Bachelor of Science in Accountancy

INCLUSION IN GROSS
INCOME
ITEMS OF GROSS INCOME SUBJECT TO RIT
1. Compensation for services in whatever form paid
2. Gross income from the conduct of trade, business, or exercise of a profession
3. Gains derived from dealings in properties
4. Interest
5. Rents
6. Royalties
7. Dividends
8. Annuities
9. Prizes and winnings
10. Pensions
11. Partner’s distributive share from the net income of general professional
partnership
1. COMPENSATION FOR SERVICES
Compensation income 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.

Compensation income is separately discussed in Chapter 10.

ILLUSTRATION
Problem 1-2

Mr. Darlow, a supervisory employee, received the following income in 2024:

Gross compensation income, before contributions

to SSS, PhilHealth, and HDMF totaling P124,000 P 800,000
Fringe benefits 200,000
Gain from redemption of shares in a mutual fund 100,000
Commission income 150,000
Gain on sale of stocks through the PSE 400,000

Answer: 800,000 – 124,000 + 150,000 = 826,000

ILLUSTRATION
Problem 1-4

Mary resigned in 2024 after 12 years of service. She had the following income
during the year:

Salary, net of P80,000 withholding tax, P20,000 SSS,

P18,000 Philhealth and P40,000 13th month pay P 480,000
Separation pay 1,000,000

Compute the gross income subject to progressive (regular) tax.

Answer: 480,000 + 80,000 + 1,000,000 = 1,560,000

2. GROSS INCOME FROM THE CONDUCT OF TRADE,
BUSINESS OR EXERCISE OF A PROFESSION
This includes income from any trade or business, legal or illegal, and whether
registered or unregistered.

Sales/Revenue/Receipts/Fees xxx
Less: Cost of sales or services (xxx)
Gross income from operations xxx
2. GROSS INCOME FROM THE CONDUCT OF TRADE,
BUSINESS OR EXERCISE OF A PROFESSION
The following business income shall not be included in gross income subject to
regular income tax:

1. Business income exempt from income tax such as:

a. Gross income from a Barangay Micro-Business Enterprise (BMBE) under
RA 9178
b. Gross income from enterprises enjoying tax holiday incentives under the
CREATE law which have not yet graduated to their income tax holiday
incentives
2. Business income subject to special tax such as:
a. PEZA-registered enterprises subject to 5% gross income tax
b. TIEZA-registered enterprises subject to 5% gross income tax
c. Income of self-employed and or individuals who opted to be taxed unde
the 8% income tax
2. GROSS INCOME FROM THE CONDUCT OF TRADE,
BUSINESS OR EXERCISE OF A PROFESSION
The following business income shall not be included in gross income subject to
regular income tax:

3. Business income subject to final tax when not subject to final tax by the payor
a. Subcontractors of petroleum service contractors subject to 8% final tax
b. Business income of foreign currency deposit units (FCDUs) and expanded
FCDUs (eFCDUs) from Philippine residents subject to 10% final tax
ILLUSTRATION
Problem 1-5

Iriga Corporation is engaged in the sales of goods. It reported the following

summarized financial statement during the year:

Sales P 3,500,000
Less: Cost of sales 2,000,000
Gross Profit P 1,500,000
Commission income on consignment 200,000
Interest income on customers 20,000
Interest income, net of final tax 10,000
Dividend income 50,000
Total Income P 1,780,000
Less: Admin & Selling Expenses 1,000,000
Net Income P 780,000
Answer: 1,500,000 + 200,000 + 20,000 = 1,720,000
3. GAINS FROM DEALINGS IN PROPERTIES
The gains or losses in dealing in ordinary assets are subject to regular income
tax. Dealings in capital assets other than domestic stocks and real properties are
also subject to regular income tax.

The tax rules on measurement and recognition of gains from dealings in

properties are discussed in detail in Chapter 12.
4. INTEREST INCOME
This particularly refers to interest income other than passive interest income
subject to final tax.
Examples of interest income subject to regular income tax:
1. Interest income from lending activities to individuals and corporations by
banks, finance companies, and other lenders
2. Interest income from corporate bonds and promissory notes
3. Interest income from bank deposits abroad

Exempt interest income

1. Interest income earned by landowners in disposing their lands to their tenants
pursuant to the Comprehensive Agrarian Reform Law
2. Imputed interest income (the opportunity cost of money)
ILLUSTRATION
Problem 1-6

Cordova, Inc., a domestic corporation, reported the following income in 2024:

Philippines Abroad
Service fees P 400,000 P 300,000
Interest income – bank 40,000 70,000
Royalties – franchise 80,000 30,000

Compute the total gross income subject to regular income tax

Answer: 400,000 + 300,000 + 70,000 + 30,000 = 800,000

5. RENTS
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
Special considerations on rent
1. Obligations of the lessor that are assumed by the lessee are additional rent
income to the lessor
2. Advance rentals are
a. Item of gross income upon receipt if:
i. Unrestricted or
ii. Restricted to be applied in future years or upon the termination of
the lease
b. Not an item of gross income if:
i. It constitutes a loan
ii. It is a security deposit to guarantee payment or rent subject to
contingency which may or may not happen
5. RENTS
3. 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.
1. Outright method
The lessor may report as income the fair market value of such buildings or
improvements subject to the lease at the time when such buildings or
improvements are completed
2. Spread-out method
The lessor may report as income the fair market value of such buildings or
improvements subject to the lease at the time when such buildings or
improvements are completed
5. RENTS
2. Spread-out method
The lessor may spread over the life of the lease the estimated depreciated value
of such buildings or improvements at the termination of the lease and report as
income for each year of the lease an aliquot part thereof.

Cost of improvement x Excess useful life over lease term

Useful life of the improvement
5. RENTS
Illustration

On January 1, 2023, Ivan leased a vacant lot to Greg under a 20-year lease
contract. Greg immediately constructed a building on the lot at a total cost of
P4,500,000. The building has useful life of 30 years.

How much is the gross income?

A. Outright method = P4,500,000

5. RENTS
Illustration
On January 1, 2023, Ivan leased a vacant lot to Greg under a 20-year lease
contract. Greg immediately constructed a building on the lot at a total cost of
P4,500,000. The building has useful life of 30 years.

How much is the gross income?

B. Spread-out method
User Years of usage Allocation Cost
Lessee 20 20/30 x P4,500,000 P3,000,000
Lessor 10 10/30 x P4,500,000 1,500,000
Total 30 P4,500,000

Under the spread-out method, Ivan shall spread the P1,500,000 income over 20
periods or recognize an annual income of P75,000 (i.e. 1.5M/20) from the
leasehold improvement from Year 2023 through Year 2042.
ILLUSTRATION
Problem 1-8

Lenj leases a building to a client. During the year, he received the following
remittance from the lessee:

Rental, net of 5% creditable withholding tax P 1,900,000

Real property tax of the leased building 50,000
Reimbursement for utilities used
by the lessee paid by Lenj 200,000

How much will be included in gross income subject to regular tax?

Answer: (1,900,000/95%) + 50,000 = 2,050,000

6. 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 outside the Philippines are
subject to regular income tax.
ILLUSTRATION
Problem 2-13

A taxpayer collected the following passive income during the year:

Passive income Philippines Abroad

Interest income from banks P 300,000 P 800,000
Royalties from books 200,000 100,000
Rent of properties 400,000 200,000
Gain on sale of domestic stocks 50,000 100,000

What is the amount to be reported in gross income if the taxpayer is a resident

citizen?

Answer: 800,000 + 100,000 + 400,000 + 200,000 = 1,500,000

ILLUSTRATION
Problem 2-13

A taxpayer collected the following passive income during the year:

Passive income Philippines Abroad

Interest income from banks P 300,000 P 800,000
Royalties from books 200,000 100,000
Rent of properties 400,000 200,000
Gain on sale of domestic stocks 50,000 100,000

What is the amount to be reported in gross income if the taxpayer is a resident

alien?

Answer: 400,000
7. DIVIDENDS
These pertain to foreign-sourced dividends or those declared by foreign
corporations. Those declared by domestic corporations are subject to the rules
of final tax.

Foreign sourced dividends are generally subject to regular tax subject to the
pre-dominance tests discussed in Chapter 3.

Cash, property, and scrip dividends from foreign corporations are generally
items of gross income subject to regular income tax.
7. DIVIDENDS
Stock Dividend

Stock dividends are exempt from income tax, but when the declaration confers
to the recipient a different interest or right after the stock dividend declaration
or when stocks dividends are subsequently redeemed such that it amounts to
payment of cash dividend, the fair market value of the stock dividends received
is taxable.

Liquidating Dividend

Liquidating dividend is not income. The liquidating dividends are considered an

amount in exchange for the investment of the investor and are subject to the
rules of dealings in properties.
7. DIVIDENDS

Source of Dividends
Recipient taxpayer Domestic corporation Foreign corporation
Individuals
Citizens and residents 10% final tax Regular tax
NRA-ETB 20% final tax Regular tax
NRA-NETB 25% final tax 25% final tax
Corporations
Domestic corporation Exempt Regular tax
RFC Exempt Regular tax
NRFC 15% final tax 25% final tax
7. DIVIDENDS
Exemption of foreign-sourced dividends received by domestic corporation

Under the CREATE Law, intercorporate dividends received by domestic

corporations from foreign corporations are generally subject to regular tax.

They may be exempted from regular income tax under the following conditions:
7. DIVIDENDS
If the ratio in the predominance test is less than 50%, the foreign-sourced
dividends shall be exempt if the following conditions concur:
1. The domestic corporation directly owns at least 20% in value of the outstanding
shares of the NRFC.
2. The shareholdings in the NRFC must have been held uninterruptedly for a
minimum of 2 years at the time of dividend distribution or throughout the entire
existence of the NRFC if it is operational for less than 2 years
3. The foreign-sourced dividend received or remitted must be reinvested within the
next taxable year in business operations, namely:
a. Working capital requirements
b. Capital expenditures
c. Dividend payments
d. Investment in domestic subsidiaries
e. Infrastructure projects

Foreign-sourced dividends that are not utilized in the following taxable year shall be
declared as taxable income subject to surcharges, interest and penalties.
7. DIVIDENDS
If the ratio in the predominance test is at least 50%, the foreign-sourced dividends
received by the domestic corporation shall be exempt from income tax even if the
previously mentioned conditions are not met.
8. ANNUITIES
The excess of annuity payments received by the recipient over premium paid is
taxable income in the year of receipt.
ILLUSTRATION
Problem 1-13

Mr. Roding purchased a life annuity for P1,000,000 which will pay him P100,000 a
year. What will Mr. Roding include in his gross income on the 11th year of the
policy?

Answer: 100,000
ILLUSTRATION
Problem 1-15

Mr. Vhinson insured his life with his children as beneficiaries. He died after paying
P200,000 premiums. His children collected the P1,000,000 life insurance
proceeds.

How much will be excluded from Mr. Vhinson’s gross income?

Answer: 1,000,000
9. PRIZES AND WINNINGS
Prizes and winnings that are exempted from final tax are not items of gross income
subject to regular income tax

Exempt prizes and winnings:

1. Prizes received without effort to join a contest
2. Prizes in athletic competitions sanctioned by their respective national sports
association
3. Winnings from PCSO games, not exceeding P10,000 in amount
ILLUSTRATION
Problem 2-15

In 2024, the taxpayer received the following prizes and winnings:

Passive income Philippines Abroad

Prizes P 10,000 P 400,000
Winnings 400,000 100,000

What is the reportable item of gross income if the taxpayer respectively is a

resident citizen and a non-resident citizen?

Answer:
RC = 10,000 + 400,000 + 100,000 = 510,000
NRC = 10,000
10. PENSIONS
These pertains to pensions and retirement benefits that fail to meet the exclusion
criteria and hence subject to regular tax.
11. TAXABLE PARTNERSHIP AND TAXABLE
JOINT VENTURE OR CO-OWNERSHIP
Taxable partnership, joint ventures or co-ownerships are taxable as corporations.
The distributive share in the net income of these unincorporated entities shall be
taxable as follows:

If partner, venturer or Place organized or constituted

co-owner is a/an: Philippines Abroad
Individual 20% final tax Regular tax
Corporation Regular tax Regular tax

The share in the net income of non-taxable entities such as general professional
partnership, exempt joint ventures or exempt coownership shall be subject to
regular income tax to the recipient payer, venturer or co-owner.
12. PARTNER’S DISTRIBUTABLE SHARE IN THE
NET INCOME OF A GPP
A general professional partnership is not subject to income tax. The partners are the
ones subject to regular tax on their share in the net income of the GPP. For this
purpose, the net income of the GPP shall include items of income which are
exempted from final tax or capital gains tax to the general professional partnership.
ILLUSTRATION
Problem 2-6
Vhinson and Khim practice their accounting profession through a general professional
partnership. They contributed equal capital and agreed to share in profits equally. The
following relates to their gross receipts and expenses:

Gross receipts P 4,000,000

Less: Cost of services 1,800,000
Gross income from operations P 2,200,000
Add: Other non-operating income P 100,000
Gain on sale of equipment 40,000 140,000
Total gross income P 2,340,000
Less: Allowable deductions 1,200,000
Net Profits P 1,140,000

What is the reportable income in the tax return of Vhinson?

Answer: P1,140,000/2 = P570,000

ILLUSTRATION
Problem 2-7
Vhinson and Khim practice their accounting profession through a general professional
partnership. They contributed equal capital and agreed to share in profits equally. The
following relates to their gross receipts and expenses:

Gross receipts P 4,000,000

Less: Cost of services 1,800,000
Gross income from operations P 2,200,000
Add: Other non-operating income P 100,000
Gain on sale of equipment 40,000 140,000
Total gross income P 2,340,000
Less: Allowable deductions 1,200,000
Net Profits P 1,140,000

In the immediately preceding problem, determine the amount of income to be reported by

Khim assuming that their partnership is a beauty parlor.

Answer: 0
THANK YOU!