Ch. 9 RIT: Inclusion in Gross Income

Question 1

is a broad category pertaining to all items of income subject to taxation, namely: Gross Income subject to final tax, gross income subject to capital gains tax, gross income subject to regular tax

Answer 1

Items of gross income, or inclusions in gross income

Question 2

What are the items of gross income subject to regular income tax

Answer 2

Gross income includes, but is not limited to, the following items:
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. Interests
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

Question 3

Under current tax rules, the term “compensation income” technically pertains to

Answer 3

the types of employee benefits that are subject to regular income tax

Question 4

Gross income from business or profession is determined as follows:

Answer 4

(Sales/Revenues/Fees/Receipts) Less (Cost of sales or services) equals (Gross income from operations)

Question 5

The following business income shall not be included in gross income subject to regular income tax

Answer 5

1. Business income exempt from income tax
2. Business income subject to special tax
3. Business income subject to final tax

Question 6

What are included and deducted in Gains from dealings in properties?

Answer 6

Ordinary gains are included as items of gross income. Ordinary losses are items of deductions against gross income. The net capital gain is also included in items of gross income but the net capital loss is not an item of deduction against gross income.

Question 7

What interest income is particularly referred to in this chapter?

Answer 7

It particularly refers to interest income other than passive interest income subject to final tax. A taxable income must have been actually paid out of an agreement to pay interest. It cannot be imputed.

Question 8

The following are exempt from regular income taxation

Answer 8

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) does not constitute an actual income; hence, it is exempt from income tax

Question 9

The power of the commissioner to allocate income and deduction does not include the power to?

Answer 9

power to impute “theoretical interest”

Question 10

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

Answer 10

Rent Income / Rents

Question 11

What are the special considerations on rent

Answer 11

1. Obligations of the lessor that are assumed by the lessee are additional rental income to the lessor
2. Advance rentals are:
   a. Item of gross income upon receipt if: unrestricted or restricted to be applied in future years or upon the termination of the lease
   b. Not an item of gross income if: it constitutes a loan or it is a security deposit to guarantee payment or rent subject to contingency which may or may not happen
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

Question 12

Royalties earned from sources within the Philippines are generally subject to final income tax except when?

Answer 12

they are active in nature. Active royalty income and royalties earned outside the Philippines are subject to regular income tax

Question 13

What kind of dividend is pertained to in this chapter?

Answer 13

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 pre-dominance tests

Question 14

What generally are the items of gross income subject to regular income tax under dividends?

Answer 14

Cash, property or script dividends

Question 15

Are stock and liquidating dividends subject to RIT?

Answer 15

No, stock has exceptions while liquidating dividends is just considered as an amount exchanged for the investment of the investor

Question 16

Under the CREATE law, inter-corporate dividends received by domestic corporations from foreign corporations are generally subject to regular tax. They may be exempted from RIT under the following conditions:

Answer 16

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 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. infrastracture projects

If the ratio is at least 50% the foreign-sourced dividends received by the domestic corporation shall be exempt from income tax even if the above-mentioned conditions are not met

Question 17

What is the taxable portion for annuities?

Answer 17

The excess of annuity payments received by the recipient over premium paid is taxable income in the year of receipt

Question 18

Prizes and winning that are exempted from final tax are?

Answer 18

not items of gross income subject to regular income tax

Question 19

What type of pensions and retirement benefits are included in RIT

Answer 19

These pertain to pensions and retirement benefits that fail to meet the exclusion criteria and hence subject to regular tax

Question 20

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

Answer 20

Place of constitution (PH)
Indiv - 20% FT
Corpo - RIT
Place of Constitution (Abroad)
Indiv and Corpo - RIT

Question 21

The share in the net income of non-taxable entities such as GPP, exempt joint ventures or exempt co-ownership shall be subject to

Answer 21

RIT to the recipient partner, venturer, or co-owner

Question 22

Under the NIRC, the RIT has a catch-all provision for all income derived from whatever sources that are:

Answer 22

1. not subject to final tax, capital gains tax, and special tax regime, and;
2. not excluded or exempted by law, treaty, or contract from taxation

Question 23

Other sources of gross income subject to RIT

Answer 23

1. Income distributions from taxable estates or trusts
2. Share from the net income of other pass-through entities:
   a. exempt joint venture
   b. exempt co-ownership
3. Farming income
4. Recovery of past deductions
5. Reimbursement of expenses
6. Cancellation of indebtedness for a consideration

Question 24

Any income distribution received by an heir or beneficiary from a taxable estate or trust shall be included in his gross income subject to regular tax, provided that

Answer 24

such income must not have been subjected to final tax or capital gains tax

Question 25

Farming operations can be classified as:

Answer 25

1. Raise and sell operation
2. Purchase and sell operation

Question 26

How is gross income computed in a raise and sell farming operation

Answer 26

The proceeds on the sales of livestock or farm products is included in gross income subject to RIT. Animal raising expenses are presented as items of deductions against gross income

Question 27

How is gross income computed in a purchase and sell farming operation

Answer 27

The gross profit from the sale (sales less cost of purchase) is included in gross income

Question 28

When past year deductions from gross income are subsequently recovered by the taxpayer or when accrued expense previously deducted are subsequently paid at an amount less than the deduction claimed, what should be done to them?

Answer 28

They should be analyzed whether or not they have resulted in tax benefit to the taxpayer. Past deductions that created tax benefit to the taxpayer must be reverted back to gross income in the year of recovery so that the government will recover the tax lost from the dedcution.

Question 29

There are two ways a taxpayer may benefit from a deduction:

Answer 29

1. Directly, through reduction of taxable income in the year deduction is made
2. Indirectly, through reduction of future taxable income through carry-over of net operating loss

Question 30

Expenses or payments which are non-deductible against gross income in the computation of taxable net income will?

Answer 30

never create tax benefit to the taxpayer. As such, their recovery should not be included in gross income

Question 31

Expenses of the taxpayer that are reimbursed or paid by the customer or client constitute?

Answer 31

additional income to the taxpayer

Question 32

The cancellation of Indebtedness may amount to gratuity or payment of income

The cancellation of debt:
1. In consideration of service or goods -
2. As an act of gratuity -
3. As capital transaction such as forfeiting the right to receive dividends in exchange of the debt -

Answer 32

1. Treated as income
2. Treated as gift; not as income
3. Treated as dividend income

Question 33

Special considerations in reporting of gross income

Answer 33

1. Accounting method
2. Situs rules
3. Effect of Value Added Tax
4. Creditable Withholding Tax
5. Power of the CIR to redistribute income and expenses

Question 34

Remember that business taxpayers are required to either register as VAT and Non-VAT taxpayers when:

Answer 34

a. VAT Taxpayers - if their sales or receipts exceeds P3,000,000 in the last consecutive 12-month period
b. Non-VAT Taxpayers - If their sales or gross receipts is below the VAT threshold or are specifically designated by the law to pay percentage taxes

Question 35

Every VAT taxpayer is mandatorily required to

Answer 35

charge 12% output tax on their sales or receipt. The regulations presume that the amount charged to customers is inclusive of the 12% VAT. The output VAT will be paid to the government net of the VAT paid by the taxpayer (input VAT) on his purchases. As such, the amount of reportable gross income shall not include the output VAT

Question 36

are creditable withholding tax exclusions or deductions?

Answer 36

Creditable Withholding Tax (CWT) deducted by income payors against the gross income of the taxpayer are not exclusions in gross income. These should be added back to the reportable amount of gross income. CWTs are tax credits that are deductible against the annual income tax due of the taxpayer.

Question 37

Explain the power of the CIR to redistribute income and deductions?

Answer 37

In the case of two or more organizations, trades, or businesses owned or controlled directly by the same interests, the Commissioner is authorized to distribute, apportion, or allocate gross income or deductions between or among such organization, trade or business, if he/she determined that such distribution, apportionment or allocation is necessary in order to prevent evasion of taxes or clearly reflect the income of any such organization, trade or business.

Question 38

What is the problem of unfair pricing between associated enterprises?

Answer 38

There is a risk that the pricing of the transfer of goods or services between associated enterprises will be controlled in such a way to further the interests of the associated enterprises as a whole in disregard of their social responsibility on taxes.

Question 39

What is the transfer pricing guideline.

Answer 39

To limit these unfair practices and to properly reflect the income of associated enterprises, the BIR and the Department of Finance promulgated Revenue Regulations No.2 series of 2013 (RR2-2013) on transfer pricing

Question 40

What are associated enterprieses

Answer 40

two or more enterprises are associated if one participates directly or indirectly in the management, control, or capital of the enterprises. Associated enterprises are also called “related parties.”

Question 41

What is the arm’s length principle

Answer 41

An uncontrolled pricing method determined by free market forces, also called arm’s length pricing, is preferred. The failure to comply may expose the taxpayer to a transfer pricing adjustment where the BIR re-computes the proper income of the associated enterprises.

Question 42

The arm’s length principle shall be applied to:

Answer 42

1. Cross-border transactions between associated enterprises
2. Domestic transactions between associated enterprises

Question 43

When operations are conducted cross-border, the taxpayer may enter into an

Answer 43

“advanced pricing agreement” with the BIR where a pricing rate is pre-agreed to apply for a period of time

Question 44

When the pricing methods between associated enterprises do not reflect arm’s length pricing, the BIR will adjust the controlled transactions to their arm’s length values using the most appropriate method considering the circumstance of the taxpayers and these methods are:

Answer 44

1. Comparable uncontrolled price (CUP) method
2. Resale price method (RPM)
3. Cost plus method (CPM)
4. Profit split method (PSM)
   5, Transactional net margin method (TNMM)

Question 45

The transactions is valued in reference to the amount charged in a comparable uncontrolled transaction under comparable circumstances

Answer 45

Comparable Uncontrolled Price (CUP) method

Question 46

This method works best for standard tangible goods sold in an open market. It does not apply to products containing unique characteristics such as those patented or those containing trade secrets

Answer 46

Comparable Uncontrolled Price (CUP) method

Question 47

The transaction is valued based on the functions performed by the reselling party to the product. This is used when products purchased from a related party are resold to an independent party.

Answer 47

Resale price method (RPM)

Question 48

The transaction is measured by valuing the function performed by the supplier of the property or services

Answer 48

Cost plus method (CPM)

Question 49

The profit or loss on the transaction is split based on the division of profits (or losses) that independent enterprises would have expected to realize from engaging in the transaction or transactions

Answer 49

Profit Split Method (PSM)

Question 50

Two approach that is applied in profit split method

Answer 50

1. Residual profit split approach
2. Contribution profit split approach

Question 51

This is similar to the cost plus and the resale price methods in the sense that it uses the margin approach by reference to the operating profit earned in comparable uncontrolled transactions.

Answer 51

Transactional net margin method (TNMM)

Question 52

When no comparatives can be derived within the industry of the subject taxpayer, the BIR may consider:

Answer 52

1. Extension of the transfer pricing method using comparatives derived from another industry segment
2. Use a combination of the transfer pricing methods or other methods

Question 53

Why would taxpayer use the selection of transfer pricing method?

Answer 53

To minimize the risks of transfer pricing adjustments, taxpayers may also consider using the transfer pricing methods used by the BIR in pricing their transactions with associated enterprises. The taxpayer must support the propriety of the method adopted through proper documentation