CHAPTER VIII

Sources of Income

Sources of Income in General

With respect to the source of income, it has
been stated that much confusion will be avoided
if the term "source" is regarded in the
fundamental light that it is not a place but an
activity or property, and as such, it has a situs or
location.
When so considered, it has been stated that
the locus of the possible sources of income is
determined as follows:

1
In the case of income derived from labor, it is the place
where labor is performed;

2 In the case of income derived from the use of capital, it is the

place where the capital is employed; and

3 In the case of profits from the sale or exchange of capital

assets, it is the place where the sale occurs although it has
been held that in the case of retail merchandising operations,
the situs alone, of the retail sale does not necessarily
determine the sources from which the income is derived. (85
C.J.S. 735.)
Situs of Source of Income

Statutory provisions may tax the situs of income with respect to

the source of such income.

Under statutory provisions, income from rental and royalties

from real estate or tangible personal property or from the
operations of any farm, mine of quarry or from the sale of real
property or tangible personal property may follow the situs of
the property from which it is derived and from personal services,
professions and vocations, stocks, bonds and securities, or from
the sale of similar intangible personal property may follow the
residence of the recipient. (Ibid.)
Classification of income as to source.
As to source, the Tax Code classifies income into three main
classes:

1
Income which is derived in full from sources within the
Philippines;

2
Income which is derived in full from sources outside the
Philippines; and

3 Income which is derived partly from sources within and

partly from sources outside the Philippines. (see Sec. 42,
NIRC; Sec. 152, Regs.)
 Importance of knowing source of
income.
1 Resident citizens of the Philippines and domestic corporations are taxable
upon income derived from all sources;

2 Non-resident citizen, and alien individuals, whether or not a resident, or

engaged in trade or business in the Philippines, and foreign corporations,
whether or not engaged in trade or business in the Philippines, are
taxable only on income from sources within the Philippines. (Secs. 23[B].
24ГА. 1. bl. 25, 28, NIRC.)
3

A claim for tax credit is subject to limitations as to amount country and

from all sources is determined. (Sec. 34[C, 41.)
Gross income from
sources within the
Philippines
 The ff. items of gross income are
treated as gross income from sources
within
(1) Interest income: the Philippines:
(a) interest income derived from sources within
the Phil.
(b) interest on bonds, notes, or other interest-
bearing obligations of residents, corporate or
ILLUSTRATION:
otherwise.
ABC Corporation, a domestic corporation
was granted a loan of $1 Million by the Bank of
New York. The interest earned by the U.S bank
was P2,000,000. This income was earned in the
Phil. because the borrower is a Philippine
(2) Dividend income:
(a) dividends received from a domestic
corporation
(b) dividends received from a foreign
The portion of the dividend to be
corporation
considered earned from sources within the
Phil. may be arrived at by using the ff.
formula:
Phil. GI (3 – year Dividend = Dividend
period) GI (3 – year x
World Income Income from
period) Phil. sources
 ILLUSTRATION:

The ABC Corporation, a domestic

corporation, received a dividend of
P100,000 from the Yersey Corporation, a
New York Corporation, whose gross
income from the Philippines and all
2007 2008 2009

sources
Philippines
follows:
P4,000,000 P4,500,000 P6,500,000

All sources 5,000,000 6,000,000 9,000,000

Question: How much of the dividend received of

P100,000 is from Philippine sources?
wer: P75,000, arrived at as follows:

Phil. Gross P15,000,000 3

or = P100,000=P75,00
World Gross Income 20,000,000 4
Income
0
(3) Compensation for personal services:
(a) compensation for lab0r or personal
services performed within the Phil. regardless
of:
(1) the residence of the payor
(2) the place in which the contract for
service was made
(3) the place of payment
(b) When the personal service or labor is
performed partly within and partly outside
the Phil.
The formula may be expressed as follows:
No. of days
labor was
performed in Total Income
the Phil. x compensat = within the
Total no. of ion
days labor was Phil.
received
performed
 ILLUSTRATION
:
Miguel Pons Garcia, a resident and citizen
of U.S.A was contracted to supervise the
dismantling of a complete chemical plant in
the U.S.A and to supervise the installation of
the same in the Phil. He received a
compensation of P150,000 for the whole job.
It took him 180 days to finish the
dismantling and installation operations, 60
n: How much was earned by Miguel Pons Garcia in the Phi
days of which was spent in the
wer: P50,000, computed as follows:
60
Phil.
x P150,0 =P50,000
days
180 days 00
(c) Wages received for services rendered inside
the territorial limits of the Phil. and wages of an
alien seaman earned on a coastwide vessel.
(4) Rentals and royalties
(a) the use of, or the right, or privilege in the Phil.
any copyright
(b) the use of, or the right to use in the Phil. any
industrial, commercial, or scientific equipment
(c) the supply of scientific, technical, industrial, or
commercial knowledge or information
(d) the supply of any assistance that is ancillary and
subsidiary to
•any such equipment as is mentioned
•or any knowledge or information
(e) the supply of services by a non-resident person or
his employee in connection with the use of property
or rights belonging to
(f) technical advice, assistance or services rendered
in connection with technical management or
administration of any scientific, industrial or
commercial undertaking
(g) the use of or the right to use:
(1) motion picture films
(2) films or video tapes for use in connection
with television
(3) films or video tapes for use in connection
with radio broadcasting
(5) Gain on sale of real property
 (a) produced in whole or in part by the
taxpayer within and sold outside the Phil.
(b) produced (in whole or in part) by the
taxpayer outside and within the Phil.
(7) Income derived from the ownership of
farms and natural deposits
(a) Income derived from the ownership
or operation of any farms, mine or gas well
located in the Phil.
(b) Income from the sale by the producer
of the products thereof within or outside the
Phil.
Enumeration
in Section 42
not all-
inclusive.
(1) Other kind of income from Philippine
sources. Section 42 of the Tax Code
enumerates the types of income that
should be treated as income coming from
sources within the Philippines. The
enumeration is not all-inclusive, for it
only directs that the types of income
mentioned therein be treated as income
from sources within the Philippines, but
does not state that no other kind of
income be likewise so considered.
(2) Taxability depends upon locus
or situs of income. - Section 28 of
the Tax Code taxes foreign
corporations on their income from
sources within the Philippines. The
word "sources" has been
interpreted to mean activity,
property, or service out of which
the income arose.
(3) Place of activity controlling.
The place of contract is not a sole
criterion that exclusively
determines the situs. Neither
should the place of business of
the foreign re-insurers be made
the norm Place of activity, not
place of business, is controlling.
(4) Income from Philippine sources
of taxpayer not engaged in
business in the Philippines. Since
an activity may consist of only a
single transaction whereas
business implies a continuity of
transactions, it follows that the
source an income can hea activity
performed outside one's place of
business.
Gross income from
sources outside
the Philippines
The items of gross income treated as income from sources
outside the Philippines as as follows:

1. Interest other than that derived from sources within

the philippines;
2. Dividends other than those derives from sources within the Philippines:

a. Dividends from foreign corporations in general; and

b. Dividends derived from foreign corporations, 50% or more of the gross

income of which for the 3-year period preceding the declaration of dividends ( or
for such part of such period as the corporation has been in existence ) was
derived from Philippines sources in an amount determined by the following
formula.

Foreign GI (3-year period) / World GI (3-year period) x Dividend =

Dividend Income from sources outside the Philippines
3. Compensation for labor or personal services
performed outside the Philippines ;
4. Rentals or royalties from property located outside the
Philippines or from any interest in such property including
rentals royalties for the use of or for the privilege of using
outside the Philippines, patents, etc.;

5. Gains, profits, and income form the sale of real property beated
outside the Philippines;

6. Gains, profits, and income from the sale of personal property

located outside the Philippines; and
7. Income derived from the purchase of personal property within and it's
sale outside the philippines.
 Sources of income
Rent received from apartment —
Located in the Philippines 6,000
Located in the U.S.A 50,000
Dividends from SMC, a domestic corporation
Royalties received on — 8,000
Patents used in the Philippines 5,000
Copyrights used in the U.S.A 7,000
Dividends received from U.S Iron
Corp., a foreign Corporation whose
gross income from the Philippines is
45% of its total gross income 3,000

Gain on sale of SMC shares sold in U.S.A 1,000

Gain on sale of Ford Motor Co. shares
sold in the Philippines 2,000

Dividends received from American —

Phil. Corp.
P65,000 + P55,000 P120,000
= x P10,000 6,000
P100,000 + P100,000 P200,000
P200,000 – P120,000 P80,000
= x P10,000 4,000
P200,000 P200,000
Gross Income P30,000 P88,000
Gross Income from
sources partly
within and partly
outside the
Philippines
Special rules are provided
by the Regulations on the
following classes of
income:
(1) Income from
transportation
(2) Income from the sale of
Gross Income from
sources within the Phil.
consist of:
(1) the items of income derived in
full from sources within the Phil.
(2) the portion of gross income
derived partly from sources
within and partly from sources
Apportionment of
Deductions in
Computation of
Taxable Income
the taxpayer may have
two(2) general classes of
deductions:
(1) Expenses, losses, or other
deductions properly allocated thereto,
from sources within or without the
Phil.
(2) A ratable part of expenses, losses,
or other deductions which cannot be
Thus:
(1) Gross Income (GI) from Philippine
sources
Less—Expenses and losses properly
apportioned to GI from Philippine
Less sources
Ratable part of unallocated
— deductions
= Taxable Income from sources within
 the ratable part of unallocated
deductions may be arrived at with the
use of ff. formula:
I from Philippine sourcesUnallocat
x =Ratable part
GI from all sources ed
deduction
(2)GI from sources outsides the Phil.
Less Expenses and losses properly
— apportioned to GI from foreign
Ratable part of unallocated deductions
Less sources
—
= Taxable Income from sources outside the
The formula for determining the ratable
part of unallocated deductions may be set
forth as follows:

GI from Philippine Unallocat

x = Ratable
sources
GI from all ed
part
sources deduction
s
 ILLUSTRATIVE PROBLEM:

Paul Gratzky, a non-resident alien, has

the ff. data on his income and deductions:
Gross Income Expenses
From Philippine Allocable to Phil.
P15,000
sources P50,000 income
From foreign Allocable to
150,000 45,000
sources foreign income
P200,000 Unallocated 30,000
expenses
P90,000
 Solutio
n:
(1) Taxable Income from Phil. sources:
Gross Income from Phil. sources P50,000

Less — Expenses allocable to

Phil. Income 15,000
35,000
Less — Ratable part of unallocated deductions:
x P30,000 7,500
Taxable income from sources within the Phil. P27,000
(2) Taxable Income from foreign sources:
Gross Income from sources outside the P150,0
Phil.
Less —Expenses allocable to foreign Income 0045,000
P105,0
00
Less —Ratable part of unallocated deductions:
x P30,000 22,500

Taxable income from sources outside the Phil. P82,50

0
Taxable Income
from Sources
within the
Philippines
 (1) General
Rule
"effectively connected with the
business or trade conducted
exclusively within the Philippines"
"fully substantiated by all the
informations necessary for its
(2) Exception
calculation"
no deduction for interest paid or
incurred abroad shall be allowed
from the items of gross income
 Income from
Personal Property
produced and sold
CASE 1. Where an
independent factory or
production price can be
established to the
satisfaction of the
Commissioner.
CASE 2. Where no
such factory or
production price
can be
 (a) The taxable income shall
be computed as follows:
Gross income from the property
Less— Expenses and losses properly apportioned
thereto
Less— Ratable part of unallocated deductions which
cannot definitely be allocated.
= Taxable income (partly within and partly outside the Phil.)
(b) After determining the taxable
income from the transaction, the
following formula may be used:
Of taxable
Value of taxpayer's income partly
property within the Phil. 1 within and
x —
Value of taxpayer's 2 partly outside
property within and outside the Phil.
the Phil.
Plus: Gross sales for the
period within the
Of taxable
Phil. of the produced
income partly
commodity 1
x— within and
Gross sales for the 2 partly outside
period within and the Phil.
outside the Phil. of the
produced commodity
Equals: Taxable income from
sources within the
Philippines
CASE 3.
Where the
books of
the
taxpayer
will be
used.
Income of foreign telegraph and
cable companies.

A foreign corporation carrying the business of transmission of telegraph or cable

messages between points in the Philippines and points outside the Philippines should
compute its income derived from Philippine sources (see Sec. 164, Ibid.) as follows:

Gross Income (GI)

Gross revenues from messages
originating in the Philippines P50,000
Add: Amount collected abroad on
collect messages originating in Phil. P10,000 P60,000
Less: Amounts paid or accrued for
transmission of messages beyond
the company's own circuit 5,000
Gross Income P55,000
Less-Deductions
All expenses incurred in the
Philippines (excluding general
overhead) incident to the carrying
on of business in the Philippines P16,000

All direct expenses incurred abroad

in the transmission of messages
originating in the Philippines (excluding
general overhead expenses of mainte-nance,
repairs and depreciation of cable and
excluding any amount already deducted
in computing gross income) 2,000

Depreciation of property (excluding cables)

located in the Philippines and used in the
trade or business therein 3,000
A proportionate part of the general
overhead expenses (not including
any items incurred abroad corresponding
to those enumerated above and of
maintenance, repairs and depreciation of
cables of the entire cable system of the
enterprise) based on the following computation:

No. of words originating

in the Phil.
x Expenses = P10,000
Total no. of words transmitted
by the enterprise

P31,000
Taxable income from sources within the Philippines
THANK
YOU!