H06 - Regular Income Tax - Gross Income PDF

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INCOME TAXATIONREX B. BANGGAWAN, CPA, MBAREGULAR INCOME TAX: GROSS INCOMEREX B. BANGGAWAN, CPA MBAREO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Conveniencereocpareview REAL EXCELLENCE ONLINE CPA REVIEWREGULAR INCOME TAXATIONRegular Income Tax applies to all other items of gross income that a...

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Page 1 of 9 | TAX Handouts No. 06 INCOME TAXATION REX B. BANGGAWAN, CPA, MBA

REGULAR INCOME TAX: GROSS INCOME REX B. BANGGAWAN, CPA MBA REGULAR INCOME TAXATION Regular Income Tax applies to all other items of gross income that are not subjected to final tax or capital gains tax on certain passive income. Most of these items of gross income are derived in the regular conduct of business, trade, profession or employment. FEAURES OF THE REGULAR INCOME TAX 1. General coverage 2. Net income tax 3. Annual tax that is paid in quarterly estimated payments 4. Advanced payment through creditable withholding taxes TYPES OF REGULAR INCOME TAX 1. Progressive Income Tax This is applicable to individuals, taxable estates and trusts. Tax rates for Year 2018 to 2022 TAXABLE INCOME PER YEAR

INCOME TAX RATE

P250,000 and below

0%

Above P250,000 to P400,000

20% of the excess over P250,000

Above P400,000 to P800,000

P30,000 + 25% of the excess over P400,000

Above P800,000 to P2,000,000

P130,000 + 30% of the excess over P800,000

Above P2,000,000 to P8,000,000

P490,000 + 32% of the excess over P2,000,000

Above P8,000,000

P2,410,000 + 35% of the excess over P8,000,000

2. Corporate Income Tax: 30% on taxable income This is applicable to corporations, partnership and joint venture. Taxable income means the pertinent items of gross income subject to regular tax less the deductions and/or exemptions, if any, authorized for such types of income under the NIRC or other special laws. GROSS INCOME Gross income includes gains, profits, and income derived from whatever sources, whether legal or illegal not covered by either final taxation or capital gains taxation.

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Page 2 of 9 | TAX Handouts No. 06 REX B. BANGGAWAN, CPA MBA REGULAR INCOME TAX: GROSS INCOME

EXCLUSIONS FROM GROSS INCOME: 1. Proceed of a Life Insurance policy - received, whether in lump sum or otherwise, by the heirs or beneficiary upon the death of the insured is tax exempt. However, if the proceed are retained by the insurer under an agreement to pay interest, the interest is included in gross income. 2. Amount received by the insured as a return of premium under a life insurance, endowment, or annuity contracts paid during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract. 3. Gifts, Bequests, and Devises or Descent – the value of property acquired by way of these are taxable under Donor’s Taxation. However, incomes from such property, as well as, gift, bequest, devise, or descent of income from any property, in case of transfer of a divided interest, are included in gross income. 4. Compensation for injuries and sickness – amounts received under Accident or Health Insurance or under Workmen’s Compensation Acts, as compensation for personal injuries plus the amount of damages received whether by suit or agreement on account of such injuries or sickness. 5. Income exempt under treaty – income of any kind to the extent required by any treaty obligation binding upon the Government of the Philippines. 6. Retirement Benefits, Pensions, Gratuities, etc. For employers with retirement plans: Retirement benefit under RA 4917 Requisites of exemption: a. The employer maintains a reasonable private benefit plan. b. The retiring official or employee has been in the services of the same employer for at least ten (10) years. c. The retiring employee is at least fifty (50) years of age at the time of retirement. d. This is the first time availment of the exemption. Reasonable private benefit plan A reasonable private benefit plan is a pension, gratuity, stock bonus or profit-sharing plan maintained by the employer for the benefit of its employees covered (plan members), wherein contributions are made by the employer, employees or both, for the purpose of distributing the corpus (principal) or earnings thus accumulated to plan members; provided that in no time shall any part of the corpus or income of the fund be used for, or diverted to, any purpose other than the exclusive benefit of said plan members. For employers without retirement plans: Retirement benefit under RA 7641 Requisites of exemption: 1. Retiring employee is at least 60 years old 2. He must have serve the company for at least 5 years *Private employees retiring between June 5, 2020 to December 31, 2020 are excluded in gross income (Bayanihan to Heal as One Act) 7. Separation or Termination Requisite of exemption: a. Due to sickness, death or other physical disability; b. Any cause beyond the control of the employee or official (i.e.: redundancy and closure of business) 8. Retirement Gratuities, Social Security Benefits and Other similar benefits from foreign government agencies and other institutions, private or public, by resident or non-resident citizens or aliens who come to settle permanently in the Philippines 9. United States Veterans Administrations - administered benefits under the laws of the United States received by any person residing in the Philippines 10. SSS benefits under RA 8282 received or enjoyed 11. GSIS benefits under RA 8291 and including retirement gratuity received by government officials and employees 12. Investment Income in the Philippines in loans, stocks, bonds, or other domestic securities, or form interest on deposits in banks in the Philippines by: a. Foreign governments b. Financing institutions owned, controlled, or enjoying refinancing from foreign government c. International or regional financial institutions established by foreign governments

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Page 3 of 9 | TAX Handouts No. 06 REX B. BANGGAWAN, CPA MBA REGULAR INCOME TAX: GROSS INCOME

13. Income of the government and its political subdivisions from a. any public utility or b. exercise of essential government function 14. Prizes and Awards in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievements but only if: a. the recipient was selected without any action on his part to enter the contest or proceeding; and b. the recipient is not required to render substantial future services as a condition to receiving the prize or award 15. Prizes and Awards in Sports Competitions granted to athletes: a. in local or international competitions and tournaments b. whether held in the Philippines or abroad; and c. sanctioned by their national sports associations 16. 13th Month Pay and Other Benefits – provided not to exceed the P90,000 ceiling (non-adjustable to inflation). 17. Contributions for GSIS, SSS, PhilHealth, HDMF and Union Dues - these are deducted from the relevant income to which they relate; for example, they are netted with the compensation income of employees 18. Gains from Sale of bonds, debentures or other certificate of indebtedness with a maturity of more than 5 years. 19. Gains realized from redemption of shares in mutual fund by the investor. 20. Certain benefits of minimum wage earners (HHON) 21. Income exempt under special laws or subject to special tax rules a. Income of BMBE b. Income on sale of gold to the BSP c. Income of BOI-registered entities under ITH Note to candidates : 1. Exclusion is different with deductions. When an item of income is exempted under the above paragraph, or under special laws, it is deducted from gross income if it was initially included therein. It is not shown as a deduction from gross income rather it is “excluded” in gross income amounts. 2. Interest income from government securities are already excluded from the list of exemptions SOURCES OF GROSS INCOME: A. Compensation for services in whatever form paid, including but not limited to fees, salaries, wages, commissions, and similar items  if received in promissory notes, the taxable portion at the time of receipt is the fair value of the note (i.e.: its discounted value); The interest portion will be recognized as income over the related period  Fringe benefits are not direct item of compensation. Please refer to your handouts on Fringe Benefits Taxation. B. Trade, Business or Exercise of a Profession, except self-employed and or professionals opting to the 8% commuted tax under TRAIN law C. Gains derived from dealings in property (Please read separate handout) D. Interests – these refers to interest other than those subject to final taxes, except: 1. Interest income under the land reform earned by the landowner to which the tenant-purchaser pays him 2. Imputed interest E. Rents Special considerations: 1. Obligations of the lessor that are assumed by the lessee is additional rental consideration. 2. Advance rentals: a) If unrestricted, the entire amount is income at the time of receipt. b) If it constitutes a loan – not rent income. c) As security deposit to guarantee payment or rent – income only when the event or condition which makes it the property of the lessor occurs (i.e.: when there is default) d) If it is to be applied at the termination of the lease, it is income at the time of receipt e) Improvements made by the lessee on the property – to be recognized as income by the lessor in two ways:  Outright method – the fair value of the property that will remain and be turn-over to the lessor upon termination of the lease (the real book value of the property at termination, i.e.: not the lessee’s book value) is recognized as income at the point of completion of the improvement NOT the fair market value of the

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Page 4 of 9 | TAX Handouts No. 06 REX B. BANGGAWAN, CPA MBA REGULAR INCOME TAX: GROSS INCOME



improvement upon completion. (Note: Although the latter is the wordings of the law, apparently, the whole fair value is, by common sense, not income.) Spread-out method – recognize the book value of the property at the termination of the lease as income over the period of the related lease

F. Royalties G. Dividends Dividends are subject to regular income tax when it is declared by foreign corporations. Dividends can either be:  Cash dividend  Property dividend – when taxable, taxable at the fair market value of the property received as dividend. Note property dividend includes stock of another corporation declared by the distributing corporation.  Stock dividend – generally not taxable except when the declaration confers to the recipient a different interest or right after the declaration. When taxable, the measure of taxable amount is the fair market value of the stock dividend received.  Liquidating dividends This is considered an exchange or sale of property. Gain or loss is fully taxable or deductible. Dividends received from resident corporations are subject to the Dominance Test. H. I. J. K.

Annuities Prizes and winnings Pensions; and Partner’s distributable share in the net income of the general professional partnership and exempt joint venture

OTHER SOURCES OF GROSS INCOME: A. Farming Taxation of farming gross income requires classification of the following: 1. Livestock and farm products raised and sold – the selling price of the livestock or farm products is considered gross income. 2. Livestock and farm purchased and sold – only the accounting gross income (sales less cost of sales) is included in gross income Taxation Rules: 1. Taxpayer may follow accrual or cash basis in accounting for inventories. 2. Expenses in raising the livestock and farm products are deductions from the computed gross income. 3. The proceeds of crop insurance or livestock insurance constitute gross income because it represents recovery of lost profits rather than lost capital. B. Tax Benefits When a taxpayer gains an advantage by an income tax deduction claimed in the past but were subsequently recovered, the tax benefit should be included in income in the year recovered as item of gross income. Examples: 1. Bad debt recovery General Rule: The recovery of bad debts previously written off constitute a receipt of taxable income 2. Tax refund General Rule: Refund of taxes that entered the determination of taxable income should be reverted back to gross income. Hence, refunds of the following taxes that will not enter the determination of taxable income will not be included in gross income: a. Estate or donor’s tax d. Philippine income tax, except the fringe benefit tax b. Stock transaction tax e. Special assessment c. Income tax paid or incurred to a foreign country, if the taxpayer claimed a credit for such tax in the year it was paid or incurred. 3. Unamortized cost of property abandoned and written off but was subsequently re-entered into use General Rule: The cost previously expensed should be reverted back into gross income in the year extraction operation is resumed.

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Page 5 of 9 | TAX Handouts No. 06 REX B. BANGGAWAN, CPA MBA REGULAR INCOME TAX: GROSS INCOME

Requisites in the taxability of expense recoveries 1. The expense is claimed as deduction against gross income in previous year/s. 2. The expense resulted in tax benefit to the taxpayer C. Cancellation of indebtedness a. in consideration of service – treated as compensation income b. with no consideration – not an income but a gift taxable under Donor’s Taxation c. by a corporation in favor of a shareholder - treated as declaration of dividend subject to final tax d. as capital transaction such as forfeiting the right to receive dividend in exchange of the debt – treated as dividends and is subject to dividend taxation rules D. Damage recovery a. Compensatory Damages - this constitute return of capital and hence, not taxable. For example: moral damages from personal action such as libel, slander; and breach of promise to marry. b. Recovered Damages – this constitute taxable income since they are recoveries of lost profit. For example: damages recovered from patent infringement suit ILLUSTRATION: EXCLUSIONS IN GROSS INCOME 1. Check the items of income that are taxable. a) Novel prize received for achievement civic achievements. b) Prizes and awards in sports competition, not sanctioned by their respective national association accredited by POSC. c) World Bank’s income earned in the Philippines. d) Cost of Living Allowance. e) Union due Contribution. f) Proceeds of from life insurance policy, revocable designation of beneficiary. g) Pensions, in general. h) Income of PAGCOR, a GOCC. i) Income of government from holders of public utility franchise. j) Interest income. k) Board of director’s fee. l) Mandatory retirement pay m) Professional athlete’s salary. n) Winnings from Philippine Sweepstakes or Lotto. o) Income derived from smuggling. p) Interest received from life insurance’s annuity. q) Hazard pay received by MWE. r) Gains from redemption of shares in mutual fund. s) Magsaysay awards. t) GSIS Retirement benefits. u) Cash surrender value received from insurance in excess of premium paid. v) Proceeds from life insurance of a deceased employee received by the employer. w) Dividend income derived in the Philippines by the Taiwan Government. x) Gains from the sale of bond with a maturity of three years. y) Cancellation of debt in lieu to services rendered. z) Share in net income of unincorporated partnership or joint venture aa) Share in net income of associate or subsidiary 2. Mr. A donated his business to his son B in the middle of the year. The business has a net worth of P2,000,000 at the start of the year. It earned P300,000 in during first half of the year and P200,000 for the rest of the year.

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Page 6 of 9 | TAX Handouts No. 06 REX B. BANGGAWAN, CPA MBA REGULAR INCOME TAX: GROSS INCOME

Required: Determine the following a. Reportable income of Mr. A and his Son B b. Net taxable gift of A 3. Mr. Pacquiao, a national athlete, received the following during the year: Ramon Magsaysay award Athlete of the year award Prize – SM Raffle Prize for winning the gold Olympic medal Car from Nissan as a gift Winnings – Philippine Sweepstake Casino winning, net of 200,000 losses Winnings, from horse race

P

50,000 100,000 10,000 500,000 1,200,000 150,000 300,000 100,000

Required: Determine the total exclusions in gross income. 4. Mr. De Silva had the following income during the year: Returns from life insurance (P40K annual premium for 15 years) P 800,000 Proceeds of father’s life insurance (P 600,000 premium paid) 1,000,000 Rent income from house worth P1M he inherited 400,000 Proceeds of redemption of mutual funds held 2 years (10,000 units bought at P10/unit) 140,000 Proceeds on sales of 10-year bonds bought P1M inclusive of P40,000 accrued interest 1,100,000 Interest on government securities 40,000 Damages awarded by the court (40% for unrealized profits) 500,000 Prize for winning 2019 Mr. Olympia in Las Vegas, Nevada, USA 20,000,000 Required: Determine the following a. Total exclusions in gross income b. Total inclusions in gross income 5. Mrs. Calderon retired from ABS Corp. effective at the end of 2019. She received the following form ABS Corp: Compensation, net of P50,000 withholding tax, P50,000 SSS, P20,000 PHilhealth P20,000 HDMF and P10,000 union dues P 1,050,000 Year-end fair value of ABS stocks acquired under ESOP 1,200,000 13th month pay 100,000 Retirement benefit 8,000,000 De minimis benefits 20,000 The employee’s required contributions for SSS, PhilHealth and HDMF were P10,000, P8,000 and P7,000, respectively. The employee stock options plan requires at least 15-year residency. Mrs. Calderon exercised the stock option during the year by purchasing P1,000,000 worth of stocks for P600,000. Required: Determine the following a. Total inclusion in gross income b. Total exclusion in gross income 6. BT, Inc. received the following refunds during the taxable year:

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Page 7 of 9 | TAX Handouts No. 06 REX B. BANGGAWAN, CPA MBA REGULAR INCOME TAX: GROSS INCOME

Licensing fee Registration fees of delivery trucks Donor’s tax Real estate tax Community tax Special assessment Corporate income tax Foreign income tax previously claimed as tax credit Foreign income tax previously claimed as deduction Value-added tax

P

200,000 40,000 50,000 30,000 10,000 20,000 300,000 50,000 100,000 150,000

Required: Compute the taxable tax benefit. 7. An individual taxpayer received the following income in 2019: Philippines Compensation income, net of P2,500 SSS, P2,100 PhilHealth, P1,800 HDMF and 5% withholding tax Business profit on sale of Bagoong Dividend from domestic corporation Dividend from foreign corporation Interest income from bank deposit Winnings from raffle Gain on sale of bonds with 5 year maturity Prizes in a singing competition Interest income from loans t...