INCOME TAXATION

What is income?
This refers to all earnings derived from service rendered (labor), from capital (business or investment) or both including gain
derived from sale or exchange of personal or real property either ordinary or capital asset.

What is taxable income?

It means the pertinent amount of gross income specified in the Tax Code less deductions, authorized by such type of
income by the Tax Code or other special laws.

Characteristics of taxable income

1. There must be gain or profit
2. The gain must be realized or received
3. The law or treaty does not exclude the gain from taxation.

What are the classifications of income?

1. Compensation income -the gain derived from labor, especially from employment such as salaries and
commissions. This is usually subject to normal tax.
2. Business Income - the value derived from an exercise of profession, business or utilization of capital.
Usually subject to normal tax
3. Passive income - an income which the taxpayer merely waits for the amount to come in. Usually subject
to final taxes.
4. Capital gains- -an income derived from sale of assets not used in trade or business. Generally subject
to capital gains taxes.

What are the kinds of Income Tax System?

1. Global Income tax system-
2. Gross income tax system-
3. Schedular tax system-
a combination of gross compensation income and/or income from business, trade or
profession to arrive at the total (global) income subject to tabular tax rates. It employs
the grouping of similar incomes and subjects them to a single tax rate or progressive
graduated rates.
the taxpayer’s income tax is fixed or computed based on gross income. The usual
allowable deductions are completely disregarded in computing this income tax.
Since income taxes are either computed based on the two previous systems, their filing
and payment should be accompanied with separate BIR form as required per category
of income.

Collection Points of Income Tax

1. Creditable withholding tax
2. Final withholding tax
3. Quarterly income tax
4. Annual income tax
5. Minimum Corporate Income Tax- An income tax of 2% based on the gross income of corporation that still incurs losses or
6. Capital gains tax
- refers to the income tax withheld by the employer before the earner receives the net
proceed of his income. The amount withheld represents an estimated portion of the
total income tax for the year. This tax is called creditable because it is deductible from
the total actual income tax computed at the end of the taxable year.
-is an income tax withheld from the total income before the earner receives the net
proceeds of his income. The tax is called final because it is not allowed as deduction
from total actual income tax at the end of the year.
- paid quarterly by those who are engaged in business. This is also creditable tax at the
end of the year.
- are normal taxes that are usually 30% for corporation and 5-32% for individual
taxpayers. These taxes are paid at the end of the taxable year and usually reduced by
the creditable taxes.
reports minimal income tax even if after the 3rd year of business operations. The MCIT is
observed starting the 4th year of the business.
- generally an income tax on sale of real property and shares of stocks classified as
capital assets.

Pro-forma computation of taxable income (Individual): BIR Form 1700 and 1701

Compensation income Pxxx

Add: Business income Pxxx
Less: Business expenses allowed xxx
Net business income Pxxx
Add: Capital gains, not subject to final tax Pxxx
Passive income without (for RC) xxx xxx xxx
Total taxable income Pxxx
====
Income Tax Due (Refer to Sec 24A)
Normal Tax Rate on Individual Taxpayers (Sec 24A)
TAXABLE INCOME PER YEAR
P250,000 and below
Above P250,000 to P400,000
Above P400,000 to P800,000
Above P800,000 to P2,000,000
Above P2,000,000 to P8,000,000
Above P8,000,000
INCOME TAX RATE
0%
20% of the excess over P250,000
P30,000 + 25% of the excess over P400,000
P130,000 + 30% of the excess over P800,000
P490,000 + 32% of the excess over P2,000,000
P2,410,000 + 35% of the excess over P8,000,000

What are the kinds of taxpayers?

1. Individuals
A. Citizens
a. Resident Citizen
b. Non resident citizen
B. Aliens
a. Resident Alien
b. Non resident alien engaged in business in the Philippines
c. Non resident alien not engaged in business in the Philippines
C. Special taxpayers

2. Corporations and Partnerships

A. Domestic Corporations
B. Resident Foreign Corporations
C. Non resident Foreign Corporations
3. Estates and Trusts (taxable as individual taxpayer)

How do you distinguish individual taxpayers?

Resident Citizen Those staying in the Philippines permanently

Those who has stayed outside for less than 183 days
Non resident citizen Those staying outside the Philippines for 183 days or more
 Those who has definite intention to reside outside the Philippines on a
permanent basis as an immigrant or employee
Resident Alien  Those residing in the Philippines
 Those who have stayed in the Philippines for more than one year from the date
of arrival
Non resident alien  Those who have stayed within the Philippines for more than 180 days
engaged in business  Those who has business income derived in the Philippines
Non resident alien not  Those who have stayed within the Philippines for only 180 days or less
engaged in business  Those who have no business income derived in the Philippines
Special taxpayers Those earning compensation income within the Philippines from special employment
(citizens or aliens) from :
 Regional or area headquarters of multi-national corporations
 Petroleum service contractors and subcontractors
 Offshore banking units

How are these taxpayers taxed?

SOURCES TAXABLE BASE Can claim PE? Can claim ISD? Can claim OSD
RC All sources SEC 24A YES YES YES
NRC Within only SEC 24 A YES YES YES
RA Within only SEC 24 A YES YES YES
NRAEBP Within only SEC 24 A YES,but BPE YES NO
only, subject to
reciprocity
NRANEBP Within only GIW 25% NO NO NO
TRUST AND Within only SEC 24A YES, BPE ONLY YES NO
ESTATES

Income taxes of individuals

1. Normal taxes - those that require the preparation and filing of income tax returns. This includes compensation
income and business income.
2. Final taxes - those that does not require the filing of income tax returns. This includes passive income and
capital gains.

What constitutes gross income?

 Gross income means the pertinent items of income referred to in Section 32A of the Tax Code. It includes income from
whatever source (unless exempt from tax by law) including but not limited to the following:

1. Compensation income Those renumeration for rendering personal services.

2. Business income Income derived from exercise of profession or engaging in business
3. Gains from dealings in Income derived from the sale and/or exchange of assets.
property
4. Interests Earnings derived from depositing or lending of money, goods or credits
5. Rents Income derived from leasing real estate as well as personal property
6. Royalties Payment or portion of proceeds paid to the owner of a right
7. Dividends A form of earnings derived from the distribution made by a corporation out of its
earnings or profits and payable to stockholders
8. Annuities Installment payments received for the life insurance sold by insurance companies
9. Prizes and winnings A prize is a reward for a contest or competition. Winning is a reward for an event
that depends by chance
10. Pensions An allowance paid regularly to a person on his retirements or to his dependents on
his death, in consideration for past services.
11. Partner’s distributive A GPP is tax exempt, but the partners are taxable on their distributive share in the
share from the net income net income.
of a GPP

As a general rule, #s 1,2,5,8,10 and 11 are subject to normal income tax. #3 is subject to capital gains taxes and #s4,6,7, and
9 are subject to final taxes.

What are the classification of deductions from gross income?

1. Itemized deductions
2. Optional Standard Deduction
- these are business expenses available to both natural persons and juridical
persons that are engaged in business.
- in lieu of itemized deductions, the OSD may be deducted from gross income
as follows:
a. For individuals- 40% of gross sales or gross receipts
b. For corporations-40% of gross income.

Compositions of itemized deductions

1. General business expenses These are ordinary and necessary expenses paid or incurred during the taxable
year in carrying on or which are directly attributable to the conduct of
business.
2. Interest The cost of money incurred within a taxable year on indebtedness in
connection with business. Deductible with limitations
3. Taxes Allowed as deduction when paid or incurred in connection with business
4. Losses Reduction on resources due to unintended destruction or deprivation of things
not in the ordinary course of business
5. Bad debts Claims that becomes worthless or uncollectible arising from money lent or
from goods sold or services rendered
6. Depreciation Annual reasonable allowance to reduce the useful value of the tangible fixed
assets resulting from wear and tear and normal obsolescence, used in business.
7. Depletion of oils and gas wells The exhaustion of natural resources like mines, oil and gas wells due to
and mines production
8. Charitable and other Although a non-operating expense, the law allows them as deductions with
contributions limitations.
9. Research and development The taxpayer has the option to consider it either as ordinary and necessary
expense or deferred expense chargeable to capital account.
10. Pension trust The amount intended to provide retirement benefits to the employees

Deductions Unique to an Individual taxpayer

1. Personal Exemptions
a. Basic Personal Exemption
-a deductible allowance whose amount allowed by the law shall depend upon the status of the taxpayer either as
single, head of the family or married.
-a basic exemption of P50,000 for each individual taxpayer (whether single, married or head of family, RA 9504)

b. Additional Personal Exemption

- a deductible allowance in addition to the basic personal exemption allowed for qualified dependent children of
an individual taxpayer.
- additional of P25,000 for each dependent child, maximum of 4 children.
-Requisites:
a. Taxpayer’s child, legitimate, illegitimate or legally adopted
b. chiefly depending for support on the taxpayer
 c. living with the taxpayer
d. not married, not gainfully employed, and not more than 21 years old, except those incapable of self-
support due to mental or physical defect.
- Rules in claiming APE:
a. If only one spouse Is deriving taxable income, only said spouse may claim.
b. If both spouses earn taxable income during the taxable year, only one of the spouses can claim. As a
rule, the husband shall be deemed the claimant. However, the wife may claim if
1. The husband explicitly waives his right in favor of his wife
2. The husband has no income
3. The husband works abroad
c. If legally separated, the spouse who has custody over the child may claim.
d. An unmarried individual who has a child out of wedlock may claim.

2. Premium payments on health and/or hospitalization insurance (PPHHI)

- allowed to those individuals whose family gross income does not exceed P250,000 for the calendar year. The deduction
shall not exceed P2,400 per family or P200 a month whichever is lower. The spouse claiming the additional exemptions shall
be the same spouse to claim for the deductions for premium payments.

Summary of Tax Rates on Individual Taxpayers

CATEGORY OF RESIDENT CITIZEN RESIDENT ALIEN NONRESIDENT NONRESIDENT NONRESIDENT
INCOME CITIZEN ALIEN ENGAGED ALIEN NOT ENGAGE
1. Compensation, Sec 24A Sec 24 A Sec 24 A Sec 24 A 25%
Business income
2. Prizes of P10,000 Sec 24A Sec 24A Sec 24A Sec 24 A 25%
or less
3. Proprietary Sec 24 A Sec 24A Sec 24A Sec 24 A N/A
education, Hospital
4. Cinematographic Sec 24A Sec 24 A Sec 24 A 25% 25%
Film and the like
5. Interest, Royalty, 20% 20% 20% 20% 25%
Winnings, Prizes
6. Royalties-books, 10% 10% 10% 10% 25%
literary, music
7. Interest (LTI) Exempt Exempt Exempt Exempt 25%
8. Cash/Property 10% 10% 10% 20% 25%
dividends
9. Interest (FCDS) 15% 15% Exempt Exempt Exempt
10. Capital gains on 15% 15% 15% 15% 15%
sale of shares (not )
11. Sale of shares 6/10 of 1% 6/10 of 1% 6/10 of 1% 6/10 of 1% 6/10 of 1%
(traded)
12. Capital gains on 6% 6% 6% 6% 6%
real property
13. Winnings in 20% in excess of 20% in excess of 20% in excess of Exempt Exempt
Lotto 10,000 10,000 10,000

Tax Credit
a. Thos withheld by source to be applied as a reduction of the tax liability of the taxpayer in the taxable year or quarter in
which the income was earned or received.
b. Those paid to Foreign Country
- Rules
1. An alien is not allowed to credit taxes paid to foreign countries because he is taxed within only.
2. At his option, a resident citizen may treat it as an item of deduction of tax credit
3. The tax credit is subject to limit:
i. One foreign country= (TI, FC/TI, All) x Philippine income tax vs actual
ii. Two or more, choose among
actual vs limit using individual countries vs limit using total of outside source.

How do you distinguish corporate taxpayers?

Domestic Corporation One organized and existing under Philipine laws

Resident Foreign Corporation
Non resident Foreign Corporation
Taxable Partnerships
Special Corporations
One organized and existing under the laws of foreign country that is
engaged in business in the Philippines
Those not engaged in business in the Philippines.
Business Partnerships taxable like a domestic corporation
Various corporation with specified tax base and tax rates
How are these taxpayers taxed?

SOURCES TAXABLE BASE Can claim Can claim GIT? MCIT? IAET?
ISD? OSD
DC ALL SOURCES Normal TI Yes YES YES YES YES
RFC Within only Normal TI Yes YES YES YES NO
NRFC Within only Gross TI No No NO NO NO

Income taxes of Corporations

1. Normal Corporate income tax(NCIT)
- starting January 1, 2009 at 30% based on net taxable income.

2. Gross Income Tax (GIT)

- Tax rate: it is an optional income tax given to corporate earners equivalent to 15% of its gross income.
-Tax base: Gross income, which means:
Gross sales
Less: Sales returns, Discounts and allowances, and cost of goods sold.
- Requirements:
a. A tax ratio of 20% of GNP
b. A ratio of 40% income tax collection of total tax revenue
c. A VAT tax effort of 4% of GNP
d. A 0.9% ratio of consolidated public sector financial position to GNP
e. Other conditions:
i. Ratio of cost of sales to sales or receipts from all sources does not exceed 55%
ii. The election shall be irrevocable for three consecutive years.
iii. Recommendation from the secretary of Finance
iv. Approval of the Office of the President

3. Minimum Corporate Income tax (MCIT)

- Tax rate: 2% of gross income
- Requirements:
a. Whenever a corporation has zero or negative taxable income, or whenever the amount of MCIT is greater than
the normal income tax due from such corporation
b. Imposed beginning on the 4th taxable year immediately following the year in which such corporation
commenced in business
- What are the reliefs from MCIT?
The Secretary of Finance is authorized to suspend the imposition of MCIT on any corporation which suffers losses
because of
a. prolonged labor disputes- those arising from a strike staged by the employees which lasted for more than 6
months within a taxable period and which caused a temporary shutdown of business operations
b. force majeure
c. legitimate business reverses- includes substantial losses sustained due to fire, robbery, theft, or embezzlement,
or for other economic reasons determined by the Secretary of Finance.
- What is the nature of the Excess Minimum Tax Over Normal Tax?
It is a deferred asset, therefore the following rules must apply:
a. Any excess of MCIT can be carried forward on a quarterly or annual basis as the case may be
b. The excess can ba carried against the normal income tax due in the next 3 immediately succeeding taxable
years.
c. Any amount of the excess MCIT which cannot be credited against the normal income tax due in the next 3year
period shall be forfeited and charged to retained earnings.

4. Improperly Accumulated Earnings Tax

- IAE are the profits of a corporation that are permitted to accumulate instead of being distributed by a corporation to its
shareholders for the purpose of avoiding the income tax wrt its shareholders or the shareholders of another corporation.
-Tax Rate: 10% of IAE, in addition to other taxes.
-Formula of IAE:
Taxable income for the year
ADD: Income EXEMPT from tax
Income EXCLUDED from gross income
Income subject to FINAL TAX
NOLCO
LESS Income tax PAID for the taxable year
DIVIDENDS actually or constructively paid from the applicable year’s taxable income
Amounts RESERVED for the reasonable needs of the business
- This covers corporations which are classified as closely-held corporations, which are those corporations at least 50% of
OCS is owned directly or indirectly by not more than 20 individuals.
 -The said tax shall not apply to
a. Publicly held corporations
b. Banks and other non-banks financial intermediaries
c. Insurance companies
d. Taxable partnerships (deemed to have actually or constructively received the taxable income)
e. GPPs
f. Non-taxable joint ventures
g. Enterprises registered with the PEZA and other similar entities.

4. Capital Gains Tax

- on sale of real property or on sale of shares of stocks

Capital Gains WITHIN DC and RFC NRFC

1. Shares of stocks NOT Traded 5-10% 5-10%
2. Shares of stocks TRADED ½ of 1% PT ½ of 1% PT
3. Real properties 6% of SP or FMV, higher 30% Final tax

5. Final tax on passive income

-taxes on income in which the taxpayer merely waits for the amount to come in, such as interest, royalties, prizes and
winnings.

Passive Income WITHIN DC and RFC NRFC

1. Interest from depositary banks under FCDS 7.5% Tax exempt
2. Royalties, yield or monetary substitutes from deposits and 20% NCIT
the like
3. Interest on currency bank deposit 20% NCIT
4. Income derived by depositary banks under FCDS from local 10% -
banks, and interest income from foreign currency loans
granted to residents
5. Inter-corporate dividends
From DC to DC Exempt
From DC to RFC Exempt
From DC to NRFC 15% FWT if with taxpayers’
clause; if without, then
subject to NCIT.
From RFC to DC Exempt
From RFC to RFC or NRFC Taxable at 30% on the portion
which is earned in the Philippines
which should be 50% or more of
the total earnings for the past 3
years

Pro forma computation of taxable income subject to normal tax (Corporation): BIR Form 1702
Sales/Revenues/Receipts/Fees from within and without Pxxx
Less: Sales returns, allowances and discounts (if any) Pxxx
Cost of sales xxx xxx
Gross income from operation Pxxx
Add: Non-operating and other income not subjected
to final tax or capital gains tax xxx
Gross income Pxxx
Less: Allowable itemized business deductions or OSD xxx
Net taxable income Pxxx
Multiply by normal corporate income tax 30%
Normal corporate income tax Pxxx
====

What are the kinds of Special Corporations?

1. Special Domestic Corporations

A. Proprietary Educational Institutions (Provided that GI from unrelated 10% of NET taxable income, Otherwise, subject to
sources does not exceed 50% of total GI) NCIT
B. Nonprofit Hospitals 10% of NET taxable income
C. Government Owned and Controlled Corporations NCIT
D. Exempt Organizations (GSIS, SSS, PHIC, PCSO) Tax Exempt

2. Special Resident Foreign Corporation

A. International Carrier 2 ½ % of the Philippine Gross Billings
PGB means gross revenue realized from the carriage or persons, excess baggage, cargo
and mail ORIGINATING from the Philippines under the ff conditions:

B. Offshore Banking Units
C. Branch Remittances
D. Regional Area Headquarters
E. Regional Operating Headquarters
a. In continuous uninterrupted flight
b. in case of transshipment, that portion of the cost of the ticket corresponding to the leg
flown from the Philippines to the point of transshipment.
10% of Gross Income
Those derived from:
a. FC transactions with local commercial banks
b. FC transactions with branches of foreign banks authorized by BSP
c. Interest income derived from foreign currency loans granted to residents
* Income of Nonresident individuals or corporations from OBU are tax exempt
15% of Remittances by branch to its head office, EXCLUDING:
a. Income from activities that are PEZA registered
b. Passive income not directly related to the conduct of its business in the Philippines
Tax Exempt
10% of Taxable Income

3. Special Nonresident Foreign Corporations

A. Cinematographic film owner, lessor/ distributor 25% of gross income
B. Lessor of machinery, equipment, aircrafts and others 7 ½ % of gross income
C. Lessor of vessels chartered by Philippine Nationals 4 ½ % of gross income

What are Cooperatives? How are they taxed?

A cooperative is a duly registered association of persons, with common bond of interest, who voluntarily joined together to achieve
a lawful common social or economic end.

Duly registered cooperatives dealing business WITH MEMBERS ONLY shall be EXEMPT from paying the following taxes for which they
are directly liable:
a. Income tax on income from operations
b. VAT (output tax on sale)
c. 3% percentage tax
d. Donor’s tax on donation to duly accredited charitable research and educational institutions.
e. Excise tax, documentary stamp tax
f. Annual registration fee of P500.
Duly registered cooperatives dealing business WITH BOTH MEMBERS AND NON-MEMBERS are exempt from ALL NIRC taxes on their
transactions to members only.

Cooperatives with accumulated reserves and undivided net savings of not more than P10,000,000 are also exempted from income
tax for a period of 10 years from the date of registration provided that at least 25% of the net income is returned to members in the
form of interest and/or patronage fund.

Cooperatives shall pay the following taxes

a. 20% final tax on interest from any currency bank deposit and yield
b. 7.5% final tax on interest income under FCDS
c. Capital gains tax on RP
d. Documentary stamp taxes on transactions with non-members, when reserves exceed P10,000,000.
e. VAT billed on purchases of goods and services.

INCOME TAXES OF PARTNERSHIPS, JOINT VENTURES, ESTATES AND TRUSTS

PARTNERSHIP

What are the kinds of partnership?

1. General Professional Partnership

-Tax liability: it is income tax exempt, but is required to file ITR for its income for the purpose of furnishing information as to
the share in the gains or profits that each partner shall include in his individual ITR. The net income of the partnership shall
be computed in the same manner as that of a corporation.
- Each partner shall report his distributive share, actually or constructively received in the net income of the partnership as
gross income, which is subject to 10% creditable withholding tax. If the income payments to partner for the current year
exceeds P720,000, the withholding tax is 15%.
2. General Co-partnership
-Tax liability: it is considered as a corporation for purposes of taxation, thus taxable at 30%. It is also subject to MCIT.
- Each partner are considered as stockholders. The profits distributed to them are considered dividends and subject to a
final tax of 10% in 2000 thereafter.

JOINT VENTURE
-It is a business activity that is organized only for a temporary or short-period of time. It is dissolved once its business
objective is accomplished.
 - An unincorporated joint venture is taxed like a corporation. The share of joint venture partners are considered as
dividends. Applicable tax depends on whether the members are corporation or individuals.
-Unincorporated joint venture formed for undertaking a construction project or engaging in petroleum operations is not
subject to the corporate income tax.
CO-OWNERSHIP

-When more than one person acquired the right to own a piece of property or mass of properties, a co-ownership exists.
-As a rule, it is tax-exempt because the activities are intended to preserve the property and to collect the income from the
property, except in the following cases:
a. Formed voluntarily or upon agreement of parties
b. Co-owner reinvests his share in the co-ownership to produce another income-generating activity
c. Inherited property remained undivided for more than 10 years and no attempt was ever made to divide the
same, the property should be considered as owned by an unregistered partnership.

ESTATE AND TRUST

-Estate is composed of all properties, rights and obligations including those properties, earnings or obligations that have
accrued thereto since the opening of the succession. The estate is to be transferred from the decedent to his successors.
- During the period when the title to the properties is not yet finally transferred to the successors, there may be earnings
generated from the estate. These earnings are subject to income tax.
-An estate is taxable as an individual taxpayer.
-A trust is an obligation imposed or a right to administer over a property given to a person for the benefit of another.
-The computation of the net taxable income of trust shall be in the same manner as that of the net taxable income of the
estate.
-In the case of two or more trusts created by the same person for the same beneficiary, the taxable income of all trusts shall
be consolidated and the tax shall be computed bases on the consolidated income. The consolidated taxable income is
allowed only for one basic single personal exemption. However, the allocation of consolidated income tax uses a base of
total net taxable income after personal exemption.
- Trust may be created as a device to lower income tax because splitting the income between two taxpayers lower the tax
bracket.
When trust is revocable, the grantor is liable for the income tax.