CHAPTER 3

INTRODUCTION TO INCOME TAXATION

THE CONCEPT OF INCOME

Why is income subject to tax?

Income is regarded as the best measure of taxpayers' ability to pay tax. It is an excellent object of
taxation in the allocation of government costs.

What is income for taxation purposes?

The tax concept of Income is simply referred to as "gross income" under the NIRC.

A taxable item of income is referred to as an "item of gross income" or "inclusion in gross income"

Gross income simply means taxable income In layman's term. Under the NIRC however, the term
"taxable income" refers to certain items of gross income less deductions and personal exemptions
allowable by law. Technically, gross income is broader to pertain to any income that can be subjected to
income tax.

Gross income is broadly defined as any inflow of wealth to the taxpayer from

whatever source, legal or illegal, that increases net worth. It includes income from

employment, trade, business or exercise of profession, income from properties,

and other sources such as dealings in properties and other regular or casual

transactions.

ELEMENTS OF GROSS INCOME

1. It is a return on capital that increases net worth.

2. It is a realized benefit.

3. It is not exempted by law, contract, or treaty.

RETURN ON CAPITAL

Capital means any wealth or property. Gross income is a return on wealth property that increases the
taxpayer's net worth.

Illustration

ABC purchased goods for P300 and sold them for P500. The P500 consideration can be

analyzed as follows: Selling price (total consideration received)

Cost (value of inventory forgone)

P 500 Total return

300 Return of capital P200 Return on capital

Mark-up (gross income) The return on capital that increases net worth is income subject to income tax
Return of capital merely maintains net worth; hence, it is not taxable. As

Improvement in net worth indicates an ability to pay tax. Capital items deemed with infinite value There
are capital items that have infinite value and are Incapable of pecuniary
valuation. Anything received as compensation for their loss is deemed a return capital

Examples: 1. Life

2. Health

3. Human reputation

Life

The value of life is immeasurable by money. Under Sec, 32 of the NIRC, the proceeds of life insurance
policies paid to the heirs or beneficiaries upon death of the insured, whether in a single sum or
otherwise, are exempt from income tax

The proceeds of a life insurance contract collected by an employer as a beneficiary from the life
Insurance of an officer or any person directly interested with ha trade are likewise exempt. These
proceeds are viewed as advanced recovery d future loss.

However, the following are taxable return on capital from Insurance policies: a. Any excess amount
received over premiums paid by the insured upon surrender or maturity of the policy (ie. the insured
outlives the policy.)

b. Gain realized by the Insured from the assignment or sale of his insurance

policy

c Interest income from the unpaid balance of the proceeds of the policy d. Any excess of the proceeds
received over the acquisition costs and premium payments by an assignee of a life insurance policy

Health
Any compensation received in consideration for the loss of health such as compensation for personal
injuries or tortuous acts is deemed a return of capital.

Human Reputation

The value of one's reputation cannot be measured financially. Any indemnity received as compensation
for its impairment is deemed a return of capital exempt from income tax.

Examples include moral damages received from:

a. Oral defamation or slander

b. Alienation of affection Breach of promise to marry

Recovery of lost capital vs. Recovery of lost profits

The loss of capital results in decrease in net worth while the loss of profits does not decrease net worth.
The recovery of lost capital merely maintains net worth while the recovery of lost profits increases net
worth. Therefore, the recovery of lost profits is a return on capital.

Taxable recovery of lost profits

The recovery of lost profits through insurance, Indemnity contracts, or legal suits

constitutes a taxable return on capital.

fThe following are taxable recoveries of lost profits:

a. Proceeds of crop or livestock Insurance

b. Guarantee payments
c. Indemnity received from patent infringement sult

Illustration 1

Mang Reyes Insured his strawberry crop in a P200,000 crop Insurance coverage

against calamities. The crop was eventually destroyed by an unusual frost. Mang Reyes was paid the
P200,000 insurance proceeds. The P200,000 proceeds which is a reimbursement for the last value of the
future harvest is an item of gross income. The value of the last crops is, in effect, realized not through

actual harvest but through the insurance contract.

Illustration 2

Mr. Ramos purchased a franchise. The franchisor guaranteed an annual franchise

Income of P100,000 to Mr. Ramos. In the first year of operation, Mr. Ramos'outlet only

earned P60,000. The franchisor paid the P40,000 difference to Mr. Ramos.

The P40,000 guarantee payment is not a gratuity but a recovery of lost profit for M Ramos; hence,
subject to Income tax Mr. Romos shall report P100,000 as franchi Income

Illustration 3

Davao Crocodile Inc. experienced an unusual decline in its income after a competitor copled its patented
invention. Davao Crocodile sued the competitor for paten infringement and was awarded an indemnity
of P3,000,000.

The P3,000,000 indemnity is a compensation for the income not realized by Daves
Crocodile due to the patent infringement. The same is an item of gross income.

The recovery of lost income or profits is not intended to compensate for the lam of

capital. It is as good as realization of income; hence, it is an item of gross income.

REALIZED BENEFIT

What is meant by realized benefit?

The "benefit" concept

The term "benefit" means any form of advantage derived by the taxpayer. There is benefit when there is
an Increase in the net worth of the taxpayer. An increase in net worth occurs when one receives income,
donation or inheritance.

The following are not benefits, hence, not taxable: a. Receipt of a loan- properties Increase but
obligations also increase resulting In an offsetting effect in net worth.

h. Discovery of last properties under the law, the finder has an obligation t return the same to the
owner. C Receipt of money or property to be held in trust for, or to be remitted ta

another person.

Illustration

1. An employee was granted P20,000 transportation advance. He liquidated P18,00 transportation

expenses and was allowed by his employer to keep the P2,00 Only the P2,000 retained by the employee
is considered income since this was the extent he was benefited. (RR2-98)

2. A security agency receives P120,000 from clients, P100,000 of which it for the
salaries of security guards. Under RMC 39-2007, only the P20,000 attributable t

the agency is considered income of the agency since it is the extent it is benefited

The P100,000 pertaining to salaries of security guards is recognized by the agend

asa liability upon receipt.

The "realized" concept

The term realized means earned. It requires that there is a degree of undertaking or sacrifice from the
taxpayer to be entitled of the benefit.

Requisites of a realized benefit: 1. There must be an exchange transaction.

2 The transaction involves another entity. 3. It increases the net worth of the recipient.

Types of Transfers

1. Bilateral transfers a Sale

b. Barter

or exchanges, such as: to)(for)

These are referred to as "onerous transactions".

42. Unilateral transfers, such as: the clint to this fox) 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

A taxpayer sold his car which was previously purchased for P100,000 and with a

current fair value of P180,000 for only P130,000. The transaction will be analyzed as follows:

Fair value

Selling price

180,000

130,000
P50,000-Subject to transfer tax

Cost

P30,000-Subject to income tax

The excess of fair value over selling price is a gratulty or gift whereas the excess of th selling price over
the cost is an item of gross income.

What is meant by another entity?

Every person, natural or juridical, is an entity. Natural persons are living perso while juridical persons are
those created by law such as partnerships and corporations. An entity may be a taxable entity or an
exempt entity. A taal item of gross income arises from transactions which lovolve another natural
Juridical entity.

Gains or income derived between relatives, corporations, and between a parte and the partnership are
taxable since it is made between separate entupin Likewise, the income between affiliated companies
such as between a holding a parent company and its subsidiaries and between sister companies are tally
because each corporation is a separate entity. This applies regardless of th underlying economic
relationship

However, the sales of a home office to its branch office are not taxable beca

they pertain to one and the same taxable entity. Furthermore, the income betwee

businesses of a proprietor should not be taxed since proprietorship businesses an

taxable upon the same owner. Note that a proprietorship business is not i

Juridical entity.
Benefits in the absence of transfers

The increase in wealth of the taxpayer in the form of appreciation or increase the value of his properties
or decrease in the value of his obligations in de

absence of a sale or barter transaction is pot taxable.

Benefits in the absence of transfers

The Increase in wealth of the taxpayer in the form of appreciation or increase

the value of his properties or decrease in the value of his obligations in the

absence of a sale or barter transaction is not taxable. These are referred to as unrealized gains or
holding gains because they have g yet materialized in an exchange transaction.

Examples of unrealized gains or holding gains: a. Increase in value of investments in equity or debt
securities

b. Increase in value of real properties held (revaluation increment) C. Increase in value of foreign
currencies held or receivable

d. Decrease in value of foreign currency denominated debt by virtue of favorabl fluctuation in exchange
rates e. Birth of animal offspring, accruals of fruits in an orchard or growth of fam

vegetables Increase in value of land due to the discovery of mineral reserves

Rendering of services
The rendering of services for a consideration is an exchange but does not cause! loss of capital. Hence,
the entire consideration received from rendering of service such as compensation income or service fees
is an item of gross income.

Ilustration

Mt. Mendoza lists the following possible items of gross income:

Compensation income Wisnings from gambling

Increase in value of investments

P 200,000

Appreciation in the value of land owned

50,000

150,000

Debt of Saladin cancelled by creditors in consideration for services he rendered to them

Debt of Saladin cancelled by his creditor out of affection

X250,000

Laan received from a bank

The items of gross income are:

Compensation Income

P200,000

Winnings from gambling Debt of Mendoza forgiven in consideration

for service rendered to his creditors

150,000

Note:

1. Gains from gambling and the forgiveness of debt in consideration of services or properties received
are realized gains from exchanges. 2. The forgiveness of debt out of affection or mere grenity of the
creditor is a gratuits

transfer subject to transfer tax 1. The loan received from a bank constitutes a transfer it is nota benefit

Basis 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 property 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 physical taking of the income in the form of cash

2. Constructive receipt

taxpayer is effectively benefited

or property. Constructive receipt involves no actual physical taking of the income but the taxpayer is
effectively benefitted

Examples:

a. Offset of debt of the taxpayer in consideration for the sale of goods

service

b. Deposit of the income to the taxpayer's checking account Matured detachable interest coupons on
coupon bonds not yet encashed

by the taxpayer d. Increase in the capital of a partner from the profit of the partnership

Inflow of wealth without increase in net worth The Inflow of wealth to a person that does not increase
his net worth is not

Income due to the total absence of benefit.

Examples:

a Receipt of property in trust b. Borrowing of money under an obligation to return

In law, the proceeds of embezzlement or swindling where money is taken without an original intention
to return are considered as income because of the increase la

net worth of the swindler.

NOT EXEMPTED BY LAW, CONTRACT, OR TREATY An item of gross income is not exempted by the
Constitution, law, contracts or treaties from taxation.

The following items of income are exempted by law from taxation; hence, they ar 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 PhilHealth benefits

4. Salaries and wages of minimum wage earners

4. Salaries and wages of minimum wage earners and qualified senior citizen

5. Regular Income of Barangay Micro-business Enterprises (BMBEs)

6. Income of foreign governments and foreign government-owned and controlled corporations

7. Income of International missions and organizations with income tax Immunity

Items of gross income that are exempted from taxation are discussed extensively

under Exclusions in Gross Income in Chapter 8.

TYPES OF INCOME TAXPAYERS

A. Individuals

1. Citizen

FC. a. Resident citizen

le b. Non-resident citizen

Allen

FA a. Resident alien

NPA b. Non-resident alien

to a engaged in trade or business

VED b. not engaged in trade or business

3 Taxable estates and trusts

B. Corporations

1. Domestic corporation FC 2 Foreign corporation

KFC
a Resident foreign corporation

NAH b. Non-resident foreign corporation

INDIVIDUAL INCOME TAXPAYERS

Citizens UFO reviding love

Under the Constitution, citizens are:

a. Those who are citizens of the Philippines at the time of adoption of th Constitution on February 2,
1987 Philippines

b. Those whose fathers or mothers are citizens of the c. Those born before January 17, 1973 of Filipino
mothers who

citizenship upon reaching the age of majority

d. Those who are naturalized in accordance with the law

Classification of citizens:

A. Resident citizen-A Filipino citizen residing in the Philippines

B. Non-resident citizen includes:

1. A citizen of the Philippines who establishes to the satisfaction of the

Commissioner the fact of his physical presence abroad with a definite

of the

Intention to reside therein;

2. A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either
as an immigrant or for an employment on a

1 permanent basis; 3. A citizen of the Philippines who works and derives Income from abroad and whose
employment thereat requires him to be physically present

abroad most of the time during the taxable year,

4. A citizen who has been previously considered as non-resident citizen and who arrives in the
Philippines at anytime during the taxable year to reside permanently in the Philippines shall likewise be
treated as a non-resident -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

Filipinos working in Philippine embassies or Philippine consulate offices are not considered non-resident
citizens.

Alien

A. Resident alien- an individual who is residing in the Philippines but is not citizen thereof, such as:

1. An alien who lives in the Philippines without definite intention as to his stay; or

2. One who comes to the Philippines for a definite purpose which in its nature would require an
extended stay and to that end makes his home temporarily in the Philippines, although it may be his
intention at all times to return to his domicile abroad,
An allen who has acquired residence in the Philippines retains his status as such until he abandons the
same or actually departs from the Philippines.

B. Non-resident alien- an individual who is not residing in the Philippines and who is not a citizen thereof
1. Non-resident aliens engaged in business (NRA-ETB)- aliens who stayed In the Philippines for an
aggregate period of more than 180 days during

the year 2. Non-resident allens not engaged in business (NRA-NETB)-Include:

a. Aliens who come to the Philippines for a definite purpose which in its nature may be promptly
accomplished; b. Aliens who shall came to the Philippines and stay therein for an

aggregate period of not more than 180 days during the year.

THE GENERAL CLASSIFICATION RULE FOR INDIVIDUALS

1. Intention un Anf

The intention of the taxpayer regarding the nature of his stay within of outside the Philippines shall
determine his appropriate residency classification. The taxpayer shall submit to the CIR of the HR
documentary proofs such as visas, work contracts and other documents indicating such Intention.

Documents purporting short term stay such as tourist visa shall not result the reclassification of the
taxpayer's normal residency. Documents purporting a Jong-term stay such as immigration visa or
working visa for an extended period would result in the automatic reclassification of the taxpayer's
residency.

Examples:

An alien is normally non-resident. An allen who come to the Philippines with a tourist visa would still be
classified as non-resident alien.
A citizen is normally resident. A citizen who would go abroad under a tourist

visa would still be considered a resident citizen.

An allen 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

4c Allens 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. 4d. Aliens who stayed in the Philippines for not more
than 180 days are considered non-resident aliens not engaged in trade or business.

lustration 1

Daniel 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, 2021 and returned to Mexico three
weeks later upon completion of the project.

Daniel Mario Aresmendi shall be classified as an NRA-NETH in 2021. His stay is for a definite purpose
which in its nature will be accomplished immediately

Ilustration 2 Mamoud Jibril, a Libyan national, arrived in the country on November 4, 2021 Mr.
Jibril stayed in the Philippines since then without any working visa or work permit.

For the year 2021, Mr. Jibril would be considered an NRA-NETR because he stayed in the Philippines for
less than 180 days as of December 31, 2021. if he is still within the Philippines until December 31, 2022,
he will qualify as a resident alien for 2022

Mustration 3 Without any definite intention as to the nature of his stay, Juan Miguel, a Filipino

citizen, left the Philippines and stayed abroad from March 15, 2020 to April 1,

2021before returning to the Philippines.

For the year 2020, 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 2021 because he is absent for

less than 183 days in 2021.

Taxable Estates and Trusts

1. Estate

Estate refers to the properties, rights, and obligations of a deceased

not extinguished by his death. Estates under judicial settlement are treated as Individual taxpayers. The
estate is taxable on the income of the properties left by the decedent. Estates under extrajudicial
settlement are exempt entities. The income of the properties of the estate under extrajudicial
settlement is taxable to the heir

2. Trust
A trust is an arrangement whereby one person (grantor or trustor) transfer (Le. donates) property to
another person (beneficiary), which will be held under the management of a third party (trustee or
fiduciary). A trust that is irrevocably designated by the grantor is treated in taxation as It is an individual
taxpayer. The income of the property held in trust is taxable

to the trust Trusts that are designated as revocable by the grantor are not

taxable entities and are not considered as individual taxpayers. The income d

properties held under revocable trusts is taxable to the grantor not to the

trust When the trust agreement is silent as to revocability of the trust, the trust is presumed to be
revocable.

CORPORATE INCOME TAXPAYERS

The term 'corporation' shall include one person corporations (OPG) partnerships, no matter how created
or organized, joint-stock companies, joint accounts, association, or Insurance companies, except general
professional partnerships and a joint venture or consortium formed for the purpose of undertaking
construction projects or engaging in petroleum, coal, geothermal, and other energy operations pursuant
to an operating consortium agréement under a service contract with the government.

Hence, the term corporation includes profit-oriented and non-profit institutions such as charitable
institutions, cooperatives, government agencies and Instrumentalities, associations, leagues, civic or
religious and other organizations

Domestic Corporation

A domestic corporation is a corporation that is organized in accordance with

Philippine laws. It includes one-person corporations (OPC) owned and registered

by resident citizens in the Philippines.

Foreign Corporation

A foreign corporation is one organized under a foreign law.

Types of foreign corporations:

1. Resident foreign corporation (RFC) - a foreign corporation which operates and conducts business in
the Philippines through a permanent establishment (Le.

a branch). 2. Non-resident foreign corporation (NRFC) - a foreign corporation which does not operate or
conduct business in the Philippines

Note:

1. A corporation that incorporates in the Philippines is a domestic corporation under the

Incorporation Test even if the same is controlled by foreigners. 2. A foreign corporation that transacts
business with residents through a resident branch is taxable on such transactions as a resident foreign
corporation through its branch. However, if it transacts directly to residents outside its branch, it is
taxable as a non-resident foreign corporation on the direct transactions

3. An Individual that establishes a one-person corporation (OPC) shall be taxable as a

corporate taxpayer for the business transactions of the OPC but he shall be subject to tax as

an individual for his personal transactions.

Special Corporations Special corporations are domestic or foreign corporations which are subject to
special tax rules or preferential tax rates.

OTHER CORPORATE TAXPAYERS

1. One-person corporation A one-person corporation is a corporation with a single stockholder who may
be a natural person, trust or an estate.

Banks and quasi-banks, preneed, trust, insurance, public and publicly-listed companies, and non-
chartered GOCCs may not Incorporate as One-person corporations. A natural person who is licensed to
exercise a profession may not organize as a One Person Corporation for the purpose of exercising such
profession except as otherwise provided under special laws.

2. Partnership

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.

Types of partnership.

a) General professional partnership (GPP)

A GPP is a partnership formed by persons for the sole purpose exercising a common profession,
no part of the income of which is derived from engaging in any trade or business.
b)
c) A GPP is not treated as a corporation and is not a taxable entity. It i exempt from income tax,
but the partners are taxable in their individ
d)
e) capacity with respect to their share in the income of the partnership.
f)
g) b) Business partnership
h)
i) A business partnership is one formed for profit. It is taxable as corporation
j)
k) Examples:
l)
m) 2 A partnership between Atty. Mendoza, a lawyer, and Mark Santes a accountant, to practice in
taxation advisory services would be a busines partnership since the two partners are not in the
same profession
 n)
o) b. A partnership between accountants Khim and Vhinson to venture into a
p)
q) beauty parlor would be a business partnership since the venture is not practice of a common
profession. A partnership between accountants Juan and Miguel to venture into aut
r)
s) services would be a general professional partnership. d. Dentists Wency and Andy partnered to
operate a dental clinic. During slat
t)
u) season, they are converting their clinic into a beauty saloon. Their partnersh is a business
partnership since it is earning income from business

3. Joint venture

A joint venture is a business undertaking for a particular purpose. It may be organized as a partnership
or a corporation.

Types of joint ventures: a. Exempt joint ventures

Exempt joint ventures are those formed for the purpose of undertaki construction projects or engaging
in petroleum, coal, geothermal and other energy operations pursuant to an operating consortium
agreement under a service contract with the Government.

Similar to a GPP, this type of joint venture is not treated as a corporation and is tax-exempt on its
regular income, but their venturers are taxable their share in the net income of the joint venture.

b. Taxable joint ventures

All other joint ventures are taxable as corporations.

4. Co-ownership

A co-ownership is joint ownership of a property formed for the purpose of preserving the same and/or
dividing its income.
A co-ownership that is limited to property preservation or income collection is not a taxable entity and is
exempt but the co-owners are taxable on their share on the income of the co-owned property.

However, a co-ownership that reinvests the income of the co-owned property to other income-
producing properties or ventures will be considered an unregistered partnership taxable as a
corporation.

THE GENERAL RULES IN INCOME TAXATION

Individual taxpayers

Resident citizen

Taxable on income earned

Within

Without

Non-resident citizen Resident alien

Non-resident alien

Corporate taxpayers

Domestic corporation

Resident foreign corporation

Non-resident foreign corporation

Note:

1. Consistent with the territoriality rule, all taxpayers, except resident citizens and domestic
corporations, are taxable only an income earned within the Philippines. 2. The NIRC uses the term
"without the Philippines" to mean outside the Philippines

The Residency and Citizenship Rule

Taxpayers who are residents and citizens of the Philippines such as resident citizen and domestic
corporations are taxable on all income from sources within and without the Philippines. A corporation is
a citizen of the country of incorporation. Thus, a domestic corporation is a citizen of the Philippines.

Basis of the extraterritorial taxation Resident citizens and domestic corporations derive most of the
benefits from the

Philippine government compared to all other classes of taxpayers by virtue of

their proximity to the Philippine government.

Under our laws, resident citizens and domestic corporations enjoy preferen privileges over allens. Also,
between resident and non-resident citizens, reside citizens have full access of the public services of our
government because they a In the country. The taxation of foreign income of resident citizens and
domest corporations properly reflects this difference in benefits consistent with 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 NIR

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 orig

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 ha

the authority to impose tax upon the income.

Situs of income vs. source of income

Situs of income should be differentiated from the source of income. The latte pertains to the activity or
property that produces the income.

Situs of income vs. source of income

Situs of income should be differentiated from the source of income. The latter pertains to the activity or
property that produces the income.

Situs is important in determining whether or not an income is taxable in the Philippines. Situs is
particularly Important to taxpayers taxable only on Incom within. However, It is also important to
taxpayers taxable on global Income fr purposes of the computation of the foreign tax credit.

INCOME SITE RULES

Types of income
1. Interest Income

2. Royalties

3. Rent income 4. Service Income

Place of taxation (situs) Debtor's residence

Where the Intangible is employed Location of the property Place where the service is rendered

Illustration

A taxpayer had the following income:

Interest income from deposits in a foreign bank P 300,000 50,000

Interest from domestic bonds Royalties from books published in the Philippines

Rent income from properties abroad (the lease contracts were executed in the Philippines)

Professional fees for services rendered in the

Philippines to non-resident clients (paid in US Dollars) 400,000

150,000

Applying the situs rules, the following are the situs of the aforementioned Income:

Interest on foreign deposits

Within

World total

300,000

P 300,000 50,000

Interest from domestic bonds Royalties from books in the Philippines

50,000

Without

150,000

150,000

400.000

Rent income on foreign properties

400.000 550.000
P 450.000 P 1.000.000

Professional fees

Total

Resident citizen or domestic corporation taxpayers would be taxable on the world Income while other
taxpayers would be taxable only on the income from within the Philippines.

OTHER INCOME SITUS RULES

A. Gain on sale of properties1. Personal property

B.
C. ✓Domestic securities- presumed earned within the Philippines Other personal properties -
earned in the place where the property is sold
D.
E. 2. Real property-earned where the property is located
F.
G. Wlustration
H.
I. A taxpayer had the following Income:
J.
K. Gain on sale of domestic stocks Gain on sale of foreign bonds
L.
M. P 200,000
N.
O. Gain on sale of a commercial lot in Baguio City Gain on sale of car In Ontario, Canada
P.
Q. Gain on sale of machineries in Mexico, Pampanga
R.
S. Interest income on foreign bands Dividends on domestic stocks
T.
U. 50,000 150,000

The following table summarizes the situs of the foregoing income:

Gain on sale of domestic stocks Gain on sale of foreign bonds

Without

Within P 200,000

250,000

Gain on sale of commercial lot Gain on sale of car in Canada

Gain on the sale of machineries

P 100,000

Interest on foreign bonds

50,000

Dividends on domestic stocks Total

150.000 P.1.100.000

P 350.000

B. Dividend income from:

1. Domestic corporation-presumed 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

the resident foreign corporation in the three-year period preceding t

year of dividend declaration is

& least 50%, the portion of the dividend corresponding to the

Philippine gross income ratio is garned within

Less than 50%, the entire dividends received is garned abroad

b) Non-resident foreign corporation-earned abroad

Illustration

In 2021, Sarah received a P400,000 dividend Income from ABC Corporation. AK Corporation had the
following gross income in 2018 through 2020:

2018

2019

2020

Abroad

Total
200,000

P 300,000

Total

P 600,000

100,000 200.000 100.000 100.000 400.000

300.000 P 300.000 P 400.000 1.000.000

Philippines

If ABC Corporation is a

1. Domestic corporation-the entire P400,000 is earned within Non-resident foreign corporation - the
entire P400,000 is earned abroad

12

3. Resident foreign corporation-the P400,000 dividend shall be split Gross Income Ratio
P600,000/P1,000,000 - 60%

Earned within the Philippines (60% x P400,000) P Earned without the Philippines (40% x P400,000) Total
dividends

Supposing that the ratio is 49%, the entire P400,000 will be deemed earned outside the Philippines.
C Merchandising Income-earned where the property is sold

Illustration

Source of gross income

Goods purchased and sold within. Goods purchased within and sold abroad-

Amount

P200,000

Goods purchased abroad and sold within Goods purchased and sold abroad

The Income earned within and without shall be

150,000 350,000

Within P200,000

Without

100,000

Purchased and sold within Purchased within and sold abroad

P
Purchased abroad and sold within

150,000

350.000 450.000

D. Manufacturing income-earned where the goods are manufactured and sold

Purchased abroad and sold abroad Total 350.000

Operations

Production Distribution

Within

Without

Remark

Total Income from production and distribution

Within

Without

is earned within the Philippines Total income from production and distribution

is earned without the Philippines

Within

Without

Without

Total Income from production and distribution is earned without the Philippines

Production

Distribution

Income:

IN earned within, without

Without

Income is earned

Within

Read aloud

income

within,

Distribution Income is earned Production is earned without

Illustration 1

Island, Inc. manufactures goods and sells them through its branch. Island bills Its branch at established
market prices. Island reported the following gross income:

Sales

Home office P 4,000,000

Branch

Total. P 2,000,000 P 6,000,000

Cost of goods sold

2.400.000 1.200.000 3.600.000 P 2.400.000

The following shows the situs of the gross income of Island under each of th

following scenario:

Scenario

Home office. Branch

No. 1 Philippines No. 2 Abroad

No.3
No.4

Philippines Abroad Abroad Philippines

Within

Without

P 2,400,000 P

2,400,000

Abroad

1,600,000 800,000 800,000

1,600,000

Note:

Philippines

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

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

Sales

Parent 4,000,000

Subsidiary

Total P 2,000,000 P. 6,000,000

Cost of goods sold Gross income

2.400.000 1.200.000 3.600.000 P1.600.000 P 800.000 E 2400,000

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

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:

Scenario No. 1

Parent Subsidiary Within Without Philippines

Philippines No. 2 Abroad Abroad

No.3 Philippines Abroad

P 1,600,000 P

1.600.000

1,600,000

No. 4

Abrood Philippines

1,600,000

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

Scenario

Parent

Subsidiary

Within

Without

No. 1
Philippines Abroad

Philippines Abroad Abroad

P 800,000 P

No. 2

No. 3 Philippines

No. 4

Abroad

Philippines 800,000

Note to readers: gr

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.