Module 2

Income Tax:
Basic Concepts

Leomar R. Cabarles
 Contents
1. Definition of income tax
2. Definition of income
3. When is income taxable?
4. Income earned tests
5. Income tax systems
6. Features of the Philippine Income Tax Law
 Contents
7. Criteria in imposing income tax
8. Types of Philippine Income tax
9. Kinds of taxpayers
10. Gross income vs. taxable income
11. Classification of income as to source
12. Unallocated expenses
Definition of Income Tax

Tax on all yearly profits arising from

property, professions, trades, or offices,
or as a tax on a person’s income,
emoluments, profits and the like

Direct tax – cannot be shifted to another

taxpayer

Excise tax – levied upon the right of a

person to receive income or profits
Definition of Income
Flow of wealth
Income
other than mere return of capital

Income Capital

• Flow of wealth • Fund or property

during a definite existing at a point
period of time in time
• Service of wealth vs. • Wealth itself
• Subject to tax • Not subject to tax
• Fruit • Tree
 Illustration 1

Taxable and Non-taxable

Income
Taxable? MORAL DAMAGES = TAXABLE

Recovery of damages (compensation for injury) NOT

Recovery of damages pertaining to lost income TAXABLE
Recovery of items previously deducted from gross
TAXABLE
income (tax benefit rule)
Forgiveness of indebtedness (if effect of entire
transaction is a reduction of purchase price of NOT
property acquired in prior year)
Forgiveness of indebtedness (of a stockholder is
equivalent to dividend distribution) TAXABLE

Forgiveness of indebtedness in exchange of a

TAXABLE
service performed
Income derived from illegal business (gain) TAXABLE
When is income taxable?

1 2 3

There is Received,
income, gain accrued or Not exempt
or profit (and realized from income
not return of during the tax
capital) year
 Illustration 2

Increase in the value of

property
Mr. Jose Castillo is a resident Filipino citizen. He purchased a parcel
of land in Makati City in 1970 at a consideration of P1 Million. In
2022, the land, which remained undeveloped and idle had a fair
market value of P20 Million. Mr. Antonio Ayala, another Filipino
citizen, is very much interested in the property and he offered to
buy the same for P20 Million. The Assessor of Makati City re-
assessed in 2022 the property at P10 Million.

Is Mr. Castillo liable for income tax in 2022 based on the offer to
buy by Mr. Ayala? Explain your answer.
NO. Mr. Castillo is not liable for income tax in 2022 because no income is
realized by him during that year. Tax liability for income tax attaches only if
there is a gain realized resulting from a closed and complete transaction

*REALIZED NA DAPAT*
Income Earned Tests
1. Realization principle
2. Right-of-claim doctrine
(or doctrine of ownership,
command, or control)
3. Economic benefit theory
(doctrine of proprietary interest)
4. Severance test theory
5. Income from whatever source
6. All events test
Realization Principle

1. The earning is 2. An exchange has

complete or taken place
virtually complete

• Advances received are not treated as revenue

• Stock dividends are not income
Actual vs. Constructive Receipt

Actual receipt Constructive receipt

• Credited to
• Physical transfer account of or
of consideration segregated in
• Possession vs. favor of a person
• Actual receipt of • No substantial
cash limitations or
conditions
Constructive Receipt: Examples
1. Deposit in banks without restrictions
2. Notice of debtor to offset a debt and accepted by
the seller as payment
3. Transfer of amounts retained by the payor to the
account of the contractor
4. Interest credited on savings bank deposit
5. Matured interest coupons not yet collected
6. Dividends applied against the debt of a
stockholder
7. Undistributed share in profit of a partner in a GPP
8. Intended payment deposited in court GENERAL
PROFESSIONAL

(consignation) PARTNERSHIP
Right-of-Claim Doctrine

• Doctrine of • Income if without

ownership, restriction as to
command, or control disposition

Should it later appear that the taxpayer was not

entitled to keep the money, the taxpayer would be
entitled to a deduction in the year of repayment
Economic Benefit Theory

• Doctrine of • Anything which

Proprietary Interest benefits a person is
taxable

“Stock options, the difference between fair value of

option and option price, constitutes additional
income to employee at the time of exercise.”
Severance Test Theory

• Separation of • Income requires a

something of realization of gain
exchangeable value

“Increase in value could only be taxed when a

disposition of the property occurred.”
Income from Whatever Source

• All income is taxable, • Whether voluntarily

unless exempt or involuntarily
produced
All Events Test

1. A right to income or 2. Amount is

liability to pay is reasonably accurate
fixed to determine
 Illustration 3

“All-events Test”
 YYY Corporation engaged the services of the Manananggol Law Firm
in 2020 to defend the corporation's title over a property used in the
business. For the legal services rendered in 2021, the law firm billed
the corporation only in 2022. The corporation duly paid.

YYY Corporation claimed this expense as a deduction from gross

income in its 2022 return, because the exact amount of the
expense was determined only in 2022. Is YYY's claim of deduction
proper? Reasons.
NO.The expense is deductible in the year it complies with the all-events test. The test is
considered met if the liability is fixed, and the amount of such liability to pay is already
fixed in 2021 when the services were rendered, and the amount of such liability is
determinable with reasonable accuracy in the same year. Hence the deduction
should have been claimed in 2021 and not in 2022.
 Income Tax Systems In the Philippines, it is a
combination of both systems but
is more schedular for individual
while more global for corporation.

1 2 3
Semi-
Global
Schedular schedular or
(Unitary)
semi-global
• All income and • Different types • Some types of
deductions are of incomes are income is global
subject to a subject to • Other types of
single tax or one different sets of income is
set of tax rates graduated or schedular
flat income tax
rates
Features of Philippine Income Tax Law

1. Direct tax
2. Progressive tax – based on
ability to pay principle
3. Comprehensive system
4. Semi-schedular or semi-global
tax system
5. National tax
6. Excise tax
Criteria in Imposing Income Tax

1. Citizenship principle

2. Residence principle
SITUS OF TAXATION
3. Source principle
Types of Philippine Income Tax

1. Graduated income tax on individuals

2. Regular corporate income tax RCIT
3. Minimum corporate income tax MCIT
4. Preferential rates (for special
corporations)
5. Gross income tax CHALLENGE:
6. Capital gains tax 1. RECOGNIZED
2. MEMORIZE
7. Final income tax 3. KNOW RULES, WHEN DOES IT APPLY

8. Fringe benefits tax

9. Branch profit remittance tax
Kinds of Taxpayers
any person subject to tax imposed by
Taxpayer
Title II of the Tax Code

means an individual, a trust, estate or

Person
corporation

1 3
Individuals Partnerships

2 Estates and 4
Corporations
trusts
Kinds of Taxpayers
 In general, tax base is taxable income except for 2
taxpayer.

Kinds of Taxpayers In general, taxable are within the Philippines except

resident citizen and domestic corporation
Gross income vs. Taxable income

Gross income Taxable income

• Income from vs. • Gross income less

whatever source the deductions

Sales Revenue
Less: COS
• Commonly known as
Gross Income net income
Less: Allowable Deductions
Taxable Income
Classification of Income as to Source
1. Gross income from sources
within the Philippines
2. Taxable income from sources
within the Philippines
Learn which
3. Gross income from sources
income are
without the Philippines considered as
4. Taxable income from sources income within,
without the Philippines and all else are
considered
5. Income partly within or partly
income without
without the Philippines
Income Within – Interest

• Obligations of Philippine
residents, corporate or
otherwise.

• Ultimately, the situs of interest

income is the residence of the
debtor
Income Within – Dividends

• Domestic corporation

• Foreign corporation – if at least

50% of gross income for the
three-year period ending with
the close of the taxable year prior
to the declaration of dividends
was derived from sources within
the Philippines
Income Within – Services

• Performed in the Philippines.

• As a rule, the situs of

compensation is the place of
performance of the services.
Income Within – Rentals and Royalties

• Property/interest in property
located in the Philippines.

• As a rule, the situs of rental

income is the place where the
property is located.

• The situs of royalty income is

where the rights are exercised.
Income Within – Real Property

• Real property is located in the

Philippines.

• As a rule, the situs of the income

from sale of real property is
where the realty is located.
Income Within – Domestic Corp.’s Stock

• Philippines regardless of where

sold
Income Within – Personal Property
 Illustration 4

Situs of Income
 A taxpayer had the following income: Amount Source
Interest income from deposits in a P300,000
foreign bank WITHOUT

Interest from domestic bonds 50,000 WITHIN

Royalties from books published in the 100,000 WITHIN

Philippines
Rent Income from properties abroad 150,000
(the lease contracts were executed in WITHOUT
the Philippines)
Professional fees for services rendered 400,000
in the Philippines for non-resident WITHIN
clients (paid in dollar)
Resident citizens or domestic corporations INCOME SITUS RULES
would be taxed on the world income while other Interest income = Debtor’s residence
Royalties = Where the tangible is employed
taxpayers would be taxable only on income Rent income Location of the property
from within the Philippines. Service income Place where the service is rendered
Unallocated Expenses

• Those which are not • Allocated using

entirely attributable the formula
to either income below:
within or without
- End -