GROSS INCOME FOR TAXATION

Question 1

What is gross income?

Answer 1

Gross income for income taxation purposes means all income derived from whatever source, including, but not limited to:

a. Compensation
b. Income derived from business or trade
c. Gains from dealings in property (except those subject to CGT)
d. Interests (except those subject to FWT)
e. Rents (except those subject to FWT)
f. Royalties (except those subject to FWT)
g. Dividends (except those subject to FWT)
h. Annuities (except those subject to FWT)
i. Prizes and winnings (except those subject to FWT)
j. Pensions
k. Partner’s distributive share from net income of GPP

Question 2

T or F
Fixed and variable allowances such as transportation/representation/communication allowance are generally not taxable compensation income.

Answer 2

False. Fixed and variable allowances are generally included in compensation income subject to income tax and CWT.

Question 3

Explain the business-related allowances subject to liquidation and its tax treatment.

Answer 3

Business-related allowances are amounts paid to employees for expenses incurred or reasonably expected to be incurred by the employee IN THE PERFORMANCE OF HIS DUTIES and therefore are NOT COMPENSATION subject to withholding, PROVIDED THAT:
a. It is for ordinary and necessary travelling and representation or entertainment expenses paid/incurred by the employee in pursuit of trade/business/profession

b. The employee is REQUIRED TO LIQUIDATE SUCH EXPENSES.

Question 4

Explain the tax treatment of Representation and Transportation Allowances.

Answer 4

These are considered reimbursements for expenses incurred in the performance of one’s duties, therefore not subject to income tax. HOWEVER, if there is an excess and the same is not returned, it becomes taxable compensation income of the employee.

Question 5

Explain how retirement benefits are subject to income tax.

Answer 5

Generally, retirement benefits are taxable, except when it is RECEIVED UNDER A REASONABLE PRIVATE BENEFIT PLAN and meets the following requirements:

a. Retirement plan is approved by BIR
b. The retiree has been under the employ of the employer for at least 10 years
c. Is NOT LESS THAN 50 YEARS OF AGE at the time of retirement

In the absence of a reasonable private benefit plan, an employee who has reached the age of 60 or more but not more than 65 years who has served at least 5 years in establishment MAY RECEIVE TAX-EXEMPT RETIREMENT BENEFITS.

Question 6

What kinds of rental income are not subject to income tax?

Answer 6

Those that are received BUT THERE IS A RESTRICTION AS TO ITS USE, such as:

a. Advance rentals representing OPTION MONEY
b. Security deposits to insure performance of obligations

The above shall then become taxable once the restriction is lifted.

Question 7

Explain how leasehold improvements are taxable on the part of the lessor.

Answer 7

Improvements made by the lessee shall be treated as income of the lessor IF:

a. The improvements will be owned by the lessor at the end of the lease
b. Lessor is not required to pay the lessee the value of such improvements

The income shall be recognized using either:
1. OUTRIGHT/LUMPSUM METHOD - FMV of improvement

2. SPREAD-OUT OR ANNUAL METHOD -
   Annual income = BV at end of lease term / remaining term of lease

If there is a pre-termination of the lease, the rest of the unrecognized income shall become taxable.

NB: Notice the huge difference in income recognition between outright and spread-out method. Answer all problems!!!

Question 8

Explain the tax treatment of stock dividends received.

Answer 8

GR: Distribution of stock dividends is not taxable because they ARE NOT REALIZED INCOME

EX: stock dividends constitute income if it gives the shareholder an interest different from that which his former stockholdings represented.

Question 9

Explain the tax treatment of liquidating dividends received.

Answer 9

The liquidating dividends are exempt UP TO THE EXTENT OF THE COST OF INVESTMENT, being a mere return of capital. The EXCESS, HOWEVER, IS INCOME AND THEREFORE TAXABLE.

If there is a loss in the the return of liquidating dividend, the same shall be allowed as a deduction for capital losses.

Question 10

T or F
Return of taxpayer’s wealth is subject to income tax.

Answer 10

False. It should be return ON taxpayer’s wealth.

Question 11

When are recovery of bad debts recognized as income?

Answer 11

Recovery of bad debts is considered income when:

a. Bad debts were written off in previous years
b. Such bad debts were deducted in arriving at taxable income
c. There is a resulting tax benefit on the deduction

Question 12

When are refunds of taxes recognized as income?

Answer 12

Refunds of taxes is considered income when:

a. There is a payment of tax in previous years
b. The taxes paid were deducted in arriving at taxable income
c. There is a resulting tax benefit on the deduction

Question 13

T or F
Condonation of debt because of gratuity of the creditor is subject to income tax.

Answer 13

False. It is a gift.

Question 14

T or F
Condonation of debt because of services performed by the debtor for the creditor is subject to income tax.

Answer 14

True.

Question 15

T or F
Condonation of debt by creditor-corporation to its debtor-shareholder shall be treated as dividends.

Answer 15

True.

Question 16

Explain the tax treatment of life insurance.

Answer 16

GR: Exempt from tax since it is a mere reimbursement for the loss of life.

EX: The following shall be taxable

1. Beneficiary was chosen for a valuable consideration
2. Interest earned on the insurance policy

Question 17

T or F
Pension payment is also considered compensation income.

Answer 17

True.

Question 18

T or F
Pension payment is also considered compensation income.

Answer 18

True.

Question 19

Explain the taxability of separation pay received.

Answer 19

Generally, separation pay is a taxable compensation, unless the reason for the separation is INVOLUNTARY, or beyond the control of the employee such as:

a. retrenchment
b. illness

Question 20

T or F
The tax treatment of retirement pay is the same with separation pay.

Answer 20

False.

Question 21

T or F
Abdul received a separation pay of 1,000,000 because he was occupying a redundant position. The 1,000,000 is subject to income tax.

Answer 21

False, because his separation from the employer is INVOLUNTARY.

Question 22

T or F
The income tax of the employee paid by the employer as part of the employee’s benefit is part of the employee’s taxable income.

Answer 22

True.

Question 23

T or F
Interest income derived from investments in government bonds are subject to FWT.

Answer 23

True. Government bonds are considered deposit substitutes, therefore its interest are subject to FWT.

Question 24

Explain how recoveries of previously written-off bad debts are taxed.

Answer 24

APPLY THE TAX-BENEFIT RULE
Amount recovered during the year shall be treated as taxable income ONLY IF:
1. The receivables written off during the previous years were allowed as a deduction from gross income during write-off
2. The WRITE-OFF RESULTED TO A LOWER INCOME TAX PAYMENT to the reduction in the taxable net income brought about by the write-off.
3. There was a recovery (partial or full) during the current taxable year.

Emphasis on number two, if there is already a loss on net income even before the deduction of receivable written off, the recovery of such receivable in the next year is not taxable anymore SINCE IT DID NOT RESULT TO A LOWER INCOME TAX PAYMENT.

Question 25

T or F
Provision for bad debts (Allowance for DA) are expenses deducted for income tax purposes.

Answer 25

False. Only those actually written off are allowed as deductions for income tax purposes.

Question 26

Which tax refunds are part of taxable net income?

Answer 26

Tax refunds that are classified as OPERATING EXPENSES MAY BE PART OF TAXABLE INCOME UPON RECOVERY. Examples include:

1. Local business-related taxes
2. OPT except stock transaction taxes
3. FBT
4. Income tax paid abroad by RCs and DCs CLAIMED AS OPEX BY THE TAXPAYER
5. Excise tax on sin products and non-essential goods
6. Customs duties
7. DST

Question 27

Which tax refunds are NOT part of taxable net income?

Answer 27

Tax refunds NOT CLASSIFIED AS OPERATING EXPENSES SHOULD NOT FORM PART OF TAXABLE INCOME UPON RECOVERY.

1. Local non-business related taxes
2. Income tax paid abroad by RCs and DCs WHERE THE TAXPAYER OPTED TO CREDIT SUCH PAYMENT AGAINST INCOME TAX
3. Income tax paid
4. Stock transaction tax
5. VAT
6. Estate and donors tax
7. Special assessments

Question 28

T or F
A dividend received by a resident foreign corporation from a domestic corporation is tax-exempt.

Answer 28

True. Intercorporate dividends are exempt from FWT and income tax.

Question 29

T or F
A dividend received by a domestic corporation from a resident foreign corporation is tax-exempt.

Answer 29

False.

Question 30

T or F
If it is stipulated in the contract of lease or rent that the lessee will pay the annual real property tax, the amount paid for the real property tax by the lessee will form part of the lessor’s income.

Answer 30

True.

Question 31

T or F
If a corporation distributes its own treasury stocks to its shareholders, this kind of corporate distribution is recognized as a liquidating dividend.

Answer 31

False. Distribution of a corporation’s own treasury stocks to its shareholders results to a stock dividend distribution.

Question 32

What dividends are tax exempt under the rules on intercorporate dividends?

Answer 32

If the dividends comes from a DOMESTIC CORPORATION and the recipient is a:

a. Domestic - EXEMPT
b. Resident Foreign - EXEMPT
c. NRFC - Taxable on the NRFC

If the dividends comes from a RESIDENT FOREIGN CORPORATIONS and the recipient is a:

a. Domestic - Taxable income
b. Resident Foreign - Subject to the rules on pre-dominance testing
c. NRFC - Subject to the rules on pre-dominance testing

Question 33

Explain the pre-dominance test.

Answer 33

The pre-dominance test is applied whenever there are DIVIDENDS COMING FROM RESIDENT FOREIGN CORPORATIONS.

If the ration of the PH gross income over the world gross income of the RFC in the THREE YEAR PERIOD PRECEDING THE YEAR OF DIVIDEND DECLARATION IS:

a. PH GI/ WORLD GI IS AT LEAST 50%: Portion of the dividend corresponding to the PH GI ration is EARNED WITHIN
b. PH GI/ WORLD GI IS LESS THAN 50%: TOTALLY EARNED ABROAD

Question 34

What is the treatment of the condonation of debt by creditor-corporation to its debtor-shareholder that is also a corporation?

Answer 34

Since the two parties involved are corporations, and condonation of debt by a creditor-corporation are treated as indirect dividends, what occurs here is an intercorporate dividend. The treatment of the dividends will depend on the classification of the recipient corporation and the corporation condoning the debt.

Question 35

What are annuities? How are annuities taxed?

Answer 35

Annuities are 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.

Annuities received REPRESENTING INTEREST IS A TAXABLE INCOME. (Return on capital)

Annuities received REPRESENTING RETURN OF PREMIUM ARE NOT TAXABLE INCOME (Return of capital)

Question 36

T or F
Cash gifts are taxable income.

Answer 36

False.

Question 37

T or F
Exemplary damages awarded to a person is part of his taxable income.

Answer 37

False.

Question 38

T or F
Actual and moral damages awarded to a person are taxable income.

Answer 38

False.

Question 39

T or F
Cash or other properties awarded for loss of income in litigations are subject to income tax.

Answer 39

True.

Question 40

Explain the holding period rule for dealings in properties.

Answer 40

The HOLDING PERIOD RULE APPLIES ONLY TO INDIVIDUALS/ESTATES/TRUSTS. Any capital asset, excluding those subject to CGT, if held for:
a. 1 year or less (short-term) - 100% of the capital gain or loss is recognized

b. More than 1 year - 50% of the capital gain or loss is recognized

For CORPORATIONS, IT IS 100% REGARDLESS OF THE TIME THE PROPERTY IS HELD.

Question 41

Abdul inherited from his father a piece of land. His father bought it for 100,000. Right now, the land has a value of 2,500,000. Abdul sold the land for 2,500,000. How shall this sale be taxed?

Answer 41

The sale involves real capital property, and therefore is subject to CGT. 2,500,000 x 6% = 150,000 CGT.

Question 42

Abdul inherited from his father a car. His father bought it for 100,000. 3 years have passed since the inheritance. Right now, the car has a value of 2,500,000. Abdul sold the car for 2,500,000. How shall this sale be taxed?

Answer 42

The sale involves a capital personal property and is therefore subject to income tax, while also applying the holding period rule. The basis of the cost of property shall be the same as it would be in the hands of the donor.

2,500,000 - 100,000 = 2,400,000 gain x 50% = 1,200,000 taxable income.

Question 43

Abdul inherited from his father a car. His father bought it for 100,000. 11 months have passed since the inheritance. Right now, the car has a value of 2,500,000. Abdul sold the car for 2,500,000. How shall this sale be taxed?

Answer 43

The sale involves a capital personal property and is therefore subject to income tax, while also applying the holding period rule. The basis of the cost of property shall be the same as it would be in the hands of the donor.

2,500,000 - 100,000 = 2,400,000 gain x 100% = 2,400,000 taxable income.

Question 44

What are excluded from gross income?

Answer 44

The following items shall not be included in gross income and shall be exempt from income tax:

1. Life insurance
2. Amount received by Insured as return of premium
3. Gifts, bequests, devises
4. Compensation for injuries and sickness
5. Income exempt under treaty
6. Retirement benefits, pensions, gratuities
7. Miscellaneous items
   a. Incomes derived by foreign government
   b. Income derived by government or its political subdivisions
   c. Prizes and awards
   d. Prizes and awards in sports competitions
   e. 13th month pay and other benefits
   f. GSIS, SSS, Medicare, and other contributions
   g. Gains from sale of bonds, debentures or other certificates of indebtedness
   h. Gains from redemption of shares in mutual fund
8. Tax exempt income under RA 11494 Bayanihan to Recover as One Act, aka Bayanihan II

Question 45

Explain the treatment of stipends received by resident physicians during their training in their residency program.

Answer 45

The stipends received by resident physicians during their residency program and individuals engaged in the practice of profession or calling are SUBJECT TO CREDITABLE WITHHOLDING TAX imposed under the Tax Code.

Question 46

Explain the Maternity Leave Pay.

Answer 46

Under RA 11210 aka 105-Day Expanded Maternity Leave Law, the maternity benefit of the female employee shall pertain to the full pay or full salary, wherein one of its components is the salary differential:

1. Full pay or full salary - pertains to the actual remuneration or earnings paid by an employer for services rendered on normal working days and hours, including allowances provided for under existing company policy or CBA
2. Actual cash benefit received from SSS -
3. Salary differential - refers to the difference that shall be shouldered by the employer when the actual cash benefit received from SSS is less than the full pay or full salary of the female employee during the duration of the maternity leave

Question 47

Explain the taxability of premiums on life insurance.

Answer 47

Premiums on life insurance covering the life of an employee paid by the employer is taxable income to the employee, where the insured employee, directly or indirectly is the beneficiary under the policy.

Question 48

Explain the taxability of rent income.

Answer 48

Taxable rent income of the lessor may be in the form of:

a. Cash received at stipulated price
b. Obligations of the lessor to 3rd persons paid or assumed by the lessee in consideration of the contract of lease
c. Advance payment which may be in the form of prepaid rent (reported in full in the year of receipt) - RENTAL INCOME SHALL BE TAXABLE ON THE YEAR RECEIVED, WHETHER EARNED OR UNEARNED, PROVIDED THERE IS NO RESTRICTION AS TO ITS USE, REGARDLESS OF METHOD OF ACCOUNTING EMPLOYED
d. Security deposit, in general, is not taxable income. It shall be recognized as liability of the lessor to the lessee and the lessor has the obligation to return the amount to the lessee upon expiration. It shall form part of taxable income only:
a. upon forfeiture in favor of lessor
b. upon application as rental payments
e. Leasehold improvements - shall be treated as income of lessor if the improvements will be owned by the lessor at the end of the lease and the lessor is not required to pay the lessee the value of such improvement

Question 49

Explain the taxability of proceeds from insurance.

Answer 49

Insurance taken out by the insured (Individual)

a. As a result of death of insured - NONTAXABLE
b. Insured outlived the policy - TAXABLE on the return on capital

Insurance taken out by employer

a. Beneficiary is employee - NONTAXABLE INCOME OF EMPLOYEE’S HEIRS OR BENEFICIARIES
b. Beneficiary is employer - TAXABLE INCOME OF EMPLOYER.

Question 50

In order for gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness be exempt from income taxation, what is the prescribed length of its maturity?

Answer 50

More than 5 years

Question 51

What are the rules on limitation of capital losses?

Answer 51

GR: Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges.

EX: The limitation on capital losses will not apply provided:

a. The seller is a domestic bank/trust company
b. A substantial part of whose business is the receipt of deposit
c. Asset sold is a bond/debenture/note/certificate/ other evidence of indebtedness

Question 52

Explain the Net Capital Loss Carry-over for sales of capital assets.

Answer 52

If any taxpayer, other than a corporation, sustains in any taxable year a net capital loss, such loss shall be treated in the SUCCEEDING TAXABLE YEAR as a loss from the sale or exchange of a capital asset held for not more than 12 months.

Question 53

Discuss the taxability when there is an exchange of property.

Answer 53

GR: Upon sale or exchange of property, the entire amount of the gain or loss shall be taxable.

EX: Amended by the CREATE LAW as follows:

1. No gain or loss shall be recognized on a corporation or on its stock or securities if such corporation is a party to a reorganization and exchanges property in pursuance of a plan of reorganization solely for stock or securities in another corporation that is party to the reorganization that is party to the reorganization. Reorganization is defined as:
   a. A corporation which is a party to a merger or consolidation, exchanges property solely for stock in a corporation, which is a party to the merger or consolidation
   b. The Acquisition by one corporation in exchange solely for all or part of its voting stock, or in exchange solely for all or part of the voting stock of a corporation which is in control of the acquiring corporation, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation whether or not such acquiring corporation had control immediately before the acquisition
   c. The Acquisition by one corporation in exchange solely for all or part of its voting stock, or in exchange solely for all or part of the voting stock of a corporation which is in control of the acquiring corporation, of substantially all of the properties of another corporation. In determining whether the exchange is solely for the stock, the assumption by the acquiring corporation of a liability of the others shall be disregarded
   d. A recapitalization, which shall mean an arrangement whereby the stock and bonds of a corporation are adjusted as to amount, income, or priority or an agreement of all stockholders and creditors to change and increase or decrease the capitalization or debts of the corporation or both
   e. A reincorporation, which shall mean the formation of the same corporate business with the same assets and the same stockholders surviving under a new charter
2. If property is transferred to a corporation by a person, alone or together with other, not exceeding FOUR (4) PERSONS, in exchange for stock or unit of participation in such a corporation of which as a result of such exchange, the transferor(s) collectively gains or maintains control of said corporation: Provided, that stocks issued for services shall not be considered as issued in return for property.
   The term CONTROL shall mean ownership possessing at least FIFTY ONE 51% of total voting power of all classes of stocks entitled to vote.

Question 54

What are the tax exempt income under RA 11494 (Bayanihan to Recover as One Act AKA Bayanihan II)?

Answer 54

a. Retirement benefits received by officials and employees of private firms, whether individual or corporate, from June 5, 2020 to December 31, 2020
b. Covid19 Special Risk Allowance given to health workers catering to or in contact with Covid 19 patients for every month that they are serving during the state of national emergency as declared by the President
c. Actual Hazard Pay given to Human Resources for Health serving in the front line during the state of emergency
d. Compensation paid to private and public health workers who have contracted COVID 19 in the line of duty or dies while fighting Covid 19 amounting to:
a. 1,000,000 in case of death
b. 100,000 in case of severe or critical illness
c. 15,000 in case of mild or moderate sickness