Module 03 - Income Tax Concepts
Module 03 - Income Tax Concepts
Income Taxation
Fundamental Principles
Income
2
Tax
A
T
Concepts
1
CONCEPT OF INCOME
One popular definition of income is the amount of wealth accumulated plus savings and the value of the personal consumption.
The term 'income' 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 classified as either ordinary or capital asset.
There is no single criterion for determining income for tax purposes, but it may be helpful to remember that the "rule-of-thumb
test” to determine income is the increase in net worth.
Capital items There are capital items that have infinite value and are incapable of pecuniary valuation. Anything
deemed with received as compensation for their loss is deemed a return of capital.
infinite value
Recovery of lost The loss of capital results in decrease in net worth while the loss of profits does not decrease net
capital vs. worth. The recovery of lost capital merely maintains net worth while the recovery of lost profits
Recovery of lost increases net worth. Therefore. the recovery of lost profits is a return on capital. The recovery of lost
profits profits through insurance, indemnity contracts, or legal suits constitutes a taxable return on capital.
Benefit 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 taxpayer. An increase in net worth occurs when one receives income,
donation or inheritance.
The following are not benefits, hence, not taxable:
a. Receipt of a loan - properties increase but obligations also increase resulting in an offsetting effect
in net worth
b. Discovery of lost properties - under the law, the finder has an obligation to return the same to
the owner
Receipt of money or property to be held in trust for, or to be remitted to, another person If the taxpayer is
entitled to keep for his account portion of a receipt, only that portion is a benefit.
Income Tax Concepts
Fundamental Principles page 6
Tax The increase in wealth of the taxpayer in the form of appreciation or increase in the value of his properties
Treatment of or decrease in the value of his obligations in the absence of a sale or barter transaction is not taxable. A
Increase in mere increase in the value of property is not income, but merely and unrealized increase in capital. These
the Value of are referred to as unrealized gains or holding gains because they have not yet materialized in an exchange
Property transaction. Examples of unrealized gains or holding gains:
a. Increase in value of investments in equity or debt securities
b. Increase in value of real properties held (revaluation increment)
c. Increase in value of foreign currencies held or receivable
d.Decrease in value of foreign currency denominated debt by virtue of favorable fluctuation in
exchange rates
e. Birth of animal offspring, accruals of fruits in an orchard or growth of farm
vegetables f. Increase in value of land due to the discovery of mineral reserves
Rendering The rendering of services for a consideration is an exchange but does not cause a loss of capital. Hence, the
of Services entire consideration received from rendering of services such as compensation income or service fees is an
item of gross income.
Income Tax Concepts
Fundamental Principles page 7
Illustration 3.3 MEANING OF REALIZED
A seller sold a piece of jewelry for P140,000 when its fair market value was P200,000. The cost of the jewelry was P90,000. The
difference of the sale price and cost of P50,000 is subject to income tax while the excess of the fair market value and the sale
price of P60,000 is deemed a donation subject to donor’s tax.
CLASSIFICATIONS OF TAXPAYERS
One of the determinants in the imposition and assessment of taxes is the classification of the taxpayer, thus, one should
consider the nationality and residence of individual taxpayers in computing for their taxes.
Individual Taxpayers
Resident A Filipino citizen residing in the Philippines
Citizen (RC) Definition of a Citizen under the Constitution
Under the Constitution, citizens are:
a. Those who are citizens of the Philippines at the time of adoption of the Constitution on February
2, 1987
b. Those whose father or mother are citizens of the Philippines
c. Those born before January 17, 1973 of Filipino mothers who elected Filipino citizenship upon
reaching the age of majority
d.Those who are naturalized in accordance with the law
Non-Resident The following are considered as non-resident citizens:
Citizen (NRC) a. A citizen of the Philippines who establishes to the satisfaction of the BIR Commissioner the fact of
his physical presence abroad with a definite intention to reside therein
Resident Alien (RA) A resident alien is someone who is residing in the Philippines but is not a citizen. a. An alien who
lives in the Philippines without definite intention as to his stay b. One who comes to the Philippines
for a definite purpose which in its nature would require an extended stay and to that end makes his
home temporarily in the Philippines, although it may be
Income Tax Concepts
Fundamental Principles page 11
his intention at all times to return to his domicile abroad In the absence of information on
intention, aliens who stayed in the Philippines for more than 1 year as of the end of the taxable
year are considered resident aliens.
An alien who has acquired residence in the Philippines retains his status as such until he abandons the
same or actually departs from the Philippines.
Non-Resident An individual who is not residing on the Philippines and is not a resident thereof, intends to conduct
Alien Engaged in trade, business or exercise of his profession.
Trade or Business In the absence of information as to taxpayer’s intent, aliens who stayed in the Philippines for an
(NRA-ETB) aggregate period of more than 180 days during the year are presumed to be engaged in trade or
business.
Non-Resident An individual who is not residing on the Philippines and is not a resident thereof, not intending to
Alien not conduct trade, business or exercise of his profession. Aliens who come to the Philippines for a definite
Engaged in purpose which in its nature may be promptly accomplished shall not be considered to be engaged in
Trade or trade or business.
Business
(NRA-NETB)
Other Estate
Individual This refers to the properties, rights and obligations of a deceased person not extinguished by death.
Taxpayers Estates under judicial settlement are treated as individual taxpayers. Estates under extrajudicial
settlement are exempt entities. The income of properties of the estate under extrajudicial settlement is
taxable to the heirs.
Trust
A trust is an arrangement whereby one person called the grantor or trustor transfers property to
another person called the beneficiary, which will be held under the management of a third party
called the trustee or fiduciary.
Corporate Taxpayers
Domestic Corporation (DC) A corporation formed and authorized to conduct trade and business under the Philippine law.
Resident Foreign A corporation organized, authorized, or existing under the laws of any foreign country but is
Corporation (RFC) authorized to engage in trade or business in the Philippines through a permanent
establishment.
Non-Resident A corporation organized, authorized, or existing under the laws of any foreign country and is
Foreign Corporation not authorized to engage in trade or business in the Philippines.
(NRFC)
Joint Venture
A joint venture is a business undertaking for a particular purpose. It may be organized as a
partnership or corporation.
Co-Ownership
It is a joint ownership of a property formed for the purpose of preserving the same and/or
dividing its income.
Taxability
The income earned by a taxpayer may be taxed depending on the situs or place where it was earned. Following is a table
summarizing taxability of a taxpayer’s income based on its situs.
Classification Income earned Within Income earned Without Rate of Tax
RC ✓ ✓ Generally, progressive tax on the
net income
NRC ✓ X
RA ✓ X
NRA-ETB ✓ X
NRA-NETB ✓ X Generally, 25% final tax on the
gross income
DC ✓ ✓
Generally, 30% ad valorem tax on
net income
RFC ✓ X
SITUS OF INCOME
The situs of income is the place of taxation. It is the jurisdiction that has the authority to impose tax upon the income. It is to be
noted that it is different from source of income as the latter pertains to the activity or property that produces the same. The
following are the specific income situs rules:
Basic Rules Interest Income Debtor’s Residence
Royalties Where the intangible is employed
Rent Income Location of the property
Service Income Place where the service is performed
Merchandising Income Earned where the property is sold
Manufacturing Income Earned where the goods are manufactured and sold
~ separated if the places of such are not the same
Gains on sale Domestic Securities Presumed earned within the Philippines
of property ersonal Properties Earned in the place where the property is sold
Real Properties Earned where the property is located