BAINCTAX

Income Taxation
TAY2022

Regular Income Taxation

Gross Income
 For purposes of the discussions in this module, when the phrase “inclusion in gross income” is used, it would mean the items
of income which are reportable under gross income in the income tax return for the regular income taxation scheme.
Consequently, the phrase “exclusion from gross income” would mean all income which not reported for return purposes,
whether exempt or excluded.

EXCLUSIONS
As discussed from the previous module, exclusions from gross income are items of income which are not reported anymore in
the gross income in the income tax return. In this module, the discussion will focus on those exempt income on regular income
tax provided by the tax code and other special laws.

Proceeds of Life Insurance

As discussed from previous modules, life is a capital item with infinite value, thus, proceeds from life insurance policies as a
result of the death of the insured is not taxable. This is only applicable if the proceeds are paid to the heirs of beneficiaries.
Proceeds, however, from sale of an insurance policy or outliving a life insurance policy is taxable to the extent to the amount
exceeding the return on capital.

Regular Income Taxation Gross Income page 1

 Illustration 8.1 PROCEEDS OF LIFE INSURANCE POLICIES
Solui applied for a P5,000,000 insurance policy requiring payment of P10,000 monthly premiums for ten years.
Scenario 1: It is a life insurance policy on Solui and he dies after three years.
The whole amount of the P5,000,000 proceed is not taxable.
Scenario 2: It is a life insurance policy on Solui and he sells it for P600,000 after paying 52 months of premium. Solui dies after
the buyer pays five months of premium.

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 The amount of P520,000 (52 months x P10,000) is a return of capital, therefore, it is not taxable. The excess of P80,000 from the proceeds,
however, is taxable to Solui since it constitutes a return on capital. The buyer of the policy shall be exempt on the P650,000 (P600,000
purchase price + P50,000 premiums paid) received. The excess of P4,350,000 is taxable since he is not the heir or beneficiary.
Scenario 3: It is a life insurance policy on Solui and he dies at the end of second year. The heirs received P5,100,000 six months
after his death.
The excess of P100,000 over the face of the insurance policy constitutes an interest income which is a return on capital, hence, taxable.
Scenario 4: It is a life insurance policy on Solui and he outlives the policy. He received the maturity value of P1,400,000.
Only the total amount of premiums paid is exempt. The excess of P200,000 is an item of gross income.
Scenario 5: It is a property insurance for a building with a tax basis of P3,000,000. The building was burnt.
The tax basis of P3,000,000 is an exclusion from gross income. Only the excess of P2,000,000 is taxable.

The exemption extends to that of corporations insuring their officers with the corporation as the beneficiary. Premium paid on
such are non-deductible against gross income.

Regular Income Taxation Gross Income page 3

 Gifts, Bequests and Devises
The value of property acquired by gift, bequest, devise, or descent: Provided, however, that income from such property as well
as gift, bequest, devise, or descent of income from any property, in cases of transfers of divided interest, shall be included in
gross income.

Illustration 8.2 GIFTS

Mark received a restaurant business as a gift on April 1, 2020. On that date, the restaurant had total properties amounting to
P400,000 including P50,000 cash income earned since January 1, 2020. The restaurant posted an additional P150,000 cash income
from April 1 to December 31, 2020.
The transfer of business properties worth P400,000 to Mark is a gratuity subject to transfer tax, not income tax. However, the
P50,000 donated income shall be included in gross income, but in the income tax return of the donor. The P150,000 income of
the donated property after the perfection of the donation is included as item of gross income in the tax return of Mark, the
donee.

Compensation for Damages

As a rule, amounts received through Accident or Health Insurance or under Workmen's Compensation Acts, as compensation
for personal injuries or sickness, plus the amounts of any damages received whether by suit or agreement on account of such
injuries or sickness are excluded from gross income.
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 Exempt Taxable
a. Personal physical injuries or sickness; a. Actual damages for loss of anticipated profits;
b. Any other damages recovered on account of personal b. Moral and exemplary damages awarded as a result of
injuries or sickness; breach of contract;
c. Exemplary and moral damages for out-of-court settlements c. Interest for nontaxable damages above: and
including attorney's fees; d. Any damages as compensation for unrealized income.
d. Alienation of affection, or breach of promise to marry; and
e. Any amount received as a return of capital or
reimbursement of expenses.

Illustration 8.3 COMPENSATION FOR DAMAGES

Mr. Sammy Haban, a supervisor in a Milling Company, was accidentally bumped by Zigzag Taxi resulting to his severe
physical injuries. The court decided that Zigzag would pay Haban the following damages which Zigzag paid for a certain
period of time:
Moral Damages 100,000
Exemplary Damages 50,000

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 Damages for permanent loss of earning capacity 200,000
Actual liquidated damages 50,000
Compensation for unrealized earnings 30,000
Only the P30,000 compensation is taxable for since it is a recovery of lost earnings. The remaining P400,000 will be exempted
from income tax.

Income Exempt under Treaty

Income items that are excluded by international agreement to which the Philippine government is a signatory are excluded from
income tax. It must be recalled that treaty agreements override provisions of our revenue tax laws in case of conflict under the
exemption doctrine of international comity.

Retirement Benefits
Exempt from income tax are retirement benefits received under R.A. 7641 and those received by officials and employees of
private firms in accordance with a reasonable private benefit plan maintained by the employer.

a. This is the first time availment of retirement benefit exemption.

Requisites b. The retiring official or employee has been in the services of the same employer for at least cumulative
ten (10) years.

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 c. The retiring employee is at least fifty (50) years of age at the time of retirement.
d. The employer maintains a reasonable private benefit plan.

Illustration 8.4 RETIREMENT BENEFITS

Yorla, a new year baby, started working on January 17, 1983 at the age of 22 years old. Following is the timeline of her
employment. All companies maintain a reasonable private benefit plan.
Company Inclusive Dates Availed Retirement Program?
Boom Aleck Co. January 15, 1983 – July 15, 1986 No
Loom Ipat Corp. July 16, 1986 – September 19, 2002 Yes
Naumay Inc. September 21, 2002 – October 14, 2011 Yes
Boom Aleck Co. October 17, 2011 – March 18, 2018 Yes
The benefit from Loom Ipat is taxable since Yorla was still 41 years old back then. The retirement benefit from Naumay is still
taxable since even though she was 50 years old, the years of service is less than 10 years. The retirement benefit from Boom
Aleck is exempt even though it is not the first time that Yorla avails the retirement program since the exemption is not availed
for the former retirement benefits received. In addition, Yorla satisfies the 10-year period of service and 50-year age.

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 Separation and Termination Benefit
Either of the following requisites must be satisfied to avail of the exemption.
1. The separation or termination must be due to job-threatening sickness, deaths, or other physical
disability; and
2. The same must be due to any cause beyond the control of the employee or official such as:
a. Redundancy
b. Retrenchment
Requisite
c. Closure of employer's business
d. Employee lay-off
e. Downsizing of employer's business
f. Sickness or death of the employee
The phrase "beyond the control of the employee" connotes involuntariness on part of the employee. In
other words, the separation must not be of his making.
The exemption of termination or separation benefits does not extend to:
Limitation 1. Backwages or illegal deductions repaid by the employer upon termination
2. Terminal leave pay or the commutation of accumulated unused leave credits

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 To avail of the tax exemption, the employee or his heirs shall request for a ruling or certificate of exemption
Availment (CTE) from the BIR. The request for a CTE and other required documents shall be filed at the RDO where
the employer is registered.

Illustration 8.5 SEPARATION BENEFITS

Kala is an employee of Goship Company which closed its business during the year. Kala's last paycheck shows the following:
Unpaid salary in the last two months 30,000
Current month salary 15,000
Separation pay 100,000
Scenario 1: Kala was chosen to be laid off first because she was the last person to be hired.
Only the P100,000 received is exempt. The backwages and current salary are taxable.
Scenario 2: Kala was chosen to be laid off first because she was had allergic rhinitis.
The whole amount of the last paycheck is taxable since the reason does not normally render the employee incapable of working.
Scenario 3: Kala chose to resign first.
The whole amount is taxable as the resignation violates the beyond the employee’s control rule.

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 Social Security Benefits
This would include social security benefits, retirement gratuities, and other similar benefits from foreign
Received from
government agencies and other institutions, private or public, received by resident or non-resident citizens
Foreign Income
or aliens who come to settle permanently in the Philippines.
SSS Benefits This would be the social security benefits under RA 8282.
These are benefits under RA 8291 including retirement gratuity received by government officials and
GSIS Benefits
employees.

Illustration 8.6 SOCIAL SECURITY BENEFITS

John was an OFW employed by Microsoft Corporation in the USA. John retired and returned to permanently settle in the
Philippines. He is paid a $2,000 monthly pension from Microsoft's pension fund and another $800 monthly benefit from the US
social security benefit.
Both the pension and the social security benefits are exempt. Note that these benefits were earned abroad when the taxpayer
was a non-resident Under situs rule, the foreign Income of non-residents is not taxable in the Philippines. This holds true even
if the taxpayer subsequently receives the income as a resident of the Philippines.

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 USVA Benefits
These are United States Veterans Administration-administered benefits under the law of the United State received by any person
residing in the Philippines.

Illustration 8.7 USVA BENEFITS

Mr. Jackson is a retired US serviceman from the Iraqi war. He married a beautiful Filipino and settled in the Philippines. He is
receiving a $1,000 monthly benefit from the USVA.
The USVA benefit is excluded in gross income. The same rule applies to USVA benefits for beneficiaries of Filipino veterans
who fought under the American flag in World War II.

MISCELLANEOUS ITEMS
By virtue of international comity, exempt are those income derived on investments in the Philippines in
Income from loans, stocks, bonds, or other domestic securities, or from interest on deposits in banks herein by:
Domestic a. Foreign governments
Securities b. Financing institutions owned, controlled, or enjoying refinancing from foreign government
c. International or regional financial institutions established by foreign governments

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 These are exempt under the exemption doctrine of international comity.
Exempt are those income derived by the government and its political subdivisions from:
a. Any public utility; or
b. Exercise of essential government function Government agencies and instrumentalities
Government The general rule with government agencies and instrumentalities is exemption because of their public
Income service nature. However, taxation applies when they engage in income-producing activities which are
proprietary or commercial in nature. This exemption does not extend to government-owned and controlled
corporations (GOCCs). GOCCs are generally taxable as regular corporations because their operations are
proprietary in nature.
These pertain to the employee share in the premium contributions to GSIS, SSS, PhilHealth, Pag-Ibig and
union dues. The portion of the salary thus contributed is exempt from income tax. Under RMC No. 21-2011,
Mandatory
the exclusion pertains only to the mandatory or compulsory monthly contributions. Voluntary
Payroll
contributions to Pag-Ibig II, GSIS or SSS in excess of the mandatory monthly contribution are taxable. Note
Deductions
that Pag-Ibig is now called the Home Development Mutual Fund or HDMF. This will not be illustrated
anymore since the same has been discussed in your BAINTE1X class.

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 PERA is a contributor's voluntary retirement account established from qualified contributions of the
contributor and or his employer for the sole purpose of being invested in qualified PERA investment
products. Contributions to PERA accounts are exclusions in gross income. This is an additional exclusion
Personal Equity and is separate with the exclusion for contributions to SSS or GSIS. Moreover, PERA contributors are
and Retirement allowed to claim 5% of their PERA contributions as tax credit against any internal revenue taxes. PERA
Account investment income are exempt from taxes (i.e. final tax, capital gains tax and regular income tax). The PERA
account assets will be distributed back to the contributor either in lump sum, life pension or in installment
upon reaching the age of 55 or to his heirs or beneficiaries upon his or her death. PERA distributions are
likewise exclusions in gross income of the contributor or his heirs or beneficiaries as the case may be.
13th Month Pay The amount received as such by officials and employees of public or private entities not exceeding P90,000.
and Other This will be further discussed in detail in Module 9.
Benefits
Gains from sale of bonds, debentures, or other certificate of indebtedness with a maturity of more than 5
Gains on Sale of
years are exempted. This exemption is grounded upon the same assumption that long-term indebtedness
Long-Term
is diverted to the financing of long-term projects which is viewed as beneficial to the development of the
Indebtedness
country. The term "gain" however, does not include "interest."

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 The term mutual fund company shall mean an open-end and close-end investment company as defined
Gain on under the Investment Company Act.
Redemption of Mutual funds pool the money invested by different investors and invest the money to earn investment
Shares in a income which shall add up to the net assets of the fund. A participating investor must purchase
Mutual Fund participation shares from the fund at their Net Asset Value (NAV). Upon redemption of his participation
Company shares, the investor gains or losses by his proportionate share in the increase or decrease in the Net Asset
Value of the fund.

Illustration 8.8 LONG-TERM INDEBTEDNESS

On September 1, 2020, an individual taxpayer sold a 6-year term bond investment for P1,100,000. These bonds bear 8% interest
payable every December 31 were previously acquired at P1,000,000 face value on January 1, 2020.
The interest accrued of P60,000 (P1,000,000 x 8% x 9/12) is taxable. The gain of P40,000 (P1,100,000 – P1,000,000 – P60,000) is
exempt.

Regular Income Taxation Gross Income page 14

 Illustration 8.9 SHARES IN MUTUAL FUNDS
A taxpayer bought 10,000 shares from Golden Dragon Mutual Fund at P120 NAV per share. The taxpayer redeemed his shares
when the NAV per share was P180
The P600,000 gain, computed as [(P180 - P120) x 10,000], on redemption is excluded from gross income; hence, exempt from
taxation.

Minimum Wage Earners

A minimum wage earner is an individual recipient of a minimum wage as fixed by the Regional Tripartite Productivity Wage
and Productivity Board of the Department of Labor and Employment. A minimum wage earner is exempt from income tax on
the minimum wage including holiday pay, overtime pay, night shift differential pay and hazard pay. This exemption, however,
does not extend to gross income from business or profession. The presence of income besides that obtain from employment does
not impair the exemption.

Barangay Micro-Business Enterprise (BMBE)

BMBE is a business entity or enterprise engaged in the production, processing or manufacturing of products or commodities,
including agro-processing, trading and services, whose total assets including those arising from loans but exclusive of the land
on which the particular business entity's office, plant, and equipment are situated, do not exceed P3,000,000. The term service
excludes those rendered by licensed professionals and partnership and corporations engaged in consultancy, advisory and
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 similar services which are essentially carried out through licensed professionals. A BMBE shall include any individual owning
such business entity or enterprise, partnership, cooperative, corporation, association, or other entity incorporated and/organized
and existing under Philippine laws and registered with the office of the treasurer of a city or municipality.

To qualify as a BMBE, an enterprise must not be a branch or a subsidiary of a large scale enterprise and its policies, and modus
operandi must not be determined by a large scale enterprise such as in the case of franchises. To avail of the benefits and
privileges of a BMBE, an applicant must secure a certificate of authority to operate as a BMBE from the Office of the Treasurer
of the city or municipality that has jurisdiction.

Tax Exemption on Income from Operations

Aside from other incentives afforded by the law, the income of BMBE from their operation is exempt; hence, excluded from the
gross income subject to regular income tax. BMBEs file an Annual Information Return in lieu of the income tax return. However,
their non-operating, passive, and capital gains are subject to the appropriate type of income tax.

Illustration 8.10 BMBE

William has a bakery with total assets of P4,000,000 inclusive of a lot with a book value of P1,200,000.
Since the total assets, net of the land, is P2,800,000, William is qualified as a BMBE. If he obtained a Certificate of Authority to
Operate as BMBE, his income is exempt from regular income tax but is still subject to other income taxation schemes.

Regular Income Taxation Gross Income page 16

 Cooperatives
Cooperatives that transact business purely with members are exempt from all taxes and fees. Cooperatives that transact business
with non-members likewise exempt from all taxes and fees if their accumulated reserve and undivided savings do not exceed
P10,000,000. Otherwise, the amount of allocated for interest on capitals is subject to regular tax. However, the income of any
cooperative from non-related sources is fully taxable to regular tax.

Non-Stock and Non-Profit Entities

Non-stock entities that are not organized for profit are exempt from income tax on their income from operations. However, their
income from unrelated sources is taxable.

Qualified Employees' Trust Fund

An employees' trust fund which forms part of a pension, stock bonus or profit sharing plan of an employer for the benefit of
some or all his employees is exempt from any income tax under the NIRC.

Conditions for exemptions of employee trust funds:

a. Contributions are made to the trust by such employer, or employees, or both for the purpose of distributing to such
employees the earnings and principal of the fund accumulated by the trust in accordance with such plan.
b. The asset of the fund shall not be diverted for other purposes other than the exclusive benefit of the employees.

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 Income under Other Income Taxation Schemes
Those items of income discussed under Modules 5 and 6 which are within the scopes of Final Income Taxation and Capital
Gains Taxation are exclusions from Gross Income under Regular Income Taxation.

INCLUSIONS
Items of gross income subject to regular income tax are not limited to those mentioned under the NIRC. The regular income
taxation scheme is a catch-all provisions for all income derived from whatever sources that are:

a. Not subject to final tax, capital gains tax and special tax regimes, and
b. Not excluded or exempted by law, treaty, or contract from taxation.

Compensation for Services

Under current tax rules, the term "compensation income" technically pertains to the types of employee benefits that are subject
to regular tax. The fringe benefits of managerial or supervisory employees are not considered compensation income and are
subject to final tax. This will be extensively discussed in the next module.

Regular Income Taxation Gross Income page 18

 Business Income
This includes income from any trade or business, legal or illegal, and whether registered or unregistered. This has been discussed
mostly on Module 7.

Gains from Dealings in Properties

This will be extensively in Module No. 11.

Interest Income
This particularly refers to interest income other than passive interest income subject to final tax. A taxable interest income must
have been actually paid out of an agreement to pay interest. It cannot be imputed.

The following are exempt from regular income taxation:

1. Interest income earned by landowners in disposing their lands to their tenants pursuant to the Comprehensive Agrarian
Reform Law
2. Imputed interest income

Illustration 8.11 INTEREST INCOME

EGA Finance reported the following interest income during the year:

Regular Income Taxation Gross Income page 19

 From loans 3,000,000
From deposits with banks 400,000
Notes rediscounting 100,000
Treasury notes 50,000
The interest income from deposits and T-notes are subject to final tax, therefore, not inclusions as gross income under regular
taxation.

Rent Income
Rent income arises from leasing properties of any kind. It is a passive income but is not subject to final tax under the NIRC;
hence, it is subject to regular income tax. Aside from the periodic receipts of such, the following should be considered.

1. Obligations of the lessor that are assumed by the lessee are additional rental income to the lessor.
2. Leasehold improvements made by the lessee on the leased property are recognized by the lessor as income using the
spread-out method or outright method.
3. On advance rentals,
Inclusion Exclusion
 Unrestricted  It constitutes a loan

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  Restricted to be applied in future years or upon the  It is a security deposit to guarantee payment or rent subject
termination of the lease to contingency which may or may not happen

Royalties
Royalties earned from sources within the Philippines are generally subject to final income tax except when they are active by
nature. Active royalty income and royalties earned from sources outside the Philippines are subject to regular income tax.

Type/Source Within Abroad

Passive X ✓
Active ✓ ✓

Illustration 8.12 ROYALTIES

Maestra Rihanna has the following royalties during the year.
From mining properties in the Philippines 550,000
From musical compositions in the Philippines 450,000
From books published abroad 250,000
All but the royalty from musical compositions is inclusions in gross income since it is subject to final tax.

Regular Income Taxation Gross Income page 21

 Dividends
These pertain to dividends declared by foreign corporations. It should be recalled that dividends declared by domestic
corporations are generally subject to 10% final tax if the recipient is an individual taxpayer and exempt if the recipient is a
domestic or a resident foreign corporation. Cash, property, and script dividends from foreign corporations are items of gross
income subject to regular income tax.

Recipient (below)/ Source (right) Domestic Resident Foreign Non-Resident Foreign

RC X ✓ ✓
DC X ✓ (but may be exempted following requisites)
NRC, RA, NRA-ETB, RFC, NRFC X Pre-dominance test X

Illustration 8.13 DIVIDENDS

A portfolio of equity investments held by a taxpayer received cash dividends from the following during the year.
Domestic Corporation 400,000
Resident Foreign Corporation 300,000
Non-Resident Foreign Corporation 200,000

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 The pre-dominance test on the RFC revealed a 60% rate.
The P400,000 dividend from domestic corporation is excluded regardless of the recipient. If the taxpayer is a resident citizen or
domestic corporation, the gross income of P500,000 should be included, otherwise, only the P180,000 relating from the pre-
dominance test is an item of gross income.

Annuities
The excess of annuity payments received by the recipient over premium paid is taxable income in the year of receipt.

Illustration 8.14 ANNUITIES

Andrew purchased an annuity contract for P100,000 which shall pay him P10,000 annually until he dies.
The receipt of the first 10 annual annuity payments is a return of capital. Any further receipt from year 11 onwards is an item
of gross income subject to regular income tax.

Prizes and Winnings

Prizes and winnings that are exempted from final tax are not items of gross income subject to regular income tax.

Earned within by Earned within by

Nature Earned abroad
individuals corporations
Prizes

Regular Income Taxation Gross Income page 23

 P10,000 and below ✓ ✓ ✓
Above P10,000 X ✓ ✓
Winnings
PCSO Winnings ≤ P10,000 X X ✓
PCSO Winnings > P10,000 X X ✓
All others X ✓ ✓

Pensions
These pertain to pensions and retirement benefits that fail to meet the exclusion criteria and hence subject to regular tax.

Share in Net Income of Special Corporations

Shares in the net income of pass-through entities are subject to the regular income tax. These would include income earned from
exempt partnerships, joint ventures and co-ownerships.

Taxability of Entity Organized Within Organized Abroad

Taxable X ✓
Exempt ✓ ✓

Regular Income Taxation Gross Income page 24

 Income Distributions from Taxable Estates and Trusts
Recall that income earned by estates and trusts which are distributed to the heirs/beneficiaries are deemed deductions against
the gross income of the estate or trust. These, however, are taxable to the beneficiary.

Illustration 8.15 INCOME DISTRIBUTION

Continuing Illustration 7.7, The P1,250,000 income distributed to the heirs is taxable to the heirs. The same goes with the
P300,000 received by Mr. Salamat in Illustration 7.8.

Recoveries of past deductions

Tax benefit rule is a general principle in taxation which states that if a taxpayer deducted an item on his income tax return and
enjoyed a tax benefit (reduced his income tax) thereby, and in a subsequent year recovers all or part of that item, he will recognize
gross income in the year the deducted item is recovered to the extent of the benefit realized.

Past deductions that created tax benefits to the taxpayers must be reverted back to gross income in the year of recovery so that
the government will recover the tax lost from the deduction.

The rule has both an inclusionary and an exclusionary component, i.e., the recovery is included in the taxpayer's gross income
to the extent that the taxpayer obtained a tax benefit from the prior year's deduction, and the recovery is excluded to the extent
that the prior year's deduction did not provide a tax benefit.

Regular Income Taxation Gross Income page 25

 Illustration 8.16 RECOVERY OF PAST DEDUCTIONS
A taxpayer incurred P60,000 bad debt expense in 2018 out of which P35,000 was recovered in 2020:
2018 2019 2020
Net income before bad debts expense 100,000 80,000 120,000
(Bad Debts Expense)/Recoveries (60,000) - 35,000
Net Income after bad debts expense 40,000 80,000 ???
The entire P60,000 deduction in 2018 is a tax benefit to the taxpayer. Hence, the P35,000 recovery from this deduction is a tax
benefit which must be reverted back to gross income in 2020. The taxable net income in 2020 shall be P155,000.

Illustration 8.17 RECOVERY OF PAST DEDUCTIONS

A taxpayer incurred P90,000 bad debt expense in 2018 out of which P60,000 was recovered in 2020.
2018 2019 2020
Net income before bad debts expense 70,000 100,000 120,000
(Bad Debts Expense)/Recoveries (90,000) - 60,000
Net Income after bad debts expense (20,000) 100,000 ???
NOLCO (20,000)

Regular Income Taxation Gross Income page 26

 Net income 80,000
The entire P90,000 deduction is a tax benefit. The taxpayer benefited by the P70,000 reduction in 2018 taxable income plus the
P20,000 carry-over of NOLCO. The P60,000 recovery from the deduction in 2020 is a tax benefit subject to tax. The reportable
net income in 2020 shall be P180,000.

Illustration 8.18 RECOVERY OF PAST DEDUCTIONS

A taxpayer incurred P60,000 bad debt expense in 2018 out of which P35,000 was recovered in 2020:
2016 2017 2018 2019 2020
Net income before bad debts expense 100,000 (130,000) 80,000 (160,000) (70,000)
(Bad Debts Expense)/Recoveries (500,000) 500,000
Net Income after bad debts expense (400,000) (130,000) 80,000 (160,000) ???
NOLCO (80,000)
Net Income -
The interest expense saved the 2016 P100,000 pre-tax income and the 2018 P80,000 net income from taxation. Note that NOLCO
can be deducted only against net income in the next three years. The P320,000 remaining NOLCO expired in 2019 without tax

Regular Income Taxation Gross Income page 27

 benefit The P500,000 interest deduction only benefited the taxpayer P180,000. Hence, only P180,000 of the P50,0000 recovery in
2020 shall be reverted back to the 2020 gross income.

Illustration 8.19 RECOVERY OF PAST DEDUCTIONS

A taxpayer incurred P90,000 bad debt expense in 2019 out of which P45,000 was recovered in 2020:
2019 2020
Net income before bad debts expense 70,000 (15,000)
(Bad Debts Expense)/Recoveries (90,000) 45,000
Net Income after bad debts expense (20,000) ???
An increase in NOLCO which has not expired before the beginning of the taxable year in which the recover), takes place shall
be treated as tax benefit. Thus, the entire P90,000 is a tax benefit to the taxpayer. Hence, the P45,000 recovered out of it is a tax
benefit which must be reverted back to gross income in 2020.
The 2020 net income shall be computed as follows:
Net loss before recovery (15,000)
Recovery 45,000
Net Income 30,000

Regular Income Taxation Gross Income page 28

 NOLCO (20,000)
Taxable net income 10,000

Illustration 8.20 RECOVERY OF PAST DEDUCTIONS

A corporate taxpayer had a change in 80% of its shareholders in 2020. Thus, any net operating loss incurred before 2019 is not
allowed to be carried over. A P90,000 bad debt write-off was made in 2019 out of which P60,000 was recovered in 2021.
2019 2020 2021
Net income before bad debts expense 70,000 100,000 120,000
(Bad Debts Expense)/Recoveries (90,000) - 60,000
Net Income after bad debts expense (20,000) 100,000 ???
The tax benefit of the P90,000 bad debt expense to the corporation in this case shall be determined using the As-If Approach.
Re-compute the net income in the year of deduction by adjusting the deduction as if the subsequent deduction recovery is
known. The computed net income is compared to what was previously reported to determine the income that is saved from
taxation. Assuming the future recovery is known, the 2019 net income should have been:
Net income before bad debt expense 70,000
Bad debt expense if recovery was known 30,000

Regular Income Taxation Gross Income page 29

 Net income if recovery was known 40,000
The tax benefit is the income that escaped taxation in 2019 computed as:
Net income if recovery was known 40,000
Net income as reported in 2019 (recovery is known) 0
Tax benefit of the bad debt expense 40,000
P40,000 out of the P60,000 recovery in 2021 constitutes tax benefits which must be included in the 2021 gross income. The 2021
net income shall be P160,000.

Reimbursements of Expenses
Expenses of the taxpayer that are reimbursed or paid by the customer or client constitute additional income to the taxpayer.

Examples:

1. When the lessee pays the ownership costs of the lessor such as real property tax and insurance on the property, the
payment constitutes income to the lessor.
2. When a client reimburses the out-of-pocket expenses of a professional practitioner, the reimbursements are income to the
practitioner.

Regular Income Taxation Gross Income page 30

 Cancellation of Indebtedness
The cancellation of indebtedness may amount to gratuity or payment of income.

The cancellation of debt:

a. In consideration of service or goods - treated as income

b. As an act of gratuity - treated as gift; not as income
c. As capital transaction such as forfeiting the right to receive dividends in exchange of the debt - treated as dividend
income

Effects of Concurrent Taxes

The effects of creditable withholding taxes and value-added taxes should be removed.

Illustration 8.21 CONCURRENT TAXES

Charles Paul Adizon, CPA obtains his only income from professional fees on his practice of accounting profession. He is a VAT
taxpayer whose income is subject to 10% creditable withholding tax. During the year, the cash inflows from professional fees
totaled P3,468,000. Allowable deductions amount to P1,400,000.
His tax payable will be:
Net Professional Receipts Received 3,468,000

Regular Income Taxation Gross Income page 31

 Divide by: (100%+12%-10%) 102%
Professional Income 3,400,000
Less: Allowable Deductions 1,400,000
Taxable Income 2,000,000

Tax Due 490,000

Less: Tax Credits (3,400,000 x 10%) 340,000
Tax Payable 150,000
Let us check the amount of the professional fee.
Professional Income 3,400,000
Value-Added Tax (3,400,000 x 12%) 408,000
Less: Creditable Withholding Tax (3,400,000 x 10%) 340,000
Net Cash Received 3,468,000

References:
Banggawan, R. (2019). Income Taxation. Pasay City: Real Excellence Publishing.
Valencia, G. & Roxas, E. (2016). Income Taxation. Baguio City: Valencia Educational Supply.
Reyes, V. (2019). Income Tax Law and Accounting under the TRAIN Law. Manila: GIC Enterprises & Co., Inc.
Ampongan O. (2018). Income Taxation. Mandaluyong City: Millennium Books, Inc.

Regular Income Taxation Gross Income page 32

 Self-Check!
Basing on your readings, answer the following questions.
1. What is the difference between exclusions, exemptions and deductions?
2. Explain the tax phrase “exclusion from gross income”.
3. When are proceeds from an insurance policy taxable?
4. Why is gift not subject to income tax?
5. When is there an instance that a government instrumentality is taxable in its income?
6. Are income exempted under final income taxation an exclusion from gross income?
7. What are the requisites for the exemption of retirement benefits?
8. What are the tax benefits of Personal Equity and Retirement Account?

Exercise 8.1 TRUE OR FALSE

Determine whether the following statements are true or false.
1. Physical, exemplary and moral damages except damages except damages as loss of profit are not taxable.
2. GSIS and SSS benefits are included in gross income to the extent they exceed P90,000.
3. A BMBE must have net assets not exceeding P3,000,000.

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 4. The proceeds of life insurance received by employer from insurance policy coverage taken and paid by such employer
constitute taxable income.
5. An employee must have rendered a continuous 10 years of service to avail exemption for retirement benefit.
6. If the minimum wage earner earns other income subject to regular income tax, his statutory minimum wage becomes
taxable.
7. The employer’s share to SSS, PhilHealth and HDMF contributions are an exclusion to gross income.
8. Cooperatives, regardless of their classification, are taxable on income from their unrelated activities.
9. Income subject to treaty obligation binding upon the Government of the Philippines is exempted from income taxation.
10. Termination pay for any cause beyond the control of an employee is not subject to tax, except I dismissal is with a
cause.
11. Actual liquidated damages are taxable.
12. Income derived by foreign government in the Philippines is taxable.
13. Donated income is included in the gross income of the donee.
14. A general professional partnership can be registered as a BMBE.
15. Benefits of veterans of war or retired US army personnel are exclusions.
16. Hazard pay of minimum wage earner

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 17. Laundry service income of a minimum wage earner
18. Income from illegal gambling
19. Interest income on peso time deposits
20. Social security benefit received by a balikbayan from employer abroad
21. Income that is not realized is not taxable, but illegal income is taxable.
22. Income received under a mistake of fact or law is to be included as part of gross taxable income.
23. If the advance rental is received as a security deposit without restriction, then such amount should be excluded in the
determination of rental income.
24. The amount of bad debts which resulted to reduction of taxable income will become a taxable income in the
subsequent year when such is eventually recovered.
25. The cancellation of a taxpayer’s indebtedness is an income unless such cancellation is intended as a gift.
26. If debt is cancelled due to services rendered by the debtor, the basis of tax is the value of the services rendered.
27. Gross income includes all income from whatever sources whether legal or illegal.
28. Income that is not realized is taxable.
29. When stock dividends received are of a different class from shares previously acquired, the stock dividends are taxable
income.

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 30. Passive income earned abroad by a resident citizen that has been subjected to foreign final tax shall not anymore be
taxed in the Philippines.
31. In terms of partnerships, joint ventures and co-ownerships, shares in their net income are subject to regular tax is the
entity is taxable.
32. The refund or recovery of non-deductible taxes shall not be reverted back to gross income.
33. Corporate prizes are exclusions in gross income subject to final tax but are inclusions in gross income subject to regular
income tax.
34. Capital gains are, in general, subject to capital gains tax, therefore, are not inclusions in gross income for regular
income tax.
35. The interest income from bonds issued by banks is subject to final tax.

Exercise 8.2 MULTIPLE CHOICE

Choose the best answer from the choices provided.
1. The following are exclusions from gross income, except
a. Proceeds of life insurance policies
b. Retirement benefits from plan approved by BIR

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 c. Gifts, bequests and devises
d. Prizes and winnings
2. The following shall be excluded from gross income, except
a. Separation pay fie to sickness
b. Separation pay due to voluntary resignation
c. Separation pay due to death
d. Retirement pay of P3,000 per month
3. The following are taxable recoveries for injuries except
a. Interest earned from nontaxable damages
b. Compensatory liquidated damages
c. Damages for loss of goods and other belongings
d. Damages for unrealized profit
4. The following are the requirements to exempt retirement pay due to old age from taxation, except
a. Must be SSS or GSIS retirement plan only
b. Equitable retirement program approved by the BIR Commissioner
c. The retiree should have been employed for at least 10 years and the retiring age of at least 50 years old

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 d. Retirement pay should have been availed of for the first time
5. The proceeds of insurance taken by a corporation on the life of the president to indemnify it against loos in case of his
death is
a. Part of taxable income of the corporation
b. Taxable income of the corporation
c. Partly exempt, partly taxable
d. Exempt from income tax
6. Which of the following is not an inclusion?
a. Prize received by a resident individual from a foreign source
b. Prize received by a domestic corporation from a foreign source
c. Winnings received by a non-resident foreigner from a foreign source
d. Winnings received by a resident corporation from a domestic source
7. Which of the following dividends should be reported as an item of gross income?
a. From domestic corporation to resident citizen
b. From non-resident foreign corporation to resident citizen
c. From domestic corporation to resident alien

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 d. From non-resident foreign corporation to resident alien
8. Which of the following will not be reported in gross income?
a. Receipt of inheritance
b. Share in the net income of a foreign partnership
c. Royalties from foreign sources
d. Income distribution from a taxable estate
9. Interest income from which of the following sources is an exclusion from gross income?
a. Notes
b. Bonds
c. Lending
d. Deposits
10. Which is subject to regular tax to a resident foreign corporation?
a. Service fee abroad
b. Gain from sale of real property capital assets in the Philippines
c. Dividends from a domestic corporation
d. Gain from dealings in properties abroad

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 Exercise 8.3 INCLUSION OR EXCLUSION
Write EX if the item is an exclusion from gross income, otherwise, write IN.
1. USVA-administered benefits
2. Dividend income derived in the Philippines by the Taiwan government
3. Magsaysay Award
4. Interest received from life insurance’s annuity
5. Separation pay received resulting from business merger
6. Separation pay due to voluntary resignation
7. Overtime pay of minimum wage earner
8. Interest income from bank deposits of a minimum wage earner
9. Union dues
10. PCSO winnings worth P10,000
11. Proceeds from sale of land held as capital asset
12. Income derived from smuggling
13. GSIS retirement benefits
14. Gains from redemption of shares in a mutual fund

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 15. Premium contributions to Modified PAG-IBIG 2 savings

Problem NON-RESIDENT TAXPAYER

8.1
Gina is a Filipino citizen residing in Australia. She earned the following during the taxable year: P900,000 from compensation,
P40,000 interest income from EFCDU, P60,000 dividends from a domestic corporation. The interest income from EFCDU has a
resident co-depositor.
How much of the P1,000,000 should be excluded from gross income?

Problem 8.2 MINIMUM WAGE EARNER

Raymond, a minimum wage earner, reveals the following income and expenses during the taxable year.
Basic Pay 96,000 PhilHealth Contribution 2,000
Overtime Pay 5,000 HDMF Contribution 1,500
13th Month Pay 8,000 Cellphone Repair Revenue 200,000
SSS Contributions 3,000 Operating Expenses 80,000
How much is the total exclusions from gross income? ..

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 Problem 8.3 RETIREMENT BENEFITS
Goship Company has three employees retiring on June 30, 2020. All of these employees rendered a continuous service since
being hired by the company. No one has previously availed of tax exemption on retirement benefits and Goship maintains a
reasonable retirement benefit plan. Each receives an equivalent of 150% if his monthly salary in every full year of service.
Name of Employee Date of Birth Date Hired Final Salary
Phunsukh Wangdu January 16, 1968 June 17, 2011 15,000
Farhan Qureshi August 3, 1972 December 1, 2008 28,000
Raju Rastogi February 22, 1969 May 15, 2010 60,000
Fill out the table below as to the taxability of their retirement benefits.
Taxability P. Wangdu F. Qureshi R. Rastogi
Taxable
Non-Taxable
..

Problem 8.4 COMPENSATION FOR DAMAGES

Mr. Rambo Tan, an entrepreneur, met an accident and was able to claim the following damages.
Actual damages for realized profit 100,000 Moral damages due to injuries 50,000
Actual damages for lost products 200,000 Interest on nontaxable damages 20,000
Exemplary damages due to injuries 50,000 Attorney’s fees 80,000
How much of the damages is taxable and exempt?

Regular Income Taxation Gross Income page 42

 Problem 8.5 TERMINAL PAY
The following amounts were received by the heir of deceased employee from his employer:
Terminal pay 60,000 SSS Death benefit 10,000
Proceeds of life insurance 500,000 Abuloy from friends and relatives 40,000
How much of the receipts is taxable and exempt?

Problem 8.6 NON-STOCK, NON-PROFIT ENTITY

A non-stock, non-profit charitable entity received the following during the taxable year.
Contributions from the public 1,400,000
Income from sale of merchandise 500,000
Gain on the sale of properties 300,000
How much is the total exclusion from gross income subject to regular tax?

Problem 8.7 DONATIONS

Suerte Monte, received the following during the year.
Donated properties 200,000 Income from donated property before donation 50,000
Inherited properties 100,000 Income from donated property after donation 30,000
How much is taxable to Miss Monte?

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 Problem 8.8 INCOME UNDER TAX TREATIES
Jor Kwang, a foreign ambassador to the Philippines, received the following items of income during his stay in the Philippines.
Salary for consular services 800,000
Honoraria received in speaking engagements in the Philippines 200,000
Capital gains on investment made in the Philippines 300,000
If there is no tax-exempt treaty, how much is the total reportable income for Philippine income tax?

Problem 8.19 COMPENSATION INCOME

A purely employed individual received her monthly basic pay of P50,000. She also deducted union dues of P100 per month.
How much is the taxable compensation?

Problem 8.11 USVA BENEFITS

Lolo Monico was one of the US military men of the Armed Forces of the United States under the Commonwealth Army of the
Philippines serving from July 26, 1941 through June 30, 1946. As a US veteran, he receives the following monthly benefits from
the USVA.
Compensation $750 Clothing Allowance 30
Pension 200 Health Benefits 30
The conversion rate is $1:P50.
How much should be excluded from gross income during the taxable year?

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 Problem 8.12 INCOME OF FOREIGN GOVERNMENT
The government of Japan invested in the Philippines with earnings within as follows:
Interest income from bonds 10,000,000
Dividend income received from JFC stocks 3,000,000
Gain on sale of listed domestic securities 2,000,000
How much should be excluded from gross income?

Problem 8.13 COMPREHENSIVE

Valkyrie reported the following income during the year.
Within Abroad
Service Fees 400,000 300,000
Interest Income from bank deposits 40,000 70,000
Royalties from franchise 80,000 30,000
Gains on property dealings 10,000 100,000
Winnings 60,000 50,000
Prizes 5,000 -
Determine the total amount of gross income if Valkyrie is a: (1) Domestic corporation, (2) Resident Citizen, (3) Resident Alien,
(4) Resident Foreign Corporation.

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 Problem 8.14 CONCURRENT TAXES
Dr. Ken Jeong is a famous celebrity doctor. He is a VAT taxpayer and is subject to 10% expanded withholding tax. The following
are his items of income and expenses during the year.
Professional medical fees from a hospital (gross of VAT and EWT) 2,016,000
Professional medical fees from his clinic (net of VAT and EWT) 432,000
Talent fees from TV guestings (gross of VAT, net of EWT) 2,040,000
Talent fees from endorsements (net of VAT, gross of EWT) 1,450,000
Allowable Deductions 650,000
Compute for his tax due.

Problem 8.15 COMPREHENSIVE

Mang Jose has several interests in various businesses and partnerships. He received the following income during the year.
Dividends from a domestic corporation 120,000
Dividends from a resident foreign corporation 80,000
Share in net income of a business partnership 200,000
Share in net income of a professional partnership 100,000
Share in net income of a joint venture 50,000
Share in net income of a co-ownership 20,000
How much is the total income to be reported in gross income?

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 Problem 8.16 DIVIDENDS
AMC received the dividends from the following sources:
Domestic corporation 245,000
Resident foreign corporation (40% pre-dominance rate) 150,000
Resident foreign corporation (70% pre-dominance rate) 200,000
Non-resident foreign corporation 50,000
Compute the total income to be reported as gross income if AMC is a: (1) Resident Citizen, (2) Non-resident Citizen, (3)
Domestic Corporation, (4) Resident Foreign Corporation.

Problem 8.17 RECOVERY OF PAST DEDUCTIONS

In 2018, Uno Company wrote-off P80,000 worth of receivables. These were fully recovered in 2021. The following were the net
income/(loss) before bad debts expense.
2019 (80,000)
2020 20,000
2021 100,000
Compute for the 2021 taxable income assuming the net income before bad debts expense during 2018 is: (1) P120,000, (2)
P50,000, (3) P70,000.

Regular Income Taxation Gross Income page 47