Chapter 3 - Introduction to Income Tax

cHAPTER3
INTRODUCTION TO INCOME TAXATION
chapter Overview and Objectives
---------- ------------------------------------------------------------------------
This chap ter discu sses the conc ept of tax income, the situs of income, and the
types of taxp ayer s.
After this chap ter, read ers are expe cted to com preh
end and dem onst rate
knowledge on the following:
1. The conc ept of gros s inco me
z. The types of income taxpayers
3. The gene ral rules in inco me taxa tion
4. The income tax situs rules

THE CONCEPT OF INCOME

Why is inco me subj ect to tax?
Income is rega rded as the best mea sure of taxp ayer s'
ability to pay tax. It is an
excellent object of taxa tion in the allocation of gove rnme
nt costs.
What is inco me for taxa tion purp oses ?
The tax conc ept of inco me is simply refer red to as "gro ss
inco me" unde r the NIRC.
A taxable item of inco me is refe rred to as an "item ofgros
s incom e" or "inclusion in
gross mcome .
• II

Gross income simp ly mea ns taxable income in laym an's

term . Und er the NIRC
however, the term "taxable income" refer s to certa in item
s of gros s inco me less
deductions and pers onal exem ption s allowable by law.
Technically, gros s inco me
is broader to pert ain to any inco me that can be subj ecte
d to inco me tax.
Gross income is broa dly defin ed as any inflow of wea lth to
the taxp ayer from
what ever sour ce, legal or illegal, that incre ases net wort h. It
inclu des inco me from
employment, trade , busi ness or exer cise of profession,
inco me from prop ertie s,
and othe r sour ces such as deal ings in prop ertie s and
othe r regu lar or casu al
transactions.

ELEMENTS OF GROSS INCOME tz~N

1. It is a retu rn on capi tal that incre ases net wort h.
2. It is a realized benefit.
3. It is not exem pted by law, cont ract, or treat y.

63
 Chapter 3 - Introduction to Income Ta
x

RETURN ON CAPITAL
Capital means any wealth or prop ertY • Gross income is a ret ur
, net worth.
property that increases the taxpay 5 n °tt \ve
er
illt~ ,
Illustration
ABC purchased goods for P300 and so Id them for PSOO. The PSOO consid
analyzed as fo1lows: eration
tq~!
Selling price (total consideration receiv d) p 500 Total return
e -~3.....,0__Q Return of capital
Cost (value of inventory forgone)
Mark-up (gross income) g_ 20.0. Return on capital

The return on capital tha t increas~s t worth is income subject to i

Return o' ne th· hence it is n t ncorne ~
1 ca pit al merely ma intams net wor ' 0
improvement in ne t worth indicates an bT ' taxable
a 1 1ty to pay tax. · A,
,
Capital items deemed with infinite val
There are capital items that have infi ue d . bl
. .
nite value an .are m~apa e of Pecunia
valuation .
. Anythmg received as compensat·10n for their loss 1s deemed a r t,
capital eturn~
Examples:
1. Life
2. Health
3. Human reputation

Life
The value of life is immeasurable
by money. Under Sec. 32 of the NIR
proceeds of life insurance policies pai C, tht
d to the heirs or beneficiaries upon dea
the insured, whether in a single sum or th ol
otherwise, are exempt from income tax
.
The proceeds of a life insurance contra
ct collected by an employer as a benefic
from the life insurance of an officer iary
or any person directly interested wit
trade are likewise exempt. These pro h h~
ceeds are viewed as advanced recov
future loss. ery ol
However, the following are taxable ret
urn on capital from insurance policies
a. Any excess amount received ov :
er premiums paid by the insure d
surrender or maturity of the policy (i.e n
. the insured outlives the pol' ) upo
b. Gain realize d by the insured fro
m the assignment or sale of h' le!.
poI1.cy 1s ins urance
c. Interest income from the unpaid bal
ance of the proceeds of the I'
d. Any excess of the pro ceeds receiv
ed ov
payments by an ass ignee of a life insura er the acquisition cos~o
nce policy
1
r .
an premium

64
 ter 3 - Introduction to Income Tax
chaP
ff ealth . receive
. d m .
compen
sat10n consideration for the loss of health sueh as
AnYpensation for personal injuries or tortuous acts is deemed a return of capital.
corn
ff uJ1lan Reputati~n . . .
The value of one s re~utat10~ ~anno_t be m_easured financially. Any mdemmty
·ved
recel as compensation for its 1mpa1rment 1s deemed a return of capital exempt
froJTl income tax.
Examples include moral damages received from:
oral defamation or slander
~- Alienation of affection
c.· Breach of promise to marry
Recovery oflo~t capital v~. Recovery _o flost profits
The Joss of capital results m decrease m net worth while the loss of profits does
not decrease net worth. The recovery of lost capital merely maintai ns net worth
while the recovery of lost profits increases net worth. Therefore, the recovery of
Jost profits is a return on capital.

Taxable recovery oflost profits

The recovery of lost profits through insurance, indemnity contracts, or legal suits
constitutes a taxable return on capital.

The following are taxable recoveries oflost profits:

a. Proceeds of crop or livestock insurance
b. Guarantee payments
c. Indemnity received from patent infringement suit

Illustration 1
Mang Tomas insured his strawberry crop in a P200,000 crop insurance coverage
against calamities. The crop was eventually destroyed by an unusual frost. Mang
Tomas was paid the P200,000 insurance proceeds.
The ?200,000 proceeds which is a reimbursement for the lost value of the future harvest,
is an item of gross income. The value of the lost crops is, in effect, realized not through
actual harvest but through the insurance contract.

Illustration 2
Mr. Santiago purchased a franchise. The franchisor guaranteed an annual franchise
income of Pl00,000 to Mr. Santiago. In the first year of operation, Mr. Santiago's outlet
only earned P60,000. The franchisor paid the P40,000 difference to Mr. Santiago.

65
 Chapter 3 - Introduction to Income Tax

The P40,000 guarantee payment is not a gratu~ty but a recovery of lost Pn

Santiago; hence, subject to income tax. Mr. Sant,ago shall report Pl00,ooo Q~t1~
income. J,,Q

Illustration 3 .
Mindoro Inc. experienced an unusual decline in its income after a competi ·
. "' t t . '" . tor
its patented invention. Mindoro sued the competitor ior pa en miringernent ~
awarded an indemnity of P3,000,000. . anq

The P3,000,000 indemnity is a compensation for the income not realized by Mind
to the patent infringement The same is an item ofgross income. Oto
1
j
The recovery of lost income or profits is not inte~d~d to_ compensate_for the l
capital. It is as good as realization ofincome; hence, It IS an Item ofgross Income. ~

REALIZED BENEFIT
What is meant by realized benefit?
The "benefit" concept
The term "benefit'' means any form of advantage derived by the taxpayer. Then
benefit when there is an increase in the net worth of the taxpayer. An increas1
net worth occurs when one receives income, donation or inheritance.
The following are not benefits, hence, not taxable: 1
1_ . ,

a. Receipt of a loan - properties increase but obligations also increase resul ·

in an offsetting effect in networth
b. Discovery of lost properties - under the law, the finder has an obligation
return the same to the owner
c. Receipt of money or property to be held in trust for, or to be remitted
another person
If the taxpayer is entitled to keep for his account portion of a receipt, only
portion is a benefit.
Illustration
1. An employee was granted P20,000 transportation advance. He liquidated P18,0
transportation expe~ses and was alJowe~ by hi~ employer to keep the P2,0
Only the P2,000 retained by the employee is considered income since this was th
extent he was benefited. (RR2-98)

2 _ A security agency receives P120,000 from clients, Pl00,000 of which is for the
salaries of security guards. . Under RMC 39-2007,. only. the. P20,OOO attn'butableto
the agency is considered mcome of the agency smce It is the extent it . b fited,
.
]anes f ·ty d . 1s ene 1
The Pl 00,000 pertaining. to sa o secun guar sis recognized bY th e agen
as a liability upon receipt.
 • introduction to Income Tax
chapter 3
"realized" concept .
_fhe term rea/i;;;ed means earned. It requires that there is a degree of undertaking
fhe jficc from the taxpayer to be entitled of the benefit.
DI• •sacr
, ttes of a realized benefit: t AI
Requ1s
There must ~e a~1 exchange transaction.
1· The transaction mvolves another entity.
2· It increases the net worth of the recipient.
3,
s of Transfers
fYP:ilateral transfers or exchanges, such as:
1. I
a. Sae
b. Barter
These are referred to as "onerous transactions".
Unilateral transfers, such as:
2
· a. succession - transfer of property upon death
b. Donation
These are also referred to as "gratuitous transactions".
Under current usage, unilateral transfers are simply referred to as "transfers"
while bilateral transfers are called "exchanges." Benefits derived from onerous
transactions are "earned or realized"; hence, they are subject to income tax.
Benefits derived from gratuitous transactions are not realized because of the
absence of an earning process. Benefits derived from gratuitous transactions are
subject to transfer tax, not income tax.
3, Complex transactions
Complex transactions are partly gratuitous and partly onerous. These are
commonly referred to as "transfers for less than full and adequate consideration".
The gratuitous portion of the transaction is subject to transfer tax while the
benefit from the onerous portion is subject to income tax.
Illustration
Ataxpayer sold his car which was previously purchased for Pl00,000 and with a
current fair value of Pl S0,000 for only P1 30,000.
The transaction will be analyzed as follows:
Fair value p 180,000 }
PS0,000 - Subject to transfer tax
Selling price 130,000 }
P30,000 - Subject to income tax
Cost 100,000 C. ~r,,'n

67
 a p ter 3 - lntrod ti.on to In
Ch uc come Tax . a
. o rg if t w h ere s th e
e s s . r a tu it y e~ces
T h e exc f fairr tVhealu e o v
_er selh n g p r ic e is a g
. come. so,
l i n . o . s s m \
g p r i c e ove
se l c o s t is an Item o f g r o
i
t. o n s a r e li v
Wh a i s m e a n t b y another e n t i t y ? an entity. Natural p e r s as Partnerng Ile,.
ical, is such t i t y shills ~
,
Every Pue rrsi ~ n , natural o r jurid those created b ! law a~ e x e m p t e n
\ ~ -- q~
While j c a l p e r sons a r e be a taxable_ e n t i t y ~icrh involve a n o t h e r .nJat• -~ ~
c o r p o r a .ions. An entity m a yfrom transactions wh '-'r-~,
i t e m f tgross income ar.ises r
. . 1_ocal . a n d b e t ween
JUrid ns ,
_corporatio e t w e e n s e p a r a t a J:>~1t1~~~
11
entity. re la ti v ~ s, b
een e he e1
i n c o m e d erived betwable since i t is m a d such a s b e t w e e n a oJ~ .)I)"&
Gains or . re tax affiliated compt w anies · t
r c o m p a n i e s a e ~~ '
4ll
e
a n d t h ptha~ersh1pbaetwe en d e een s
b i s e l r
n e iarie s a n T h is a p p lies regard ess O iJ
Like,A .Se, e m c o d its subs m id
rate entity
. f
n .1 a sepa
p a r e n t company an t '1on• is •
b
a u s e e a c h corpora lationship. f f ic e a r e n o t taxabJ e be~,..
ec economic re i t s branFch h rmore, t h e i n c o m e bet-.. e~·
o
d e r l y i n g o ff ic e to
u n
f a hom e
b le e n ti•
ty . u r t e . r s h i p busin ess-~
IesaOnd the same ta x a d sm . c e proprieto
o w e v e r .th e sa
t b e ta x e · h 1•p b u s i n e s s 1. s ells0a.,
' to one s
H r should n o proprietor
t h e y. pertain fa proprieto wner. Note t h a t a t
o e o
businesses n the sam
taxa ble up o . .
ti ty . 0n or inc reas
juridical en nsfer s . a p p r e c 1 a
rm o f f h . obligations il} e
t1
th e a b s ence o f trataxpayer m t.h ethfo 1ue o 1s
Benefits in a lt h o f th e e v a
. r,ease in we r ti e s o r decrease
m
le.
e s n o t taxab
•i.
Tu e vm e f his pro p
th e a lu e o
te r tr a n s a c ti o n i
n s b e c a u s e t h e y h ave r
a sale o r ba
r ai
absen ce o f d g a i n s o r h o l di n g g ,
liz e .
r e fe r r e d to as unrea a c ti on.
These are exc h a n g e tr a ns
r ia lized in an
y e t m a te
s o r h o l d i n g gains: e b t securities
e d g a in y o r d
m p le s o f u nrealiz s t m e n t s i n equit t i o n i n c r ement)
Exa inve lu a
s e in value o f t i e s h e l d (reva
a. I n c r e a e a lp r o p e r
r r eceivable vora
c re a s e in v a lu e o f r
c u r r e n c i e s h e l d o
d e b t b y v i r t u e o f fa
b. I n n d
e a s e in v a lue o f foreig u r r e n c y d enominate
c. Incr a lu e o f foreign
c
r o w t h of fa
a s e in v r d o r g
d. Decre x c h a nge r a t e s f r u i t s in an orc
ha
i n e o f
fluctuation l o ff s p r ing, accru
als
f anim a l reserves
e. Birth o o f m in e r a
g e ta b le s u e t o t h e discovery
v e nd d
value o f l a
l In c re a s e in
g e b u t d o e s n o t cauS'
an
f s e r v ic e s e r a t i o n i s an exch n d e r i n g o f se
rn
Render in g o a c o n s i d fr o m r e
s ervices for o n received e.
The rend e r i n g o f
e n t i r e c o n s i d e r a t i
t e m o f g r o s s in co m
, the ni
s o f c a p ital. Hence o r s e r v i c e fees is a
lo s me
s c o m p e n sation i n c o
s uch a 68
 _introduction to Income Tax
t~hapter 3
,rrarton
!,,
Jlh1 1adin lists the following possible Items of gross Income:
i r. ;,,
~ >cnsntion income p 200,000
01111
C • os from gambling 100 000
·•'iJllllllr,• f'i
r value o · nvestments
I
" 50 000
rr,1s 111 I fl ,
inc reciation _in the va ue o and owned 300,000
APP 0f Saladm cancelled by creditors in
ocbt .dcration for services he rendered to them 150,000
cons1 . II d b h
t of satadm cance e Y Is creditor out of affection 250,000
oeb eceived from a bank 400,000
~ollll r
·ccrns of gross income are:
fhe 1
ensation income · P 200,000
Co_lll~ngs from gambling 100,000
w,nn ., . . 'd
ebt of Saladm 1org1ven 111 c~ns1 e~ation
D for service rendered to his creditors 150,000

'
Note:Gains from gambl'mg an d the 1orgiveness of debt in consideration of services or properties
1· received are realized gains from exchanges.
The forgiveness of debt out of affection or mere generosity of the creditor is a gratuitous
2· transfer subject to transfer tax.
3. The loan received from a bank constitutes a transfer but Is not a benefit.

oasis of Exemption of Unrealized Income

Normally, taxpayers will have the ability to pay tax when their income
materializes in an exchange transaction since tax is generally payable in money.
This does not mean, however, that only income realized in cash is subject to tax.
Income realized in non-cash properties are, in effect, received in cash but the
taXpayer used the same to acquire the non-cash property. Income received in non-
cash considerations is taxable at the fair value of the properly received. Moreover,
exempting income realized in non-cash considerations would open a wide avenue
for tax evasion since taxpayers can easily divert their income in the form of non-
cash consideration.

Mode of Receipt/Realization Benefits

Taxable items of income may be realized by the taxpayer in two ways:
1. Actual receipt
Actual receipt involves actual phy~irnl taking of the income in the form of cash
or property.
2. Constructive receipt
Constnu;tfve receipt i11volves 1w aclunl physical taking of the income but the
taxpayer is effaclivcly benefited.
69
Chapter 3 - Introduction to Income Tax

Ex:unp les: . nsideration for the sale of go 0

a. () ff, l't 0f debt of the taxpayer in co <1~~
se1v ict' a er's checking accoun t
b. Deposit of the income to th e taXP ~ns on coupon bonds not yet enc
c. Matured det.1th~ble interest coup a,
by the taxpayer r from the profit of the partnership
d. lnt1 ?,1se in the capital of a partne
. ease in net worth .
Inflow of wealth without mer th t does not increase his net worth i
The iniluw of wealth to a person \t sI
, H i.n11e due to the total absence of bene .

Examples: . trUS t
a. Receipt ofproperty m d n obligation to return
b. Borrowing of money un er a .
embezzlement or swindling where money 1s tak~n With0
re considered as income because of the mcrea .
In Jaw, the proce~ds of
an onginal inten~on to return a ~
net worth of the swindler.
NOT EXEMPTED BY LAW,iscoNTRACT, OR TREATY . .
. f • me not exempted by the Const1tut10n, law, contracts
An item o gross mco
treaties from raxation.
The followi ng items of income are exempted by law from taxation; hence, they
not considered items of gross income:
1. Income of qualified employee trust fund
2. Revenues of non-profit non-stock educational institutions
3. SSS, GSIS, Pag-Ibig, or PhilHeaJth benefits
4. Salaries and wages of minim um wage earners and qualified senior citizen
s. Regular income of Barangay Micro-business Enterprises (BMBEs)
6. Income of foreign governments and foreign government-owned ai
controlled corporations
7. Income of interna tional missions and organizations with income tax immuni

Items of gro~s in~ome that are exempted from taxation are discussed extensiv11
under Exclusw ns m Gross Income in Chapter 8.

TYPES OF INCOME TAXPAYERS

A, Individuals
1. Cilizen
a. Resident citizen
b. Non-resi dent citizen

70
cnapter 3 - Introduction to Income Tax

2. Alien
a. Resident alien
b. Non-resident alien
a. engaged in trade or business
b. not engaged in trade or business
3. Taxable estates and trusts
B corporations
1. Domestic corporation
2. Foreign corporation
a. Resident foreign corporation
b. Non-resident foreign corporation

INDIVIDUAL INCOME TAXPAYERS

Citizens
Under the Constitution, citizens are:
at the time of adoption of the
a. Those who are citizens of the Philippines
Constitution on February 2, 1987
of the Philippines
b, Those whose fathers or mothers are citizens
hers who elected Filipino
c. Those born before January 17, 1973 of Filipino mot
citiz enship upon reaching the age of majority
the law
d. Those who are nat uralized in accordance with
Classification of citizens:
in the Philippines
A. Resident citizen - A Filipino citizen residing
s. Non-resident citizen includes:
1. A citizen of the Philippines who esta
blishes to the satisfaction of the
e abr oad with a definite
Commissio ner the fact of his physical presenc
intention to reside therein;
Philippines during the taxable
2. A citizen of the Philippines who leaves the
or for an employment on a
year to reside abroad, either as an immigrant
permanent basis;
3. A citizen of the Philippines who works
and derives income from abroad
to be physically present
and whose employment thereat requires him
r;
abroad most of the time during the taxable yea
red as non-resident citizen and
4. A citizen who has been previously conside
the taxable year to reside
who arrives in the Philippines at anytime during
be treated as a non -resident
permanently in the Philippines shall likewise
ves in the Philippines with
citizen for the taxable year in which he arri
abroad until the date of his
respect to his income derived from sources
arrival in the Philippines
71
Ch apt er 3 - Introduction to Income Tax

sie s or Philipp ine con sulate Offile~

Fil ipi nos wo rki ng in Philippine em bas s il~
con 51·ct er ed non -re sid ent citizens.
~

Alien
A. Re sid ent alien - an individual wh o is res idin g in the Philippines b
~tis
citi zen the reo f, suc h as:
s wit hou t definit e int ent io:n ~
1. An alie n wh o lives in the Philippine ils¼
. . .
stay; or
for a defm1t e pur pos e Wh ·
2. On e wh o com es to the PhiJippmes
_and to tha~ ~nd makes ~~n
nat ure wo uld req uir e an ext end ed sta y
1
1s ~~
1t ma y be his inte ntio n at
tem por aril y in the Philippines, alth oug h ill! ~:
to ret urn to his domicile abr oad ;
the Phi lipp ine s ret ain s his
An alie n wh o has acq uir ed res ide nce in s~~-
ly dep art s from the Philipp·llles
suc h until he aba ndo ns the sam e or act ual
wh o is not res idin g in the Philip}) 1· ·
B. Non-resident alien - an ind ivid ual lles
wh o is not a citizen the reo f
1. Non-resident alie ns eng age d in bus
iness (NRA-ETB) - alie ns Wh
of mo re tha n 180 day ~ s~
in the Phflippines for an aggreg ate per iod ~
ili e~ ~
2. Non-resident aliens no t eng age d in
business (NRA-NETB) - incJud
for a def init e pur pos e Whict
a. Aliens wh o com e to the Philippines 1t
nat ure ma y be pro mp tly acc om plis hed ;
lippines and sta y therein t01
b. Aliens wh o shall com e to the Phi
s dur ing the yea r
agg reg ate per iod of not mo re tha n 180 day
FOR INDIVIDUALS
THE GENERAL CLASSIFICATION RULE
1. Int ent ion
the nat ure of his sta y With ·
The inte ntio n of the tax pay er reg ard ing
ine his app rop ria te resi~:
out sid e the Philippines shall det erm
to the CIR of the BIR docurn e ;.)
classification. The tax pay er shall sub mit
!3roof~ suc h as visas, wo rk con trac
ts and oth er doc um ent s indicating :1
1ntent10n.
suc h as tou rist visa sha ll not resu]
Do cum ent s pur por tin g sho rt ter m sta y
rec las sifi cat ion of the tax pay er's nor ma l res ide ncy. Do cum ent s purpol
the
Jon g-t erm sta y suc h as imm igr atio n vis a or wo rki ng vis a for an exten
a
wo uld res ult in the aut om atic rec lass ific atio n of the taxpay
per iod
res ide ncy .

72
chapter 3 - Introduction to Income Tax

Examples: .. . .
a. An alien is normally non-resident. An alien who come to the Ph1hppmes with a
tourist visa would still be classified as non-resident alien.
b. A citizen is normally resident. A citizen who would go abroad under a tourist
visa would still be considered a resident citizen.
c. An alien who come to the Philippines with an immigration visa would be
reclassified as a resident alien upon his arrival.
d. A citizen who would go abroad with a two-year working visa would be
reclassified as a non-resident citizen upon his departure.

2. Length of stay
In default of such documentary proof, the length of stay of the taxpayer is
considered:
a. Citizens staying abroad for a period of at least 183 days are considered
non-resident.
b. Aliens who stayed in the Philippines for more than 1 year as of the end of
the taxable year are considered resident.
c. Aliens who are staying in the Philippines for not more than 1 year but
more than 180 days are deemed non-resident aliens engaged in business.
d. Aliens who stayed in the Philippines for not more than 180 days are
considered non-resident aliens not engaged in trade or business.

Illustration 1
Luiz Mario Aresmendi, a Mexican actor, was contracted by a Philippine television
company to do a project in the Philippines. He arrived in the country on February 29,
2019 and returned to Mexico three weeks later upon completion of the project.
Luiz Mario Aresmendi shall be classified as an NRA-NETB in 2019. His stay is for a
definite purpose which in its nature will be accomplished immediately.

Illustration 2
Mamoud Jibril, a Libyan national, arrived in the country on November 4, 2019. Mr.
Jibril stayed in the Philippines since then without any working visa or work permit.
1 For the year 2019, Mr. fibril would be considered an NRA-NETB because he stayed in the
Philippines for less than 180 days as of December 31, 2019. If he is still within the
Philippines until December 31, 2020, he will qualify as a resident alien for 2020.

Illustration 3
~ Without any definite intention as to the nature of his stay, Juan Masipag, a Filipino
0 citizen, left the Philippines and stayed abroad from March 15, 2019 to April 1, 2020
! before returning to the Philippines.
~
For the year 2019, Juan is a non-resident citizen because he is absent for more than 183
days but he will be classified as resident citizen for the year 2020 because he is absent for
less than 183 days in 2020.
73
 " -I
,

Income Tax
~hapter 3 - Introduction to

Taxable E st at es an d Tr us ts
1. E st at e ed Pe rSC)
e pr op er tie s rig ht s an d ob lig at io ns of a de ce as
Es ta te re fe rs to th I I ·~I
•
at h.
no t ex tin gu is he d by hi s de l'h /
se ttl em en t ar e tre at e~ as in di vi du al ta xp ay er s.
Es ta te s un de r ju di ci al ~ by th e d~ ce d en t. Estat e
es ta te is ta xa bl e on th e in
co
em
m e
en t
of
ar
th
e
e pr
ex
op
em
er
pt
tie s
en
l~
t1t1e~. Th e in co m e of tt
un de r ex tra ju di cial se ttl tra ju di ci al se ttl em en t 1s ta xa bl e to th e heirs. e
de r ex
pr op er tie s of th e es ta te un

2. Tr us t
w he re by on e pe rs on (g ra nt or or tru sto r) transfer
t
A tr us t is an ar ra ng em en pe rs on (b en ef tc ia ~} , wh ic h wi Jl be he,;
an ot he r
(i. e. do na te s) pr op er ty to uc ia ry ).
de r th e m an ag em en t of a th ird pa rty (tr us te e or fid
un
sig na te d by th e gr an to r is tre at e_d in ta x~ tio n as if
de
A tru st th at is irr ev oc ab ly m e of th e pr op er ty he ld 1n tr us t 1s taxab/~
. Th e in co
it is an in di vi du al ta xp ay er
e de sig na te d as re vo ca bl e by th e gr an to r ar e no
to th e tru st Tr us ts th at
ar
ns id er ed as in di vi du al ta xp ay er s. Th e incorne 0;
t co
tax ab le en tit ie s an d ar e no tru sts is ta xa bl e to th e gr an to r n o t to the
ca bl e
pr op er tie s he ld un de r re vo
tru st. lit y of th e tru st , th e tru st is
is sil en t as to re vo ca bi
W he n th e tru st ag re em en t
pres um ed to be re vo ca bl e.
ERS
CORPORATE INCOME TAXPAY er sh ip s, no m at te r ho w cr ea te d or
al l in cl ud e pa rtn
The te rm 'co rp or at io n' sh , jo in t ac co un ts, as so ci at io n, or ins
urance
co m pa ni es
or ga ni ze d, jo in t-s to ck es sio na l pa rtn er sh ip s an d a jo in t ve nt ur
e or
ra l pr of
co m pa ni es , ex ce pt ge ne os e of un de rta ki ng co ns tru ct io n pr oj ec ts
or
e pu rp
co ns or tiu m fo rm ed fo r th he rm al , an d ot he r en er gy op er at io ns pu rs ua
nt to
ge ot
en ga gi ng in pe tro le um , coal, em en t un de r a se rv ic e co nt ra ct w ith
the
ag re
an op er at in g co ns or tiu m
go ve rn m en t
in cl ud es pr of it- or ie nt ed an d no n- p r of it in stitu tions
io n
Hence, th e te rm co rp or at ns , co op er at iv es , go ve rn m en t ag en ci es
and
tu tio
su ch as ch ar ita bl e in sti gu es , ci vi c or re lig io us an d ot he r or ga ni zations.
io ns , lea
in str um en ta lit ie s, as so ci at
D om es tic Co rp or at io n n th at is or ga ni ze d in a cc or da nc e wi th
a co rp or at io
A do me sti c corporation is
Ph ili pp in e Jaws .
Fo re ig n Co rp or at io n w.
ig n co rp or at io n is on e or ga ni ze d un de r a fo re ig n Ja
A fo re
74
 - Introduction to Income Tax
chapter 3
es offoreign corporatio~s: . . .
1YP •dent foreign corporatwn (RFC) - a foreign corporat10n which operates and
J. [?esid cts business in the Philippines through a permanent establishment (i.e.
con u
a branch). . .
N n-resident foreign corporation (NRFC) - a foreign corporat10n which does
2· nit operate or conduct business in the Philippines

Note: rporation that incorporates in the Philippines is a domestic corporation under the
1. f c;rporation Test even if the same is controlled by foreigners.
:~oreign corporation that transacts business with residents through a resident branch 1s
.

2. ble on such transactions as a resident foreign corporation through its branch. However,
~:transacts directly to residents outside its branch, it is taxable as a non-resident foreign
1
~ rporation on the direct transactions.
0

ecial corporations
5/ cial corporations are domestic or foreign corporations which are subject to
;:cial taX rules or preferential tax rates.
5
OTHER CORPORATE TAXPAYERS
partnership
1. A partnership is a business organization owned by two or more persons who
contribute their industry or resources to a common fund for the purpose of
dividing the profits from the venture.
Typesofpartnership
a) General professional partnership (GPP)
AGPP is a partnership formed for the exercise of a common profession. All
partners must belong to the same profession.
A GPP is not treated as a corporation and is not a taxable entity. It is
exempt from income tax, but the partners are taxable in their individual
capacity with respect to their share in the income of the partnership.
b) Business partnership
A business partnership is one formed for profit. It is taxable as a
corporation.
Examples:
a. Apartnership between Andrix, a lawyer, and Mark, an accountant, to practice
in taxation advisory services would be a business partnership since the two
partners are not in the same profession.
b. Apartnership between accountants Zeus and Darrell to venture into a beauty
parlor would be a business partnership since the venture is not in practice of
a common profession.

75
 \/
I

Chapter 3 - Introduction to Income Tax

inic and Jasmine May to venture 1.
c. A partnership between accountants Dom nto
al partnership.
audit services would be a general profession

2. Joint ven tur e

nt ven tur e is a bus ine ss undertaking for a particular pur pos e. It may be
A joi
. d as a partnership or a corporat1.0n.
org ze
ani
1
Ty pes of joint ventures:
a. Exempt joi nt ventures
the purpose of undertaki
Exempt joint ventures are those formed for geothermal aOdng
roleum, coal, rt·
constr uction projects or engaging in pet .
ratmg conso mm agreernent
oth er energy operations pursuant to an ope
ent.
under a service con tract with the Governm
is not treated as a corporatio
Similar to a GPP, this type of joint venture
their venturers are taxable t:
and is tax-exempt on its regula r incom e, but
ture.
their share in the net income of the joint ven

b. Taxable joi nt ventures ations.

All other joint ventures are taxable as corpor

3. Co-ownership
A co-ownership is joint ownership of
a property formed for the purpose of
ome.
preserving the same and / or dividing its inc

nership tha t is limited to pro per ty pre servat ion or income collection
A co-ow
the co-owners are taxable on their
is not a taxable entity and is exempt but
ty.
share on the income of the co-owned proper
income of the co-owned property
However, a co-ownership that reinvests the
oth er incom e-p rod ucing proper ties or ventures will be considered an
to
poration.
unregiste red par tnership taxable as a cor
XA TION
THE GENERAL RULES IN INCOME TA
Taxable on income earned
Within Without
I nd"JVJ'd uaI taxpayers ✓
✓
I Resident citizen ✓
Non-resident citizen ✓
Resident alien ✓
Non-resident alien

76
 _Introduction to Income Tax
cnapter 3
rs
✓ ✓
·on ✓
oration ✓

Note: nsistent with the territoriali~ rule, all taxpayers, except resident citizens and domestic
1. Co rations, are taxable only on mcome earned within the Philippines.
cohrp~JRC uses the term "without the Philippines" to mean outside the Philippines.
z. T e

Residency and Citizenship Rule

tbe ·ct
ayers who are res1 ents and citizens of the Philippines such as resident
T_~ P n and domestic corporations are taxable on all income from sources within
d without the Ph1T1ppmes.
c1t1ze . A corporation is a citizen of the country of
~:corporation. Thus, a domestic corporation is a citizen of the Philippines.

•s of the extraterritorial taxation

BaSI .
Resident citizens and domestic corporations derive most of the benefits from the
Philippine g?vernment ~~m~ared to all other classes of taxpayer~ by virtue of
their proximity to the Ph1hppme government.

U der our laws, resident citizens and domestic corporations enjoy preferential
~vileges over aliens. Also, between resident and non-resident citizens, resident
P_tizens have full access of the public services of our government because they are
Cl . ff
•n the country. The taxat10n o oreign income of resident citizens and domestic
~orporations properly reflects this difference in benefits consistent with the
Benefit Received Theory.
The extra-territorial tax treatment of resident citizens and domestic corporations
is also intended as a safety net to the potential loss of tax revenues brought by
situs relocation or the practice of executing or structuring transactions such that
income will be realized abroad to avoid Philippine income taxes.

The issue of international double taxation

The rule on extraterritorial taxation on resident citizens and domestic
corporations exposes these taxpayers to double taxation. However, the NIRC
allows a tax credit for taxes paid in foreign countries. In fact, resident citizens and
domestic corporations pay minimal taxes in the Philippines on their foreign
income because of the tax credit.

SITUS OF INCOME
The situs of income is the place of taxation of income. It is the jurisdiction that has
the authority to impose tax upon the income.
77
 Chap ter 3 - Introduction to Income Tax
y
.
s·•tus of incom e vs. sourc e of income
Situs _of incom e shoul d be differ entiat ed from the sourc e of income. Th
e httt
perta ins to the activity or prope rty that produ ces the income. ~t

.
Situs is impo rtant in determ ining whet her or not an income is taxable
. •n tnn
Philip pines . Situs is particularly impo rtant to taxpa yers taxable only on 111c ~
w1·th·1n. However, it is also impo rtant to taxpa yers taxable on global inco
Ollie
Ille fat
purpo ses of the comp utatio n of the foreign tax credit.

INCOME SITUS RULES

types of income Place of taxation (situs}

1. Intere st income Debtor's residence
2. Royalties Wher e the intangible is employed '
3. Rent income Location of the prope rty
4. Service income Place wher e the service is rende red

Illustration
A taxpa yer had the following income:

Intere st incom e from depos its in a foreign bank P 300,0 00 ' '
50,000 fl\
Intere st from dome stic bonds
Royalties from books publis hed in the Philip pines 100,0 00 ,
Rent incom e from prope rties abroa d (the lease
150,0 00 .,.·(
contra cts were execu ted in the Philippines)
Profe ssiona l fees for servic es rende red in the
Philip pines to non-r esiden t client s (paid in US Dollars) 400,000 I

Apply ing the situs rules, the following are the situs of the aforem ention
ed income:

Within Witho ut World total

Inter est on foreig n depos its p - p 300,0 00 p 300,000
50,00 0 50,000
Inter est from dome stic bonds
100,0 00 100,000
Roya lties from books in the Philip pines
150,0 00 150,000
Rent incom e on foreig n prope rties
4OO,OOQ 4OO,OQQ
Profe ssion al fees
Total e 550,QQQ e
150,QQQ p 1,QQQ,QQQ

Resid ent citize n or dome stic corpo ration taxpa yers woul d be tax on the worlo
incom e while other taxpa yers woul d be taxable only on the income from withii
the Philippines.

78
 r 3 - Introduction to Income Tax
coaPte
orlf£R INCOME SITU~ RULES
Gain on sale of properties
A, 1. personal p~operty . .
✓ Domestic secuntie s - presume d earned within the Philippines
✓ Other personal properti es - earned in the place where the property is
sold
the property is located
2. Real property- earned where

1uustration
Ataxpayer had the following income:

Gain on sale of do~estic stocks P 200,000

·n on sale of foreign bonds 100,000
Ga1 . II .
•non sale of a commercia ot m Baguio City 500,000
Ga1 0 . C
G in on sale of car in ntano, anada 200,000
/in on sale of machineries in Mexico, Pampanga 250,000
~erest income on foreign bonds 50,000
In . ks 150,000
Dividends on domestic stoc

The following table summarizes the situs of the foregoing income:

Within Without
Gain on sale of domestic stocks p 200,000
Gain on sale of foreign bonds p 100,000
Gain on sale of commercial lot 500,000
Gain on sale of car in Canada 200,000
Gain on the sale of machineries 250,000
Interest on foreign bonds 50,000
Dividends on domestic stocks lSQ,QQQ
Total e 1.100.000 e 35Q,QQQ

B. Dividend income from:

1. Domestic corporation - presume d earned within
2. Foreign corporation
a) Resident foreign corporation - depends on the pre-dominance test
The pre-dominance test
If the ratio of the Philippine gross income over the world gross income of
the resident foreign corporation in the three-year period preceding the
year of dividend declaration is:
✓ At least 50%, the portion of the dividend corresponding to the
Philippine gross income ratio is earned within
✓ less than 50%, the entire dividends received is earned abroad

b) Non-resident foreign corporation - earned abroad

79
 V
Chapter 3 - Introduction to Income Tax

Illustration
In 2019, Sarah received a P400,000 dividend income from ABC Corporation
Corporation had the following gross income in 2016 through 2018: · Aat
2016 2017 2018 Total
P 100,000 p 200,000 P 300,000 P 600,000
Philippines
Abroad
200,000 100,000 100,000 400,000
Total
P 300.000 f 300,000 P 400,000 P 1,000,000

If ABC Corporation is a:
1. Domestic corporation - the entire P400,000 is earned within
2. Non-resident foreign corporation - the entire P400,000 is earned abroad
3. Resident foreign corporation - the P400,000 dividend shall be spJit
Gross Income Ratio= P600,000/Pl,000,000 = 60%
240,000
Earned within the Philippines (60% x P400,000) P
Earned without the Philippines (40% x P400,000) 160,000
400,000
Total dividends P
Supposing that the ratio is 49%, the entire P400,000 will be deemed ear
outside the Philippines. n~

C. Merchandising income - earned where the property is sold

Illustration
Source of ~oss income Amount
Goods purchased and sold within P 200,000
Goods purchased within and sold abroad 100,000
Goods purchased abroad and sold within 150,000
Goods purchased and sold abroad 350,000

The income earned within and without shall be:

Within Without
Purchased and sold within p 200,000
Purchased within and sold abroad p 100,000
Purchased abroad and sold within 150,000
Purchased abroad and sold abroad 350,000
Total e 350,000 e 450,QQQ

D. Manufacturing income - earned where the goods are manufactured and soil
Operations Remark
I
Production Distribution
Within Within Total income from production and distribution
is earned within the Philippines
80
 r 3 - Introduction to Income Tax
chaPte
Without Without Total income from production and distribution
is earned without the Phili ines
Without Production income is earned within,
Distribution income is earned without
Without Within Distribution income is earned within,
Production income is earned without

111ustration 1
autuan \nc. ma~ufactures good_s and sells them through its branch. Butuan bills
its
branch at estabhshed market prices. Butuan reported the following gross income:

Home office Branch Total

sales P 4,000,000 P 2,000,000 P 6,000,000
cost of goods sold 2,400,000 1,200,000 3,600,000
Gross income P 1,600,000 P 800,000 P 2,400.000

The following shows the situs of the gross income of Butuan under each of the
following scenario:

_sgnariQ. HQme Qffii;;e Bran,h Within WithQllt

No.1 Philippines Philippines P 2,400,000 p 0
No. 2 Abroad Abroad 0 2,400,000
No.3 Philippines Abroad 1,600,000 800,000
No.4 Abroad Philippines 800,000 1,600,000

Note:
1. Both production and distribution are conducted by the same taxable entity, Butuan
Inc.
2. The branch is not a separate taxable entity but is an integral part of Butuan Inc.;
hence, its
income is taxable to Butuan Inc.

Illustration 2
Assuming production is conducted by a parent corporation and the distribution
is
conducted by its subsidiary corporation:

Parent Subsidiary Total

Sales P 4,000,000 P 2,000,000 P 6,000,000
Cost of goods sold 2,400,000 1,200.000 3.600.000
Gross income P 1,600,000 P 800.000 P 2.400.000

The gross income recognized by each corporation is taxable to each corporation

because each corporation is a separate taxpayer. The situs of taxation shall be
the
place of sale without regard to the seller or the supplier.

The following are the situs of income for the parent corporation:

81
Chapter 3 - Introduction to Income Tax
Within Without U1
Subsidiary
I

Scenario Parent p 1,600,000 p

,L IL( ct)

No. 1 Philippines Philippines 1,600,000

Abroad -,,e,o-o
No. 2 Abroad
Abroad 1,600,000
No. 3 Philippines 1,600,000 ~r;1)

No. 4 Abroad Philippines

The following are the situs of income for the subsidiary corporation:

Subsidiary Within Without

Scenario -~P-arl,Je~ou:.t_ P 800,000 P
No. 1 Philippines Philippines
Abroad · 800,000
No. 2 Abroad
Abroad 800,000
No. 3 Philippines
No. 4 Abroad Philippines 800,000

Note to readers:
Readers are advised to master the situs rules as this have a significant effect
on your comprehension of advanced tax rules to be introduced in succeeding
chapters.