TAXATION 1 – INCOME TAXATION
2020
Chapter 4
GROSS INCOME
GROSS INCOME DEFINED
Gross income means the pertinent items of income referred to in Section 32(A) of the Tax Code. It
includes all income from whatever source (unless exempt from tax by law) including, but not limited
to, the following items.
1. Compensation for services in whatever form paid including fees, salaries and wages,
commissions, and similar items;
2. Gross income derived from the conduct of trade or business or the exercise of a profession;
3. Gains from dealings in property;
4. Interests;
5. Rents;
6. Royalties;
7. Dividends;
8. Annuities;
9. Prizes and winnings;
10. Pensions; and
11. Partner’s distributive share from the net income of general professional partnership.
GROSS COMPENSATION INCOME
Gross compensation income means any remuneration for rendering personal services. Generally,
compensation income is obtained from an employer-employee relationship between payor and
recipient.
Classification of Gross Income
1. Basic salary or wage
Salary refers to earnings received periodically for a regular work other than manual labor, such
as a monthly salary of an employee.
Wages, on the other hand, are earnings received usually according to specified intervals of
work, as by the hour, day or week. An example is a carpenter’s daily wage.
2. Honoraria are payments given in recognition for services performed for which established
practice discourages charging a fixed fee. The honorarium of a guest lecturer is an example.
3. Fixed or variable allowances In general, fixed or variable transportation, representation and
other allowances that are received by a public officer or employee or officer or employee of a
private entity, in addition to the regular compensation fixed for his position or office, is a
compensation subject to withholding tax.
4. Commission is usually a percentage of total sales or on certain quota of sales volume attained as
part of incentive, such a s sales commission.
5. Fees are received by an employee for the services rendered to the employer including a
director’s fee of the company, fees paid to the public officials such as clerks of court or sheriffs
for services rendered in the performance of their official duty over and above their regular
salaries.
6. Tips and gratuities
7. Hazard or emergency pay
8. Retirement pay
9. Separation pay
a. Death;
b. Sickness;
Chapter 4 – Gross Income Page 1
TAXATION 1 – INCOME TAXATION
2020
c. Disability;
d. Reorganization/merger of company; and
e. Company at the brink of bankruptcy.
10. Pension
11. Vacation and sick leave
12. Thirteenth month pay and other benefits
13. Overtime pay
14. Profit sharing
15. Awards for special services
16. Beneficial payments
17. Other forms of compensation
Shares of Stock Received as Compensation
Compensation paid to an employee of a corporation in its stock is to be treated as if the corporation
sold the stock at its market value and paid the employee in cash.
Employee Stock Option
A stock option is a privilege granted to some key employees of a corporation to avail of the said
corporation’s share of stock in the future for a certain price.
Cancellation of Debt
The cancellation and forgiveness of indebtedness may amount to a payment of income, gift or capital
transaction, depending upon the circumstances.
Insurance Premiums as Compensation
These are premiums paid by the employer on life insurance coverage of the employee wherein the
beneficiary is the employee’s family. These constitute taxable income on the basis of the amount of
premium paid.
Income Tax Paid as Compensation
For income tax paid by the employer in favor of the employee, the basis of tax is the amount of tax
paid.
GROSS INCOME FROM BUSINESS AND PROFESSION
Business Defined
Business means any commercial activity engaged in as a means of livelihood or profit of an individual
or group of individuals. Examples are trading, merchandising, manufacturing and other similar
activities.
Profession Defined
For tax purposes, profession is primarily any endeavor or work requiring specialized training in the
field of learning, art or science engaged in as a means of livelihood or profit of an individual or group
of individuals. In general, a practice or profession is a service business. Examples are Certified Public
Accountants, Lawyers, Medical Doctors, and the like.
Classification of Gross Income from Business
1. Manufacturing;
2. Merchandising or Trading;
3. Servicing;
4. Farming; and
5. Long-term contract.
The Cost of Sales
Chapter 4 – Gross Income Page 2
TAXATION 1 – INCOME TAXATION
2020
1. Cost of goods manufactured and sold of manufacturing concern;
2. Cost of goods sold of trading or merchandising concern; and
3. Cost of service of servicing concern. (Sec. 27 [A], NIRC)
Cost of Goods Manufactured and Sold
For manufacturing business, all costs of finished goods that are sold (such as raw materials used, direct
labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring
the raw materials to the factory or warehouse) are called cost of goods manufactured and sold.
Cost of Goods Sold of Trading or Merchandising Concern
Cost of goods sold of trading or merchandising business refers to the invoice cost of the goods sold,
plus import duties and freight-in transporting the goods to the place where they are actually sold,
including insurance while the goods are in transit.
Cost of Services
Cost of services are the direct costs and expenses necessarily incurred to provide the services required
by the customers and clients including:
a. Salaries;
b. Benefits of personnel, consultants and specialists directly rendering the service; c. Cost of
facilities directly utilized in providing the service such as depreciation or rental of equipment used
and cost of supplies; and
d. In the case of banks, costs of services shall include interest expense.
Rental Income
1. Prepaid Rental. If the advanced payment is a prepaid received without restriction as to its use,
the entire amount is taxable in the year it is received whether the lessor uses cash or accrual
method of accounting.
2. Security Deposit with Restriction. If the advanced payment is a security deposit which restricts
the lessor as to its use, then such amount should be excluded in the determination of rental
income.
3. Security Deposit with an Acceleration Clause. If the advanced payment is a loan deposit, or
option money for the property, or a security deposit for the faithful compliance of the lessee of
the lease contract, such advance payment is not an income to the lessor. The income to the
lessor inures which the lessee violates the terms of the contract.
Income from Leasehold Improvements
∙ Outright Method
∙ Spread-Out Method
Termination of the Contract of Lease
Where there is an immovable improvement made by the lessee on the lease property and the
termination of the contract of lease is made before the expiration of the lease term, the following rules
should regulate the circumstances:
PASSIVE INCOME
1. Yield from deposit substitutes and trust fund;
2. Interest income;
3. Royalty income;
4. Dividend income; and
5. Prizes and winnings
A deposit substitute is a debt instrument issued by the bank to borrow money from the public other
than from the client’s deposit.
Chapter 4 – Gross Income Page 3
TAXATION 1 – INCOME TAXATION
2020
A trust fund is any estate, especially stock, securities or money which is held in trust by a person in
behalf of another person.
Interest income is an earning derived from depositing or lending of money, goods, or credits. Unless
exempted by law, interest income received by the taxpayer, whether or not usurious, is subject to
income tax.
A royalty income is a payment or portion of proceeds paid to the owner of a right, such as an oil right
or a patent for the use of it, or a portion of the proceeds from the work of an author or composer.
Dividend income is a form of earnings derived from the distribution made by a corporation out of its
earnings or profits and payable to its stockholders, whether in money or in other property.
Summary of Taxes on Dividends
∙ Tax exempt
Dividends are tax-exempt if:
1. Received from a Domestic Corporation by:
a. Another Domestic Corporation.
b. Resident Foreign Corporation.
2. Received from a Cooperative.
3. Pure stock dividend.
4. Pure liquidating dividend (return of capital)
∙ Subject to Final Tax
Dividends are subject to final tax if received from a Domestic Corporation by
a: 1. Citizen or Resident Alien
2. Non-resident Alien doing business in the Philippines
3. Non-resident Alien not doing business in the Philippines
4. Non-resident Foreign Corporation
∙ Subject to Normal Tax
Dividends are subject to year-end normal tax of individuals or corporations if such dividends
are:
1. Not included as tax-exempt dividends.
2. Not subject to final tax.
3. Distributive shares of a partner in professional partnership.
Forms and Valuations of Dividend Income
1. Cash dividend;
2. Property dividend;
3. Stock dividend;
4. Scrip dividend;
5. Indirect dividend; and
6. Liquidating dividend.
OTHER SOURCES OF INCOME
1. Bad debt recovery;
2. Tax refund or credit;
3. Annuities; and
4. Income from whatever source.
Bad Debt Recovery
The following are requisites for deductibility of bad debts:
1. There must be a valid and existing debt.
2. The debt must be actually ascertained to be worthless and uncollectible during the taxable year.
3. The debt must be charged off during the taxable year.
4. The debt must arise from business or trade of the taxpayer.
Chapter 4 – Gross Income Page 4
TAXATION 1 – INCOME TAXATION
2020
COMPUTATION OF GROSS INCOME
Problem 1 – Gross Compensation Income
Pamela Lantes has earned the following income in 2019:
Salary as a professor, net of withholding tax of ₱10,000 ₱290,000 Income
from practice of profession as CPA 200,000 Per Diem as a board of director
120,000 Thirteenth month pay 25, 000 First Prize in essay writing contest
50,000
What is the amount of gross compensation income?
a. ₱420,000 b. ₱445,000 c. ₱645,000 d. ₱695,000
Problem 2 – Taxable Compensation Income
The following incomes are reported by Cute, a CPA:
Salary as an accountant ₱240,000 Overtime pay 30,000 13th month pay and
bonuses 15,000 Audit professional fee 60,000 Gains from sale of car 25,000
The amount of taxable compensation income is:
a. ₱240,000 b. ₱270,000 c. ₱285,000 d. ₱295,000
Problem 3 – Retirement Pay
Sue reported the following retirement:
First employment for 30 years received at the age of 50 ₱500,000 Second
employment for 10 years received at the age of 60 400,000 Third employment
for 10 years received at the age of 70 300,000
How much is the non-taxable retirement pay of Sue?
a. ₱0 b. ₱300,000 c. ₱400,000 d. ₱500,000
Problem 4 – Cancellation of Debt
Bingcol works as the CEO of B Company. His compensation income is ₱50,000 per month . In
January 31, 2019, he borrowed ₱300,000 from B Co. As a result his monthly compensation
income is reduced by ₱25,000 as payment to his borrowing. If on December 31, 2019, B Co.
cancelled Bingcol’s indebtedness, how much is the latter’s compensation income in December
2019?
a. ₱25,000 c. ₱75,000
b. ₱50,000 d. ₱100,000
Chapter 4 – Gross Income Page 5
TAXATION 1 – INCOME TAXATION
2020
Problem 5 – Cost of Goods Sold
During the year, the total purchases of goods for sale amounted to ₱500,000. Transportation
cost is ₱5,000 for goods purchased and ₱10,000 expenses for goods sold. During the year, total
sales amounted to ₱550,000. At the end of the year unsold goods amounted to ₱40,000. The
cost of goods sold for the period is:
a. ₱505,000 b. ₱475,000 c. ₱465,000 d. ₱460,000
Problem 6 – Gross Service Income
From the following data compute for the gross profit of a servicing business:
Professional fee, accounting services ₱500,000 Salaries of accounting staff
150,000 Salaries of office assistant 60,000 Accounting Supplies 10,000
General Supplies 5,000
a. ₱340, 000 b. ₱335, 000 c. ₱280, 000 d. ₱275, 000
Problem 7 – Passive Income
Which of the following is subject to 10% final tax?
a. ₱10,000 prizes
b. ₱20,000 winnings
c. ₱50,000 cash dividend received by an individual
d. ₱100,000 property dividend received by a domestic corporation from another domestic
corporation.
Problem 8 – Interest Income
The following are the income of a resident citizen for the period:
Interest income from an investment in a 10-year bond ₱40,000 Interest
income from 5 year time deposit in Philippine bank ₱50,000 Interest income
from expanded foreign currency deposit ₱60,000
His interest income subject to normal tax is
a. ₱150,000 c. ₱40, 000
b. ₱100,000 d. 0
Problem 9 – Dividend Income
A domestic corporation received ₱500,000 cash dividend from a foreign corporation the
earnings of which are 70% earned in the Philippines. The taxable dividend income of the
domestic corporation is
a. ₱500, 000 c. ₱150, 000
b. ₱350, 000 d. ₱100, 000
Chapter 4 – Gross Income Page 6
TAXATION 1 – INCOME TAXATION
2020
Problem 10 – Nontaxable Compensation
A MWE employee received a total take home pay amounting to ₱280,800 for the year inclusive
of 13th month pay of P22,000. The ₱280,800 is net of ₱2,200 withholding tax on compensation
and ₱3,000 SSS, Philhealth and Pag-ibig share contribution. In addition, he earned a ₱20,000 as
other income subject to normal tax.
How much is the total amount of his taxable income?
a. ₱261,000 c. ₱286,000
b. ₱281,000 d. ₱284, 000
Problem 11 – Employer’s Benefits
Mr. X was hired with a condition (due to the nature of his work) that he will be a stay-in at
monthly salary of ₱21, 000 per month, he was also provided with free lodging valued at ₱2,000
per month and free meals, valued at ₱3,000 per month.
The taxable monthly compensation income of the employee is
a. ₱21,000 c. ₱24,000
b. ₱23,000 d. ₱26,000
Problem 12 – Proceeds of Life Insurance
Twinkle Co. insured Mr. Rodrigo Pajama, its President for ₱500,000. Mr. Pajama died and
Twinkle Co. received the proceeds of the insurance after paying insurance premium of
₱50,000. The reportable taxable income would be:
a. ₱500,000 c. ₱300,000
b. ₱450,000 d. ₱0
Problem 13 – Income from Life Insurance
Mrs. Vina Luchina was insured under an endowment policy with value of ₱500,000. Total
premiums paid by her during the term of premium payments on the policy were ₱490,000 from
which there was a return of premiums of ₱40,000. At the maturity of the policy, Mrs. Luchina
received ₱500,000. The income of Mrs. Luchina under the policy is
a. ₱500, 000 c. ₱10, 000
b. ₱50, 000 d. ₱0
Problem 14 – Taxable and Non-taxable Terminal Pay
The heir, upon the death of an employee, received the following amounts:
Terminal pays ₱ 60,000
Life insurance 500,000
SSS death benefit 10,000
Donation of relatives 40,000
What amount of these receipts is taxable and not taxable with income tax?
Taxable Nontaxable
a. ₱610, 000 ₱ 0
b. ₱500, 000 ₱110, 000
c. ₱110, 000 ₱500, 000
d. ₱ 0 ₱610, 000
Chapter 4 – Gross Income Page 7
TAXATION 1 – INCOME TAXATION
2020
Problem 15 – Income from Separation
During the year, the resident citizen received the following among others: Last
pay upon resignation from his 1st employment ₱100, 000 Separations pay due
to closure of his 2nd employer 70, 000 Retirement pay received from SSS as
member 150, 000
How much is the reportable income from the above data?
a. ₱220,000 c. ₱150,000
b. ₱170,000 d. ₱100,000
Problem 16 – Non-taxable Receipts
Eddie Gil received the following cash during a taxable year:
Actual damages for injuries suffered ₱30,000 Separation pay due to sickness
100,000 SSS Retirement benefits 500,000 Inheritance from his grandparents
100,000
How much amount of cash receipts is subject to income tax?
a. ₱0 c. ₱130, 000
b. ₱100, 000 d. ₱230, 000
Problem 17 – Gifts, Bequests and Devices
Pandoy received the following fits during the year:
Christmas gifts from his employer ₱ 5,000 Gifts from relatives on account of
his birthday 100,000 Inheritance from his grandfather 500,000 Donations
from his friends 30,000
How much is the gifts subject to income tax?
a. ₱635,000 c. ₱5,000
b. ₱ 35,000 d. ₱ 0
Problem 18 – Non-taxable Interest Income
A non-resident alien earned the following interest income:
Interest income from peso savings deposit ₱50,000 Interest from expanded
foreign currency deposit (converted to peso) 100,000 Interest from yield
deposit 30,000
How much of the above income is non-taxable?
a. ₱30,000 c. ₱ 80, 000
b. ₱50,000 d. ₱100, 000
Problem 19 – Cooperative Income
A CDA registered cooperative reported a total income of ₱500,000 inclusive of ₱10,000
interests in bank savings deposit. The taxable income of this cooperative would be a. ₱500,000
c. ₱10,000
b. ₱490,000 d. ₱ 0
__________________________________________________________________________________
Chapter 4 – Gross Income Page 8
