Gross Income Lecture PDF 2024

GROSS INCOME PROF. ELVIRA P. CRUDO ACCO 203 1ST SEMESTER, 2024-2025 BSMA 2-7 PUP-STA MESA GROSS INCOME 1. General Principles of Income Taxation 2. Classification of Income Taxpayers 3. Situs of Income CONCEPT OF GROSS INCOME CONCEPT OF GROSS INCOME regarded as the best measure of taxpayer’s...

GROSS INCOME PROF. ELVIRA P. CRUDO ACCO 203 1ST SEMESTER, 2024-2025 BSMA 2-7 PUP-STA MESA GROSS INCOME 1. General Principles of Income Taxation 2. Classification of Income Taxpayers 3. Situs of Income CONCEPT OF GROSS INCOME CONCEPT OF GROSS INCOME regarded as the best measure of taxpayer’s ability to pay tax;  GROSS INCOME Any inflow of wealth to the taxpayer from whatever source, legal or illegal, that increases net worth; 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 Return on capital that increases net worth; Realized benefit; Not exempted by law, contract, or treaty 1. RETURN ON CAPITAL THAT INCREASES NET WORTH CAPITAL means any wealth or property. Gross income is a return on wealth or property that increases the taxpayer’s net worth. Return on capital is subject to tax. Return of capital merely maintains net worth, hence, not taxable. An improvement in net worth indicates an ability to pay tax.  ILLUSTRATION ABC purchased goods for P300 and sold them for P500. Selling price P 500 total return Less: Cost 300 return of capital Mark-up (gross income). 200 return on capital  CAPITAL ITEMS WITH INFINITE VALUE LIFE HEALTH HUMAN REPUTATION Proceeds of life insurance to heirs or Return of capital- Return of capital – beneficiaries, employer- Tax exempt Tax exempt Tax exempt Return on capital /insurance Compensation Indemnity received as policies-taxable received in compensation for its a. Excess over premiums; consideration for impairment b. Gains from assignment /sale of the loss of health Moral damages: policy; Oral defamation c. Interest income from the unpaid Compensation for Alienation of balance of insurance proceeds; personal injuries or affection d. Excess of proceeds over acquisition tortuous act Breach or promise to cost and premiums. marry  RECOVERY OF LOST CAPITAL / LOST PROFIT Loss of capital – decreases net Recovery of lost capital-maintains worth NW Loss of profits – maintains net Recovery of lost profits- increases worth net worth Taxable recovery of lost profits = thru insurance, indemnity contracts, or legal suits Examples: 1. Proceeds of crop or livestock insurance 2. Guarantee payment 3. Indemnity received from patent infringement suit EXAMPLE: Mr. Ramos purchased a franchise. The franchisor guaranteed an annual franchise income of P100,000 to Mr. Ramos. In the 1st year of operation, Mr. Ramos’ outlet earned P60,000. The franchisor paid the P40,000 difference to Mr. Ramos. The P40,000 guarantee payment is not a gratuity but a recovery of lost profit for Mr. Ramos, hence, subject to income tax. Mr. Ramos shall report P100,000 as franchise income.  EXAMPLE 2: Davao Crocodile Inc. experienced an unusual decline in its income after a competitor copied its patented invention. The Co. sued the competitor for patent infringement and was awarded an indemnity of P3,000,000. The P3,000,000 indemnity is a compensation for the income not realized by Davao Crocodile Inc. due to the patent infringement. It is an item of gross income. Not intended to compensate for the capital, but good as realization of income.  2. REALIZED BENEFIT Benefit means any form of advantage derived by taxpayer. There is benefit when there is an increase in the net worth of the taxpayer. An increase in net worth occurs when one receives income, donation or inheritance. NOT BENEFITS: (1) Receipt of a loan; (2) Discovery of lost properties; (3) Money/ property held in trust IF THE EMPLOYEE ENTITLED TO KEEP FOR HIS ACCOUNT PORTION OF A RECEIPT, ONLY THAT PORTION IS A BENEFIT. Illustration 1: An employee was granted P20,000 transportation advance. He liquidated P18,000 transportation expenses and was allowed by his employer to keep the P2,000. Only the P2,000 retained by the employee is considered income since this was the extent he was benefited.  EXAMPLE 2: A security agency receives P120,000 from clients, P100,000 of which is for salaries of security guards. Under RMC 39-2007, only the P20,000 attributable to the agency is considered income of the agency since it is the extent it is benefited. THE “REALIZED” CONCEPT realized means “earned”. there is a degree of undertaking or sacrifice from the taxpayer to be entitled to the benefit. Requisites of a realized benefit: ❑ There must be an exchange transaction. ❑ The transaction involves another entity. ❑ It increases net worth of the recipient. TRANSFERS Bilateral transfers or exchanges Sale Barter Unilateral transfers/gratuitous transactions Succession Donation  3. COMPLEX TRANSATIONS Partly gratuitous, partly onerous Transfer for less than full and adequate consideration Transfer tax and income tax  ILLUSTRATION Transaction : Sale of car Current Fair value = P180,000 P 50,000 = gratuity / gift subject to transfer tax Selling price. = 130,000 P 30,000 = gross income Original Cost= 100,000 subject to income tax TRANSFERS WITH ANOTHER ENTITY Either natural (living persons) or juridical (created by law) Relatives, corporations, partnership, partner = taxable Home office and branch = not taxable Owner, proprietor and business = not taxable  BENEFITS IN THE ABSENCE OF TRANSFERS INCREASE IN WEALTH AND VALUE IN THE ABSENCE OF SALE/ TRANSFER IS NOT TAXABLE ✔ Unrealized gains or holding gains- not yet materialized in an exchange transactions ✔ Increase in value of investments in equity or debt securities ✔ Increase in value of real properties held (revaluation increment) ✔ Increase in value of foreign currencies held or receivable ✔ Decrease in value of fx denominated debt by virtue of favorable fluctuations ✔ Birth of an animal offspring, accruals or fruits in an orchard/growth of vegetables ✔ Increase in value of land due to discovery of mineral reserves What are possible items of Gross Income ? a. Compensation income P 200,000 b. Winnings from gambling 100,000 c. Increase in value of investments 50,000 d. Appreciation in the value of land owned 300,000 e. Debt of Mr. Dela Cruz cancelled by creditors in consideration for services he rendered to them 150,000 f. Debt of Mendoza cancelled by his creditors out of affection 250,000 g. Loan received from a bank 400,000 Items of Gross Income: a. Compensation income P 200,000 b. Winnings from gambling 100,000 c. Debt of Mr. dela Cruz cancelled by creditors in 150,000 consideration for services he rendered to them  MODE OF RECEIPT/REALIZATION BENEFITS TAXABLE INCOME 1. Actual receipt –physical taking of the income in cash/property 2. Constructive receipt-taxpayer effectively benefited; no actual physical taking Examples: a. Offset of taxpayer’s debt in consideration for the sale of goods or service b. Deposit of the income to the taxpayer’s checking account c. Matured detachable interest coupon on coupon bonds not yet encashed d. Increase in the capital of a partner from the profit of the partnership INFLOW OF WEALTH WITHOUT INCREASE IN NET WORTH Absence of benefit from: Receipt of property in trust Borrowing of money under an obligation to return Note: In law, proceeds of embezzlement or swindling where money is taken without an original intention to return are considered as income because of the increase in net worth of the swindler CLASSIFICATION OF TAXPAYERS  CLASSIFICATION OF INCOME TAXPAYERS A. Individuals B. Corporations 1. Citizens 1. Domestic corporations a. Resident citizens b. Non-resident citizens 2. Aliens 2. Foreign corporations a. Resident alien a. Resident foreign corporations b. Non-resident alien b. Non-resident foreign Engaged in trade or corporation business Not engaged in trade or business INDIVIDUAL INCOME TAXPAYERS CITIZENS 1. Citizens of the Philippines at the time of adoption of February 2, 1987 Constitution; 2. Whose fathers or mothers are citizens of the Philippines; 3. Born before January 17, 1973 of Filipino mothers who elected Filipino citizenship upon reaching the age of majority; and 4. Who are naturalized in accordance with the law.  CLASSIFICATION OF CITIZENS A. Resident citizen- residing in the Philippines B. Non-resident citizen includes: 1. Establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein. 2. Leaves the Philippines during the taxable year to reside abroad, either as an immigrant or for an employment on a permanent basis. 3. 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. Previously considered as non-resident citizen and who arrives in the Philippines anytime during the taxable year to reside permanently in the Philippines., with respect to his income derived from abroad until his arrival in the Philippines.  ALIENS A. Resident alien- residing in the PhiIippines but not a citizen 1. lives in the Philippines without definite intentions as to his stay 2. comes to the Philippines for a definite purpose which in its nature would require an extended stay, making Philippines his home but with intention to return to his domicile abroad. B. Non-resident alien-not a citizen, not residing in the Philippines 1. Non-resident aliens engaged in business (NRA-ETB)-aliens staying for an aggregate period of more than 180 days during the year. 2. Non-resident aliens not engaged in business ✔ With definite purpose which may be promptly accomplished ✔ In the Philippines staying for not more than 180 days during the year GENERAL CLASSIFICATION RULE FOR INDIVIDUALS Intention Length of stay Resident A Filipino citizen residing in the Philippines. citizen Non-resident A Filipino citizen who establishes to the satisfaction of citizen the CIR the fact of his physical presence abroad with a definite intention to reside therein. Resident alien An alien who comes to the Philippines without definite intention as to his stay. Non-resident An alien who is not residing in the Philippines, can be: alien a) engaged in business (NRA-ETB), or not engaged in business (NRA-NETB). Non-resident citizen Staying abroad for at least 183 days Resident alien Who stayed in the Philippines for more than 1 year as of the end of the taxable year Non-resident alien An alien staying in the Philippines for not more than engaged in trade or 1 year but more than 180 days business Non-resident alien not An alien who stayed in the Philippines for not more engaged in trade or than 180 days business  EXAMPLES: 1. Daniel Aresmendi, a Mexican actor, was contracted by a Phil TV Co. to do a project in the Phils. He arrived Feb. 29, 2021 and returned to Mexico 3 weeks later upon completion of project. He shall be classified as an NRA-NETB in 2021. His stay is for a definite purpose which in its nature will be accomplished immediately.  EXAMPLES: 1. Daniel Aresmendi, a Mexican actor, 2. Mamoud Jibril, a Libyan national, arrived on Nov. 4, 2021. he stayed in the Phis. since then without any working visa or work permit. For 2021, he would be considered an NRA-NETB because he stayed in the Philippines for less than 180 days as of December 31, 2021. If he is still in the Philippines until December 31, 2022, he will qualify as a resident alien for 2022.  EXAMPLES: 1. Daniel Aresmendi, a Mexican actor, was contracted by a Phil TV Co. to do a project in the Phils. He arrived Feb. 29, 2021 and returned to Mexico 3 weeks later upon completion of project. 2. Mamoud Jibril, a Libyan national, arrived on Nov. 4, 2021. he stayed in the Phis. since then without any working visa or work permit. 3. Without any definite intention as to the nature of his stay, Juan Miguel, a Filipino citizen, left the Philippines and stayed abroad from March 15, 2020 to April 1, 2021 before returning to the Philippines. For year 2020, he is a non-resident citizen because he is absent for more than183 days, But in 2021, he will be classified as resident citizen because he is absent for less than 183 days in 2021.  OTHER TAXPAYING ENTITIES: TAXABLE ESTATES AND TRUST Estate Properties, rights, and obligations of a deceased person not extinguished by his death Trust Arrangement whereby one person (grantor or trustor) transfers (i.e. donate) property to another person (beneficiary) which will be held under the management of a 3rd party (trustee or fiduciary).  TAXABILITY ESTATE TRUST Under judicial settlement Irrevocably designated by grantor Taxable on the income left by Taxed as an individual taxpayer decent Under extra judicial settlement Revocable, by the grantor Tax-exempt Not taxable, nor individual Income on properties-taxable to Income taxable to the grantor the heirs  CORPORATE INCOME TAXPAYERS Includes one person corporations, partnerships, no matter how created or organized, joint-stock companies, joint accounts, association, or insurance companies, except general professional partnerships and a joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal, and other energy operations pursuant to an operating consortium agreement under a service contract with the government. Profit oriented and non-profit institutions such as charitable institutions, cooperatives, government agencies, and instrumentalities, associations, leagues, civic or religious and other organizations.  Domestic Corporation Organized under Philippine laws Foreign Corporation Resident foreign corporations o Operates and conducts business in the Philippines through a permanent establishment (i.e. branch) Non-resident foreign corporations o Does not operate or conduct business in the Philippines Special Corporation o Domestic or foreign, subject to preferential tax rates.  OTHER CORPORATE TAXPAYERS 1. One person corporation With single stockholder who may be a natural person, trust or an estate 2. Partnership Owned by 2 or more persons 3. Joint venture Business undertaking for a particular purpose, partnership or corporation 4. Co-ownership Joint ownership of a property formed for the purpose of preserving the same and dividing its income  GENERAL RULES IN INCOME TAXATION Taxable on income earned INDIVIDUAL TAXPAYERS Within Without Resident citizen yes yes Non-resident citizen yes Resident alien yes Non-resident alien yes CORPORATE TAXPAYERS Domestic corporation yes yes Resident foreign corporation yes Non-resident foreign corporation yes 3. SITUS OF INCOME SITUS OF INCOME Place of taxation of income; Jurisdiction having authority to impose tax on the income INCOME SITUS RULES Types of income Place of taxation (situs) 1. Interest income Debtor’s residence 2. Royalties Where the intangible is employed 3. Rent income Location of the property 4. Service income Place where the service is rendered EXAMPLE: DETERMINE THE SITUS OF THE FOLLOWING: Interest income from deposits in a foreign bank P 300,000 Interest from domestic bonds 50,000 Royalties from books published in the Philippines 100,000 Rent income from properties abroad (the lease contracts were 150,000 executed in the Philippines) Professional fees for service rendered in the Philippines to 400,000 non-resident clients (paid in US $)  Within Without World Total Interest on foreign deposits P P300,000 P 300,000 Interest from domestic bonds 50,000 50,000 Royalties from books in the Philippines 100,000 100,000 Rent income on foreign properties 150,000 150,000 Professional fees 400,000 400,000 Total 550,000 450,000 1,000,000  OTHER INCOME TAX SITUS RULES A. Gain on Sale of Properties B. Dividend Income from a. Personal Property a. Domestic Corporation Domestic securities b. Foreign Corporation Other personal properties b. Real Property  ILLUSTRATION: DETERMINE THE SITUS OF THE FF: Gain on sale of domestic stocks P 200,000 Gain on sale of foreign bonds 100,000 Gain on sale of a commercial lot in Baguio City 500,000 Gain on sale of car in Ontario, Canada 200,000 Gain on sale of machineries in Mexico, Pampanga 250,000 Interest income on foreign bonds 50,000 Dividends on domestic stocks 150,000 THE FOLLOWING TABLE SUMMARIZES THE SITUS OF THE FOREGOING INCOME Within Without Gain on sale of domestic stocks P 200,000 Gain on sale of foreign bonds P 100,000 Gain on sale of commercial lot 500,000 Gain on sale of car in Canada 200,000 Gain on sale of machineries 250,000 Interest on foreign bonds 50,000 Dividends on domestic stocks 150,000 Total P. 1,100,000 P 350,000  DIVIDEND INCOME from resident foreign corporations depends on the pre-dominance test. ❖ If the ratio of the Philippine gross income over the world gross income of the resident foreign corporation in the 3-year period preceding the year of dividend declaration is: ✔ At least 50%, the portion of the dividend corresponding to the Philippines gross income ratio is earned within; ✔ Less than 50%, the entire dividends received is earned abroad FROM non-resident foreign corporation – earned abroad  In 2021, Sarah received a P400,000 dividend income from ABC Corporation. ABC had the following gross income from 2018-2020. 2018 2019 2020 Total Philippines P. 100,000 200,000 300,000 600,000 Abroad 200,000 100,000 100,000 400,000 Total 300,000 300,000 400,000 1,000,000 If ABC Corporation is a: Domestic corporation Non resident foreign corporation Resident foreign corporation  2018 2019 2020 Total Philippines P. 100,000 200,000 300,000 600,000 Abroad 200,000 100,000 100,000 400,000 Total 300,000 300,000 400,000 1,000,000 If ABC Corporation is a: Domestic corporation – entire P400,000 is earned within Non-resident foreign corporation-entire P400,000 is earned abroad Resident foreign corporation – P400,00 dividend shall be split: Gross income ratio = P600,000/P1,000,000 = 60% Earned within the Philippines (60% x P400,000) P 240,000 Earned outside the Philippines (40% x P400,000) 160,000 Total dividends P 400,000 If ratio is 49%, entire P400,000 will be deemed earned outside of the Philippines. OTHER INCOME SITUS RULES A. Gain on sale of properties B. Dividend income C. Merchandising income Earned where the property is sold Source of gross income Amount Goods purchased and sold within P 200,000 Goods purchased within and sold abroad 100,000 Goods purchased abroad and sold within 150,000 Goods purchased and sold abroad 350,000 INCOME EARNED WITHIN AND WITHOUT : Within Without Purchased and sold within P200,000 Purchased within and sold abroad P100,000 Purchased abroad and sold within 150,000 Purchased abroad and sold abroad 350,000 Total 350,000 450,000 A. Gain on sale of properties B. Dividend income C. Merchandising income D. Manufacturing income Earned where the goods are manufactured and sold Operations Remarks Production Distribution within within Total income from production and distribution is earned within the Philippines without without Total income from production and distribution is earned without the Philippines within without Production income is earned within. Distribution income is earned without. without within Distribution income is earned within. Production income is earned without.  ILLUSTRATION Island Inc. manufactures goods and sell them through its branch. Island bills its branch at established market prices. Island reported the following gross income. Home office Branch Total Sales P4,000,000 P2,000,000 P6,000,000 Cost of goods sold 2,400,000 1,200,000 3,600,000 Gross income P1,600,000 P 800,000 P2,400,000  UNDER THE 4 SCENARIO, SITUS OF THE GROSS INCOME OF ISLAND ARE: Home Ofice Branch Within Without No. 1 Philippines Philippines P 2,400,000 P 0 No. 2 Abroad Abroad 0 2,400,000 No. 3 Philippines Abroad 1,600,000 800,000 No. 4 Abroad Philippines 800,000 1,600,000 Note: 1. Both production and distribution are conducted by the same taxable entity, Island Inc. 2. The Branch is not a separate taxable entity, but an integral part of Island, Inc.; hence, its income is taxable to Island, Inc.  ILLUSTRATION 2 Assuming production is conducted by a parent corporation and the distribution is conducted by its subsidiary corporation: Parent Subsidiary Total Sale P 4,000,000 P 2,000,000 P 6,000,000 Cost of goods sold 2,400,000 1,200,000 3,600,000 Gross income P 1,600,000 800,000 2,400,000 The gross income recognized by each corporation is taxable to each corporation because each corporation is a separate taxpayer. The situs of taxation shall be the place of sale without regard to the seller or the supplier.  ILLUSTRATION 2 The following are the situs of income for the parent corporation: Scenario Parent Subsidiary Within Without No. 1 Philippines Philippines P 1,600,000 P - No. 2 Abroad Abroad - 1,600,000 No. 3 Philippines Abroad 1,600,000 - No. 4 Abroad Philippines 1,600,000  ILLUSTRATION 2 The following are the situs of income for the subsidiary corporation: Scenario Parent Subsidiary Within Without No. 1 Philippines Philippines P 800,000 P - No. 2 Abroad Abroad - 800,000 No. 3 Philippines Abroad - 800,000 No. 4 Abroad Philippines 800,000 -  END GROSS INCOME (Part 1)