CHAPTER 3 Taxable return on capital from insurance

INTRODUCTION TO INCOME TAXATION policies

Why is income subject to tax?  Excess amount received over premiums
 Income is regarded as the best measure of paid by the insured upon surrender or
taxpayer’s ability to pay tax. maturity of the policy
 It is an excellent object of taxation in the  Gain realized by the insured from the
allocation of government costs assignment or sale of his insurance policy
INCOME FOR TAXATION PURPOSES  Interest income from the unpaid balance of
“GROSS INCOME” – taxable income in the proceeds of the policy
layman’s  Any excess of the proceeds received over
term. Tax concept of income under NIRC the acquisition costs and premium
Taxable income in NIRC refers to certain items payments by an assignee of a life insurance
of policy
gross income less deductions and personal  Health – compensation received in
exemptions allowable by law consideration for the loss of health such as
Taxable item of income – “item of gross compensation for personal injuries or tortuous
income” or acts is deemed a return of capital
“inclusion in gross income”  Human Reputation – any indemnity received
GROSS INCOME – any inflow of wealth to the as
taxpayer (legal or illegal) that increases net compensation for its impairment is deemed a
worth. return of capital exempt from income tax
Ex. income for employment, trade, Ex. moral damages from oral defamation or
business/exercise of profession, income from slander, alienation of affection, breach of
properties promise to marry.
ELEMENTS OF GROSS INCOME Recovery of lost capital vs. Recovery of lost
1. RETURN ON CAPITAL THAT profit
INCREASES NET Loss of Capital Decrease in net worth
WORTH Recover of Lost Capital Merely maintains net
CAPITAL – any wealth or property. Gross worth
income is Los of Profits DO NOT decrease net
a return or wealth or property worth
Ex. purchased goods at 300, sold for 500 Recover of Lost Profits Return on capital
SP 500 Total Return Taxable recovery of lost profits
Cost (300) Return OF Capital - recovery of lost profits through insurance,
Mark-up 200 Return ON Capital indemnity contracts, or legal suits (taxable
RETURN ON CAPITAL – increases net worth. return on
Subject to income tax capital)
RETURN OF CAPITAL – merely maintains net Taxable recoveries of lost profits
worth, not taxable. a) proceeds of crop or livestock insurance
*Improvement in net worth indicates ability to b) guarantee payments
pay c) indemnity received from patent infringement
tax suit
Capital Items with INFINITE VALUE 2. REALIZED BENEFIT
 Life – proceeds from life insurance policies “BENEFIT CONCEPT” – benefit means
paid advantage
to heirs/beneficiaries upon death of insured, derived by taxpayer. There is benefit when net
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an employer as beneficiary from the life worth of taxpayer is increased (increase when
insurance of an officer are exempt from income receives income, donation, or inheritance)
tax. (viewed as advance recovery of future loss) NOT BENEFITS (NOT taxable)
a) Receipt of a Loan – properties and obligation - increase in wealth through appreciation or
increase (off set) decrease in obligation in the absence of a sale or
b) Discovery of lost properties – finder has an barter transaction is NOT TAXABLE. Referred
obligation to return to owner to as
c) Receipt of money property – to be held in UNREALIZED GAINS OR HOLDING GAINS
trust as
for or to be remitted to another person they have NOT yet materialized in an exchange
*if taxpayer is entitled to keep for his account transaction. Examples
portion of a receipt, only that portion is a a. Increase in value of investments in equity or
benefit. debt securities
“REALIZED CONCEPT” – realized means b. Increase in value of real properties held
earned. (revaluation increment)
Requires a degree of undertaking/sacrifice from c. Increase in value of foreign currencies held or
the receivable
taxpayer to be entitled of the benefit. d. Decrease in value of foreign currency
Requisites of a realized benefit denominated debt by virtue of favorable
1. there must be an exchange of transaction fluctuation in exchange rates
2. transaction involves another entity e. Birth of animal offspring, accruals of fruits in
3. increases the net worth of the recipient an
TYPES OF TRANSFERS orchard or growth of farm vegetables
1. Bilateral Transfers or Exchanges – onerous f. Increase in value of land due to the discovery
transactions; benefits are “earned or realized” of
thus subject to income tax mineral reserves
a. Sale Rendering of Services – considered an exchange
b. Barter but does NOT cause a loss of capital. Hence,
2. Unilateral Transfers or Transfers – entire
gratuitous consideration received (compensation income,
transactions; benefits are NOT realized services fee) is an item of gross income.
because of the absence of an earning process. Ex. debt cancelled in consideration for services
Subject to TRANSFER TAX, NOT income tax rendered. This is considered realized gains from
a. Succession – transfer of property upon exchanges thus an item of gross income.
death BASIS OF EXEMPTION OF UNREALIZED
b. Donation INCOME
3. Complex Transactions – partly gratuitous and - income received in NON-cash consideration is
partly onerous; “transfers for less than full and taxable at the FV of property received.
adequate consideration”. Gratuitous portion MODE OF RECEIPT/REALIZATION
subject to TRANSFER TAX, while Onerous BENEFITS
portion is subject to INCOME TAX. taxable income may be realized by taxpayer in:
Ex. excess of FV over selling price is gratuity, 1. Actual Receipt – actual physical taking of
excess of SP over cost is item of gross income. income in form of cash or property
NOTES: 2. Constructive Receipt – NO actual physical
- sales of a home office to its branch office are taking of income, but the taxpayer is effectively
NOT benefited (ex. offset of debt, deposit of income
taxable as they pertain to one and the same in checking account)
taxable entity. Inflow of wealth without increase in net worth
- income between businesses of proprietor - inflow that does NOT increase net worth is
should income
NOT be taxed since proprietorship business are due to total absence of benefit
taxable upon the same owner. Examples: receipt of property in trust,
BENEFITS IN THE ABSENCE OF borrowing
TRANSFERS money under an obligation to return (LOAN)
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lOMoARcPSD|13628712  Father and mother are citizen of PH
*proceeds of embezzlement or swindling where  Born before Jan. 17, 1973 of Filipino Mothers
money is taken without original intention to who elected Filipino citizenship upon reaching
return is the age of majority
considered income because of the increase in net  Naturalized in accordance with the law
worth of the swindler. Classification of Citizens
3. NOT EXEMPTED BY LAW, A. Resident Citizen – filipino citizen residing in
CONTRACT, OR PH
TREATY B. Non-resident Citizen
- item of gross income is NOT exempted by the  Citizen of PH with physical presence
Constitution, law, contracts of treaties from
abroad with a definite intention to reside
taxation.
therein
Following items are exempted by LAW from
 Leaves PH during taxable year to reside
taxation (NOT considered items of gross
income): abroad (immigrant or employment on
1. Income of qualified employee trust fund permanent basis)
2. Revenues on non-profit, non-stock  Citizen of PH who works and derives
educational income from abroad and whose
institutions (ex. AdDU) employment threat requires him to be
3. SSS, GSIS, Pag-IBIG, or PhilHealth benefits physically present abroad most of the
4. Salaries and Wages of Minimum Wage time during the taxable year
earners  Citizen previously considered as NONresident
and qualified senior citizen citizen who arrives in the PH at
5. Regular income of barangay Micro-business anytime during the taxable year to
enterprise (BMBEs) reside permanently in PH shall be
6. Income of foreign governments and foreign treated as NON-resident citizen for the
Government owned controlled corporations taxable year in which he arrives in the
(GOCC) PH with respect to his income derived
7. Income form international missions and from sources abroad until the date of his
organizations with income tax immunity arrival in the PH
TYPES OF INCOME TAXPAYERS *Filipinos working in PH embassies or PH
A. INDIVIDUALS consulate offices are NOT considered non-
1. Citizen resident
a. Resident Citizen citizens.
b. Non-Resident Citizen Alien
2. Alien 1. Resident Alien – residing in the PH but is
a. Resident Alien NOT
b. Non-Resident Alien citizen
i. Engaged in trade or business  Lives in the PH without definite intention
ii. NOT engaged in trade or as to his intention
business  Comes to PH for a definite purpose
3. Taxable estates and trust which in its nature would require an
B. CORPORATIONS extended stay and to that end makes his
1. Domestic Corporation home temporarily in the PH although
2. Foreign Corporation intention at all times is to return to his
a. Resident foreign Corporation domicile abroad
b. Non-Resident Foreign Corporation *if acquired residence in PH retains his
INDIVIDUAL INCOME TAXPAYERS status as such until he abandons the same
Citizens or actually departs from the PH
 Citizens of PH at time of adoption of 2. Non-Resident Alien – NOT residing in PH
Constitution on Feb. 2, 1987 retains his status as such until he abandons the
same or actually departs from PH income of properties left.
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lOMoARcPSD|13628712 - Estates under extrajudicial settlement are
a. Non-Resident Aliens Engaged in exempt entities. Income under these properties
Business (NRA-ETB) – aliens who is taxable to the heirs
stayed in PH for an aggregate period of 2. TRUST
MORE THAN 180 days during the year - An arrangement where one person
b. Non-Resident Aliens NOT Engaged in (grantor/trustor) transfers (donates) property to
Business (NRA-NETB) another person (beneficiary), which will be held
i. Comes to PH for a definite under the management of a third party
purpose which in its nature may (trustee/fiduciary)
be promptly accomplished - Trust irrevocably designated by the grantor is
ii. Comes to PH and stay therein treated as if it’s an individual taxpayer
for aggregated period for NOT - Income of property held in trust is taxable to
more than 180 days during the the
year trust
THE GENERAL CLASSIFICATION RULE - Trust designated as revocable by grantor are
FOR NOT taxable entities and NOT considered as
INDIVIDUALS individual taxpayers. Income is taxable to the
1. Intention – the intention shall determine his grantor
appropriate residential classification. Taxpayers - When trust agreement is silent as to
submit to the CIR of the BIR documentary revocability, presumed to be revocable
proofs (visas, work contracts, etc.) indicating CORPORATE INCOME TAXPAYERS
intention. Documents with short term stay Term ‘corporation’ includes OPC (One Person
(tourist visa) shall NOT result in reclassification Corporation), partnerships, joint-stock
of normal residency. If long-term stay companies,
documents (immigration visa, working visa) for joint accounts, associations, insurance
an extended period would result to automatic companies
reclassification of residency (EXCEPT: general professional partnerships,
2. Length of Stay – in default of such joint
documentary proof, the length of stay is venture in consortium formed for undertaking
considered: construction project or engaging petroleum,
a. Citizens staying abroad for a period of at coal,
least 183 days are considered nonresident. geothermal and other energy operations pursuant
b. Aliens who stayed in PH for more than 1 to an operating consortium agreement under
year as of the end of taxable year are service contract with the govt). hence,
considered resident corporation
c. Aliens who are staying in PH for not includes profit-oriented and non-profit
more than 1 year, but more than 180 institution
days are deemed non-resident aliens (charitable institutions, cooperatives,
engaged in business government
d. Aliens who stayed in PH for NOT more agencies and instrumentalities, associations,
than 180 days are considered nonresident leagues, civic or religious and other
aliens NOT engaged in trade or organizations.
business DOMESTIC CORPORATION – organized in
TAXABLE ESTATES AND TRUSTS accordance with PH laws. Includes OPC owned
1. ESTATE and registered by resident citizens in PH. Still a
- Refers to properties, rights, and obligation of domestic corporation if controlled by foreigners
deceased person NOT extinguished by his but
death. incorporated in PH
- Estates under judicial settlement are treated as FOREIGN CORPORATION – organized under
individual taxpayers. Estate is taxable on foreign law
TYPES OF FOREIGN CORPORATION preserving the same and/or dividing its income.
1. RESIDENT FOREIGN CORPORATION - If limited to property preservation or income
(RFC) collection, NOT taxable entity but co-owners are
– operates and conducts business in PH taxable on their share on income of co-owned
through permanent establishment (ex. branch). property.
taxable on transaction through branch - If reinvests income of co-owned property to
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2. NONRESIDENT FOREIGN will be considered an unregistered partnership
CORPORATION – taxable as corporation
does NOT operate or conduct business in PH. THE GENERAL RULES IN INCOME
Transacts directly to residents outside its TAXATION
branch, taxable on the direct transactions. Taxable On Income Earned
SPECIAL CORPORATIONS – domestic or INDIVIDUAL
foreign TAXPAYERS
corporation subject to special tax rules or WITHI
preferential tax rates. N
OTHER CORPOARATE TAXPAYERS WITHOUT
1. One Person Corporation (OPC) – single (outside
stockholder (can be natural, trust, or estate). PH)
Banks etc. and practice for procession cannot Resident Citizen / /
incorporate as OPC. Non-Resident Citizen /
2. Partnership Resident Alien /
a. General Professional Partnership Non-Resident Alien /
(GPP) – sole purpose of exercising CORPORATE
profession (NO part of income can TAXPAYERS
be derived from trade or business). Domestic Corporation / /
NOT treated as corporation and is Resident Foreign
NOT a taxable entity. Exempt from Corporation
income tax but partners are taxable /
individually with respect to share in Non-Resident Foreign
income of the partnership. (ex. Corporation
practice in same professions – both /
accountants) Note: “territoriality rule” – ALL taxpayers
b. Business Partnership – formed for (except
profit. Taxable as corporation. (ex. resident citizens and domestic corporations) are
practice of two different profession – taxable only on income earned within the PH
atty and accountant) THE RESIDENCY AND CITIZENSHIP RULE
3. Joint Venture Resident Citizens of PH and Domestic
a. Exempt Joint Ventures – for purpose Corporations – taxable on ALL income from
of undertaking construction projects sources WITHIN and WITHOUT
or engaging petroleum, coal, *corporation is a citizen of the country where it
geothermal and other energy incorporated.
operations. NOT treated as BASIS OF THE EXTRATERRITORIAL
corporation thus tax-exempt on TAXATION
regular income, but venturers are Resident citizens and domestic corporation have
taxable on share on net income of full access on benefits from government. The
JV taxation on their foreign income properly
b. Taxable Joint Ventures – other than reflects
JV (residual) this difference in benefits consistent with the
4. Co-Ownership Benefit Received Theory. The extraterritorial
- joint ownership of property formed for treatment is intended as a safety net to the
potential loss of tax revenues brought by situs i. Resident Foreign Corporation –
relocation or practice of executing or structuring depends on predominance test
transaction transactions such that income will be ii. Non-Resident Foreign
realized abroad to avoid PH income taxes. Corporation – earned abroad
ISSUE OF INTERNATIONAL DOUBLE *PRE-DOMINANCE TEST – if ratio of PH
TAXATION gross
Rule on extraterritorial taxation exposes resident income over world gross income of the resident
citizens and domestic corporation to DOUBLE foreign corporation in the three-year period
TAXATION. However, NIRC allows a tax preceding the year of dividend declaration is:
credit for  At least 50% the portion of the dividend
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corresponding to the PH gross income ratio
taxes paid in foreign countries. They also pay is earned within
minimal taxes in PH on their foreign income  Less than 50%, the entire dividends are
because of tax credit. earned abroad
SITUS OF INCOME – place of taxation of NOTE: If ratio is less than 50% then the gross
income. income from abroad will be deemed earned
It is the jurisdiction that has the authority to outside
impose the PH, thus dividends will NOT be split to
tax upon the income. Determines whether or not Within/Without PH (Refer to page 80)
an C. Merchandising Income – earned where the
income is taxable in the PH. Particularly property is sold
important D. Manufacturing Income – earned where the
to taxpayers taxable only on income WITHIN goods are manufactured and sold
but OPERATIONS REMARK
also important on global income for computation PRODUCTION DISTRIBUTION
of Within Within Total Income from
foreign tax credit. production and
SOURCE OF INCOME – pertains to distribution earned
activity/property that produces the income WITHIN the PH
(different with SITUS OF INCOME) Without Without Total Income from
INCOME SITUS RULES the production and
Types of Income Place of Taxation (situs) distribution is earned
1. Interest Income Debtor’s Residence WITHOUT the PH
2. Royalties Where the intangible is Within Without Production Income
employed is earned within,
3. Rent Income Location of Property Distribution Income
4. Service Income Place where service is is earned WITHOUT
rendered Without Within Distribution Income
OTHER INCOME SITUS RULES is earned within,
A. Gain on Sale of Properties Production Income
a. Personal Property – is earned WITHOUT
i. Domestic Securities – presumed NOTE: page 82
earned within PH  Home Office and Branch – NOT separate
ii. Other Personal Properties –  Parent and Subsidiary - Separate
earned where property is sold
b. Real Property – earned where the
property is located
B. Dividend Income
a. Domestic Corporation – presumed
earned within
b. Foreign Corporation