Philippine Income Tax: An Overview

Individual Income Tax Defined

• A tax on money earned from work, business, or property
• Classified as a direct tax, which is paid by the person earning the income
• Used by the government to fund public services and national expenses

Purpose of Imposing Income Tax

• To fund the government for public services like education, healthcare, and infrastructure
• To reduce wealth inequality by taxing higher earners more under a progressive tax system

Income Terms

• Gross income signifies all money earned before any deductions
• Taxable income item is called an "item of gross income" or an "inclusion in gross income"
• Gross income includes salary/wages, business profits, professional fees, rental income, investments/asset sales, and even illegal income (if proven taxable)
• Taxable income means gross income minus allowable deductions and exemptions

Key Characteristics of Philippine Income Tax

• It is a national tax collected nationwide, and used for general public expenses
• Falls under excise tax, meaning it applies to income-earning activities
• Considered a direct tax, since the person earning the income pays it
• It cannot be transferred to others
• Functions as a progressive tax, where higher earners pay a higher percentage
• Operates under a comprehensive tax system, following citizen, residence, and source principles
• Works as a semi-global or semi-schedular system, grouping some incomes under a single rate while taxing others separately

Elements of Gross Income

• Increases a person's net worth and wealth
• Pertains to actual income received, not expected earnings
• Is taxable unless specifically exempted by law, contract, or treaty

Income and Capital Differences

• Capital is a resource or investment; income is the earning or profit gained from that capital
• Only the income earned from capital is taxable

Return on Capital vs. Return of Capital

• Return on capital increases wealth and is taxable; return of capital maintains wealth and isn't taxable
• An increase in net worth demonstrates the ability to pay tax

Separability Theory

• Income must be detached from capital and have exchangeable value to be considered taxable
• Income is only taxed when a gain is realized

Non-Taxable Items

• Stock dividends do not increase a person's net worth and are not taxable
• Increased property value is not taxed until the property is sold for a profit

Income Tax Conditions

• Must demonstrate a gain or profit, whether in cash or value
• The gain must be realized or received; potential earnings are not taxed
• The gain must not be legally exempted by international treaty

Income Classification by Source

• Income is classified and taxed by where it is earned
• Income earned can be within the Philippines; outside the Philippines; or both within and outside

Determining if Income Originates from the Philippines

• Interest income is taxable in the Philippines if the debtor (payer) resides there
• Income from services in the Philippines is taxable if work was performed there
• Rental income from property located in the country is taxable
• Royalty income is taxable if the intangible (patent/copyright) is used in the Philippines
• Sale of real property in the Philippines is taxable, personal property is taxable where the sale occurs
• Dividends from domestic corporations are always taxable in the Philippines, dividend income from foreign corporation depends on percentage of earnings from the PH

Dividends from Foreign Corporations and Tax Implications

• If a foreign corporation earns money in the Philippines, a portion of profits is considered income within the country
• If 50%+ of a foreign corporation's earnings over the past 3 years came from Philippine sources, dividends are taxable
• If less than 50% of income is from the Philippines, dividends are considered "income without" and not subject to tax

Sale of Shares: Philippine vs Foreign Companies

• Selling shares of a Philippine company always yields income within the Philippines, thus taxable
• Sale of shares in a foreign company yields income considered "without", not taxable

Taxation on Services Performed in Multiple Countries

• Only the portion of service performed in the Philippines will be taxed
• For transport businesses operating international routes, it is only the income from Philippine routes that will be taxed

Situs of Income Defined

• Situs is the location where income, property, or business is taxed and determines if it falls under the Philippine tax system

Examples of Situs Rules

• Business Tax Situs: A business is taxed where it operates
• Income Tax Situs on Services: Services are taxed where they are performed
• Income Tax Situs on Sale of Goods: Taxable where the sale is legally completed
• Property Tax Situs: Real estate is taxed where it is located
• Personal Tax Situs: Individuals are taxed where they reside

Income Tax System Types

• Gross Income Taxation (Schedular System): Final tax on specific income types like interest and dividends, no deductions allowed
• Net Income Taxation (Global System): Grouping income not subject to final tax, allowing deductions, and taxing net income

Types of Taxable Income

• Returnable Income (Active)
• Passive Income (Subject to Final Tax)
• Captial Gains (Subject to Capital Gains Tax)

Returnable Income (Active Income)

• Earnings from actively participated work, business, or profession
• Includes; Salary, wages, employment, profits, professional fees, gains from selling assets
• Generally subject to Net Income Taxation and income tax rates

Passive Income (Subject to Final Tax)

• Income earned without active participation, such as dividends, interests, and certain capital gains
• Subject to Final Withholding Tax (FWT)
• Rates vary; no deductions are allowed

Capital Gains

• Arises from the sale of capital assets
• Refers to real property in the Philippines or shares of domestic corporations
• Taxation operates under Final Withholding Tax (CGT)

Tax Computation Steps

• Step 1: Identify the Type of Income
• Step 2: Identify the Type of Tax Liability
• Step 3: Compute the Taxable Amount using rates / tables

Categories of Taxpayers

• Classified based on citizenship and residency, which determine taxation rules

Requirements for Citizen Taxpayer Status

• Born as Filipino citizen
• Naturalized
• Born to a Filipino mother before January 17, 1973

Classifications of Citizen Taxpayers

• Resident citizen living in the Philippines
• Non-resident citizen residing aboard for specific reasons

Non-Resident Citizen Inclusion Criteria

• Permanently resides abroad
• Leaves the Philippines to live abroad
• Works abroad, with overseas phsycial presence for most of the year
• Returning Filipino previously classified as non-resident

Requirements for Alien Taxpayer Status

• Non-Filipino citizen living or earning income from the Philippines

Classifications of Alien Taxpayers

• Resident alien living in the Philippines
• Non-resident alien who does not reside in the Phillipines

Resident Alien Inclusion Criteria

• Lives indefinitely in the Philippines or stays with intent for an extended period

Non-Resident Alien Inclusion Criteria

• Non-Resident Aliens Engaged in Business (NRA-ETB): Stays more than 180 days in a taxable year
• Non-Resident Aliens Not Engaged in Business (NRA-NETB): Stays 180 days or less, or comes for a temporary purpose

Factors for Residency Status

• Residency status depends on the taxpayer's intention to stay
• Proving residency relies on Visas, work contracts, or official documents
• Tourist visas do not change residency; immigration visas can

Default Classification of Residency

• Filipinos abroad form >183 days are non-resident citizens
• Aliens in the Philippines for 1+ years areresident aliens
• Aliens may be NRA-ETB or NRA-NETB depending on length of stay

Income Base for Taxpayers

• Resident citizens are taxed on worldwide net income
• Non-resident citizens and resident aliens are taxed on their net income within the Philippines
• NRA-ETB are taxed on their net income, and NRA-NETB are taxed on their gross income whthin the Philippines

Ordinary or Regular Income

• Includes business ops, earnings from compensation, and professional services
• It is subject to regular income tax rates

Passive Income (Final Withholding Tax)

• Certain passive incomes such as royalties received from sources within the Philippines are subject to final withholding taxes.

Capital Gains Income (Capital Gains Tax - CGT)

• Pertains to certain properties and are subject to capital gains tax
• Capital gains from the sale of shares of stock of a domestic corporation
• Pertains to capital gains from the sale of real property located in the Philippines

Graduated Income Tax

• Tax rates are determined by this, and applicable to people earning above the tax-exempt threshold
• Ranges from 0% to 35% depending on annual taxable income

Income Classifications

• Pure Compensation Income
• Pure Business or Professional Income

Compensation Income Details

• Derived from employment
• Includes all wages, salaries, and all other compensation paid by an employer

Business or Professional Income

• Involves sole proprietors or independent contractors earning via self-employment
• May include professionals who earn from their practice without an employer-employee relationship

Classifications of Professionals

• Anyone formally certified by a professional body in a specific profession
• Measured against established industry standards.

Tax Rules for Self Employed

• Can choose between graduated tax rate or 8% flat rate if annual income is below 3 million
• File tax returns quarterly and annually.

8% Preferential Tax Rate Conditions

• Gross sales, receipts and other non-operating income can not exceed ₱3 Million
• Taxpayer must be Non-VAT registered
• Taxpayer must not be subject to Percentage Tax
• The taxpayer must signify their intention to elect the 8% income tax in the first quarterly return / initial business quarter

Mixed Income Earners Defined

• Someone who earns compensation income, AND also generates income from self-employment.
• Compensation is subject to graduated income tax rate

Self-Employment Income Rules

• If gross sales/receipts and other non-operating income do not exceed the VAT threshold, can be taxed at graduated income tax rates OR 8% income tax rate.
• If gross sales/receipts and other non-operating income exceed the VAT threshold, must be taxed under graduated income tax rates.
• 8% income tax rate is only available to self-employed individuals and/or professionals; ₱250,000.00 threshold is not applicable to mixed income earners

Mixed Income Calculations

• Mixed Income Earners must calculate taxes due for compensation and self-employment
• Must combine their taxable income from both compensation and business/practice of profession to compute their total taxable income

Passive Income Definition

• An income earned with minimal effort, usually from investments or financial assets
• Subject to Final Withholding Tax (FWT)