Chapter 3 - Introduction to Income Tax CHAPTER 3 INTRODUCTION TO INCOME TAXATION Chapter Overview and Objectives This chapter discusses the concept of tax income, th ii types of taxpayers. » the situs of income, and the After this chapter, readers are ex; knowledge on the following: 1. The concept of gross income 2, The types of income taxpayers 3. The general rules in income taxation 4,_The income tax situs rules pected to comprehend and demonstrate THE CONCEPT OF INCOME Why is income subject to tax? Income is regarded as the best measure of taxpayers’ ability to pay tax. It is an excellent object of taxation in the allocation of government costs. What is income for taxation purposes? The tax concept of income is simply referred to as “gross income” under the NIRC. A taxable item of income is referred to as an “item of grass income” or “inclusion in gross income”. Gross income simply means taxable income in layman's term. Under the NIRC however, the term “taxable income” refers to certain items of gross income less deductions and personal exemptions allowable by law. Technically, gross income is broader to pertain to any income that can be subjected to income tax. Gross income is broadly defined as any inflow of wealth to the taxpayer from whatever source, legal or illegal, that increases net worth, It 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 1. Itisa return on capital that increases net worth. tis a realized benefit. [tis not exempted by law, contract, or treaty. 63Chapter 3 - Introduction to Income Tax RETURN ON CAPITAL Capital means any wealth or property. G , property that increases the taxpayer's net worth. ross income is a return on Wealy Mlustration ABC purchased goods for P300 and sold them for p500. The analyzed as follows: P500 consideration ta Selling price (total consideration received) P 500 Total return Return of capital Cost (value of inventory forgone) Mark-up (gross income) p__200 Return on capital The return on capital that increases net worth is income subject to income, Return of capital merely maintains net worth; hence, it is not taxable; improvement in net worth indicates an ability to pay tax. Capital items deemed with infinite value There are capital items that have infinite value and are incapable of pecunz valuation. Anything received as compensation for their loss is deemed a retin capital. Examples: 1. Life 2. Health 3. Human reputation Life The value of life is immeasurable by money. Under Sec. 32 of the NIRG? proceeds of life insurance policies paid to the heirs or beneficiaries upon death! the insured, whether in a single sum or otherwise, are exempt from income t& The proceeds of a life insurance contract collected by an employer as a benefice? from the life insurance of an officer or any person directly interested wit!’ trade are likewise exempt. These proceeds are viewed as advanced recovell future loss. However, the following are taxable return on capital from insurance police a, Any excess amount received over premiums paid by the insured of ; suranga or nee Polley (ie. the insured outlives the policy) . jain realizes the insure i ‘4 mice y ed from the assignment or sale of his i"®* c. Interest income from the unpaid balance of th ie d. Any excess of the proceeds received over the ze he of nol prem payments by an assignee of a life insurance policy one aeeChapter 3 - Introduction to Income Tax Health Any compensation received in consideration for the loss of health such as compensation for personal injuries or tortuous acts is deemed a return of capital. Human Reputation The value of one’s reputation cannot be measured financially. Any indemnity received as compensation for its impairment is deemed a return of capital exempt from income tax. Examples include moral damages received from: a. Oral defamation or slander b. Alienation of affection c. Breach of promise to marry Recovery of lost capital vs. Recovery oflost profits The loss of capital results in decrease in net worth while the loss of profits does not decrease net worth. The recovery of lost capital merely maintains net worth while the recovery of lost profits increases net worth. Therefore, the recovery of lost profits is a return on capital. Taxable recovery of lost profits The recovery of lost profits through insurance, indemnity contracts, or legal suits constitutes a taxable return on capital. The following are taxable recoveries of lost profits: a. Proceeds of crop or livestock insurance b. Guarantee payments | c. Indemnity received from patent infringement suit Illustration 1 : Mang Tomas insured his strawberry crop in a P200,000 crop insurance coverage against calamities. The crop was eventually destroyed by an unusual frost. Mang Tomas was paid the P200,000 insurance proceeds. The P200,000 proceeds which is a reimbursement for the lost value of the future harvest, is an item of gross income. The value of the lost crops is, in effect, realized not through actual harvest but through the insurance’ contract. Ilustration 2 Mr. Santiago purchased a franchise. ‘The franchisor guaranteed an annual franchise income of P100,000 to Mr. Santiago- In the first year of operation, Mr. Santiago's outlet only earned P60,000. The franchisor paid the P40,000 difference to Mr. Santiago.Chapter 3 - Introduction to Income Tax The P49,000 guarantee payment is not a gratuity but a recovery of lost Profit fy Santiago; hence, subject to income tax. Mr. Santiago shall report P100,000 as fp. "| ij ing’ p tra incame, 4) Mlustration 3 \ Mindoro Inc. experienced an unusual decline in its income after a ieee its patented invention. Mindoro Sued the competitor for patent infringemen andy, ‘warded an Indemnity ‘of P3,000,000, The P3,000,000 indemnity isa compensation for the income not realized by Mindorg., to the patent infringement, The same is an item Of gross income. The recovery of Jost income or profits is not intended to compensate capital. Ie is ‘5. good as realization ofincome; hence, itis REALIZED BENEFIT Sor the log, an item of gross income, ‘Whatis Meant by realized benefit? The “benefit” concept The term "benefi benefit when there het worth occurs wh idvantage derived b: '€ net worth of the come, donation of ji y the taxpayer. There taxpayer, An increases inheritance, is an increase in th en one receives in The following are not benefits, hence, not taxable: a Receipt of a loan - Properties increase but obligations also increase resulting in an offse! tting effect in networth Discovery of lost Properties - under the law, the finder has an Obligation ty return the same to the owner c. Receipt of money or property to be held in trust for, or to be remitted ta another person b. If the taxpayer is entitled to keep for his account portion of 4 receipt, only that Portion isa benefit. Mustration : 1. An employee was granted P20,000 transportation advance, He liquidated P1g.000 ‘i ‘ion expenses and was allowed by his employer af transportation expen a Tara by Ms eh tig Only the P2,000 retained by the emp! sy red incon since te 2.08 extent he was benefited. (RR2-98) ives P120,000 from clients, P1a9,9q9 of 204A social recirity guard Under RMC 39-2007, only the pay phi a Se he is considered income of the agency since itis th, extent ity kasd P1000 000 pertaining to salaries of security guards ig Fecopnizay The P100,| kz asa liability upon receipt.‘Chapter 3 - Introduction to Income Tax The “realized” concept The term realized means earned. It re ‘quires that there is a d orsacrifice from the taxpayer tobe entitled of thebenef ens Requisites ofa realized benefit: 4. There must be an exchange transaction, 2, The transaction involves another entity. 3. Itincreases the net worth of the recipient. Types of Transfers 1, Bilateral transfers or exchanges, such as: a Sale b, Barter These are referred to as "onerous transactions”. 2, Unilateral transfers, such as: a, Succession - transfer of property upon death b. Donation These are also referred to as “gratuitous transactions”. Under current usage, unilateral transfers are simply referred to as “transfers” while bilateral transfers are called “exchanges.” Benefits derived from onerous transactions are “earned or realized"; hence, they are subject to income tax. Benefits derived from gratuitous transactions are not realized because of the absence of an earning process. Benefits derived from gratuitous transactions are subject to transfer tax, not income tax. 3. Complex transactions Complex transactions are partly gratuitous and partly onerous. These are commonly referred to as “transfers for less than full and adequate consideration”. The gratuitous portion of the transaction is subject to transfer tax while the benefit from the onerous portion is subject to income tax. Mustration A taxpayer sold his car which was previously purchased for P100,000 and with a Current fair value of P180,000 for only P130,000. The transaction will be analyzed as follows: Falr value P 180,000 } P50,000 - Subject to transfer tax Selling price 130,000 } P30,000 - Subject to income tax fee 100,000Chapter 3 - Introduction to Income Tax ling price is a gratuity or gift whereas the toe i The excess of fair value over se Fgross income. selling price over the cost is an item 0 What is meant by another entity? : Every person, natural or juridical, is an entity. Natural persans os sata while juridical persons are those created by law suc sanronti: A Ps corporations. An entity may be a taxable entity of an i P th + A tay item of gross income arises from transactions which involve another natury, juridical entity. Gains or income derived between relatives, corporations, and between a part, and the partnership are taxable since it is made between separate nti, Likewise, the income between affiliated companies such as between a holding, parent company and its subsidiaries and between sister companies are tani because each corporation is a separate entity. This applies regardless of § underlying economic relationship. However, the sales of a home office to its branch office are not taxable becaut they pertain to one and the same taxable entity. Furthermore, the income betwee businesses of a proprietor should not be taxed since proprietorship businessesar taxable upon the same owner. Note that a proprietorship business is noti juridical entity. Benefits in the absence of transfers The increase in wealth of the taxpayer in the form of appreciation or increase! the value of his properties or decrease in the value of his obligations in absence of a sale or barter transaction is not taxable, These are referred to as unrealized gains or holding gains because they have 1 yet materialized in an exchange transaction. Examples of unrealized gains or holding gains: a. Increase in value of investments in equity or debt securities b. Increase in value of real properties held (revaluation increment) cc. Increase in value of foreign currencies held or receivable 4. Decrease in value of foreign currency denominated debt by virtue of favorabl! fluctuation in exchange rates o Birth of animal offspring, accruals of fruits in an orchard or ae vegetables f. Increase in va e Jue of land due to the discovery of mineral reserves Rendering of eT eacvites for a consideration is an exchange but does not cause # The rendering © oe the entire consideration received from rendering of service’ loss of cap ital, Hence, me or service fees is an item of gross income. j jnco! com nsation in =. “PChapter 3 - Introduction to Income Tax Illustration Mr, Saladin lists the following possible items OE tcc Compensation income Winnings from gambling P ene Increase in value of investments 50,000 Appreciation in the value of land owned 300,000 Debt of Saladin cancelled by creditors in : consideration for services he rendered to them 150,000 Debt of Saladin cancelled by his creditor out of affection 250,000 Loan received from a bank 400,000 ‘The items of gross income are: Compensation income P 200,000 Winnings from gambling 100,000 Debt of Saladin forgiven in consideration for service rendered to his creditors 150,000 Note: 1, Gains from gambling and the forgiveness of debt in consideration of services or properties received are realized gains from exchanges, The forgiveness of debt out of affection or mere generosity of the creditor is a gratuitous transfer subject to transfer tax. 3. The loan received from a bank constitutes a transfer but is not a benefit. 2 Basis of Exemption of Unrealized Income Normally, taxpayers will have the ability to pay tax when their income materializes in an exchange transaction since tax is generally payable in money. This does not mean, however, that only income realized in cash is subject to tax. Income realized in non-cash properties are, in effect, received in cash but the taxpayer used the same to acquire the non-cash property. Income received in non- cash considerations is taxable at the fair value of the property received. Moreover, exempting income realized in non-cash considerations would open a wide avenue for tax evasion since taxpayers can easily divert their income in the form of non- cash consideration. Mode of Receipt/Realization Benefits | . ‘axable items of income may be realized by the taxpayer in two ways: 1. Actual receipt r Actual rectip? involves actual physical taking of the income in the form of cash ©T property. Constructive receipt « ss j Constructive ecatpt tvolve no actual physical taking of the income but the taxpayer is effectively benefited.Chapter 3 - Introduction to Income Tax Examples: | a. Offset of debt of the taxpayer in consideration for the sale of goods or service b, Deposit of the income to the taxpayer's checking account yet encashed c. Matured detachable interest coupons on coupon bonds no! | by the taxpayer ship d. Increase in the capital ofa partner from the profit of the partne! | Inflow of wealth without increase in net worth j< net worth is not The inflow of wealth to a person that does not increase his ne ] income due to the total absence of benefit. Examples: a. Receipt of property in trust ‘’b. Borrowing of money under an obligation to return where money is taken withou tor swindlin % 7 In law, the proceeds of embezzlement 6 ve because of the increase ix an original intention to return are considered as inco! net worth of the swindler, NOT EXEMPTED BY LAW, CONTRACT,ORTREATY = An item of gross income is not exempted by the Constitution, law, contracts or treaties from taxation, The following items of income are exempted by law from taxation; hence, they are not considered items of gross income: 1. Income of qualified employee trust fund 2, Revenues of non-profit non-stock educational institutions 3. SSS, GSIS, Pag-Ibig, or PhilHealth benefits 4. Salaries and wages of minimum wage earners and qualified senior citizen 2 Regula ee of Barangay Micro-business Enterprises (BMBEs) » Income of foreign governments i controlled carport icine sat “orci “government-owned 7. Income of international missions and Organizations with income tax immutil Items of gross income that are exempted from taxatioy under Exclusions in Gross Inco; n are discussed extensit# me in Chapter 8, TYPES OF INCOME TAXPAYERS A. Individuals 1. Citizen a. Resident citizen Non-resident citizen(Ulapest vy — rneweens uy Income Tax 2. Alien a. Resident alien. pb. Non-resident alien a. engaged in trade or business b. 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 INDIVIDUAL INCOME TAXPAYERS. Under the Constitution, citizens are: a. Those who are citizens of the Philippines at the time of adoption of the Constitution on February 2, 1987 b. Those whose fathers or mothers are citizens of the Philippines c. Those born before January 17, 1973 of Filipino mothers who elected Filipino citizenship upon reaching the age of majority d. Those who are naturalized in accordance with the law Slassification 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. Acitizen 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Chapter 3 - Introduction to Income Tax ces AFe Nyy Filipinos working in Philippine embassies or Philippine consulate considered non-resident citizens. Alien b A. Resident alien — an individual who is residing in the philippine’ citizen thereof, such as: 1. An alien who lives in the Philippines without definite intel stay; or ich in 2. One who comes to the Philippines for a definite purpose his ing nature would require an extended stay and to that an nition at all tine, temporarily in the Philippines, although it may be his inte! to return to his domicile abroad; ut iS Not nition aS to hic i his status An alien who has acquired residence in the Philippines re TpalRee a such until he abandons the same or actually departs from B. Non-resident allen - an individual who is not residing in the Philippines arg who is nota citizen thereof . 1. Non-resident aliens engaged in business (NRA-ETB)- aliens who stayei in the Philippines for an aggregate period of more than 180 days duriy the year 2. Non-resident aliens not engaged in business (NRA-NETB) ~ include: a. Aliens who come to the Philippines for a definite purpose which int nature may be promptly accomplished; b. Aliens who shall come to the Philippines and stay therein for 2 aggregate period of not more than 180 days during the year THE GENERAL CLASSIFICATION RULE FOR INDIVIDUALS 1. Intention The intention of the taxpayer regarding the nature it ithi the 1 of his stay within! outside the Philippines shall determine his appropriate reside classification, The taxpayer shall submit to ti proofs such as visas, work contra: he CIR of the BIR document! intention. ets and other documents indicatingChapter 3 - Introduction to Income Tax Examples: a. Analien Is normally non-resident, An alien who come to the Philippines with a tourist visa would still be classified as non-resident alien. b, A citizen is normally resident. A citizen who would go abroad under a tourist visa would still be considered a resident citizen. ¢, An alien who come to the Philippines with an immigration visa would be reclassified as a resident alien upon his arrival. d. A citizen who would go abroad with a two-year working visa would be reclassified as a non-resident citizen upon his departure, 2. Length of stay In default of such documentary proof, the length of stay of the taxpayer is considered: a. Citizens staying abroad for a period of at least 183 days are considered non-resident. b. Aliens who stayed in the Philippines for more than 1 year as of the end of the taxable year are considered resident. c. Aliens who are staying in the Philippines for not more than 1 year but more than 180 days are deemed non-resident aliens engaged in business. d. Aliens who stayed in the Philippines for not more than 180 days are considered non-resident aliens not engaged in trade or business, Illustration 1 Luiz Mario Aresmendi, a Mexican actor, was contracted by a Philippine television company to do a project in the Philippines. He arrived in the country on February 29, 2019 and returned to Mexico three weeks later upon completion of the project. lulz Mario Aresmendi shall be classified as an NRA-NETB in 2019. His stay is for a definite purpose which in its nature will be accomplished immedi ately. Mlustration 2 Mamoud Jibril, a Libyan national, arrived in the country on November 4, 2019, Mr. Vibril stayed in the Philippines since then without any working visa or work permit. For the year 2019, Mr. jibril would be considered an NRA-NETB because he stayed in the Philippines for less than 180 days as of December 31, 2019. If he is still within the Philippines unetl December 31, 2020, he will qualify as a resident alien for 2020. Mustration 3 Without any definite intention as to the nature of his stay, Juan Masipag, a Filipino citizen, left the Philippines and stayed abroad from March 15, 2019 to April 1, 2020 before returning to the Philippines. For the year 2019, Juan is a non-resident citizen because he is absent for more than 183 days but he witl be Classified as resident citizen for the year 2020 because he is absent for 'e8s than 183 days in 2020. 73Chapter 3 - Introduction to income Tax Taxable Estates and Trusts FE : igati oe 1. Fo aie to the properties, rights, and obligations of a deceased Pe, not extinguished by his death. a der judicial settlement are treated as individual taxpayers. cael ‘taxable ‘on the income of the properties left by the decedent. Esta, eae ee aaical settlement are exempt entities. The income of he propétties of the estate under extrajudicial settlement is taxable to the hein, 2. Trust A trust is an arrangement whereby one person (grantor or trustor) transfeq (ie. donates) property to another person (beneficiary), which will be hej under the management of a third party (trustee or fiduciary). A trust that is irrevocably designated by the grantor is treated in taxation asi itis an individual taxpayer. The income of the property held in trust is taxable to the trust. Trusts that are designated as revocable by the grantor are not taxable entities and are not considered as individual taxpayers. The income of Properties held under revocable trusts is taxable to the grantor not to the trust. When the trust agreement is silent as to revocability of the trust, the trust is presumed to be revocable. CORPORATE INCOME TAXPAYERS The term ‘corporation’ shall include partnerships, no matter how created of Organized, joint-stock companies, joint accounts, association, or insurance companies, except general professional partnerships and a joint venture of consortium formed for the purpose of undertaking construction projects of engaging in petroleum, coal, geothermal, and other energy operations pursuant (0 an operating consortium agreement under a service contract with thé government. Hence, the term corporation includes 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 A domestic corporation is a Corporation that is organized in accordance with Philippine laws, Foreign Corporation A foreign corporation is one Organized under a foreign law. 74Chapter 3 - Introduction to Income Tax Types of foreign corporations: 1. Resident foreign corporation (RFC) - a foreign corporation which operates and conducts business in the Philippines through a permanent establishment (i.e- a branch). 2. Non-resident foreign corporation (NRFC) - a foreign corporation which does not operate or conduct business in the Philippines Note: 1. A corporation that incorporates in the Philippines is a domestic corporation under the Incorporation Test even if the same is cantrolled by foreigners. 2. A foreign corporation that transacts business with residents through 2 resident branch ls taxable on such transactions asa resident foreign corporation through its branch. However, if it transacts directly to residents outside its branch, it is taxable as a non-resident foreign corporation on the direct transactions. Special Corporations Special corporations are domestic or foreign corporations which are subject to special tax rules or preferential tax rates. OTHER CORPORATE TAXPAYERS 1. Partnership A partnership is a business organizatiot contribute their industry or resources dividing the profits from the venture. n owned by two or more persons who: to a common fund for the purpose of Types of partnership A) General professional partnership (GPP) AGPP is a partnership formed for the exercise of a common profession. All partners must belong to the same profession. ‘A GPP is not treated as a corporation and is not a taxable entity. It is exempt from income tax, but the partners are taxable in their individual capacity with respect to their share in the income of the partnership. b) Business partnership A business partnership is one formed for p! corporation. — Examples: a. A partnership between Andrix, in taxation advisory services would be a b Partners are not in the same profession. b. A parmership between accountants Zeus and Darrell to venture into a beauty parlor would be a business partnership since the venture is not in practice of 4 common profession. rofit. It is taxable as a a lawyer, and Mark, an accountant, to practice usiness partnership since the twoChapter 3 - introduction to Income Tax d Jasmine May to ventury, n accountants Dominic ani ' E ‘anteetoney eeata bea general professional partnership. 2. Joint venture A joint venture is a business undertaking for a particular purpose. It may, Organized as a partnership or a corporation. Types of joint ventures: a. Exempt joint ventures Exempt joint ventures are those formed for the purpose of undertaly construction projects or engaging in petroleum, coal, geothermal y, other energy operations pursuant to an operating consortium agreems under a service contract with the Government. Similar to a GPP, this type of joint venture is not treated as a corporatig and is tax-exempt on its regular income, but their venturers are taxabley their share in the net income of the joint venture. b. Taxable joint ventures All other joint ventures are taxable as corporations. 3. Co-ownership A co-ownership is joint ownership of a property formed for the purpose ¢ Preserving the same and/or dividing its income. A co-ownership that is limited to property preservation or income collecti® is not a taxable entity and is exempt but the co-owners are taxable on tt share on the income of the co-owned property, However, a co-ownership that reinvests the income of the co-owned prope to other income-producing properties or ventures will be considered? Unregistered partnership taxable as a corporation. THE GENERAL RULES IN INCOME TAXATION Individual taxp Resident citizen Non-resident citizen Resident alien [ Non-residentaten 76eS oe Se eee ee Chapter 3 - Introduction to Income Tax Corporate taxpayers Domestic corporation Resident foreign corporation Non-resident foreign corporation Note: 1, Consistent with the territariality rule, all taxpayers, except resident citizens and domestic corporations, are taxable only on income earned within the Philippines. 2, The NIRC uses the term "without the Philippines” to mean outside the Philippines. The Residency and Citizenship Rule Taxpayers who are residents and citizens of the Philippines such as resident citizen and domestic corporations are taxable on all income from sources within and without the Philippines. A corporation is a citizen of the country of incorporation. Thus, a domestic corporation is a citizen of the Philippines. Basis of the extraterritorial taxation Resident citizens and domestic corporations derive most of the benefits from the Philippine government compared to all other classes of taxpayers by virtue of their proximity to the Philippine government. Under our laws, resident citizens and domestic corporations enjoy preferential privileges over aliens. Also, between resident and non-resident citizens, resident citizens have full access of the public services of our government because they are in the country. The taxation of foreign income of resident citizens and domestic corporations properly reflects this difference in benefits consistent with the Benefit Received Theary. The extra-territorial tax treatment of resident citizens and domestic corporations is also intended as a safety net to the potential loss of tax revenues brought by Situs relocation or the practice of executing or structuring transactions such that income will be realized abroad to avoid Philippine income taxes. The issue of International double taxation ’¢ rule on extraterritorial taxation on resident citizens and domestic ‘orporations exposes these taxpayers to double taxation. However, the NIRC aes a tax credit for taxes paid in foreign countries. in fact, resident citizens and i Mestic corporations pay minimal taxes in the Philippines on their foreign come because of the tax credit. SITUS OF INCOME Hog Situs of income is the place of taxation of income. It is the jurisdiction that has authority to impose tax upon the income. 77Chapter 3 - introduction to Income Tax Situs: of income vs. source of income Situs of income should be differentiated from the source of income. The lay, Pertains to the activity or property that produces the income. Situs is important in determining whether or not an income is taxable in Philippines. Situs is particularly important to taxpayers taxable only on ‘toy, within. However, it is also important to taxpayers taxable on global income purposes of the computation of the foreign tax credit. INCOME SITUS RULES 1. Interestincome Debtor's residence 2. Royalties Where the intangible is employed 3. Rent income Location of the property 4. Serviceincome Place where the service is rendered Mlustration A taxpayer had the following income: 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 executed in the Philippines) 150,000 Professional fees far services rendered in the Philippines to non-resident clients (paid in US Dollars) 400,000 Applying the situs rules, the following are the situs of the aforementioned income i ' Interest on foreign deposits P > P 300000 P 30008 Interest from domestic bonds 50,000 5008 Royalties from books in the Philippines 100,000 100; Rent income on foreign properties 150,000 15 Professional fees 400,000 Total 2350000 p__ 450,000 Resident citizen or domestic corporation taxpayers would be tax on the C4 income while other taxpayers would be taxable only on the income from wt the Philippines.Chapter 3 - Introduction to Incame Tax OTHER INCOME SITUS RULES A. Gain on sale of properties 1, Personal Property ¥ Domestic securities - ¥ Other personal propel sold Presumed earned within the Philippines ties - earned in the place where the property is 2. Real property - earned where the Property is located IMustration A taxpayer had the following income: 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 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 the sale of machineries 250,000 Interest on foreign bonds 50,000 Dividends on domestic stocks —150,000__ Total £.1.100,000 p__350.000 B. Dividend income from: 1. Domestic corporation - presumed earned within 2. Foreign corporation a) Resident foreign corporation - depends on the pre-dominance test The pre-dominance test IF the ratio of the Philippine gross income over the world gross income of the resident foreign corporation in the three-year period Preceding the year of dividend declaration is: ¥ At least 50%, the portion of the dividend corresponding to the Philippine gross income ratio is earned within Y Less than 50%, the entire dividends received is earned abroad b) Non-resident foreign corporation - earned abroad 79 zChapter 3 - Introduction to Income Tax Mustration In 2019, Sarah received a P400,000 dividend income from ABC Corporation ,, Corporation had the following gross income in 2016 through 2018: —2016___ ___2017__ __2018 _ 00 Philippines P 100,000 P 200,000 P 300,000 P 600,0 Abroad ——200,000 __ 100,000 Total P_200,000 P_300,000 Pp 400.000 1,000,000 ane Corporation Is a: Domestic corporation - the entire P400,000 is earned within : Non-resident foreign corporation - the entire P400,000 is earned abroad 3. Resident foreign corporation - the P400,000 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 without the Philippines (40% x P4.00,000) Total dividends Supposing that the ratio is 49%, the entire P400,000 will be deemed eame outside the Philippines. C. Merchandising Income - earned where the property is sold illustration Source of gross income J _ 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 The income earned within and without shall be: —Within _ Without Purchased and sold within P 200,000 Purchased within and sold abroad P 100,000 Purchased abroad and sold within 150,000 Purchased abroad and sold abroad — 250.000 Total P350,000 P_ 450.000 D. Manufacturing income - earned where the goods are manufactured and sold Remark Total income from production and distributio, is earned within the Philippines 7Chapter 3 - Introduction to income Tax Total income from production and distribution is earned without the Philippines Production income is earned within, Distribution income is earned without. Distribution income is earned within, Production income is earned without. IMustration 1 Butuan Inc. manufactures goods and sells them through its branch. Butuan bills its branch at established market prices. Butuan reported the following gross income: Home office __Branch _ __Total__ Sales 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 £.1.600,000 P_ 990,000 P2.400,000 The following shows the situs of the gross income of Butuan under each of the following scenario: Scenario Home office _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, Butuan Inc. 2. The branch is not a separate taxable entity but is an integral part of Butuan Inc. hence, its income is taxable to Butuan Inc. Mustration 2 Assuming production is conducted by a parent corporation and the distribution is conducted by its subsidiary corporation: Parent _Subsidiary. __Total _ Sales 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.1600,000 p_ 800,000 P_2.400,000 The gross income recognized by each corporation is taxable to each corporation use each corporation is a separate taxpayer. The situs of taxation shall be the Place of sale without regard to the seller or the supplier. The following are the situs of income for the parent corporation:Chapter 3 - Introduction to Income Tax No.1 Philigeticy “Subsidiary. —Wwithin— ies ippines Philippines P 1,600,000 P - : Abroad Abroad - 1,600,000 lo.3 Philippines Abroad 1,600,000 : No. 4 Abroad Philippines - 1,600,000 The following are the situs of income for the subsidiary corporation: Scenario ___Parent _ _Subsidiary —Without _ No.1 Philippines Philippines P 800,000 P z No.2 Abroad Abroad - 800,000 No.3 Philippines Abroad - 800,000 No.4 Abroad Philippines 800,000 Note to readers: Readers are advised to master the situs rules as this have a significant effect on your comprehension of advanced tax rules to be introduced in succeeding chapters.