Income Taxation

Question 1

Income

Answer 1

All wealth which flows into the taxpayer other than mere return of capital and includes gains

Question 2

Why is income taxed?

Answer 2

Income is the best measure of a taxpayer’s ability to pay.

Question 3

Gross Income

Answer 3

refers to what is income for taxation purposes

Question 4

Taxable Income

Answer 4

as the pertinent items of gross income that are subject to tax after allowable deductions

Question 5

Tax Base

Answer 5

The value of a certain good or property for taxation purposes.

Question 6

Return of Capital

Answer 6

Resulted to increase in net worth at the moment of its generation

Question 7

Realized Benefit

Answer 7

Realization- means actual or constructive receipt of cash.

Example:
1. Credit to an account owned by taxpayer
2. Declaration of a share of the profits of a GPP
3. Offsetting debt with the right to receive dividends
4. Cancellation of debt in payment of service

Question 8

Do NOT constitute Gross Income

Answer 8

1. Receipts representing returns of capital

• Proceeds of life insurance (upon death of insured
• Proceeds received by insured (still alive) return of premium

2. Unrealized income

• Appreciation of value of properties
• Unrealized gains on investments

3. Exempted by the Constitution, statutes, treaty or contract with taxpayers

• Receipt of non-profit institutions from main activities
• Contributions to GSIS, SSS, PhilHealth, PAG-IBIG
• Retirement and separation benefits under certain circumstances
• Tax Holiday for entities registered pursuant to Omnibus Investment Code
• Income of Foreign Govt. or Corporations owned by them

Question 9

Passive Income Tax

Answer 9

1. Capital gains tax- few final tax imposed on certain gains on dealings on properties

• Final tax on net gain on sale of domestic stocks sold directly to buyer (withheld at source)
• Final tax on gains on sale of **real property located in the Phils. classified as capital asset

2. Other withheld final tax- these are groups of passive income that are subject to withholding by the income payor.

• Interest on deposits with banks (Winnings)
• Prizes, Royalties
• Dividends received from Domestic Corp.

Question 10

Regular (Active) Income Tax

Answer 10

Applies to all items of gross income that are generated by the taxpayer in the ordinary course of business or those items of passive income that are not covered by final taxes.

1. Progressive tax

• schedular rates on graduated tax table.
• applicable to Individual and Taxable trusts and estates

2. Final tax- applicable to Corporations

Example of Active Income:

• Compensation Income
• Professional Income
• Business Income

Question 11

Situs: Interest

Answer 11

Debtor’s residence

Question 12

Situs: Dividends

Answer 12

Domestic Corp.- within the Philippines.

Foreign Corp.- apply the Income Dominance test

Basis:

• Phil. Income is less than 50%- the whole dividend is considered earned outside
• Phil. Income is more than 50%- the ratio of Phil. Income is considered earned within

Question 13

Situs: Service

Answer 13

Place of performance of service

Question 14

Situs: Rent

Answer 14

Location of the property

Question 15

Situs: Royalties

Answer 15

Place where the tangible is used

Question 16

Situs: Gain on sale

Answer 16

1. Real property- location of property
2. Domestic shares of stock- Always within the Phils.
3. Personal property- place of sale

Question 17

Situs: Mining

Answer 17

Location of the Mine

Question 18

Situs: Farm

Answer 18

Location of the farm.

1. Merchandising- place of sale
2. Manufacturing- place of production and sale
3. Allocation methods- governed by transfer pricing regulations which mandates measurement of revenue or costs at arm’s length price.

Question 19

Tax Accounting Period types

Answer 19

1. Calendar year- the 12-month period ending Dec. 31 and is applicable to:

• Individuals
• Taxpayers who do not keep books
• Taxpayers with accounting periods other than the fiscal year
• Taxpayers with no annual accounting period

2. Fiscal period

• any 12 months period ending the last day of any month other than Dec. 31.
• This is not available to non-corporate taxpayers.

Question 20

Short Accounting Period causes

Answer 20

1. Death of a taxpayer
2. Newly organized business
3. Dissolution of business
4. Change in accounting period
5. Termination of accounting period by the CIR

Question 21

Tax Payments

Answer 21

Tax shall be paid on the 15th day of the 4th month following the close of the taxpayer’s taxable year

Question 22

Tax Accounting methods

Answer 22

1. Principal methods
2. Deferred Payment sales
3. Long-term Construction Contracts
4. Farming income
5. Leasehold improvements

Question 23

Principal methods of tax accounting

Answer 23

1. Cash basis method- income is recorded in the year it is actually or constructively received, expenses are reported in the year paid.
2. Accrual method- income is reported in the year it is earned and expenses are deducted in the year incurred
3. Hybrid method- combination of both cash basis and accrual basis method

Question 24

Deferred Payment Sales methods

Answer 24

1. Installment method- applicable when:

• Sale of Personal property of dealer
• Casual sale of Personal property

1. SP is more than 1K
2. Initial payments do not exceed 25% of SP
3. Property is included in taxpayer’s inventory if on hand at the close of taxable year.

• Sale of Real property where the initial payment do not exceed 25% of SP

2. Deferred Payment basis

• applicable when buyer has issued notes.
• notes shall be valued at market value at date of receipt.
• difference the fair value and the face value is reported as interest income in future taxable period.
• an alternative to delaying tax payments when the installment method is not available

Question 25

Long-term Construction Contracts

Answer 25

1. **Percentage of Completion**- applicable to long-term construction contracts covering a period in excess of 1 yr. (Architect's or Engineer's Certification is required) 2. **Completed Contract basis**- gross income is recognized upon completion of construction contract

Question 26

Farming income

Answer 26

**Crop year basis** - applicable only to farmers engaged in the production of crops which takes **more than 1 yr.** from the time of planting to the process of gathering and disposal. - expenses paid/incurred are **deductible in the year the gross income from the sale** of the crops is realized.

Question 27

Leasehold improvements

Answer 27

1. **Outright method**- the value of leasehold improvements is attributable to the lessor is reported in taxable income at the time of completion of the leasehold. 2. **Spread-out method**- value of leasehold improvements is attributable to the lessor is recognized in taxable income over the lease term.

Question 28

Reminders on Tax Accounting methods

Answer 28

1. Absence of accounting method/ use of one that does **not** clearly reflects the income 2. Consolidation of gross income from two or more methods 3. Change of Tax method - Prior BIR approval - if change is from accrual to installment method, should include future periods the collection of receivables in future gross income 4. Expenditures be benefiting future periods 5. Advance receipt of items of gross income

Question 29

Tax Compliance

Answer 29

- **Self assessment method** is followed in the Phils. - Tax return filed is **presumed to be correct** unless proven otherwise by govt. - if **failure to file a return**, CIR shall file return from best available info. and such is presumed correct (Taxpayer has burden of proof) same rule applies if return is **gross misstated.**

Question 30

Income tax return is required

Answer 30

1. Regular Income Tax (Quarterly & Annual consolidated return) 2. Capital Gains Tax (per transaction and annual conso return)

Question 31

Who shall file income tax returns?

Answer 31

1. Every resident Filipino citizen. 2. Every non-resident Filipino citizen on his income from sources within the Phils. 3. Every resident alien on income from sources within the Philippines; and 4. Every non-resident alien engaged in trade or business or in the exercise of profession in the Philippines, on income from sources within the Philippines

Question 32

Who are **not** required to file individual returns for Income tax?

Answer 32

1. An individual whose gross income does not exceed P 250,000, except those engaged in business or profession 2. An individual with respect to pure compensation income, derived from sources in the Philippines, the income tax on which has been correctly withheld, except those with concurrent employment 3. An individual whose income has been subjected to final income tax 4. An individuals who is exempt from filing income tax returns in pursuant to other provisions of the Tax Code and other laws

Question 33

Where to file income tax returns?

Answer 33

1. Authorized agent bank 2. Revenue District Officer 3. Collection Agent 4. Duly authorized Treasurer of the city or municipality in which the taxpayer has his legal residence or principal place of business in the Philippines or 5. Office of the Commissioner if the taxpayer has no legal residence or place of business in the Philippines

Question 34

Payment of Income Tax

Answer 34

1. Outright 2. Installments (for individual taxpayers)

Question 35

The Networth Method

Answer 35

The Networth Method serves as a test of the existence of income when not specifically disclosed. **Possible Gross income = Personal Expenditures + Change in Networth** The **possible gross income is generally taxable**, except when it: 1. is excluded by law, contract, treaty, public policy from taxation 2. result from additional investment 3. is not income for income tax purposes (ie. does not meet the three characteristics of gross income)