1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
LEARNING OUTCOMES
At the end of this module, you are expected to:
1. Explain the concepts for gross income;
2. Identify and differentiate the different classifications of income taxpayers;
3. Differentiate the treatment of recovery of loss capital and loss profits;
4. Explain the general rules in income taxation;
5. Explain the concepts of realized benefit and identify the modes where income is
realized; and
6. Identify the situs of income taxes.
Pre-Activity
Try to answer the following questions.
1. When is a foreigner considered a resident of the Philippines?
2. Are compensations from vehicular accidents taxable?
3. Name a type of permanent difference as discussed in your BAFACR4X class?
4. Do you think a dead person is still liable to pay income tax?
5. When can you say you are a Filipino citizen?
CONCEPT OF INCOME
One popular definition of income is the amount of wealth accumulated plus savings and the value
of the personal consumption.
The term ‘income’ refers to all earnings derived from service rendered (labor), from capital
(business or investment), or both including gain derived from sale or exchange of personal or real
property classified as either ordinary or capital asset.
There is no single criterion for determining income for tax purposes, but it may be helpful to
remember that the “rule-of-thumb test” to determine income is the increase in net worth.
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.
Increase in Net Worth
The following must be considered if a transaction would result to an increase in net worth.
Return on Capital vs. Return of Capital
Capital means any wealth or property. Gross income is a return on wealth or property that
increases the taxpayer’s net worth. 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. An
improvement in net worth indicates an ability to pay tax.
Illustration 3.1.
Miss Dina B. Nalican invested P10,000 in the stocks of a mining company. On December 29,
2020, she received P2,500 dividends from the company. Twenty percent of the dividend
received was considered liquidating dividends.
Only P2,000 of the receipt is taxable as this is the return on capital. Since the P500 received was
liquidating dividend, this clearly suggest a return of capital.
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 of capital.
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 his trade are likewise exempt. These
proceeds are viewed as advanced recovery of 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 (i.e. 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.
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. The recovery of
lost profits through insurance, indemnity contracts, or legal suits constitutes a taxable return on
capital.
Illustration 3.2.
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 P200,000 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.
Realized Benefit
The following must be met for the income to have a realized benefit.
Realized
The term realized means earned. It requires that there be a degree of undertaking or sacrifice from
the taxpayer to be entitled of the benefit. For a benefit to be realized, there must be an exchange
transaction and the transaction involves another entity.
Exchange Transaction
Bilateral transfers such as sale and barter are onerous transactions and gains from these
transactions are more likely taxable as income. For unilateral transfers such as donations and
succession, these gratuitous transfers do not involve an earning process. Complex transactions
like transfers for less than full and adequate consideration are taxable under income tax and
transfer tax.
Illustration 3.3.
A seller sold a piece of jewelry for P140,000 when its fair market value was P200,000. The cost
of the jewelry was P90,000.
The difference of the sale price and cost of P50,000 is subject to income tax while the excess of the fair
market value and the sale price of P60,000 is deemed a donation subject to donor’s tax.
Involvement of Another Entity
Every person, natural or juridical, is an entity. Natural persons are living persons, 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 taxable item of gross income arises from transactions which
involve another natural or juridical entity.
