Introduction to Income Taxation PDF

INCOME TAXATION An income tax is a government tax on the taxable profit earned by an individual or corporation. The resulting revenue is usually one of the chief sources of cash for a government entity. It is considered one of the fairer forms of taxation, since it is only imposed if a per...

INCOME TAXATION An income tax is a government tax on the taxable profit earned by an individual or corporation. The resulting revenue is usually one of the chief sources of cash for a government entity. It is considered one of the fairer forms of taxation, since it is only imposed if a person or business has been successful enough to generate taxable income. Thus, its impact on the poor or unprofitable is minor to nonexistent. WHY IS INCOME SUBECT TO TAX? Income is regarded as the best measure of taxpayer’s ability to pay tax. It is an excellent object of taxation in the allocation of government costs. INCOME FOR TAXATION PURPOSES? The tax concept of income is simply referred to as the “gross income” under the National Internal Revenue Code. A taxable item of income is referred to as an “item of gross income” or “inclusion in gross income.” Section 32(A) of the NIRC: (A) General Definition. - Except when otherwise provided in this Title, gross income means all income derived from whatever source, including (but not limited to) the following items: (1)Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items; (2)Gross income derived from the conduct of trade or business or the exercise of a profession; (3)Gains derived from dealings in property; (4)Interests; (5)Rents; (6)Royalties; (7)Dividends; (8)Annuities; (9)Prizes and winnings; (10)Pensions; and (11)Partner's distributive share from the net income of the general professional partnership. “Taxable income” on the other hand means the pertinent items of gross income specified in this Code, less the deductions, if any, authorized for such types of income by this Code or other special laws. (Section 31 of the NIRC). ELEMENTS OF GROSS INCOME 1. It is a return on capital that increases net worth; 2. It is a realized benefit; and 3. It is not exempted by law, contract, or treaty. 1. RETURN Capital means any wealth or property. Gross income is a return ON CAPITAL on wealth or property that increases the taxpayer’s net worth. Distinguish from RETURN OF CAPITAL.  1. Life CAPITAL ✓ Value of life is immeasurable. ITEMS ✓ Proceeds of life insurance policies are exempt. ❖ Exceptions: a. Any excess amount received over the premiums. DEEMED b. Gain realized on the sale or assignment of his/her insurance. WITH c. d. Interest income on unpaid insurance proceeds. Excess of proceeds from the acquisition cost and premiums paid by the assignee. INFINITE 2. Health VALUE ✓ Any compensation received in consideration for the loss of health. 3. Human Reputation ✓ Any indemnity received as consequence for its impairment is deemed a return of capital exempt from income tax. RECOVERY Recovery of lost capital through insurance, insurance, indemnity OF LOST contracts or legal suits is not taxable CAPITAL while recovery of lost profits through insurance, indemnity contracts or legal v. suits is taxable. RECOVERY OF LOST PROFITS 2. REALIZED The term “realized” means earned. It requires that there is a degree of BENEFIT undertaking or sacrifice from the taxpayer to be entitled to the benefit. The term “benefit” means any form of advantage derived by the taxpayer. There is benefit when there is increase in the net worth of the taxpayer. 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.  EXCHANGE TYPES OF TRANSFERS: 1. Bilateral transfers are called “exchanges.” TRANSACTION This are onerous transactions that is subject to income tax. ✓ Rendering of services for a consideration is an exchange. The entire consideration is considered as income. 2. Unilateral transfers are called “transfer.” This are gratuitous transactions that are subject to transfer taxes like estate or donor’s tax. 3. Complex transactions are partly gratuitous and party onerous. Thus, it is subject to both income tax and transfer tax. INVOLVES Entity are persons which are either natural or juridical. ANOTHER Unrealized gains or holding gains are ENTITY not taxable because it do not involve any entity. INCREASES Increase of net worth can be realized through different modes: NET WORTH 1. Actual receipt involves actual physical taking of the income in the form, of cash or property. 2. Constructive receipt involves no actual physical taking of the income but the taxpayers is effectively benefited. Inflow of wealth without increase in net worth is not taxable. 3. NOT An item of gross income is not exempted by the Constitution, law, EXEMPTED contracts or treaties from taxation. BY LAW, These are also called exclusions in Gross Income. CONTRACT, OR TREATY TYPES OF INCOME TAXPAYERS A. INDIVIDUALS (Natural Persons) B. CORPORATIONS (Juridical Persons) 1. Citizen (Filipino) 1. Domestic corporation a. Resident citizen 2. Foreign corporation b. Non-resident citizen a. Resident foreign corporation 2. Alien (Non-Filipino) b. Non-resident foreign corporation a. Resident alien b. Non-resident alien i. engaged in trade or business C. ESTATE and TRUSTS ii. not engaged in trade or business INDIVIDUAL CITIZENS Section 1, Article III of the 1987 Philippine INCOME Constitution provides, to wit: Section 1. The following are citizens of the TAXPAYERS Philippines: Those who are citizens of the Philippines at the time of the adoption of this Constitution; Those whose fathers or mothers are citizens of the Philippines; Those born before January 17, 1973, of Filipino mothers, who elect Philippine citizenship upon reaching the age of majority; and Those who are naturalized in accordance with law.  CLASSIFICATION OF CITIZENS INDIVIDUAL A. Resident citizen B. Non-resident citizen (Sec. 22E of the NIRC) INCOME The term 'nonresident citizen' means; (1) A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to TAXPAYERS 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 employment on a 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 nonresident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines shall likewise be treated as a nonresident 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. (5) The taxpayer shall submit proof to the Commissioner to show his intention of leaving the Philippines to reside permanently abroad or to return to and reside in the Philippines as the case may be for purpose of this Section. *Note: Filipinos working in Philippine embassies/consulate offices are not considered non-resident citizens.  ALIEN INDIVIDUAL A. Resident alien - s an individual who is stateless or is a national of another country and who lives in INCOME the Philippines with no definite intention as to length of stay, but who is not a mere transient or TAXPAYERS sojourner. B. Non-resident alien 1. A non-resident alien individual who comes to the Philippines and stays for more than 180 days during any calendar year will be deemed a non- resident alien engaged in trade or business in the Philippines. 2. If the aggregate stay in the Philippines during any calendar year covered by the assignment period does not exceed 180 days, the individual may be deemed a non-resident alien not engaged in trade or business in the Philippines. CORPORATE A. Domestic corporation. B. Foreign corporation INCOME 1. Resident foreign corporation (RFC) 2. Non-resident foreign corporation (NRFC) TAXPAYERS C. Special corporations D. Other corporate taxpayers 1. One-person corporation (OPC) 2. Partnership a. General professional partnership (GPP) b. Business partnership 3. Joint venture a. Exempt joint ventures b. Taxable joint ventures 4. Co-ownership GENERAL RULES IN INCOME TAXATION SEC. 23. General Principles of Income Taxation in the Philippines. - Except when otherwise provided in this Code: (A) A citizen of the Philippines residing therein is taxable on all income derived from sources within and without the Philippines; (B) A nonresident citizen is taxable only on income derived from sources within the Philippines; (C) An individual citizen of the Philippines who is working and deriving income from abroad as an overseas contract worker is taxable only on income derived from sources within the Philippines: Provided, That a seaman who is a citizen of the Philippines and who receives compensation for services rendered abroad as a member of the complement of a vessel engaged exclusively in international trade shall be treated as an overseas contract worker; (D) An alien individual, whether a resident or not of the Philippines, is taxable only on income derived from sources within the Philippines; (E) A domestic corporation is taxable on all income derived from sources within and without the Philippines; and (F) A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. SITUS OF INCOME A government or state exercises its taxing power and authority only on taxpayers, income or transactions that fall within its jurisdiction. Thus, the situs, or place, of taxation is critical in determining whether or not a state has the power to tax, especially with respect to nonresident or foreign individuals or corporations that are taxed only on Philippine-sourced income. The situs of taxation has been defined as the place where an authority has the right to impose and collect taxes.  SITUS OF Situs of income literally means place of income. The general rule is that the taxing power cannot INCOME go beyond the territorial limits of the taxing authority. Basically, the state where the subject vs. to be taxed has a situs may rightfully levy and collect the tax. SOURCE OF Source of income pertains to the activity or INCOME property that produce the income. INCOME SITUS RULES Section 42(A) of our NIRC embodies a set of situs rules and provides that the following are Philippine- sourced income: (1) Interest income from borrowings of residents, whether individual or corporate; (2) Dividends from domestic corporations or from foreign ones that derived 50 percent or more of its income for a three-year period preceding the dividend declaration from Philippine sources: (3) Service fees or Compensation for services rendered in the Philippines; (4) Rentals and Royalties from property or interest located or used in the Philippines; (5) Gains from the sale of real property in the Philippines. (6) Gains, profits and income from personal property sold in the Philippines. (7) Gain, profit or income from the sale of shares of stock of a domestic corporation, regardless where these are sold. SALE What determines the place of sale? Answer: Place of delivery As to “where” the sale of property is made, it has long been settled by the Supreme Court that it is not the place where the contract was perfected, but the place of delivery that determines the taxable situs of the property sought to be taxed (Shell vs. Sipocot, G.R. L-12680, March 20, 1959). SERVICES What determines the place of services? Answer: Place of performance of services For services, the place where these are performed should be established. Proof of where the services were performed can be shown through the terms of the contract or other evidence. if payments are made in the Philippines, the Bureau of Internal Revenue (BIR) will immediately assume they are for services rendered in the country, and thus subject these payments to withholding tax. It will then become the burden of the taxpayer to prove that the services were rendered outside. ROYALTIES Royalties are generally Philippine-sourced if the technology or intellectual property right is used in the Philippines. A clear description of the services or transaction that gives rise to royalty fees is important. With respect to software, payments are deemed to be royalties when only copyright rights are transferred. On the other hand, payments for transfer copyright ownership are considered business income from a sale. INCOME TAXATION SCHEMES 1. Final income taxation 2. Capital gains taxation 3. Regular income taxation  FINAL Final Withholding Tax is a kind of withholding tax which is prescribed on certain income payments and is not creditable against the income tax due of the INCOME payee on other income subject to regular rates of tax for the taxable year. Income Tax withheld constitutes TAXATION the full and final payment of the Income Tax due from the payee on the particular income subjected to final withholding tax. Final taxation is applicable only on certain passive income listed by law. Not all items of passive income are subject to final tax like rental income.  CAPITAL Capital gains tax is imposed on the gain realized on the sale, exchange and other disposition of certain capital assets. GAINS TAXATION REGULAR Regular income taxation covers all other income not subject to final INCOME tax and capital gains tax. TAXATION ACCOUNTING PERIOD 1. Regular accounting period a. Calendar – default accounting period. b. Fiscal – available only to corporate taxpayer and not allowed to individual tp. 2. Short accounting period a. Newly commenced business. b. Dissolution of business. c. Change if accounting period by corporate taxpayers. d. Death of the taxpayer. e. Termination of the accounting period of the taxpayer by the Commissioner of Internal Revenue. DEADLINE ✓ Due on the fifteenth day of the fourth month following the OF FILING close of the taxable year of the THE taxpayer. INCOME ✓ The regular tax due is payable upon filing of the income tax RETURN return. ACCOUNTING METHODS 1. Accrual basis 2. Cash basis 3. Hybrid basis 4. Sale of goods with extended payment terms 5. Percentage of completion Method for Construction Contracts 6. Income from Leasehold Improvement 7. Agricultural or Farming Income  TAX ✓ Advanced income is taxable upon receipt. – applicable to ACCOUNTING sale of service RULES ✓ Pre-paid expense is non- FOR CASH & deductible. ✓ Special tax accounting ACCRUAL requirement must be followed BASIS  SALE OF 1. Installment method a. Dealers of personal property on the GOODS WITH b. sale of properties they regularly sell. Dealer of real properties, only if their EXTENDED initial payment does not exceed 25% of the selling price. PAYMENT c. Casual sale of non-dealers in property, when their selling price exceeds P1,000 TERMS and their initial payment does not exceed 25% of the selling price. 2. Deferred payment method ✓ For non-interest bearing note. INSTALLMENT ✓ Initial payment – total payments by the buyer, in cash or property, in the taxable METHOD year the sale was made. ✓ Contract price –usually equal to the Selling price With indebtedness assumed by the buyer. – The contract price is the residual amount after deducting the mortgage from the selling price. Indebtedness assumed exceeds tax basis of property sold. – the excess mortgage is a collection of income. PERCENTAGE OF COMPLETION METHOD INCOME FROM 1. Outright method ✓ The FMV of the improvement is treated LEASEHOLD as an income from its completion. IMPROVEMENT 2. Spread-out method ✓ Amortize the residual value of the improvements over the life of the lease. AGRICULTURAL 1. Animal husbandry OR FARMING 2. Crops – use of crop year basis INCOME a. Perennial crops b. One-time crops