ITEMS OF GROSS INCOME

REGULAR INCOME TAX: 1. Gross income subject to final tax

INCLUSIONS 2. Gross income subject to capital gains tax

IN GROSS INCOME
Lesson 9
3. Gross income subject to regular tax

COMPENSATION FOR SERVICES IN WHATEVER FORM

ITEMS OF GROSS INCOME SUBJECT TO REGULAR TAX
PAID
Compensation for services in whatever form paid
1)
● Compensation income technically pertains to the
2) Gross income from the conduct of trade, business, or exercise of a
profession types of employee benefits that are subject to regular
3) Gains derived from dealings in properties tax.
4) Interest
● Employer- employee relationship
5) Rents
6) Royalties
7) Dividends Note:
8) Annuities
9) Prizes and winnings The fringe benefits of managerial or supervisory employees are not
10) Pensions
considered compensation income and are subject to final tax.
11) Partners’ distributive share from the net income of general professional
partnership
 GROSS INCOME FROM THE CONDUCT OF TRADE, BUSINESS,
OR EXERCISE OF A PROFESSION GAINS FROM DEALINGS IN PROPERTIES
● Income from any trade or business, legal or illegal, and whether registered or unregistered.
● Gains subject to regular income tax
Sales/Revenues/Receipts/Fees P xxx
✔ Gains or losses in dealing in ordinary assets
Less: Cost of Sales or services xxx
Gross income from operations P xxx ✔ Dealings in capital assets other than domestic stocks and real properties

● Business income which shall not be included in gross income subject to regular tax:
● Ordinary gains- included as items of gross income
1. Business income exempt from income tax such as:
Gross income from a Barangay Micro- Business Enterprise (BMBE) under RA 9178
a.
b. Gross income from enterprises enjoying tax holiday incentives under EO 226 which have not yet graduated to
● Ordinary losses- items of deductions against gross income
their income tax holiday incentives
2. Business income subject to special tax regime such as: ● Net capital gain- included as an item of gross income ; derived
a.
b.
Philippine Economic Zone Authority (PEZA)- registered enterprises subject to 5% gross income tax
Tourism Infrastructure and Enterprise Zone Authority (TIEZA)- registered enterprises subject to 5% gross
from other capital assets after deducting capital losses
income tax
c. Income of self- employed and or individuals (SE/P) who opted to be taxed under the 8% income tax ● Net capital loss- not an item of deduction against gross income
3. Business income subject to final tax when not subjected to final tax by the payor
a. Subcontractors of petroleum service contractors subject to 8% final tax
b. Business income of foreign currency deposit units (FCDUs) and offshore banking units (OBUs)

INTEREST INCOME Illustration

Sapphire bank has the ff. income in 2018:
● Refers to interest income other than passive interest income
subject to final tax Interest income from loans P 3,000,000
● Taxable interest income – must have been actually paid out Interest income from deposits with other banks 400,000
of an agreement to pay interest and it cannot be imputed
Interest income from notes rediscounting 100,000
● Example of interest income subject to regular income tax:
1. Interest income from lending activities to individuals and corporations Interest income from Treasury notes 50,000
by banks, finance companies and other lenders
2. Interest income from bonds and promissory notes
3. Interest income from bank deposits abroad
Only the interest income from loans and notes rediscounting are items of gross income
● Exempt interest income subject to regular income tax . The interest on deposits and treasury notes are subject to
1. Interest income earned by landowners in disposing their lands to their final income tax.
tenants pursuant to the Comprehensive Agrarian Reform Law
2. Imputed interest income (the opportunity cost of money) – exempt
from income tax because it does not constitute an actual income
RENTS
● Rent income arises from leasing properties of any kind. It is a Illustration
passive income but not subject to final tax under the NIRC.
● Special considerations on rent Under the Iba Leasing Corporation's standard lease contract, leases shall run for
1. Obligations of the lessor that are assumed by the lessee are additional rental a non- preterminable 12-month period for a monthly rental of P25,000. The lessee
income to the lessor.
2. Advance rentals are shall pay three months rental in advance plus one month security deposit. The
Item of gross income upon receipt if: rent for the last two months of the lease shall be taken from the advance while the
i. Unrestricted or security deposit will be returned if there are no damages sustained by the
ii. Restricted to be applied in future years or upon the termination of the lease property during the lease term.
Not an item of gross income if:
i. It constitutes a loan
The entire P75,000 rental payments for the current month and the advanced rental
ii. It is a security deposit to guarantee payment or rent subject to contingency
which may or may not happen. for the last two months is an item of income subject to regular tax. The P25,000
4. Leasehold improvements made by the lessee on the leased property are security deposit is not an income.
recognized by the lessor as income using the spread-out method or outright
method.

ROYALTIES Illustration 1
Forressoftware is a distributor of computer program an earns royalties from its
licensed users . Computer programs are specifically tailored to each client and
● Active royalty income and royalties earned from sources regular continuing maintenance services are provided. During the year, client- users
outside the Philippines are generally subject to regular income remitted a total of P500,000 royalty payments.
tax. The entire P500,000 is subject to regular income tax since the royalty is an active
income.
● Royalties earned from sources within the Philippines are
Illustration 2
generally subject to final income tax except when they are active Mang Damian has the ff. royalties:
by nature. Royalties from the mining properties in the Philippines P 550,000
Royalties from the books published in the Philippines 200,000
Royalties from books published abroad 300,000
Royalties from franchise exercised abroad 400,000

The royalties from mining properties and from books in the Philippines are subject to
final tax. The royalties from sources abroad aggregating to P700,000 are subject to
regular income tax. FWT does not apply to foreign income.
 Illustration

DIVIDENDS Cubao Company, a domestic corporation , received cash dividends from the ff.:
Domestic corporations P400,000
● Pertains to dividends declared by foreign corporations Resident foreign corporations 200,000
Non- resident foreign corporations 300,000
✔ Cash dividends
Subject to regular The P400,000 inter-corporate dividends declared by a domestic corporation is exempted from
✔ Property dividends
income tax final tax. Therefore, it is not an item of gross income subject to regular income tax.
✔ Scrip dividends

The P500,000 total dividends from the resident and non-resident foreign corporations are items
● Dividend declared by domestic corporations are generally subject to 10% final of regular income subject to regular income tax and shall be reported as follows:
tax if the recipient is an individual taxpayer and exempt if the recipient is a
domestic or a resident foreign corporation. Scenario 1: Assuming Cubao is a domestic corporation, the P500,000 total dividends from foreign
● Stock dividends are exempt from income tax, but when the declaration corporations shall be included in gross income because domestic corporations are taxable on
confers to the recipient a different interest or right after the stock dividend world income.
declaration or when stock dividends are subsequently redeemed such that it
amounts to payment of cash dividend, the fair value of the stock dividends Scenario 2: Assuming Cubao is a resident foreign corporation, only a portion of the P200,000
received is taxable
dividends from the resident foreign corporation determined as earned within by the
● Liquidating dividend is not an income. It is the amount in exchange for the Pre-dominance test discussed shall be included in gross income. The situs of dividends from the
investment of an investor and are subject to the rules of dealings in properties.
non-resident foreign corporation is abroad.

ANNUITIES PRIZES AND WINNINGS

● Prizes and winnings that are exempted from final tax are not items of gross
● The excess of annuity payments received by the recipient over premium paid income subject to regular income tax.
is taxable income in the year of receipt. ● Exempt prizes and winnings
1. Prizes received without effort to join a contest
2. Prizes in athletic competitions sanctioned by their respective national sports association
3. Winnings from PCSO or lotto, not exceeding P20,000 in amount
Illustration
● Summary of rules of prizes and winnings for individual taxpayers
Earned from Earned from
Andrew purchased an annuity contract for P100,000 which shall pay him P10,000 sources sources
annually until he dies. WITHIN ABROAD
P10,000 and below Regular tax Regular tax
The receipt of the first 10 annual annuity payments is a return of capital. Any further More than P10,000 Final tax Regular tax
receipt from year 11 onwards is an item of gross income subject to regular income
PCSO and lotto, exceeding P20,000 Final tax N/A
tax.
PCSO and lotto, not exceeding P20,000 Exempt N/A
Winnings from other sources Final tax Regular tax
 PARTNER’S DISTRIBUTABLE SHARE FROM THE NET INCOME
PENSIONS OF THE GENERAL PROFESSIONAL PARTNERSHIP (GPP)
● Thesepertain to pensions and retirement benefits that fail to ● GPP are not subject to income tax because they are merely viewed-as pass
meet the exclusion criteria and hence subject to regular tax. through entities. The partners are the ones subject to regular tax on their
share in the net income of the GPP (This rule also applies to other pass
through entities such as exempt joint ventures and exempt co-ownership).
REGULAR
TAX
Net Income

GPP PARTNERS

Illustration

Zef and Siegfried practice their profession in a general professional partnership

and share profits 60:40. Their firm reported the ff.:
Gross receipts P2,000,000
Business partnership and taxable joint venture or co- ownership
Less: Professional expenses 1,200,000 ● These entities are subject to corporate income tax.
Net income from operations P 800,000
Interest from bank deposits 20,000 ● The distributive share of a partner, venturer, or co-owner from the
Distributive net income P 820,000 net income of these entities, if organized within the Philippines, is
subject to 10% final withholding tax.
The share of the partners in the net income of the partnership shall be computed
● If these entities are organized or constituted abroad, the share from
as:
their profit is subject to regular income tax for taxpayers taxable on
Total distribution to Zef (60% x P820,000) P492,000 global income.
Total distribution to Siegfried (40% x P820,000) 328,000
Distributive net income P 820,000
 OTHER SOURCES OF INCOME SUBJECT TO REGULAR
GENERAL CRITERIA FOR ITEMS OF GROSS INCOME INCOME TAX
● Under the NIRC, the regular income tax has a catch all 1. Income distributions from taxable estates or trusts
provision for all income derived from whatever sources 2. Share from the net income of other pass through entities
that are: (exempt joint venture and exempt co-ownership)
1. Not subject to final tax, capital gains tax, and special tax
regime 3. Farming income
2. Not excluded or exempted by law, treaty, or contract from 4. Recovery of past deductions
taxation
5. Reimbursement of expenses
6. Cancellation of indebtedness for consideration

Income distribution from taxable estates or trusts Farming income

● Any income distribution received by an heir or beneficiary from a taxable
estate or trust shall be included in his gross income subject to regular tax,
1. Raise and sell operation
provided that such income must not have been subjected to final tax or o Proceeds on the sale of livestock or farm products is included in the
capital gains tax. gross income
Share from the net income of exempt joint ventures and co- o Animal raising expenses are presented as items of deductions against
ownership gross income (allowable deductions).
▪ Same tax treatment on recognition of share in the net income of a GPP
2. Purchase and sell operation
o The gross profit from the sale (sale less cost of purchase) is included
in gross income.
 Recovery of past deductions Reimbursement of expenses
● Example of recoveries of past deductions: ● Expenses of the taxpayer that are reimbursed or paid by the
1. Recovery of previously claimed bad debt expense customer or client constitute additional income to the taxpayer.
2. Refund of local tax expense
3. Refund of foreign tax previously claimed as deduction ● Examples:
4. Recommissioning of abandoned petroleum service 1. When the lessee pays the ownership costs of the lessor such as real
5. Contracts or mining tenements property tax and insurance on the property, the payment
6. Release of reserve funds of insurance companies constitutes income to the lessor.
7. Interest expense which were subsequently condoned by the lender 2. When the client reimburses the out-of-pocket expenses of a
professional practitioner, the reimbursements are income to the
● Past deductions that created tax benefit to the taxpayer must be
practitioner.
reverted back to gross income in the year of recovery so that the
government will recover the tax loss from the deduction.

SPECIAL CONSIDERATIONS IN REPORTING OF GROSS

INCOME
Cancellation of indebtedness 1. Accounting methods
● May amount to gratuity or payment of income 2. Situs rules
3. Effect of value added tax
The cancellation of debt: 4. Creditable withholding tax
a. In consideration of service or goods- treated as income 5. Power of the CIR to redistribute income and expenses
b. As an act of gratuity – treated as gift; not as income
c. As capital transactions such as forfeiting the right to receive dividend
in exchange of the debt- treated as dividend income
ACCOUNTING METHOD SITUS RULES
● The accounting method adopted by the taxpayer has a direct effect on ● Situs
of taxation (place of taxation) also affects the extent of
the reportable amount of gross income subject to regular income tax. income included as items of gross income of the taxpayer
● Cash-basis taxpayers report their gross receipts or collection as gross ● Taxpayers are taxable only on Philippine income except resident
income citizens and domestic corporations which are taxable on global
● Accrual basis taxpayers report their revenue consisting of collected income.
and uncollected income as gross income ● For taxpayers taxable only on Philippine income, only their items of
● Regardless of the accounting methods used, advanced income must be gross income subject to regular income tax from sources within the
included in gross income in the period received. Philippines are included in gross income.
● For taxpayers taxable on global income, their items of gross income
subject to regular income tax from sources within and without the
Philippines are included in gross income.

EFFECT OF VALUE ADDED TAX ON REPORTABLE GROSS

INCOME
CREDITABLE WITHHOLDING TAX (CWT)
● Business taxpayers are required to either register as: ● Tax credits that are deductible against the annual income tax
a. VAT taxpayers - sales or receipts exceeds P3,000,000 due of the taxpayer
b. Non- VAT taxpayers - sales or receipts is below the VAT threshold or are
specifically designated by law to pay percentage taxes ● CWT deducted by income payors against the gross income of
the taxpayer are not exclusions in gross income. It should be
● Every VAT taxpayer is mandatorily required to charge 12% output added back to the reportable amount of the gross income.
tax on their sales or receipt. The regulations presume that the
amount charged to customers is inclusive of the 12% VAT. The ● VAT taxpayers shall revert back to gross income amounts of
output VAT will be paid to the government net of the VAT paid by withholding tax but excludes therefrom the amount of VAT
the taxpayer (input VAT) on his purchases. As such, the amount charged to customers/clients.
of reportable gross income shall not include the output VAT.
POWER OF THE CIR TO REDISTRIBUTE INCOME AND The Problem of Unfair Pricing between Associated Enterprise
DEDUCTIONS ● Risk that the pricing of the transfer of goods and services between associated
● SEC. 50, NIRC. Allocation of Income and Deductions. - In the case of enterprises as a whole in disregard of their social responsibility on taxes.
two or more organizations, trades or businesses (whether or not ● Examples:
incorporated and whether or not organized in the Philippines) 1. A domestic corporation which is subject to 30% corporate tax in the Philippines has
owned or controlled directly or indirectly by the same interests, the a subsidiary that operates in a tax haven country where no income tax is imposed.
The domestic corporation transfers goods to its foreign subsidiary at a transfer
Commissioner is authorized to distribute, apportion or allocate pricing based on production cost so that no gross income will be recognized in the
gross income or deductions between or among such organization, Philippines while the entire gross income will be recognized abroad where no tax is
imposed.
trade or business, if he determined that such distribution, 2. A foreign corporation subject to 10% corporate tax in its home country has branch
apportionment or allocation is necessary in order to prevent evasion in the Philippines which is subject to the 30% corporate income tax herein. The
foreign corporation transfers goods at a pricing method that will allow very
of taxes or clearly to reflect the income of any such organization, minimal profit for the Philippine branch to minimize exposure to higher income
trade or business. tax.
3. Mr. Wais has a business enjoying a tax holiday under an investment promotion
1aw. Mr. Wais also has a business that is subject to regular income tax. Mr. Wais
orders his taxable business to sell goods and supplies at cost to his exempt
business thereby shifting the profits to the exempt business to save from income
tax.

The Transfer Pricing Guideline The Arm’s Length Principle

● BIR and DOF – Revenue Regulations No. 2 series of 2013 (RR2-2013) ● The arm's length principle Under RR2-2013, transfer pricing between associated
enterprises shall be made under comparable conditions and circumstances as those
● What are associated enterprises? entered into between independent parties where market forces drive the terms and
conditions of the transaction rather than being controlled solely by reason of special
Under RR2-2013, two or more enterprises are associated if one relationship between the associated enterprises.
participates directly or indirectly in the management, control, or capital ● An uncontrolled pricing method determined by free market forces, also called arm's length
of the other; or if the same persons participate directly or indirectly in pricing, is preferred. The failure to comply may expose the taxpayer to a transfer pricing
the management, control, or capital of the enterprises. Associated adjustment where the BIR re-computes the proper income of the associated enterprises.
enterprises are also called "related parties." ● The arm's length principle shall be applied to:
● Examples of associated enterprises: 1. Cross-border transactions between associated enterprises
2. Domestic transactions between associated enterprises
1. Parent corporation and its subsidiary corporation
● When operations are conducted cross-border, the taxpayer may enter into an advanced
2. Sister companies or businesses owned by the same parent pricing agreement with the BIR whereas pricing rate is pre-agreed to apply for a period of
corporation time. Although this is not a mandatory requirement, this may serve as a safety net for the
taxpayer to avoid the risk of transfer pricing examination and adjustment and the
3. All corporations controlled under the same holding company inconvenience it may possibly cause.
4. Businesses owned by the same person
 Transfer pricing methods
When the pricing methods between associated enterprises do not reflect arm's length pricing,
PERIOD IN WHICH ITEMS OF GROSS INCOME ARE
INCLUDED
●
the BIR will adjust the controlled transactions to their arm's length values.
● Methods:
1. Comparable uncontrolled price (CUP) method- The transaction is valued in reference to the ● Theamount of all items of gross income shall be included in the
amount charged in a comparable uncontrolled transaction under comparable gross income for the taxable year in which received by the
circumstances.
2. Resale price method (RPM)- The transaction is valued based on the functions performed by taxpayer, unless, under methods of accounting permitted, any
the reselling party to the product. This is used when products purchased from a related such amounts are to be properly accounted for as of a different
party are resold to an independent party.
3. Cost plus method (CPM) - The transaction is measured by valuing the function performed by period.
the supplier of the property or services.
4. Profit split method (PSM) - The profit or loss on the transaction is split based on the division
of profits (or losses) that independent enterprises would have expected to realize from
engaging in the transaction or transactions. (Residual profit split approach and Contribution
profit split approach)
5. Transactional net margin method (TNMM) - This is similar to the cost plus an the resale
price methods in the sense that it uses the margin approach by reference to the operating
profit earned in comparable uncontrolled transactions.
● When no comparatives can be derived within the industry of the subject taxpayer, BIR may
consider from extension of the transfer pricing methods using comparatives derived another
industry segment or use a combination of the transfer pricing methods or other methods.