Concept of Income

CONCEPT OF INCOME

▪ Concept of Income
▪ Tax treatment of Increase in the Value of Property
▪ The Net-worth Method
▪ Return on Capital
▪ Distinctions between Income and Other terms
▪ Characteristics of Taxable Income
▪ Income Constructively Received
▪ Sources of Income
▪ Classifications of Income
▪ Forms and Valuation of Income
▪ Tax accounting periods to report income
▪ Accounting periods and methods
Concept of Income

Income- refers to all earnings derived from :

1. Service rendered (labor)

2. Capital (business or investment)
3. Or both (including GAIN derived from sale or exchange from SALE
or Exchange of PERSONAL or REAL property classified either as
ORDINARY or CAPITAL asset)
Tax treatment of Increase in the Value
of Property

• Mere increase in the value of property is not income

• It is merely an UNREALIZED increase in capital
The Net-worth method

▪ It is used when the taxpayer has no accounting records

▪ Net worth = Total Assets – Liabilities
Steps Using the Net-worth method

1. Compute for the Net worth(Capital) ending balances of each year

2. ADD personal withdrawals ( it decreased ending capital yet it is not
income related)
3. DEDUCT Additional Investments (it increased the ending capital yet
it is not income related)
4. Compare the Balances of Each year to get the INCREASE or
DECREASE in Net-worth
5. ADD Nondeductible Items
6. DEDUCT Nontaxable Items
 Illustration
▪ Mr. Carlos Padilla, a sole proprietor, reports the following during the
taxable year
2015 2016

Total Assets 300,000 800,000

Total Liabilities 250,000 200,000

Additional Investments 100,000

Personal Withdrawals 100,000 230,000

Gain on proceeds of life insurance RECEIVED 150,000

Unrealized loss- debt securities DEDUCTED 20,000

Step 1: 1. Compute for the Net
worth(Capital) ending balances of each year

2015 2016
Total Assets End 300,000 800,000
Total Liabilities, end (250, 000) (200, 000)
Capital, end 50,000 600,000
STEP 2: ADD personal withdrawals ( it
decreased ending capital yet it is not
income related)
2015 2016
Total Assets End 300,000 800,000
Total Liabilities, end (250, 000) (200, 000)
Capital, end 50,000 600,000
Personal 100,000 230,000
Withdrawals
STEP 3: DEDUCT Additional Investments (it
increased the ending capital yet it is not
income related)
2015 2016
Total Assets End 300,000 800,000
Total Liabilities, end (250, 000) (200, 000)
Capital, end 50,000 600,000
Personal 100,000 230,000
Withdrawals
Additional (100,000)
Investments
Net worth 150,000 730,000
STEP 3: DEDUCT Additional Investments (it
increased the ending capital yet it is not
income related)
2015 2016
Total Assets End 300,000 800,000
Total Liabilities, end (250, 000) (200, 000)
Capital, end 50,000 600,000
Personal 100,000 230,000
Withdrawals
Additional (100,000)
Investments
Net worth 150,000 730,000

Get the Change in Networth= (150, 000

- 730,000 = Increase by 580,000
STEP 5. ADD Nondeductible Items

Increase in Net worth 580, 000

Add: Nondeductible expenses 20,000
STEP 6: Deduct: Nontaxable item

Increase in Net worth 580, 000

Add: Nondeductible expenses 20,000
Deduct: Nontaxable item 150,000
Increase in Net worth 580, 000
Add: Nondeductible expenses 20,000
Deduct: Nontaxable item 150,000
Net Taxable Income 450,000
Always keep
in mind the
basic
accounting
formula ☺
RETURN ON CAPITAL vs. RETURN OF CAPITAL

▪ Return ON Capital – profit in excess of capital

▪ Return OF Capital- return of your investment

DISTINCTIONS BETWEEN INCOME AND OTHER
TERMS

▪ Capital Distinguished from Income

▪ Capital- Denotes the Original Investment

– Fund used to generate earning
– Wealth

▪ Income- Service of wealth

DISTINCTIONS BETWEEN INCOME AND OTHER
TERMS

▪ Revenue vs. Income

▪ Revenue- all funds accruing to the treasury of government derived
from tax, donation, grants and any other source
▪ Income- refers to earning of individual persons, partnerships, or
corporation or estate and trust whether or not subject to tax

THEREFORE: Not all income are subject to tax

DISTINCTIONS BETWEEN INCOME AND OTHER
TERMS

▪ Receipts VS Income
▪ Receipts- considered cash collected over a business period
– May include capital or earnings

▪ Income- amount after excluding capital invested, COS, and other

deductions allowed by law
Non taxable and Taxable Income

▪ Nontaxable Income= income which are not subject to tax

▪ E.g. 13th month pay and other benefits (P90,000)
Income of Not for profit organizations

▪ Taxable Income= income which are subject to income taxes

▪ If income is subject to final taxes, it is no longer required to be
reported in the ITR
CHARACTERISTICS OF TAXABLE INCOME

▪ 1. There must be a gain of profit

▪ 2. The gain must be realized or received
– Forms = a. actual receipt of cash
b. Constructive receipt
3. The law or treaty does not exclude the gain from transaction
1. There must be a gain or profit

▪ A value is received in the form of cash or its

equivalent as a result of rendition of service or
EARNING IN EXCESS of capital invested
2. The gain must be realized or received

▪ The realization of gain make take the form of actual receipt of cash or
may occur as Constructive receipt of cash
When is income constructively received?
when it is credited to the account of, or segregated in favor of a
person, and it may be withdrawn without any substantial limitations or
conditions
Examples: Interest credited on savings account, share in the profit of a
partner in a general professional partnership although not yet distributed
“as if” theory of constructive income

▪ It prevents cash basis taxpayers to delay reporting of income

▪ Presumes the existence of income on transactions
– E.g. capital gains tax
3. The law or treaty does not exclude
the gain from transaction

Income taxpayers
Sources of Income Resident Citizen/Dom NRC/RA/NRA/Foreig
Corp n Corp
Earned:
Within ✓ ✓
Without ✓ X
Partly within and ✓ Partly taxable
without
 Income sources within the Philippines

1. Compensation for labor or service derived from Philippine Sources

2. Interest on bonds, notes, deposits and the like EARNED in the
Philippines
3. Dividends declared received from Domestic Corpo
4. Rentals, royalties from property LOCATED in the Philippines
5. Gains, profits and income from sale or real property as well as from
personal property in the Philippines
 Income sources outside the Philippines

1. Compensation for labor or service rendered by overseas contract

workers
2. Interest on bonds, notes, deposits and the like EARNED abroad
3. Dividends declared received from Nonresident Foreign Corpo
4. Rentals, royalties form property LOCATED OUTSIDE the
Philippines
5. Gains, profits and income from sale or real property as well as from
personal property located outside the Philippines
 Income partly within and partly without

▪ Earnings from sources within and partly without the Philippines

includes gains, profits and income derived from:
a) Transportation or other services rendered within and partly outside
b) Dividend received from a domestic corporation and foreign
corporation
NOTE: if 3 year Gross See Sec 42. NIRC par 2(b)
Income WITHIN of a
foreign corpo is < 50
%, dividend declared =
EARNED entirely
WITHOUT
 Classifications of Income

1. Compensation Income- gained derived from labor, especially

employment
2. Business or profession- derived from the exercise of a profession, or
conduct of business
3. Passive Income- an income in which the taxpayer merely waits for
the amount to come in
4. Capital gain- income derived from sale of assets NOT used in trade
or business
Normal VS Final tax

▪ Normal tax- also called regular or customary tax.

Imposed on earnings such as compensation, profession or
business NOT SUBJECT to final tax
– Normal taxes withheld on certain income are
CREDITABLE because they are INTENDED TO
EQUAL or at least APPROXIMATE the TAX due of
the payee on income

– Income recipient is still required to file an income tax

return to report the income and or pay the difference
between the tax withheld and tax due
Normal VS Final tax

▪ Final tax
– Term used to describe the tax on earnings that have been
subjected to complete withholding tax payment at source
– Final taxes withheld by the withholding agent constitute FULL
and FINAL payment
– In case of failure to withhold the tax, or under-withholding, the
deficiency tax shall be collected FROM the WITHHOLDING
AGENT
– The payee is not required to file an income tax return
 Forms and Valuation of Income

▪ Income may be received either:

1. Cash – pertains to money or its equivalent, received as compensation
or earnings derived from labor, practice of profession, and conduct of
business
2. Property – right of ownership over tangible or intangible objects
3. Service – based on performance received in payment for work
previously rendered
 VALUATION

1. Cash received for income earned

2. FV of the property received
3. FV (at the date of income was earned) of the share of stock received
4. FV of the service received (in the absence of stipulated price)
5. FV of the promissory notes received
a) FACE of the note = interest bearing
b) Discounted value= if noninterest bearing
 TAX Accounting periods

1. Calendar period – period which covers January 1 to December 31

2. Fiscal period- period covering 12 month which ends on the last day
of any calendar month other than December 31
3. Short Period – income for a period of less than 12 months
4. Variable period- a period covers taxes paid on per transaction basis.
E.g. mothly, quarterly, or at a specific time per sale of transaction
 Method of Reporting Income and Expenses

1. Cash method
2. Accrual
3. Special Methods
 Cash Basis

Income Expense

▪ Cash received ( received and ▪ Cash paid (incurred and paid)

earned)
▪ Amortization of prepayment
▪ Advance Income (not yet (meaning, Asset method is
earned) used)
▪ Depreciation
 Accrual

Income Expense

▪ Cash received ( earned and ▪ Cash paid (incurred)

received)
▪ Accrued ( incurred)
▪ Accrued (not yet received)
▪ Amortization of prepayment
▪ ===================== (meaning, Asset method is
used)
▪ Advance Income (not year
earned) ▪ Depreciation
Special Methods
▪ The taxpayer may use special methods in reporting income when the
nature of its operation is PECULIAR to the business or industry
▪ The following are special methods in reporting income:
1. Installment
2. Deferred payment
3. LTCC
a) Completed Contract method
b) Percentage of completion

4. Farming
a) Cash basis
b) Accrual
c) Crop basis
 THANK YOU

Summarized notes from various sources

jmc_Mar2019