Chapter 4: Sources of Income

Reporters: Lizzette Angelica A. Danan

Jessica Geane Manglicmot

Classification of Income as to Sources

• Income purely within;

• Income purely wihout;

• Income partly within and partly without;

Determination of Income as to Source ITEMS OF INCOME TEST OF SOURCE OF INCOME

DIVIDENDS

1) From domestic corporation INCOME WITHIN

2) From foreign corporation (based on the ratio of the gross income of the foreign corporation for the preceding 3 years prior to declaration of dividends derived from Philippine sources)

Phil. Gross Income x DividendTotal Gross Income

Income within if ration is more than 85%

Income partly within and partly without if ratio is between 50% and 85%

Income purely without if ratio is less than 50%

Income from services Place of performance

Rent Location of property

Royalties Place of use of intangibles

Gain on sale of real property Location of property

Gain on sale of personal property purchased in one country and sold in another

Place of sale

Gain on sale of domestic shares Income within

Income Partly from Sources within and Partly from Sources without

Examples: a) Income from transportation and other services rendered partly within and partly without the Philippines.

b) Income from the sale of personal property produced in whole in or in part by the taxpayer within and sold without the Philippines.

c) Income from sale of property producer, in whole or in part by the taxpayer without and sold wihin the Philippines.

Computation of income within when independent factoryor production price has not been established

Taxable income x Value of property, within 2 Value of property, wihin and without xxxAdd: Taxable income x Gross sales, within 2 Gross sales, within or without xxxIncome within xxx

Computation of Taxable Income

Corporation Gross Income P xxxLess: Deductions xxxTaxable income P xxx

Individual Gross income P xxxLess: Deductions xxxIncome before personal exemptions PxxxLess: Personal exemption xxxTaxable income P xxx

Meaning of Income

Broad sense Income means all wealth, which flows into the taxpayer’s hands other than as a mere return of capital

Judicial definition Income is the gain derived from labor, from capital, or from labor and capital, including the gain derived from the sale or exchange of capital asset.

Requisites of a taxable income a) There must be gain;b) The gain must be realized or received;c) The gain must not be excluded by law

from taxation.

Gross Income

- Means all income from whatever source, including (but not limited to the following items):

a) Compensation for services in whatever form paid, including but not limited to fees, salaries, wages, commissions, and similar items;

b) Gross income derived from the conduct of trade or business or the exercise of a profession;

c) Gains derived from dealings in property;

d) Interests;

e) Rent;

f) Royalties;

g) Dividends;

h) Annuities;

i) Prizes and winnings;

j) Pensions

k) Partner’s distributive share from the net income of the general professional partnership.

Income Distinguished from other Items

• From capital

- Capital is the fund or property existing at one distinct time, while income denotes a flow of weath during the definite period.

• From receipts

- Receipts have reference to all wealth that flows into the taxpayer, which includes returns of capital.

• From revenue

1) Revenue, as applied to taxation, refers to all the funds or income derived by the government, wheather from tax or any other source while income, for tax purposes, is employed in its “natural and obvious sense” to mean money or gain received, coming to a person (natural or juridical) during a given period of time.

2) Revenue is to the government while income is to a person (natural or juridicial).

• Gross compensation income means all remuneration for services performed by an employee

for his employer, wheather paid in cash or in kind, unless specifically excluded under the Tax Code (e.g. salaries, wages, emoluments, honoraria, bonuses, allowances, director’s fees.)

Examples of compensation for services rendered: All kinds of compensation for services rendered constitute gross income. They include:

1. Salaries, wages, and fees;

2. Commissions paid to salesmen;

3. Compensation for services on the basis of a percentage of profits;

4. Commissions on insurance premiums;

5. Tips;

6. Pensions or retiring allowances paid by private persons or by the government (except pension exempt from tax); and

7. Marriage fee, baptismal offerings, sums paid for saying masses for the dead, and other contribution received by a clergyman, evangelist, or religious worker for services rendered.

Forms of compensation

Forms of compensation Taxable amount

a) Payments made in cash The full amount received

b) Services paid for with something other than money (in kind)

The fair market value (FMV) of the thing taken in payment

c) Services rendered at a stipulated price

In the absence of evidence to the contrary, the stipulated price shall be presumed to be the fair market value (FMV)

Examples of payments in kind

Payments in kind Taxable amount

a) Compensation paid to an employee of a corporation in its stock

Fair market value of the stock at the time received by the employee

b) Promissory note and other evidence of indebtedness in payment of services, and not merely as security for such payment

a) Promissory note is not interest bearingYear received – Fair discounted valueYear collected – Face value less fair discounted value

b) Promissory note is interest bearingYear received – Face valueYear collected – Maturity value less face value

Direct dividend – is one where the paying corporation acknowledges that the distribution is a dividend payment.

Indirect dividend – is a distribution of profits disguised as payment of services, properties, etc.

Annuity

Is a specified income payable at stated intervals for a fixed or a contingent period, often for the recipient’s life, in consideration of a stipulated premium paid either in prior installment payments or in a single payment.

Non-taxable annuity – representing return of premium Taxable annuity – excess of the amount returned as premium

Income from whatever source

a) Gains arising from expropriation of property;

b) Gambling gains;

c) Income from illegal business or from embezzlement;

d) Damage recovery (compensation for damages);

e) Forgiveness of debt;

f) Bad debt recovery;

g) Tax refunds; and

h) Prizes and awards

Damage recovery

a) Recovery of lost profit is taxable.b) Recovery of lost capital is not taxable.

Forgiveness of debt

1. If debtor rendered service in favor of the creditor forgiveness of debt results in a taxable income to the debtor.

2. If the debtor did not render service in favor of the creditor forgiveness of debt results in a taxable indirect gift.

3. If the debtor is a stockholder of a corporation forgiveness of debt by the creditor-corporation results in dividend distribution.

Bad debt recovery

1. Bad debt recovery is generally taxable.

2. Tax benefit rule: If in the year the bad debt was written off there was a reduction of taxable income, bad debt recovery shall constitute a taxable income.

Tax refunds

a) If the refunded tax is a deductible, the tax refunded is taxable.

b) If the refunded tax is not a deductible, the tax refund is not taxable.

Examples of non-deductible taxes;

1. Philippine income tax;

2. Transfer taxes (estate tax and donor’s tax);

3. Special assessment;

4. Foreign income tax claimed as tax credit;

5. Value-added tax;

6. Stock transaction tax.

END!