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Income Taxation

CHAPTER 5
ALLIEN GRACE APOLINARIO
Definition of Terms
Estate or Inheritance
All properties, rights and obligations of a person which are not
extinguished by his death and also those which have accrued thereto
since the opening of succession
Trust
An agreement created by will or an agreement under which title to
property is passed to another by conversation or investment with the
income therefrom and ultimately the corpus or principal to be
distributed in accordance with the directives of the creator as
expressed in the governing instrument.
Trust or or Grantor
The person who establishes trust.
Beneficiary
The person whose benefit the trust has been created. A beneficiary has
the equitable title to the property transferred to the trust, including,
generally, the possession and use of the property.
Fiduciary
The general term which applies to all persons or corporations that
occupy positions of peculiar confidence towards others, such as
trustees, executors, guardians, or administrators, receivers or
conservators.
Income Tax Purposes (Fiduciary is any persons or corporations that holds
in trust and estate of another person or persons.
Taxable Estates
Estates of deceased person under judicial settlement.
Taxable Trust
Trust are unique form of legal entity: Pure Taxpayer or Pure
Conduit
Tax payers such as corporations, all income is tax to the
income-earning corporations.
Conduit such as general professional partnerships, no income is
taxed to the income-earning organization. Rather income is
taxed to the owners of the partnership when earned,
regardless of whether the income is distributed to them.
Gross Income
The items of gross income of estates and trusts are the same items of gross
income of individuals as provided in the Tax Code. They include:

Income accumulated in trust for the benefit of unborn or unascertained


person or persons with contingent interest, and income accumulated or held
for future distribution under the terms of the will or trust.
Income which is to be distributed currently by the fiduciary to the
beneficiaries, and income collected by a guardian of an infant which is to be
held or distributed as the court may of direct.
Income received by states of deceased persons during the period of the
administration or settlement of the estate.
Income which, in the discretion of the fiduciary, may be either distributed to
the beneficiaries or the accumulated.
Allowable Deductions

Estate or trust is allowed a personal exemption of P20,000. This


is regardless of the number of trust a beneficiary may receive
income from. Income of trust or state may be deductible from
gross income.

Income which is to be distributed currently by the fiduciary to the


beneficiaries; and income collected by a guardian of an infant which is
to be held or distributed as the court may direct, are deductible from
gross income of the fiduciary. This is so because such income is taxable
directly to the beneficiary, whether distributed or not.
Illustration 1: Ms. Red died of August 14, 2014. Her estate is now under
judicial settlement. The estate had P1,500,000 gross income from
August 14 to December 31, 2014. Expenses related to this income is
P400,000. There was no distribution of income among the heirs. How
was the tax due for the year?

Gross Income
Less: Deductions
Personal Exemption
Taxable Income

Tax Due:
On P500,000
580, 000 at 32%
Illustration 2:
Mr. Henry Argos created an irrevocable trust designating his two daughters, aged 3
and 1 beneficiaries. Under the terms of the trust, only half of the income shall be
distributed to the beneficiaries. The other half shall be left to accumulate and be
distributed when the beneficiaries reach 21 years of age. For the year of 2014, income
of the trust was P500,000. Compute for the tax due.

Gross Income
Less: Deductions
Personal Exemption
Taxable Income

Tax Due:
On P140, 000
90,000 at 25%
Consolidated of Income of Two or More Trusts
When two or more trust are created by the same grantor and the beneficiary in both trusts
is the same, the taxable income of all trusts shall be consolidated and the tax computed
on such consolidated income.

Consolidated Gross Income xxx


Less: Consolidated Deductions xxx
Consolidated Taxable Income xxx
Less: Personal Exemption xxx

Taxable Income xxx


Multiply by Tax Rate x%
Amount of Income Tax on
Consolidated Taxable Income xxxxx
Each trustee shall compute his share of the income tax of the consolidated
taxable income based on the formula below:

Taxable Income of the Trust


_________________________________ Income Tax on
Consolidated taxable income of
x consolidated
taxable income
all trusts before exemption

income tax
=
payable by each
trustee
Mr. Black maintains two irrevocable trusts that name his three
children, all minors, as common beneficiaries. The terms of the trust
provide that no income shall be distributed to the beneficiaries until
the youngest should become 25 years of age. Following are the data
relative to the trust:

Trust 1 Trust 2

Gross Income P450,000 P600,000

Deductions 150,000 200,000


Consolidated Gross Income
Less: Consolidated Deductions
Consolidated Taxable Income
Less: Personal Exemption

Taxable Income
Multiply by Tax Rate
Amount of Income Tax on
Consolidated Taxable Income

Trust 1 Trust 2
Gross Income as defined in the Tax Code means all income
derived from whatever source including but limited to the
following terms:

COMPENSATION INCOME
Compensation for services, in whatever form paid, including
but not limited to fees, salaries, wages, commissions and
similar item.

General Term
Compensation means all remuneration for services
performed by an employee for his employer under an
employer-employee relationship, unless specifically excluded
by the Code.
Definition of Terms

Payroll Period means the period of services for which a payment


of compensation is ordinarily made to an employer by his
employer. It is immaterial that the compensation is not always
paid at regular intervals.

Employee. The term employee is an individual performing


services under an employer-employee relationship. The term
covers all employees including officers and employees, whether
elected or appointed, of the Government of the Philippines
political subdivision thereof of any agency or instrumentality.
Employer. The term employer means any person for whom an
individual performs or performed any service, or whatever
nature, under an employee-employer relationship.

Statutory Minimum Wage (SMW) refers to the rate fixed by the


regional Tripartite Wage and Productivity Board (RTWPB), as
defined by the BLES of the DOLE (Section 1 of R.A 9504, June 17,
2008)
Minimum Wage Earner (MWE) refers to a worker in the private
sector paid by the statutory minimum wage, or to an employee
in the public sector receiving compensation exam equivalent to
salary grade 5 and below (Section 1 of R.A 9504, June 17, 2008).
Forms of Compensation
Amendments in Revenue Regulations 3-2015, 1-2015, 8-2012, 5-
2011, 10-2008 and 8-2000 have been incorporated in the
discussion. Compensation does not always come in the form
of money or is always termed as such. Compensation has
various forms as follows:

1. Compensation paid in kind. Compensation may be in some


medium other that money, as for example, stocks, bonds or
other forms of property. In this case, the fair market value of the
thing taken in payment is the amount to be included as
compensation subject to withholding.
2. Living quarters and meals. If a person receives a salary as remuneration for
services rendered, and in addition thereto, living quarters or meals are
provided, the value to such person of the quarters and meals so furnished
shall be added to the remuneration paid for the purpose of determining the
amount of compensation subject to withholding. However, if living quarters
or meals are furnished to an employee for an inconvenience of the
employer, the value thereof need to be included as part of compensation
income.
3. Facilities and privileges of relatively small value. De Minimis Benefits,
furnished or offered by an employer to his employees, are not considered as
compensation subject to income tax and consequently to withholding tax if
such facilities or privileges are of relatively small value are offered of
furnished by the employer merely as a means of promoting the health,
goodwill, content or efficiency of his employees.
The following shall be considered de minimis benefits not subject to income
tax, hence, not subject to withholding tax on compensation income of both
managerial and rank-and-file employees:
Monetized unused vacation leave credits of private employees not
exceeding ten days during the year.
Monetized value of vacation and sick leave credits paid to government
officials and employees.
Medical cash allowance to dependents of employees not exceeding P750
per employee per semester of P125 per month.
Rice subsidy of P1,500 or one sack of 50-kgs. rice per month amounting to
not more than P1,500.
Uniforms and clothing allowance not exceeding P5,000 per annum.
Actual medical assistance, e.g medical allowance to cover medical and
healthcare needs, annual medical/executive check-up, maternity
assistance and routine consultations, not exceeding P10,000 per annum.
Laundry allowance not exceeding P300 per month.
Employee achievement awards , e.g. for length of service of safety
achievement which must be in the form of tangible personal property
other than cash or gift certificate with an annual monetary value no
exceeding P10,000 received by the employee under an established
written plan which does not discriminate in favor of high paid employees.
Gifts given during Christmas and major anniversary celebrations not
exceeding P5,000 per employee per annum.
Daily meal allowance for overtime work and night/graveyard shift not
exceeding 25% of the basic minimum wage on a person for region basis.
Benefits received by an employee by virtue of a collective bargaining
agreement (CBA) and productivity incentive schemes provided that the
total annual monetary value received from both CBA and productivity
incentive schemes combined do not exceed P10,000 per employee per
taxable year.
Illustration 1 and 2
4. Tips and gratuities paid directly to an employee
by a costumer of the employer which are not
accounted for by the employee to the employer
are considered as taxable income but not subject
to withholding.

5. Pensions, retirement, and separation pay


constitute compensation subject to withholding,
except those provided.
Illustration: Source: BIR Ruling 22-01, June 13,2001
Taxation of amounts received by a reason of a valid dismissal
under section 32(B)(6)(b) of the Tax Code of 1997 requires the
presence of two conditions in order that the employee benefits
may be granted tax exemption:
1. The employee is separated from the service of the employer
due to death, sickness or other physical disability or for any
cause beyond the control of the said official or employee: and
2. The employer pays the benefits to the official or employee or
his heirs as a consequence of such separation.
6. Fixed or variable transportation, representation and other
allowances.

a. In general, fixed or variable transportation, representation and


other allowances which are received by a public officer or
employee of a private entity, in addition to the regular
compensation fixed for his position or office, is compensation subject
to withholding.
Illustrations: Source: BIR Ruling 25-01, June 13, 2001
The fixed monthly vehicle maintenance allowance of P5,000 given
by BWSCMI to its expatriate employees holding managerial and
supervisory positions shall be treated as allowance which shall form
part of their compensation income subject to income tax and
consequently to withholding tax.
b. Any amount paid specifically, either as advances or
reimbursement tor traveling representation and other
bona fide ordinary o necessary expenses incurred or
reasonably expected to be incurred by the employee
in the performance of his duties are not compensation
subject to withholding
Illustration: Source: BIR Ruling, June 23, 2004
A call centre gives pre-computed transportation
allowances amounting to P91 per day to its customer
service representatives (CRS) and P136 per day to its
coaches who are on the 9 p.m. 6 a.m. shift.
7. Vacation and sick leave allowances. Amounts of
vacation allowances or sick leave credits which are
paid to an employee constitute compensation. Thus,
the salaries of an employee on vacation or on sick
leave, which are not withstanding his absence from
work, constitute compensation.
8. Deductions made by employer from compensation
of employee. Any amount which is required by the law
to be deducted by the employer including the
withheld tax is considered as a part of the employee
compensation and is deemed to be paid to the
employee as compensation at the time the deduction
is made.
9. Remuneration for services as employee of a non-resident
alien individual or foreign entity. The term compensation
includes remuneration for service performed by an employee of
an non-resident alien individual, foreign partnership or foreign
corporation, whether or not such alien individual or foreign
entity is engaged in business or trade in the Philippines.
10. Compensation for services performed outside the
Philippines. Remuneration for services performed outside the
Philippines by a resident citizen for a domestic or a resident
foreign corporation or partnership, or for a non-resident
corporation or partnership, or for a non-resident individual not
engaged in trade or business in the Philippines shall be treated
as compensation which is subject to tax.
BUSINESS INCOME
Manufacturing, Merchandising or Mining
Gross income means total sales, less cost of goods sold plus any
income from investments and from incidental or outside operation
or sources.

Gross Sales xxx


Less. Cost of Goods Sold xxx
Gross Profit from Sales xxx
Add: Other Income xxx
Gross Income xxx

*Subtractions are not allowed for depreciation, depletion, selling expenses or losses, or for
items not ordinary used in computing cost of goods sold.
Farming
Gross Income from farming includes gain or profit derived from the operations of
farms, such as stock, dairy, poultry, fruits and truck farms; plantations; ranches; etc.
Income pf farmers may be reported using either the cash basis, accrual basis crop
year basis.

Cash Basis

Cash Sales (or value of merchandise or xxx


other property received) of livestock
and farm products raised in the farm

Sales of livestock and other items xxx


purchased
Less: Cost of Sales xxx
Gross Profit xxx
Miscellaneous Income xxx
Gross Income xxx
Accrual Basis. Beginning and ending inventories of livestock
and farm products raised and purchased are considered to
arrive at the gross income.

Ending Inventory xxx


Cash Sales (or value of merchandise or other
property received) of livestock and farm products xxx
raised in the farm

Sales of livestock and other items purchased xxx


Miscellaneous Income xxx
Total xxx
Less: Beginning Inventory xxx
Cost of livestock and other items purchased xxx xxx
Gross Income xxx
Crop year basis. The basis is used by farmers whose crop take more
than one year from planting up to harvesting and disposing. The
entire cost of production is deducted from the gross income in the
year it was realized.
GAINS DERIVED FROM DEALINGS IN PROPERTY

All income derived from the disposition of property---real,


personal, or mixed--- for money (sale) or for other property
(exchange) or for a combination of both, which results in gain
(or loss) because of the difference between the taxpayers
investment in what he disposed of and the value in what he
received.

General Rule: The entire of the gain (or loss, as the case may
be) arising therefrom is a taxable gain (or deductible loss).
INTEREST

Gross income derived from interest is only such


interest as arising from indebtedness, that is, the
compensation for the loan or forbearance of
money, goods, or credits. Unless exempted by law,
interest received by taxpayer is taxable, whether
business or non-business, legal or illegal.
INTER COMPANY ADVANCES
Inter-company advances more properly pertain to
transactions between affiliated companies and between
parent and subsidiaries. These are not limited to financially
distress situations. Common financing is resorted to even
among corporations that are financially sound.

RENTS
Rent is the amount paid for the use of enjoyment
of a thing or right. Gross income derived from rent
comes not only from real state but also from the
use of personal property
ROYALTIES
Gross income derived from loyalties includes earnings from copyright,
trademarks, patents, and natural resources under lease. It involves not
only the use of property but also its exhaustion. Royalties for properties
which produce coal, gas, oil, copper, timber or other similar products
shall form part of gross income for purposes of computing the income
tax liability of the taxpayer under Section 24(A), 27, 28.

SOFTWARE
In view to the rapid development of computer technology in recent
years and the extent of transfers of such technologies across national
borders, the BIR issued on Nov. 18,2003 RMC 77-03. Subsequently, the
BIR issued RMC 44-05 dated Sept. 01,2005 amending RMC 77-03. The
circular classifies payments for software for income tax purpose.
Terms:

Software a program, or series of programs, containing programs


instructions for a computer required either for the operational processes of
the computer itself (operation software) or for the accomplishment of other
tasks (application software)

Royalties generally used means payment of any kind received as a


consideration for the use of, or the right use of, any copyright of literary,
artistic or scientific work including cinematographic films or tapes used for
radio or television broadcasting, any patent, trade mark, design or model,
plan, secret formula or process, of for the use of, or the right to use, industrial,
commercial or scientific equipment, or for the information concerning
industrial, commercial or scientific experience.
Categories of Transactions

Transaction involving software may take one or more of the


following categories:

1. A (full or partial) transfer of a copyright right in the software.


2. A transfer of a copy of the software (a copyrighted article).
3. The provisions of service for the development or
modification of the software or
4. The provision of know-how relating to software
programming techniques.
Computer Hardware Bundled with Software
The tax treatment of payments involving the sale of computer
hardware bundled with software, where the software is bundled in the
Philippines, are covered by this circular.
A. Acquisition of Ownership over a Copyright

Payment made to Tax Rate Tax Base


Local Owner of a Copyright
a. Resident individual owner of a copyright 5%- 32% (Sec. 24) Gross Income (Sec. 32)
b. Domestic corporation owner 32% (Sec. 27) Gross Income (Sec. 32)
Foreign Licensor
a. Non-resident alien individual engaged on 5%- 32% Gross Income
trade or business in the Philippines (Sec. 24) (Sec. 32)
b. b.1. Resident foreign corporation 32% Gross Income
engaged in trade or business in the (Sec. 28) (Sec. 32)
Philippines
b.2. non-resident foreign corporation 32% final tax Gross Income
(Sec. 28)
*However if the foreign owner of the copyright is a resident of a country which has a existing
treaty with the Philippines, royalties to paid to such owner are subject to the reduced tax
rates on royalties under the relevant tax treaty, provided the conditions prescribed therein
are complied with the owner.
B. Acquisition of Copyrights Rights

Payment Made Tax Rate Tax Base


BY TO
1. Local subsidiary/ a. Local licensor or
reseller/ reseller/distributor licensee
distributor/retailer 1. Domestic Corporation Owner 20% Final Tax Gross Amount of
2. Reseller/distributor licensee of (Sec. 27)(D)) Royalties
a copyright
a. Non-resident foreign 32% Final Tax Gross Amount of
licensor/owner of the (Sec. 28(B)(1))** Royalties
software
1. End User a. Local subsidiaries, resellers, 32% Net Taxable
distributors of resellers (Sec. 27(A)) Income
b. Foreign Owner and/or 32% Gross Amount of
licensor of the software (Sec. 28(B)(1))** Royalties
DIVIDENDS
Dividend are distributions made by the corporation out of its earnings or
profits accrued since Mar. 1, 1913, and payable to its shareholders,
whether in money or in other property.

Form of Dividends and Income Tax Treatment

Cash dividend. It is paid to shareholders or members in cash and is taxable


at 6%, 8%, and 10% final tax, beginning Jan. 01, 1998, 1999, and 2000,
respectively.
Property dividend. It is paid in property of the corporation such as bonds,
securities or stock investments held by the corporation paying the dividend
and is taxable at the same rate as cash dividend.

Stock dividend. It is paid in stock and is taxable unless it represents a


distribution of earnings or profit.
Scrip dividend. It is issued in the form of a promissory note and is taxable in
the same rate as cash dividend.

Liquidating dividend. In itself, liquidating dividend, does not constitute


income. But when a corporation distributes all assets incomplete liquidation
or dissolution, and transaction is deemed a sale or exchange between the
corporation and the stockholder. As such, the difference between the
amount received from the corporation and the cost of the shares
surrendered by the stockholder is a taxable gain and deductible capita
loss to the extent of the capital gain.

Indirect dividend. These are other payments or rights received by the


taxpayers which in reality, are dividends. Thus, if a corporation to which the
stockholder is indebted forgives his debt, the transaction has the effect of
payment in cash dividend.
Tax Rates on Dividend Distribution

If a domestic corporation distributes dividends to:

a. Resident citizen, non-resident citizen and resident alien

1998 - 6% final tax


1999 - 8%final tax
2000 - 10% final tax

b. Non-resident alien engaged in business in the Philippines 20% final tax.


c. Non-resident alien not engaged in business in the Philippines 25% final tax.
d. Domestic corporations and resident foreign corporation income tax exempt.
e. Non-resident foreign corporation, under certain conditions15% final tax.
Taxable and non-taxable Stock Dividend

a. A non-taxable stock dividend does not constitute income if


the new certificates plus the old ones do not change the
proportionate interest of the stockholder in the net assets of the
corporation.

b. A taxable stock dividend constitutes income if it gives the


shareholder a greater proportionate interest in the corporation
after its distribution. If a stock holder receives a taxable stock
dividend, the measure of income on his part is the fair market
value of the shares on the date the stock holder receives the
shares.
ANNUITIES
The annuity policies sold by the insurance companies, which provides
instalment payment for life, of for a guaranteed period of time whichever
is longer or for life and guaranteed fixed period. The portion of each
annuity payment that represents return of premium is not taxable while
that portion that represents interest is taxable.

PRIZES AND WINNINGS


Prizes and awards received in recognition of religious, charitable
scientific, educational, artistic, literary or civic achievement are not
taxable if:
a. The recipient was selected without any action on his part to enter the
contest or proceedings; and
b. The recipient is not required to render substantial future services as a
condition to receiving the prize or award.
PENSION
It is taxable to the extent of the amount received except there is an
approved pension plan by the Bureau of Internal Revenue.

INCOME FROM WHATEVER SOURCE


These include all other incomes not expressly exempt under the laws:

a. Income derived from illegal sources, such as gambling, extortion, theft,


bribes, embezzlement and smuggling is taxable.
b. Compensation from damages.
c. The amount of the debt of a stock holder to a corporation when forgiven.
d. Bad debts previously charged off but later recovered.
e. Taxes paid and subsequently refunded.
f. Tax informers reward to persons instrumental in the discovery of violations
of the National Internal Revenue Code and the discovery and seizure of
smuggled goods.
SOURCES OF INCOME

1. Within the Philippines


2. Without the Philippines
3. Partly within and partly without

Determination of Source of Income

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