base of a domestic and resident foreign corporation is the taxable net income (gross
income less allowable deduction). For a non-resident foreign corporation, the tax base is the
gross income.
4. Domestic and resident foreign corporations are imposed an NCIT rate of 30% effective January
1,2009 based on taxable net income, or a MCIT rate of 20% based on gross income. The amount
of tax liability shall be the higher amount between the NCIT and the MCIT.
5. For a non –resident foreign corporation, a tax rate of 30% based on gross income shall be
imposed. The tax principle on MCIT is not applicable.

Tax exempt corporation means that the earning by such corporation is not subject to income
taxation. Section 30 of the NIRC, as amended, lists following types of corporation as tax-exempt:
1. Non-profit labor, agricultural or horticultural organizations.
2. Non-stock and non-profit mutual savings and cooperative banks.
3. Non- stock organizations operating for the exclusive benefits of the members like providing
payment of life, sickness and accident benefits.
4. Non-stock corporations operating exclusively for religious, charitable, scientific, athletic or
cultural purposes or for the rehabilitation of veterans, provided that their assets or income shall
not accrue to the benefit of any member.
5. Non-profit business leagues, chambers of commerce or boards of trade.
6. Non-profit civic league or organizations organized for the promotion of social welfare
7. Non-stock and non-profit educational institutions
8. Government educational institutions
9. Non- profit organizations such as cooperative telephone companies, fire insurance companies
and mutual ditch or irrigation companies with income from assessment, dues and fees collected
from members to meet the needs and expenses of the organization.
10. Non-profit organizations of farmers, fruit growers or any other similar association for the
purpose of marketing the products of their members.

However, once the foregoing organizations earn an income from their properties, real or
personal, or from any of their activities conducted for profit, the income earned shall be subject to tax.
Furthermore, the following governmental organizations are also tax- exempt under special laws:
1. Government Service Insurance System (GSIS)
2. Social Security System (SSS)
3. Philippine Health Insurance Corporation (PHIC)

Ordinary or Special Corporation

An ordinary corporation, either domestic or foreign, is subject to the basic 30% NCIT rate or to
the 2% MCIT rate.
A special corporation, either domestic or foreign, is subject to special tax rates as provided by
the existing law.
The following domestic entities are considered special corporation:
1. Proprietary educational institutions
2. Non-profit proprietary hospitals

82
 Similarly, the following entities are classified as special resident and non-resident foreign
corporations:
1. International carries
2. Regional operating headquarters of multinational corporations
3. Regional area headquarters of multinational corporations
4. Offshore banking units
5. Branches remitting to the head office
6. Owners, lessors or distributors of cinematographic films
7. Non- resident lessors/owners of machinery, equipment, and aircraft
8. Non-resident lessors/owners of vessels charted by Philippine nationals.

INCOME TAX LIABILTY OF A CORPORATION

The NIRC, as amended, subjects a corporation into the following methods of tax computation to
determine the income tax liability:
1. Normal or basic income tax
2. Minimum corporate income tax
3. Optional gross income tax

NORMAL CORPORATE INCOME TAX (NCIT)

The normal or basic income tax is imposed on corporations, either domestic or foreign, that are
classified as ordinary. The concept of normal income tax is not applicable to a special corporation.
The two factors influencing the amount of normal or basic income taxes are:
1. The tax base; and
2. The tax rate.

Tax Base of the Normal Income Tax

The tax base used in computing the normal or basic income tax of a corporation is either the
gross taxable income or the net taxable income. The term “net taxable income” refers to the amount of
gross income less the allowance deductions. The amount of allowable deductions is computed using
either the itemized deductions o the OSD of 40%.

Domestic Corporation
Domestic corporations are taxable on income derived from within and outside the Philippines.
The basis of income tax computation of domestic corporations, whether ordinary or special, is the net
taxable income.

Resident Foreign Corporation

A resident foreign corporation is taxable on its income within the Philippines only. Hence, the
tax base of a resident foreign corporation is its net taxable income within the Philippines.
In case it cannot be identified whether the income is sourced from within or outside the Philippines,
the income from within is computed using the following formula:

Income from within = Identified gross income- Phils. X Unidentified

The Philippines Identified gross income – World gross income

83
 The following types of income are considered sourced partly with and partly from outside the
Philippines:
1. Income from transportation and other services rendered partly within and partly outside the
Philippines.
2. Income from sale of property produced in whole or in part, by the taxpayer outside and sold
within the Philippines.
3. Income from the sale of personal property produced, in whole or in part, by taxpayer within and
sold outside the Philippines
In case there are no sales or there are isolated sales only in the Philippines or when the independent
factory of production price has not been established, the net income in the Philippines is computed as
follows:

Taxable net income = Value of property used- Phils. xxxxxx

2 Value of property used- World

Add:
Taxable net income = Gross sales- Phils. xxxxxx
2 Gross sales- World

Non- resident Foreign Corporation

A non-resident foreign corporation not engaged in business or trade in the Philippines is taxable
at 30% based on gross income derived from sources within the Philippines. A non-resident foreign
corporation may earn its income from the following sources:
1. Interest
2. Dividends
3. Rents
4. Royalties
5. Salaries
6. Premium, except reinsurance premiums
7. Annuities
8. Emoluments or other fixed or determinable annual, periodic or casual gains, profits and income
9. Capital gains, except capital gains from the sale of shares of stock not traded in the stock
exchange.

Tax Rate of the Normal Income Tax

Effective January 1, 2009, the tax rate for the normal basic tax of a corporation is 30%,
notwithstanding its classification.
Historically, the following tax rates were imposed under the normal income tax:
Legal Basis Effective Date Tax Rate
R.A. 8424 Jan. 1- Dec. 31, 1997 35%
(National Internal Revenue Jan.1- Dec, 31,1998 34%
Code) Jan.1- Dec. 31, 1999 33%
Jan. 1, 2009 and thereafter 32%
R.A. 9337 Nov. 1, 2005- Dec. 31, 2008 35%
(Expanded Value –added Jan. 1, 2009 and thereafter 30%
Tax Act of 2005)
The president signed into law R. A. 9337, otherwise known as the “Expanded Value- added Tax
Act”, on May 24, 2005.

84
 Illustration
CICT Company has the following data for the current taxable year:
Philippines Australia
Gross sales ₱ 3,000,000 ₱ 2,000,000
Cost of sales 1,200,000 800,000
Other income 600,000 400,000
Total itemized business expenses 1,200,000 540,000

In addition, CICT Company earned an income of ₱ 700,000 during the year, which cannot be
identified if sourced from within the Philippines or from Australia.

Required: Compute the amount of corporate tax liability under each of the following cases:
1. Domestic corporation using the itemized deduction
2. Resident foreign corporation using OSD
3. Non-resident foreign corporation assuming that the income from within the
Philippines is derived from interest, rents and dividends

Answer 1 - Domestic corporation (taxable within and outside the Philippines)

Gross sales ₱ 5,000,000
Less: Cost of sales 2,000,000
Gross income from operation 3,000,000
Add: Other income ₱ 1,000,000
Unidentified income 700,0000 1,700,000
Gross income ₱ 4,700,000
Less: Allowable itemized deduction 1,740,000

Net taxable income ₱ 2,960,000

Multiply by- tax rate (effect. Jan. 1, 2009) 30%
Normal income tax ₱ 888,000

The tax liability of ₱ 888,000 is still due deductible from income taxes paid in Australia, if
claimed as a tax credit. The concept of tax credit on taxes paid in a foreign country is discussed in
succeeding topics.

Answer 2 - Resident foreign corporation (taxable within the Philippines only)

Gross sales ₱ 3,000,000
Less: Cost of sales 1,200,000
Gross income from operation ₱ 1,800,000
Add: Identifiable other income ₱ 600,000
Unidentifiable other income
( ₱ 2,400,000/ ₱ 4,000,000) x ₱ 700,000 ₱ 420,000 1,020,000
Gross income within the Philippines ₱ 2,820,000
Less: Allowable deduction- optional
(₱ 2,820,000 x 40%) 1,128,000
Net taxable income ₱ 1,692,000
Multiply by- tax rate _30%
Normal income tax liability ₱ 507,600
The unidentifiable income of ₱ 700,000 is apportioned based on the ratio of identifiable gross
income from within the Philippines over the identifiable gross income in the world.

85
 The identifiable gross income of ₱ 2,400,000 within the Philippines is computed as follows:
Gross income from operation (₱ 3,000,000- ₱ 1,200,000) ₱ 1,800,000
Other income – Philippines 600,000
Total identifiable income- Philippines ₱ 2,400,000

The ₱ 4,000,000 identifiable gross income in the world is determined as follows:

Total identifiable income within the Philippines ₱ 2,400,000
Add: Gross income from operation- Australia
(₱2,000,000-₱ 800,000) ₱ 1,200,000
Other income – Australia 400,000 1,600,000
Total identifiable gross income- World ₱ 4,000,000

Answer 3. Non-resident foreign corporation (taxable on gross income from within the Philippines)
Total gross income within (as computed above) ₱ 2,820,000
Multiply by tax rate 30%
Normal income tax liability ₱ 846,000

MINIMUM CORPORATE INCOME TAX (MCIT)

A minimum corporate income tax of 2% of the gross income as of the end of the taxable year
shall be imposed on both domestic and resident foreign corporations.
The following guidelines may be observed in handling the MCIT:
1. Applicable beginning on the fourth year of business operation.
2. Applicable even if a corporation incurs business loss.
3. Applicable only to ordinary domestic and resident foreign corporations.
4. Compute the tax liability at 2% based on gross income.
5. Starting on the fourth year of operation, the corporate income tax liability shall be based on the
NCIT of 30% or the MCIT of 2%, whichever is higher.
6. Excess of MCIT over NCIT is creditable.

Illustration
COED Company started its business operation in Year 1 On Years 4 and Years 5, it provided the
following data:
Year 4 Year 5
Gross income from business operation ₱ 5,000,000 ₱ 4,000,000
Other income not subject to final tax 800,000 300,000
Business expenses- total itemized 2,500,000 4,100,000
Required: Determine the amount of tax liability, assuming the company adopted the itemized deduction on:
1. Year 4; and
2. Year 5
Answer 1 - The tax liability on Year 4 is computed as follows:
NCIT MCIT
Gross income – business ₱ 5,000,000 ₱ 5,000,000
Other income 800,000 800,000
Total gross income ₱ 5,800,000 ₱ 5,800,000
Less: Allowable deduction 2,500,000 -__
Net taxable income/ Gross taxable ₱ 3,300,000 ₱ 5,800,000
Multiply by applicable tax rate 30% 2%
Income tax liability ₱ 990,000 ₱ 116,000

86
 The corporate income tax due and payable on Year 4 shall be ₱ 990,000, since the
NCIT is higher than the minimum corporate income tax of ₱ 116,000.

Answer 2 - The tax liability on Year 5 is computed as follows:

NCIT MCIT
Gross income- business ₱ 4,000,000 ₱ 4,000,000
Other income 300,000 300,000
Total gross income ₱ 4,300,000 ₱ 4,300,000
Less: Allowable deduction 4,100,000 -__
Net taxable income/ Gross taxable ₱ 200,000 ₱ 4,300,000
Multiply by applicable tax rate 30% 2%
Income tax liability ₱ 60,000 86,000

The corporate income tax due and payable on Year 5 shall be ₱ 86,000, since the tax
liability computed under MCIT is greater than the amount under NCIT.

EXCESS MINIMUM CORPORATE INCOME TAX

The Tax Law provides that any excess amount of MCIT Over the NCIT shall be carried forward
and credited against the normal income tax for the three years immediately succeeding the taxable
year.
In Illustration above, the excess of ₱ 26,000 (₱ 86,000- ₱ 60,000) shall be carried forward and
credited against the NCIT for the three years only, that is, Years 6,7, and 8.
The principle of carrying forward the excess MCIT and crediting it against the NCIT is only
applicable if in the immediately succeeding three years the normal corporate tax is higher than the
minimum corporate tax. Otherwise, the excess of MCIT cannot be credited. After the three immediately
succeeding taxable years, any excess that cannot be credited shall lose its creditability. Thus, in
Illustration above the excess of ₱ 26,000 of MCIT in Year 5 can be carried forward and credited in Year 6
if the NCIT of Year 6 is higher than the MCIT.
The excess MCIT can be carried over and be credited against the income tax due by a domestic
corporation. Foreign corporations, whether resident or non- resident, cannot claim the excess as a tax
credit.

Quarterly Payment of MCIT

Revenue Regulations No. 12-2007 prescribes the guidelines for the filling and payment of
corporate income tax where the MCIT will apply:
1. If the computed MCIT is higher than the quarterly normal income tax, the tax due shall be the
MCIT, which is 2% of the quarterly gross income. The quarterly gross income is computed on
cumulative basis.
2. If the corporate quarterly income tax is based on the MCIT, the excess MCIT from previous
taxable year (s) is not creditable. The following taxes, however, are allowed to be applied
against the quarterly MCIT due:
a. Expanded withholding tax
b. Quarterly corporate tax under the NCIT
c. MCIT paid in previous taxable quarter(s)

87
OPTIONAL GROSS INCOME TAX

The President, upon the recommendation of the Secretary Finance, may, effective January 1, 2000,
allow a corporation the option to be taxed at 15% of its gross income after the following conditions have
been satisfied.
1. A tax effort ratio of 20% of Gross National Product (GNP)
2. A ratio of 40% of income tax collection to total tax revenues
3. A VAT ratio 4% of GNP
4. A 0.9 % ratio of the Consolidated Public Sector Financial Position (CPSFP) to GNP

The option to be taxed based on gross income shall be available only to firms whose ratio of cost of
sales to gross sales or receipts from all sources does not exceed 55%.
The election of the gross income tax option by the corporation shall be irrevocable for three
consecutive taxable years during which the corporation is qualified under the scheme.
The optional gross income tax allowed by R.A. 8424 has not yet been implemented because of
the stringent conditions required by the scheme.

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET)

Section 29 of the Tax Code, as amended, provides that an IAET that is equal to 10% of the
improperly accumulated taxable income shall apply to every corporation formed availed for the purpose
of avoiding the income tax with respect to its shareholders of any other corporation by permitting
earnings and profits to accumulate instead of being divided or distributed.
Otherwise stated, accumulation of profits beyond the reasonable needs of the corporation will
be subject to 10% IAET.

Coverage and Effect of IAET

The 10% IAET is imposed on improperly accumulated taxable income earned starting January 1,
1998 by a domestic corporation as defined under the Tax Code, as amended and which is classified as a
closely held corporation; provided, however, that IAET shall not apply to the following corporations:

1. Banks and non- bank financial intermediaries

2. Insurance companies
3. Publicly held corporations
4. Taxable partnerships
5. General professional partnerships
6. Non-taxable joint ventures
7. Enterprises duly registered with the Philippine Economic Zone Authority (PEZA) under R.A. 7961,
and enterprises registered pursuant to the Bases Conversion and Development Act of 1992
under R.A. 7227, as well as other enterprises duly registered under special economic zones
declared by law, which enjoy or activities in lieu of other taxes, national or local.

The term “closely held corporations” shall refer to those corporations where at least 50% in
value of the outstanding capital stock or at least 50% of the total combined voting power of all classes of
stock entitled to vote is owned, directly or indirectly, by or for not more than 20% individuals. Domestic
corporations not falling under the aforesaid definition are, therefore, classified as publicly held
corporations.

88
Tax Base of IAET
The tax base of IAET is determined by adding first to the year’s taxable income the following:
1. Income exempt from tax
2. Income excluded from gross income
3. Income subject to final tax
4. The amount of NOLOCO deducted
5.
The taxable income as thus determined shall be reduced by the sum of:
1. Income tax paid or payable for the taxable year;
2. Dividends actually or constructively paid/ issued from the applicable year’s income; and
3. Amount reserved for the reasonable needs of the business as defined, emanating from the
covered year’s taxable income.

The pro-forma formula will appear as follows:

Net taxable income xxxxx

Add: Tax exempt income xxxxx
Income excluded xxxxx
Income subject to final tax xxxxx
NOLCO deducted xxxxx xxxxx
Total xxxxx
Less: Tax due/paid xxxxx
Dividend paid xxxxx
Reserved amount for business needs xxxxx xxxxx
Improperly accumulated earnings xxxxx

Illustration
COE Company, closely held corporation, presented the following data at the end of the current
taxable year:
Gross income from business operation ₱ 6,000,000
Other income not subject to final tax 500,000
Business expenses- itemized total 4,200,000
Dividends received from domestic corporation 300,000
Interest income under foreign currency deposit system
(Subject to final tax of 7 ½ %) at gross amount 150,000
Dividends paid during the year 700,000

Required: Compute the following:

1. The amount of income tax due and payable
2. The IAET if assessed and declared by the BIR that the company is accumulating earnings
beyond reasonable needs
Answer 1: The income tax liability is computed as follows:
Gross income from operation ₱ 6,000,000 ₱ 6,000,000
Other income 500,000 500,000
Gross income ₱ 6,500,000 ₱ 6,500,000
Less: Allowable deduction 4,200,000
Taxable net income/ Gross income ₱ 2,300,000 ₱ 6,500,000
Multiply by – tax rate 30% 2%
Income tax liability ₱ 690,000 ₱ 130,000

89
 The amount of income tax due and payable is ₱ 690,000

Answer 2. The IAET Is computed as follows:

Net taxable income ₱ 2,300,000
Add: Income exempt from tax dividends
received from domestic company ₱ 300,000
Income subject to final tax interest income
under foreign currency deposit system 150,000 450,000
Total ₱ 2,750,000
Less: Dividends paid ₱ 700,000
Final tax (₱ 150,000 x 71/2%) 11,250 711,250
Improperly accumulated earnings ₱ 2,038,750
Multiply by tax rate 10%
Improperly accumulated earning ₱ 203,875

SPECIAL CORPORATIONS

Special corporations simply refer to corporations not subject to the normal income tax rate of
30%. In other words, they are corporations with a different tax rate as provided by the Tax Code as
amended.
Special corporations are broadly classified into:
1. Domestic special corporations
2. Foreign special corporations

Domestic Special Corporations

The two entities classified as domestic special corporation are:
1. Proprietary educational institutions; and
2. Proprietary hospitals

Both the proprietary educational institutions and proprietary hospitals are subject to 10%
corporation income tax based on their taxable net income. However, if the gross income from unrelated
trade, business or other activity exceeds 50% of the gross income derived from all sources, the tax rate
of 30% shall be imposed on the entire taxable income of such domestic special corporation.
In other words, if the income from unrelated business or other activity exceeds 50% of the total
gross income, the proprietary educational institution or hospital shall be treated as an ordinary domestic
corporation and be imposed the normal tax rate of 30% effective January 1, 2009.
The term “unrelated trade, business or other activity” means its conduct is not substantially
related to the exercise or performance by such educational institution or hospital for its primary
purpose or function.
A proprietary educational institution is any school maintained and administered by private
individuals or groups with an issued permit to operate from the Department of Education (DEPED), or
the Commission on Higher Education (CHED) or the Technical Education and Skills Development
Authority (TESDA), as the case may be, in accordance with existing laws and regulations.
When the proprietary educational institutions and hospitals are subject to the basic normal tax
rate of 30%, they shall also be subject to the imposition of the MCIT of 10%.

90
 Illustration
Premiere Medical Center (PMC), a 40- bed private hospital in Nueva Ecija province, presented
the following data for the current taxable year:
Gross receipts from patients and laboratory ₱ 5,000,000
Income earned from unrelated activities 1,500,000
Total hospitals expenses 2,300,000

Required: Determine the income tax liability of PMC.

Answer and analysis - The ratio of income from unrelated activity to gross income is 23% (₱ 1,500,000/
₱ 6,500,000); hence, PMC is subject to the 10% tax rate based on net taxable income computed as
follows:
Gross receipts from patients and laboratory ₱ 5,000,000
Other income 1,500,000
Gross Income ₱ 6,500,000
Less: Allowable expenses 2,300,000
Net taxable income ₱ 4,200,000
Multiply by tax rate 10%
Income tax due 420,000

Foreign Special Corporations

The following corporate entities and activities are considered as foreign special corporations,
hence, subject to special tax rates or tax- exempt.
1. International carrier
2. Regional operating headquarters
3. Regional are headquarters
4. Offshore banking units
5. Branch remittance
6. Owner, lessor or distributor of cinematographic film
7. Non-resident lessor/ owner of machinery, equipment and aircraft
8. Non-resident lessor/ owner of vessels charted by Philippine nationals

International Carrier
International carrier doing business in the Philippines is subject to tax at 2 1/2% based on gross
Philippine billings.
Gross Philippine billings refer to the amount of gross revenue derived from carriage of persons,
excess baggage, cargo, and mail originating from the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue and place of payment of the ticket.
In case of a flight which originates from the Philippines but transshipment of passenger takes
place at any port outside the Philippines on another airline, only a portion of the cost of the ticket
corresponding to the leg flown from the Philippines to the point of transshipment shall from part of the
gross Philippine billings.
Income of international carrier doing business in the Philippine other than those classified as gross
Philippine billings may be subject to 30% income tax.

91
 Illustration
The Air World, an international carrier doing business in the Philippine, provided the following
data during the current taxable year:
Gross receipts for flight Manila to Italy
(tickets sold in the Philippines) ₱ 12,000,000
Gross receipts for flight Manila to Germany
(tickets sold in Germany) 6,000,000
Gross receipts for flight Italy to Manila (tickets sold in Italy) 4,000,000
Gross receipts for flight to Manila to England
(tickets sold in the Philippines). The passengers were
Transshipment in Germany to England by another airline.
Flight from Manila to Germany is nine hours
And flight from Germany to England is three hours 5,000,000
Operating expenses in Philippine activities 2,000,000

Required: Determine the income tax payable of Air World

Answer and analysis. The international carrier doing business in the Philippines is subject to 2½% based
on gross revenue from persons and cargoes originating from the Philippines to places outside the
Philippines, Expenses incurred by the international carrier are disregarded in the determination of the
tax base.
The tax payable is computed as follows:
Gross receipts for flight Manila to Italy ₱12,000,000
Gross receipts for flight Manila to Germany 6,000,000
Gross receipts from transshipment
(9 hours /12 hours x ₱ 5,000,000) 3,750,000
Total gross Philippine billing ₱ 21,750,000
Multiply by tax rate 2½%
Income tax rate ₱ 543,750
The gross receipts derived from flight Italy to Manila are not included in the computation of the
tax base, since the flight is not originating from the Philippines.

Regional Operating Headquarters

Regional operating headquarters are branches established in the Philippines by multinational
companies which are engaged in any of the following services: general administration and planning;
business planning coordination; sourcing and procurement of raw materials and components; corporate
finance advisory services; marketing control and sales promotion; training and personal management;
logistic services; research and development services and product development ; technical support and
maintenance; data processing and communications ; and business development.
Regional operating headquarters of multinational corporations is subject to 10% tax rate based
on taxable income.

Regional Area Headquarters

Regional area headquarters of multinational corporations are tax exempt entities.
Regional area headquarters are branches established in the Philippines by multinational
companies and which headquarters do not earn income from the Philippines and which act as
supervisory, communications, and coordinating center for their affiliates, subsidiaries or branches in the
Asia Pacific Region and foreign markets.

92
Offshore Banking Unit
Offshore banking unit operating in the Philippines is subject 10% tax based on gross income.
Offshore banking unit means a branch or a subsidiary of foreign banking company duly
authorized by the Bangko Sentral ng Pilipinas to trasnsact offshore banking business in the Philippines.
Offshore banking system is the conduct of business transactions in foreign currencies.
Any income of non-resident individuals or corporations derived from transaction with said
offshore banking unit shall be exempt from income tax.

Branch Remittances
Any profit remitted by a branch to its heads office shall be subject to a tax 15% which shall be
based on total profits applied or earmarked for remittance without any deduction for the tax
component except income from activities registered with the PEZA.
Interests, dividends, rents, royalties, including remuneration for technical services, salaries,
wages, premiums, annuities emoluments or other fixed or determinable annual, periodic or casual gains,
profits, income and capital gains, received by a foreign corporation for all sources within the Philippines
shall not be treated as branch profits unless the same are effectively connected with the conduct of
trade or business in the Philippines.

Illustration
CON Company, branch of foreign corporation doing business in the Philippines, presented the
following data:
Gross income- Philippines ₱ 25,000,000
Operating expenses- Philippines 12,000,000
Income tax 3,900,000
Dividend received from domestic corporation 3,000,000
Interest income, net of final tax 400,000
The following year, the company earmarked for remittance to the head office the following:
Net income after tax of previous year ₱ 7,000,000
Dividend from domestic corporation 3,000,000
Interest income 400,000

Required: Determine the branch profit remittance tax.

Answer - The branch profit remittance is computed based solely on profits earmarked for remittance
without deduction of applicable tax component. Likewise, dividends and interest received that are
remitted to the head office are not subject to 15% branch profit remittance tax.
The branch profit remittance tax is computed as follows:

Net profit earmarked for remittance ₱ 7,000,000

Multiply by 15%
Tax payable ₱ 1,050,000

Owner, Lessor or Distributor of Cinematographic Film

A cinematographic film owner, lessor or distributor shall pay a tax of 25% of its gross income
from all sources within the Philippines.

93
Non- Resident Lessor/ Owner of Machinery, Equipment, Aircraft
Rentals, charters, and other fees derived by a non- resident lessor of aircraft, machinery, and
other equipment shall be subject to tax of 7 ½ % of gross rental or fees.

Non- resident Lessor/ Owner of Vessels Charted by Philippine Nationals.

A non- resident owner or lessor of vessels shall be subject to a tax of 4 ½ % of gross rentals,
lease or charter fees form leases or charters by Filipino citizens or corporation.

Illustration
HRM Corporation had the following data in 2018:
Gross income- Philippines ₱ 5,000,000
Gross income- Australia 3,000,000
Operating expenses- Philippines 1,800,000
Operating expenses- Australia 900,000
Dividends received from domestic corporation 200,000

Required: Determine the income tax assuming the corporation is a:

1. Non –resident lessor or owner of machinery, aircraft and other equipment
2. Non- resident lessor or owner of vessels charted by Philippine nationals; and
3. Owner lessor or distributor of cinematographic film.

Answer 1. The tax due is computed as follows:

Gross income- Philippines ₱ 5,000,000
Multiply by 7½%
Income tax due ₱ 375,000

Answer 2. The taxpayer is subject to 4 ½% tax based gross rental within the Philippines, computed as
follows:
Gross income – Philippines ₱ 5,000,000
Multiply by 4½%
Income tax due ₱ 225,000

Answer 3. The amount of tax due on lessor or distributor of cinematographic films will be ₱ 1,250,000
computed as follows
Gross income- Philippines ₱ 5,000,000
Multiply by 25%
Income tax due ₱ 1,250,000

94
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 6.1

TRUE OR FALSE. State whether the statement is TRUE or FALSE.

1. A corporation is created by a mere agreement of the incorporators.

2. A corporation, for income tax purposes, includes a general professional partnership.
3. A domestic corporation is subject to tax on its income earned from within and outside the
Philippines.
4. A resident foreign corporation is liable on its income from within and outside the Philippines.
5. In computing tax liability of a domestic and a resident foreign corporation, the tax base used is
the net taxable income.
6. The unidentified income of a domestic corporation, whether earned from within or outside the
Philippines, is prorated based on the ratio of income from within with the total gross income in
the world.
7. The tax liability of a non – resident foreign corporation is determined based on its net taxable
income.
8. The principle of MCIT applies to non-resident foreign corporations.
9. Domestic and resident foreign corporations are subject to MCIT.
10. The earnings of tax-exempt corporations from sale of properties shall be subject to tax.
11. Proprietary educational institutions and non-profit hospitals are classified as domestic special
corporations.
12. The principle of MCIT applies to special corporations.
13. The normal tax rate for corporations effective January 1, 2009 is 35%.
14. Corporations are prohibited to use the OSD.
15. The concept of MCIT becomes applicable at the end of the third year of corporate operation.
16. Special corporations may be subject to MCIT.
17. The MCIT is computed based on net taxable income.
18. A domestic ordinary corporation is subject to NCIT or MCIT, whichever is advantageous on the
part of the corporate entity.
19. When the NCIT exceeds the MCIT, the excess shall be carried forward against the tax liability the
following year.
20. Improperly accumulated earnings refer to the earnings accumulated beyond the reasonable
needs of the business.
21. The concept of IAET applies to both public listed and closely held corporations.
22. Generally proprietary educational institutions is subject to 10% tax computed based on net
taxable income.
23. The international carrier and owner or distributor of cinematographic films are subject to 25%
tax rate based on gross income derived from earnings from within the Philippines.
24. Tax credit can only be claimed by domestic and resident foreign corporations.
25. A domestic, resident foreign and non-resident foreign corporations may deduct from their
business income, itemized deductions under the Tax Code.

95
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 6.2
Problem

Nueva Ecija University, a proprietary educational institution, had the following financial data for
2018:

Gross income from business operation ₱ 14,000,000

Total itemized expenses 9,000,000
Other income not related to school deposit 1,500,000
Interest income from bank deposit 200,000

Required: Determine the income tax liability of Nueva Ecija University for 2018.

96
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 6.3
Problem
Tax Corporation just completed its third year of operations. It has the following financial
information for the taxable year 2018, its third year:
Philippines China
Gross income ₱ 1,250,000 ₱ 800,000
Deductions 945,000 540,000

Required: Compute for the following:

1. Assuming that the taxpayer is a domestic corporation, what is the taxable income?
2. What is the tax due?
3. Assuming that the taxpayer is a resident foreign corporation, what is the taxable income?
4. What is the tax due?
5. Assume that the taxpayer is a non-resident foreign corporation, what is the taxable income?
6. What is the tax due?

97
NAME: SCORE:
COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 6.4
Problem
For taxable year 2018, the company’s sixth year of operations, the records of HRDM Major Corp., a
domestic corporation, show the following:

Gross sales ₱ 2,463,500

Sales returns and allowances 27,500
Sales discounts 42,750
Cost of goods manufactured and sold 1,313,600
Operating expenses 586,040

Required: Compute for the following:

1. Net Sales
2. Gross income
3. Minimum corporate income tax
4. Tax due

98
 LESSON 7
TAX RETURNS AND COMPLIANCE REQUIREMENTS
Learning Objectives:

At the end of the chapter, the student should be able to:

 Determine the different kinds of BIR Forms
 Know how to prepare tax returns.

Taxpayers are required to use the new BIR forms, otherwise, the same will not be accepted by
Accredited Agent Banks (AABs) where the forms are supposed to be filed and taxes paid. The form
should bear the correct form number and the latest revision date.

SUMMARY OF BIR FORMS

FORM NO. FORM NAME WHEN TO FILE/ISSSUE

INCOME TAX RETURNS
th
1700 Version Annual Income Tax Return for Individuals Earning Purely On or before fifteenth (15 ) day of April of
June 2013 Compensation Income (Including each year covering income for the preceding
Non-Business/Non-Profession Income) taxable year.
th
*1701 Version Annual Income Tax Return for Self-Employed Individuals, On or before fifteenth (15 ) day of April of
January 2018 Estates and Trusts (including those with both Business and each year covering income for the preceding
Compensation Income) taxable year.
th nd
1701Q Version Quarterly Income Tax Return for Self-Employed On the fifteenth (15 ) day of the 2 month
January 2018 Individuals, Estates and Trusts (including those with both following the close of each of the first three
Business and Compensation Income) quarters of the taxable year

Quarter Months Due date

(CY) Covered
First Jan-Mar **On or before
May 15
Apr-Jun On or before
Second August 15
On or
Third July-Sept before
November 15
th
1702-RT Annual Income Tax Return for Corporations, Partnerships, With or without payment, on or before 15 day
th
Version June and other Non-Individual Taxpayers subject only to of the 4 month following the close of the
2013 Regular Income Tax Rate taxpayer’s taxable year
th th
1702-EX Annual Income Tax Return for use only by Corporations, On or before 15 day of the 4 month
Version June Partnerships, and Other Non-Individual Taxpayers exempt following the close of the taxpayer’s taxable
2013 under the Tax Code, as amended [Sec.30 and those year
exempted in Sec. 27(C)] and other Special Laws, with No
Other Taxable Income
th
1702-MX Annual Income Tax Return for Corporations, Partnerships, With or without payment, on or before 15 day
th
Version June and other Non-Individuals with mixed income subject to of the 4 month following the close of the
2013 Multiple Income Tax Rates or with Income subject to taxpayer’s taxable year
Special/Preferential Rate
1702Q Quarterly Income Tax Return for Corporations, Within 60 days following the close of each of
Partnerships, and Other Non-Individual Taxpayers. the first of 3 quarters of the taxable year.

99
 For Calendar Year
Quarter Months Due
CY Covered Date
First Jan-Mar May 30
Apr-June Aug 29
Second
Third July-Sept November 29

For Fiscal Year

Example: Fiscal Year Ending Nov. 30
Quarter Months Due
CY Covered Date
First Dec-Feb Apr 29
Second Mar-May July 30
Third June-Aug Oct. 30

th
1702Q Annual Income Information Return (for Non-Resident On or before 15 day of April of each year
Citizens/OCWs and Seamen – Foreign Source Income) covering income for the preceding year.

*Revenue Memorandum Circular No. 37-2019 enhanced the BIR forms 1701 (enhanced Annual Income Tax
Return).

INCOME TAX RETURN FOR INDIVIDUALS

Income Tax Return is a sworn statement or declaration in which the taxpayer discloses the
nature and extent of his tax liability by formally making a report of his income and allowable deductions
for taxable year in the prescribed form.

Who Shall File Income Tax Return Using BIR Form 1701
This return shall be filed by the following individuals regardless of amount of gross income:
1. A resident citizen engaged in trade, business, or practice of profession within and without the
Philippines.
2. A resident alien, non-resident citizen or non-resident alien individual engaged in trade, business
or practice of profession within the Philippines.
3. A trustee of a trust, guardian of a minor, executor/admin of an estate, or any person acting in
any fiduciary capacity for any person, where such trust, estate, minor, or person is engaged in
trade or business.
4. An individual engaged in trade or business or in the exercise of their profession and receiving
compensation as well.

Married individuals shall file a return for the taxable year to include the income of both spouses,
computing separately their individual income tax based on their respective total taxable income.
Were it is impracticable for the spouses to file one return, each spouse may file a separate
return of income. If any income cannot be definitely attributed or identified as income exclusively
earned or realized by either of the spouses, the same shall be divided equally between the spouses for
the purpose of determining their taxable income.

Who Shall File Income Tax Return Using BIR Form 1700
This return shall be filed by every resident citizen deriving compensation income from all resources,
or resident alien and non-resident with respect to compensation income from within the Philippines,
except the following:

100
 1. An individual whose gross compensation income does not exceed his total personal and
additional exemptions.
2. An individual receiving purely compensation income, regardless of amount, from only one
employer in the Philippines for the calendar year, the income tax of which has been withheld
correctly by the said employer (tax due equals tax withheld): Provided, that an individual
deriving compensation concurrently from two or more employers at any time during the taxable
year shall file an income tax return.
3. An individual whose income has been subjected to final income tax (alien employee as well as
Filipino employee occupying the same position as that of the alien employee of regional or area
headquarters and regional operating headquarters of multinational companies, petroleum
service contractors, and sub-contractors, and offshore business units; non-resident alien not
engaged in trade or business).
4. A minimum wage earner or an individual who is exempt from income tax.

Substituting Filing of Individual ITR

Substituted filing is when the employer’s annual return (BIR Form 1604CF) may be considered as
the “substitute” Income Tax Return (ITR) of the employee in as much as the information provided in his
income tax return (BIR Form 1700) would exactly be the same information contained in the employer’s
annual return (BIR Form 1604-CF). However, in cases covered by substituted filing, the employer shall
furnish each employee with the original copy of BIR Form 2316 and file/submit to the BIR the duplicate
copy not later than February 28 following the close of the calendar year (Revenue Regulations 11-2013,
May 20, 2013).

Mandatory Itemized Deductions

Individual taxpayers who are not entitled to avail of the OSD and thus use only the itemized
deduction method are the following:
1. Those exempt under the Tax Code, as amended, and other Special laws with no other taxable
income (e.g., Barangay Micro Business Enterprise)
2. Those with income subject to Special/Preferential Tax Rates; and
3. Those with income subject to the Income Tax Rate under Sec.24 of the Tax Code, as amended
and also with income subject to special/preferential tax rates.

BIR Form 1700 and 1701 – When and Where to File and Pay
1. For Electronic Filing and Payment System (eFPS) Taxpayer
The return shall be e-filed and the tax shall be e-paid on or before the 15th day of April of
each year covering income for the preceding taxable year using the eFPS facilities thru the BIR
website http://www.bir.gov.ph.
2. For Non-Electronic Filing and Payment System (non-eFPS) Taxpayer
The return shall be filed and the tax shall be paid on or before the 15 th day of April of each
year covering the income for the preceding taxable year with any Authorized Agent Banks (AABs)
located within the territorial jurisdiction of the Revenue District Office (RDO) where the taxpayer
is registered. In places where there is no AABs, the return shall be filed an tax shall be paid with
the concerned Revenue Collection Officer (RCO) under the jurisdiction of the RDO.
Non-eFPS tax filer may opt to use the electronic format under “eBIRForms” for the
preparation, generation and submission and/or payment of this return with greater ease and
accuracy.

101
3. For Installment Payment
When the tax due exceeds P2,000, the taxpayer may elect to pay in 2 equal installments, the
first installment to be paid at the time the return is filed, and the second installment, on or before
July 15 of the same year.
4. For Non-Resident Taxpayer
In case the taxpayer has no legal residence or place of business in the Philippines, the Return
shall be filed with the Office of the Commissioner or RDO 39, South Quezon City.

Excess Withholding Tax

Over-withholding of income tax on compensation shall be refunded by the employer, except if
the over withholding is due to the employee’s failure or refusal to file the withholding exemption
certificate, or supplies false or inaccurate information, the excess shall not be refunded but shall be
forfeited in favor of the government.

Required Attachments - BIR Form 1700

1. Certificate of Income Tax Withheld on Compensation (BIR Form 2316).
2. Duly approved Tax Debit Memo, if applicable.
3. Proof of Foreign Tax Credits, if applicable.
4. For amended return, proof of tax payment and the return previously filed.

Required Attachments - BIR Form 1701

1. Certificate of Income Tax Withheld on Compensation (BIR Form 2316), if applicable.
2. Certificate of Income Payments not subjected to Withholding Tax (BIR Form No. 2304).
3. Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307).
4. Duly approved Tax Debit Memo, if applicable.
5. Proof of Foreign Tax Credits, if applicable.
6. Income Tax Return previously filed and proof of payment, if filing an amended return for the
same year.
7. Account Information Form (AIF) or the Certificate of the Independent Certified Public
Accountant (CPA) with Audited Financial Statement if the gross annual sales, earnings, receipts
or output exceed three million pesos (P3,000,000).
8. Account Information Form (AIF) or Financial Statement not necessarily audited by independent
Certified Public Accountant (CPA) if the gross annual sales, earnings, receipts or output do not
exceed three million pesos (P3,000,000).

INCOME TAX RETURN FOR CORPORATIONS

Who Shall File BIR Form 1702-RT

This return shall be filed by corporation, partnership and other non-individual taxpayer subject
only to REGULAR income tax rate of 30%. Every corporation, partnership no matter how created or
organized, joint stock companies, joint accounts, associations (except foreign corporation not engaged
in trade or business in the Philippines and joint venture or consortium formed for the purpose of
undertaking construction projects or engaging in petroleum, coal, geothermal and other energy
operations), government-owned or controlled corporations, agencies and instrumentalities shall render
a true and accurate income tax return in accordance with the provisions of the Tax Code. The return
shall be filed by the president, vice-president or other principal officer, and shall be sworn to by such
officer and by the treasurer or assistant treasurer.

102
Who Shall File BIR Form 1702-EX
This return shall be filed by a corporation, partnership and other non-individual taxpayer
EXEMPT under the Tax Code, as amended [Sec. 30 and those exempted in Sec. 27(C)] and other special
laws with no other taxable income such as but not limited to foundations, cooperatives, charitable
institutions, nonstock and non-profit educational institutions, general professional partnership (GPP)
etc., otherwise use BIR Form 1702-MX.
Every GPP shall file this return setting forth the items of gross income and of deductions and the
names, TINs, addresses and share of its partners.

Who Shall File BIR Form 1702-MX

This return shall be filed by every corporation, partnership and other non-individual taxpayer
with MIXED income subject to multiple income tax rates or with income subject to special/preferential
rate.

Mandatory Itemized Deductions

Corporations, partnerships and other non-individuals are mandated to use the itemized
deductions in the following cases:
1. Those exempt under the Tax Code, as amended [Sec. 30 and those exempted under Sec. 27(C)]
and other special laws, with no other taxable income;
2. Those with income subject to special/preferential tax rates, and
3. Those with income subject to income tax rate under Sec. 27 (A), and 28 (A) (1) of the Tax Code,
as amended, and also with income subject to special/preferential tax rates.

Juridical entities whose taxable base is gross revenue or receipts (e.g., non-resident foreign
international carriers) are not entitled to the itemized deductions nor to the optional standard
deduction (OSD) under Sec. 34 (L) of the Tax Code, as amended.

BIR Form 1702-RT, 1702-EX and 1702-MX - When and Where to File and Pay
1. For Electronic Filing and Payment System (FPS) Taxpayer
The return shall be e-filed and the tax shall be e-paid on or before the 15th day of the
fourth month following the close of the taxpayer's taxable year using the eFPS facilities thru the
BIR website http://www.bir.gov.ph.
2. For Non-Electronic Filing and Payment System (non-eFPS) Taxpayer
The return shall be filed and the tax shall be paid on or before the 15th day of the fourth
month following the close of the taxpayer's taxable year with any Authorized Agent Bank (AAB)
located within the territorial jurisdiction of the Revenue District Office (RDO) where the
taxpayer's principal office is registered. In places where there are no AABS, the return shall be
filed and the tax shall be paid with the concerned Revenue Collection (RCO) under the
jurisdiction of the RDO.
Non-eFPS tax filer may opt to use the electronic format under "eBIRForms" (refer to
www.bir.gov.ph) for the preparation, generation and submission and/or payment of this return
with greater ease and accuracy.

Required Attachments - BIR Form 1702-RT

1. Certificate of Income Payments not subjected to withholding Tax (BIR Form No. 2304).
2. Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307).
3. Duly approved Tax Debit Memo, if applicable.
4. Proof of Foreign Tax Credits, if applicable.

103
 5. For amended return, proof of tax payment and the return previously filed.
6. Account Information Form (AIF) or the Certificate of independent CPA with Audited Financial
Statements (FS), if the gross annual sales, earnings, receipts or output exceed P3,000,000.
7. Proof of prior years’ excess credits, if applicable.

Required Attachments - BIR Form 1702-MX

In addition to the above attachments, the Certificate of Tax Treaty Relief/Entitlement
Issued by the concerned Investment Promotion Agency (IPA) shall be provided.

Required Attachments - BIR Form 1702-EX

In addition to the above attachments, the Schedule of Returns filed by General Professional
Partnership. shall be provided.
If a corporation claimed 40% of the gross income as optional standard deduction (OSD), it is still
required to submit its financial statements when it files its annual income tax
return and to keep such records pertaining to its gross income (RR 2-1010, Feb. 18
2010).
A corporation may employ either calendar year or fiscal year as basis for filing its annual income
tax return. This basis, however, cannot be changed without prior approval from the Commissioner.

Returns of General Professional Partnerships

Every general professional partnership shall file a return of its income except income exempted
by law, showing the items of gross income and of deductions allowed; and the names, TIN, addresses
and shares of each of the partners.
General professional partnerships as such are not subject to income tax. It is the partners who
are liable for income tax in their separate and individual capacities. The partner shall report as gross
income his distributive share, actually and constructively received from the net income of the
partnership.
The general professional partnership is not required to file quarterly income tax
return/quarterly information return. It is required, however, to file annual income tax return/annual
information return (Form 1702-EX) with audited financial statements.
Per Revenue Regulations 2-2010, a taxpayer who elected to avail of the optional standard
deduction (OSD) shall signify in the return such intention; otherwise, itemized deductions will be
considered. Once the election to avail of the OSD or itemized deduction is signified in the return, it shall
be irrevocable for the taxable year for which the return is made. The election to claim either the OSD or
the itemized deduction for the taxable year must be signified by checking the appropriate box in the
income tax return filed for the first quarter of the taxable year adopted by the taxpayer.

eFPS AND BIRForms

Revenue Memorandum Circular 61-2012, Revenue Memorandum Order 24-2013, Revenue
Regulations 6-2014 and 5-2015, Revenue Memorandum Circular 19-2015 provide guidance on the
implementation of the electronic platform in filing tax returns through the eFPS or the eBIRForms for
filing ITRs.
There are two BIR electronic platforms available for filing tax returns:
1. eFPS
2. eBIRForms

The following are mandated to use eFPS:

1. Taxpayer Account Management Program (TAMP) Taxpayers;

104
 2. Accredited and prospective importers required to secure the BIR Importer's Clearance
Certificate (BIR-ICC) and BIR Broker's Clearance Certificate (BIR-BCC);
3. National Government Agencies (NGAs);
4. All Licensed Local Contractors;
5. Enterprises enjoying fiscal incentives (PEZA, BOI, Various Zone Authorities, etc.);
6. Top 5,000 Individual Taxpayers;
7. Corporations with Paid-Up Capital Stock of P10 Million and above;
8. Corporations with a complete computerized accounting system (CAS);
9. Procuring Government Agencies with respect to Withholding of VAT and Percentage Taxes;
10. Government Bidders;
11. Insurance companies and stock brokers;
12. Large taxpayers;
13. Top 20,000 private corporations.

The following are mandated to use eBIRForms and eFile:

1. Accredited tax agents, practitioners and all their client-taxpayers who have authorized them to
file on their behalf;
2. Accredited printers of principal and supplementary receipts/invoices;
3. One-Time Transaction (ONETT) taxpayers;
4. Those engaged in business, or those with mixed income (both compensation and business
income) who shall file a "No Payment" Return;
5. Government-Owned or Controlled Corporations (GOCCS);
6. Local Government Units (LGUs), except barangays;
7. Cooperatives, registered with National Electrification Administration (NEA) and Local Water
Utilities Administrations (LWUA).

The following are exempted from the mandatory use of eBIRForms and electronically
filing "No Payment Returns":
1. Senior Citizens (SCs) or Persons with Disability (PWDs) filing their own returns;
2. Employees deriving purely compensation income whether from one or more employers,
whether or not they have any tax due that has to be paid;
3. Employees qualified for substituted filing under RR 2-98, Sec. 2.83.4, as amended, but who
opted to file an ITR and are filing for purposes of promotion (PNP/AFP), loans, scholarship,
foreign travel requirements, etc.

Other taxpayers, such as Micro Small Medium Enterprises (MSMEs), which are filing their own
returns and have tax payments due, are not required to file electronically, but can voluntarily enroll and
file using either the eFPS/eBIRForms electronic platforms of the BIR.

Taxpayers who are mandated to use the eFPS and eBIRForms but continue to file manually, shall
be subject to the P1,000 penalties per return pursuant to Sec. 250 of the Tax Code, and 25% surcharge
for wrong venue under RR 5-2015.

105
 COMPLIANCE REQUIREMENTS

Title IX of the NIRC, as amended, provides guidelines on the compliance requirements that must
be observed by all person’s subject to income tax.

KEEPING OF BOOKS OF ACCOUNTS

All corporations, companies, partnerships or persons required by law to pay internal revenue
taxes shall keep a journal and a ledger or their record.
In addition, the following taxpayers are required to keep documents and records below:
1. Those whose quarterly sales, earnings, receipts or outputs do not exceed ₱ 50,000 shall keep
and use simplified set of bookkeeping records duly authorized by the Secretary of Finance,
wherein all transactions and results of operations are shown.
2. Those whose quarterly sales, earnings, receipts or outputs exceed ₱ 150,000 shall have their
book of accounts audited and examined yearly by an independent CPA, as well as and their
income tax return accompanied with a duly accomplished Account Information Form (AIF).

Accordingly, the taxpayers should maintain books and records that would reflect the reconciling
items between figures of financial statements and those reflected in the income tax return. The
recording and presentation of the reconciling items in the books and records should be done in a
manner that would facilitate understanding by BIR examiners/ auditors.

Subsidiary Books
All corporations, companies, partnerships or persons keeping the books of accounts may keep
subsidiary books as the needs their business may require; provided that, where subsidiaries are kept,
they shall form part of the accounting system of the taxpayer and shall be subject to the same rules and
regulations as to keeping, translation, production, and inspection as are applicable to the journal and
ledger.

Preservation of Books of Accounts

All the books of accounts, including the subsidiary books and other accounting records, shall be
preserved within three years from the last entry in each book, except in case of false or fraudulent filling
of return. Within the three years’ period, the BIR Commissioner is authorized to make an assessment.
The books of accounts and records shall be subject to examination and inspection by internal
revenue officers only once in a taxable year, except in the following cases:
1. Fraud, irregularity or mistakes as determined by the BIR Commissioner
2. The taxpayer requests reinvestigation
3. Verification of compliance with withholding tax laws and regulations
4. Verification of capital gains tax liabilities.

Responsibility of a Certified Public Accountant (CPA)

An independent CPA who audited the records and certified the financial statements of the tax
payer shall maintain and preserve copies of audited financial statements for a period of three years,
except a longer period is required by the Tax Code, from the due date of filling the annual tax return or
the actual date of filling, whichever comes later.
An independent CPA who, in his/her capacity as external auditor, willfully falsifies any report or
statement or certifies financial statements of business enterprise containing material misstatement
of facts or omission shall be subject to the applicable penalty provisions of the Tax Code and related
revenue regulations.

106
REGISTRATION REQUIREMENTS
Every person subject to any internal revenue tax shall register once with the appropriate revenue
district officer:
1. Within 10 days from date of employments;
2. On or before the commencement of business;
3. Before payment of any tax due; or
4. Upon filling of a return, statement or declaration as required by the Tax Code.

The registration shall contain the taxpayer’s name, style, place of residence, business and such
other information as may be required by the BIR Commissioner.
A person maintaining a head office, branch or facility shall register with the revenue district officer
having jurisdiction over the head office, branch or facility. The term facility may include, but not limited
to, sales outlets, places of production, warehouses or storage places.

Annual Registration Fee

An annual registration fee in the amount of ₱ 500 for every separate or distinct establishment or
place of business, including facility types where sales transactions occur, shall be paid upon registration
and every year thereafter on or before the last day of January.
The annual registration fee shall be paid to an authorized agent bank located within the revenue
district, or to the revenue district officer or duly authorized treasure of the city or municipality where
the place of each business or branch is registered.
The imposition of annual registration fee shall likewise apply in case where part of the activities or
undertakings conducted in a facility of the business involved sales transactions, regardless of the facility
of the business involved sales transactions, regardless of the frequency of the occurrence. Sales
transactions need not be conducted on regular basis. Thus, even if the warehouse or place of production
is predominantly used for storage, warehouse or production purposes, a single conduct of sale
consummated threat is enough to warrant the imposition of the annual registration fee.
When an individual who has paid the registration fee died, and the same business is continued by
the person or persons interested in his/her estate, no additional payment shall be required for the
remaining time of which the tax was paid. However, the person or persons interested in the estate
should, within 30 days from the death of the decedent, must submit to the revenue district office
inventories of goods at the time death. This also applies in the case of the transfer of ownership or
change of name of the business establishment.
The following shall be exempt from the imposition of annual registration fee:
1. Cooperatives duly registered with the Cooperative Development Authority (CDA)
2. Individuals earning purely compensation income, whether locally or abroad
3. Overseas contact workers
4. Marginal income earners
5. Government agencies and instrumentalities in the discharge of their governmental functions
6. LGUs in the discharge of their governmental functions
7. Tax-exempt persons
8. Non-stock / non- profit organization not engaged in business
9. Persons subject to tax under one-time transaction
10. Facilities where no sales transactions occur.

Registration of Each Type of Internal Revenue Tax

Every person required to register with the BIR shall register each type of internal revenue tax for
which he/she is obligated to file a return, pay such taxes, and update the registration of any changes.

107
 The following internal revenue taxes by a business entity shall be registered:
1. Income tax
2. VAT
3. Percentage Tax
4. Withholding tax compensation
5. Creditable withholding tax at source on certain tax payments.
6. Final withholding tax on certain income payment
7. Documentary stamp tax
8. Excise tax
9. Annual registration fee.
The nature of the business to which the taxpayer belongs should be taken into consideration in
determining the types of taxes that should be registered. In the registration of the type of internal
revenue tax, only those taxes that the taxpayer is expected to periodically pay should be registered.
In case the business entity has a branch, the following guidelines may be observed:
1. For income tax and VAT – Registration shall be with the head office.
2. For percentage tax, withholding tax on compensation, creditable withholding tax at source,
final withholding tax on certain payments, documentary stamp tax and excise tax- The tax
payer has the option to register with the head office for consolidated percentage tax return
or in its respective branches.
3. For annual registration fee- Registration shall be with the head office and in all the branches
or facilities with sale transactions.

Transfer of Registration
In case a registered person transfers his/her place of business or his/her office or branches, it shall
be his/her duty to update his/her registration status by filling an application for registration information
update in a prescribed form.
It shall be the duty of the old revenue district office (RDO) to transfer accountabilities of the tax
payer to the new RDO where he/she is transferring. However, the old RDO can still institute collection
on concluded audit tax cases at the time of transfer of registration. Also, the old RDO is still duty-bound
to terminate audit cases that are prescribing within six months from the date of transfer. The filling of
tax return and payment of taxes to the new RDO shall start at the time the transfer is effected by the old
RDO.

Request for Transfer of Business Registration During the Interim Period

Transfer of business registration during the interim period shall only be officially effected in the
records of the BIR by the end of the year. The taxpayer is allowed to physically transfer his/her business
to the intended RDO. However, the filling of return and the payments f taxes in the new RDO shall bear
the RDO Code of the old RDO until the end of the year and without the imposition of any surcharge for
“wrong – venue filling of return”

Other Updates
Updates refer to the processes by which the information supplied during the primary registration
process is changed either upon the initiative of the taxpayer or the BIR.
Basically, any person registered and subject to payment of any internal revenue tax, whenever
applicable, shall update his/her registration with the revenue district office where he/she is registered,
specifying therein any change in type and other taxpayer details.
The taxpayer shall update his/her registration information under the following instances.
1. A person’s business has become exempt in VAT.

108
 2. A change in the nature of the business itself from sale of taxable goods or services to
exempt sales
3. A person whose transactions are exempt from VAT, who voluntarily registered under VAT
system, who after the lapse of three years after his/her registration, applies for cancelation
of his/her registration
However, optional registration as a VAT taxpayer a franchise grantee of radio and or
television broad casting whose gross receipts for the preceding year did not exceed ₱
10,000,000 shall not be revocable.
4. A VAT – registered person whose gross sales or receipts for three consecutive years did not
exceed ₱ 3,000,000 beginning January 1, 2018
5. Any other changes or updates in registration information previously supplied, including
cancelation or change in any tax types.

Cancelation of Registration
Cancelation refers to the process by which the information pertaining to primary registration of a
taxpayer is tagged as “canceled” but nevertheless, remains as part of the BIR’s registration data base.
Basically, the registration of any person who ceases to be liable to a tax type shall be cancelled
upon filling with the revenue district office where he/she is registered, an application for registration
information update in a prescribe form.
The cancelation of registration may either pertain to cancelation of business registration and or
taxpayer’s identification number (TIN). The cancelation of business registration shall not automatically
cancel the TIN of the person.
Cancelation of business registration may be granted on the following grounds:
1. Closure or cessation of business operation
2. Dissolution of corporation or partnership
3. Merger or consolidation
4. Death of an individual

The cancelation of business registration due to any of the above instances requires the filling of
a notice of closure or cessation of business to the RDO where it is registered by accomplishing the
prescribed registration update forms.
The taxpayer’s identification number is canceled upon:
1. Death of an individual;
2. Dissolution, merger or consolidation of juridical person;
3. Discovery of a taxpayer having multiple TINs; and
4. Payment of estate tax by the heirs, administration or executor.

109
 LESSON 8
BUSINESS TAXES
Learning Objectives:

At the end of the chapter, the student should be able to:

 Discuss what business taxes are.
 Explain the how to arrive at value added tax and percentage tax due.

Under the Tax Code, the three major business internal revenue taxes are:
1. Value-added taxes;
2. Percentage taxes; and
3. Excise taxes.

VALUE-ADDED TAX
Value-added tax is a tax on the value added to the purchase price or cost in the sale or lease of
goods, property or services in the course of the trade or business. It is imposed on the value added in
each stage of distribution. It is an indirect tax that may be shifted or passed on to the buyer, transferee
or lessee of the goods, property or services.
Per Republic Act 10963, also known as the Tax Reform for Acceleration and Inclusion, every
person who, in the course of trade or business, sells, barters, exchanges, leases goods or property, or
renders services is subject to VAT, if the aggregate of his/her actual or expected gross sales and/or gross
receipts exceeds Three Million Pesos (₱3,000,000), new threshold.
Any business or business pursued by an individual where the aggregate gross sale or receipts do
not exceed ₱100,000 during any 12-month period shall be considered principally for subsistence or
livelihood and not in the course of business.

VAT on Sale of Goods or Property

Goods or property shall mean all tangible and intangible objects that are capable of pecuniary
estimation and shall include:
1. Real property held primarily for sale to customers or held for lease in the ordinary course of
trade or business;
2. The right or the privilege to use patent, copyright, design or model, plan, secret formula or
process, goodwill, trademark, trade brand or other like property or right;
3. The right or the privilege to use in the Philippines of any industrial, commercial or scientific
equipment;
4. The right or the privilege to use motion picture films, films, tapes and discs; and
5. Radio, television, satellite transmission and cable television time.

Gross Selling Price

Gross selling price is the total amount of money or its equivalent, which the purchaser pays or is
obligated to pay to the seller in consideration of the sale, barter or exchange of the goods or properties,
excluding the value-added tax. The excise tax, if any, on such goods or property shall form part of the
gross selling price.

110
 Sales returns and allowances for which a proper credit or refund was made, and sales discounts
determined and granted at the time of sale which are expressly indicated in the invoice, are proper
deductions from gross selling price to arrive at the tax base.

Tax Base and Rates

There shall be levied, assessed and collected on every sale, barter or exchange, or transactions
“deemed sale" of taxable goods or property, value-added tax equivalent to 12% of the gross selling price
or gross value in money of the goods or property sold, bartered or exchanged, or deemed sold in the
Philippines.

Transactions Deemed Sale

The following transactions are "deemed sale" and are subject to VAT:
1. Transfer, use or consumption not in the course of business of goods or property originally
intended for sale or for use in the course of business.
2. Distribution or transfer to:
a. Shareholders or investors as share in the profits of the VAT-registered persons;
b. Creditors in payment of debt or obligation;
3. Consignment of goods if actual sale is not made within sixty (60) days following the date such
goods were consigned; and
4. Retirement from or cessation of business, with respect to inventories of taxable goods existing
as of such retirement or cessation.

Sale of Real Properties (Based on New Thresholds)

Sale of real properties held primarily for sale to customers or held for lease in the ordinary
course of trade or business of the seller shall be subject to VAT. The following sale of properties is
subject to output VAT:
1. Sale of residential lot with gross selling price exceeding P1,500,000.00 and
2. Sale of residential house and lot or other residential dwellings with gross selling price exceeding
P2,500,000.00, where the instrument of sale (whether the instrument is nominated as a deed of
absolute sale, deed of conditional sale or otherwise) is executed on or after Jan 1, 2018 shall be
subject to 12% output VAT.
3. Installment sale of residential house and lot or other residential dwellings with gross selling
price exceeding P1,000,000.
4. A real estate investment trust (REIT) shall be subject to VAT on its gross sales from any disposal
of real property (Revenue Regulations 13-2011, July 25, 2011).

VAT on Sale of Services and Use or Lease of Property

The phrase "sale or exchange of services" means the performance of all kinds of services in the
Philippines for others for a fee, remuneration or consideration, including those performed or rendered
by:
1. construction and service contractors;
2. stock, real estate, commercial, customs and immigration brokers;
3. lessors of property, whether personal or real;
4. warehousing services;
5. lessors or distributors of cinematographic films;
6. persons engaged in milling, processing, manufacturing or repacking goods for others;
7. proprietors, operators or keepers of hotels, motels, rest houses, pension houses, inns, resorts,
theaters and movie houses;

111
 8. proprietors or operators of restaurants, refreshment parlors, cafes and other eating places,
including clubs and caterers;
9. dealers in securities;
10. lending investors;
11. transportation contractors on their transport of goods or cargoes, including persons who
transport goods or cargoes for hire and other domestic common carriers by land relative to
their transport of goods or cargoes;
12. domestic common carriers by air and sea relative to their transport of passengers, goods or
cargoes from one place in the Philippines to another place in the Philippines;
13. sale of electricity by generation, transmission and distribution companies;
14. franchise grantees of electric utilities, telephone and telegraph, radio and/or television
broadcasting and all other franchise grantees, except franchise grantees of radio and/or
television broadcasting whose annual gross receipts of the preceding year do not exceed Ten
Million Pesos (P10,000,000), and franchise grantees of gas and water utilities;
15. non-life insurance companies including surety, fidelity, companies;
16. pre-need companies;
17. health maintenance organizations; and
18. similar services regardless of whether or not the performance thereof calls for the exercise or
use of the physical or mental faculties (R.A. 9337).

Gross Receipts
The term "gross receipts" means the total amount of money or its equivalent representing the
contract price, compensation, service fee, rental or royalty, including the amount charged for materials
supplied with the services and deposits applied as payments for services rendered and advanced
payments actually or constructively received during the taxable period for the services performed or to
be performed for another person, excluding value-added tax.

Tax Base and Rate

There shall be levied, assessed and collected, a value-added tax equivalent to twelve percent (12%)'
of the gross receipts excluding the value-added tax, derived from the sale or exchange of services,
including the use or lease of properties.

VAT on Importation of Goods

Importation connotes permanency and for gain, either for personal use or for business.
Importation of goods is subject to 12% VAT based on the total value used by the Bureau of Customs
in determining tariff and customs duties, plus customs duties, excise taxes, if any, and other charges.
The importerº, prior to the release of such goods from customs custody, shall pay the value-added tax.
Where the custom duties are determined on the basis of the quantity or volume of the goods, the
value-added tax shall be based on the landed cost plus excise taxes, if any.

OUTPUT AND INPUT TAXES

Output tax means the value-added tax due on the sale or lease of taxable goods or property or
services by a VAT-registered person. Input tax is the value-added tax due from or paid by a
VAT-registered person in the course of his/her trade or business on importation of goods or local
purchase of goods or services, including lease or use of property from a VAT-registered person.
Generally, any input tax evidenced by a VAT invoice or official receipt shall be creditable against the
output tax.

112
 To the VAT-registered purchaser, the tax burden passed on does not cost, but input tax which is
creditable against his/her output tax liabilities. This voids the cascading effect which is a characteristic of
the sales tax system of old, where the sales tax is necessarily cost to the buyer, and as such becomes a
factor of cost which is a basis of the marked up seller price in turn to his/her customers, and so on and
so forth down the distribution chain. In the VAT system, however, it is only in the case of a non-VAT
purchaser that VAT forms part of cost of the purchase (BIR Ruling 141-99, Sept. 13, 1999). Input taxes on
the following are creditable against the output tax:
1. Purchase or importation of goods:
a. For sale;
b. For conversion into or intended to form part of a finished product for sale including
packaging materials;
c. For use as supplies in the course of business;
d. For use as materials supplied in the sale of service;
e. For use in trade or business for which deduction for depreciation or amortization is
allowed under the Tax Code.
2. Purchase of real properties for which a value-added tax has actually been paid.
3. Purchase of services in which a value-added tax has actually been paid.
4. Transactions "deemed sale".
5. Transitional input tax allowed.
6. Presumptive input tax allowed.
7. Transitional input tax credits allowed under the transitory and other provisions.

The input tax on domestic purchase of goods, properties or services or importation of goods by a
VAT-registered person shall be creditable to:
a. the purchaser of the domestic goods or properties upon consummation of the sale;
b. the purchaser of services, or the lessee or licensee upon payment of the compensation,
rental, royalty or fee; or
c. the importer upon payment of the value-added tax prior to the release of the goods from
the custody of the Bureau of Customs.

OTHER PERCENTAGE TAX

Any person whose sales or receipts are exempt under Section 109(V) of Tax Code from the payment
of value-added tax is who is not a VAT-registered person shall pay a tax equivalent to three percent (3%)
of his gross quarterly sales or receipts.

PERCENTAGE TAXES AND RATES (Summarized)

Percentage Tax Tax Base Tax Rate
Sec. 116 – Tax on persons exempt from
VAT under Sec. 109 (BB) (annual gross Gross monthly sales or receipts 3%
sales or receipts do not exceed
₱3,000,000
Sec. 117 – Percentage tax on domestic
carriers and keepers of garage Actual or minimum monthly gross receipts whichever is higher 3%
(transport of passengers)
Sec. 118 – Percentage tax on Monthly gross receipts 3%
international carriers
Sec. 119 – Tax on franchises Gross receipts:
Franchise on radio and/or TV broadcasting companies whose
annual gross receipts of the preceding year do not exceed ₱
10,000,000 3%

113
 Franchise on gas and water utilities 2%
Sec. 120 – Tax on overseas dispatch, Amount paid for such services (by the person who used the
message or conversation originating communications facilities) 10%
from the Philippines
Sec. 121 – Tax on banks and non-bank Gross receipts on interest, commissions and discounts from lending
financial intermediaries performing activities; income from financial leasing:
quasi-banking functions
Remaining maturity period of instrument is 5 years or less 5%

Remaining maturity period of instrument is more than 5 years 1%

Dividends and equity shares in net income of subsidiaries 0%

Royalties, rentals of property, real or personal, profits from

exchange and all other items treated as gross income under the Tax
Code 7%

Net trading gains within the taxable year on foreign currency,

debt securities, derivatives and other similar financial instruments 7%

Sec. 122 – Tax on other non-bank Gross receipts derived from interest, commissions, discounts and all
financial intermediaries other items treated as gross income under the Tax Code 5%

Interest, commissions and discounts from lending activities, as well as

income from financial leasing:
Remaining maturity of instrument is 5 years or less 5%
Remaining maturity of instrument is more than 5 years 1%
Sec. 123 – Tax on life insurance Total premiums collected 2%
Sec. 124 – Tax on agents of foreign Total premiums collected/paid
insurance companies (fire, marine or Generally 4%
miscellaneous insurance) Owners of property obtain insurance directly with foreign
insurance companies 5%
Sec. 125 – Amusement taxes Gross receipts
Jai-alai and race track 30%
Cockpits, cabarets, night or day clubs 18%
Professional basketball games 15%
Boxing exhibitions 10%
Sec. 126 – Tax on winnings Actual amount paid for every winning ticket after deducting the cost of
the ticket 10%
Winnings from double, forecast/quinella and trifecta bets 4%
Prize of winning race horse owners 10%
Sec 127 (A) Tax on sale, barter or
exchange of shares of stock listed and
traded through the local stock exchange Gross selling price or gross value in money 6/10 of 1%
(B) Tax on shares of stock sold Gross selling price or gross value in money in accordance with the
or exchanged through public offerings proportion of shares of stock sold, bartered, exchanged or otherwise
disposed to the total, outstanding shares of stock after listing in the
local stock exchange
Up to 25% 4%
Over 25% but not over 33 1/3% 2%
Over 33 1/3% 1%

114
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 8.1

TRUE OR FALSE. State whether the statement is TRUE or FALSE.

1. Output tax means the value-added tax due on the sale or lease of taxable goods or property or
services by a VAT-registered person.
2. Any input tax evidenced by a VAT invoice or official receipt shall be creditable against the output
tax.
3. A VAT-registered person who is also engaged in transactions not subject to the value-added tax
shall be allowed input tax which can be directly attributed to transactions subject to VAT.
4. The value of goods or property sold and subsequently returned may be deducted from the gross
sales or receipts for the quarter in which the refund is made.
5. VAT, being an indirect tax, may be shifted or passed on to the buyer of goods, property or
services.
6. When a sale of service is subject to VAT, it cannot be subject to percentage tax.
7. Any person, in the course of trade or business, sells, barters, exchanges, leases goods or
property, renders services, and any person who imports goods shall be subject to value-added
tax.
8. Government entities and instrumentalities, including government-owned or controlled
corporations, are not subject to VAT.
9. Value-added tax is a privilege tax.
10. Buyers of services are the ones primarily liable for the payment of VAT to the Bureau of Internal
Revenue.
11. Sale of goods or services which are subject to Other Percentage Tax are subject also to
value-added tax.
12. A person or transactions which are subject to Other Percentage Tax may still be subject to
income tax.

115
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 8.2

Problem

A Vat-registered person purchased an article from another VAT-registered person for ₱ 134,400. He
sells the same article for ₱ 224,000.

Required: Compute for the following:

1. Output tax
2. Input tax
3. VAT payable

116
NAME: SCORE:

COURSE/YEAR/SECTION: PROFESSOR:

EXERCISES 8.3

Problem

BSBA Corporation is a value-added tax registered dealer of appliances. The following data are for
the last quarter of 2018:

Sales, VAT inclusive ₱ 6,720,000

Purchases, net of input taxes 5,500,000
Sales Returns 200,000
Purchases Returns 300,000

Required: Compute for the following:

1. Output tax on net sales

2. Input tax on net purchases
3. VAT payable for the last quarter of 2018

117
 REFERENCES

Aduana, Nick L., SIMPLIFIED AND PROCEDURAL HANDBOOK ON INCOME TAXATION

Austria-Cruz & Bulandos, THE BASICS OF INCOME AND BUSINESS TAXATION

Ballada, Win, INCOME AND BUSINESS TAXATION

Sacdalan-Casasola, Eufrocina M., NATIONAL INTERNAL REVENUE CODE OF 1997

Republic Act 10963 – Tax Reform for Acceleration and Inclusion

Philippine Law Library

BIR Website @ www.bir.gov.ph

118