Chapter 3 - Introduction to Income Tax

CHAPTER 3
INTRODUCTION TO INCOME TAXATION
Chapter Overview and Objectives

This chapter discusses the concept of tax income, the situs of income, and the
types of taxpayers.

After this chapter, readers are expected to comprehend and demonstrate

knowledge on the following:
1. The concept of gross incomne
2. The types of income taxpayers
3. The general rules in income taxation
4. Theincome tax situs rules
THE CONCEPT OF INCOME

Why is income subject to tax?

Income is regarded as the best measure of taxpayers' ability to pay tax. It is an
excellentobject bf taxation in the allocation of government costs.

What is income for taxation purposes?

Thetax concept ofincome is simply referred to as "gross income" under the NIRC.
A taxable item of income is referred to as an "item of gross income" or "inclusion in

gross income.

Gross income simply taxable income in layman's term. Under the NIRC
means
certain items of gross income less
however, the term "taxable income" refers to
deductions and personal exemptions allowable by law. Technically,gross income)
can be subjected to income tax.
1Sbroader to pertain to any income that
any inflow of wealth to the taxpayer from
uross incomeis broadly defined as
includes income from
Whatever source, legal or illegal,thatincreasesnet worth, It
exercise of profession, income from
properties,
Employment, trade, business or and other regular or casual
and other sources such as dealings in properties

transactions. O 39008
ELEMENTS OF GROSS INCOME od bisrgu sdtorol 9tnuag
t is areturn on capital that increases net worth. 1qr 3o
. It is a realized benefit.n t 8 e n i ot 1u 99tgl2rs ns ga
t is not exempted by law, contract, ortreaty.
Chapter 3 - Introduction to Income Tax

RETURN ON CAPITAL
Capital means any wealth or property. Gross income is a return on wealu
property that increases the taxpayer's net worth.
lustration
ABC purchased goods for P300 and sold them for P500. The P500 considerationca
analyzed as follows: can

Selling price (total consideration received) P 500 Total return

Cost (value of inventory
forgone) 300 Return of capital
Mark-up (gross income) P 200 Return on capital
The lreturn on
capital that increases net worth is income subject to income t
Return of capital
merely maintains net worth; hence, it is not taxable. A
improvement in net worth indicates an ability
to tax.
pay
Capital items deemed with infinite value
There capital items that have linfinite valuej and are incapable of
are
valuation. Anything received as pecuniar-
compensation for their loss is deemed a returno
capital
Examples:
1. Life
2. Health
3. Human reputation

Life
The value of life is immeasurable by
money. Under Sec. 32 of the NIRC, hes
proceeds of life insurance policies paid to the heirs or
the insured, whether in a single sum or otherwise, are beneficiaries upon deatho
exempt from income tax.
The proceeds of a life insurance contract collected by an employer as a
from the life insurance of an officer or any person beneficiar
directly
trade are likewise exempt. These proceeds are viewed as interested with his
future loss. advanced recovery o
However, the following are taxable return on capital from insurance policies:
a. Any excess amount received over premiums paid by the insured un0
surrender or maturity of the policy (i.e. the insured outlives the policy ) upo
b. Gain realized by the insured from the assignment or sale of his
ineranCe
policy
C. Interest income from the unpaid balance ofthe proceeds of the policy
d. Any excess of the proceeds received over the acquisition costs and nremium
payments by an assignee of a life insurance policy
Chapter 3 Introduction to Income
Tax

Health
Any compensation received consideration
campensation for personal
in
for the loss of
injuries or tortuous acts is deemed a
health such as
return of capital.
Human Reputation
The value of one's
reputation cannot be measured
received as compensation
from income tax.
for its
impairment is deemedfinancially.
a return of
Any indemnity
capital exempt
Examples include moral damages received
from:
a. Oral defamation or slander
b. Alienation of affection
c. Breach of promise to marry

Recovery of lost capital vs. Recovery of lost

The loss of profits
capital
results in decrease in net worth
while the loss of profits does
not decrease net worth. The
recovery of lost capital merely maintains net worth
while the recovery of lost profits increases net
worth. Therefore, the
lost profits is a return on recovery of
capital.
Taxable recovery of lost profits
The recovery of lost profits through insurance, indemnity contracts, or legalsuits
constitutes a taxable return on capital.

The following are taxable recoveries of lost

profits:)
a. Proceeds of crop or livestock insurance
b. Guarantee payments
C. Indemnity received from patent infringement suit

Illustration 1
Mang Reyes insured his strawberry crop in a P200,000 crop insurance coverage
against calamities. The crop was eventually destroyed by an unusual frost. Mang Reyes
was paid the P200,000 insurance proceeds.
ne Pz00,000 proceeds which is a reimbursement for the lost value of the future harvest,
ISs an item of gross income. The value of the lost crops is, in effect, realized not through
actual harvest but through the insurance contract.

Illustration 20 d leo se an annual franchise

r. Kamos purchased a franchise. The franchisor guaranteed
COme of P100,000 to Mr. Ramos. Tn the first year of operation, Mr. Ramos'outlet only
d P60,000. The franchisor paid the P40,000 difference to Mr. Ramos.

65
 to Income lax
Introduction
Chapter 3-
but a recovery lost n r a d of
gratuity
00 as frano
not a
payment is P100,000
The P40,000 guarantee Ramos shall report
income tax. Mr.
to
Ramos; hence, subject
income.

llustration 3 its income after a

unusual decline in
con

Davao Crocodile Inc. experienced an

sued the competitor or
ompeti
for
for pate
invention. Davao Crocodile
copied its patented
of P3,000,000.
infringement and was awarded an indemnity

The P3,000,000 indemnity is a compensation for

the income not realized by h
an item ofgross income.
Crocodile due to the patent infringement. The same is

The recovery of lost income or profits is not intended to compensate for the los
capital It is as good as realization ofincome; hence, it is an item ofgross income

REALIZED BENEFIT
What is meant by realized benefit?
The "benefit" concept
The term "benefit" means any form of advantage derived by the taxpayer. There is
benefit when there is an increase in the net worth of the
net worth occurs when one receives taxpayer. An increase in
income, donation or inheritance.
The following are not benefits, hence, not taxable:
a. Receipt of a loan properties increase but
in an offsetting effect in net worth. obligations also increase resulting|
b. Discovery of lost properties under the law, the finder
return the same to the owner. has an obligation to
C. Receipt of money or property to be held in trust
another person. for, or to be remitted to
If the taxpayer is entitled to
keep for his account
portion of a
portion is a benefit. receipt, only that
Illustration
1. An employee was
granted P20,000 transportation advance. He
transportation expenses and was allowea by ns liquidated p18 000
employer keep the P2.000.
Only the P2,000 retained by the employee is considered to
extent he benefited. (RR2-98) income since this
was was the
2. A security agency receives P120,000 from clients,
P100,000 of which is far the
salaries of security guards. Under RMC
the agency is considered income of the 39-2007,joniyit the P20,000 attributable to
agency since IS the extent it is benefited
The P100,000 pertaining to salaries of
security guards is recognized by the apency
as a liability upon receipt. gen
The "realized" concept
The term realized means earned. It
requires that there is a degree of undertaking
or sacrifice from the taxpayer to be entitled of the benefit.
Requisites of a realized benefit:
1 There must be an exchange transaction.
2. The transaction involves another entity.
3. It increases the net worth of the recipient.
Types of Transfers
1. Bilateral transfers or exchanges, such as:
a. Sale
b. Barter

These are referred to as "onerous transactions".

2. Unilateral transfers, such as:

a. Succession transfer of property upon death
b. Donation
These are also referred to as "gratuitous transactions'".
Under current usage, unilateral transfers are simply referred to as "transfers"
while bilateral transfers are called "exchanges." Benefits derived from onerous
tax.
transactions are "earned or realized"; hence, they are subject to income
because of the
Benefits derived from gratuitous transactions are not realized
transactions are
absence of an earning process. Benefits derived from gratuitous
subject to transfer tax, not income tax.
3. Complex transactions
gratuitous and partly onerous. These are
Complex transactions partly
are

as "transfers for less than full

and adequate consideration".
commonly referred to
The gratuitous portion of the transaction is
subject to transfer tax while the
income tax.
benefit from the onerous portion is subject to

Illustration for P100,000 and with a

A taxpayer sold his carwhich was previously purchased
current fair value of P180,000
for only P130,000.

The transaction will be analyzed as follows:

Fair value P 180,000
P50,000 Subject to transfer tax
-

130,000
Selling price P30,000 Subject to income tax
100,000
Cost
67
 The excess of fair value over selling price is a gratuity or gift whereas the
selling price over the cost is an item of gross income.
excess of
ex

What is meant by
another entity?
Every person, natural or juridical, is entity. Natural persons are ivino
while juridical persons are those an created by law such as
corporations. An entity may be a taxable entity or an
partnershin
arises from transactions which exempt entity. A ta
item of gross income
juridical entity. involve another
naturaaxa
Gains or income derived
between relatives,
taxable since it iscorporations,
and the and between a
partnership are
made between parh
Likewise, the income between affiliated separate
parent company and its companies such as between a entite
because each subsidiaries and between sister holding
corporation is a separate entity. This companies are taxab
underlying economic relationship. applies regardless of t
However, the sales of a home office
to its branch
they pertain to one and the same office are not taxable
businesses of a proprietor should taxable entity. Furthermore, the income becaus
taxable upon the not be taxed since betweea
juridical entity.
same owner. Note that proprietorship businessesar
a
proprietorship business is not
Benefits in the absence of transfers
The increase in wealth of
the taxpayer the
the value of his in form of
properties
absence of a sale or barter
or decrease
in the appreciation or increase in
transaction value of his
is not taxable. obligations in the
These are referred to as
unrealized gains or
yet materialized in an exchange
transaction.
holding gains because they have
not
Examples of unrealized gains or holding gains:
a. Increase in value of investments in
b. Increase in value of real equity or debt securities
C.
properties held (revaluation increment)
Increase in value of foreign currencies held or
d. Decrease in value of foreign currency receivable
aenominated debt by
fluctuation in exchange rates virtue of favorable
e. Birth of animal offspring, accruals of fruits in an
orchard or
vegetables growth of farm
f. Increase in value of land due to the discovery of mineral
reserves
Rendering of services
The rendering of services for aconsiderationis an exchange but does
not cause a
loss of capital. Hence, the entire consideratüon received from
rendering of services
such as compensation income or service fees is an item of gross income
Chapter 3 - Introduction to Income Tax

Tllustration
Mendoza lists the following possible items of gross incomne
Compensation income P 200,000
Winnings from gambling
100,000
Increase in value of investments 50,000
Appreciation in the value of land owned 300,000
Debt of Saladin cancelled by creditors in
consideration for services he rendered to them 150,000
Debt of Saladin cancelled by his creditor out of affection 250,000
Loan received from a bank 400,000
The items of gross income are:
Compensation income P 200,000
Winnings from gambling 100,000
Debt of Mendoza forgiven in consideration
for service rendered to his creditors 150,000
Note:
Gains from gambling and the forgiveness of debt in consideration of services or properties
1.
received are realized gains from exchanges.
The forgiveness of debt out of affection or mere generosity of the creditor is a gratuitous
2.
transfer subject to transfer tax.
The loan received from a bank constitutes a transfer but is not a benefit.
3.

Basis of Exemption of Unrealized Income

tax when their income
Normally, taxpayers will have the ability to pay
materializes in an exchange transaction since tax is generally payable in money.

income realized in cash is subject to tax.

This does not mean, however, that only
in effect, received in cash but the
Income realized in non-cash properties are,
the non-cash property. Income received in
non-
taxpayer used the same to acquire
value of the property received. Moreover,
cash considerations is taxable at the fair
would open a wide avenue
income realized in non-cash considerations
exempting divert their income in the form of non-
for tax evasion since taxpayers can easily
cash consideration.

Benefits
Mode of Receipt/Realization
Taxable items of income may be
realized by the taxpayer in two ways:
1. Actual receipt form of cash
Actual receipt involves actual physical
taking of the income in the
or property.

2. Constructive receipt income but the

Constructive receipt involves
no actual physical taking of the
taxpayer is effectively benefited.
69
 Introduction to Income
Tax
Chapter 3 -

Examples: consideration for the sale

sale of go00ds
of good.
a. Offset of debt of the taxpayer in
service
account
b. Deposit of the income to the taxpayer's checking
C. Matured detachable interest coupons on coupon bonds not yet encash
shec
by the taxpayer
d. Increase in the capital of a partner from the profit of the partnership

Inflow of wealth without increase in net worth

The inflow of wealth to a person that does not increase his net worth is na
income due to the total absence of benefit.

Examples:
a.
Receipt of property in trust
b. Borrowing of money under an obligation to return
In law, the proceeds of embezzlement or
swindling where money is taken without
an
original intention to return are considered as income because of the increase in
net worth of the swindler.

NOT EXEMPTED BY LAW,

An item of gross income
CONTRACT, OR TREATY
is not exempted by the
treaties from taxation. Constitution, law, contracts or
The following items of income are exempted by law from
not considered items of gross income: taxation; hence, they are
1. Income of qualified employee trust fund
2. Revenues of non-profit,
3. non-stock educational institutions
SSS, GSIS, Pag-IBIG, or PhilHealth benefits
4. Salaries and wages of minimum
5. wage earners and qualified senior
Regular income of Barangay Micro-business citizen
6. Income of foreign governments and
Enterprises. (BMBEs)
foreign
7.
controlled corporations
Income of international missions and
government-owneed and
and

organizations with income tax

Items of gross income that are immunity
exempted from
in Chapter taxation
are
underExclusions in Gross Income discussed extensively
tens
8.
TYPES OF INCOME TAXPAYERS
A. Individuals
1. Citizen
a. Resident citizen
b. Non-resident citizen
Chapter 3 - Introduction to Income Tax

2. Alien
a. Resident alien
b. Non-resident alien
aa. engaged in trade or business
b. not engaged in trade or business
3. Taxable estates and trusts

B. Corporations
1. Domestic corporation
2. Foreign corporation
a. Residentforeign corporation
b. Non-resident foreign corporation

INDIVIDUAL INCOME TAXPAYERS

Citizens
Under the Constitution, citizens are: of the
of the Philippines at the time of adoption
a. Those who are citizens
Constitution on February 2, 1987
of the Philippines
b. Those whose fathers or mothers are citizens who elected Filipino
1973 of Filipino mothers
C. Those born before January 17,
the age of majority
citizenship upon reaching law
in accordance with the
d. Those who are naturalized

Classification of citizens:
in the Philippines
Resident citizen
-

A Filipino citizen residing

A.
includes: satisfaction of the
B. Non-resident citizen establishes to the
Philippines who definite
1. A citizen of the presence abroad with a
C o m m i s s i o n e r the
fact of his physical
intention toreside therein; the taxable
Philippines during
of the Philippines who
leaves the employment on a
or for
22. A citizen
reside abroad,
either as an immigrant
an

year to abroad
permanent basis; derives income from
who works and
Philippines him to be physically
present
3. A citizen of the thereat requires
employment
and whose taxable year;
of the time during the citizen and
abroad most
previously
considered
as non-resident
taxable year to reside
has been
44. A citizen who at anytime during the non-resident
arrives in the Philippines be treated as a
who shall likewise with
the Philippines in the Philippines
permanently in
arrives
which he
in date of his
the taxable year abroad until the
citizen for derived from
sources

income
his
respect to
PhiliPpines
arrival in the
71
Chapter 3 - Introduction to Income Tax

Filipinos working in Philippine embassies or Philippine consulate offices

considered non-resident citizens offices are
Alien
A. Resident alien an individual who is residing in the Philippines but is
citizen thereof, such not
as
1. An alien who lives in
the Philippines without definite intention as to
stay; or
2. One who comes to the Philippines for
definite purpose which in
a
nature would
require extended stay and to that end makes his it
an
temporarily in the Philippines, although it may be his intention at hom-
to return to his
domicile abroad; all time
An alien who has
acquired residence in the Philippines retains his
such until he abandons
the same or status
actually departs from the Philippines. aa
B. Non-resident
alien an individual
who is not residing in the Philippines and
-

who is not a citizen thereof

1.
Non-resident aliens engaged in business
in the
the year
Philippines for an aggregate period (NRA-ETB)-
of more than
aliens who stayed
180 days during
2. Non-resident
aliens not engaged in
a. Aliens who come to the business (NRA-NETB)
Philippines fora definite purpose include:
-

nature may be which in its

b. Aliens who shall
promptly accomplished;
come to the
aggregate period of not more thanPhilippines
180
and stay therein for an
days during the year
THE GENERAL CLASSIFICATION RULE FOR
1. Intention INDIVIDUALS
The intention of the
outside
taxpayer regarding thenature of his
the
classification.
Philippines
The taxpayer
shall stay/within or
determinethe his appropriate
shall submit residency
nroofs such as visas, work contracts to CIR of the
BIR
and other documentary
documents indicating
intention. such
Documents purporting short term stay
the reclassification of the taxpayer s such tourist visa shall not result in
as

a long-term stay such as

normal resiaency. Documents purporting
immigration visa or working
visa for
period would result in the automatic reclassincation of an
the taxpaver's
extended
residency

72
Chapter 3
-

Introduction to Income Tax

ExampleS:
a. An alien is normally non-resident. An alien who come to the Philippines with a
tourist visa would still be classified as non-resident alien.
b. A citizen is normally resident. A citizen who would go abroad under a tourist
isa would still be considered a resident citizen.
C. An alien who come to the Philippines with an immigration visa would be
reclassified as a resident alien upon his arrival.
d. A citizen who would go abroad with a two-year working visa would be
reclassified as a non-resident citizen upon his departure.

2. Length of stay
In default of such documentary proof, the length of stay of the taxpayer is

considered:
a. Citizens staying abroad for a period of at least 183 days are considered
non-resident.
b. Aliens who stayed in the Philippines for more than 1 year as of the end or
the taxable year are considered resident.
C. Aliens_who are staying in the Philippines for than 1 year but
not more
in business.
more than 180 days are deemed non-resident aliens engaged
d. Aliens who stayed in the Philippines for not more than 180 days
are

considered non-resident aliens not engaged in trade or business.

llustration 1
television
Daniel Mario Aresmendi, a Mexican actor, was contracted by Philippine
a

He arrived in the country on February 29,

company to do a project in the Philippines.
2021 and returned to Mexico three weeks later upon completion ofthe project.
an NRA-NETB in 2021. His stay is for a
Daniel Mario Aresmendi shall be classified as
immediately.
definite purpose which in its nature will be accomplished
llustration 2
in the country on November 4, 2021 Mr.
Mamoud Jibril, a Libyan national, arrived
then without any working visa or work permit.
Jibril stayed in the Philippines since
considered an WRA-NETB because he stayed in the
For the year 2021, Mr. Jibril would be
as of December 31,
2021. f he is still within the
Philippines for less. than 180 days
as a resident alien for 2022.
Philippines until December 31, 2022, he will qualify

llustration 3
the nature of his stay, Juan Miguel, a Filipino
Without any definite intention as to
abroad from March 15, 2020 to April 1,
left the Philippines and stayed
Citizen,
2021before returning to the Philippines.
citizen because he is absent for more than
183
the 2020, Juan is a non-resident
ror year
resident citizen for the year
2021 because he is absent for
aays but he will be classified as
less than 183 days in 2021.
73
 IntrodUction tO INTOI
Cnapter 3

Taxable Estates and Trusts

1. Estate
Estate refers to the properties, rights, and obligations of a deceased
not extinguished by his death.
deceased perso
Estates under judicial settlement are treated as individual taxpayers.
estate is taxable on the income of the properties left by the decedent. EstaT
T.
under extrajudicial settlement are exempt entities. The
income of tthe tate
of
properties the estate under extrajudicial settlement is taxable to the heirs
2. Trust
A trust is an
arrangement whereby person (grantor or trustor) transfer
one
i.e. donates) property to another person (beneficiary), which will be held
under the management of a third party (trustee orfiduciary).
A trust that is
irrevocably designated by the grantor is treated in taxation as i
it is an individual
taxpayer. The income of the property held in trust is taxable
to the trust. Trusts that are designated as revocable
taxable entities and are not considered as individual by
the grantor are not

properties held under revocable trusts is taxable totaxpayers.

the
The income of
not to the
trust. grantor
When the trust agreement is silent to
presumed to be revocable.
as
revocability of the trust, the trust is

CORPORATE INCOME TAXPAYERS

The term 'corporation' shall include
one person
corporations (OPCs)
partnerships, no matter how created or
organized, (OPCs)
accounts, association, or joint-stock companies, joint
insurance companies, (except
partnerships and a joint venture or general professional
consortium formed for
undertaking construction projects engaging in petroleum/coal, the purpose of
or
other energy operations.pursuant to an operaung consortium geothermal, and
service contract with the government agreement under a
Hence, the term corporation includes proit-oriented and non-profit institutions
such as charitable institutions, cooperatives, government
instrumentalities, associations, leagues, civic or agencies and
rengious and
and
other organizatior
ons.

Domestic Corporation
A domestic corporation is a corporation that i s organized in accordance with
Philippine laws. It includes one-person corporations (OPC) owned and registered

by resident citizens in the Philippines.

 Chapter 3 - Introduction to Income Tax

Foreign Corporation
A foreign corporation is one organized under a foreign law.

Types of foreign corporations:

1. Resident foreign corporation (RFC) a foreign corporation which operates and
-

conducts business in the Philippines through a

a branch). permanent establishment (L.e.
2. Non-resident foreign corporation (NRFC) a foreign
not operate or conduct business in the
corporation which
-

does
Philippines
Note:
1. A corporation that incorporates in the Philippines is a domestic corporation under the
Incorporation Test even if the same is controlled by foreigners.
2. Aforeign corporation that transacts/business/ with residents through a resident branch is
taxable on such transactions as a resident foreigncorporation through its branch. However,
if it transacts directly to residentsoutside its branch, it is taxable as a non-resident
foreign
corporation on the direct transactions.
3. An individual that establishes a one-person corporation (OPC) shall be taxable as a
corporate taxpayer for the business transactions of the OPC but he shall be subject to tax as
an individual for his personal transactions.

Special Corporations
Special corporations are domestic or foreign corporations which are subject to
special tax rules or preferential tax rates.

OTHER CORPORATE TAXPAYERS

1. One-person corporation
A one-person corporation is a corporation with a single stockholder who may
be a natural person, trust or an estate.

Banks and quasi-banks, preneed, trust, insurance, public and publicly-listed

companies, and non-chartered GOCCs may not incorporate as One-person

corporations. A natural person who islicensedto exercise profession may

a

for the purpose of exercising such

not organize as a One Person Corporation
under special laws.
profession except as otherwise provided

2. Partnership
business organization owned by two or more persons who
A partnership is a
fund for the purpose of
to a common
Contribute their industry or resources
dividing the profits from the venture.
Types of partnership
a General professional partnership (GPP)
75
 Chapter 3 - Introduction to Income Tax

A GPP is a partnership formed by persons for the sole Dum

exercising a common profession, no part of the income of which i
from engaging in any trade or business. hichpurpose
is der
A GPP is not treated as a corporation and is not a taxable
entity. t
exempt from income tax, but the partners are
taxablejin their individ
capacity with respect to their share in the income of the
b) Business partnership
partnership.
A business partnership is one formed for
profit. It is taxable as
corporation.
Examples:
a. A
partnership between Atty. Mendoza, a
accountant, to
practice in taxation advisory lawyer, and Mark Santos,
services would be
a
b.
partnership
A
since the two
partners are not in the same abusines
partnership between accountants profession.
beauty parlor would be a business Khim and Vhinson to venture intoa
practiceof a common
profession. partnership
since the venture is not
in
A
C.
partnership between accountants
Juan and Miguel
services would be a to
d. Dentists Wency and general professional partnership. venture into audit
Andy
they are converting partnered
season,
their
to
operate a dental clinic.
is a business clinic into a
beauty saloon. TheirDuring slack
partnership since it is earning income
3. Joint venture from business. partnership
A ioint venture is a business
organized as a
partnership or undertaking
a for a
corporation. particular purpose. It may DE

Types of joint ventures:

a.
Exempt jointventures
Exempt joint ventures are those
construction projects or engagingrormed
in
for the
purpose of undertaking
other energy petroleum,
operations pursuant to an operating coal, geothernmal and
under a service contract with the
Government. consortium agreement
reement
Similar to a GPP, this type of
joint venture is not treated as
and is tax-exempt on its regular income, but their a
corporation
their share in the net income of the
joint venture.
venturers are taxable
axable to

b. Taxable joint ventures

All other joint ventures are taxable as
corporations.
 4. Co-ownership
A co-Ownership is joint ownership of a property formed for the purpose or
preserving the same and/or dividing its income.

A co-ownership that is limited to property preservation or income collection

is not a taxable entity and is exempt but the co-owners are taxable on their
share on the income of the co-owned property.

However, a co-ownership that reinvests the income of the co-owned property

to other income-producing properties or ventures will be considered an
unregistered partnership taxable as a corporation.

THE GENERAL RULES IN INCOME TAXATION

Taxable onincomeearned
Individualtaxpayers Within Without
Resident citizen
Non-resident citizen
Resident alien
Non-resident alien

Corporate taxpayers
Domestic corporation
Resident foreign corporation
Non-resident foreign corporation
Note: all taxpayers, except resident
citizens and domestic
1. Consistent with the territoriality rule,
on income earned
within the Philippines.
corporations, are taxable only mean outside the Philippines.
"without the Philippines" to
2. The NIRC uses the term

Rule
The Residency and Citizenship as resident
residents and citizens of the Philippines such
Taxpayers who are
are taxable on
all income from sources within
citizen and domestic corporations citizen of the country of
Philippines. A corporation is a
and without the is a citizen of the Philippines.
domestic corporation
incorporation. Thus, a

extraterritorial taxation
Basis of the benefits from the
domestic corporations derive most
the of
Resident citizens and other classes of taxpayers by virtue of
Philippine government compared to all
government.
their proximity to the Philippine
77
 Chapter3 Introduction to Income Tax

Under our laws, resident citizens and domestic corporations enjoy prefern.
non-resident citizens. Po
privileges over aliens. Also, between resident and esidew
citizens have full access of the public services of our government because th
in the country. The taxation of foreign income of resident citizens and dam
corporations properly reflects this difference in benefits consistent withmeste
t
Benefit Received Theory the
The extra-territorial tax treatment of resident citizens and domestic corporation
1s also intended as a
safety net to the potential loss of tax revenues brought h
situs relocation or the practice of executing or structuring transactions such tha
income will be realized abroad to avoid Philippine income taxes.

The issue of international double taxation

The rule on extraterritorial taxation on resident citizens and domestic
corporations exposes these taxpayers to double taxation. However, the NIRC
allowsa tax credit for taxes
paid in foreign countries, In fact, resident citizens and
domestic corporations pay minimal taxes in the
income because of the tax credit.
Philippines on their foreign

SITUS OF INCOME
The situs of income is the place of taxation of
the authority to impose tax upon the income.
incomeIt is the jurisdiction that has

Situs of income vs. source of income

Situs of income should be differentiated from the source of
income. The latter
pertains to the activity or property that produces the income.

Situs is important in determining(whether or not an

income is taxable in the
Philippines. Situs is particularly important to taxpayers taxable only on income
within. However, it is also important to taxpayers taxable on global
purposes of the computation of the foreign tax credit.
income for

INCOME SITUS RULES

Tvpes ofincome Place oftaxation (situs)

1. Interestincome Debtor's residence
2. Royalties Where theintangiblelis employed
3. Rent income Location of the property
4. Service income Place where the service is rendered
Chapter 3- Introduction to Income Tax

Illustration
A taxpayer had the following income:

Interest income from deposits in a foreign bank P 300,000

Interestfrom domesticbonds 50,000
Royalties from books published in the Philippines 100,000
Rent income from properties abroad (the lease
contracts were executed in the Philippines) 150,000
Professional fees for services rendered in the
Philippines to non-resident clients (paid in US Dollars) 400,000

Applying the situs rules, the following are the situs ofthe aforementioned income:

Within Without World total_

Interest on foreign deposits P P 300,000 P 300,000
Interest from domestic bonds 50,000 50,000
Royalties from books in the Philippines 100,000 100,000
Rent income on foreign properties 150,000 150,000
Professional fees 400.000 400.000
Total P 550.000 P 450.000 P 1.000.000
Resident citizen or domestic corporation taxpayers would be taxable on the world
income while other taxpayers would be taxable only on the income from within
the Philippines.

OTHER INCOME SITUS RULES

A. Gain on sale of properties

1. Personal property
Domestic securities - presumed earned within the Philippines
the property is
Other personal properties earned in the place where
-

sold
is located
2. Real property- earned where the property

Illustration
A taxpayer had the following income:
P 200,000
Gain on sale of domestic stocks
100,000
Gain on sale of foreign bonds
in-Baguio City 500,000
Gain on sale of a commercial lot
Canada 200,000
ain on sale of car in Ontario,
in Mexico, Pampanga 250,000
ain on sale of machineriesbonds 50,000
Interest income on foreign 150,000
Dividends on domestic stocks
79
 Chapter 3 - Introduction to Income Tax

The following table summarizes the situs of the foregoing income:

Gain on sale of domestic Within Without

stocks P 200,000
Gain on sale of
Gain on sale of
foreign bonds P 100,000
commercial lot 500,000
Gain on sale of car in
Canada 200,000
Gain on the sale of
machineries 250,000
Interest on foreign bonds
Dividends on domestic stocks 50,000
Total 150.000
P 1.100.000 P 350.000
B. Dividend income
1. Domestic from:
corporation
2 . Foreign corporation presumed earned within
a) Resident foreign corporation depends on
The pre-dominance test
the pre-dominance test
If the ratio of the
the resident Philippine
gross income over the, world gross
foreign corporation in the income of
year of dividend declaration is: three-year period preceding the
At least 50%. the
portion of the dividend corresponding to the
Philippine gross income ratio is earned
Less than 50%, the entire dividends within
received is earnéd
b) Non-resident foreign abroad
corporation earned abroad
Illustration
In 2021, Sarah received P400,000 dividend income from
a
Corporation had the following gross income in 2018 ABC
through 2020: Corporation. ABC
2018 2019 2020
Philippines P 100,000 P 200,000 P Total
Abroad 300,000 P
200.000 100.000 100.000 600,000
Total P300.000 P 300,000 P 400.000
400.000 P 1000,000
If ABC Corporation is a:
1. Domestic corporation the entire P400,000
-

is earned within
2. Non-resident foreign corporation the entire P400,000 is
-

earned ahroadd
3. Resident foreign corporation the P400,000 dividend shall be
-

split
Gross Income Ratio = P600,000/P1,000,000 60%
Earned within the Philippines (60%x P400,000) P 240,000
Earned without the Philippines (40% x P400,000)
160.000
Total dividends P 400.000
 Chapter 3
-
Introduction to Income Tax

Supposing that the ratio is 49%, the entire P400,000 will be deemed earned
outside the Philippines

C. Merchandising income earned where the property is sold

llustration

Source ofgross income Amount

Goods purchased and sold within P 200,000
Goods purchased within and sold abroad 100,000
Goods purchased abroad and sold within 150,000
Goods purchased and sold abroad 350,000

The income earned within and without shall be:

- Within Without
Purchased and sold within P 200,000
Purchased within and sold abroad P 100,000
Purchased abroad and sold within 150,000
Purchased abroad and sold abroad 350.000
Total P350.000 P 450.000
D. Manufacturing income earned where the goods are manufactured and sold

Operations Remark
Production | Distribution
Within Within Total income from production and distribution
isearned within the Philippines
Without Without Total income from production and distribution
isearned withoutthe Philippines
Within Without Production income is earned within, |
Distribution income is earned without
Without Within Distribution income is earned within,
Production income is earned without
Illustration 1
Island, Inc. manufactures goods and sells them through its branch. Island bills its
branch at established market prices. Island reported the following gross income:

Home office Branch Total_

Sales P 4,000,000 P 2,000,000 P 6,000,000
Cost of goods sold 2.400.000 1.200.000 3.600.000
Gross income P1.600.000 P 800.000 P 2.400.000
 Chapter 3 Introduction to Income Tax
The following shows the situs of the gross income of lsland
following scenario: under under each of
each

Scenario Homeoffice Branch Within Without

No. 1
No. 2
Philippines Philippines P 2,400,000 P 0
Abroad Abroad 0
No. 3 Philippines 2,400,000
Abroad 1,600,000
No. 4 Abroad 800,000
Note:
Philippines 800,000 1,600,000
1. Both
2.
production and
The branch is not a distribution are conducted by the same
taxable entity, Island,
separate
income is taxable to Island taxable entity, but Inc.
Inc.
an
integral part of Island, Inc; hence,
i-
Illustration 2
Assuming production is conducted a
conducted by its by
subsidiary corporation: parent corporation and the distribution is
Sales Parent Subsidiary
P 4,000,000 P Total
Cost of goods sold 2,000,000
6,000,000 P
Gross income 2.400.000 1.200.000 3.600,000
The gross income
P1.600.000 P 800,000 P 2.400.000
because each recognized by each corporation is
corporation is a taxable to
separate taxpayer. The situs
place of sale without regard to the each corporation
seller or the of taxation shall be the
supplier.
The following are the situs of income for the
Scenario Parent parent corporation:
No. 1 Subsidiary Within
No. 2
Philippines Philippines P
1,600,000 Without
P
Abroad Abroad
No.3
No. 4
Philippines Abroad
1,600,000 1,600,000
Abroad Philippines
1,600,000
The following are the situs of income for the
subsidiary corporation:
Scenario Parent Subsidiary Within
No. 1 Philippines Philippines P 800,000 Without
P
No. 2 Abroad Abroad
No. 3 Philippines Abroad 800,000
No. 4 Abroad Philippines 800,000 800,000
Note to readers:
Readers are advised to master the situs rules as this have a
significant
on your comprehension of advanced tax rules to be introduced in succeedi
chapters.