Income Tax

Concept of Income

1st Discussion:
 Definition (Taxable Income)
 Difference Income under the old NIRC v the New NIRC

NIRC (old): Sec. 31. Taxable Income Defined. -The term 'taxable income' means the
pertinent items of gross income specified in this Code, less the deductions and/or personal and
additional exemptions, if any, authorized for such types of income by this Code or other special
laws

TRAIN: SEC. 31. Taxable Income Defined. – The term ‘taxable income’ means the pertinent
items of gross income specified in this Code, less deductions, if any, authorized for such types of
income by this Code or other special laws.”

Analysis:

1) Sec. 31 defines “TAXABLE INCOME”

2) Under the TRAIN LAW, personal and additional exemptions are repealed

Sec. 12. Section 35 of the NIRC, as amended, is hereby repealed.

 Return of Capital v. Return on Capital – it is important to know because under the tax
code Income is Return ON Capital (Return ON Investment) rather that just a mere
return OF Capital (Return OF Investment)

a) Return of Capital
b) Return on Capital

Example:

Scenario 1:

INVESTMENT of Jayvee is 100,000.

At the end of the month he earned (kumita siya ng) 100,000

There is Return OF Capital of P100,000. In short bumalik balik lang inenvest.

 Scenario 2:

INVESTMENT of Jayvee is 100,000.

At the end of the month he earned (kumita siya ng) 150,000

There is Return ON capital of 50,000. Kumita ka ng 50,000 or, in other words, kumite
iyong investment mo ng 50,000.

2nd Discussion

 How to determine if there is income for tax purposes?

- Ano mga ginagamit ng BIR na computation/formula to arrive at TAXABLE INCOME

Rule: There is no single criterion for determining income for tax purposes, but one
method used by BIR and allowed by the GAAP is by determining (or computing) the
INCREASE IN NET WORTH

BASIC FORMULA:

Net worth, ending Pxx

Less: Net worth, beginning ( xx)

Increase (decrease) in net worth xx or (xx)

Add: nondeductible items xx

Total xx

Less: Nontaxable items Pxx

Personal Exemptions (REPEALED) xx xx

Net Taxable Income Pxx

What is net worth? Net worth is total asset less total liabilities

Sample picture No. 1

 Applying Sample No. 1

3rd Discussion

ALL-EVENTS TEST – for a taxpayer using the accrual method, the accrual of income
and expense is permitted when the all-events test has been met.

The all-events test requires:

1) The fixing of a right to income or liability to pay; and

2) The availability of the reasonable accurate determination of such income or liability
(CIR v. ISABELA CULTURAL CORPORATION; GR No. 172231, February
12, 2007)

DEDUCTIONS

 Definition: Deductions or Allowable Deductions are business expenses and losses

incurred which the law allows to reduce gross business income to arrive at net income
subject to tax. (Sec. 65 Rev. Reg. No. 2)

 General Concept of Deductions

1) Deductions are strictly construed against taxpayer (People v. Castaneda, 165 SCRA
327)
2) They are not presumed but allowable only by reason of specific provisions of law
and not under any general equitable or Constitutional concept. (Baltimore Dairy
Lunch, Inc. v. U.S., 231 F (2d) 870)
3) The taxpayer seeking deduction must be able to prove that he is entitled to the
deduction which the law allows (White v. US, 305 US 2181)

Situs of Business – the Place of Business becomes the basis if business expenses are
deductible for Philippine Income tax Purposes
  Classification of Deductions from Gross Income
1) Optional Standard deduction (OSD)
2) Regular Allowable Itemized Deduction
3) Special Allowable Itemized Deduction

 REGULAR ALLOWABLE ITEMIZED DEDUCTIONS

ITEMIZED DEDUCTIONS – are allowed deductible ordinary and necessary business

expenses paid or incurred during taxable year.

Rule: Deductions require supporting documents to justify the reduction from gross
income (Sec. 34 (A to M), NIRC)

Composition:
1) General business expenses
2) Interest
3) Taxes
4) Losses
5) Bad Debts
6) Depreciation
7) Depletion of oil and gas wells and mines
8) Charitable and other contributions
9) Research and Development
10) Pension and trust; and
11) Premium payments on health and/or hospitalization insurance (for individual
taxpayers only)

General Business Expenses – refers to ordinary and necessary expenses paid or incurred during
the taxable year which are directly attributable to, the development, management, operation
and/or conduct of the trade, business or expenses of a profession.

Sec. 34, (A) (1) xxx There shall be allowed as deduction from gross income all the
ordinary and necessary expenses paid or incurred during the taxable year in carrying on
or which are directly attributable to, the development, management, operation and/or
conduct of the trade, business or exercise of a profession xxx

 Requisites of Deductibility. It must be:

1) Ordinary and necessary for the conduct of business or exercise of profession;

 2) Substantiated with Official Receipts or any other adequate records (Sec. 34A 1b,
NIRC)
3) Reasonable in amount (Sec. 34(a)(i), NIRC)
4) Withheld with tax and paid to the BIR, if required
5) Not contrary to law, morals, public policy, or public order; and
6) Incurred or paid and deducted within the taxable year

Meaning of ORDINARY AND NECESSARY

 An expenses is ORDINARY – reasonable and common to the particular business of the

taxpayer as distinguished from a capital expenditure.

Revenue v Capital Expenditure (2 major classifications):

Revenue Expenditures
 are ordinary recurring expenditures that provide benefits to the current
accounting period.
 A.k.a “Period Cost” because they are related to a particular period of time of
business operation
 Charged to expense account and are deductible from gross incomeif they satisfy
the conditions as prescribed by the Tax Code.
 Examples: Salaries Expenses, Supplies Expenses

Capital Expenditures
 Nonrecurring expenditures related to the acquisition of depreciable assests to be
used in the business, but not for sale, having a useful life of several years.
 Cost incurred in acquiring such assets is capitalized; they are gradually expended
from period to period in the form of depreciation or amortization within the
estimated useful life.

Example:

 An expenses is NECESSARY when it is useful or helpful to the business.

INCLUDED in GENERAL BUSINESS EXPENSE

1) Salaries, wages, management expenses, commissions and labor

2) Supplies and repairs and maintenance and other incidental expenses
3) Operating Expenses of transportation equipment used I the trade, profession or
business
 4) Rental for the use of business property
5) Advertising and other selling expenses
6) Travelling expenses in the pursuit of trade, profession or business; and
7) Insurance premium

MEANING of TRADE AND BUSINESS – an activity intended to make profit

Salaries & Wages – inclusive of other forms of compensation including the grossed-up
monetary value of fringe benefits

General Rules: salary expenses are allowed as deductions from gross business income
only if the corresponding withholding tax has been deducted and remitted to the BIR

ILLUSTRATION

INTEREST EXPENSE – the cost of money incurred within a taxable year on

indebtedness in connection with the taxpayer’s profession, trade or business.

Requisites to be deductible:

1) There must be indebtedness stipulated in writing;

2) The indebtedness must be that of the taxpayer in connection with trade, business or
profession
3) The interest must have been paid or accrued during the taxable year (Commisioner v.
Prieto, GR L-13912, September 30, 1960)
4) The interest payment must not be in favor of a relative. (Rev. Reg. 13-2000)

EXPENSES

LOSSES