1. Gross Income: Inclusions/Exclusions LECTURE No. 8A ESTELITA C. AGUIRRE, CPA, MM

2. Chapter V: Computation of Taxable Income (Sec 32A) Compensation Income Business/Profession Income Dividends Interests Rents Services Dealings in Property

3. Compensation Income * All kinds of remunerations/emoluments earned or received for services rendered, out of an employee-employer relationship. * May be derived from employment or from contractual activities

4. Compensation Income A. Regular compensation 1. Basic salary 2. Transportation allowance 3. Representation allowance 4. Other remuneration paid regularly B. Supplementary compensation 1. Fees including director fees 2. Commissions 3. Overtime pay 4. Taxable retirement/separation pay 5. Taxable money value of leave credits 6. Other supplementary compensation C. Taxable fringe benefits

5. Compensation Income Elements of an employer-employee relationships: 1. the selection and engagement of the employee 2. the payment of wages 3. the power of dismissal 4. the employer’s power to control the employee with respect the to the means and methods by which the work is to be accomplished. (This is the most important element which is called the “control test.”

6. Business Income Generally comes from sale of goods, properties or services. An individual who carries on trade or business as a proprietor or who renders services as an independent contractor is a “self-employed” taxpayer. A stock corporation is presumed to carry on trade or business.

7. Business Income In the case of seller of goods, gross income means the total sales, less cost of goods manufactured and sold, plus any income from investments an from incidental or outside operations or sources. In the case of seller of services, gross income is computed by deducting all direct cost and expenses as prescribed in RMC 4-2003.

8. Professional Income Refers to the fees received by a professional from the practice of his profession, provided that there is no employer-employee relationship between him & clients. A lawyer is a legal officer of a private corporation and receives compensation income for his services. This is not professional income. A lawyer practicing his profession receiving retainer from his client. This is income as there is no employer-employee relationship.

9. Dividends Corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time.

10. Cash Dividends Cash Disbursement to the stockholder of the accumulated earnings with the corporation parting irrevocably with all interest therein.

11. Property Dividends Dividend payable in property, which may be investments in shares of stocks of the corporation, or real property, or some other property owned by the corporation. Different from stock dividend in that the shares of stocks declared as property dividend by a corporation are shares of stock of another corporation to which the corporation paying dividend has investments and shown as assets in the balance sheet.

12. Script Dividends A property dividend issued in the form of a promissory note.

13. Stock Dividends Dividend payable in the shares of stock of the corporation declaring such stock dividend The issuance of the stock dividend increases the number of shares issued and outstanding of the corporation that declared the stock dividend. It is merely a certificate of stock which evidences the interest of the stockholder in the increased capital of the corporation, declared from retained earnings.

14. Stock Dividends Taxable: When it gives the stockholder an interest different from that which his former stockholding represented. Not taxable: When after the distribution, the stockholder has the same proportionate interests in the net assets of the corporation. The receipt of the tax-free stock dividends will reduce the cost or adjusted basis of the stocks in determining the gain or loss upon the subsequent sale or transfer thereof.

15. Dividends distribution Dividend is paid by a domestic corporation to 1. citizen – 10% 2. resident alien – 10% 3. nonresident citizen -10% 3. NRA engaged in trade or business – 20% 4. NRA not engaged in trade or business – 25% 5. Domestic corporation – exempt 6. Resident foreign corporation – exempt 7. Nonresident foreign corporation – 15% if there is tax sparing clause

16. Dividends distribution Dividend is paid by a foreign corporation to 1. resident citizen - 5 -32% with foreign income tax credit against income tax due subject to limitation 2. nonresident citizen - exempt 3. nonresident alien engaged in T or B – exempt 4. nonresident alien not engaged in T or B - exempt 5. domestic corporation – 30% or rate under tax treaty 6. resident foreign corporation – exempt 7. non-resident foreign corporation - exempt

17. Intercorporate Dividends Dividend paid by a domestic corporation to 1. domestic corporation - exempt 2. resident foreign corporation – exempt 3. non-resident foreign corporation – 15% under the tax-sparing clause; 30 % if no TSC. Dividend is paid by a foreign corporation to 1. domestic corporation – subject to normal corporate income tax with foreign tax paid creditable subject to limitation (unless lower rate of tax is allowed under tax treaty. 2. foreign corporation – exempt

18. Tax-sparing clause It means a credit granted by the residence country for foreign taxes that for some reasons were not actually paid to the source country but that would have been paid under the country’s normal tax rule. Tax rate is 15% only if the country in which the NRFC is domiciled, shall allow a credit against the tax due from such NRFC taxes deemed to have been paid in the Phil equivalent to 20% (now 15%) which represents the difference between the 30%) and the 15% tax actually paid to the Phil govt.

19. Liquidating Dividends (LD) Although so-called dividend, it is not truly dividend as contemplated under the income tax law. It takes place when a corporation liquidates by redeeming t the outstanding stock for cash, or by distributing its assets to the stockholders in exchange for shares of stocks. The gain from the surrender of shares (treated as sales or exchange) is subject to normal income tax rates, anchored on a Supreme Court ruling that gain realized in liquidation shall be taxed to the distributee as “other gains or profits”.

20. Interest Income In general, interests received or credited to the account of the depositor or investor are included in his gross income unless they are exempt from tax or subject to final tax. A distinction between debt and equity is that periodic payments on debts called interest can be deducted by the debtor from gross income while the payment for equity in a corporation which is dividend, cannot be deducted.

21. Interest Income on 1. Phil currency deposits & deposit substitutes- 20% 2. Foreign currency deposits by residents-7.5% 3. Foreign currency deposits by non-residents (exempt) 3. Traditional loans of banks and other creditors (Normal rates) 4. Loans from non-resident alien not engaged in trade or business (25%FT) 5. Loans from non-resident foreign corporations (20% final tax unless tax treaty has lower rate)

22. Interest Income 6. From long-term deposits or deposit substitutes and investments of individuals on investment management accounts and other investments evidenced in such form prescribed by BSP received by a citizen, resident alien and non- resident alien engaged in trade or business in the Phil (5 years term or more). Exempt but if preterminated, final income tax rates is: 4 years to less than 5 years 5% 3 years to less than 4 years 12% less than 3 years 20%

23. Royalty Income Royalty a valuable property that can be developed and sold on a regular basis for a consideration, in which case, any gains derived therefrom is considered an active business income subject to the normal income tax. However, when a person pays royalty to another for the use of its intellectual property, such royalty is a passive income of the owner subject to final withholding tax.

24. Royalty Income Royalty paid by a domestic corporation to: 1. citizen – 20%FT 2. resident alien -20%FT 3. NRA engaged in trade/business in Phil -20%FT 4. domestic corporation – 20%FT 5. resident foreign corporation – 20%FT except royalty on books, other literary works, musical composition, which is 10%FT 6. NRA not engaged in trade/business in the Phil- 25%FT 7. Non-resident foreign corporation – 35% (now 30%) or rate under tax treaty, whichever is lower

25. Royalty Income “Most-favored-nation clause (MFNC)”Royalty income paid by a domestic corporation to a non-resident corporation which is a resident of a Contracting State with which the Phil has a tax treaty, is generally subject to 15% FWT.The rate may be reduced to 10% for certain royalty payments or under the MFNC. The purpose of the MFNC in a tax treaty is to grant to the other Contracting State a tax treatment that is no less favorable than that granted to the “most favored” among nations.

26. Dealings in Property Sale, barter or exchange of real property and other capital assets: 1. Capital gains 2. Ordinary gains Lease or rental of personal and real property

27. Rental or Lease Income Refers to the amount of consideration earned and derived in exchange for the right to use taxpayer’s property (real or personal) for a given period of time. Rental income or lease income which may be and advance, prepaid, arrears, current, deposits are deemed taxable in the period/year received. Rental deposits which is deemed security deposit is non-taxable receipt if its use is restricted.

28. Rental or Lease Income Rental income consists of the following: 1. Fixed/basic rent charged for the property 2. Additional rent charged for the property such as the cancellation or assumption of debts or obligations of the lessor by the lessee 3. Fair market value of the improvements on lease born by the lessee but to be owned by the lessor at the end of the contract of lease.

29. Rental Income On personal property located in the Phil NR Corp NR Alien Vessel 4.5% 25% Aircraft, machineries and other equipment 7.5% 25% Other assets 30.0% 25%

30. Lease of Real Property Treated as business income to which the lessor may claim allowable deductions. If the lessor is 1. a citizen, resident alien or non-resident alien engaged in trade or business: normal tax rate 2. a non-resident alien not engaged in trade/business – 25%FT unless there is lower treaty rate 3. domestic/resident foreign corporation – normal corporate income tax rate 4. non-resident foreign corporation – 35%

31. Leasehold Improvements Made by a lessee not to be removed at the end of the lease contract may at lessor’s option, be reported by the as follows: 1. report as income the fair market value of such building s or improvements at the time when they are completed; or 2. spread over the life of the lease the estimated depreciated value of buildings or improvements at the termination of the lease and report as income for each year an aliquot part thereof.

32. Pre-termination of lease contract: If for any reason other than a bona fide purchase from the lessee by the lessor, the lease ended before original agreed date and the lessor comes to own the property prior, he should declare as income the excess of the value of the improvements over the amount already reported as income. If the building or improvements are destroyed prior to the expiration of the lease, the lessor shall claim as loss the amount already declared as income less any salvage value to the extent that is not compensated by insurance.

33. Long-Term Contracts Income is taxable for the period in which the income is determined, such determination depending on the nature and terms of the particular contract. Long-term contracts means building, installation, or construction contracts covering a period of more than one year. Persons whose income is derived in whole or in part for such contracts shall report their income on the basis of percentage of completion.

34. Long-Term Contracts There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the materials and supplies for use in connection with the work under the contract but not yet so applied. These contracts are generally adopted for construction contracts as well as for real estate development projects.

35. Farming Income Cash basis of reporting (in which no inventory to determine profits is used) : Include in gross income 1. the amount of cash/value of property received from the sale of livestock and produce which were raised during the taxable year and previous years; 2. the profits form the sale of livestock or other items that were purchased; and 3. gross income from all other sources.

36. Farming Income Accrual basis of reporting (in which an inventory is used to determine profits): Include 1. inventory value of livestock and products on hand at the end of the year 2. amount received from sale of livestock 3. miscellaneous receipts from hire of farm machinery Deduct 1. inventory value of livestock/products on hand at the beginning of the year 2. cost of livestock and products purchased during the year

37. Other Income Recovery of bad debts Refunds/Tax credits granted Cancellation of Debts Prizes and Awards Pensions Annuities Share in taxable partnerships Share in General Professional Partnerships Income from any source whatever

38. Recovery of bad debts Not taxable: If written off in previous years when there was no realized tax benefit in the year said receivables were written off. Taxable under “Tax benefit rule”: If written off in previous years when there was realized tax benefit in the year said receivables were written off.

39. Refunds or Tax Credits Taxable under the “Tax Benefit Rule” A tax credit certificate or refund received by a taxpayer for erroneously paid tax which was claimed as a deduction from gross income that resulted in a lower net taxable income or a higher net operating loss that was carried over to the succeeding taxable year, is considered a taxable income.

40. Cancellation of Debts The cancellation or forgiveness of indebtedness may amount to 1. a payment of income 2. a gift Examples: #1 – person performs services for a creditor to cancel the debt – taxable income #2 – cancel debt without consideration – gift

41. Prizes and Awards Prizes from sources within the Phil received by a 1. citizen – 20% 2. resident alien – 20% 3. NRA engaged in trade or business in the Phil- 20% 4. NRA not engaged in trade or business in the Phil – 25% 5. Resident foreign corporation – 35% (now 30%) normal rate 6. Domestic corporation - 35% (now 30%) normal rate

42. Annuities Refers to the amounts earned and/or received by an annuitant (insured person) at regular intervals, such as quarterly or annually, for a certain or uncertain period of time under a contract of annuity. A contract of annuity is a life insurance contract under which a person shall receive annuities in return for a prior set payments made by him or by another person usually his employer.

43. Annuities Not taxable: If the total amount of annuity receipts are equal to the total annuity insurance premium payments, then it is not income item because it is a mere return of capital. Taxable: If the total amount received exceeds the total premium payments, then the excess is deemed taxable income.

44. Partnerships, definitions Ordinary partnership refers to one which is by law assimilated within the context of and so legally contemplated as a corporation. Likewise known as general partnership, general co-partnership, trade partnership or business partnership. General Professional Partnership is an association of individuals who are all professionals, formed for the purpose of exercising their common profession, no part of the income which is derived from engaging in any trade or business.

45. Partner’s Distributive shares in Taxable Partnerships Ordinary partnerships are subject to 35% (now 30%) normal corporate income tax like corporations. The partners are deemed stockholders of the firm. Their distributive share in the net income after corporate income tax are considered dividend income similar to a domestic corporation subject to final tax of 10%

46. Partner’s Distributive shares in Taxable Partnerships Ordinary partnerships are subject to 35% (now 30%) normal corporate income tax like corporations. The partners are deemed stockholders of the firm. Their distributive share in the net income after corporate income tax are considered dividend income similar to a domestic corporation subject to final tax of 10%

47. Partner’s Distributive shares in GPPs A GPP is treated as a tax-exempt entity. The partners of such firm shall report in their individual income tax returns the amount of his share in the net income of said GPP whether actually distributed or not, subject to the normal graduated schedular income tax rates

48. Income from any source whatever The phrase is broad enough to cover all gains. It discloses a legislative policy to include all income not expressly exempted within the class of taxable income under our laws, irrespective of the voluntary or involuntary action of the taxpayer in producing the gains.

49. Income Taxation End of presentation... estelitaaguirre@yahoo.com