TAXATION

MODULE 4 - INCOME TAXATION

1. Income Taxation
a. Definition and Nature
It is a 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.
Taxable on or before 15th day of the 4th month in one taxable year.
It is an excise tax levied upon privilege of receiving income or profit.
The function of income tax is to:
(1) Provide large amounts of revenues
(2) Offset regressive sales and consumption taxes
(3) Mitigate the evils arising from inequalities in the distribution of income and
wealth
Protection Theory - The flow of wealth occured within the Philippines and as such it
is protected. In consideration of this protection, income taxation is a burden of
supporting the goverment
Theory of Favorable Business Climate - The government ensure favorable business
climate, therefore it requires them to make a reasonable contribution to the public
expenses.

2. Income Tax Systems

a. Global Tax System
All items of gross income (all income derived from whatever source), deductions,
personal and additional exemptions reported in one income tax return (ITR)
regardless of the activities which produced the income.
Tax views indifferently, treats in common all categories of taxable income of the
individual.
b. Schedular Tax System
Different types of activities are subjected to different types of tax rates.
Depends on the kind or category of taxable incomes and provides for varied
percentage of taxes to be applied.
c. Semi-Schedular or Semi Global Tax System
Certain passive income and capital gains are subjected to different final taxes while
other income are added to arrive at the gross income (where deductions can be
used)

3. Feaures of the Philippine Income Tax Law

a. Direct Tax - tax is borne by the income recipient upon whom the tax is imposed
b. Progressive - tax rate increases as the tax base increases. (Ability to pay
principle)
c. Comprehensive - adopts the citizenship, residence and source principle.
d. Semi-Schedular or Semi-Global Tax System
It is GLOBAL in such a way that compensation income not subject to final tax are
added together with other income to arrive at the gross income and the taxable
income (gross income-deductions and exemptions).
It is SCHEDULAR in such a way that passive investment income subject to final tax
and capital gains remain subject to different sets of tax rates covered by different
tax returns.

4. Criteria in Imposing Philippine Income Tax

a. Citizenship Principle (Sec 23 NIRC)
The basis of the imposition is the taxpayer's citizenship. Citizen are taxed on all
income derived from sources within and without the Philippines
b. Residence Principle (Sec 23 NIRC)
The basis of the imposition is the residence of the taxpayer. Non-Resident Citizen
are taxed on all income derived from sources only within the Philippines
c. Source Principle (Sec 24 NIRC)
The basis of the imposition is the source of the income. Taxes derived from sources
without the Philippines

5. Kinds of Taxpayers (Sec 22 NIRC) - any person subject to tax imposed by this title
General Classification Rule
Intention and Length of Stay - shows the residency of the person
a. Individual - a type of person
Resident Citizen - Citizen of the Philippines and Residing in the Philippines
Article 4, Section 1 of the 1987 Constitution
Citizens of the Philippines at the time of adoption of Constitution
Fathers or mothers are citizens
Born before 1973 of Filipino mothers, who elect Philippines upon reaching the age of
majority
Naturalize

RESIDENCE AND DOMICILE

Animus Revetendi (Intent to Return) and Animus Manendi (Intent to Remain) needed
to establish domicile

Non-resident citizen
(1) A citizen the fact of his physical presence abroad with a definite intention to
reside

(2) A citizen who leaves the Philippines during the taxable year to reside abroad, as
an immigrant or employment on a permanent basis (OFW or Overseas Contract
Workers OCW)
NRC considered RC from the start of the taxable year to the date of his departure
NRC only in a taxable year in which he departed from the Philippines
Hence an individual taxpayer may be NRC or RC in one taxable year

(3) A citizen of the Philippines who works and derives income from abroad and
whose employment requires him to be physically present abroad most of the time
during the taxable year
The worker must hav ebeen outside the PH for not > 183 days during the taxable
year
If the worker works outside the Philippines for a minimum of 183 days is still
considered RC if the employer is a Filipino

(4) A citizen who has been previously considered as nonresident citizen and who
arrives in the Philippines at any time during the taxable year to reside permanently
in the Philippines shall likewise be treated as a nonresident citizen for the taxable
year in which he arrives in the Philippines with respect to his income derived from
sources abroad until the date of his arrival in the Philippines.
Taxable as NRC from sources abroad until the date of his arrival

(5) The taxpayer shall submit proof to the Commissioner to show his intention of
leaving the Philippines to reside permanently abroad or to return to and reside in
the Philippines as the case may be for purpose of this Section.

Overseas Contract Worker (OCW) - Filipino citizen employed in a foreign country

who is physically present in a foreign country as a consequence of his employment
Physically present in a foreign country
Registered with POEA and had OEC
Salary by employer abroad (foreign employer)
Income arising from overseas employment is tax exempted

Seaman
Considered as OCW:
Citizen of the Philippines
Receives compensation abroad as a member of the vessel
Vessel engaged exclusively in international trade
Registered with POEA
Has OEC

Resident Alien - an individual whose residence is within the Philippines but not a
citizen
CONSIDERED IF:
(1) Not a mere transient or sojourner
(2) No definite intention to his stay in the philippines
(3) Purpose is such that needs an extended stay such that he makes his home
temporarily in the Philippines
Mere intention to change his residence is not enough to change residency of an
alien.

Nonresident Alien - an individual whose resident is not in the Philippines and not a
citizen
NON-RESIDENT ALIEN ENGAGED IN TRADE OR BUSINESS (NRA-ETB)
Not doing business in the Philippines
A NRA who comes to the PH and stay for a period of more than 180 days during any
taxable year is considered NRA ETB

NON-RESIDENT ALIEN NOT ENGAGED IN TRADE OR BUSINESS (NRA NETB)

A NRA who comes to the PH and stay for a period of less than 180 days

b. Corporation - includes partnerships, joint-stock companies, joint accounts,

association, or insurance companies but does not include general professional
partnerships and a joint venture or consortsium
Domestic Corporation - created or organized in the Philippines
Foreign Corporation - corporation which is not domestic
Resident Foreign Corporation - foreign corporation engaged in business within the
Philippines
(1) If the foreign corporation has a an agent by which it conducts its business in the
Philippines, he is considered as a RFC
Nonresident Foreign Corporation - foreign corporation not engaged in trade or
business within the Philippines

c. Partnership - included in the term of corporation

Also included: joint stock companes, joint accounts, associations and insurance
companies

d. General Professional Partnership - NOT INCLUDED partnerships formed by persons

for the sole purpose of exercising their common profession, no part of the income of
which is derived from engaging in any trade or business. Including Joint Ventures
which are formed for the execution of a single transaction and temporary in nature.
e. Estates and Trusts (Sec 60 NIRC)
Trust is- where a trustor transfer ownership to a trustee to hold and control the
property for the benefit of another person.
Income tax should not apply to employee's trust.
Estate - is created by operation of law when an individual dies, leaving properties to
heirs, refers to the mass of properties left by the decedent
Judicial Administration and Not Judicial Administration
It is taxable upon death of person, for income tax and estate income tax if judicial.

f. Co-Ownerships - whenever the ownership of an undivided thing or right is from

different persons (Article 484, NCC)
Co-ownership is tax exempt

6. Income `
a. Definition
As the amount of money coming to a person or corporation within a specified time
whether as payment for services, interest or profit from investment.

All wealth that flows into the taxpayer other than as a mere return of capital.
Includes gains and profits from sale or disposition of capital assets.

It means cash or its equivalent

INCOME (FRUIT) (FLOW OF WEALTH) VS CAPITAL (TREE) (WEALTH)

b. Requisites of a Taxable Income

There must be a gain or profit
The gain must be realized or received
The gain must not be excluded by law or treaty

c. Realized Income vs Recognized Income

Realized Income
When income is actually or physically transferred to a person or constructively
received by him.
TEST OF REALIZATION
ACTUAL
When income is actually reduced to possession. (Cash)
CONSTRUCTIVE
The income is credited to the taxpayer which he can draw upon at anytime without
limitation or restriction.

Recognized Income
When it is recorded at the amount received or to be received.
This is relevant for those who are accounting their expenses.
There are two ways to recognize income:

CASH METHOD AND ACCRUAL METHOD

Cash Method:
What is important in a cash method is when the cash is received or constructively
received.
It would only appear as income at the time when the cash is received or when the
cash is paid, the date of transaction does not matter, what matters is only when the
cash is received.
Expenses are accounted for when they are actually paid
Used by taxpayers who do not keep regular books of accounts

Accrual Method
What is important on the other hand is when the transaction occured.
Income is earned regardless of whether it has been received or not
Expenses are accounted for in the period they are incurred
Used by taxpayers whose nature of business uses inventories.
Gross Income
Gross Income - means all income derived from whatever source (General Statutory
Definition)
Gross Income - means all items of income less exclusions

Gross Income - All income less exclusions

Net or Taxable Income - Gross income less allowable deductions
Income Tax Due - Taxable or Net Income multiplied by the tax rate
Income Tax Payable - Income Tax Due Less Creditable Witholding Tax or Tax Credit

Gross Income vs Net Income

Gross income no deductions, net income deductions are allowed
Gross income no exemptions, net income exemptions are granted
Gross income tax base, net income tax base

d. Test in Determining Income

Flow of Wealth Test
The test of tax liability is the source, it is the property, activity or service that
produced that income determine any gain was derived from the transaction

Realization Test
An income is realize when:
(a) The earning is complete or virtually complete
(b) An exchange has taken place

Claim of Right Doctrine

Taxable gain is conditioned upon the presence of a claim of right to the alleged gain
and the absence of a definite unconditional obligation to return or repay that which
would constitute a gain.
Even if the right to the income has not been perfected yet.
If the taxpayer who has included amounts in income pursuant to a claim of right
and subsequently repay those amounts, the taxpayer is entitled to a deduction in
the year of repayment

All-Events Test
a. The fixing of a right to income or liability to pay
b. The availability of the reasonable accurate determination of such income or
liability