Module 6

Introduction to Income Tax

This lesson discusses the Concept of tax Income, the situs of income, and the types of taxpayers.

After this lesson, readers are expected to comprehend and demonstrate knowledge on the
following:

1. The general rules in income taxation

2. The income tax situs rules

THEGENERAL CLASSIFICATION RULE FOR INDIVIDUALS

1. Intention
The intention of the taxpayer regarding the nature of his stay within or outside the Philippines
shall determine his appropriate residency classification. The taxpayer shall submit to the CIR of
the BIR documentary proofs such as visas, work contracts and other documents indicating such
intention.

Documents purporting short term stay such as tourist visa shall not result in the reclassification
of the taxpayer‟s normal residency. Documents purporting a long-term stay such as immigration
visa or working visa for an extended period would result in the automatic reclassification of the
taxpayer residency.

Examples:
a. An alien 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.
c. 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 0f 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.

Luiz 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 immediately.

Illustration 2
Mamoud jibril, a Libyan national, arrived in the country on November 4 2019. Mr. Jibril stayed
in the Philippines since then without any working visa or work permit.

For theyear 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
until December 3l, 2020, he will qualify as a resident alien for 2020.

Illustration 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 will be classified as resident citizen for the year 2020 because he is absent for less than
183 days in 2020.

Taxable Estates and Trusts

1. Estate
Estate refers to the properties, rights, and obligations of a deceased person not extinguished by
his death.

Estates under judicial settlement are treated as individual taxpayers. The estate is taxable on
income of the properties left by the decedent. Estates under extrajudicial settlement are exempt
entities. The income of the properties of the estate under extrajudicial settlement is taxable to the
heirs.

2. Trust
A trust is an arrangement whereby one person (grantor or trustor) transfers (i.e. donates) property
to another person (beneficiary), which will be held under the management of a third party
(trustee or fiduciary).

A trust that is irrevocably designated by the grantor is treated in taxation as if it is 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 or organized, joint-
stock companies, joint accounts, association, or insurance companies, except general
professional partnerships and a joint venture or consortium formed for the purpose of
undertaking construction projects or engaging in petroleum, coal, geothermal, and other energy
operations pursuant to an operating consortium agreement under a service contract with the
government.

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.

Types of foreign corporations:

1. Resident foreign corporation (RFC)- a foreign corporation which operates andconducts

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 controlled by foreigners.
2. A foreign corporation that transacts business with residents through a resident branch is taxable on such
transactions as a 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 organization owned by two or more persons who contribute
theirindustry or resources to a common fund for the purpose of dividing the profits from
theventure.

Types of partnership

a) General professional partnership (GPP)

A GPP 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 profit. It is taxable as a corporation

Example
a. Partnership between Andrix, a lawyer, and Mark, an accountant, to practice In taxation
advisory services would be a business partnership since the two partners are not in the same
profession
b. A Partnership between açcountants Zeus and Darrell to venture into a beauty parlor would be
a business partnership since the venture is not in practice of a common profession.
c. A partnership between accountants Dominic and Jasmine May to venture into audit services
would be a 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 undertaking construction projects or
engaging in petroleum coal, geothermal and other energy operations pursuant to an operating
consortium agreement under a service contract with the Government.

Similar to a GPP, this type of joint venture is not treated as a corporation and is tax-exempt on its
regular income, but their venturers are taxable 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 of preserving the same
and/or dividing its income.

A co-ownership that is limited to property preservation or income collection is not a taxable

entity and is exempt but the co-owners are taxable on their share on the income of the co-owned
property.

However, a co-ownership that reinvests the income of the co-owned property to other income-
producing properties or ventures will be considered a unregistered partnership taxable as a
corporation.

THE GENERAL RULES IN INCOME TAXATION

Taxable on income earned

Individual taxpayers Within Without
Resident citizen / /
Non-resident citizen /
Resident alien /
Non-resident alien /
Corporate taxpayers
Domestic corporation / /
Resident foreign corporation /
Non-resident foreign corporation /
Note:
1. Consistent with the territoriality rule, all taxpayers, except resident citizens and domestic corporation 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 Theory.

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

The rule on extraterritorial taxation on resident citizens and domestic corporations exposes these
taxpayers to double taxation. However, the NIRC allows a tax credit for taxes paid in foreign
countries. In fact, resident citizens and domestic corporations pay minimal taxes in the
Philippines on their foreign income because of the tax credit.

SITUS OF INCOME
The situs of income is the place of taxation of income. It is the jurisdiction that has the authority
to impose tax upon the income.

Situs of income vs. source of income

Situs of income should be differentiated from the source of income. The latter pertains to the
activity or property that produces the income.

Situs is important in determining whether or not an income is taxable in the Philippines. Situs is
particularly important to taxpayers taxable only on income within. However, it is also important
to taxpayers taxable on global income purposes of the computation of the foreign tax credit.

INCOME SITUS RULES

Types of Income Place of taxation (situs)

1. Interest income Debtor‟s residence
2. Royalties Where the intangible is employed
3. Rent income Location of the property
4. Service income Place where the service is rendered

Illustration
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 for 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:
Within Without World Total
Interest on foreign deposit P - P 300,000 P 300,000
Interest from domestic bond 50,000 50,000
Royalties from books in the Philippines 100,000 100,000
Rent income on foreign properties 150,000 150,000
Professional fees 400,000 400,000
Total 550,000 450,000 1,000,000
Resident Citizen or domestic corporation taxpayers would be tax on the world income while
other taxpayers would be taxable only on the income from within the Philippines

OTHER INCOME SITUS RULE

A. Gain on sale of properties

1. Personal property
√ Domestic securities- presumed earned within the Philippines
√ Other personal properties- earned in the place where the property is
2. Real Property- earned where the property is located

Illustration
A taxpayer had the following income:

Gain on sale of domestic stock P 200,000

Gain on sale of foreign bonds 100,000
Gain on sale of a commercial lot in Baguio City 500,000
Gain on sale of car in Ontario, Canada 200,000
Gain on sale of machineries in Mexico, Pampanga 250,000
Interest income on foreign bonds 50,000
Dividends on domestic stocks 150,000

The following table summarizes the situs of the foregoing income:

Within Without
Gain on sale of domestic stocks 200,000
Gain on sale of foreign bonds 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 P 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 predominance 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
√ Less than 50%, the entire dividends received is earned abroad

b) Non-resident foreign corporation- earned abroad

Illustration
in 2019, Sarah received a P 400,000 dividends income from ABC Corporation. ABC Corporation
had the following gross income in 2016 through 2018:

(In Php) 2016 2017 2018 Total

Philippines 100,000 200,000 300,000 600,000
Abroad 200,000 100,000 100,000 400,000
Total 300,000 300,000 400,000 1,000,000

If ABC Corporation is a:
1. Domestic corporation- the entire P 400,000 is earned within
2. Non-resident foreign corporation- the entire P 400,000 is earned abroad
3. Resident foreign corporation- the P 400,000 dividend shall split

Gross Income = P 600,000/P 1,000,000 = 60%

Earned within the Philippines (60% x P400,000) 240,000

Earned without the Philippines (40% x P400,000) 160,000
Total dividends 400,000

Supposing that the ratio is 49% the entire P 400,000 will be deemed earned outside the
Philippines.
C. Merchandising Income- earned where the property is sold

Illustration

Source of gross income Amount in Php

Goods purchased and sold within 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 200,000
Purchased within and sold abroad 100,000
Purchased abroad and sold within 150,000
Purchased abroad and sold abroad _______ 350,000
Total 350,000 450,000

D. Manufacturing Income- earned where the goods are manufactured and sold

Operations
Production Distribution Remark
Within Within Total income from production and distribution is earned within the
Philippines
Without Without Total income from production and distribution is earned without the
Philippines
Within Without Production income is earned within, Distribution income is earned
without
Without Within Distribution income is earned within, Production income is earned
without
Illustration 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:

(In Php) Home Office Branch Total

Sale 4,000,000 2,000,000 6,000,000
Cost of goods sold 2,400,000 1,200,000 3,600,000
Gross Income 1,600,000 800,000 2,400,000

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 2,400,000 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.

Illustration 2
Assuming production is conducted by a parent corporation and the distribution is conducted by
its subsidiary corporation:

(In Php) Parent Subsidiary Total

Sale 4,000,000 2,000,000 6,000,000
Cost of goods sold 2,400,000 1,200,000 3,600,000
Gross Income 1,600,000 800,000 2,400,000

The gross income recognized by each corporation is taxable to each corporation because each
corporation is a separate taxpayer. The situs of taxation shall be the place of sale without regard
to the seller or the supplier

The following are the situs of income for the parent corporation:

Scenario Home office Branch Within Without

No.1 Philippines Philippines 1,600,000 -
No.2 Abroad Abroad - 1,600,000
No.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 Home office Branch Within Without

No.1 Philippines Philippines 800,000 -
No.2 Abroad Abroad - 800,000
No.3 Philippines Abroad - 800,000
No.4 Abroad Philippines 800,000 -