Chapter 3

Income Taxation – Introduction to Income Taxation

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I. CONCEPT OF INCOME
 Income is regarded as the best measure of taxpayers’ ability to pay tax.

Definition of income for taxation purposes?

 The tax concept of income is simply referred to as “gross income” wherein “gross income” is broadly defined
as any inflow of wealth to the taxpayer from whatever source, legal or illegal, that increases net worth.

II. ELEMENTS OF GROSS INCOME

1. It is a 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

Illustration:
Memeyu purchased goods for P300 and sold them for P500. The P500 is analyzed as follows:
Selling price (total consideration received) P500 Total return
Cost (value of inventory sold) P300 Return of capital
Mark-up (gross income) P200 Return on capital

Capital items deemed with infinite value

A. Life – value of life is immeasurable by money
 Proceeds of life insurance policies paid to their beneficiaries upon death of the insured are
exempt from income tax
 Gain from sale of insurance policies and interest from unpaid balance of proceeds of the policy
are taxable return on capital
B. Health
 Compensation for personal injuries or tortuous acts is deemed return of capital
C. Human reputation
 Examples are slander, alienation of affection or breach of promise to marry

 Recovery of lost capital – merely maintains net worth; not taxable

e.g. Junjun lost a P1,000 bill last week and found it today
 Recovery of lost profits – increases net worth; taxable
e.g. Jonjon lost his inventories from flood, however, he received P100,000 insurance

2. It is a realized benefit
A. The “benefit” concept
 Increase in net worth in the form of income, donation or inheritance
B. The “realized” concept
 Realized means “earned”
 It requires that there is a degree of undertaking from the taxpayer to be entitled of the benefit

Requisites of a realized benefit:

i. There must be an exchange transaction
Types of transfers
Reference: Income Taxation, 2019 OBE Edition, Rex B. Banggawan, CPA, MBA
Chapter 3
Income Taxation – Introduction to Income Taxation
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 Bilateral or onerous transfers – e.g. sale and barter
 Unilateral or gratuitous transfers – e.g. donation and succession
 Complex transactions – partly onerous and partly gratuitous

ii. The transaction involves another entity

 Every person, natural or juridical, is an entity
 Partnerships & corporations have separate juridical personality
 However, sole proprietorships don’t, so any transactions between businesses under the same
owner is not considered as involving another entity
iii. It increases the net worth of the recipient

Mode of Receipt/Realization Benefits

A. Actual receipt
 Involves physical taking of the income in the form of cash or property
B. Constructive receipt
 Involves no physical taking of the income but taxpayer is effectively benefitted
i. Offset of debt in consideration for sale of goods/services
ii. Increase in the capital of a partner from the profit of the partnership

3. It is not exempted by law, contract or treaty

III. TYPES OF INCOME TAXPAYERS

A. Individuals
1. Citizen
a. Resident citizen
b. Non-resident citizen
2. Alien
a. Resident alien
b. Non-resident alien
i. Engaged in trade or business
ii. Not engaged in trade or business
3. Taxable estates and trusts

B. Corporations
1. Domestic corporation
2. Foreign corporation
a. Resident foreign corporation
b. Non-resident foreign corporation

IV. INDIVIDUAL INCOME TAXPAYERS

Under the Constitution, citizens are:
1. Those who are citizens of the Philippines at the time of adoption of the Constitution on February 2, 1987.
2. Those whose fathers or mothers are citizens of the Philippines.
3. Those born before January 17, 1973 of Filipino mothers who elected Filipino citizenship upon reaching the
age of majority
4. Those who are naturalized in accordance with the law
Reference: Income Taxation, 2019 OBE Edition, Rex B. Banggawan, CPA, MBA
Chapter 3
Income Taxation – Introduction to Income Taxation
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Classification of citizens:
A. Resident citizen – a Filipino citizen residing in the Philippines
B. Non-resident citizen includes;
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 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 an 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 non-resident citizen and who arrives in the
Philippines at anytime during the taxable year to reside permanently in the Philippines shall likewise
be treated as a non-resident 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
C. Resident alien – an individual residing in the Philippines but is not a citizen thereof
D. Non-resident alien – an individual not residing in the Philippines and not a citizen thereof
1. Non-resident aliens engaged in business (NRA-ETB) – stayed for a total period of more than 180
days during the taxable year
2. Non-resident aliens not engaged in business (NRA-NETB) – stayed for a total period of 180 days or
below during the taxable year

General classification rule as to length of stay

A. Citizens staying abroad for at least 183 days are considered non-resident
B. Aliens;
i. More than 1 year in the Philippines at the end of taxable year – Resident
ii. More than 180 days but not more than 1 year – NRA-ETB
iii. Not more than 180 days – NRA-NETB

V. CORPORATE INCOME TAXPAYERS

 The term ‘corporation’ shall include partnerships, except general professional partnerships, and cooperatives,
as well as non-profit institutions

Classification of Corporations:
A. Domestic Corporation – organized in accordance with Philippine laws
B. Foreign Corporation – organized under a foreign law
i. Resident foreign corporation - foreign corporation which operates in the Philippines
ii. Non-resident foreign corporation – foreign corporation which does not operate in the Philippines

Other Corporate Taxpayers

A. Partnership
i. General Professional Partnership
ii. Business Partnership

B. Joint Venture
C. Co-ownership

VI. GENERAL RULES IN INCOME TAXATION

Taxable on income earned
Within Without
Resident citizen  
Non-resident citizen 

Reference: Income Taxation, 2019 OBE Edition, Rex B. Banggawan, CPA, MBA
Chapter 3
Income Taxation – Introduction to Income Taxation
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Resident alien 
Non-resident alien 

Domestic corporation  
Resident foreign corporation 
Non-resident foreign corporation 

VII. SITUS OF INCOME

 It is the place of taxation of income
 It is the jurisdiction that has the authority to impose tax upon the income

Income Situs Rules

Types of Income Place of taxation (situs)

A. Interest income Debtor’s residence
B. Royalties Where the intangible is employed
C. Rent income Location of the property
D. Service income Place where the service is rendered
E. Income from sale of goods Place where the goods are sold
F. Gain on sale of personal properties
 Domestic securities Presumed earned within the Philippines
 Other personal properties Where the property is sold
G. Gain on sale of real properties Where the property is located
H. Dividend income from:
 Domestic corporation Presumed earned within
 Resident foreign corporation Apply pre-dominance test
 Non-resident foreign corporation Earned abroad

Reference: Income Taxation, 2019 OBE Edition, Rex B. Banggawan, CPA, MBA