GROSS INCOME

TAXATION 1
 I. GENERAL STATUTORY DEFINITION
 Gross income means all income derived from whatever source, including but not limited to the following:

1. Compensation for services in whatever form paid including but not limited to fees, salaries, wages,
commissions and similar items;
2. Gross income derived from the conduct of trade or business or the exercise of profession;
3. Gains derived 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 the general professional partnership.
 FORMULA: GROSS INCOME; NET INCOME; TAXABLE
COMPENSATION INCOME; INCOME TAX DUE; INCOME
TAX PAYABLE
 GROSS INCOME = All income less exclusions
 NET OR TAXABLE INCOME = Gross income less allowable deductions
 TAXABLE COMPENSATION INCOME = Gross compensation less personal
and additional exemptions (Individual Taxpayers)
 INCOME TAX DUE = Taxable or net income multiplied by income tax rate
 INCOME TAX PAYABLE = Income Tax due less creditable withholding tax or
tax credit
GROSS INCOME TAXATION AND NET INCOME
TAXATION; DISTINCTIONS; ADVANTAGES AND
DISADVANTAGES

GROSS INCOME TAXATION NET INCOME TAXATION

Allows no deductions Deductions are allowed
Grants no exemptions Exemptions are granted
Tax base: Gross income Tax base: Net income
ADVANTAGES OF GROSS INCOME ADVANTAGES OF NET INCOME
TAXATION TAXATION
Simplifies the income tax system Fair and just due to grant of deductions
Does away with wastage of manpower Tax audit minimizes fraud
and supplies
Substantial reduction in corruption and Provides equitable reliefs in the form of
tax evasion – exercise of discretion to deductions, exemptions and tax credits
allow or disallow deductions dispensed
with
DISADVANTAGES OF GROSS INCOME DISADVANTAGES OF NET INCOME
TAXATION TAXATION
No deductions and exemptions allowed Vulnerable to corruption on account of margin
of discretion in the grant of deductions
Susceptible of fraud in the absence of general Confusing and complex process of filing
audit income tax return
Taxpayers lose interest to earn more thereby Difficult/costly to administer
lessening their purchasing capacity
II. EXCLUSIONS FROM GROSS INCOME

 A. REASONS FOR EXCLUSION

1. The item of receipt does not fall within the definition of income for income tax
purposes.
 Damages recovered in libel and slander suits
 Damages recovered for alienation of affection
 Damages recovered for breach of promise to marry
 Damages recovered for loss of life of spouse
 Damages recovered in annulment of marriage
2. A provision of the Tax Code or special law exempts it from income tax.
 B. EXCLUSIONS FROM GROSS INCOME
1. Proceeds of life insurance – received in a single sum or instalments – not taxable –
Reason: indemnity rather than as gain or profit. Insurance contract is a contract of indemnity.
Exception – interest payments shall be included in gross income if such amount is held by
the insurer under the agreement to pay interest thereon.

2. Amount received as return of premium – under life insurance, endowment or annuity

contracts, either during the term or at the maturity of the contract. Cash surrender value of the
policy is also non-taxable. Return of premium means a repayment of a part or the whole of the
premiums paid.
Reason for the exclusion: Return of capital
3. Gifts, bequests and devises
Reason: Not a product of capital nor industry.
 Gifts are subject to donor’s tax, whereas bequests and devises are subject to estate tax.

4. Compensation for injuries or sickness

Reason: Compensatory; not gain/profit; adds nothing to the individual.
 5. Income exempt under treaty. This is premised on our adherence to the generally
accepted principles of international law. In this category, the following items of income
are tax exempt:
 Income derived by the US Consular officials in the Philippines in connection with
such consular service.
 Income exempt under tax treaty with foreign countries.

6. Retirement benefits, pensions, gratuities, etc.

a. Retirement benefits received by officials and employees of private firms,
individuals or corporations.
b. Retirement benefits paid to employees who have reached the age of 60 or more but
not beyond 65 years with at least five (5) years of credited (R.A. No. 7641)
c. Separation benefits due to death, sickness or other physical disability or for any
cause beyond the control of the said official or employee.
 d. Social Security benefits, retirement gratuities received by resident or non-
resident citizens or resident aliens from foreign government agencies and other private or
public institutions.
e. Benefits received from US Veterans Administration (R.A. No. 360) by veterans
residing in the Philippines.
f. Payment of benefits under the Social Security System in accordance with the
provisions of R.A. No. 8282.
g. Benefits received from the GSIS under R.A. No. 8291 including retirement
gratuity.
 7. Miscellaneous items
a. Income received by foreign governments from their investments in the
Philippines. Reason: To lessen the burden of foreign loans inasmuch as the interest of these
loans are, by contractual arrangement, borne by the domestic borrowers.
b. Income derived by the Government of the Philippines or any political subdivision
from any public utility or from the exercise of any essential governmental function (e.g.,
income derived by a municipality from the operation of a market or an electric power plant)
c. Prizes and awards under the following conditions:
 i. Received in recognition of religious, charitable, scientific,
educational, artistic, literary or civic achievement.
ii. Recipient was selected without any action on his part to enter the
contest or proceeding.
iii. Recipient is not required to render substantial future services as
a condition to receiving the prize or award.
d. Prizes and awards in sports competition granted to athletes whether held in
the Philippines or abroad and sanctioned by their national sports associations.
 e. 13th-month pay and other benefits:
i. Other benefits cover productivity incentives and Christmas
bonus;
ii. Total exclusion shall not exceed P82,000.00 (R.A. No. 10653).
f. GSIS, SSS, Medicare and other contributions.
g. Gains from the sale or exchange of retirement of bonds, debentures, or other
certificates of indebtedness with a maturity of more than five (5) years.
h. Gains from redemption of shares in Mutual Fund Company.
 Tax-exempt income under special laws/agreements
INCLUSIONS (ITEMS OF GROSS INCOME)
Sec. 32 (A)
1. Compensation Income
Compensation means all remuneration for services performed by an employee for his
employer under an employer-employee relationship, unless specifically excluded by the Code,
2. Business Income – gains or profits derived from rendering services, selling merchandise,
manufacturing products, farming and long-term contracts
3. Gains from Dealings in Property – it includes all income derived from the disposition of
property whether real, personal or mixed
4. Interests – source of income which rests on the residence of the debtor
5. Rents
All rentals derived from lease of real estate or personal property, of copyrights,
trademarks, patents and natural resources under lease
6. Royalties
Sums of money paid to a creator or a participant in an artistic work, based on individual
sales of the work. In order to receive royalties, the work must generally have a copyright or
patent.
7. Dividends
Any distribution made by a corporation to its shareholders out of its unrestricted retained
earnings payable to its shareholders, whether in money or in other property.
8. Annuities – refers to annuity policies sold by insurance companies, which provides
installment payments for life, or for a guaranteed fixed period of time, whichever is longer.
9. Prizes and winnings
It refers to amount of money in cash or in kind received by chance or through luck and
are generally taxable except if specifically mentioned under the exclusion from computation of
gross income under Sec 32 [B] of NIRC.
10. Pensions
It refers to amount of money received in lump sum or on staggered basis in consideration
of services rendered given after an individual reaches the age retirement.
11. Share in income of General Professional Partnership (GPP)
GPP is not taxable as an entity but the partner’s share in the net income of GPP is
included in his gross income.
COMPENSATION INCOME

 Benefits & Allowances

 Convenience of the Employer Rule
It grants exemption to benefits which are given for the exclusive benefit or
convenience of the employer.
 Separation Pay
The amount that an employee receives at the time of his severance from the service and is
designed to provide the employee with the wherewithal during the period that he is to look for
another employment
 Remuneration after Termination
Terminal leave pay is the amount received arising from the accumulation of sick leave or
vacation leave credits
 Beneficial Payments
1. Insurance premiums
2. Club membership monthly dues
3. Income Tax
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.
 Other Forms of Payment
 In kind
o Shares of Stock

o Stock Option

o Facilities and Privileges

 • Fringe Benefits - refer to goods, services, or other benefits furnished or granted by an
employer, in cash or in kind, in addition to basic salaries, to managerial or supervisory
employees
• De Minimis Benefits – refers to facilities or privileges furnished or offered by an employer to
his employees that are of relatively small value and are offered or furnished by the employer
merely as a means of promoting health, goodwill, contentment or efficiency of his employees
• Promissory Note
- a written promise to pay at a fixed or determinable future time a sum of money to a
specified individual or to bearer
 Cancellation of debt
 If income – it is income to the extent of the amount realized by the debtor as compensation for his services
 If gift – if it is a gift from the creditor to the debtor; need not be included in the latter’s income
 If capital transaction – the transaction has the effect of a dividend
 Remuneration for Casual Labor
 Remuneration for Agricultural Labor
 Remuneration for Domestic Services
 Remuneration for Past Services
BUSINESS (PROFESSION) INCOME

 Business income – income derived by self-employed from trade and business (trading,
manufacturing, merchandising, forming and others)
 Profession income – income derived by professionals from the practise of professions
 Manufacturing concern
 Mechandising or trading concern
- in this case, gross income is computed by the total sales less the cost of goods sold
plus any income from investments and incidental operations
 Service Concern
 Farming
Gross income of farmers include:
a. sale of livelihood and farm products received from the farm;
b. value of merchandise and other property received from such sales;
c. profit from the sale of livestock and other items purchased;
d. gross income from all other sources, rent received on crop shares, proceeds of
income of growing crops
 Long-term contracts
 Percentage of completion basis – gross income already earned though not yet
received, based on estimates of architects or engineers duly duly certified by them
is reported in a taxable year and all deductions relating to such for the taxable
year, even if not yet paid, are taken into account
 Completed contract basis – taxpayer reports his income and deductions in the year
the contract is finally completed
 Cost of sales
 Telegraph and cable services
 Rental Income – fixed sum either in cash or property equivalent, to be paid at a
definite period for the use or enjoyment of a thing or right
 Prepaid rental – shall only be considered as rental income of the lessor once the
advance rental is utilized by the lessee
 Security deposits – paid by a lessee to a lessor are not considered income for tax
purposes since they will eventually be returned to the lessees, hence the lessor did
not gain or profit therefrom
 Income from leasehold Improvement – annual depreciation of the cost of the
leasehold improvements introduced by the lessee over the remaining period of the
lease, or over the remaining period of the lease, or over the life of the
improvement, whichever period is shorter
GAINS DERIVED FROM DEALINGS IN
PROPERTY
All income derived from disposition of property whether real, personal or mixed for :
1. Money, in case of sale
2. Property, in case of exchange
3. Combination of both sales and exchange, which results in gain

Gain – difference between the proceeds of the sale or exchange and the acquisition value of
the property disposed by the taxpayer
PASSIVE INCOME

a. It is an income subject to final withholding tax

b. The withholding agent withholds the tax and remits the same to the BIR
c. The recipient is not required to include the income in his gross income. Neither is the
taxpayer required to include it in the taxable income.
d. Taxpayer is not required to file ITR if his or her income consists solely of income subject to
final tax.
e. The tax withheld constitutes final settlement of the tax liability on the income.
f. Example of income subject to final tax:
 Interest income from bank deposit;
 Royalties;
 Dividend received from domestic corporation by individual or non-resident foreign corporation;
 Prizes amounting to more than P 10,000,00;
 Winnings (except sweepstakes and lotto);
 Partner’s share from the net income after tax of business partnership; joint account; joint venture
or consortium
PARTNER’S DISTRIBUTIVE SHARE FROM GPP
(GENERAL PROFESSIONAL PARTNERSHIP) NET INCOME

GPP is exempt from income tax as an entity, the partner’s distributive share on
the net income of the GPP is included in the gross income of the partner. Persons
engaging in business as partners in a GPP shall be liable for income tax in their
separated individual capacities.
MORE SOURCES

a. Bad Debt Recovery – taxable if it results in reduction of the taxpayer’s tax liability in the
previous year
 Equitable Doctrine of Tax Benefit
 Taxpayer is obliged to declare as taxable income subsequent recovery of bad debts in the year they were
collected to the extent of the tax benefit enjoyed by the taxpayer when the bad debts were written off and
claimed as deduction from gross income

b. Tax Refund (Credit) – taxation if it results in reduction of the taxpayer’s liability in the
preceding year. This means that the tax refunded must be previously claimed as
deduction from gross income
 Tax benefit rule – taxes allowed as deductions, when refunded or credited shall be included as
part of gross income in the year of receipts to the extent of the income tax benefit of said
deduction
c. Damages Recovery – taxable – it represents lost profit/income
d. Annuities
e. Other sources
 illegal gains – gambling, betting, lotteries, extortion or fraud
III. DEDUCTIONS FROM GROSS INCOME

A. BASIC PRINCIPLES
1. The taxpayer must point to some specific provisions of the statute authorizing the
deduction; and
2. He must be able to prove that he is entitled to the deduction authorized or allowed
 If a taxpayer fails to deduct certain expenses for the taxable year, he cannot deduct them from the income
of the next or any succeeding year
 Not allowed to claim deductions (tax base: Gross Income)

B. THE COHAN RULE PRINCIPLE :

If there is showing that expenses have been incurred but the exact amount thereof cannot
be ascertained due to the absence of documentary
evidence, it is the duty of the BIR to make an estimate of deduction that may be allowed in
computing the taxpayer’s taxable income bearing heavily against the taxpayer whose
inexactitude is of his own making. A disallowance of 50% of the taxpayer’s claimed deduction
is valid.

KINDS OF ALLOWABLE DEDUCTIONS

1. Itemized deductions
a. Business expenses
b. Interest
c. Taxes
 d. Losses
e. Bad debts
f. Depreciation
g. Depletion
h. Charitable and other contributions
i. Research and development expenditure
j. Pension trust contribution

2. Optional Standard Deduction (OSD)

C. BUSINESS EXPENSES
Requisites for deductibility
1. The expenses must be ordinary and necessary.
 It depends upon particular facts such as, the type of business (custom), intention of the taxpayer,
time, place and prevailing circumstances.
 However, Section 34(A)[1a] of the NIRC, as amended by RA no. 8424, provides that expenses
are considered “ordinary and necessary” if they are directly attributable to development,
management, operation, and or conduct of the trade or business of the taxpayer, or in the exercise
of the taxpayer’s profession.
2. The expenses must be incurred in the trade or business carried on by the taxpayer – this means that
the same is not incurred in the trade or business of another.
 3. The expenses must be substantiated by proof
4. The expenses must be reasonable
5. Paid or incurred during the taxable year
a. cash basis method – deducts expenses in the year in which they are
paid.
b. accrual basis method – recognizes expenses in the year they
accrue.
6. Expenses must not be against public policy, public moral or law
7. If subject to withholding tax, proof of payment to BIR must be shown
D. INTEREST EXPENSES
Definition – amount which one has contracted to pay for the use of borrowed money or
amount of compensation paid for the use of money or forbearance from such use.

Requisites for deductibility:

a. There must be indebtedness
b. Incurred in connection with taxpayer’s trade or business
c. Indebtedness must be that of the taxpayer.
d. The interest must have been stipulated in writing in consonance with
Article 1956, New Civil Code which provides that no interest
 shall be due unless it has been expressly stipulated in writing.
e. Paid or accrued within the taxable year.

E. TAXES
Nature and Scope – All taxes, whether national or local paid or accrued, within the
taxable year in connection with the taxpayer’s tarde or business, except:
a. Philippine income tax;
b. Income, war profit, and excess profit taxes imposed by the authority of
any foreign country provided the taxpayer chooses to take a tax credit;
 c. Estate and donor’s tax;
d. Special assessment tax;
e. Taxes paid for commodity not connected with the taxpayer’s
business.

Requisites for deductibility:

1. Paid or incurred within the taxable year;
2. Paid or incurred in connection with taxpayer’s business;
3. Deductible only by the person upon whom the tax is imposed by law
(VAT is deductible only by seller).
 EXCEPTIONS:
a. Taxes of shareholder upon his interest as such and paid by the
corporation without reimbursement from him can be claimed by the corporation as
deduction.
b. A corporation paying the tax for the holder of its bond or other
obligations containing a tax-free covenant clause cannot claim deduction for
such taxes paid by it pursuant to such covenant. (Sec. 80, Rev. Reg. No. 2)
When may deduction for taxes be claimed?
Answer: Year paid or incurred in general. However, in the case of contingent tax
liability, the obligation to deduct arises only when the liability is finally determined.
 Tax Credit – amount allowed by the law to reduce the Philippine income tax due on
account of income, war-profit tax, excess profit tax, paid or accrued to a foreign country.

Tax Deduction v. tax Credit

Deductible from gross income Deductible from Phil. Income tax

Sources: Deductible taxes such as Sources: Foreign income war-profits and
business tax, excise tax, percentage tax excess profit tax
and other business-connected taxes
F. LOSSES
Definition
The term implies an unintentional parting with something of value. It is used in
the income tax law in a very broad sense to comprehend all losses which are not general or
natural to the ordinary course of business and are not covered under some other heading
such as bad debts, inventory losses, depreciation, etc.

Requisites for deductibility (in general):

a. The taxpayer must prove that the loss was suffered by said taxpayer.
 b. The loss must have been sustained during the taxable year.
A taxpayer is not allowed to defer the deduction to some other time
other than the year in which the loss was actually sustained.
c. Loss evidenced by a closed and completed transaction.
d. Loss not compensated by the insurance or otherwise.

G. BAD DEBTS
Definition
Debts due to the taxpayer which are actually ascertained to be worthless and
charged off within the taxable year.
 Requisites for deductibility:
a. Existence of a valid debt and subsisting debt (legal and factual).
b. Debts must be actually ascertained to be worthless.
c. Debt must charged off within the year of worthlessness.
A taxpayer may not defer deduction to a later year of a bad debt.
If the charge off is made in a later year; the deduction will be disallowed.
d. Debt arises from business or trade.
e. Does not arise from transactions between related taxpayers.
f. Additionally, before a debt can be ascertained to be worthless,
 the taxpayer must also show that it is indeed uncollectible in the
future.

H. DEPRECIATION
Definition
Gradual diminution in the useful (service) value of tangible property used in trade,
profession or business resulting from exhaustion, wear and tear, and obsolescence.
Necessity of depreciation allowance – certain property used in the business gradually
approaches a point where its usefulness is exhausted
 Requisites for Deductibility:
a. The allowance for depreciation must be reasonable.
The Tax Code, provides for the use of the following methods of depreciation:
i. Straight line method;
ii. Declining balance method;
iii. Sum of the years digit method;
iv. Any other method which may be prescribed by the Secretary of Finance upon
recommendation of the BIR Commissioner.
b. It must be for property used in trade or business or profession (depreciable assets).
I. DEPLETION
Definition
It is the exhaustion of natural resources like mines and oil gas wells as a result of a
production or severance from such mines or wells.

Theory and purpose of Depletion Allowance – as the product of the mine is sold, a
gradual sale is being made of the taxpayer’s capital interest in the property.
 Requisites for deductibility:
1. Depletible asset – natural resources – mines, gas and oil wells
2. Charged off within the taxable year.
3. Allowance for depletion is computed in accordance with the cost
depletion method.
4. Depletion deductible:
a. Domestic Corp. – oil, gas wells or mines located within and
without;
b. Resident Corp. – gas wells and mines located in the Philippines
J. CHARITABLE AND OTHER CONTRIBUTIONS
1. Kinds
a. Ordinary – subject to limitation;
b. Special – deductible in full.
2. Entitled:
a. Corporate taxpayer except NRA-NETB – 10% of the Net Income
before Charitable Contribution.
3. Requisites for deductibility:
a. Contribution or gift must be actually paid during the taxable year;
 b. Must be given to the organization specified by the Tax Code or
special law.
c. The net income of the institution must not inure to the benefit of any
member or individual.

K. RESEARCH AND DEVELOPMENT EXPENDITURE

1. In General – A taxpayer may treat research or development expenditures which are
paid or incurred by him during the taxable year in connection with his trade, business or
profession as ordinary and necessary expenses which are not chargeable to capital account.
 2. Limitations on Deduction – The following expenditures are not deductible:
a. Any expenditure for the acquisition or improvement of land, or for the
improvement of property to be used in connection with research and development of
a character which is subject to depreciation; and
b. Any expenditure paid or incurred for the purpose of ascertaining the
existence, location, extent, or quality of any deposit of ore or other mineral, including
oil or gas.
L. EMPLOYER’S CONTRIBUTION TO PENSION TRUST
1. Nature – applicable only to the employer on account of its contribution to a private
pension plan for the benefit of its employee. Purely business in character.

2. Requisites for Deductibility:

a. Employer must have established a pension or retirement plan for the
payment of reasonable pension to its employees;
b. Pension plan is reasonable and actuarially sound;
c. Funded by the employer ;
 d. Amount contributed must no longer be subject to control of the
employer;
e. Payment has not yet been allowed as deduction.

OPTIONAL STANDARD DEDUCTION

The scheme whereby a taxpayer is given the option to deduct from his gross revenue
or gross income a lump sum equivalent to a percentage of such gross revenue or gross income
for purposes of computing the net taxable income on which the income tax rate will be
applied.